4/1/12 Form 10-K 10-K 1 d263785d10k.htm FORM 10-K Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K ? ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2011 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: 0-31271 RTI BIOLOGICS, INC. (Exact Name of Registrant as Specified in Its Charter) Delaware (State or Other Jurisdiction of Incorporation or Organization) (Address of Principal Executive Offices) (Zip Code) 59-3466543 (I.R.S. Employer Identification No.) 11621 Research Circle, Alachua, Florida 32615 (386) 418-8888 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.001 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ? No ? Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ? No ? 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 ? No ? Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (?232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files.) Yes ? No ? Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ? Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of "accelerated filer", "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer ? Accelerated Filer ? Non-Accelerated Filer ? Smaller Reporting Company ? Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ? No ? The aggregate market value of the Common Stock held by non-affiliates of the registrant, based upon the last sale price of the Common Stock reported on the Nasdaq Stock Market as of the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2011), was approximately $148.5 million. www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 1/77 4/1/12 Form 10-K The number of shares of Common Stock outstanding as of February 8, 2012 was 55,604,945. DOCUMENTS INCORPORATED BY REFERENCE As stated in Part III of this Annual Report on Form 10-K, portions of the registrant's definitive proxy statement for the registrant's 2012 Annual Meeting of Stockholders are incorporated by reference in Part III of this Annual Report on Form 10- K. www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 2/77 4/1/12 Form 10-K Table of Contents RTI BIOLOGICS, INC. FORM 10-K Annual Report Table of Contents Part I Item 1 Page Item 1A Item 1B Item 2 Item 3 Part II Item 5 Item 6 Item 7 Item 7A Item 8 Item 9 Item 9A Item 9B Part III Item 10 Item 11 Item 12 Item 13 Item 14 Part IV Item 15 Business Company Overview Corporate Information Industry Overview Marketing and Distribution The BioCleanse(R) Tissue Sterilization Solution The TUTOPLAST(R) Tissue Sterilization Solution Tissue Recovery Research and Development Intellectual Property Competition Government Regulation Environmental Employees Executive Officers of the Registrant Available Information Risk Factors Unresolved Staff Comments Properties Legal Proceedings Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk Financial Statements and Supplementary Data Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Controls and Procedures Other Information Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions, and Director Independence Principal Accounting Fees and Services Exhibits and Financial Statement Schedules Index to Consolidated Financial Statements 1 1 2 3 4 8 9 9 10 10 11 11 13 13 13 14 14 22 22 22 24 25 27 39 39 40 40 40 41 41 41 41 41 42 43 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 3/77 4/1/12 Form 10-K Table of Contents PART I This Annual Report on Form 10-K and the documents incorporated by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward- looking statements are based on current expectations, estimates and projections about our industry, our management's beliefs and certain assumptions made by our management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," "requires" "hopes," "may," "assumes," variations of such words and similar expressions are intended to identify such forward-looking statements. Do not unduly rely on forward-looking statements. These statements give our expectations about future performance, but are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict? therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Some of the matters described below in the "Risk Factors" section constitute cautionary statements which identify factors regarding these forward-looking statements, including certain risks and uncertainties that could cause actual results to vary materially from the future results indicated in these forward-looking statements. Other factors could also cause actual results to vary materially from the future results indicated in such forward-looking statements. Forward-looking statements speak only as of the date they are made, and unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Item 1. BUSINESS. Company Overview We are a leader in the use of natural tissues and innovative technologies to produce orthopedic and other surgical implants that repair and promote the natural healing of human bone and other human tissues and improve surgical outcomes. We recover and process donated human musculoskeletal and other tissue, including bone, cartilage, tendon, ligament, fascia lata, pericardium, sclera and dermal tissue, and bovine animal tissue in producing allograft and xenograft implants utilizing proprietary BIOCLEANSE(R) and TUTOPLAST(R) sterilization processes, for distribution to hospitals and surgeons. We process at two facilities in Alachua, Florida and one facility in Neunkirchen, Germany and distribute our products and services in all 50 states and in over 30 countries worldwide. We process human and bovine animal tissue and distribute the tissue through various distribution channels. Our lines of business are comprised primarily of five categories: sports medicine, spine, dental, surgical specialties, bone graft substitutes and general orthopedic ("BGS and general orthopedic"). The following table presents revenues from tissue distribution and other revenues and their respective percentages of our revenues for the years ended December 31, 2011, 2010 and 2009: 2011 Year Ended December 31, 2010 (In thousands) 2009 Fees from tissue distribution: Sports medicine Spine Surgical specialties BGS and general orthopedic Dental Other revenues Total revenues Domestic revenues International revenues Total revenues $ 48,122 39,722 30,328 26,291 18,392 6,461 $169,316 28.4% 23.5% 17.9% 15.5% 10.9% 3.8% 100.0% $ 45,065 33,906 26,871 25,413 29,746 5,170 $166,171 27.1% 20.4% 16.2% 15.3% 17.9% 3.1% 100.0% $ 39,533 41,087 26,278 23,161 29,985 4,483 $164,527 24.0% 25.0% 16.0% 14.1% 18.2% 2.7% 100.0% $148,315 87.6% $147,943 89.0% $141,275 85.9% 21,001 12.4% 18,228 11.0% 23,252 14.1% $169,316 100.0% $166,171 100.0% $164,527 100.0% 1 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 4/77 4/1/12 Form 10-K Table of Contents For additional financial information concerning our operating performance, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report and our Consolidated Financial Statements in Part II, Item 8 of this report. We pursue a market-by-market approach to the distribution of our implants, and establish strategic distribution arrangements in order to increase our penetration in selected markets. In the domestic sports medicine and BGS and general orthopedic applications, we have developed a direct distribution organization and a network of independent distributors. We have distribution arrangements with Integra Life Sciences Corporation. ("Integra"), along with Wright Medical Technology, Inc. ("Wright") who distributes certain of our sports medicine implants. For our spine implants we distribute through Medtronic, Inc. ("Medtronic"), Zimmer, Inc. ("Zimmer"), Orthofix International NV ("Orthofix"), Stryker Spine, a division of Stryker Corporation. ("Stryker"), Integra, Alphatec Spine, Inc. ("Alphatec") and Aesculap Implant Systems, Inc. ("Aesculap"). For our surgical specialties markets, we distribute through Davol, Inc., a subsidiary of C. R. Bard, Inc. ("Davol") for hernia repair and breast reconstruction, through Coloplast A/S of Denmark ("Coloplast") for urology, through IOP, Inc. ("IOP") for ophthalmology, through ENTrigue Surgical, Inc. ("ENTrigue") for ENT applications, and through Integra for our bovine pericardium and dural repair applications. For our BGS and general orthopedic implants, we distribute through Zimmer, Exactech, Inc., ("Exactech"), Aesculap, Pioneer Surgical Technology, Inc. ("Pioneer"), Stryker, Medtronic, Orthofix, Wright Medical, and Integra. For our domestic dental implants we distribute exclusively through Zimmer. In the international market we use Zimmer for our dental implants, a direct distribution force in Germany, and a network of independent distributors outside Germany for other implants. As part of the tissue procurement process we rely on tissue recovery agencies to obtain appropriate consent and perform federally-mandated donor screening, such as a medical and social history interview with an authorized person. Upon receipt of the tissue, we conduct pre-processing donor screening to determine its medical suitability for transplantation, including reviewing available medical records and testing of blood collected from each donor by the recovery agency for the presence of viral or bacterial diseases. We also screen tissue at various points during processing, including, for example, mechanical tests. For processing, bone tissue, soft tissue, tendon and ligament grafts are sterilized through our BioCleanse(R) process or TUTOPLAST(R) process only after they have passed prior tissue screening steps. Our BioCleanse(R) process is a patented tissue sterilization process that is designed to add a measure of safety to our tissue implants and provide surgeons and patients with tissue implants that are free of spores, fungi, bacteria and viruses and is the only tissue sterilization process that has been reviewed by the U.S. Food and Drug Administration ("FDA"). The BioCleanse(R) process is an automated, multi-step cleansing process which first removes blood and fats, then chemically sterilizes the tissue, while maintaining the structural integrity and biocompatibility of the tissue, and is applied to bone tissue and tendon and ligament tissue. The TUTOPLAST(R) process utilizes solvent dehydration and chemical inactivation, and is applied to two types of preserved allografts: soft tissue, consisting of fascia lata, fascia temporalis, pericardium, dermis and sclera? and bone tissue? consisting of various configurations of cancellous and cortical bone material. We believe that the BioCleanse(R) and TUTOPLAST(R) processes are the industry leading sterilization processes. We are an accredited member of the American Association of Tissue Banks, or AATB, a nationally recognized association of the tissue banking industry. The accreditation covers the processing, storage and distribution of tissues for transplantation and research and informs users of our human tissue implants that we are in compliance with the minimum safety guidelines of the association. Corporate Information We were incorporated in 1997 in Florida as a wholly-owned subsidiary of the University of Florida Tissue Bank, "UFTB". We began operations on February 12, 1998 when UFTB contributed to us its allograft processing operations, related equipment and technologies, distribution arrangements, research and development activities and certain other assets. At the time of our initial public offering in August 2000, we reincorporated in the State 2 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 5/77 4/1/12 Form 10-K Table of Contents of Delaware. On February 27, 2008, we completed our merger with Tutogen Medical, Inc., a Delaware corporation ("TMI"), in a tax-free stock-for-stock exchange pursuant to which TMI shareholders received 1.22 shares of our common stock for each share of TMI's common stock. In connection with the merger, we changed our name from Regeneration Technologies, Inc. to RTI Biologics, Inc. The results of TMI's operations have been included in our consolidated financial statements since the merger. Our principal offices are located at 11621 Research Circle, Alachua, Florida, and our phone number is (386) 418- 8888. Industry Overview Defects in bone and other human tissue can be caused by a variety of sources including trauma, congenital defect, aging, revision of joint replacements, infectious disease, cancer and other similar conditions. The prevalent method used to repair and promote the healing of defective tissue is surgical intervention, principally through the use of surgical implants. When considering a surgical procedure for tissue repair, surgeons and patients have a number of treatment options including: o o o o metals and synthetics? "xenograft" tissue from an animal source? "autograft" tissue from the patient? and "allograft" tissue from another human donor. Metals and Synthetics Historically, the medical community has used metal and synthetic materials for implant procedures. Metal and synthetic technologies, however, have several shortcomings. One of the principal drawbacks to the use of these materials is that, despite best efforts, they do not facilitate the body's natural tissue healing process known as "remodeling." Metal exhibits different properties than bone, and one concern with its use in orthopedics is "stress shielding," where the bone adjoining the metal can become weak and fragile over time. This problem can be of particular concern to elderly patients who are more likely to suffer from osteoporosis. Additionally, a number of synthetics can wear away in the body, causing a negative immune system response. Other synthetics can chemically break down over time with negative biological and clinical consequences. Using metal and synthetic products may also make it difficult to do a second surgery or revision. Finally, some metal and synthetic products may need to be removed and/or replaced, requiring the risk, expense and inconvenience of a second surgery. Xenograft Tissue Surgical procedures using xenograft tissue-based implants are common in many areas of medicine including cardiac and vascular procedures, soft tissue repair and wound care. Xenograft based products are also used in the repair of bone defects in orthopedic surgery as carriers for demineralized bone matrix and bone morphogenic protein products. The production of xenograft products involves recovering animal tissue, typically from cattle (bovine) or pigs (porcine), processing and sterilization, and then transplanting that recovered tissue into a human patient. Autograft and Allograft Tissue Surgeons are increasingly utilizing autograft and allograft tissue in their surgical procedures to take advantage of their natural healing characteristics. Autograft procedures involve a surgeon harvesting tissue from one part of a patient's body for transplant to another part of the body. In contrast to autograft, allograft tissues are recovered from cadaveric donors, processed for certain intended uses and then transplanted by a surgeon into the patient's body to make the needed repair. 3 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 6/77 4/1/12 Form 10-K Table of Contents Autografts and allografts are not only "osteoconductive," meaning they provide a scaffold for new bone to attach itself to, but, in contrast to metals and some synthetics, can be "osteoinductive" as well, meaning they stimulate the growth of new tissue. A significant drawback to autograft procedures is that they require an additional surgery to harvest the tissue from a second site in the patient's body. Often in autograft procedures, the site where the patient's tissue is harvested becomes painful and uncomfortable, and can take longer to heal than the primary surgical site. Additional complications can involve infection, nerve and arterial injury and joint instability. Moreover, a patient may not have sufficient quantities of quality autograft tissue for transplant procedures. We believe allograft is a superior surgical solution compared to autograft because the procedure involves only the primary surgical site. Marketing and Distribution Our lines of business are comprised primarily of the following markets: sports medicine, spine, surgical specialties, BGS and general orthopedic and dental. Our current implants range from allografts and xenografts that are precision machined for specific surgical applications to grafts conventionally processed for general surgical uses. The following summarizes the marketing and distribution in each of our markets: Market Sports Medicine Estimated US Market Size $2,121 Million Distributor RTI (Direct) Implants Matrix(R) HD Sterling(R) Interference Screws Sterling(R) Wedge Fresh OC--Femoral Condyles, Distal Tibia and Talus Menisci Patellar Tendon (BTB) Series Tibialis Tendons Achilles Tendons Assembled BTB and BTB Select Peroneus Longus Semi-T - Gracilis HTO Wedge Cornerstone(R) SR Series Grafts Cornerstone(R) Reserve Series Grafts Cornerstone(R) Select Series Grafts Cornerstone(TM) Conventional Allografts Tangent(TM) Impacted Cortical Wedge Precision(TM) ALIF MD(TM) Series Threaded Cortical Bone Dowel Puros(R) A Puros(R) S Puros(R) S2 Puros(R) P Puros(R) Conventional Allografts AlloQuent(TM) S AlloQuent(TM) ALIF AlloCraft(TM) C AlloCraft(TM) L CAPISTRANO(TM) Cervical Spacer Cambria ACC Allograft Blocks Self Distracting Bone Spacer CEspace(R) Bone Cortical/Cancellous Laminoplasty Allograft Spacer Spine $1,246 Million Medtronic Zimmer Orthofix Stryker Integra Spine Alphatec Aesculap 4 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 7/77 4/1/12 Form 10-K Table of Contents Market Surgical Specialties Hernia Breast Reconstruction Urology Estimated US Market Size $336 Million $137 Million $38 Million Distributor Davol (Bard) Davol (Bard) Coloplast Implants Allomax(R) Dermis Allomax(R) Dermis Suspend(R) Fascia Lata Axis(R) Dermis Tutoplast(R) Pericardium IO Patch(R) BioDome(R) BioElevation(R) Allograft Dermis Allograft Fascia Lata Allograft Pericardium RegenerENT(TM) Bovine Pericardium Puros(R) DBM CopiOs Cancellous Bone Graft Altiva DBM (Synergent DBM) Regenafil(R) Regenaform(R) Optefil(R) Opteform(R) ProSpace DBM BioSet(TM) BIO DBM Shape(TM) BIO DBM Boat(TM) BIO DBM Putty(TM) Osteofil(R) Cortico-Cancellous Chips Cancello-Pure(R) Wedge ALLOPURE(R) Allograft Wedge BioSet(TM) BioAdapt(TM) Cancellous Chips and Cubes Conventional Fashioned Conventional Intercalary Conventional Other Faslata Puros(R) Blocks Puros(R) Cancellous Chips Puros(R) Cortical Chips Puros(R) Membranes CopiOs(R) Cancellous Chips CopiOs(R) Pericardium Ophthalmology $14 Million IOP ENT $28 Million ENTrigue BGS and general orthopedic $514 Million Zimmer Exactech Aesculap Pioneer Stryker Medtronic OrthoFix Wright Medical Integra Life Sciences RTI (Direct) Dental $245 Million Zimmer Sports Medicine Many repetitive use and sports-related injuries can be addressed with allograft implants. The most prevalent surgeries include repairs to the anterior cruciate ligament, or ACL in the knee, and rotator cuff, in the shoulder. Our principal sports medicine allografts are tendons for ligament reconstruction and our meniscal allografts for transplantation. Many of our sports medicine allografts utilize our patented pre-shape technology and are shaped to fit surgeon's requirements making them easier and/or faster to implant. Our sports medicine implants are marketed domestically through our direct biologics representatives and through our network of independent distributors and internationally through a network of independent distributors. On February 9, 2007, we entered into a Xenograft Distribution and Supply Agreement with Wright. Under this contract, Wright distributes certain allografts, xenografts as well as xenografts designed by Wright which we process and package. This agreement was expanded to include additional designs effective March 9, 2007. 