##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended March 31, 2007.
 or
 o
    
    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.
  Delaware
(State or other jurisdiction of 
incorporation or organization)
    
    13-3357370
(I.R.S. Employer Identification No.)
 51 James Way, Eatontown, New Jersey 07724
 (732) 542-2800
 Not Applicable
 þ o
  o þ o
 o þ




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##### 



OSTEOTECH, INC.
 FORM 10-Q
 Table of Contents
 Page No.PART I.  FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsCondensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006
    
    
    3Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2007 and 2006
    
    
    4Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risks
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    21PART II.  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    22Item 6.
    
    Exhibits
    
    
    23EX-10.1: TISSUE RECOVERY AGREEMENTEX-10.2: FIRST AMENDMENT TO TISSUE RECOVERY AGREEMENTEX-10.3: EMPLOYMENT AGREEMENTEX-10.4: EMPLOYMENT AGREEMENTEX-31.1: CERTIFICATIONEX-31.2: CERTIFICATIONEX-32.1: CERTIFICATIONEX-32.2: CERTIFICATION
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PART I. FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 
 OSTEOTECH, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS  (dollars in thousands)
 March 31,
    
    December 31,2007
    
    2006(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    18,848
    
    
    $
    17,946Accounts receivable, net of allowance of $456 in 2007
and $488 in 2006
    
    
    18,179
    
    
    
    18,507Deferred processing costs
    
    
    30,337
    
    
    
    29,067Inventories
    
    
    1,191
    
    
    
    1,005Prepaid expenses and other current assets
    
    
    2,517
    
    
    
    2,795Total current assets
    
    
    71,072
    
    
    
    69,320Property, plant and equipment, net
    
    
    35,194
    
    
    
    36,340Other assets
    
    
    6,512
    
    
    
    7,373Total assets
    
    $
    112,778
    
    
    $
    113,033LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    16,161
    
    
    $
    15,861Current maturities of capital lease obligation
    
    
    746
    
    
    
    727Total current liabilities
    
    
    16,907
    
    
    
    16,588Capital lease obligation
    
    
    14,682
    
    
    
    14,876Other liabilities
    
    
    7,724
    
    
    
    7,716Total liabilities
    
    
    39,313
    
    
    
    39,180Commitments and contingenciesStockholders equity:Preferred stock, $.01 par value; 5,000,000 shares
authorized; no shares issued or outstandingCommon stock, $.01 par value; 70,000,000 shares
authorized; issued and outstanding 17,425,959 shares in 2007 and 17,396,775 shares in 2006
    
    
    174
    
    
    
    174Additional paid-in capital
    
    
    66,057
    
    
    
    65,784Accumulated other comprehensive income
    
    
    1,101
    
    
    
    1,114Retained earnings
    
    
    6,133
    
    
    
    6,781Total stockholders equity
    
    
    73,465
    
    
    
    73,853Total liabilities and stockholders equity
    
    $
    112,778
    
    
    $
    113,033
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OSTEOTECH, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS   (dollars in thousands, except per share data)
 Three Months EndedMarch 31,2007
    
    2006(Restated)Revenue
    
    $
    25,217
    
    
    $
    25,080Cost of revenue
    
    
    12,900
    
    
    
    13,244Gross profit
    
    
    12,317
    
    
    
    11,836Marketing, selling and general and administrative
    
    
    11,777
    
    
    
    10,096Research and development
    
    
    1,077
    
    
    
    1,17212,854
    
    
    
    11,268Operating income (loss)
    
    
    (537
    )
    
    
    568Other income (expense):Interest income
    
    
    260
    
    
    
    154Interest expense, net
    
    
    (410
    )
    
    
    (424
    )Other
    
    
    136
    
    
    
    244(14
    )
    
    
    (26
    )Income (loss) before income taxes
    
    
    (551
    )
    
    
    542Income tax provision
    
    
    97
    
    
    
    43Net income (loss)
    
    $
    (648
    )
    
    $
    499Earnings (loss) per share:Basic
    
    $
    (.04
    )
    
    $
    .03Diluted
    
    $
    (.04
    )
    
    $
    .03Shares used in computing earnings (loss) per share:Basic
    
    
    17,419,332
    
    
    
    17,265,853Diluted
    
    
    17,419,332
    
    
    
