Summary of OSTEOTECH INC - Yahoo! Finance

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 AND NINE MONTHS ENDED SEPTEMBER 30, 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                    Nine Months Ended
(dollars in thousands, except per            September 30,                        September 30,
share amounts)                        2009       2008       Change        2009        2008        Change
Net income (loss)                   $ (1,907 )   $  58     $ (1,965 )   $ (4,907 )   $ 2,612     $ (7,519 )
Earnings (loss) per share:
Basic                               $  (0.11 )   $   -                  $  (0.27 )   $  0.15
Diluted                             $  (0.11 )   $   -                  $  (0.27 )   $  0.15

We generated a net loss for the third quarter and first nine months of 2009 compared to net income in the comparable prior year periods. The net losses in both periods were attributable to a more than expected decline in revenue which resulted in lower gross profit and a decline in gross margin. In the second quarter and first nine months of 2008, we realized income from a litigation settlement of $1.0 million.
Revenue
For the three months ended September 30, 2009, revenue was $23.0 million as compared to $24.1 million for the three months ended September 30, 2008. For the nine months ended September 30, 2009, revenue was $70.4 million compared to $79.2 million in the comparable prior year period.

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The following table details the components of our revenue for the three and nine months ended September 30, 2009 and 2008:

                                         Three Months Ended                                   Nine Months Ended
                                           September 30,                                        September 30,
                                                                  Percent                                              Percent
(dollars in thousands,)     2009         2008        Change       Change         2009         2008        Change       Change
DBM                       $ 14,611     $ 14,023     $    588             4 %   $ 43,445     $ 47,564     $ (4,119 )          -9 %
Hybrid/Synthetic          $    894     $    816     $     78            10 %   $  2,289     $  2,187     $    102             5 %
Traditional Tissue        $  5,101     $  5,246     $   (145 )          -3 %   $ 15,821     $ 15,606     $    215             1 %
Spinal Allograft          $  1,966     $  1,943     $     23             1 %   $  5,708     $  6,479     $   (771 )         -12 %
Client Services           $    125     $  1,706     $ (1,581 )         -93 %   $  2,013     $  6,527     $ (4,514 )         -69 %
Other                     $    264     $    329     $    (65 )         -20 %   $  1,087     $    884     $    203            23 %

                          $ 22,961     $ 24,063     $ (1,102 )          -5 %   $ 70,363     $ 79,247     $ (8,884 )         -11 %

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, increased 4% for the three months ended September 30, 2009, as compared to the same period in 2008, mostly as a result of improved domestic pricing and an increase in private label DBM revenue. DBM Segment revenue decreased 9% for the nine months ended September 30, 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 and Xpanse™ Bone Inserts and revenue from private label DBM tissue forms increased 1% and 424%, respectively, in the third quarter of 2009 compared to the third quarter of 2008. Revenue from Grafton® DBM and Xpanse™ Bone Inserts and revenue from private label DBM decreased 8% and 22%, respectively, in the first nine months of 2009 compared to the prior year period, primarily as a result of lower unit sales volumes.
Revenue in the Hybrid/Synthetic Segment, which consists of revenue from our Plexur Biocomposites and GraftCage® Spacers, increased 10% in the third quarter of 2009 as compared to the same period in 2008 as a result of an increase in revenue from the GraftCage® Spacers. For the first nine months of 2009, increased Plexur P® revenue offset a decline in revenue from GraftCage® Spacers resulting in a 5% increase in revenue compared to the prior year period. Traditional Tissue Segment revenue generated from the worldwide distribution of allograft bone tissue grafts decreased 3% in the third quarter of 2009 as compared to the same period in 2008 primarily due to a decrease in international unit sales volume. For the first nine months of 2009, increased domestic unit sales volume offset a decline in international revenue resulting in an increase of 1% in revenue compared to the same prior year period.
Revenue in the Spinal Allograft Segment increased 1% in the third quarter of 2009 as compared to the same period in 2008. For the first nine months of 2009, revenue in the Spinal Allograft Segment decreased 12% primarily due to a decrease in domestic 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 93% and 69%, respectively, in the third quarter and first nine months of 2009 as compared to the same comparable periods in 2008. The revenue generated in 2009 relates mainly to the winding down of our relationship with the Musculoskeletal Transplant Foundation ("MTF") as our contractual agreements expired at the end of 2008. For the three and nine months ended September 30, 2009, international revenue was $4.6 million and $15 million, respectively, or 20% and 21% of total revenue. For the three and nine months ended September 30, 2008, international revenue was $5.1 million and $17.2 million, respectively, or 21% and 22% of total revenue. The reduction in revenue for the three and nine months ended September 30, 2009 mainly results from a decline in revenue from the Greek market, as a result of economic and government reimbursement conditions in Greece, and a loss of revenue in a key Asian market. We also now expect to recover less of the revenue we lost in the Asian market as a result of our self-imposed temporary suspension of the distribution of Bulgarian tissue which was lifted early in the third quarter.