5 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 8/77 4/1/12 Form 10-K Table of Contents During 2007 we enhanced the sports medicine implant and product category by introducing the following new implants and products: BioCleanse Meniscus, Bone-Tendon-Bone Select, BioCleanse Peroneus Longus and Sterling Xenograft Wedge. In May 2008, our first fresh-stored osteochondral (OC) allograft for cartilage repair was successfully implanted. In 2009, we introduced our Matrix HD dermis products for wound repair in addition to our Fresh OC Talus implants, an extension of the fresh osteochondral line. Spine The spine market for allografts includes precision machined implants and bone paste utilized in spinal procedures. Our spine allografts are marketed domestically through our non-exclusive relationships with Medtronic, Orthofix, Zimmer, Stryker, Aesculap, Alphatec and Integra. Medtronic is our principal distributor in the spine market. We originally entered into an Exclusive Distribution and License Agreement with Medtronic, dated June 1, 2002, pursuant to which Medtronic distributed specialty allograft and bone paste for use in spinal surgery. We have amended our agreement with Medtronic several times. Our current agreement with Medtronic expires June 1, 2014. During September 2000, Zimmer began distributing TMI bone implants under a ten-year agreement for applications in the spine market. In April 2003, TMI entered into an exclusive license and distribution agreement with Zimmer. Effective with that agreement, Zimmer became a "stocking distributor". Currently, Zimmer distributes both traditional bone and specialty allografts, and bone paste for use in spinal surgery. Our current spine agreement with Zimmer expires March 8, 2012 and renews automatically for successive one year terms. The contract is expected to be renewed. On November 21, 2006, we entered into an Allograft Distribution and Supply Agreement with Orthofix for an initial term of 3 years with additional one year renewals unless terminated in writing by either party. Under this agreement, we process and package implants designed by Orthofix for distribution by Orthofix. On November 17, 2007, this agreement was expanded to include four additional implant designs. On June 6, 2007, we entered into an Allograft Distribution and Supply Agreement with an initial term of 3 years and one year automatic renewals with Stryker, under which we process and package implants designed by Stryker for distribution by Stryker. The current agreement with Stryker expires June 5, 2012 and renews automatically for successive one year terms. The contract is expected to be renewed. On December 15, 2008, we entered into an Implant Development and Supply Agreement with an initial term of 10 years with Aesculap, under which we agreed to process and package implants designed by Aesculap for distribution by Aesculap. On July 29, 2010, we entered into a Contract Processing and Supply Agreement with an initial term of 3 years with Integra, under which we agreed to process and package implants designed by Integra for distribution by Integra. On March 7, 2011, we entered into a Contract Processing and Supply Agreement with an initial term of 3 years with Alphatec, under which we agreed to process and package implants designed by Alphatec for distribution by Alphatec. Surgical Specialties We distribute implants for surgical specialties which include hernia, breast reconstruction, urology, ophthalmology, and ENT. In January 2006, TMI entered into a four-year exclusive worldwide distribution agreement with Davol Inc., a subsidiary of C.R. Bard, Inc. ("Davol"), to promote, market and distribute TMI's line of allograft biologic tissues for hernia repair and the reconstruction of the chest and abdominal walls. Under the agreement, Davol 6 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 9/77 4/1/12 Form 10-K Table of Contents paid TMI $3.3 million in fees for the exclusive distribution rights. On July 13, 2009, we and Davol amended their January 2006 distribution agreement with TMI. Under the amended agreement, 1) Davol paid us $8.0 million in non-refundable fees for exclusive distribution rights for the distribution to the breast reconstruction market until July 13, 2019, 2) the exclusive worldwide distribution agreement related to the hernia market was extended to July 13, 2019, and 3) Davol agreed to pay us certain additional exclusive distribution rights fees contingent upon the achievement of certain revenue milestones by Davol during the duration of the contract. In the fourth quarter of 2010, Davol paid us the first revenue milestone payment of $3.5 million. The $8.0 million and $3.5 million exclusivity payments have been deferred and are being recognized as other revenue on a straight-line basis over the initial term of the amended contract of ten years, and the remaining term of the amended contract, respectively. The straight-line method approximates the expected pattern of product distribution based on the distribution agreement's annual minimum purchase requirements. In May 2007, TMI signed an agreement with Coloplast extending its then current distribution agreement and expanding its scope both internationally, and to include TMI's Tutoplast(R) processed bovine pericardium. As a stocking distributor, Coloplast markets TUTOPLAST(R) fascia lata, dermis, and pericardium tissue grafts. This agreement was renewed for a period of 3 years effective December 1, 2011. IOP has been a distributor of TMI's since 1998, and is the exclusive distributor for TUTOPLAST(R) processed tissue for ophthalmic applications. Our current distribution agreement with IOP expires on December 15, 2015 and renews automatically for three consecutive one year terms. In December 2008, we entered into a biologics development, distribution and supply agreement with ENTrigue to develop, promote, distribute and supply our line of allograft biologic tissues for the ear, nose and throat market. This agreement has an initial term of six years with automatic three year renewals unless terminated in writing by either party. Initial shipments of implants to ENTrigue began in 2009. On April 11, 2011, we entered into a Distribution and Supply Agreement with an initial term of 5 years with Integra, under which we agreed to process and package bovine pericardium and dural repair applications for distribution by Integra. We do not have regulatory clearance for this product. The product will be made available to Integra once regulatory clearance has been completed. BGS and general orthopedic Allograft Paste. Surgeons principally use our allograft paste implants, which are composed of demineralized bone matrix ("DBM") and in some cases a biologic gel carrier, in fracture treatment, bone and joint reconstruction and periodontal applications, such as ridge augmentation for dental implants. Our allograft paste implants are marketed under Osteofil(R) by Medtronic, Puros(R) DBM by Zimmer and the Optefil(TM), Opteform(R), Regenafil(R) and Regenaform(R) brands with Exactech and we distribute directly the BioSet(TM) and BioAdapt(TM) families of paste implants through our direct distributor force, Pioneer, and our international distribution network. Our DBM Boat implants are marketed under BIO DBM by Stryker. In 2007, we entered into an exclusive distribution agreement with Zimmer with an initial term of 10 years, relating to new bone paste implants. The field of use for these implants includes all orthopedic, trauma, reconstruction, spine, sports medicine, dental and oral maxillofacial applications. As part of the agreement, Zimmer has made payments to us totaling $5.0 million for the aforementioned exclusive distribution rights, and has to maintain certain minimum order volumes through the duration of the contract. The $5.0 million exclusivity payment is being recognized as other revenue on a straight-line basis over the initial term of the contract. The contract provides for repayment, on a pro rata basis, of the exclusivity payments during the initial contract term for specific events of non-performance, as defined in the agreement. The agreement also includes automatic two-year renewal terms, as well as buy-out provisions by both parties upon proper notice of cancellation. Milled Allograft and Xenograft. Our bone graft substitutes business also includes certain types of blended and milled bone allografts and xenografts, such as our demineralized bone matrix, cortical cancellous chips and ground cancellous chips, used in total hip and knee replacements and for various injuries. 7 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 10/77 4/1/12 Form 10-K Table of Contents Conventional Allografts. Our conventional allograft business includes a wide variety of allograft categories including our intercalary grafts, such as our frozen femoral heads which are used for cancer treatment procedures and hip and knee reconstruction. We also produce various types of fashioned bone, such as strips and shafts used for various orthopedic procedures. On July 1, 2011, we entered into a Distribution and Supply Agreement with an initial term of 5 years with Integra, under which we agreed to process and package allograft wedge implants for distribution by Integra. Dental We currently provide various implants including cancellous and cortical bone and human and bovine membranes primarily for dental procedures related to augmenting ridge restoration. During September 2000, Zimmer entered into a ten-year agreement to represent TUTOPLAST(R) processed bone, under the brand name Puros(R), for dental applications. Zimmer marketed the implants to the end user and in the United States we shipped and billed the customer directly. Distribution fees earned pursuant to the agreement were recognized ratably over the term of the agreement. During 2006, TMI expanded its relationship with Zimmer by adding pericardium and dermis soft tissue implants for dental applications. The additions of these implants provided Zimmer with a full line of biologic implants for the dental surgeons. In August 2007, TMI entered into an agreement to extend Zimmer's exclusivity internationally into Europe, the Middle East and Asia. The international agreement included both human and bovine bone and soft tissue implants and allowed Zimmer to provide the dentist with a complete offering of implants for the regenerative procedure. On September 3, 2010, we entered into a new exclusive distribution agreement (the "Agreement"), with Zimmer Dental Inc. ("Zimmer"), a subsidiary of Zimmer, Inc., with an effective date of September 30, 2010. The Agreement has an initial term of ten years. Under the terms of the Agreement, we have agreed to supply sterilized allograft and xenograft implants (the "Implants") at an agreed upon transfer price, and Zimmer has agreed to be the exclusive distributor of the Implants for dental and oral applications worldwide (except the Ukraine), subject to certain Company obligations under an existing distribution agreement with a third party with respect to certain implants for the dental market. In consideration for Zimmer's exclusive distribution rights, Zimmer agreed to the following: 1) payment to us of $13.0 million within ten days of the effective date (the "Upfront Payment"), 2) annual exclusivity fees ("Annual Exclusivity Fees") paid annually for the term of the contract to be paid at the beginning of each calendar year, and, 3) escalating annual order minimums to maintain exclusivity. Upon occurrence of an event that materially and adversely affects Zimmer's ability to distribute the Implants, Zimmer may be entitled to certain refund rights with respect to the Upfront Payment and the then current Annual Exclusivity Fee, where such refund would be in an amount limited by a formula specified in the Agreement that is based substantially on the number of days from the occurrence of such event to the date that it is cured by us to the satisfaction of Zimmer. The Upfront Payment and the Annual Exclusivity Fees are deferred as received and are being recognized as other revenues based on the expected contractual escalating annual purchase minimums relative to the total contractual minimum purchase requirements in the Agreement. Additionally, we have considered the potential impact of the Agreement's contractual refund provisions and we do not expect these provisions to impact future expected revenue related to the Agreement. The BioCleanse(R) Tissue Sterilization Solution We have developed and utilized in the United States the patented BioCleanse(R) tissue sterilization process, which is an automated, pharmaceutical grade chemical sterilization process for musculoskeletal bone and certain soft tissue. This process is fully validated to kill or inactivate all classes of conventional pathogens, viruses, microbes, bacteria and fungi. Our BioCleanse(R) process is able to remove greater than 99% of the blood, fats, lipids and other unwanted materials from the tissue we process. An important element of the BioCleanse(R) process is that while it removes unwanted materials embedded within the tissue, it maintains the tissue's structural integrity and compression strength. Studies have shown that tissue sterilized with BioCleanse(R) maintains the same compression strength as untreated tissue and has significantly greater compression strength than tissue treated with other sterilization processes. 8 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 11/77 4/1/12 Form 10-K Table of Contents The BioCleanse(R) process has been reviewed by the FDA which concluded that BioCleanse(R) was a validated tissue sterilization process demonstrated to prevent contamination and cross contamination of tissue grafts. The significance of the review is that we are not aware of any other tissue sterilization process related to human tissue in our industry that has been reviewed or approved by the FDA. The FDA does not have a formal approval process in place for tissue related processing techniques. Our BioCleanse(R) process is currently used on most of our bone allografts and most of our musculoskeletal soft tissue implants. In addition to the safety advantage of BioCleanse(R), it provides us with a number of significant research and development opportunities, including the ability to introduce bone-growth factors and anti-bacterial, anti-viral and cancer fighting agents into our implants. The TUTOPLAST(R) Tissue Sterilization Solution The TUTOPLAST(R) tissue sterilization process utilizes solvent dehydration and chemical inactivation to remove blood, lipids and extraneous materials, inactivate viruses and prions, and break down RNA and DNA into fragments not capable of replication and disease transmission while preserving the biological and mechanical properties. We apply the TUTOPLAST(R) process to two types of preserved allografts: soft tissue, consisting of fascia lata, fascia temporalis, pericardium, dermis and sclera? and bone tissue? consisting of various configurations of cancellous and cortical bone material. Processed pericardium, fascia lata and dermis are collagenous tissue used to repair, replace or line native connective tissue primarily in dental, ophthalmology, urology, plastic and reconstructive surgeries. Dermis is also used in hernia repair and pelvic floor reconstruction. Sclera is used in ophthalmology procedures such as anterior and posterior segment patch grafting applications for glaucoma, retina and trauma surgery and oculoplastics, as well as contour wrapping of an orbital implant. Processed cortical and cancellous bone material is used in a wide variety of applications in spine, orthopedic and dental surgeries. Tissue Recovery Tissue recovery is the actual removal of tissue from a donor after receiving appropriate consent. Consent is obtained by the tissue recovery group. We operate certain tissue recovery groups directly, and contract with other independent FDA registered tissue recovery groups which specialize in this activity. Tissue recovery personnel aseptically recover musculoskeletal tissue within 24 hours following a donor's death, using surgical instruments and sterile techniques similar to those used in hospitals for routine surgery. Recovered tissue is placed on wet or dry ice and then transported by the donor recovery agency to the tissue processor or possibly a research institution. Under U.S. law, human tissue cannot be sold. However, the law permits the recovery of reasonable payments for the provision of certain services, such as those involved in recovering, processing and storing tissue and related to the advancement of tissue processing technologies, all types of activities in which we are involved. Donor recovery groups recover a variety of tissue types from donors including the fibula, femur, tibia, humerus, ilium, pericardium, fascia lata, dermis, sclera, tendons and ligaments. In addition to tissue received from recovery groups we control, we also receive donated tissue from independently registered tissue recovery organizations. To make an initial determination as to whether tissues may be appropriately recovered, these independent tissue recovery organizations are responsible for obtaining appropriate consents and conducting federally-mandated donor screening, such as a medical and social history interview with the next of kin. Upon receipt of the tissue, we conduct pre-processing donor screening to determine its medical suitability for transplantation. Pre-processing screening performed by us includes laboratory testing and a donor eligibility assessment. With respect to laboratory testing, we perform an extensive panel of serological and microbiological tests. These results are subject to stringent criteria in order to release the donor tissue to the processing stage. 9 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 12/77 4/1/12 Form 10-K Table of Contents We have relationships with over thirty tissue donor recovery agencies across the country. We also have relationships outside the United States. Our largest single donor recovery group represented 13% of our total donor tissue for the year ended December 31, 2011. We believe additional recovery group relationships would be available if needed and consequently that the loss of any one of our sources of donor tissue would not have a material impact on our operating results. We continue to develop new xenograft tissue implants. Implants processed from xenograft tissue are regulated by the FDA as devices and require approval or licenses from the FDA prior to marketing in the United States. The sources of our animal tissues are regulated closed herds. The herds are located in the United States and Australia. We believe the continued development of our xenograft implants will help us meet unmet demand for certain allografts and also allow us to develop new biological implants that cannot currently be made due to structural limitations of human tissue. Research and Development Our research and development costs for the years ended December 31, 2011, 2010 and 2009 were $9,806, $9,435 and $8,899, respectively. In 2011, we continued to increase our investment in our R&D efforts by funding new projects including research and development projects at our facility in Neunkirchen, Germany. Our scientists are focusing their studies on delivering optimal regenerative medicine solutions through allograft and xenograft, as well as expanding the uses of the BioCleanse(R) and Tutoplast processing technologies. We plan to continue to develop new implants and technologies within our current market, and to develop additional tissue-related technologies for other markets. We plan to do this by building on our core technology platforms: BioCleanse(R), TUTOPLAST(R), precision machining, assembled grafts, and tissue and mediated osteoinduction, We operate a dedicated research team working on advanced technologies, and have embedded development/technical teams who work with the business/marketing teams focused on expanding the scope and scale of existing competencies such as tissue sterilization and tissue machining to meet specific surgical needs. This approach has resulted in the development of core science platforms, a pipeline of concepts for development and marketing and focused development to meet immediate needs. In 2011 we launched 19 new implants in sports medicine, spine, surgical specialties and BGS and general orthopedic developed by our research and development teams. Intellectual Property Our business depends upon the significant know-how and proprietary technology we have developed. To protect this know-how and proprietary technology, we rely on a combination of trade secret laws, patents, licenses, trademarks and confidentiality agreements. The effect of these intellectual property rights is to define zones of exclusive use of the covered intellectual property. Our United States patent holdings include patents relating to or covering: BioCleanse(R), our proprietary method of cleaning, sterilizing and virally inactivating donor tissue? our MD-Series(TM) cortical bone dowel? soft and calcified tissue implants? certain precision machined allograft intervertebral spacers and other spinal implants? matrix compositions comprised of gelatin, musculoskeletal tissue or pulverized dermis? the use of the interference screw technology? our segmentally demineralized graft? methods and instruments for improved meniscus transplantation? materials and methods for improved bone- tendon-bone transplantation? and various assembled bone-tendon-bone implant designs. Our foreign patent holdings include: our MD-Series(TM) cortical bone dowel technology, our precision machined spinal implants, pre-shaped bone-tendon-bone implants, and our BioCleanse(R) process. The duration of patent rights generally is 20 years from the date of filing of priority application, while trademarks, once registered, are essentially perpetual. We also have patent applications pending in the U.S. (including continuation and divisional applications), and corresponding foreign patent applications pending in various countries including, but not limited to, Canada, Japan, Australia and the 10 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 13/77 4/1/12 Form 10-K Table of Contents European Union. We have also entered into exclusive and non-exclusive licenses relating to a wide array of third-party technologies. In addition, we rely on our substantial body of know-how, including proprietary tissue recovery techniques and processes, research and development, tissue processing and quality assurance. The TUTOPLAST(R) process utilizes proprietary trade secrets. No significant patents are expected to expire in the next five years. Competition Competition in the tissue reconstruction and healing industry is intense and subject to rapid technological change and evolving industry requirements and standards. Companies within the industry compete on the basis of design of related instrumentation, efficacy of products, relationships with the surgical community, depth of range of implants, scientific and clinical results, and pricing. Our allograft and xenograft implants compete with autograft, metals and synthetic tissues. Our principal competitors in the conventional allograft market include the Musculoskeletal Transplant Foundation, or MTF, AlloSource, LifeCell, Inc., a subsidiary of Kinetic Concepts Inc. and LifeNet. Among our competitors in precision machined allograft are MTF, LifeNet and AlloSource. Other companies who process and distribute allograft pastes include Medtronic, AlloSource, Integra, Wright, and MTF. Companies who process and distribute xenograft tissue include Synovis, LifeCell, Cook Surgical and Medtronic. Government Regulation Government regulation plays a significant role in the processing and distribution of allografts. We procure, process and market our tissue implants worldwide. Although some standards of harmonization exist, each country in which we do business has its own specific regulatory requirements. These requirements are dynamic in nature and, as such, are continually changing. New regulations may be promulgated at any time and with limited notice. While we believe that we are in compliance with all existing pertinent international and domestic laws and regulations, there can be no assurance that changes in governmental administrations and regulations will not adversely affect our operations. Failure to comply with applicable requirements could result in fines, injunctions, civil penalties, recall or seizure of products, suspension of production, inability to market current products, criminal prosecution, and/or refusal of the government to authorize the marketing of new products. In the United States, our allograft implants are regulated by the FDA under Title 21 of the Code of Federal Regulations, Parts 1270 and 1271, "Current Good Tissue Practice for Human Cell, Tissue, and Cellular and Tissue-Based Products" (cGTP). Xenograft tissues and allograft bone paste are regulated as medical devices and subject to FDA 21 CFR, Part 820. Current Good Manufacturing Practices for Medical Devices and related statutes from the FDA. In addition, our U.S. operation is subject to certain state and local regulations, as well as compliance to the standards of the tissue bank industry's accrediting organization, the AATB. In Germany, allografts are classified as drugs and the German government regulates such implants in accordance with German Drug Law. On April 7, 2004, the European Commission issued a human tissue directive to regulate allografts within the European Union ("EU"). Our Neunkirchen facility is presently licensed by the German Health Authorities and in compliance with applicable international laws and regulations, allowing us to market our human and animal implants globally. The FDA and international regulatory bodies conduct periodic compliance inspections of both our U.S. and our German processing facilities. Both operations are registered with the U.S. FDA Center for Biologics Evaluation and Research ("CBER") and are certified to ISO 13485:2003. The Alachua facility is also accredited by the AATB and is licensed in the states of Florida, New York, California, Maryland, Delaware and Illinois. The Neunkirchen facility is registered with the German Health Authority ("BfArM") as a pharmaceutical and 11 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 14/77 4/1/12 Form 10-K Table of Contents medical device manufacturer and is subject to German drug law. We believe that worldwide regulation of allografts and xenografts is likely to intensify as the international regulatory community focuses on the growing demand for these implants and the attendant