UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

                                   (Mark One)

[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities  Exchange
Act of 1934 For the Period Ended September 30, 1998

                                       or

[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Transition Period from ___________ to __________

Commission File Number 0-19278

                                 OSTEOTECH, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                               13-3357370 
(State or other jurisdiction of                               (I.R.S. Employer
 incorporation or organization)                              Identification No.)

   51 James Way, Eatontown, New Jersey                               07724  
(Address of principal executive offices)                          (Zip Code)

                                  (732)542-2800
              (Registrant's telephone number, including area code)

                                 Not Applicable
              (Former name, former address and former fiscal year,
                         if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes _X_ No ___

                      Applicable Only to Corporate Issuers

Indicate the number of shares  outstanding  of each of the  issuer's  classes of
common stock, as of the latest practical date.

Common Stock, $.01 par value - 8,896,911 shares as of October 31, 1998.


                                       1
<PAGE>



PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

                        OSTEOTECH, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (unaudited)
                             (dollars in thousands)

<TABLE>
<CAPTION>
                                                                                September 30,         December 31,
                                                                                    1998                  1997
<S>                                                                               <C>                   <C>     
-----------------------------------------------------------------------------------------------------------------
ASSETS
-----------------------------------------------------------------------------------------------------------------
Current assets:
     Cash and cash equivalents                                                    $ 16,434              $ 13,884
     Short-term investments                                                          2,919                 1,473
     Accounts receivable, net                                                        8,205                 7,547
     Deferred processing costs                                                       1,935                 1,070
     Inventories                                                                     1,243                   792
     Deferred income taxes                                                           3,327                   457
     Prepaid expenses and other current assets                                         787                 2,860
                                                                                  ------------------------------
        Total current assets                                                        34,850                28,083

Property, plant and equipment, net                                                  14,261                11,650
Excess of cost over net assets of business acquired,
     less accumulated amortization of $1,638 in 1998 and
     $1,449 in 1997                                                                  2,060                 2,249
Other assets                                                                         1,758                 1,070
-----------------------------------------------------------------------------------------------------------------
Total assets                                                                      $ 52,929              $ 43,052
=================================================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY
-----------------------------------------------------------------------------------------------------------------
Current liabilities:
     Accounts payable and accrued liabilities                                     $  9,946              $  6,919
     Notes payable                                                                      26                   608
     Current maturities of long-term debt and
         Obligations under capital leases                                              352                   634
                                                                                  ------------------------------
        Total current liabilities                                                   10,324                 8,161

Long-term debt and obligations under capital leases                                      0                   203
Other liabilities                                                                      408                   396
-----------------------------------------------------------------------------------------------------------------
Total liabilities                                                                   10,732                 8,760
-----------------------------------------------------------------------------------------------------------------

Commitments and contingencies

Stockholders' equity:
     Preferred stock, $.01 par value; 5,676,595 shares
         Authorized; no shares issued or outstanding
     Common stock, $.01 par value; 20,000,000 shares
         Authorized; issued and outstanding 8,895,461
         shares in 1998 and 8,686,346 shares in 1997                                    89                    87
     Additional paid-in capital                                                     36,796                36,130
     Accumulated other comprehensive income(loss)                                        9                   (75)
     Retained earnings(deficit)                                                      5,303                (1,850)
-----------------------------------------------------------------------------------------------------------------
Total stockholders' equity                                                          42,197                34,292
-----------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity                                        $ 52,929              $ 43,052
=================================================================================================================
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       2
<PAGE>


                        OSTEOTECH, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (unaudited)
                  (dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                           Three Months                         Nine Months
                                                                        Ended September 30,                 Ended September 30,
                                                                    ---------------------------         ----------------------------
                                                                       1998              1997              1998              1997
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>               <C>               <C>               <C>      
Net revenues:
     Service                                                         $ 14,001          $ 11,551          $ 42,085          $ 30,916
     Product                                                              282               382               803             1,547
     Licensing fee                                                          0                 0               124               257
                                                                     --------          --------          --------          --------
                                                                       14,283            11,933            43,012            32,720

Costs and expenses:
     Cost of services                                                   3,910             3,971            12,424            10,917
     Cost of products                                                     232               246               584             1,108
     Marketing, general and administrative                              4,851             4,317            15,432            11,946
     Research and development                                           1,079               861             3,285             2,687
                                                                     --------          --------          --------          --------
                                                                       10,072             9,395            31,725            26,658

