The following discussions should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
Information included herein contains "forward-looking statements" 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 variations thereon or comparable terminology, or by discussions of strategy. No assurance can be given that the future results covered by the forward-looking statements will be achieved. Some of the matters set forth in Item 1A, "Risk Factors", of our Annual Report on Form 10-K for the year ended December 31, 2008 constitute cautionary statements identifying 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. Other factors could also cause actual results to vary materially from the future results indicated in such forward-looking statements. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
Results of Operations
Critical Accounting Policies and Estimates The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate the estimates and may adjust them based upon the latest information available. These estimates generally include those related to product returns, bad debts, inventories including purchase commitments, deferred processing costs including reserves for rework, excess and obsolescence, long-lived assets, asset retirement obligations, income taxes, stock-based compensation, contingencies and litigation. We base the estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Our accounting practices are discussed in more detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2008 as well as in "Recent Accounting Developments" included elsewhere herein. There have been no significant modifications in our critical accounting policies or estimates since December 31, 2008.

Net Income (Loss)

                                                                  Three Months Ended
                                                                       March 31,
                                                                                             Percent
(dollars in thousands, except per share amounts)     2009         2008          Change       Change
Net income (loss)                                  $ (1,796 )   $    808       $ (2,604 )        (322 )%
Earnings (loss) per share:
Basic                                              $   (.10 )   $    .05
Diluted                                            $   (.10 )   $    .05

We generated a net loss of $1.8 million, or $0.10 per basic and diluted share, in the first quarter of 2009 compared to net income of $0.8 million, or $0.05 per basic and diluted share, in the first quarter of 2008. The net loss was attributable to lower gross profits primarily as a result of an expected decline in revenue, the impact of lower interest income and fluctuations in the exchange rates, mainly the euro against the U.S. dollar, which resulted in a loss on foreign exchange in this year's first quarter versus a gain in the prior year.

Revenue
For the three months ended March 31, 2009, revenue was $23.9 million as compared
to revenue of $27.6 million for the three months ended March 31, 2008.
The following table details the components of our revenue for the three months
ended March 31, 2009 and 2008:

                                                    Three Months Ended
                                                        March 31,
                                                                             Percent
        (dollars in thousands)         2009         2008        Change       Change

        DBM Segment                  $ 14,026     $ 16,966     $ (2,940 )         (17 )%
        Hybrid Synthetic Segment          748          644          104            16 %
        Traditional Tissue Segment      5,277        5,110          167             3 %
        Spinal Allograft Segment        1,880        2,250         (370 )         (16 )%
        Client Services Segment         1,633        2,424         (791 )         (33 )%
        Other Product Lines               367          237          130            55 %

                                     $ 23,931     $ 27,631     $ (3,700 )         (13 )%

DBM Segment revenue, which consists of revenue from the sale of Grafton® DBM and Xpanse™ Bone Inserts and revenue from the processing of private label DBM, declined 17% in the first quarter of 2009 as compared to the same period in 2008, primarily as a result of the anticipated loss in revenue from the temporary suspension of distributing tissue recovered by our Bulgarian subsidiary and a decline in domestic unit sales volume. Revenue from Grafton® DBM/Xpanse™ Bone Inserts and, private label DBM tissue forms, declined 14% and 41%, respectively, in the first quarter of 2009 compared to the first quarter of 2008.
Revenue in the Hybrid/Synthetic Segment, represented sales of our Plexur P Biocomposites and GraftCage® Spacers, increased 16% in the first quarter of 2009 as compared to the same period in 2008 as a result of increased Plexur P® revenue partially offset by a decline in revenue from the GraftCage® Spacers. Traditional Tissue Segment revenue generated from the worldwide distribution of allograft bone tissue grafts increased 3% in the first quarter of 2009 as compared to the same period in 2008. The increase in 2009 traditional tissue revenues resulted from increased domestic unit sales volume.
Revenue in the Spinal Allograft Segment declined 16% in the in the first quarter of 2009 as compared to the same period in 2008 primarily due to a decrease in unit sales volume. We anticipate continued competitive challenges for our spinal allografts in 2009.
Client Services Segment revenue, which is generated by the processing of allograft bone tissue for our clients, declined 33% in the first quarter of 2009 as compared to the same period in 2008. The revenue generated in the first quarter of 2009 relates mainly to the winding down of our relationship with MTF as our contractual agreements with MTF expired at the end of 2008. For the three months ended March 31, 2009, no customer accounted for more than 10% of revenue. For the three months ended March 31, 2008, MTF accounted for 14% of revenue.

Gross Profit Margin

                                              Three Months Ended
                                                   March 31,
                   (dollars in thousands)      2009          2008
                   Gross profit             $   11,967     $ 14,242
                   Gross margin                     50 %         52 %

In the first quarter of 2009, gross margin declined over gross margin levels in the first quarter of 2008, primarily due to the recording of certain reserves for our tissue inventories which accounted for approximately one percentage point of the decline in gross margin, increased pricing pressures, and a slight change in the mix of our revenue streams.