safety and efficacy issues of citizen recipients. We currently market and distribute allografts that are subject to the FDA's "Human Tissue Intended for Transplantation" and "Human Cells, Tissues, and Cellular and Tissue-Based Products" regulations. Under these regulations, we are required to perform donor screening and infectious disease testing and to document this screening and testing for each donor from whom we process tissue, and to process tissues in compliance with cGTP. The FDA has authority under the rules to inspect human tissue processing facilities, and to detain, recall, or destroy tissues for which appropriate documentation and evidence of compliance is not available. We are not required to obtain pre-market approval or clearance from the FDA for allografts that meet the regulation's definition of "human tissue." The FDA may regulate certain allografts as medical devices, drugs, or biologics, which would require that we obtain approval or product licensure from the FDA. This would occur in those cases where the allograft is deemed to have been "more than minimally manipulated or indicated for non-homologous use." In general, "homologous use" occurs when tissue is used for the same basic function that it fulfilled in the donor. The definitional criteria for making these determinations appear in the FDA's rules. If the FDA decides that certain of our current or future allografts are more than minimally manipulated or indicated for non-homologous use, it would require licensure, approval or clearances of those allografts. Allografts requiring such approval are subject to pervasive and continuing regulation by the FDA. We would be required to list these allografts as a drug, as a medical device, or as a biologic, and to manufacture them in specifically registered or licensed facilities in accordance with FDA regulation "Current Good Manufacturing Practices." We would also be subject to post-marketing surveillance and reporting requirements. In addition, our manufacturing facilities and processes would be subject to periodic inspection to assess compliance with Current Good Manufacturing Practices. Our labeling and promotional activities would be subject to scrutiny by the FDA and, in certain instances, by the Federal Trade Commission. The export of drugs, devices and biologics is also subject to more intensive regulation than is the case for human tissue products. Certain of our allograft pastes are subject to regulation as medical devices under the 510(k) pre-market notification process because they incorporate a non-human gelatin constituent as a carrier. We have received FDA clearance for our flowable and moldable allograft paste implants for orthopedic and spinal applications and for our allograft bone paste for dental applications. Our xenograft implants are regulated by the FDA as medical devices and are subject to pre-market approval or clearance by the FDA. Our xenograft implants are CE-marked and are therefore subject to a design examination review by a Notified Body. In 2006, the RTI US facility received initial CE mark approval for ten different implant models, followed by additional implant approvals in subsequent years. In 2009, the TMI facility received initial CE mark approval for nine different product models. In addition, the US facility received A "Certificate of Suitability" from the European Directorate for the Quality of Medicines & HealthCare (EDQM) for bovine bone in 2008. This certifies that the bovine bone material complies with the European Pharmacopoeia monograph for products at risk for transmission of animal spongiform disease. The FDA requires tissue processors to register with the Agency and list their tissue implants. We are currently an FDA registered tissue processor. Our tissue processing generates by-products classified as medical hazardous waste by the U.S. Environmental Protection Agency and the Florida Department of Environmental Protection. All such by-products must be segregated and properly disposed of in compliance with applicable environmental regulations. We believe that we are in compliance with the applicable regulations. 12 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 15/77 4/1/12 Form 10-K Table of Contents Environmental Our allografts and xenografts, as well as the chemicals used in processing, are handled and disposed of in accordance with country-specific, federal, state and local regulations. We contract with independent, third parties to perform all gamma- terminal sterilization of our allografts. In view of the engagement of a third party to perform irradiation services, the requirements for compliance with radiation hazardous waste does not apply, and therefore we do not anticipate that having any material adverse effect upon our capital expenditures, results of operations or financial condition. However, we are responsible for assuring that the service is being performed in accordance with applicable regulations. Employees As of December 31, 2011, we had a total of 706 employees of whom 160 were employed in Germany and of whom 3 were employed in France. Management believes its relations with its employees are good. Executive Officers of the Registrant Our executive officers and their respective ages and positions as of the date of this report and their previous business experience are as follows: NAME AGE POSITION WITH THE COMPANY Brian K. Hutchison Robert P. Jordheim Thomas F. Rose Roger W. Rose Caroline A. Hartill 52 48 61 52 55 President and Chief Executive Officer Executive Vice President and Chief Financial Officer Executive Vice President, Chief Operations Officer and Secretary President, RTI Donor Services, Executive Vice President and Chief Commercial Officer Executive Vice President and Chief Scientific Officer Brian K. Hutchison was named President and Chief Executive Officer for RTI Biologics in December 2011. On May 10, 2011, Mr. Hutchison stepped down as Chairman while continuing to serve as Chief Executive Officer and a member of our board of directors. He joined RTI in December 2001 as President and Chief Executive Officer and was elected chairman of the board of directors in December 2002. In his role at RTI, Hutchison oversees all aspects of the company and its affiliates. Hutchison spent the previous 12 years with Stryker Corporation, based in Kalamazoo, MI. He served most recently as vice president, worldwide product development and distribution. A native of Muskegon, MI, Hutchison earned a bachelor's degree in business administration from Grand Valley State University in 1981. He also completed the Program for Management Development from Harvard Business School in 1995. Robert P. Jordheim joined RTI in June, 2010 as Executive Vice President and Chief Financial Officer, and oversees all aspects of finance for the company. Jordheim has 24 years of progressive corporate finance experience, including 17 years with Medtronic, Inc. Most recently, he served as vice president, finance and business development for Medtronic's Spinal and Biologics business unit. Previously, he served as vice president, finance for Medtronic's Surgical Technologies business unit. His tenure with Medtronic also included responsibilities in corporate development and international experience gained through a five-year assignment in Europe. Previous to his tenure at Medtronic, Jordheim served as manager of external reporting at The Fairchild Corporation and an auditor for Deloitte & Touche LLP. Jordheim earned a bachelor's degree in business administration from Southern Methodist University and a master's degree in business administration from the University of Pittsburgh with a concentration in finance. Thomas F. Rose was named Executive Vice President and Chief Operations Officer in June, 2010. He also serves as corporate secretary to the board of directors. Rose joined RTI as vice president and Chief Financial Officer in May 2002. Rose served the previous 10 years as vice president and chief financial officer at A.M. 13 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 16/77 4/1/12 Form 10-K Table of Contents Todd Group, based in Kalamazoo, MI. Rose earned a bachelor's degree in business administration from Western Michigan University. He has also completed numerous executive education courses at University of Michigan and Northwestern University focusing on strategy and organizational issues. Roger W. Rose was named Executive Vice President and Chief Commercial Officer in June, 2010. In February 2008, he was named president of RTI Donor Services, and, in August 2004, he was named executive vice president of RTI. Rose oversees all aspects of the organization's not-for-profit affiliate, RTI Donor Services, marketing, and the distribution of donated tissue back into the community. He is committed to ensuring a meaningful connection between the donation and transplantation communities. Rose joined RTI as vice president of donor services in October 2002 and assumed additional responsibility for distribution and marketing in October 2003. Prior to this, Rose spent seven years at Stryker Corporation based in Kalamazoo, Mich., where he held leadership positions in sales and marketing in both the medical and orthopedic divisions. Rose earned a bachelor's degree in business administration from Western Michigan University and completed numerous executive education courses at UCLA, University of Michigan and Harvard Business School, focusing on finance, leadership, medical marketing, negotiation and strategy. Caroline A. Hartill was named Executive Vice President and Chief Scientific Officer in June, 2010. She was named Chief Scientific Officer in March 2007. She joined RTI in November 2001 and was named vice president of quality assurance and regulatory affairs in January 2003. In her role at RTI, Hartill oversees all scientific research, quality assurance, regulatory affairs and clinical studies. She has served as a board member for BioFlorida and is a member of the Advanced Medical Technology Association (AdvaMed). She also serves on the Accreditation Committee and the Strategic Planning Task Force of the American Association of Tissue Banks (AATB). For the previous 18 years, she worked in the areas of technology development and market approvals as a consultant working with many major and start-up biotechnology and medical device companies worldwide. Hartill earned a bachelor's degree with honors in health sciences from Birmingham University Medical School in England, as well as a master's degree in management from the University of Wolverhampton in England. Hartill has also earned master's level credits in sterilization science from Manchester University. Available Information Our Internet address is www.rtix.com. Information included on our website is not incorporated by reference in our Form 10-K. We make available, free of charge, on or through the investor relations portion of our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable after we file such material with, or furnish it to the Securities and Exchange Commission ("SEC"). These filings are also available on the SEC's website at www.sec.gov. Also available on our website is our Code of Conduct, our Code of Ethics for Senior Financial Professionals, and the charters for our Audit Committee, Compensation Committee and Nominating and Governance Committee. Within the time period required by the SEC and Nasdaq, we will post any amendment to our Code of Ethics for our Senior Financial Professionals and any waiver of our Code of Conduct applicable to our senior financial professionals, executive officers and directors. Item 1A. RISK FACTORS An investment in our common stock involves a high degree of risk. You should consider each of the risks and uncertainties described in this section and all of the other information in this document before deciding to invest in our common stock. Any of the risk factors we describe below could severely harm our business, financial condition and results of operations. The market price of our common stock could decline if any of these risks or uncertainties develops into actual events. You may lose all or part of the money you pay to buy our common stock. We depend heavily upon sources of human tissue, and any failure to obtain tissue from these sources in a timely manner will interfere with our ability to process and distribute allografts. 14 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 17/77 4/1/12 Form 10-K Table of Contents The supply of human tissue has at times limited our growth, and may not be sufficient to meet our future needs. In addition, due to seasonal changes in mortality rates, some scarce tissues that we currently use for allografts are at times in particularly short supply. Other factors, some of which are unpredictable, such as negative publicity and regulatory actions in the industry in which we operate also could unexpectedly reduce the available supply of tissue. We rely on donor recovery groups for their human tissue supplies and we have relationships with over thirty tissue donor recovery agencies across the country. We also have relationships outside the United States. Donor recovery groups are part of relatively complex relationships. They provide support to donor families, are regulated by the FDA, and are often affiliated with hospitals, universities or organ procurement organizations. Our relationships with donor recovery groups, which are critical to our supply of tissue, could be affected by relationships recovery groups have with other organizations. Any negative impact of the regulatory and disease transmission issues facing the industry, as well as the negative publicity that these issues create, could adversely affect our ability to negotiate contracts with recovery groups. We cannot be sure that the supply of human tissue will continue to be available at current levels or will be sufficient to meet our needs. If we are not able to obtain tissue from current sources sufficient to meet our needs, we may not be able to locate additional replacement sources of tissue on commercially reasonable terms, if at all. Any interruption of our business caused by the need to locate additional sources of tissue would significantly impact our revenues. We expect that our revenues would decline in proportion to any decline in tissue supply. If we fail to maintain existing strategic relationships or are unable to identify distributors of our implants, revenues may decrease. We currently derive the majority of our revenues through our relationships with Medtronic, Zimmer, Davol, Stryker and Exactech. In addition, our spine partners provide nearly all of the instrumentation, surgeon training, distribution assistance and marketing materials for the lines of spinal allografts they distribute. Variations in the timing and volume of orders by Medtronic and Zimmer may have a material effect upon our revenues. If our relationships with Medtronic or Zimmer are terminated or reduced for any reason and we are unable to replace these relationships with other means of distribution, we would suffer a material decrease in revenues. We may need to obtain the assistance of additional distributors to market and distribute our new allografts and technologies, as well as to market and distribute our existing allografts and technologies to new markets or geographical areas. We may not be able to find additional distributors who will agree to and successfully market and distribute our allografts and technologies on commercially reasonable terms, if at all. If we are unable to establish additional distribution relationships on favorable terms, our revenues may decline. If adverse macro-economic conditions persist, our business and revenues could be adversely affected. We have been adversely affected by the current macro-economic conditions. If this slowdown continues or worsens, it could have a material adverse effect upon our business and future revenues. If third-party payors fail to provide appropriate levels of reimbursement for the use of our implants, revenues could be adversely affected. Political, economic and regulatory influences are subjecting the healthcare industry in the United States to fundamental change. In March 2010, President Obama signed the Affordable Care Act into law. The new law will result in sweeping changes across the health care industry. The primary goal of this comprehensive legislation is to extend health coverage to approximately 32 million uninsured legal U.S. residents through a combination of public program expansion and private sector health insurance reforms. To fund the expansion of 15 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 18/77 4/1/12 Form 10-K Table of Contents insurance coverage, the legislation contains measures designed to promote quality and cost efficiency in health care delivery and to generate budgetary savings in the Medicare and Medicaid programs. We are unable to predict the full impact of the Affordable Care Act at this time due to the law's complexity and current lack of implementing regulations or interpretive guidance. However, we expect that several provisions of the Affordable Care Act could have a material effect on our business. Our revenues will largely depend on the reimbursement of patients' medical expenses by government health care programs and private health insurers. Governments and private insurers closely examine medical procedures incorporating new technologies to determine whether the procedures will be covered by payment, and if so, the level of payment which may apply. We cannot be sure that third-party payors will continue to reimburse for our implants at the current levels. If we fail to maintain the high processing standards that implants require or if we are unable to develop processing capacity as required, our commercial opportunity will be reduced or eliminated. Implants require careful calibration and precise, high-quality processing. Achieving precision and quality control will require skill and diligence by our personnel. If we fail to achieve and maintain these high processing standards, including avoiding processing errors, and, depending on the nature of the complaint, design defects or component failures? we would be forced to recall, withdraw or suspend distribution of our implants? our implants and technologies could fail quality assurance and performance tests? production and deliveries of our implants could be delayed or cancelled? and our processing costs could increase. Further, to be successful, we will need to manage our human tissue processing capacity related to tissue recovery and demand for our allografts. It may be difficult for us to match our processing capacity to demand due to problems related to the amount of suitable tissue, quality control and assurance, tissue availability, adequacy of control policies and procedures, and lack of skilled personnel. If we are unable to process and produce our implants on a timely basis, at acceptable quality and costs, and in sufficient quantities, or if we experience unanticipated technological problems or delays in processing, it will reduce revenues and increase our cost per allograft processed. Our allograft and xenograft implants and technologies could become subject to significantly greater regulation which could disrupt our business. The FDA and several states have statutory authority to regulate allograft processing, including our BioCleanse(R) and TUTOPLAST(R) processes, and allograft-based materials. The FDA could identify deficiencies in future inspections of our facilities or our suppliers or promulgate future regulatory rulings that could disrupt our business, reducing profitability. If any of our allografts fall under the FDA's definitions of "more than minimally manipulated or indicated for non- homologous use," we would be required to obtain medical device approval or clearance or biologics licenses, which could require clinical testing and could result in disapproval of our license applications and restricted distribution of any of our allografts which may become subject to pre-market approval. The FDA could require post-market testing and surveillance to monitor the effects of such allografts, could restrict the commercial applications of these allografts, and could conduct periodic inspections of our facilities and our suppliers. Delays encountered during the FDA approval process could shorten the patent protection period during which we have the exclusive right to commercialize such technologies or could allow others to come to market before us with similar technologies. FDA regulations of human cellular and tissue-based products, titled "Good Tissue Practices," cover all stages of allograft processing, from procurement of tissue to distribution of final allografts. These regulations increased regulatory scrutiny within the industry in which we operate and have led to increased enforcement action which affects the conduct of our business. In addition, these regulations have a significant effect upon 16 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 19/77 4/1/12 Form 10-K Table of Contents recovery agencies which supply us with tissue and increase the cost of recovery activities. Any such increase would translate into increased costs, as we would expect to reimburse the recovery agencies based on their cost of recovery. Other regulatory entities include state agencies with statutes covering tissue banking. Regulations issued by Florida, New York, California and Maryland will be particularly relevant to our business. Most states do not currently have tissue banking regulations, but this status could change. It is possible that others may make allegations against us or against donor recovery groups or tissue banks, including those with which we have relationships, about non-compliance with applicable FDA regulations or other relevant statutes and regulations. Allegations like these could cause regulators or other authorities to take investigative or other action, or could cause negative publicity for our business and the industry in which we operate. Some of our implants contain tissue derived from animals, commonly referred to as xenografts. Xenograft implants are medical devices that are subject to pre-market approval or clearance by the FDA. We have received FDA clearance on several xenograft implants. However, we may not receive FDA approval or clearance to market new implants as we attempt to expand the quantity of xenograft implants available for distribution. The allograft industry is subject to additional local, state, federal and international government regulations and any increased regulations of our activities could significantly increase the cost of doing business, thereby reducing profitability. Some aspects of our business are subject to additional local, state, federal or international regulation. Changes in the laws or new interpretations of existing laws could negatively affect our business, revenues or prospects, and increase the costs associated with conducting our business. In particular, the procurement and transplantation of allograft tissue is subject to federal regulation under the National Organ Transplant Act, or NOTA, a criminal statute that prohibits