Operating income                                                        4,211             2,538            11,287             6,062

Other income (expense):
     Interest income                                                      257               189               768               458
     Interest expense                                                     (14)              (30)              (64)             (109)
     Other                                                                 42                15               182                59
                                                                     --------          --------          --------          --------
                                                                          285               174               886               408
                                                                     --------          --------          --------          --------

Income before income taxes                                              4,496             2,712            12,173             6,470

Income tax provision                                                    1,878             1,104             5,020             2,627

------------------------------------------------------------------------------------------------------------------------------------
Net income                                                           $  2,618          $  1,608          $  7,153          $  3,843
====================================================================================================================================
Net income per share:
     Basic                                                           $    .30          $    .19          $    .81          $    .47
     Diluted                                                         $    .28          $    .18          $    .76          $    .45
------------------------------------------------------------------------------------------------------------------------------------
Shares used in computing net income per share:
     Basic                                                          8,779,253         8,309,783         8,817,209         8,144,737
     Diluted                                                        9,305,756         8,961,404         9,378,624         8,604,910
====================================================================================================================================
</TABLE>


     See accompanying notes to condensed consolidated financial statements.


                                       3
<PAGE>


                        OSTEOTECH, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (unaudited)
                             (dollars in thousands)

<TABLE>
<CAPTION>
Nine Months Ended September 30,                                             1998                   1997
----------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                    <C>     
Cash Flow From Operating Activities
   Net income                                                             $  7,153               $  3,843
   Adjustments to reconcile net income to net cash
      provided by operating activities:
         Depreciation and amortization                                       2,042                  1,721
         Deferred income taxes                                              (2,870)                   (50)
         Income tax benefit related to stock options                         2,870
         Changes in assets and liabilities:
               Accounts receivable                                            (624)                  (829)
               Deferred processing costs                                      (865)                   314
               Inventories                                                    (467)                   (18)
               Prepaid expenses and other current assets                     2,083                    598
               Accounts payable and other liabilities                        2,938                  1,952
----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities                                   12,260                  7,531

Cash Flow From Investing Activities
   Capital expenditures                                                     (4,326)                (2,443)
   Purchases of investments                                                 (7,387)                (4,431)
   Proceeds from sale of investments                                         5,941                  5,445
   Increase in other assets                                                   (746)                   (98)
----------------------------------------------------------------------------------------------------------
Net cash used in investing activities                                       (6,518)                (1,527)

Cash Flow From Financing Activities
   Proceeds from issuance of common stock                                    2,756                  1,747
   Repurchase of common stock                                               (4,958)
   Proceeds from issuance of notes payable                                                             93
   Principal payments on notes payable                                        (582)                  (722)
   Principal payments on long-term debt
     and obligations under capital leases                                     (482)                  (594)
----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities                         (3,266)                   524

Effect of exchange rate changes on cash                                         74                     33
----------------------------------------------------------------------------------------------------------

Net increase in cash and cash equivalents                                    2,550                  6,561
Cash and cash equivalents at beginning of period                            13,884                  7,290
----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period                                $ 16,434               $ 13,851
==========================================================================================================

Supplementary cash flow data:
   Cash paid during the period for taxes                                  $  1,065               $  1,071
   Cash paid during the period for interest                                     63                    110
</TABLE>


     See accompanying notes to condensed consolidated financial statements.


                                       4
<PAGE>


                        OSTEOTECH, INC. AND SUBSIDIARIES
              Notes To Condensed Consolidated Financial Statements
                                   (unaudited)

1.   Basis of Presentation

     The accompanying  unaudited  condensed  consolidated  financial  statements
     reflect all  adjustments  (consisting  only of normal  recurring  accruals)
     considered   necessary  by  management  to  present  fairly  the  Company's
     consolidated  financial  position as of September 30, 1998 and December 31,
     1997, and the  consolidated  results of operations for the  three-month and
     nine-month  periods ended September 30, 1998 and 1997, and the consolidated
     cash flows for the nine-month periods then ended. The results of operations
     for the respective  interim periods are not  necessarily  indicative of the
     results  to be  expected  for the full  year.  The  condensed  consolidated
     financial  statements  should  be  read in  conjunction  with  the  audited
     financial  statements  for the year  ended  December  31,  1997  which were
     included as part of the Company's Report on Form 10-K.