Operating Expenses

                                                          Three Months Ended
                                                               March 31,
                                                                                       Percent
(dollars in thousands)                   2009           2008           Change          Change
Marketing, selling and general and
administrative                         $  11,618      $  11,680      $      (62 )             (1 )%
Research and development                   1,653          1,760            (107 )             (6 )%

Total                                  $  13,271      $  13,440      $     (169 )             (1 )%

Marketing, selling and general and administrative expenses were relatively flat in the first quarter of 2009 when compared to the first quarter of 2008. Generally, we had higher sales and marketing costs which were offset by lower performance based compensation costs. In the first quarter of 2009, research and development expenses decreased 6% as compared to the same period in 2008, primarily due to a decline in research activities and studies. We anticipate that our quarterly research and development expenditures for the remainder of 2009 will approximate or decline slightly from the first quarter level as several new tissue products will move from research and development to commercialization.

Operating Income (Loss)

                                                    Three Months Ended
                                                        March 31,
                                                                             Percent
        (dollars in thousands)         2009         2008        Change       Change
        DBM Segment                  $  3,932     $  5,981     $ (2,049 )         (34 )%
        Hybrid/Synthetic Segment          102         (172 )        247           159 %
        Traditional Tissue Segment        290          856         (566 )         (66 )%
        Spinal Allograft Segment          244         (238 )        482          (203 )%
        Client Services Segment         1,193        1,429         (236 )         (17 )%
        Other Product Lines              (129 )        232         (361 )        (156 )%

                                        5,632        8,088       (2,456 )         (30 )%
        Corporate                      (6,936 )     (7,286 )        350             5 %

        Operating income (loss)      $ (1,304 )   $    802     $ (2,106 )        (263 )%

Total product segment operating income for the first quarter of 2009 declined 30% as compared to 2008 principally due to lower gross profit as a result of the decline in revenues and higher selling expenses. In 2009, product segment operating income, as a percent of revenue, declined to 24% compared to 29% in 2008.
Costs and expenses associated with Corporate declined 5% in 2009 as compared with the same period last year, primarily due to lower performance based compensation costs.

Other Income (Expense)
In the first quarter of 2009, other expense of $0.4 million primarily represented interest expense associated with our capital lease obligation and foreign exchange losses. Interest income on our invested cash balances was not significant.
Other income in the first quarter of 2008 of $0.1 million was principally the result of interest income of $.2 million on invested cash balances and foreign currency gains of $.3 million primarily related to intercompany debt, which was partially offset by $.4 million in interest expense associated with our capital lease obligation.
Income Tax Provision
For the three months ended March 31, 2009, after the application of available net operating loss carryforwards, we provided for Federal taxes based on the alternative minimum tax method, as well as recorded a provision for certain minimum state taxes. We continue not to recognize any Federal, state and certain foreign tax benefits, which were subject to full valuation allowances in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes." We intend to maintain the valuation allowances until sufficient positive evidence exists to support the reversal of a valuation allowance that we have established. We evaluate our position with respect to the valuation allowances each quarter by taking into consideration numerous factors, including, but not limited to: past, present and forecasted results; the impact in each jurisdiction of operating activities; and the anticipated effects of our strategic plan. We file U.S., state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2003 through 2007 tax years generally remain subject to examination by Federal, foreign and most state authorities including, but not limited to, the United States, France, Bulgaria and the State of New Jersey. Our 2003 through 2004 Federal tax returns are currently under examination by the U.S. Internal Revenue Service ("IRS"). The State of New Jersey is examining certain of the Company's 2003 and 2007 state tax filings and an audit of its 2006 and 2007 tax filings by its French subsidiary has recently commenced.
We have reached a tentative agreement with the IRS regarding the audit of the Company's Federal tax returns which is subject to review and approval by the Joint Committee on Taxation. Under the tentative settlement, we owe no additional tax and the aggregate amount of our available Federal net operating loss carryforwards will not be materially impacted although certain research and development credit carryforwards will be eliminated. Any remaining items disallowed would be deductible in future periods. Until such time as Joint Committee on Taxation approval is received, the IRS examination will not be closed or effectively settled for financial reporting purposes. The components of our unrecognized tax benefits ("UTBs") are substantially comprised of deferred tax assets which are subject to a full valuation allowance. To the extent we prevail in matters for which either a receivable or a liability for a UTB has been established or are required to pay an amount or utilize net operating losses ("NOLs") to settle a tax liability or estimates regarding a UTB change as a result of changes in facts and circumstances, our effective tax rate in a given financial reporting period may be affected. Subsequent to December 31, 2008, there has been no significant change in our gross UTBs of $3.6 million. It is expected that the amount of UTBs will change in the next twelve months due to our filing of amended Federal and state tax returns, resolution of the revenue authority examinations and expiring statutes of limitation and audit activity; however, we do not anticipate the change, if any, to be significant.