    17,363,156
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OSTEOTECH, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS   (dollars in thousands)
 Three Months EndedMarch 31,2007
    
    2006(Restated)Cash Flow From Operating ActivitiesNet income (loss)
    
    $
    (648
    )
    
    $
    499Adjustments to reconcile net income (loss)
to net cash provided by operating activities:Depreciation and amortization
    
    
    1,365
    
    
    
    1,380Stock-based compensation expense
    
    
    155
    
    
    
    61Changes in current assets and liabilities:Accounts receivable
    
    
    328
    
    
    
    (3,142
    )Deferred processing costs
    
    
    (554
    )
    
    
    (23
    )Inventories
    
    
    (186
    )
    
    
    (114
    )Prepaid expenses and other current assets
    
    
    278
    
    
    
    (241
    )Note receivables from patent litigation settlement
    
    
    250
    
    
    
    250Accounts payable and other liabilities
    
    
    299
    
    
    
    1,638Net cash provided by operating activities
    
    
    1,287
    
    
    
    308Cash Flow From Investing ActivitiesCapital expenditures
    
    
    (163
    )
    
    
    (786
    )Other, net
    
    
    (174
    )
    
    
    (164
    )Net cash used in investing activities
    
    
    (337
    )
    
    
    (950
    )Cash Flow From Financing ActivitiesProceeds from issuance of common stock
    
    
    118
    
    
    
    73Principal payments on capital lease obligation
    
    
    (175
    )
    
    
    (158
    )Net cash used in financing activities
    
    
    (57
    )
    
    
    (85
    )Effect of exchange rate changes on cash
    
    
    9
    
    
    
    33Net increase (decrease) in cash and cash equivalents
    
    
    902
    
    
    
    (694
    )Cash and cash equivalents at beginning of period
    
    
    17,946
    
    
    
    13,484Cash and cash equivalents at end of period
    
    $
    18,848
    
    
    $
    12,790Supplementary cash flow data:Cash paid during the period for interest
    
    $
    409
    
    
    $
    424Cash (refunded) paid during the period for taxes
    
    $
    (36
    )
    
    $
    191
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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
 1. Basis of Presentation
 General
  Adoption of New Accounting Pronouncement
   Three Months EndedMarch 31, 2006
    
    June 30, 2006Restated
    
    Reported
    
    Restated
    
    ReportedRevenue
    
    $
    25,080
    
    
    $
    25,080
    
    
    $
    25,282
    
    
    $
    25,282Cost of Revenue
    
    
    13,244
    
    
    
    13,501
    
    
    
    12,879
    
    
    
    13,222Gross Profit
    
    
    11,836
    
    
    
    11,579
    
    
    
    12,403
    
    
    
    12,060Operating Expenses
    
    
    11,268
    
    
    
    11,268
    
    
    
    11,152
    
    
    
    11,152Operating Income
    
    
    568
    
    
    
    311
    
    
    
    1,251
    
    
    
    908Other, net
    
    
    (26
    )
    
    
    (26
    )
    
    
    (3
    )
    
    
    (3
    )Income before income taxes
    
    
    542
    
    
    
    285
    
    
    
    1,248
    
    
    
    905Income tax provision
    
    
    43
    
    
    
    43
    
    
    
    136
    
    
    
    136Net Income
    
    $
    499
    
    
    $
    242
    
    
    $
    1,112
    
    
    $
    769Earnings per share:Basic
    
    $
    .03
    
    
    $
    .01
    
    
    $
    .06
    
    
    $
    .04Diluted
    
    $
    .03
    
    
    $
    .01
    
    
    $
    .06
    
    
    $
    .04
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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
 Three Months EndedSeptember 30, 2006
    
    December 31, 2006Restated
    
    Reported
    
    Restated
    
    ReportedRevenue
    
    $
    23,448
    
    
    $
    23,448
    
    
    $
    25,431
    
    
    $
    25,431Cost of Revenue
    
    
    11,994
    
    
    
    11,878
    
    
    
    13,322
    
    
    
    12,838Gross Profit
    
    
    11,454
    
    
    
    11,570
    
    
    
    12,109
    
    
    
    12,593Operating Expenses
    
    
    10,943
    
    
    
    10,943
    
    
    