2.   Changes in Accounting Policies

     Effective  January 1, 1998,  the Company  adopted  Statement  of  Financial
     Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130").
     SFAS 130 established  standards for reporting and display of  comprehensive
     income and its components in financial statements.

     Comprehensive  income was $2,701,000 and $7,237,000 in the three months and
     nine months ended September 30, 1998, respectively,  compared to $1,608,000
     and $3,891,000 in the same periods last year.  Other  comprehensive  income
     consists solely of foreign currency translation adjustments.

3.   Financing Arrangements

     The Company has a Loan and Security agreement with a US bank which provides
     for  borrowings  of up to $3,000,000  under a revolving  line of credit and
     $4,000,000  under an equipment  line of credit.  In July 1998,  the Company
     received a commitment  from the same bank for a new credit  facility  which
     will replace the current  facilities which expire in December 1998. The new
     credit  facility will include a $5,000,000  revolving  line of credit and a
     $21,500,000  building  mortgage loan and equipment line of credit which the
     Company  will  use to fund the  planned  construction  of a new  processing
     facility. Consummation of the new credit facility is subject to negotiation
     and execution of a definitive agreement.


                                       5
<PAGE>


4.   Commitments and Contingencies

     Acquisition

     In June 1998, the Company acquired a 5% interest in OST Developpement  S.A.
     ("OST"), a subsidiary of Transphyto S.A. of Clermont-Ferrand, France for an
     aggregate purchase price of 496,662 French Francs ("FRF"), or approximately
     $84,400.  OST is a  processor  of bovine bone  grafts for  orthopaedic  and
     dental use. The Company will  acquire an  additional  85% interest no later
     than March 1999,  provided that certain milestones are achieved by OST. The
     purchase  price  for the  additional  interest  will be FRF  8,503,338,  or
     approximately  $1,519,000  at the September  30, 1998  exchange  rate.  The
     Company also has the option to purchase the remaining 10% of OST at a price
     to be determined at the time of purchase.

     In addition,  the Company has agreed to provide  interest-bearing  loans to
     OST of up to FRF 10,000,000,  or approximately  $1,787,000 at the September
     30, 1998  exchange  rate,  to support its capital  expenditure  and working
     capital requirements. In July and August 1998, the Company made advances to
     OST aggregating FRF 1,600,000 or $268,000.

     Litigation

     The Company  remains a defendant  in two lawsuits in which  patients  claim
     that  they  have  suffered  damages  from  the  implantation  of  allegedly
     defective  spinal fixation  devices  allegedly  distributed by the Company.
     Both  cases  have been  stayed  with  respect  to the  Company.  Management
     believes  that the  claims  made in these  suits  are  without  merit  and,
     accordingly,  both  such  cases  are and  will  continue  to be  vigorously
     defended.

     In January 1998,  the Company filed a patent  infringement  action  against
     GenSci   Regeneration   Laboratories,   Inc.  ("GenSci  Labs")  and  GenSci
     Regeneration  Sciences,  Inc.  ("GenSci  Sciences")  alleging  that  GenSci
     parties has violated  claims of one of the patents  involving the Company's
     Grafton(R) Demineralized Bone Matrix (DBM) process. Approximately two weeks
     after  Osteotech's  filing,  GenSci  Labs filed a suit  against the Company
     alleging  patent  infringement  of two  patents  assigned to GenSci Labs in
     addition to tortious  interference  with a business  expectancy,  negligent
     interference with a prospective  economic  advantage and inducing breach of
     contract and seeking a declaratory judgment of the invalidity of two of the
     Company's  patents covering  Grafton(R) DBM. In February 1998,  GenSci Labs
     amended its complaint  alleging  essentially  the same causes of action but
     adding a third patent to the allegation of patent infringement. The actions
     have been  consolidated  into one lawsuit.  In September 1998,  GenSci Labs
     served an amended complaint,  which asserted, in addition to the previously
     asserted  claims,  claims  of  false  advertising  under  Federal  law.  In
     September  1998, the Company  served its answer to this amended  complaint,
     asserted  counterclaims  against  GenSci  Labs  and  served  a  third-party
     complaint against GenSci Sciences,  DePuy, Inc. and DePuy Motech,  Inc. The
     Company's  counterclaims  and third  party  complaint  accuses  the  GenSci
     parties of infringing a second  Company  patent,  in addition to the patent
     referred  to above,  and  accuses  the DePuy and  GenSci  parties of acting
     jointly  and  severally  in  infringing  the  claims of both such  patents.
     Discovery has  commenced and is ongoing.  The Company has and will continue
     to vigorously  defend any claims against it and prosecute the claims it has
     asserted against the GenSci and DePuy parties.