the purchase and sale of human organs, including bone and other tissue. NOTA permits the payment of reasonable fees associated with the transportation, processing, preservation, quality control and storage of human tissue. If NOTA were amended or interpreted in a way that made us unable to include some of these costs in the amounts we charge our customers, it could reduce our revenues and therefore negatively impact our business. It is possible that more restrictive interpretations or expansions of NOTA could be adopted which could require us to change one or more aspects of our business, at a substantial cost, in order to continue to comply with this statute. A variety of additional local, state, federal and international government laws and regulations govern our business, including those relating to the storage, handling, generation, manufacture, disposal of medical wastes from the processing of tissue, and collaborations with health care professionals. If we fail to conduct our business in compliance with these laws and regulations, we could be subject to significant liabilities for which our insurance may not be adequate. Moreover, such insurance may not always be available in the future on commercially reasonable terms, if at all. If our insurance proves to be inadequate to pay a damage award, we may not have sufficient funds to do so, which would harm our financial condition and liquidity. Our success depends on the continued acceptance of our allograft and xenograft implants and technologies by the medical community. New allograft and xenograft implants, technologies or enhancements to our existing implants may never achieve broad market acceptance, which can be affected by numerous factors, including lack of clinical acceptance of implants and technologies? introduction of competitive tissue repair treatment options which render implants and technologies too expensive or obsolete? lack of availability of third-party reimbursement? and difficulty training surgeons in the use of tissue implants and technologies. Market acceptance will also depend on our ability to demonstrate that our existing and new implants and technologies are an attractive alternative to existing tissue repair treatment options. Our ability to do so will 17 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 20/77 4/1/12 Form 10-K Table of Contents depend on surgeons' evaluations of the clinical safety, efficacy, ease of use, reliability and cost-effectiveness of these tissue repair options and technologies. For example, we believe that some in the medical community have lingering concerns over the risk of disease transmission through the use of allografts. Furthermore, we believe that even if the medical community generally accepts our implants and technologies, acceptance and recommendations by influential surgeons will be important to their broad commercial success. If our implants and technologies are not broadly accepted in the marketplace, we may not achieve a competitive position in the market. Rapid technological changes could result in reduced demand for our implants. Technologies change rapidly in the industry in which we operate. For example, steady improvements have been made in synthetic human tissue substitutes which compete with our tissue implants. Unlike allografts, synthetic tissue technologies are not dependent on the availability of tissue. If one of our competitors successfully introduces synthetic technologies using recombinant technologies, which stimulate the growth of tissue surrounding an implant, it could result in a decline in demand for tissue implants. We may not be able to respond effectively to technological changes and emerging industry standards, or to successfully identify, develop or support new technologies or enhancements to existing implants in a timely and cost- effective manner, if at all. If we are unable to achieve the improvements in our implants necessary for their successful commercialization, the demand for our implants will suffer. We face intense competition, which could result in reduced acceptance and demand for our implants and technologies. The medical technology/biotechnology industry is intensely competitive. We compete with companies in the United States and internationally that engage in the development and production of medical technologies and processes including biotechnology, orthopedic, pharmaceutical, biomaterial and other companies? academic and scientific institutions? and public and private research organizations. Many of our competitors have much greater financial, technical, research, marketing, distribution, service and other resources than ours. Moreover, our competitors may offer a broader array of tissue repair treatment products and technologies or may have greater name recognition in the marketplace. For example, we compete with a number of divisions of Johnson & Johnson, a company with significantly greater resources and brand recognition than ours. Our competitors, including several development stage companies, may develop or market technologies that are more effective or commercially attractive than our technologies, or that may render our technologies obsolete. For example, the development of a synthetic tissue product that permits remodeling of bones could reduce the demand for allograft and xenograft-based products and technologies. If we do not manage the medical release of donor tissue into processing in an effective and efficient manner, it could adversely affect profitability. Many factors affect the level and timing of donor medical releases, including the effectiveness of donor screening performed by donor recovery groups, the timely receipt, recording and review of required medical documentation, and employee loss and turnover in our medical records department. We can provide no assurance that releases will occur at levels which maximize our processing efficiency and minimize our cost per allograft processed. Negative publicity concerning methods of human tissue recovery and screening of donor tissue in the industry in which we operate may reduce demand for our allografts and impact the supply of available donor tissue. Media reports or other negative publicity concerning both improper methods of tissue recovery from donors and disease transmission from donated tissue may limit widespread acceptance of our allografts. Unfavorable 18 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 21/77 4/1/12 Form 10-K Table of Contents reports of improper or illegal tissue recovery practices, both in the United States and internationally, as well as incidents of improperly processed tissue leading to transmission of disease, may broadly affect the rate of future tissue donation and market acceptance of allograft technologies. Potential patients may not be able to distinguish our allografts, technologies and the tissue recovery and the processing procedures from those of our competitors or others engaged in tissue recovery. In addition, families of potential donors may become reluctant to agree to donate tissue to for-profit tissue processors. If our patents and the other means we use to protect our intellectual property prove to be inadequate, our competitors could exploit our intellectual property to compete more effectively against us. The law of patents and trade secrets is constantly evolving and often involves complex legal and factual questions. The U.S. government may deny or significantly reduce the coverage we seek for our patent applications before or after a patent is issued. We cannot be sure that any particular patent for which we apply will be issued, that the scope of the patent protection will be comprehensive enough to provide adequate protection from competing technologies, that interference proceedings regarding any of our patent applications will not be filed, or that we will achieve any other competitive advantage from a patent. In addition, it is possible that one or more of our patents will be held invalid if challenged or that others will claim rights in or ownership of our patents and other proprietary rights. If any of these events occur, our competitors may be able to use our intellectual property to compete more effectively against us. Because patent applications are secret until patents are actually issued (or until 18 months after a patent application has been filed) and the publication of discoveries in the scientific or patent literature lags behind actual discoveries, we cannot be certain that our patent application was the first application filed covering a particular invention. If another party's rights to an invention are superior to ours, we may not be able to obtain a license to use that party's invention on commercially reasonable terms, if at all. In addition, our competitors, many of which have greater resources than ours, could obtain patents that will prevent, limit or interfere with our ability to make use of our inventions either in the United States or in international markets. Further, the laws of some foreign countries do not always protect our intellectual property rights to the same extent as the laws of the United States. Litigation or regulatory proceedings in the United States or foreign countries also may be necessary to enforce our patent or other intellectual property rights or to determine the scope and validity of the proprietary rights of our competitors. These proceedings can be costly, result in development delays, and divert the attention of our management. We rely upon unpatented proprietary techniques and processes in tissue recovery, research and development, tissue processing and quality assurance. It is possible that others will independently develop technology similar to our technology or otherwise gain access to or disclose our proprietary technologies. We may not be able to meaningfully protect our rights in these proprietary technologies, which would reduce our ability to compete. Our success depends in part on our ability to operate without infringing on or misappropriating the proprietary rights of others, and if we are unable to do so we may be liable for damages. We cannot be certain that U.S. or foreign patents or patent applications of other companies do not exist or will not be issued that would prevent us from commercializing our allografts and technologies. Third parties may sue us for infringing or misappropriating their patent or other intellectual property rights. Intellectual property litigation is costly. If we do not prevail in litigation, in addition to any damages we might have to pay, we could be required to stop the infringing activity or obtain a license requiring us to make royalty payments. It is possible that a required license will not be available to us on commercially acceptable terms, if at all. In addition, a required license may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around another company's patent, we may be unable to make use of some of the affected technologies or distribute the affected allografts, which would reduce our revenues. 19 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 22/77 4/1/12 Form 10-K Table of Contents The defense costs and settlements for patent infringement lawsuits are not covered by insurance. Patent infringement lawsuits can take years to settle. If we are not successful in our defenses or are not successful in obtaining dismissals of any such lawsuit, legal fees or settlement costs could have a material adverse effect on our results of operations and financial position. We or our competitors may be exposed to product or professional liability claims which could cause us to be liable for damages or cause investors to think we will be liable for similar claims in the future. The development of allografts and technologies for human tissue repair and treatment entails an inherent risk of product or professional liability claims, and substantial product or professional liability claims may be asserted against us. We are party to a number of legal proceedings relating to professional liability. The prevailing view among the states throughout the United States is that providing allografts is a service and not the sale of a product. As such, allografts are not subject to products liability causes of action. However, the law of a particular state could change in response to legislative changes or by judicial interpretation in a state where such issue has either not been previously addressed or prior precedent is overturned or subject to different interpretations by a court of higher precedential authority. In addition, due to the international scope of our activities we are subject to different laws which may treat allografts as products in those jurisdictions. The implantation of donated human tissue implants creates the potential for transmission of communicable diseases. Although we comply with Federal and state regulations and guidelines intended to prevent communicable disease transmission, and our tissue suppliers are also required to comply with such regulations, there can be no assurances that: (i) our tissue suppliers will comply with such regulations intended to prevent communicable disease transmissions? (ii) even if such compliance is achieved, that our implants have not been or will not be associated with transmission of disease? or (iii) a patient otherwise infected with disease would not erroneously assert a claim that the use of our implants resulted in disease transmission. We currently have $20 million of product and professional liability insurance to cover claims. This amount of insurance may not be adequate for potential claims if we are not successful in our defenses. Moreover, insurance covering our business may not always be available in the future on commercially reasonable terms, if at all. If our insurance proves to be inadequate to pay a damage award, we may not have sufficient funds to do so, which would harm our financial condition and liquidity. In addition, successful product liability claims made against one of our competitors could cause claims to be made against us or expose us to a perception that we are vulnerable to similar claims. Claims against us, regardless of their merit or potential outcome, may also hurt our ability to obtain surgeon acceptance of our allografts or to expand our business. If we are not successful in expanding our distribution activities into international markets, we will not be able to pursue one of our strategies for increasing revenues. Our international distribution strategies vary by market, as well as within each country in which we operate. For example, we distribute only a portion of our line of allograft and xenograft products within each country. Our international operations will be subject to a number of risks which may vary from the risks we face in the United States, including the need to obtain regulatory approvals in additional foreign countries before we can offer our implants and technologies for use? longer distribution-to-collection cycles, as well as difficulty in collecting accounts receivable? dependence on local distributors? limited protection of intellectual property rights? fluctuations in the values of foreign currencies? and political and economic instability. The outcome of litigation or arbitration in which we are involved is unpredictable and an adverse decision in any such matter could adversely impact our business, financial condition or results of operations. We are from time to time subject to legal proceedings and claims that arise in the ordinary course of business. For example, we are currently involved in an arbitration brought by Medtronic Sofamor Danek, USA, Inc. ("MSD"), a subsidiary of Medtronic, related to events stemming from the actions of Biomedical Tissue Services, Ltd. ("BTS"), an unaffiliated company recovery agency, and the subsequent voluntary recall of 20 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 23/77 4/1/12 Form 10-K Table of Contents allografts processed by us from tissue originating from BTS. MSD seeks indemnification from us for its legal fees, costs and expenses allegedly incurred during the defense of cases brought by recipients of these allografts. Any material litigation or arbitration, even if without merit, inevitably results in the diversion of the attention of our management and other relevant personnel. To the extent uninsured, such claims further require the expenditure of our resources for defense costs for us and for parties to whom we may have indemnification obligations. We also may be required to pay material amounts in settlement costs or damages. No assurances can be given that the results of the current arbitration or any new legal matters will be favorable to us. This claim is not covered by insurance. In addition, we have been named as a party, along with a number of other processor defendants, in lawsuits relating to the tissue recovery practices of Biomedical Tissue Service, Ltd., an unaffiliated recovery agency ("BTS"). As of December 31, 2011, there are 79 lawsuits pending against us related to the misconduct of BTS and BTS's owner, Michael Mastromarino, as well as several funeral homes and their owners with which BTS conducted its affairs. These lawsuits generally allege that we were negligent in not discovering deficiencies in recovery practices at BTS. We deny the allegations and, due at least in part to the favorable law currently in place in the states where such cases are pending, i.e. New York, New Jersey, and Pennsylvania, we do not anticipate a materially adverse event arising from this litigation. However, reactions of juries cannot be predicted with reasonable reliability, and currently favorable laws in the jurisdictions may be subject to change. In addition to the favorable law, we believe that we have meritorious factual defenses to these claims, and will defend them vigorously. We have $2 million in answerable indemnity insurance, with non-eroding defense limits. Of the pending cases, however, our insurer has disclaimed coverage on approximately 33 of the cases. We believe this disclaimer is improper, and have brought a declaratory action against the insurer to obtain coverage on these disclaimed cases. Pending resolution of the declaratory action, or if the declaratory action is not resolved in our favor, we will be responsible for paying both the legal fees and any indemnification that may be owed in connection with those disclaimed cases. An adverse resolution of lawsuits or arbitrations could adversely impact our business, financial condition or results of operations. Any acquisitions we make may require the issuance of a significant amount of equity or debt securities and may not be scientifically or commercially successful. As part of our business strategy, we may perform acquisitions to obtain additional businesses, product and/or process technologies, capabilities and personnel. If we make one or more significant acquisitions in which the consideration includes securities, we may be required to issue a substantial amount of equity, debt, warrants, convertible instruments or other similar securities. Such an issuance could dilute your investment in our common stock or increase our interest expense and other expenses. Further, acquisitions involve a number of operational risks, such as: o o o o o o difficulty and expense of assimilating the operations, technology and personnel of the acquired business? our inability to retain the management, key personnel and other employees of the acquired business? our inability to maintain the acquired company's relationship with key third parties, such as alliance partners? exposure to legal claims for activities of the acquired business prior to the acquisition? the diversion of our management's attention from our core business? and the potential impairment of goodwill and write-off of in-process research and development costs, adversely affecting our reported results of operations. 