    12,092
    
    
    
    12,092Operating Income
    
    
    511
    
    
    
    627
    
    
    
    17
    
    
    
    501Other, net
    
    
    (350
    )
    
    
    (350
    )
    
    
    (119
    )
    
    
    (119
    )Income (loss) before income taxes
    
    
    161
    
    
    
    277
    
    
    
    (102
    )
    
    
    382Income tax provision (benefit)
    
    
    (74
    )
    
    
    (74
    )
    
    
    (163
    )
    
    
    (163
    )Net Income
    
    $
    235
    
    
    $
    351
    
    
    $
    61
    
    
    $
    545Earnings per share:Basic
    
    $
    .01
    
    
    $
    .02
    
    
    
    
    
    
    $
    .03Diluted
    
    $
    .01
    
    
    $
    .02
    
    
    
    
    
    
    $
    .03
 Segment Realignment
  
    
    Demineralized Bone Matrix (DBM),
    
    Traditional Tissue,
    
    Spinal Allograft,
    
    Hybrid/Synthetic, and
    
    Client Services.
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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
 2. Deferred Processing Costs
  March 31,
    
    December 31,2007
    
    2006Unprocessed donor tissue
    
    $
    12,514
    
    
    $
    11,957Tissue in process
    
    
    6,253
    
    
    
    5,533Implantable donor tissue
    
    
    11,570
    
    
    
    11,577$
    30,337
    
    
    $
    29,067
  3. Inventories
  March 31,
    
    December 31,2007
    
    2006Supplies
    
    $
    186
    
    
    $
    187Raw materials
    
    
    638
    
    
    
    489Finished goods
    
    
    367
    
    
    
    329$
    1,191
    
    
    $
    1,005
 4. Stock Compensation Plans
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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
 Share-Based Awards
      Three Months EndedWeighted Average Assumptions
    
    March 31, 2006Expected holding period (years)
    
    
    5Risk-free interest rate
    
    
    4.32
    %Volatility factor
    
    
    76
    %Dividend yield
    
    
    0Annual forfeiture rate
    
    
    3
    %Fair value per share at date of grant
    
    $
    3.79
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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
  Three Months EndedMarch 31,2007
    
    2006Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    AverageShares
    
    Exercise Price
    
    Shares
    
    Exercise PriceOutstanding at January 1,
    
    
    2,587,125
    
    
    $
    8.35
    
    
    
    2,937,062
    
    
    $
    8.03Granted
    
    
    
    
    
    
    
    
    
    
    20,000
    
    
    
    5.87Exercised
    
    
    (25,150
    )
    
    
    3.51
    
    
    
    (10,000
    )
    
    
    4.09Cancelled or expired
    
    
    (60,275
    )
    
    
    7.44
    
    
    
    (73,875
    )
    
    
    5.58Outstanding at March 31,
    
    
    2,501,700
    
    
    $
    8.43
    
    
    
    2,873,187
    
    
    $
    8.09Exercisable at March 31,
    
    
    2,435,450
    
    
    $
    8.53
    
    
    
    2,683,187
    
    
    $
    8.39Available for grant at
March 31,
    
    
    308,800
    
    
    
    
    
    
    
    317,500
  Weighted AverageGrant DateNonvested Options
    
    Shares
    
    Fair ValueNonvested at January 1, 2007
    
    
    82,500
    
    
    $
    2.99Granted
    
    
    
    
    
    
    Vested
    
    
    (5,000
    )
    
    
    3.79Forfeited
    
    
    (11,250
    )
    
    
    2.42Nonvested at March 31, 2007
    
    
    66,250
    
    
    $
    3.02
  -10-




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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
  Weighted AverageGrant Date FairRestricted Stock
    
    ValueUnits
    
    Per ShareOutstanding at January 1, 2007
    
    
    119,900
    
    
    $
    4.85Granted
    
    
    17,200
    
    
    $
    6.73Vested
    
    
    Forfeited
    
    
    Outstanding at March 31, 2007
    
    
    137,100
    
    
    $
    5.09Unvested at March 31, 2007
    
    
    137,100
    
    
    $
    5.09
 5. Debt and Financing Agreement
  6. Income Taxes
   -11-




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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
     7. Commitments and Contingencies
 Litigation
  Kment and Filan v. Osteotech, Inc.
  Scotty Foster and Linda Foster v. Osteotech, Inc.
   -12-