                                       6
<PAGE>


4.   Commitments and Contingencies (Continued)

     In July 1998,  a  complaint  was filed  against  the  Company in the Second
     Judicial  District  Court,  Bernallilo  County,  New Mexico,  which alleges
     negligence,    strict    liability,    breach   of   warranty,    negligent
     misrepresentation,  fraud,  and  violation  of the New Mexico  Unfair Trade
     Practices Act arising from allegedly  defective  dental implant coating and
     coating services provided to plaintiffs by a subsidiary of the Company, Cam
     Implants BV. Plaintiffs have demanded monetary damages. On August 14, 1998,
     the Company removed this action to the United States District Court for the
     District of New Mexico.  On August 24, 1998,  the Company  filed and served
     its answer,  denying any and all  liability  in this  action,  and moved to
     dismiss  five of the  seven  claims  alleged  against  it in this  action -
     negligence,  strict  liability,  negligent  misrepresentation,  fraud,  and
     violation  of the New Mexico  Unfair  Trade  Practices  Act. On November 5,
     1998,  the Company  moved for  summary  judgment in its favor on all of the
     claims alleged in this action, on the ground that all of plaintiffs' claims
     are  barred  by their  applicable  statutes  of  limitations.  The  Company
     believes that the claims  against it are without merit and will continue to
     vigorously defend against such claims.

     Litigation  is subject to many  uncertainties  and  management is unable to
     predict the outcome of the pending  suits and claims.  It is possible  that
     the results of operations or liquidity and capital resources of the Company
     could  be  adversely  affected  by the  ultimate  outcome  of  the  pending
     litigation  or as a result  of the  costs of  contesting  such  suits.  The
     Company is unable to estimate the  potential  liability,  if any,  that may
     result from any of the pending  litigation and,  accordingly,  no provision
     for any liability has been made in the consolidated financial statements.

5.   Stock Repurchase Program

     In June  1998,  the  Board  of  Directors  of the  Company  authorized  the
     repurchase and retirement of up to $5,000,000 of the Company's common stock
     through  open market  purchases.  As of  September  30,  1998,  the Company
     completed this program and had  repurchased  and retired  245,000 shares of
     common stock at a cost of $4,958,000.



                                       7
<PAGE>


6.   Earnings Per Share

     The  following  table  sets  forth the  computation  of basic  and  diluted
     earnings per share:

<TABLE>
<CAPTION>
                                                                            Three Months Ended                Nine Months Ended
                                                                               September 30,                    September 30,
                                                                       ---------------------------       ---------------------------
     (dollars in thousands
      except per share data)                                              1998             1997             1998             1997
     -------------------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>              <C>              <C>              <C>       
     Net income available to Common
         Shareholders                                                  $    2,618       $    1,608       $    7,153       $    3,843
     -------------------------------------------------------------------------------------------------------------------------------

     Weighted average common shares                                     8,779,253        8,196,979        8,817,209        8,016,508
     Nominal warrants outstanding (a)                                                      112,804                           128,229
                                                                       -------------------------------------------------------------
     Denominator for basic earnings per share                           8,779,253        8,309,783        8,817,209        8,144,737
     Effect of dilutive securities:
         Stock options                                                    526,270          611,093          561,337          446,664
         Warrants                                                             233           40,528               78           13,509
                                                                       -------------------------------------------------------------
     Denominator for diluted earnings per share                         9,305,756        8,961,404        9,378,624        8,604,910
     -------------------------------------------------------------------------------------------------------------------------------

         Basic earnings per share                                      $      .30       $      .19       $      .81       $      .47
     -------------------------------------------------------------------------------------------------------------------------------

         Diluted earnings per share                                    $      .28       $      .18       $      .76       $      .45
     -------------------------------------------------------------------------------------------------------------------------------
</TABLE>

        (a) Nominal warrants are warrants with an exercise price of $.03.

7.   Reclassifications

     Certain prior year amounts have been  reclassified to conform with the 1998
     presentation.