21 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 24/77 4/1/12 Form 10-K Table of Contents Any one of these risks could prevent an acquisition from being scientifically or commercially successful, which could have a material impact on our results of operations not only with respect to the operations of the acquired company but with respect to us on a consolidated basis. Item 1B. UNRESOLVED STAFF COMMENTS. None. Item 2. PROPERTIES. UNITED STATES. Our headquarters and U.S. manufacturing facilities are located in Alachua, Florida, near metropolitan Gainesville, include three buildings on approximately 21 acres of property that we own, including a 65,000 square foot processing facility, a 50,000 square foot office building and a 20,000 square foot commons building. These facilities include clean-rooms for tissue processing and packaging, BioCleanse(R) sterilization chambers, freezers for storage of tissue and laboratory facilities. Our processing facility meets the FDA's Current Good Manufacturing Practices requirements and allows us to meet the requirements of an FDA approved medical device manufacturer. We believe that we have sufficient space to meet our current and foreseeable future needs. We currently have separate BioCleanse(R) and TUTOPLAST(R) processing units and laboratory operations in approximately 17,000 square feet of leased space related to processing and research in Alachua, Florida. We also currently lease approximately 3,600 square feet of separate R&D laboratory building space, 6,000 square feet of leased offsite warehouse space, and approximately 12,000 square feet of leased distribution and marketing office space in Alachua, Florida. We also lease space at two of our recovery group locations throughout the United States. GERMANY. Our facility in Neunkirchen consists of six buildings totaling approximately 58,000 square feet on approximately two acres of land. We own this property and believe it will be sufficient in size and condition to handle anticipated production levels for international markets into the foreseeable future. FRANCE. Our facility in Metz consists of a small leased distribution office. Item 3. LEGAL PROCEEDINGS. We are, from time to time, involved in lawsuits and arbitration proceedings relating to claims arising out of our operations in the ordinary course of business. We believe that none of these claims that were outstanding as of December 31, 2011 will have a material adverse impact on our financial position or results of operations. The development of allografts and technologies for human tissue repair and treatment entails an inherent risk of product or professional liability claims, and substantial product or professional liability claims may be asserted against us. We are party to a number of legal proceedings relating to product or professional liability. The prevailing view among the individual states throughout the United States is that providing allografts is a service and not the sale of a product. As such, allografts are not subject to products liability causes of action. However, the law of a particular state could change in response to legislative changes or by judicial interpretation in a state where such issue has either not been previously addressed or prior precedent is overturned or subject to different interpretations by a court of higher precedential authority. In addition, due to the international scope of our activities we are subject to different laws which may treat allografts as products in those jurisdictions. The implantation of donated human tissue implants creates the potential for transmission of communicable disease. Although we comply with Federal and state regulations and guidelines intended to prevent communicable disease transmission, and our tissue suppliers are also required to comply with such regulations, there can be no assurances that: (i) our tissue suppliers will comply with such regulations intended to prevent 22 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 25/77 4/1/12 Form 10-K Table of Contents communicable disease transmissions? (ii) even if such compliance is achieved, that our implants have not been or will not be associated with transmission of disease? or (iii) a patient otherwise infected with disease would not erroneously assert a claim that the use of our implants resulted in disease transmission. We currently have $20 million of product and professional liability insurance to cover claims. This amount of insurance may not be adequate for potential claims if we are not successful in our defenses. Moreover, insurance covering our business may not always be available in the future on commercially reasonable terms, if at all. If our insurance proves to be inadequate to pay a damage award, we may not have sufficient funds to do so, which would harm our financial condition and liquidity. In addition, successful product liability claims made against one of our competitors could cause claims to be made against us or expose us to a perception that we are vulnerable to similar claims. Claims against us, regardless of their merit or potential outcome, may also hurt our ability to obtain surgeon endorsement of our allografts or to expand our business. Medtronic Sofamor Danek, USA, Inc. We and Medtronic Sofamor Danek, USA, Inc. ("MSD"), a subsidiary of Medtronic, Inc., ("Medtronic"), have filed claims against each other with the American Arbitration Association related to events stemming from the actions of Biomedical Tissue Services, Ltd. ("BTS"), an unaffiliated company recovery agency, and the subsequent voluntary recall of allografts processed by us from tissue originating from BTS (the "Allografts"). MSD seeks indemnification from us for its legal fees, costs and expenses allegedly incurred during the defense of cases brought by recipients of Allografts. We deny that we are obligated to indemnify MSD in respect of the Allografts. In the same proceeding, we are seeking damages from MSD due to actions taken by MSD during the recall process. Among other allegations, we allege that MSD's actions were negligent and in breach of the contractual agreements between us and MSD. As of the filing date, hearings have concluded on the matter and post-hearing briefs are being prepared for submission to the arbitrator. Final resolution of the matter is anticipated to occur in the first quarter of 2012. The probability of a favorable or unfavorable outcome to us is unknown and a range of loss, if any, cannot be estimated at this time. However, while we believe our defenses and counterclaims are meritorious, the ultimate resolution of the matters, which is expected to occur within three months, could adversely impact our business, financial condition or results of operations. This claim is not covered by insurance. Biomedical Tissue Service, Ltd. We have been named as a party, along with a number of other processor defendants, in lawsuits relating to the tissue recovery practices of Biomedical Tissue Service, Ltd., an unaffiliated recovery agency ("BTS"). As of December 31, 2011, there are 79 lawsuits pending against us related to the misconduct of BTS and BTS's owner, Michael Mastromarino, as well as several funeral homes and their owners with which BTS conducted its affairs. These lawsuits generally allege that we were negligent in not discovering deficiencies in recovery practices at BTS. We deny the allegations and, due at least in part to the favorable law currently in place in the states where such cases are pending, i.e. New York, New Jersey, and Pennsylvania, we do not anticipate a materially adverse event arising from this litigation. However, reactions of juries cannot be predicted with reasonable reliability, and currently favorable laws in the jurisdictions may be subject to change. In addition to the favorable law, we believe that we have meritorious factual defenses to these claims, and will defend them vigorously. We have $2 million in answerable indemnity insurance, with non-eroding defense limits. Of the pending cases, however, our insurer has disclaimed coverage on approximately 33 of the cases. We believe this disclaimer is improper, and have brought a declaratory action against the insurer to obtain coverage on these disclaimed cases. Pending resolution of the declaratory action, or if the declaratory action is not resolved in our favor, we will be responsible for paying both the legal fees and any indemnification that may be owed in connection with those disclaimed cases. The probability of an unfavorable outcome to us is unknown and a range of loss, if any, cannot be estimated at this time. However, while we believe our defenses are meritorious, the ultimate resolution of the matters could adversely impact our business, financial condition or results of operations. 23 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 26/77 4/1/12 Form 10-K Table of Contents PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information and Holders Our common stock is quoted on the Nasdaq Stock Market under the symbol "RTIX." The following table sets forth the range of high and low sales prices for our common stock for each quarterly period in the last two fiscal years. 2010 High Low First Quarter Second Quarter Third Quarter Fourth Quarter 2011 $4.44 $4.54 $3.02 $2.86 High $3.04 $2.92 $2.09 $2.28 Low First Quarter Second Quarter Third Quarter Fourth Quarter $2.95 $3.18 $3.82 $4.79 $2.40 $2.54 $2.72 $2.82 As of February 8, 2012, we had 384 stockholders of record of our common stock. The closing sale price of our common stock on February 8, 2012 was $4.09 per share. 24 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 27/77 4/1/12 Form 10-K Table of Contents Stock Performance Graph The Securities and Exchange Commission requires us to present a chart comparing the cumulative total stockholder return on our common stock with the cumulative total stockholder return of: (1) a broad equity market index, and (2) a published industry or line-of-business index. We selected the Standards & Poors Biotechnology Index based on our good faith determination that this index fairly represents the companies which compete in the same industry or line-of-business as we do. The chart below compares our common stock with the Nasdaq Composite Index and the Standards & Poors Biotechnology Index and assumes an investment of $100.00 on December 31, 2006 in each of the common stock, the stocks comprising the Nasdaq Composite Index and the stocks comprising the Standards & Poors Biotechnology Index. Total Return Analysis 12/06 12/07 12/08 12/09 12/10 12/11 RTI Biologics, Inc. NASDAQ Composite S&P Biotechnology Dividend Policy $100.00 $148.12 $ 47.10 $65.51 $ 45.55 $ 75.74 100.00 110.66 66.41 96.54 114.06 113.16 100.00 96.58 106.54 98.80 100.72 123.76 We have never paid cash dividends. We do not expect to declare or pay any dividends on our common stock in the foreseeable future, but instead intend to retain all earnings, if any, to invest in our operations. The payment of future dividends, if any, will depend upon our future earnings, if any, our capital requirements, financial condition, debt covenant terms, and other relevant factors. Item 6. SELECTED FINANCIAL DATA. The statement of operations data set forth below for the years ended December 31, 2011, 2010, and 2009, and selected balance sheet data as of December 31, 2011, and 2010 have been derived from our audited consolidated financial statements and accompanying notes. The consolidated financial statements as of December 31, 2011, and 2010 and for the three years ended December 31, 2011 are included elsewhere in this Form 10-K. The selected consolidated financial data set forth below should be read along with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," and our consolidated financial statements and accompanying notes included elsewhere in this document. 25 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 28/77 4/1/12 Form 10-K Table of Contents The statement of operations data set forth below for the years ended December 31, 2008, and 2007, and the balance sheet data set forth as of December 31, 2009, 2008 and 2007 have been derived from our audited consolidated financial statements and accompanying notes which are not included elsewhere in this Form 10-K. 2011 Year Ended December 31, 2010 2009 2008 (In thousands, except share and per share data) 2007 Statements of Operations Data: Revenues: Fees from tissue distribution Other revenues Total revenues Costs of processing and distribution Gross profit Expenses: Marketing, general and administrative Research and development Gain on business exchange Restructuring charges Goodwill impairment Asset impairments and abandonments Total expenses Operating income (loss) Other (expense) income: Interest expense Interest income Foreign exchange (loss) gain Total other (expense) income--net Income (loss) before income tax (provision) benefit Income tax (provision) benefit Net income (loss) Net income (loss) per common share-- basic Net income (loss) per common share-- diluted Weighted average shares outstanding --basic Weighted average shares outstanding --diluted $ 162,855 6,461 169,316 92,102 77,214 $ 161,001 5,170 166,171 90,168 76,003 $ 160,044 4,483 164,527 87,034 77,493 $ 140,886 5,749 146,635 77,821 68,814 $ 88,708 5,499 94,207 56,557 37,650 $ 55,576 9,806 -- -- -- 61 65,443 11,771 (201) 193 (159) (167) 11,604 (3,226) 8,378 $ 59,232 9,435 -- -- 134,681 30 203,378 (127,375) (537) 114 4 (419) (127,794) (1,605) (129,399) $ 59,325 8,899 -- 42 -- 208 68,474 9,019 (544) 273 (293) (564) 8,455 (2,600) 5,855 $ 54,168 8,143 -- 451 103,007 1,402 167,171 (98,357) (788) 567 (9) (230) (98,587) (1,391) (99,978) $ 31,040 5,190 (197) -- -- 4,185 40,218 (2,568) (753) 849 -- 96 (2,472) 376 (2,096) $ $ 0.15 0.15 $ $ (2.36) (2.36) $ $ 0.11 0.11 $ $ (2.00) (2.00) $ $ (0.07) (0.07) 55,150,886 55,354,675 2011 54,729,608 54,729,608 2010 54,349,391 54,772,489 As of December 31, 2009 49,912,154 49,912,154 2008 29,824,816 29,824,816 2007 Balance Sheet Data: Cash and cash equivalents Working capital Total assets Long-term obligations--less current $ 46,178 124,064 230,027 $ 28,212 125,629 225,758 $ 17,382 114,944 354,507 $ 20,076 90,189 334,080 $ 18,560 70,621 135,966 29/77 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 4/1/12 Form 10-K portion Total stockholders' equity 143 172,419 1,877 161,936 26 11,029 289,889 3,183 281,050 1,875 111,643 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 30/77 4/1/12 Form 10-K Table of Contents Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. You should read the following discussion of our financial condition and results of operations together with those financial statements and the notes to those statements included elsewhere in this filing. This discussion contains forward looking statements based on our current expectations, assumptions, estimates and projections about us and our industry. Our actual results could differ materially from those anticipated in these forward looking statements. We undertake no obligation to update publicly any forward looking statements for any reason, even if new information becomes available or other events occur in the future. Executive Level Overview: RTI Biologics, Inc., together with its subsidiaries, produces orthopedic and other surgical implants that repair and promote the natural healing of human bone and other human tissues. We process donated human musculoskeletal and other tissues, including bone, cartilage, tendon, ligament, fascia lata, pericardium, sclera, and dermal tissues, as well as bovine animal tissues to produce allograft and xenograft implants by utilizing our proprietary BIOCLEANSE (R) and TUTOPLAST(R) sterilization processes. We process and distribute human and bovine animal tissues for use in the fields of sports medicine, spine, surgical specialties, bone graft substitutes, and general orthopedic and dental. We market our implants through a direct distribution organization, as well as through a network of independent distributors to hospitals and surgeons in the United States and internationally. We were founded in 1997 and are headquartered in Alachua, Florida Domestic sales and services accounted for 88% of total revenues in 2011. Most of our implants are marketed directly to doctors, hospitals and other healthcare facilities through a direct distribution force and through various strategic relationships. International sales and services accounted for 12% of total revenues in 2011. Our implants are marketed in approximately 30 countries through a direct distribution force in Germany and through stocking distributors in the rest of the world outside of Germany and the U.S. Our business is generally not seasonal in nature? however, the number of orthopedic implant surgeries and elective procedures generally declines during the summer months. Our principal goals are to honor the gift of donated tissue, donor families, and patients while building our competitive strength in the marketplace to increase revenues, profitability and cash flow as we focus on improved operational efficiency, productivity and asset management. We are making investments in new implant and product development and our U.S. direct distribution network to fuel growth in 2012 beyond. In addition, we actively look externally for new products / technologies to augment our existing implant offerings. We continue to maintain our commitment to research and development and the introduction of new strategically targeted allograft and xenograft implants as well as focused clinical efforts to support their acceptance in the marketplace. Merger with Tutogen Medical, Inc. On February 27, 2008, we completed our merger with TMI, a Delaware corporation, in a tax-free stock-for-stock merger transaction. TMI, with its consolidated subsidiaries, processes, manufactures and distributes specialty surgical products and performs tissue processing services for dental, spine, urology, hernia repair, breast reconstruction, ophthalmology, and ear, nose and throat applications. The transaction was accounted for using the purchase method of accounting in accordance with Financial Accounting Standards Board ("FASB") ASC 805, Business Combinations. The results of TMI's operations have been included in our consolidated financial statements since the merger date of February 27, 2008. 27 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 31/77 4/1/12 Form 10-K Table of Contents Critical Accounting Policies The preparation of our financial statements in accordance with accounting principles generally accepted in the United States often requires us to make estimates and judgments that affect reported amounts. These estimates and judgments are based on historical experience and assumptions that we believe to be reasonable under the circumstances. Assumptions and judgments based on historical experience may provide reported results which differ from actual results? however, these assumptions and judgments historically have not varied significantly from actual experience and we therefore do not expect them to vary significantly in the future. The accounting policies which we believe are "critical," or require the most use of estimates and judgment, relate to the following items presented in our financial statements: 1) Tissue Inventory Valuation? 2) Accounts Receivable Allowances? 3) Long-Lived Assets? 4) Intangible Assets and Goodwill and? 5) Revenue Recognition. Tissue Inventory Valuation. Accounting principles generally accepted in the United States require that inventory be stated at the lower of cost or market value. Due to various reasons, some tissue within our inventory will never become available for distribution. Therefore, we must make estimates of future distribution from existing inventory in order to write- off inventory which will not be distributed and which therefore has reduced or no market value. Our management reviews available information regarding processing costs, inventory distribution rates, industry supply and demand, medical releases and processed tissue rejections, in order to determine write-offs of cost above market value. For a variety of reasons, we may from time to time be required to adjust our assumptions as processes change and as we gain better information. Although we continue to refine the information on which we base our estimates, we cannot be sure that our estimates are accurate indicators of future events. Accordingly, future adjustments may result from refining these estimates. Such adjustments may be significant. Accounts Receivable Allowances. We maintain allowances for doubtful accounts based on our review and assessment of payment history and our estimate of the ability of each customer to make payments on amounts invoiced. If the financial condition of any of our customers were to deteriorate, additional allowances might be required. From time to time we must adjust our estimates. Changes in estimates of the collection risk related to accounts receivable can result in decreases and increases to current period net income. Long-Lived Assets. We periodically evaluate the period of depreciation or amortization for long-lived assets to determine whether current circumstances warrant revised estimates of useful lives. We review our property, plant and equipment for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Recoverability is measured by a comparison of the carrying amount to the net undiscounted cash flows expected to be generated by the asset. An impairment loss would be recorded for the excess of net carrying value over the fair value of the asset impaired. The fair value is estimated based on expected discounted future cash flows. The results of impairment tests are subject to management's estimates and assumptions of projected cash flows and operating results. Changes in assumptions or market conditions could result in a change in estimated future cash flows and the likelihood of materially different reported results. Past estimates by management of the fair values and useful lives of long-lived assets and investments have been accurate but have periodically been impacted by one-time events. Intangible Assets and Goodwill. FASB ASC 350, Goodwill and Other Intangible Assets, requires companies to test goodwill for impairment on an annual basis at the reporting unit level (or an interim basis if an event occurs that might reduce the fair value of a reporting unit below its carrying value). We have one reporting unit and the annual impairment test is performed at each year-end unless indicators of impairment are present and require more frequent testing. FASB ASC 350 also requires that the carrying value of an identifiable intangible asset that has an indefinite life be determined by using a fair value based approach. Intangible assets generally consist of patents, trademarks, procurement contracts, customer lists, non-compete agreements, distribution agreements and acquired exclusivity rights. Patents and trademarks are 28 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 32/77 4/1/12 Form 10-K Table of Contents amortized on the straight-line method over the shorter of the remaining protection period or estimated useful lives of between 8 and 16 years. Procurement contracts, customer lists, acquired exclusivity rights, non-compete agreements and distribution agreements are amortized over estimated useful lives of between 5 to 25 years. Goodwill is tested for impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. In concluding as to fair value of the reporting unit for purposes of testing goodwill, an income approach and a market approach are utilized. The conclusion from these two approaches are weighted equally and then adjusted to incorporate a control premium or acquisition premium that reflects the additional amount a buyer is willing to pay for elements of control and for a premium that reflects the buyer's perception of its ability to add value through synergies. In general, the income approach employs a discounted cash flow model that considers 1) assumptions that marketplace participants would use in their estimates of fair value, including the cash flow period, terminal values based on a terminal growth rate and the discount rate, 2) current period actual results, and 3) projected results for future periods that have been prepared and approved by senior management of the Company. The forecasted cash flows do not include synergies that a marketplace participant would be expecting to achieve. The market approach employs market multiples from guideline public companies operating in our industry. Estimates of fair value are derived by applying multiples based on revenue and earnings before interest, taxes, depreciation and amortization ("EBITDA") adjusted for size and performance metrics relative to peer companies. A control premium was included in determining the fair value under this approach. If the carrying amount of the reporting unit exceeds its calculated fair value, the second step of the goodwill impairment test is performed in accordance with FASB ASC 350 to measure the amount of the impairment loss, if any. Both approaches used in the analysis have a degree of uncertainty. Potential events or changes in circumstances which could impact the key assumptions used in our goodwill impairment evaluation are as follows: o o o o Change in peer group or performance of peer group companies Change in the Company's markets and estimates of future operating performance Change in the Company's estimated market cost of capital Change in implied control premiums related to acquisitions in the medical device industry. Based on the then existing economic environment and the severe decline in our stock price beginning late in the second quarter of 2010 and sustained through year-end 2010, and the significant gap between the book and market value of our equity, we concluded that there were sufficient indicators to require an interim goodwill impairment analysis as of September 30, 2010. For purposes of this analysis, estimates of fair value were based on a combination of the income approach, which estimates the fair value of our reporting unit based on future discounted cash flows, and the market approach, which estimates the fair value of our reporting unit on comparable market prices. Based on the goodwill impairment analysis performed, we recorded a $134,681 goodwill impairment charge for the remaining balance of goodwill on the balance sheet during the third quarter of 2010. The goodwill impairment charge did not affect our liquidity, nor does it affect any financial covenants of our credit agreements. We concluded our goodwill impairment assessment in the fourth quarter of 2010, which resulted in no change to the goodwill impairment charge recorded during the third quarter of 2010. The valuation of goodwill and intangible assets with indefinite useful lives requires management to use significant judgments and estimates including, but not limited to, projected future revenue and cash flows. Changes in assumptions or market conditions could result in a change in estimated future cash flows and the likelihood of materially different reported results. 