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For the three and nine months ended September 30, 2009, no customer accounted for more than 10% of revenue. For the three and nine months ended September 30, 2008, MTF accounted for 12% and 13% of revenue, respectively.

Gross Profit Margin

                                    Three Months Ended          Nine Months Ended
                                       September 30,              September 30,
         (dollars in thousands)      2009          2008         2009          2008
         Gross Profit             $   10,459     $ 12,881     $  33,957     $ 41,625
         Gross Margin                     46 %         54 %          48 %         53 %

In both the three and nine months ended September 30, 2009, gross margin declined from gross margin levels in the comparable prior year periods primarily due to lower unit processing volumes required to support lower revenues. Also impacting gross profit in the three and nine months ended September 30, 2009 was the cost of our annual plant preventative maintenance shutdown, which occurred in the second quarter in 2008, and a number of inventory reserves and adjustments.
Operating Expenses

                                          Three Months Ended                                      Nine Months Ended
                                            September 30,                                           September 30,
                                                                    Percent                                                 Percent
(dollars in thousands)      2009          2008        Change        Change          2009          2008        Change        Change
Marketing, selling and
general and
administrative            $ 10,648      $ 10,476      $   172              2 %    $ 33,034      $ 33,479      $  (445 )           -1 %
Research and
development               $  1,544      $  1,739      $  (195 )          -11 %    $  5,195      $  5,273      $   (78 )           -1 %

                          $ 12,192      $ 12,215      $   (23 )            0 %    $ 38,229      $ 38,752      $  (523 )           -1 %

Marketing, selling and general and administrative expenses were relatively flat in the three and nine months ended September 30, 2009 compared to the same prior year periods. In the three months ended September 30, 2009, selling expenses declined in absolute dollars although increased as a percentage of sales compared to the prior year period. In the nine months ended September 30, 2009, selling expenses increased over the comparable year period both in absolute dollars and as a percentage of sales. Marketing costs in both the three and nine months ended September 30, 2009 increased over the prior year amounts while general and administrative expenses in the 2009 periods have remained relatively flat when compared with the prior year periods. In the third quarter and first nine months of 2009, research and development expenses decreased 11% and 1%, respectively, as compared to the same periods in 2008, primarily due to several new tissue technologies and products moving from development to commercialization.

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Operating Income (Loss) By Segment

                                         Three Months Ended                                    Nine Months Ended
                                           September 30,                                         September 30,
                                                                  Percent                                               Percent
(dollars in thousands,)     2009         2008        Change       Change         2009          2008         Change       Change
DBM                       $  4,462     $  4,262     $    200             5 %   $  12,162     $  15,345     $ (3,183 )        -21 %
Hybrid/Synthetic          $   (261 )   $    104     $   (365 )        -351 %   $    (393 )   $      (2 )   $   (391 )      19550 %
Traditional Tissue        $   (220 )   $    923     $ (1,143 )        -124 %   $     848     $   2,449     $ (1,601 )        -65 %
Spinal Allograft          $    320     $   (116 )   $    436          -376 %   $     871     $    (100 )   $    971         -971 %
Client Services           $      8     $    956     $   (948 )         -99 %   $   1,133     $   4,002     $ (2,869 )        -72 %
Other Product Lines       $   (418 )   $    115     $   (533 )        -463 %   $    (338 )   $     577     $   (915 )       -159 %