                                       8
<PAGE>


Item 2. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

Information contained herein contains "forward-looking statements" (as such term
is defined in the Private Securities Litigation Reform Act of 1995) which can be
identified  by the  use  of  forward-looking  terminology  such  as  "believes",
"expects",  "may", "will", "should", or "anticipates" or the negative thereof or
other variations thereon or comparable terminology. Certain statements contained
in "Management's  Discussion and Analysis of Financial  Condition and Results of
Operations" and other sections herein, including without limitation,  statements
regarding the Company's  liquidity  and capital  resources and other  statements
contained  herein  regarding   matters  that  are  not  historical   facts,  are
forward-looking  statements.  No assurance can be given that the future  results
covered by the  forward-looking  statements  will be  achieved.  The matters set
forth in Exhibit 99.0 to the Company's Form 10-K for the year ended December 31,
1997,  constitute  cautionary  statements  identifying  important  factors  with
respect  to  such  forward-looking  statements,   including  certain  risks  and
uncertainties,  that could  cause  actual  results to vary  materially  from the
future results indicated in such forward-looking statements.

FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997

Results of Operations

Net Income

Net income in the third  quarter of 1998  increased to  $2,618,000 or $.30 basic
earnings per share and $.28 diluted earnings per share compared to net income of
$1,608,000  or $.19  basic  and $.18  diluted  earnings  per  share in the third
quarter of 1997.  Net income in the first nine months of 1998 was  $7,153,000 or
$.81 basic  earnings per share and $.76 diluted  earnings per share  compared to
net income of  $3,843,000  or $.47  basic  earnings  per share and $.45  diluted
earnings per share in the first nine months of 1997.

Following is a discussion of factors which  affected  results of operations  for
the three-month and nine-month periods ended September 30, 1998 and 1997.

Revenues

Consolidated  revenues in the third quarter of 1998 increased 20% to $14,283,000
from $11,933,000 in the third quarter of 1997. Revenues in the first nine months
of 1998 increased 31% to $43,012,000  from  $32,720,000 in the first nine months
of 1997.  During the third  quarter  and first nine  months of 1998,  two of the
Company's  major  customers   accounted  for  58%  and  38%  and  56%  and  39%,
respectively, of revenues.



                                       9
<PAGE>


Results of Operations (continued)

Domestic revenues increased 22% to $13,738,000 in the third quarter of 1998 from
$11,274,000 in the third quarter of 1997 and increased 35% to $41,177,000 in the
first nine  months of 1998 from  $30,403,000  in the first nine  months of 1997.
Revenue  growth was slower in the third quarter of 1998 as compared with the two
preceding  quarters  of 1998 due to: (i) the  Company's  decision to perform the
annual  shutdown of its  allograft  tissue  processing  facility in the quarter,
which lasted for  approximately  two weeks and impacted the Company's ability to
ship base  allograft  tissue  products to its  clients and (ii) the  traditional
slowdown in surgical procedures in July and August which impacted demand for the
Company's  proprietary  Grafton(R)  (DBM) in the quarter.  In 1997, the facility
shutdown  occurred  during the second  quarter.  The net  increase  in  domestic
revenues   resulted   principally   from  increased  demand  for  the  Company's
proprietary  Grafton(R) (DBM) allograft  processing services which increased 32%
in the  third  quarter  of 1998  and 50% in the  first  nine  months  of 1998 as
compared to the same periods in 1997.

Foreign  non-allograft  revenues  decreased  17% in the third quarter of 1998 to
$545,000  from  $659,000 in the third  quarter of 1997 and  decreased 21% in the
nine months ended  September 30, 1998 to $1,835,000  from $2,317,000 in the nine
months ended  September  30, 1997.  The  decrease in foreign  revenues  resulted
principally  from lower  ceramic  product  revenues  and, in  accordance  with a
license  agreement  entered  into in 1997  related to the  Company's  PolyActive
patents and technology, lower licensing fee revenues. Additionally,  orthopaedic
coating  revenues   decreased  due  to  European  summer  slowdown  in  surgical
procedures,  and  in  the  nine  months,  the  temporary  closing  of one of the
Company's major coating  customer's  facility in conjunction with the relocation
of such facility.

Cost of Services and Products

Cost of  services as a  percentage  of service  revenues  was 28% and 30% in the
third quarter and first nine months of 1998,  respectively,  compared to 34% and
35% in the same  periods  last year.  The  decline in costs as a  percentage  of
revenues as compared  with the same  periods last year results from an increased
percentage of revenue coming from services with higher gross margins,  operating
efficiencies  resulting from increased volume and an increase in fees charged to
the Company's customers for certain allograft processing services.