29 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 33/77 4/1/12 Form 10-K Table of Contents If we overestimate the useful life of an asset, or overestimate the fair value of an asset, and at some time in the future we dispose of that asset for a lower amount than its carrying value, our historically reported total assets and net income would have been higher than they would have been during periods prior to our recognition of the loss on disposal of assets, and lower during the period when we recognize the loss. The fair value of these long-term investments is dependent on their performance, as well as volatility inherent in the external markets for these investments. These determinations require complex calculations based on estimated future benefit and fair value. We have often made investments for which the expected future benefit has not been easily estimated. Examples of such investments include, but are not limited to, our acquisition of TMI, our acquisition of RTI Biologics, Inc.-- Cardiovascular (inactive)? our investment in equipment? and our investment in obtaining patents. In assessing potential impairment for these investments, we consider these factors as well as forecasted financial performance. If forecasts are not met, impairment charges may be required. Revenue Recognition. We recognize revenue upon shipping, or receipt by our customers of the processed tissue for implantation, depending on our distribution agreements with our customers or distributors. We recognize our other revenues when all appropriate contractual obligations have been satisfied. We permit returns of tissue in accordance with the terms of contractual agreements with customers if the tissue is returned in a timely manner, in unopened packaging and from the normal channels of distribution. We provide allowances for returns based upon analysis of our historical patterns of returns, matched against the fees from which they originated. Historical returns have been within the amounts we reserved. On September 3, 2010, we entered into a new exclusive distribution agreement (the "Agreement") with Zimmer Dental Inc. ("Zimmer"), a subsidiary of Zimmer, Inc., with an effective date of September 30, 2010. The Agreement has an initial term of ten years. Under the terms of the Agreement, we have agreed supply sterilized allograft and xenograft implants (the "Implants") at an agreed upon transfer price, and Zimmer has agreed to be the exclusive distributor of the Implants for dental and oral applications worldwide (except the Ukraine), subject to certain obligations we have under an existing distribution agreement with a third party with respect to certain implants for the dental market. In consideration for Zimmer's exclusive distribution rights, Zimmer agreed to the following: 1) payment to us of $13.0 million within ten days of the effective date (the "Upfront Payment") which was paid in October, 2010, 2) annual exclusivity fees ("Annual Exclusivity Fees") paid annually for the term of the contract to be paid at the beginning of each calendar year, and, 3) escalating annual purchase minimums to maintain exclusivity. Upon occurrence of an event that materially and adversely affects Zimmer's ability to distribute the Implants, Zimmer may be entitled to certain refund rights with respect to the Upfront Payment and the then current Annual Exclusivity Fee, where such refund would be in an amount limited by a formula specified in the Agreement that is based substantially on the number of days from the occurrence of such event to the date that it is cured by us to the satisfaction of Zimmer. The Upfront Payment and the Annual Exclusivity Fees are deferred as received and will be recognized as other revenues over the term of the Agreement based on the expected escalating annual purchase minimums relative to the total minimum purchase requirements in the Agreement. Additionally, we have considered the potential impact of the Agreement's contractual refund provisions and we do not expect these provisions to impact future expected revenue related to the Agreement. On July 13, 2009, we and Davol Inc., a subsidiary of C.R. Bard, Inc. ("Davol"), amended the January 2006 distribution agreement with TMI. Under the amended agreement, 1) Davol paid us $8.0 million in non-refundable fees for exclusive distribution rights for the distribution to the breast reconstruction market until July 13, 2019, 2) the exclusive worldwide distribution agreement related to the hernia market was extended to July 13, 2019, and 3) Davol agreed to pay us certain additional exclusive distribution rights fees contingent upon the achievement of certain revenue milestones by Davol during the duration of the contract. In the fourth quarter of 2010, Davol paid us the first revenue milestone payment of $3.5 million. The $8.0 million and $3.5 million exclusivity payments have been deferred and are being recognized as other revenue on a straight-line basis over the initial term of the amended contract of ten years, and the remaining term of the amended contract, respectively. The straight-line method approximates the expected pattern of product distribution based on the distribution agreement's annual minimum purchase requirements. 30 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 34/77 4/1/12 Form 10-K Table of Contents On May 14, 2007, we entered into an exclusive distribution agreement with Zimmer with an initial term of ten years, relating to certain new bone graft substitutes implants. As part of the agreement, Zimmer made payments to us totaling $5,000 for the aforementioned exclusive distribution rights, and has to maintain certain minimum order volumes through the duration of the contract. The $5,000 exclusivity payment has been deferred and is being recognized as other revenue on a straight-line basis over the initial term of the contract. The contract provides for repayment, on a pro rata basis, of the exclusivity payments during the initial contract term for specific events of non-performance, as defined in the agreement. The agreement also includes automatic two-year renewal terms, as well as buy-out provisions by both parties upon proper notice of cancellation. Off Balance-Sheet Arrangements As of December 31, 2011, we had no off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K. Recent Regulatory Approvals o o o o March 2011: Three commercial partner spine grafts cleared in New Zealand June 2011: Two commercial partner DBM products approved in South Korea October 2011: Two commercial partner dental membrane products approved in Columbia October 2011: BioSet(R) bone paste approved in Columbia. Certifications, Accreditations and Inspections o o o o May 2011: SGS ISO 13485 surveillance audit at our Alachua, Florida facility. June 2011: German Health Authority (District Government of Upper Bavaria) inspection at our Alachua, Florida facility. July 2011: Food and Drug Administration ("FDA") inspection at our Dallas, Texas RTI Donor Services facility. October 2011: U.S. Food and Drug Administration ("FDA") tissue bank inspection at our Alachua, Florida facility. All registrations, licensures, certifications and accreditations were renewed or continued and no regulatory actions are pending from state and federal inspections. Recalls o March 2011: We initiated a voluntary recall with the Center for Devices and Radiological Health ("CDRH") for 25 Regenaform(R) Allograft Moldable Blocks 1cm x 4cm x 0.5cm 2cc grafts which are utilized in general orthopedics and dental applications. These grafts were recalled due to incorrect product codes applications to our labels which denotes the measurement. May 2011: We initiated a voluntary recall with the Center for Biologics Evaluation and Research ("CBER"). This pending recall was for one BioCleanse(R) Semitendinosus tendon. This tissue was distributed from a donor that was determined ineligible upon receiving late arriving information. All activities are completed and the closure was requested from the FDA on May 16, 2011. 31 o www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 35/77 4/1/12 Form 10-K Table of Contents Results of Operations The following tables set forth, in both dollars and as a percentage of revenues, the results of our operations for the years indicated: 2011 Year Ended December 31, 2010 (Dollars in thousands) 2009 Statement of Operations Data: Revenues: Fees from tissue distribution Other revenues Total revenues Costs of processing and distribution Gross profit Expenses: Marketing, general and administrative Research and development Restructuring charges Goodwill impairment Asset abandonments Total expenses Operating income (loss) Other (expense) income: Interest expense Interest income Foreign exchange (loss) gain Total other expense--net Income (loss) before income tax provision Income tax provision Net income (loss) $162,855 6,461 169,316 92,102 77,214 100.0% 54.4 45.6 $ 161,001 5,170 166,171 90,168 76,003 100.0% 54.3 45.7 $160,044 4,483 164,527 87,034 77,493 100.0% 52.9 47.1 55,576 9,806 -- -- 61 65,443 11,771 (201) 193 (159) (167) 11,604 (3,226) $ 8,378 32.8 5.8 -- -- -- 38.6 7.0 (0.1) 0.1 (0.1) (0.1) 6.9 (1.9) 5.0% 59,232 9,435 -- 134,681 30 203,378 (127,375) (537) 114 4 (419) (127,794) (1,605) $(129,399) 35.6 5.7 -- 81.1 -- 122.4 (76.7) (0.3) 0.1 -- (0.2) (76.9) (1.0) (77.9%) 59,325 8,899 42 -- 208 68,474 9,019 (544) 273 (293) (564) 8,455 (2,600) $ 5,855 36.1 5.4 -- -- 0.1 41.6 5.5 (0.3) 0.2 (0.2) (0.3) 5.2 (1.6) 3.6% 2011 Year Ended December 31, 2010 2009 Percent Change 2011/2010 2010/2009 Fees from tissue distribution: Sports medicine Spine Surgical specialties BGS and general orthopedic Dental Other revenues Total revenues Domestic revenues International revenues Total revenues $ 48,122 39,722 30,328 26,291 18,392 6,461 $169,316 $148,315 21,001 $169,316 32 $ 45,065 33,906 26,871 25,413 29,746 5,170 $166,171 $147,943 18,228 $166,171 $ 39,533 41,087 26,278 23,161 29,985 4,483 $164,527 $141,275 23,252 $164,527 6.8% 17.2% 12.9% 3.5% -38.2% 25.0% 1.9% 0.3% 15.2% 1.9% 14.0% -17.5% 2.3% 9.7% -0.8% 15.3% 1.0% 4.7% -21.6% 1.0% www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 36/77 4/1/12 Form 10-K Table of Contents 2011 Compared to 2010 Revenues. Our total revenues increased $3.1 million, or 1.9%, to $169.3 million for the year ended December 31, 2011 compared to $166.2 million for the year ended December 31, 2010. Sports Medicine--Revenues from sports medicine allografts increased $3.1 million, or 6.8%, to $48.1 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. Sports medicine revenues increased primarily as a result of increases in unit volumes of 10.2% due to higher number of tendons distributed partially offset by lower average revenue per unit of 3.1% due primarily to changes in product mix. Spine--Revenues from spinal allografts increased $5.8 million, or 17.2%, to $39.7 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. Spine revenues increased primarily as a result of increases in unit volumes of 15.5% due to an inventory reduction of approximately $6.0 million from our largest spine distributor that took place in the first half of 2010. Surgical Specialties--Revenues from surgical specialty allografts increased $3.5 million, or 12.9%, to $30.3 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. Surgical specialties revenues increased primarily as a result of higher unit volumes of 2.5% and increases in average revenue per unit of 10.4% due primarily to changes in product mix. Bone Graft Substitutes (BGS) and General Orthopedic--Revenues from BGS and general orthopedic allografts increased $878,000, or 3.5%, to $26.3 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. BGS and general orthopedic revenues increased primarily as a result of higher unit volumes of 1.1% and higher average revenues per unit of 2.6% due to changes in product mix. Dental--Revenues from dental allografts decreased $11.4 million, or 38.2%, to $18.4 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. Dental revenues decreased primarily as a result of a 27.0% decrease in average revenue per unit, which was a function of the new exclusive distribution agreement with our dental distributor. Effective September 30, 2010, we changed from a marketing fee structure to a transfer fee structure, which lowered distribution revenue per unit. Additionally, unit volumes decreased 15.0% primarily due to a $4.0 million stocking order at transfer fees related to the new exclusive distribution agreement with our dental distributor that took place in the third and fourth quarters of 2010. Other Revenues--Revenues from other sources, consisting of tissue recovery fees, biomedical laboratory fees, recognition of previously deferred revenues, shipping fees, distribution of reproductions of our allografts to distributors for demonstration purposes, and restocking fees, increased by $1.3 million, or 25.0%, to $6.5 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase was due to higher deferred revenue amortization resulting from exclusivity payments received from our dental and surgical specialties distributors. Foreign Currency Fluctuations--For the year ended December 31, 2011, foreign currency exchange fluctuations resulted in an increase in total revenues of $875,000 due to a 4.9% decrease in the value of the U.S. dollar versus the Euro, as compared to the prior year period. Costs of Processing and Distribution. Costs of processing and distribution increased by $1.9 million, or 2.1%, to $92.1 million for the year ended December 31, 2011. The increase in cost of processing and distribution was primarily due to volume increases and changes in product mix. As a percentage of revenues, costs of processing and distribution increased from 54.3% for the year ended December 31, 2010 to 54.4% for the year ended December 31, 2011 due primarily to the new distribution agreement with our dental distributor effective September 30, 2010, where all orders are distributed at transfer fees resulting in lower average revenues per unit, partially offset by higher production levels and operating efficiencies for the year ended December 31, 2011 compared to the year ended December 31, 2010. 33 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 37/77 4/1/12 Form 10-K Table of Contents Marketing, General and Administrative Expenses. Marketing, general and administrative expenses decreased by $3.7 million, or 6.2%, to $55.6 million for the year ended December 31, 2011 from $59.2 million for the year ended December 31, 2010. Marketing, general and administrative expenses decreased as a percentage of revenues from 35.6% for the year ended December 31, 2010 to 32.8% for the year ended December 31, 2011. The decrease in marketing, general and administrative expenses was primarily due to decreases in distributor commissions attributable to the new distribution agreement with our dental distributor effective September 30, 2010, partially offset by increases in compensation, legal, and marketing programs. Research and Development Expenses. Research and development expenses increased by $371,000, or 3.9%, to $9.8 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. As a percentage of revenues, research and development expenses increased from 5.7% for the year ended December 31, 2010 to 5.8% for the year ended December 31, 2011. These increases are primarily due to increases in research tissue and studies expenses of $410,000 and $120,000, respectively, partially offset by decreases in compensation expenses of $200,000. Goodwill Impairment and Asset Abandonments. Asset abandonments were $61,000 for the year ended December 31, 2011, compared to $30,000 the year ended December 31, 2010. We recognized a $134.7 million loss on goodwill impairment during the year ended December 31, 2010. Net Other (Expense) Income. Net other expense was $167,000 for the year ended December 31, 2011 compared to $419,000 for the year ended December 31, 2010. Interest expense decreased by $336,000 for the year ended December 31, 2011 to $201,000 from $537,000 for the year ended December 31, 2010 due a reduction in interest bearing long-term obligations. Interest income increased by $79,000 for the year ended December 31, 2011 to $193,000 from $114,000 for the year ended December 31, 2010 due to higher average balances of cash and cash equivalents than the comparable prior year period. Foreign exchange loss was $159,000 for the year ended December 31, 2011 compared to an exchange gain of $4,000 for the year ended December 31, 2010 due to changes in the value of the U.S. dollar versus the Euro and the timing of payments on foreign currency liabilities. Income Tax Provision. Income tax provision for the year ended December 31, 2011 was $3.2 million compared to $1.6 million for the year ended December 31, 2010. Our effective tax rate for the year ended December 31, 2011 and 2010 was 27.8% and (1.3)%, respectively. Our effective tax rate for the year ended December 31, 2011 was positively impacted by the de-recognition of an uncertain tax liability resulting from new safe harbor guidance issued by the Internal Revenue Service regarding the deductibility of success based fees. The effective tax rate was negatively impacted in the year ended December 31, 2010 by the non-deductible goodwill impairment. 2010 Compared to 2009 Revenues. Our total revenues increased $1.6 million, or 1.0%, to $166.2 million for the year ended December 31, 2010 compared to $164.5 million for the year ended December 31, 2009. Sports Medicine--Revenues from sports medicine allografts increased $5.5 million, or 14.0%, to $45.1 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. Sports medicine revenues increased primarily as a result of increases in unit volumes of 8.6% due to higher number of tendons distributed, and higher average revenue per unit of 4.9% due primarily to changes in product mix. Spine--Revenues from spinal allografts decreased $7.2 million, or 17.5%, to $33.9 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. Spine revenues decreased primarily as a result of unit volume decreases of 17.2% due to an inventory reduction of approximately $6.0 million in the first half of 2010 from our largest spine distributor. 34 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 38/77 4/1/12 Form 10-K Table of Contents Surgical Specialties--Revenues from surgical specialty allografts increased $593,000, or 2.3%, to $26.9 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase resulted primarily from higher unit volumes of 3.8%, partially offset by decreases in average revenue per unit of 1.5% due primarily to changes in product mix. Bone Graft Substitutes (BGS) and General Orthopedic--Revenues from BGS and general orthopedic allografts increased $2.3 million, or 9.7%, to $25.4 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. BGS and general orthopedic revenues increased primarily as a result of higher unit volumes of 15.0%, partially offset by lower average revenue per unit of 3.2% due to changes in product mix. Growth in unit volumes resulted from new products introduced in the last twenty-one months increased distributor orders and increased market penetration through our direct distribution force both domestically and internationally. Dental--Revenues from dental allografts decreased $239,000, or 0.8%, to $29.7 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. Dental revenues decreased primarily as a result of a 21.7% decrease in average revenue per unit which was a function of the new exclusive distribution agreement with our dental distributor. Effective September 30, 2010, we changed from a marketing fee structure to a transfer fee structure, which lowered distribution revenue per unit. The new agreement included a $4.0 million stocking order at transfer fees which offset the decrease in revenue and resulted in an increase in unit volumes of 26.6%. Other Revenues--Revenues from other sources, consisting of tissue recovery fees, biomedical laboratory fees, recognition of previously deferred revenues, shipping fees, distribution of reproductions of our allografts to distributors for demonstration purposes, and restocking fees, increased by $687,000, or 15.3%, to $5.2 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase was due to higher deferred revenue amortization resulting from exclusivity payments received from our dental and surgical specialty distributors. Foreign Currency Fluctuations--For the twelve months ended December 31, 2010, foreign currency exchange fluctuations resulted in a decrease in total revenues of $738,000 due to a 2.8% increase in the value of the U.S. dollar versus the Euro, as compared to the prior year period. Costs of Processing and Distribution. Costs of processing and distribution increased by $3.1 million, or 3.6%, to $90.2 million for the year ended December 31, 2010. As a percentage of revenues, costs of processing and distribution increased from 52.9% for the year ended December 31, 2009 to 54.3% for the year ended December 31, 2010. The increase in cost of processing and distribution was primarily due to higher levels of tissue distributed during the year. Marketing, General and Administrative Expenses. Marketing, general and administrative expenses decreased by $93,000, or 0.2%, to $59.2 million for the year ended December 31, 2010 from $59.3 million for the year ended December 31, 2009. Marketing, general and administrative expenses decreased as a percentage of revenues from 36.1% for the year ended December 31, 2009 to 35.6% for the year ended December 31, 2010. The decrease in marketing, general and administrative expenses was primarily due to decreases in legal, distributor commissions, bad debt, and utilities expenses offset by an increase in payroll and benefits expenses. Research and Development Expenses. Research and development expenses increased by $536,000, or 6.0%, to $9.4 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. As a percentage of revenues, research and development expenses increased from 5.4% for the year ended December 31, 2009 to 5.7% for the year ended December 31, 2010. These increases are primarily due to increases in legal expenses of $229,000 for patent prosecution and research supplies of $780,000, offset by decreases in studies and compensation expenses of $309,000. 