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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
  8. Comprehensive Income (Loss)
  Three Months EndedMarch 31,2007
    

    2006(Restated)Net income (loss)
    
    $
    (648
    )
    
    $
    499Currency translation adjustments
    
    
    (13
    )
    
    
    (77
    )Comprehensive income (loss)
    
    $
    (661
    )
    
    $
    422
 9. Earnings (Loss) Per Share
  Three Months EndedMarch 31,2007
    
    2006(Restated)Net income (loss) available to common
stockholders
    
    $
    (648
    )
    
    $
    499Denominator for basic earnings (loss) per share,
weighted average common shares outstanding
    
    
    17,419,332
    
    
    
    17,265,853Effect of dilutive securities:Stock options after application of the
treasury stock method
    
    
    
    
    
    
    97,303Denominator for diluted earnings (loss) per
share
    
    
    17,419,332
    
    
    
    17,363,156Basic earnings (loss) per share
    
    $
    (.04
    )
    
    $
    .03Diluted earnings (loss) per share
    
    $
    (.04
    )
    
    $
    .03
  -13-




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OSTEOTECH, INC. and SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements  (dollars in thousands, except per share data)
 10. Operating Segments
  Three Months EndedMarch 31,2007
    
    2006(restated)Revenue:DBM
    
    $
    15,482
    
    
    $
    14,974Traditional Tissue
    
    
    4,611
    
    
    
    3,754Spinal Allografts
    
    
    2,788
    
    
    
    4,036Hybrid/Synthetics
    
    
    233
    
    
    
    218Client Services
    
    
    1,928
    
    
    
    1,920Other
    
    
    175
    
    
    
    178$
    25,217
    
    
    $
    25,080
 Three Months EndedMarch 31,2007
    
    2006(restated)Operating income (loss):DBM
    
    $
    3,039
    
    
    $
    4,907Traditional Tissue
    
    
    1,399
    
    
    
    522Spinal Allografts
    
    
    321
    
    
    
    670Hybrid/Synthetics
    
    
    42
    
    
    
    (25
    )Client Services
    
    
    1,578
    
    
    
    492Other
    
    
    138
    
    
    
    (18
    )Corporate
    
    
    (7,054
    )
    
    
    (5,980
    )$
    (537
    )
    
    $
    568
  11. Other Income (Expense)
  -14-




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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
 Results of Operations
 Critical Accounting Policies and Estimates
  Operating Segment Realignment and Adoption of New Accounting Principle
    -15-




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Net Income (Loss)
 Three Months EndedMarch 31,(dollars in thousands,
    
    2007
    
    2006
    
    
    
    
    
    Percentexcept per share amounts)
    

    
    
    


    
    (Restated)
    
    Change
    
    ChangeNet income (loss)
    
    $
    (648
    )
    
    $
    499
    
    
    $
    (1,147
    )
    
    
    (230
    )%Earnings (loss) per share:Basic
    
    $
    (.04
    )
    
    $
    .03Diluted
    
    $
    (.04
    )
    
    $
    .03
   Revenue
  Three Months EndedMarch 31,2007
    
    2006
    
    
    
    Percent(dollars in thousands)
    

    
    
    

    
    (restated)
    
    Change
    
    ChangeDBM Segment
    
    $
    15,482
    
    
    $
    14,974
    
    
    $
    508
    
    
    
    3
    %Traditional Tissue Segment
    
    
    4,611
    
    
    
    3,754
    
    
    
    857
    
    
    
    23
    %Spinal Allograft Segment
    
    
    2,788
    
    
    
    4,036
    
    
    
    (1,248
    )
    
    
    (31
    )%Hybrid Synthetic Segment
    
    
    233
    
    
    
    218
    
    
    
    15
    
    
    
    7
    %Client Services Segment
    
    
    1,928
    
    
    
    1,920
    
    
    
    8
    
    
    
    Other Product Lines
    
    
    175
    
    
    
    178
    
    
    
    (3
    )
    
    
    (2
    )%$
    25,217
    
    
    $
    25,080
    
    
    $
    137
    
    
    