Cost of  products as a  percentage  of product  revenues  was 82% and 73% in the
third quarter and first nine months of 1998,  respectively,  compared to 64% and
72% in the same  periods  last year.  The  changes in costs as a  percentage  of
product  revenues during the third quarter and first nine months of 1998 results
primarily from a shift in product mix.

Marketing, General and Administrative

Marketing,  general and administrative expenses increased $534,000 or 12% in the
third quarter and  $3,486,000 or 29% in the first nine months of 1998,  compared
to the same periods last year.  The increases  were  primarily  attributable  to
expanded  marketing and  promotional  activities,  increased  agent  commissions
directly  related to the  increase in  Grafton(R)  DBM  revenues  and  increased
administrative costs, principally outside professional services.


                                       10
<PAGE>


Research and Development

Research and development  expenses increased $218,000 or 25% and $598,000 or 22%
in the third  quarter and first nine months of 1998,  respectively,  compared to
the same periods last year.  The increases  result  principally  from  increased
spending   associated   with  the  future   expansion  of  the  Company's  viral
inactivation  process  to a  broader  range of  allograft  bone  tissue  and the
development of new allograft bone tissue products, certain of which are expected
to be introduced into the market before the end of 1998.

Other Income (expense)

In the third  quarter and first nine months of 1998,  other income  increased by
$111,000 and $478,000, respectively,  compared to the same periods last year due
to higher invested cash and lower outstanding debt balances.

Income Tax Provision

The Company's  effective income tax rate was 42% and 41%,  respectively,  in the
third quarter and first nine months of 1998 compared to 41% in both periods last
year. The effective income tax rate in the third quarter of 1998 was impacted by
foreign losses for which no current tax benefit was available.

Liquidity and Capital Resources

At  September  30,  1998,  the Company had cash and  short-term  investments  of
$19,353,000  compared to  $15,357,000  at December  31,  1997.  Working  capital
increased  $4,604,000 to $24,526,000  at September 30, 1998 from  $19,922,000 at
December 31, 1997.

Net cash  provided by  operations  was  $12,260,000  in the first nine months of
1998,  compared to  $7,531,000  in the first nine months of 1997.  The  increase
resulted  primarily  from  improved  earnings in 1998 and a reduction in prepaid
income taxes.

Cash used in  investing  activities  increased to  $6,518,000  in the first nine
months of 1998 from  $1,527,000  in the first nine months of 1997.  The increase
results principally from capital  expenditures that increased to $4,326,000 from
$2,443,000 as the Company continues to invest in facilities and equipment needed
for current and future  business  requirements  and a net increase in short-term
investments of $1,446,000.  The Company plans to commence  construction of a new
processing  facility  which  it  expects  to  occupy  by the  end of  1999 at an
aggregate  anticipated cost of approximately  $25 million.  The Company plans to
fund the  construction  of this facility  primarily from the new credit facility
described below.

Net cash used in financing  activities increased by $3,790,000 in the first nine
months of 1998,  principally  as a result of cash used to repurchase  and retire
245,000 shares of common stock at a cost of $4,958,000.


                                       11
<PAGE>


Liquidity and Capital Resources (continued)

The Company has a loan and security  agreement with a US bank which provides for
borrowings of up to $3,000,000  under a revolving  line of credit and $4,000,000
under  an  equipment  line of  credit.  At  September  30,  1998,  $294,000  was
outstanding  under the  equipment  line of credit and there  were no  borrowings
outstanding  under the  revolving  line of  credit.  In July 1998,  the  Company
received a commitment  from the same bank for a new credit  facility  which will
replace the current  facilities  which expire in December  1998.  The new credit
facility  will include a $5,000,000  revolving  line of credit and a $21,500,000
building  mortgage loan and equipment  line of credit which the Company will use
to fund the planned construction of a new processing  facility.  Consummation of
the new credit  facility is subject to negotiation and execution of a definitive
agreement.  The  Company  also  has a line of  credit  with a Dutch  bank  which
provides  for  borrowings  of  up  to  5,000,000  Dutch  Guilders  ("dfl"),   or
approximately  $2,657,000 at the September 30, 1998 exchange  rate.  Analysis of
the Company's  cash position and  anticipated  cash flow  indicated that it most
likely would not be necessary  to utilize a  significant  portion of the line of
credit and, therefore, the Company agreed with the bank to limit its borrowings,
if any,  to no more  than dfl  3,000,000,  or  approximately  $1,594,000  at the
September 30, 1998  exchange  rate.  There were no borrowings  under this credit
line as of September 30, 1998.