35 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 39/77 4/1/12 Form 10-K Table of Contents Restructuring Charges. As a result of the merger with TMI we implemented a formal restructuring plan which resulted in $42,000 of severance benefits for the year ended December 31, 2009. There were no restructuring charges for the year ended December 31, 2010. Goodwill Impairment, Asset Impairments and Abandonments. We recognized a $134.7 million loss on goodwill impairment, asset impairments and abandonments during the year ended December 31, 2010, compared to $208,000 for the year ended December 31, 2009. Based on the then existing economic environment, the severe decline in our stock price beginning late in the second quarter of 2010 and sustained through year-end, and the significant gap between the book and market value of our equity, we concluded that there were sufficient indicators to require an interim goodwill impairment analysis as of September 30, 2010. For purposes of this analysis, estimates of fair value were based on a combination of the income approach, which estimates the fair value of our reporting unit based on future discounted cash flows, and the market approach, which estimates the fair value of our reporting unit on comparable market prices. Based on the goodwill impairment analysis, we recorded a $134.7 million goodwill impairment charge for the remaining balance of goodwill on the balance sheet during the year ended December 31, 2010. The goodwill impairment charge did not affect our liquidity or financial covenants. We concluded our goodwill impairment assessment in the fourth quarter of 2010 which resulted in no change to the goodwill impairment charge recorded during the third quarter of 2010. Net Other (Expense) Income. Net other expense was $419,000 for the year ended December 31, 2010 compared to $564,000 for the year ended December 31, 2009. Interest expense decreased by $7,000 for the year ended December 31, 2010 to $537,000 from $544,000 for the year ended December 31, 2009 due to lower interest rates paid on long-term obligations. Interest income decreased by $159,000 for the year ended December 31, 2010 to $114,000 from $273,000 for the year ended December 31, 2009 due to the lower interest earned on the investment of excess cash in interest bearing cash equivalents than the comparable prior year period. Foreign exchange gain was $4,000 for the year ended December 31, 2010 compared to an exchange loss of $293,000 for the year ended December 31, 2009 due to changes in the value of the U.S. dollar versus the Euro and the timing of payments on foreign currency liabilities. Income Tax Provision. Income tax provision for the year ended December 31, 2010 was $1.6 million compared to an income tax provision of $2.6 million for the year ended December 31, 2009. Our effective tax rate for the year ended December 31, 2010 and 2009 was (1.3)% and 30.8%, respectively. Our effective tax rate for the year ended December 31, 2010 as compared to 2009 was negatively impacted by the non-deductible goodwill impairment for the year ended December 31, 2010. Liquidity and Capital Resources Our working capital at December 31, 2011 decreased $1.5 million to $124.1 million from $125.6 million at December 31, 2010. The decrease in working capital was primarily due to a decrease in inventories and deferred tax assets partially offset by an increase in cash and cash equivalents on hand. At December 31, 2011, we had 45 days of revenues outstanding in trade accounts receivable, an increase of 1 day compared to December 31, 2010. The increase was due to lower cash receipts from customers than shipments and corresponding billings to customers during 2011. At December 31, 2011 we had 300 days of inventory on hand, a decrease of 40 days compared to December 31, 2010. The decrease was primarily as a result of heightened focus on our management of inventory. We had $46.2 million of cash and cash equivalents at December 31, 2011. Our long term obligations at December 31, 2011 decreased $2.4 million to $591,000 from $3.0 million at December 31, 2010. The decrease in long term obligations was primarily due to our paying down $2.1 million of our term loans. At December 31, 2011, we have $17.1 million of borrowing capacity available under our revolving credit facilities. As of December 31, 2011, we believe that our working capital, together with our borrowing ability under our revolving credit facilities, will be adequate to fund our on-going operations for the next twelve months. 36 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 40/77 4/1/12 Form 10-K Table of Contents Certain Commitments. On September 3, 2010, we entered into a new exclusive distribution agreement (the "Agreement"), with Zimmer Dental Inc. ("Zimmer"), a subsidiary of Zimmer, Inc., with an effective date of September 30, 2010. The Agreement has an initial term of ten years. Under the terms of the Agreement, we have agreed to supply sterilized allograft and xenograft implants at an agreed upon transfer price, and Zimmer has agreed to be the exclusive distributor of the implants for dental and oral applications worldwide (except the Ukraine), subject to certain obligations under an existing distribution agreement with a third party with respect to certain implants for the dental market. In consideration for Zimmer's exclusive distribution rights, Zimmer agreed to the following: 1) payment to the Company of $13.0 million within ten days of the effective date ("the Upfront Payment"), 2) annual exclusivity fees ("Annual Exclusivity Fees") paid annually for the term of the contract to be paid at the beginning of each calendar year, and, 3) escalating annual purchase minimums to maintain exclusivity. Upon occurrence of an event that materially and adversely affects Zimmer's ability to distribute the Implants, Zimmer may be entitled to certain refund rights with respect to the Upfront Payment and the then current Annual Exclusivity Fee, where such refund would be in an amount limited by a formula specified in the Agreement that is based substantially on the number of days from the occurrence of such event to the date that it is cured by us to the satisfaction of Zimmer. The Upfront Payment and the Annual Exclusivity Fees are deferred as received and will be recognized as other revenues over the term of the Agreement based on the escalating annual purchase minimums relative to the total minimum purchase requirements in the Agreement. Additionally, we have considered the potential impact of the Agreement's contractual refund provisions and we do not expect these provisions to impact future expected revenue related to the Agreement. On September 10, 2010, we entered into an Exclusive License Agreement (the "Exclusive License") with Athersys, pursuant to which Athersys will provide us access to its Multipotent Adult Progenitor Cell ("MAPC") technologies to develop and commercialize MAPC technology-based biologic implants for certain orthopedic applications. In consideration for the Exclusive License, we agreed to pay Athersys the following: 1) a non-refundable $3.0 million license fee, payable in three time-based $1.0 million installments, the last of which was paid in the first quarter of 2011, 2) payment of $2.0 million contingent upon successful achievement of certain development milestones which we have recorded in accrued expenses, and 3) up to $32.5 million contingent upon achievement of certain cumulative revenue milestones in future years. In addition, we will pay Athersys royalties from the distribution of implants under a tiered royalty structure based on achievement of certain cumulative revenue milestones. The term of the Exclusive License Agreement is the longer of five years, or the remaining life of any patent or trade secret. These acquired licensing rights are being amortized to expense on a straight-line basis over the expected life of the asset. On November 24, 2008, we entered into a License Agreement with LifeNet Health, Inc. to license from LifeNet Health certain intellectual property rights that may be used in or useful to our tissue processing efforts. The term of the License Agreement is for seven years or the remaining life of any patent covered by the License Agreement, whichever is longer. Total monetary consideration for the License Agreement is $4.9 million, to be paid in five annual installments of approximately $1.0 million in each of November 2008 through 2012. The asset is being expensed on a straight-line basis over the life of the asset. On May 14, 2007, we entered into an exclusive distribution agreement with Zimmer with an initial term of 10 years, relating to certain new bone graft substitutes products. As part of the agreement, Zimmer made payments to us totaling $5.0 million for the aforementioned exclusive distribution rights, and has to maintain certain minimum order volumes through the duration of the contract. The $5.0 million exclusivity payment has been deferred and is being recognized as other revenue on a straight-line basis over the initial term of the contract. The contract provides for repayment, on a pro rata basis, of the exclusivity payments during the initial contract term for specific events of non-performance, as defined in the agreement. The agreement also includes automatic two-year renewal terms, as well as buy-out provisions by both parties upon proper notice of cancellation. 37 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 41/77 4/1/12 Form 10-K Table of Contents The Company's short-term and long-term obligations and availability of credit as of December 31, 2011 are as follows: Outstanding Available Balance Credit (In thousands) Short-term obligations: Credit facilities Total short-term obligations Long-term obligations: Credit facility Long-term obligations Capital leases Total long-term obligations Total obligations $ $ -- -- -- 131 460 591 591 $ 2,201 2,201 14,905 -- -- 14,905 $17,106 We have two outstanding term loans with German banks. The first term loan of 63,000 Euro, or $82,000, maturing March 31, 2012 has an associated interest rate swap agreement. Under this agreement, we pay a fixed interest rate of 5.15% and payments or receipts on the agreement are recorded as adjustments to interest expense. Such adjustments have not been significant. The second term loan of 38,000 Euro, or $49,000, maturing September 30, 2012 has a fixed interest rate of 5.75%. We also have capital leases with interest rates ranging from 5.00% to 8.46% and maturity dates from May 2013 through December 2013. We have a total of four revolving credit facilities, one credit facility with a U.S. bank and three credit facilities with German banks. We have $17.1 million total available credit on the four revolving credit facilities at December 31, 2011. As of December 31, 2011, there were no amounts outstanding on any of the four revolving credit facilities. On July 21, 2010, we entered into a second amendment to our credit agreement with Mercantile Bank, a division of Toronto-Dominion Bank. Under the second amendment to the credit agreement, 1) the revolving U.S. credit facility was increased from $10 million to $15 million, available based on levels of accounts receivable and inventories, 2) the revolving credit facility's maturity date was extended from February 3, 2011 to July 21, 2012, and 3) a $5 million compensating balance requirement was eliminated. The revolving credit facility contains various restrictive covenants which limit, among other things, indebtedness and liens and is secured by our domestic accounts receivable, inventory and certain processing equipment. The current interest rate for this line of credit is 4.25%. Under the terms of the revolving credit facilities with three German banks, we may borrow up to 1.7 million Euro, or approximately $2.3 million, for working capital needs. The 1 million Euro revolving credit facility is secured by a mortgage on our German facility. The 500,000 Euro revolving credit facility is secured by accounts receivable of our German subsidiary. The 200,000 Euro revolving credit facility is unsecured. The current interest rates for these lines of credit vary from 3.30% to 6.18%. 38 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 42/77 4/1/12 Form 10-K Table of Contents The following table provides a summary of our debt obligations, operating lease payments, estimated future expenditures, other purchase obligations, and unrecognized tax benefits as of December 31, 2011. Total Contractual Payments Due by Period 2012 2013 2014 2015 (In thousands) After 2015 Debt obligations Operating lease payments Other significant obligations(1) Unrecognized tax benefits Total (1) $ 591 2,349 5,061 567 $8,568 $ 448 1,312 4,854 -- $6,614 $ 135 714 207 -- $1,056 $ 8 165 -- 567 $740 $-- 79 -- -- $ 79 $ $ -- 79 -- -- 79 These amounts consist of contractual obligations for tissue recovery development grants and licensing fees. As of December 31, 2011, we had state net operating loss carryforwards of $18.0 million, research tax credit carryforwards of $5.0 million, and we have consumed all of our federal net operating loss carryforwards. We anticipate a portion of these amounts will be utilized to offset our tax liability in 2012, with any remainder used in ensuing years. When these carryforwards are fully utilized, they will reduce our income taxes payable by $6.4 million. Impact of Inflation Inflation generally affects us by increasing our cost of labor, equipment and processing tools and supplies. We do not believe that the relatively low rates of inflation experienced in the United States since the time we began operations have had any material effect on our business. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. We are subject to market risk from exposure to changes in interest rates based upon our financing, investing and cash management activities. We do not expect changes in interest rates to have a material adverse effect on our income or our cash flows in 2012. However, we cannot assure that interest rates will not significantly change in the future. In the United States and Germany, we are exposed to interest rate risk. Changes in interest rates affect interest income earned on cash and cash equivalents and interest expense on revolving credit arrangements. Except for an interest rate swap associated with 63,000 Euros (or $82,000) of long-term debt over six years that was started March 31, 2006 we have not entered into derivative transactions related to cash and cash equivalents or debt. Accordingly, we are subject to changes in interest rates. Based on December 31, 2011 outstanding intercompany balances, a 1% change in interest rates would have had a de-minimis impact on our results of operations. The value of the U.S. dollar compared to the Euro affects our financial results. Changes in exchange rates may positively or negatively affect revenues, gross margins, operating expenses and net income. The international operation currently transacts business primarily in the Euro. Assets and liabilities of foreign subsidiaries are translated at the period end exchange rate while revenues and expenses are translated at the average exchange rate for the period. Intercompany transactions are translated from the Euro to the U.S. dollar. Based on December 31, 2011 outstanding intercompany balances, a 1% change in currency rates would have had a de-minimis impact on our results of operations. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Our consolidated financial statements and supplementary data required in this item are set forth at the pages indicated in Item 15(a)(1). 39 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 43/77 4/1/12 Form 10-K Table of Contents Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. Item 9A. CONTROLS AND PROCEDURES. Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), which are required in accordance with Rule 13a-15 of the Exchange Act. This "Controls and Procedures" section includes information concerning the controls and controls evaluation referred to in the certifications. As of the end of the period covered by this report, an evaluation was performed on the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Disclosure controls and procedures include controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and accumulated and communicated to the Company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures were effective as of the end of the period covered by this report. Changes in Internal Controls There have been no changes in the Company's internal control over financial reporting during the Company's last fiscal quarter that materially affected, or are reasonably likely to materially affect the Company's internal control over financial reporting. Management's Report on Effectiveness of Internal Controls The management of RTI Biologics, Inc. and subsidiaries (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Securities Exchange Act Rules 13a-15(f) and 15d-15(f)). The Company's internal control system was designed to provide reasonable assurance to the Company's management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2011. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control--Integrated Framework. Based on this assessment, management believes that, as of December 31, 2011, the Company's internal control over financial reporting is effective based on those criteria. The Company's independent registered public accounting firm has issued a report on the Company's internal control over financial reporting. This report appears on page 44. Item 9B. OTHER INFORMATION. None. 40 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 44/77 4/1/12 Form 10-K Table of Contents PART III Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. The information set forth under the caption "Directors and Executive Officers" in our definitive proxy statement to be used in connection with our 2012 Annual Meeting of Stockholders is incorporated by reference. Information relating to our Code of Ethics that applies to our senior financial professionals is available on our website at www.rtix.com/codeofethics.aspx. Item 11. EXECUTIVE COMPENSATION. The information set forth under the caption "Executive Compensation" in our definitive proxy statement to be used in connection with our 2012 Annual Meeting of Stockholders is incorporated by reference. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information set forth under the captions "Beneficial Ownership of Common Stock by Certain Stockholders and Management" and "Securities Authorized For Issuance Under Equity Compensation Plans" in our definitive proxy statement to be used in connection with our 2012 Annual Meeting of Stockholders is incorporated by reference. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. The information set forth under the caption "Certain Relationships and Related Transactions, and Director Independence" in our definitive proxy statement to be used in connection with our 2012 Annual Meeting of Stockholders is incorporated by reference. Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. The information set forth under the caption "Audit Matters" in our definitive proxy statement to be used in connection with our 2012 Annual Meeting of Stockholders is incorporated by reference. 41 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 45/77 4/1/12 Form 10-K Table of Contents PART IV Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) (1) Financial Statements: See "Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule" on page 43, the Independent Registered Public Accounting Firm's Report on page 44 and the Consolidated Financial Statements on pages 46 to 49, all of which are incorporated herein by reference. (2) Financial Statement Schedule: The following consolidated financial statement schedule is filed as part of this Report: Schedule II, Valuation and Qualifying Accounts for the years ended December 31, 2011, 2010 and 2009 is included in the Consolidated Financial Statements of RTI Biologics, Inc. and subsidiaries on page 70. All other financial statement schedules are omitted because they are inapplicable, not required or the information is indicated elsewhere in the consolidated financial statements or the notes thereto. (3) Exhibits: The information required by this item is set forth on the exhibit index that follows the signature page of this report. 42 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 46/77 4/1/12 Form 10-K Table of Contents INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Consolidated Financial Statements of RTI Biologics, Inc. and Subsidiaries Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets--December 31, 2011 and 2010 Consolidated Statements of Operations--Years Ended December 31, 2011, 2010 and 2009 Consolidated Statements of Stockholders' Equity--Years Ended December 31, 2011, 2010 and 2009 Consolidated Statements of Cash Flows--Years Ended December 31, 2011, 2010 and 2009 Notes to Consolidated Financial Statements--Years Ended December 31, 2011, 2010 and 2009 Schedule II--Valuation and Qualifying Accounts 43 44 46 47 48 49 50 - 69 70 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 47/77 4/1/12 Form 10-K Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of RTI Biologics, Inc. Alachua, Florida We have audited the accompanying consolidated balance sheets of RTI Biologics, Inc. and subsidiaries (the "Company") as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in Item 15(a)(2). We also have audited the Company's internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for these financial statements and the financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Effectiveness of Internal Controls. Our responsibility is to express an opinion on these financial statements and the financial statement schedule and an opinion on the Company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company? (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company? and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 44 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 48/77 4/1/12 Form 10-K Table of Contents In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RTI Biologics, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. /s/ DELOITTE & TOUCHE LLP Certified Public Accountants Tampa, Florida February 15, 2012 45 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 49/77 4/1/12 Form 10-K Table of Contents RTI BIOLOGICS, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except share data) December 31, 2011 2010 Assets Current Assets: Cash and cash equivalents Accounts receivable--less allowances of $323 at December 31, 2011 and $490 at December 31, 2010 Inventories--net Prepaid and other current assets Deferred tax assets--net Total current assets Property, plant and equipment--net Deferred tax assets--net Other intangible assets--net Other assets--net Total assets Liabilities and Stockholders' Equity Current Liabilities: Accounts payable Accrued expenses Deferred tax liabilities Current portion of deferred revenue Current portion of long-term obligations Total current liabilities Long-term obligations--less current portion Other long-term liabilities Deferred tax liabilities Deferred revenue Total liabilities Stockholders' equity: Common stock, $.001 par value: 150,000,000 shares authorized? 