    1
    %
 ® ®
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® ® ® ®
 ® ®
   Gross Profit Margin
 Three Months EndedMarch 31,2007

    
    2006(dollars in thousands)
    
    
    
    


    
    (Restated)Gross profit
    
    $
    12,317
    
    
    $
    11,836Gross margin
    
    
    49
    %
    
    
    47
    %
  -17-




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Operating Expenses
 Three Months Ended March 31,(dollars in thousands)
    
    2007
    
    2006
    
    Change
    
    Percent ChangeMarketing, selling and
general and administrative
    
    $
    11,777
    
    
    $
    10,096
    
    
    $
    1,681
    
    
    
    17
    %Research and development
    
    
    1,077
    
    
    
    1,172
    
    
    
    (95
    )
    
    
    (8
    )%Total
    
    $
    12,854
    
    
    $
    11,268
    
    
    $
    1,586
    
    
    
    14
    %
   Operating Income (Loss)
 Three Months Ended March 31,(dollars in thousands)
    
    2007
    
    2006
    
    Change
    
    Percent ChangeDBM Segment
    
    $
    3,039
    
    
    $
    4,907
    
    
    $
    (1,868
    )
    
    
    (38
    )%Traditional Tissue Segment
    
    
    1,399
    
    
    
    522
    
    
    
    877
    
    
    
    168
    %Spinal Allograft Segment
    
    
    321
    
    
    
    670
    
    
    
    (349
    )
    
    
    (52
    )%Hybrid/Synthetic Segment
    
    
    42
    
    
    
    (25
    )
    
    
    67
    
    
    
    268
    %Client Services Segment
    
    
    1,578
    
    
    
    492
    
    
    
    1,086
    
    
    
    221
    %Other Product Lines
    
    
    138
    
    
    
    (18
    )
    
    
    156
    
    
    
    867
    %6,517
    
    
    
    6,548
    
    
    
    (31
    )
    
    
    Corporate
    
    
    (7,054
    )
    
    
    (5,980
    )
    
    
    (1,074
    )
    
    
    (18
    )%Operating income (loss)
    
    $
    (537
    )
    
    $
    568
    
    
    $
    (1,105
    )
    
    
    (51
    )%
   -18-




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##### Table of Contents



Other Income (Expense)
  Income Tax Provision
       -19-




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##### Table of Contents



Liquidity and Capital Resources
       Contractual Obligations
  Impact of Inflation and Foreign Currency Exchange Fluctuations
  -20-




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##### Table of Contents



Litigation
  
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Control Over Financial Reporting
  -21-




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##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  Kment and Filan v. Osteotech, Inc.
  Scotty Foster and Linda Foster v. Osteotech, Inc.
   -22-




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##### Table of Contents



Item 6. EXHIBITS AND REPORTS ON FORM 8-K
 (a)
    
    Exhibits (numbered in accordance with Item 601 of Regulation S-K)
 Exhibit
    
    
    
    PageNumber
    
    Description
    
    Number10.1
    
    Tissue Recovery Agreement between the Company and Community Blood Center d/b/a
Community Tissue Services dated March 1, 2006*
    
    +10.2
    
    First Amendment to Tissue Recovery Agreement between the Company and Community Blood
Center dated February 27, 2007*
    
    +10.3
    
    Employment Agreement, dated April 1, 1999, between the Company and Richard Russo**
    
    +10.4
    
    Employment Agreement, dated September 27, 2004, between the Company and Robert Honneffer**
    
    +31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    
    +31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    
    +32.1
    
    Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    
    +32.2
    
    Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    
    +
 
 +
    
    Filed herewith.*
    
    Portions of this exhibit have been redacted and filed separately with the Commission pursuant to
a confidential treatment request.**
    
    Management contracts or compensatory plans and arrangements required to be filed pursuant to
Item 601(b)(10)(ii)(A) or (iii) of Regulation S-K. SIGNATURES
  Date:  May 10, 2007
    Osteotech, Inc.(Registrant)Date:  May 10, 2007
    By:
    /s/ Sam Owusu-AkyawSam Owusu-AkyawPresident and Chief Executive Officer
(Principal Executive Officer)Date:  May 10, 2007
    By:
    /s/ Mark H. BurroughsMark H. BurroughsExecutive Vice President,
Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer) -23-