The Company believes that its cash and cash equivalents,  short-term investments
and available lines of credit,  together with anticipated  future cash flow from
operations, will be sufficient to meet its near-term requirements.  From time to
time the Company may seek  additional  funds through  equity or debt  financing.
However, there can be no assurances that such additional funds will be available
to the  Company,  or if  available,  that such funds will be  available on terms
favorable to the Company.

Impact of Inflation and Foreign Currency Exchange Fluctuations

The results of the Company's operations for the periods discussed above have not
been significantly affected by inflation or foreign currency fluctuations.

Year 2000

The  Company  recognizes  the need to  ensure  that Year  2000  issues  will not
adversely  impact its operations and has identified its potential Year 2000 risk
in  three  categories:   internal  business  software  and  hardware;   internal
non-financial software and hardware; and external noncompliance by suppliers and
customers.

INTERNAL  BUSINESS  SOFTWARE AND HARDWARE.  During 1994, the Company  determined
that its existing  business systems were not adequate to support the anticipated
growth in the Company's  business  operations  and purchased a fully  integrated
management  information system, which is Year 2000 compliant.  Implementation of
the new system  commenced in 1995 and most of the system is  operational at this
time. Full  implementation  of the remainder of the system is scheduled for June
30, 1999. The completion cost for  implementation  of the remaining  software is
not  expected to be  material.  All related  hardware  used to support  internal
business  software is currently Year 2000  compliant.  As a result,  the Company
does not  believe  that it  requires  a  contingency  plan with  respect  to its
internal  business  systems,  and therefore has not developed one,  however,  if
significant  risks are  identified  or progress  deviates  from the  anticipated
timeline, the Company will develop contingency plans as deemed necessary at that
time.



                                       12
<PAGE>


INTERNAL  NON-FINANCIAL   SOFTWARE.  The  Company  is  currently  assessing  the
potential effect of, and cost of remediating internal non-financial software and
hardware such as fax machines, photocopiers, telephone systems, security systems
and other business  equipment and believes that minimal changes will be required
for Year 2000 compliance.  The Company expects to be in full compliance with its
internal non-financial systems before the year 2000 and further anticipates that
the cost to achieve such compliance is not expected to be material.

SUPPLIERS AND CUSTOMERS.  The Company has initiated written  communications with
all of its significant  suppliers and customers to determine the extent to which
the Company is vulnerable to those third parties' failure to remediate their own
Year 2000  issues.  To the extent  that the Company  does not  receive  adequate
responses by December 31, 1998, it will develop  contingency  plans with respect
to the affected  suppliers  and, or customers.  At this time the Company  cannot
estimate the  additional  cost,  if any,  that may result from such  contingency
plans.

Based on the progress the Company has made in  addressing  its Year 2000 issues,
it does not foresee  significant  risks associated with its year 2000 compliance
program at this time.  Although the Company  expects to be compliant  before the
year 2000, there is no guarantee that these results will be achieved. Partial or
total business systems  interruption or the inability of a significant  supplier
or customer to achieve Year 2000 compliance could have a material adverse effect
on the Company's business operations, financial condition, results of operations
and business prospects.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Not Applicable


                                       13
<PAGE>



PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     "O" Company,  Inc. v. Osteotech,  Inc., Case No. Civ. 98-981 BB/LFG (United
     States District Court for the District of New Mexico)

     On July 16, 1998,  the Company  received a complaint that was filed against
     it in the Second Judicial District Court,  Bernallilo  County,  New Mexico.
     The complaint alleges  negligence,  strict  liability,  breach of warranty,
     negligent misrepresentation,  fraud, and violation of the New Mexico Unfair
     Trade Practices Act arising from allegedly defective dental implant coating
     and coating services provided to plaintiffs by a subsidiary of the Company,
     Cam Implants BV. Plaintiffs have demanded  monetary damages.  On August 14,
     1998, the Company  removed this action to the United States  District Court
     for the District of New Mexico.  On August 24, 1998,  the Company filed and
     served its answer,  denying any and all liability in this action, and moved
     to dismiss  five of the seven  claims  alleged  against it in this action -
     negligence,  strict  liability,  negligent  misrepresentation,  fraud,  and
     violation of the New Mexico Unfair Trade  Practices Act. The motion remains
     sub judice.  On November 5, 1998, the Company moved for summary judgment in
     its favor on all of the claims  alleged in this action,  on the ground that
     all of  plaintiffs'  claims  are  barred by their  applicable  statutes  of
     limitations.  The Company  believes that the claims  against it are without
     merit and will continue to vigorously defend against such claims.