                          $  3,891     $  6,244     $ (2,353 )         -38 %   $  14,283     $  22,271     $ (7,988 )        -36 %
Corporate                 $ (5,624 )   $ (5,578 )   $    (46 )           1 %   $ (18,555 )   $ (19,398 )   $    843           -4 %

Operating Income (Loss)   $ (1,733 )   $    666     $ (2,399 )        -360 %   $  (4,272 )   $   2,873     $ (7,145 )       -249 %

Total product segment operating income, revenue less cost of revenue and marketing and selling expenses, for the third quarter and first nine months of 2009 declined as compared to the comparable prior year periods principally due to lower gross profit as a result of the decline in revenues. Marketing and selling expenses for the three months ended September 30, 2009 declined slightly from the comparable 2008 period but for the nine month period September 30, 2009 increased slightly compared to the prior year period although in both 2009 periods, revenue declined from the comparable prior year period. As a result, in the third quarter and first nine months of 2009, product segment operating income, as a percent of revenue, declined to 17% and 20%, respectively, compared to 26% and 28% respectively in comparable prior year period. Costs and expenses associated with Corporate for the three months ended September 30, 2009 were flat when compared to the prior year period but declined in the nine month period ending September 30, 2009 compared to the prior year period primarily due to lower professional fees and performance based compensation expense.
Other Income (Expense)
In the third quarter and first nine months of 2009, other expense of $0.3 million and $1.0 million, respectively, primarily consists of interest expense associated with our capital lease obligation partially offset by foreign exchange gains. Interest income on our invested cash balances was not significant.
Other expense in the third quarter of 2008 of $0.5 million is principally the result of $0.4 million in interest expense associated with our capital lease obligation and $0.3 million in foreign exchange loss partially offset by interest income on invested cash balances. Other income in the first nine months of 2008 of $0.2 million was primarily the result of the litigation settlement of $1.0 million, interest income and foreign exchange gains of $0.4 million, principally on intercompany debt, which were partially offset by interest expense of $1.2 million.
Income Tax Provision
For the three and nine months ended September 30, 2009, we were not required to provide for Federal taxes but recorded a provision for certain state taxes. For the three and nine months ended September 30, 2008, 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 state taxes. During the three and nine months ended September 30, 2009, certain unrecognized tax positions were effectively settled resulting in the recognition of tax benefits of $152 and $482, respectively. We continue not to recognize any Federal, state or certain foreign tax benefits, which were subject to full valuation allowances in accordance with ASC 740, "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 United States, 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. During the three months ended September 30, 2009, the U.S. Internal Revenue Service ("IRS") examination of our 2003 through 2004 Federal tax returns, the State of New Jersey's examination of our 2003 through 2006 state income tax filings and the French tax authority's audit of the 2006 and 2007 tax filings by our French subsidiary were concluded. The IRS's examination of our 2005 Federal tax return was concluded in the second quarter of 2009.

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The audits resulted in us owing no additional tax, except for a minor amount of taxes payable as a result of the French tax audit, and the aggregate amount of our available Federal and State of New Jersey net operating loss carryforwards ("NOLs") was not materially impacted. Certain Federal research and development credit carryforwards were eliminated. Any remaining minor items disallowed are expected to be deductible in future periods.
The components of our unrecognized tax benefits ("UTBs") are substantially comprised of deferred tax assets which are subject to a full valuation allowance. If we prevail in matters for which either a receivable or a liability for a UTB has been established, are required to pay an amount or utilize NOLs to settle a tax liability, or estimates regarding a UTB change as a result in changes in facts and circumstances, our effective tax rate in a given financial reporting period may be affected.
Due mainly to the settlement of certain prior year unrecognized tax positions, subsequent to December 31, 2008, our gross UTB declined by $2,885 to $787. It is expected that the amount of UTBs will change in the next twelve months due mainly to expiring statutes of limitation; however, we do not anticipate the change, if any, to be significant.