     Patent Infringement Litigation

     The  following  development  occured  in  the  previously  reported  patent
     infringement   litigation  between  the  Company  and  GenSci  Regeneration
     Laboratories,  Inc.  and  GenSci  Regeneration  Sciences,  Inc.  during the
     quarter ended  September 30, 1998. In September 1998,  GenSci  Regeneration
     Laboratories,  Inc. served an amended  complaint  against the Company which
     asserted,  in addition to the previously  asserted claims,  claims of false
     advertising  under Federal law. In September  1998,  the Company served its
     answer to this amended  complaint,  asserted  counterclaims  against GenSci
     Regeneration Laboratories,  Inc. and served a third-party complaint against
     GenSci Regeneration  Sciences,  Inc. DePuy, Inc. and DePuy Motech, Inc. The
     Company's  counterclaims  and third  party  complaint  accuses  the  GenSci
     parties of  infringing  a second  Company  patent and accuses the DePuy and
     GenSci  parties of acting jointly and severally in infringing the claims of
     both such patents.



                                       14
<PAGE>


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

     (a)  Exhibits (numbered in accordance with Item 601 of Regulation S-K)

          Exhibit                                                          Page
          Number            Description                                   Number
          ------            -----------                                   ------

          10.22             Lease for the Company's
                            Shrewsbury, New Jersey Facility                E-1

          27.0              Financial Data Schedule                        E-11

     (b)  Reports on Form 8-K

          On July 15,  1998,  the Company  filed with the  Commission  a current
          report on Form 8-K to  announce  that on June 26,  1998 the  Company's
          Board of Directors had  authorized the repurchase and retirement of up
          to $5  million of the  Company's  common  stock  through  open  market
          purchases  which  will be made from time to time as market  conditions
          allow.  There  were  approximately  8,860,832  shares of common  stock
          issued and  outstanding  as of May 31, 1998.  Additionally,  Osteotech
          announced on July 2, 1998 that it will acquire a majority  interest in
          OST  Developpement  SA,  ("OST")  a  subsidiary  of  Transphyto  SA of
          Clermont-Ferrand, France, in a two step transaction. On June 25, 1998,
          Osteotech  acquired  a  5%  interest  in  OST,  and  will  acquire  an
          additional  85%  interest  no later than  March  1999,  provided  that
          certain  milestones  are  achieved by OST. The  aggregate  cost of the
          transaction  will be FF  9,000,000  (about  $1.5  million  at  current
          exchange rates).  The acquisition will not be dilutive to Osteotech in
          1998,  and is expected to contribute  about $4 million in revenues and
          be accretive to net income in 1999.  The  agreement  also provides for
          the future  purchase by  Osteotech  of the  remaining  10% of OST at a
          price to be determined at the time of the acquisition of the remaining
          shares.

          On September 21, 1998, the Company filed with the Commission a current
          report on Form 8-K to  announce  that the  Company  amended its patent
          infringement  lawsuit against GenSci Regeneration  Laboratories,  Inc.
          and its parent  GenSci  Regeneration  Sciences,  Inc.  ("GenSci"),  to
          include as defendants DePuy Inc. and DePuy Motech, Inc. ("DePuy").  In
          its amendment to the lawsuit, the Company accuses GenSci of infringing
          the claims of a second patent and states that DePuy is infringing  the
          claims  of the two  patents  as a result  of DePuy  offering  for sale
          products  made and  distributed  by  GenSci  marketed  under the names
          DynaGraft  Gel  and  DynaGraft  Putty.  DePuy  is the  North  American
          marketing and sales agent for GenSci's DynaGraft products.


                                       15
<PAGE>


SIGNATURES


Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.


                                                      Osteotech, Inc.      
                                           -------------------------------------
                                                       (Registrant)
                                     
                                     
                                     
Date: November 12, 1998                By: /s/ RICHARD W. BAUER                
                                           -------------------------------------
                                           Richard W. Bauer
                                           President, Chief
                                           Executive Officer
                                     
                                     
                                     
Date: November 12, 1998                By: /s/ MICHAEL J. JEFFRIES             
                                           -------------------------------------
                                           Michael J. Jeffries
                                           Executive Vice President
                                           Chief Operating Officer
                                           Chief Financial Officer