55,568,345 and 54,806,762 shares issued and outstanding, respectively Additional paid-in capital Accumulated other comprehensive loss Accumulated deficit Less treasury stock, 133,296 shares, at cost Total stockholders' equity Total liabilities and stockholders' equity $ 46,178 $ 20,674 76,598 4,883 11,348 159,681 44,532 11,700 13,654 460 230,027 $ 28,212 $ 20,126 87,278 7,646 15,810 159,072 43,346 7,099 15,611 630 225,758 $ 11,141 19,378 -- 4,650 448 35,617 143 920 339 20,589 57,608 $ 12,570 14,340 939 4,474 1,120 33,443 1,877 3,135 249 25,118 63,822 56 411,699 (2,184) (237,138) (14) 172,419 $ 230,027 55 408,849 (1,438) (245,516) (14) 161,936 $ 225,758 See notes to consolidated financial statements. 46 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 50/77 4/1/12 Form 10-K Table of Contents RTI BIOLOGICS, INC. AND SUBSIDIARIES Consolidated Statements of Operations (In thousands, except share and per share data) 2011 Year Ended December 31, 2010 2009 Revenues: Fees from tissue distribution Other revenues Total revenues Costs of processing and distribution Gross profit Expenses: Marketing, general and administrative Research and development Restructuring charges Goodwill impairment Asset abandonments Total expenses Operating income (loss) Other (expense) income: Interest expense Interest income Foreign exchange (loss) gain Total other expense--net Income (loss) before income tax provision Income tax provision Net income (loss) Net income (loss) per common share--basic Net income (loss) per common share--diluted Weighted average shares outstanding--basic Weighted average shares outstanding--diluted $ $ $ $ 162,855 6,461 169,316 92,102 77,214 55,576 9,806 -- -- 61 65,443 11,771 (201) 193 (159) (167) 11,604 (3,226) 8,378 0.15 0.15 $ $ $ $ 161,001 5,170 166,171 90,168 76,003 59,232 9,435 -- 134,681 30 203,378 (127,375) (537) 114 4 (419) (127,794) (1,605) (129,399) (2.36) (2.36) $ $ $ $ 160,044 4,483 164,527 87,034 77,493 59,325 8,899 42 -- 208 68,474 9,019 (544) 273 (293) (564) 8,455 (2,600) 5,855 0.11 0.11 55,150,886 55,354,675 54,729,608 54,729,608 54,349,391 54,772,489 See notes to consolidated financial statements. 47 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 51/77 4/1/12 Form 10-K Table of Contents RTI BIOLOGICS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (In thousands) Additional Paid-in Capital Accumulated Other Comprehensive Loss Common Stock Accumulated Deficit Treasury Stock Total Balance, January 1, 2009 Net income Foreign currency translation adjustment Comprehensive income Exercise of common stock options Stock-based compensation Income tax benefit from nonqualified stock option exercises Balance, December 31, 2009 Net loss Foreign currency translation adjustment Comprehensive loss Exercise of common stock options Stock-based compensation Change in income tax benefit from stock-based compensation Balance, December 31, 2010 Net income Foreign currency translation adjustment Comprehensive (loss) income Exercise of common stock options Stock-based compensation Change in income tax benefit from stock-based compensation Balance, December 31, 2011 $ $ 55 -- -- -- -- -- -- 55 -- -- -- -- -- -- 55 -- -- -- 1 -- -- 56 $403,746 -- -- -- 525 1,882 186 406,339 -- -- -- 764 1,758 (12) 408,849 -- -- -- 1,121 1,973 (244) $411,699 $ $ (765) -- 391 391 -- -- -- (374) -- (1,064) (1,064) -- -- -- (1,438) -- (746) (746) -- -- -- (2,184) $(121,972) 5,855 -- 5,855 -- -- -- (116,117) (129,399) -- (129,399) -- -- -- (245,516) 8,378 -- 8,378 -- -- -- $(237,138) $ $ (14) -- -- -- -- -- -- (14) -- -- -- -- -- -- (14) -- -- -- -- -- -- (14) $ 281,050 5,855 391 6,246 525 1,882 186 289,889 (129,399) (1,064) (130,463) 764 1,758 (12) 161,936 8,378 (746) 7,632 1,122 1,973 (244) $ 172,419 See notes to consolidated financial statements. 48 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 52/77 4/1/12 Form 10-K Table of Contents RTI BIOLOGICS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (In thousands) Year Ended December 31, 2011 2010 2009 $ 8,378 8,026 22 450 4,840 (4,353) (1,584) 1,973 -- 313 (282) 61 -- (1,054) 5,558 2,717 147 (2,564) 5,353 (234) -- $(129,399) 7,498 82 166 2,107 (2,917) 1,719 1,758 134,681 -- -- 30 -- 1,681 4,095 (1,612) 289 (5,126) 792 (2,955) 16,500 29,389 (3,244) -- (3,812) (7,056) $ 5,855 7,139 72 209 1,940 (2,283) 1,529 1,882 -- 212 (186) 200 8 (7,665) (20,540) 1,984 (790) 2,007 (4,866) 919 8,000 (4,374) (4,422) 18 (387) (4,791) 525 186 (2,092) 13,103 (5,358) 6,364 107 Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization expense Amortization of deferred financing costs Provision for bad debts and product returns Provision for inventory writedowns Amortization of deferred revenue Deferred income tax (expense) benefit Stock-based compensation Goodwill and intangible asset impairments Tax benefit attributable from exercise of stock options Excess tax benefit from exercise of stock options Loss on asset abandonments Write-off of capitalized patent and trademark expenses Changes in assets and liabilities: Accounts receivable Inventories Prepaid and other current assets Other long-term assets Accounts payable Accrued expenses Other non-current liabilities Deferred revenue Net cash provided by (used in) operating activities Cash flows from investing activities: Purchases of property, plant and equipment Proceeds from sale of property, plant and equipment Patent and acquired intangible asset costs Net cash used in investing activities Cash flows from financing activities: Proceeds from exercise of stock options Excess tax benefit from exercise of stock options Net proceeds on short-term obligations Proceeds from long-term obligations Payments on long-term obligations Net cash (used in) provided by financing activities Effect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year 27,767 (6,345) -- (2,139) (8,484) 1,122 282 -- -- (2,600) (1,196) (121) 17,966 28,212 $46,178 764 -- (1,947) 9,750 (20,074) (11,507) 4 10,830 17,382 (2,694) 20,076 $ 17,382 $ 28,212 See notes to consolidated financial statements. 49 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 53/77 4/1/12 Form 10-K Table of Contents RTI BIOLOGICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years Ended December 31, 2011, 2010 and 2009 (In thousands, except share and per share data) 1. Business RTI Biologics, Inc. ("the Company"), and its subsidiaries recover and process human and animal tissue. The processing transforms the tissue into either conventional or precision machined allograft implants (human) or xenograft implants (animal), for orthopedic and other surgical applications to promote the natural healing of human bone and other human tissue. These implants are distributed domestically and internationally, for use in reconstruction and fracture repair. 2. Summary of Significant Accounting Policies Principles of Consolidation--The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Tutogen Medical, Inc. ("TMI"), RTI Biologics, Inc. - Cardiovascular (inactive), Biological Recovery Group (inactive), and RTI Services, Inc. The consolidated financial statements also include the accounts of RTI Donor Services, Inc. ("RTIDS"), which is a controlled entity. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. All intercompany balances and transactions have been eliminated in consolidation. RTIDS is a taxable not-for-profit entity organized and controlled by the Company. RTIDS is the corporate entity that is responsible for procuring tissue for the Company. Expenses incurred by RTIDS to procure tissue are passed through to the Company. RTIDS has no significant assets or liabilities except for its intercompany accounts receivable and accounts payable to tissue recovery agencies. The Company pays all expenses of RTIDS. Use of Estimates--The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates and assumptions relating to inventories, receivables, long-lived assets, investment valuations and litigation are made at the end of each financial reporting period by management. Actual results could differ from those estimates. Foreign Currency Translation--The functional currency of the Company's German subsidiary is the Euro. Assets and liabilities of the foreign subsidiary are translated at the period end exchange rate while revenues and expenses are translated at the average exchange rate for the period. The resulting translation adjustments, representing unrealized, noncash gains and losses are recorded and presented as a component of comprehensive (loss) income. Gains and losses resulting from transactions of the Company and its subsidiaries, which are made in currencies different from their own, are included in income or loss as they occur and are included in net other (expense) income in the consolidated statements of operations. Derivative Instruments--The Company accounts for its hedging activities in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 815, Accounting for Derivatives and Hedging Activities, as amended. FASB ASC 815 requires that all hedging activities be recognized in the balance sheet as assets or liabilities and be measured at fair value. Gains or losses from the change in fair value of hedging instruments that qualify for hedge accounting are recorded in other comprehensive (loss) income. The Company's policy is to specifically identify the assets, liabilities or future commitments being hedged and monitor the hedge to determine if it continues to be effective. The Company does not enter into or hold derivative instruments for trading or speculative purposes. The Company has an interest rate swap agreement as disclosed in Note10 of the financial statements. 50 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 54/77 4/1/12 Form 10-K Table of Contents Fair Value of Financial Instruments--The estimated fair value of financial instruments disclosed in the consolidated financial statements has been determined by using available market information and appropriate valuation methodologies. The carrying value of all current assets and current liabilities approximates fair value because of their short-term nature. The carrying value of the long-term debt obligations approximates fair value. The carrying value of capital lease obligations approximates the fair value, based on current market prices. Cash and Cash Equivalents--The Company considers all funds in banks and short-term investments with an original maturity of three months or less to be cash and cash equivalents. Accounts Receivable Allowances--The Company maintains allowances for doubtful accounts based on the Company's review and assessment of payment history and its estimate of the ability of each customer to make payments on amounts invoiced. If the financial condition of any of its customers were to deteriorate, additional allowances might be required. From time to time the Company must adjust its estimates. Changes in estimates of the collection risk related to accounts receivable can result in decreases and increases to current period net income. Inventories--Implantable donor tissue inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out method. Inventory writedowns are recorded for unprocessed donor tissue based on the estimated amount of inventory that will not pass the quality control process based on historical data, and the amount of inventory that is not readily distributable or is unusable. In addition, provisions for inventory writedowns are estimated for tissue in process inventory that is not readily distributable or is unusable. Any implantable donor tissue deemed to be obsolete is included in the writedown at the time the determination is made. Recalls--The Company accrues the estimated cost of recalls at the date the recall is initiated. The cost of recalls is primarily comprised of implant replacement costs. The Company had two recalls in both 2011 and 2010, and in 2009 the Company had one recall. The Company incurred immaterial costs related to all of the recalls for the years ended December 31, 2011, 2010 and 2009. Property, Plant and Equipment--Property, plant, and equipment are stated at cost less accumulated depreciation. The cost of equipment under capital leases and leasehold improvements is amortized on the straight-line method over the shorter of the lease term or the estimated useful life of the asset. Depreciation is computed on the straight-line method over the following estimated useful lives of the assets: Buildings Building improvements and leasehold improvements Processing equipment Office equipment, furniture and fixtures Computer hardware and software 25 to 40 years 8 to 40 years 7 to 10 years 5 to 7 years 3 years Software Costs--Included in property, plant and equipment are costs related to purchased software that are capitalized. Debt Issuance Costs--Debt issuance costs include costs incurred to obtain financing and are amortized using the straight-line method, which approximates the effective interest method, over the life of the related debt. Debt issuance costs are included in other assets--net in the accompanying consolidated balance sheets. Long-Lived Assets--The Company periodically evaluates the period of depreciation or amortization for long-lived assets to determine whether current circumstances warrant revised estimates of useful lives. The Company reviews its property, plant and equipment for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Recoverability is measured by a comparison of the carrying amount to the net undiscounted cash flows expected to be generated by the asset. An impairment 51 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 55/77 4/1/12 Form 10-K Table of Contents loss would be recorded for the excess of net carrying value over the fair value of the asset impaired. The fair value is estimated based on expected discounted future cash flows. The results of impairment tests are subject to management's estimates and assumptions of projected cash flows and operating results. Changes in assumptions or market conditions could result in a change in estimated future cash flows and the likelihood of materially different reported results. Goodwill--FASB ASC 350, Goodwill and Other Intangible Assets, requires companies to test goodwill for impairment on an annual basis at the reporting unit level (or an interim basis if an event occurs that might reduce the fair value of a reporting unit below its carrying value). The Company has one reporting unit and the annual impairment test is performed at each year-end unless indicators of impairment are present and require more frequent testing. The Company currently does not have any identifiable intangible assets with indefinite useful lives. Goodwill is tested for impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. In concluding as to fair value of the reporting unit for purposes of testing goodwill, an income approach and a market approach are utilized. The conclusion from these two approaches are weighted equally and then adjusted to incorporate a control premium or acquisition premium that reflects the additional amount a buyer is willing to pay for elements of control and for a premium that reflects the buyer's perception of its ability to add value through synergies. In general, the income approach employs a discounted cash flow model that considers 1) assumptions that marketplace participants would use in their estimates of fair value, including the cash flow period, terminal values based on a terminal growth rate and the discount rate, 2) current period actual results, and 3) projected results for future periods that have been prepared and approved by senior management of the Company. The forecasted cash flows do not include synergies that a marketplace participant would be expecting to achieve. The market approach employs market multiples from guideline public companies operating in our industry. Estimates of fair value are derived by applying multiples based on revenue and earnings before interest, taxes, depreciation and amortization ("EBITDA") adjusted for size and performance metrics relative to peer companies. A control premium was included in determining the fair value under this approach. If the carrying amount of the reporting unit exceeds its calculated fair value, the second step of the goodwill impairment test is performed in accordance with FASB ASC 350 to measure the amount of the impairment loss, if any. Both approaches used in the analysis have a degree of uncertainty. Potential events or changes in circumstances which could impact the key assumptions used in our goodwill impairment evaluation are as follows: o o o o Change in peer group or performance of peer group companies Change in the Company's markets and estimates of future operating performance Change in the Company's estimated market cost of capital Change in implied control premiums related to acquisitions in the medical device industry. Based on the then existing economic environment and the severe decline in the Company's stock price beginning late in the second quarter of 2010 and sustained through year-end 2010, and the significant gap between the book and market value of the Company's equity, the Company concluded that there were sufficient indicators to require an interim goodwill impairment analysis as of September 30, 2010. For purposes of this analysis, estimates of fair value were based on a combination of the income approach, which estimates the fair value of the Company's reporting unit based on future discounted cash flows, and the market approach, which estimates the fair value of the Company's reporting unit on comparable market prices. Based on the goodwill 52 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 56/77 4/1/12 Form 10-K Table of Contents impairment analysis performed, the Company recorded a $134,681 goodwill impairment charge for the remaining balance of goodwill on the balance sheet during the third quarter of 2010. The goodwill impairment charge did not affect the Company's liquidity, nor does it affect any financial covenants of the Company's credit agreements. The Company concluded its goodwill impairment assessment in the fourth quarter of 2010, which resulted in no change to the goodwill impairment charge recorded during the third quarter of 2010. Intangible Assets--ASC 350 requires that definite lived intangible assets subject to amortization be tested for recoverability at the asset group level in accordance with ASC 360. The Company had one asset group for the year ended December 31, 2011. The recoverability test is described in the Company's accounting policy for long-lived assets set forth above. Intangible assets generally consist of patents, trademarks, procurement contracts, customer lists, non-compete agreements, distribution agreements, licensing rights, and acquired exclusivity rights. Patents and trademarks are amortized on the straight-line method over the shorter of the remaining protection period or estimated useful lives of between 8 and 16 years. Procurement contracts, customer lists, non-compete agreements, licensing rights, and distribution agreements are amortized over estimated useful lives of between 5 to 25 years. The acquired exclusivity rights are being amortized over eight years, the remaining term of the amended distribution agreement. Research and Development Costs--Research and development costs, including the cost of research and development conducted for others and the cost of contracted research and development, are expensed as incurred. Revenue Recognition--Revenue is recognized upon shipping, or receipt by the Company's customers of the processed tissue for implantation, depending on the Company's distribution agreements with the Company's customers or distributors. Other revenues are recognized when all significant contractual obligations have been satisfied. The Company permits returns of tissue in accordance with the terms of contractual agreements with customers if the tissue is returned in a timely manner, in unopened packaging, and from the normal channels of distribution. Allowances for returns are provided based upon analysis of the Company's historical patterns of returns matched against the revenues from which they originated. On September 3, 2010, the Company and Zimmer Dental Inc. ("Zimmer"), a subsidiary of Zimmer, Inc., entered into a new exclusive distribution agreement (the "Agreement"), with an effective date of September 30, 2010. The Agreement has an initial term of ten years. Under the terms of the Agreement, the Company has agreed to supply sterilized allograft and xenograft implants at an agreed upon transfer price, and Zimmer has agreed to be the exclusive distributor of the implants for dental and oral applications worldwide (except the Ukraine), subject to certain Company obligations under an existing distribution agreement with a third party with respect to certain implants for the dental market. In consideration for Zimmer's exclusive distribution rights, Zimmer agreed to the following: 1) payment to the Company of $13,000 within ten days of the effective date ("the Upfront Payment"), 2) annual exclusivity fees ("Annual Exclusivity Fees") paid annually for the term of the contract to be paid at the beginning of each calendar year, and, 3) escalating annual purchase minimums to maintain exclusivity. Upon occurrence of an event that materially and adversely affects Zimmer's ability to distribute the Implants, Zimmer may be entitled to certain refund rights with respect to the Upfront Payment and the then current Annual Exclusivity Fee, where such refund would be in an amount limited by a formula specified in the Agreement that is based substantially on the number of days from the occurrence of such event to the date that it is cured by the Company to the satisfaction of Zimmer. The Upfront Payment and the Annual Exclusivity Fees are deferred as received and will be recognized as other revenues over the term of the Agreement based on the expected contractual escalating annual purchase minimums relative to the total contractual minimum purchase requirements in the Agreement. Additionally, the Company has considered the potential impact of the Agreement's contractual refund provisions and does not expect these provisions to impact future expected revenue related to the Agreement. 53 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 57/77 4/1/12 Form 10-K Table of Contents On July 13, 2009, the Company and Davol amended their previous distribution agreement with TMI for human dermis implants. Under the amended agreement, 1) Davol paid the Company $8,000 in non-refundable fees for exclusive distribution rights for the distribution to the breast reconstruction market until July 13, 2019, 2) the exclusive worldwide distribution agreement related to the hernia market was extended to July 13, 2019, and 3) Davol agreed to pay the Company certain additional exclusive distribution rights fees contingent upon the achievement of certain revenue milestones by Davol during the duration of the contract. In the fourth quarter of 2010, Davol paid the first revenue milestone payment of $3,500. The $8,000 and $3,500 exclusivity payments have been deferred and are being recognized as other revenues on a straight-line basis over the initial term of the amended contract of ten years, and the remaining term of the amended contract, respectively. The straight-line method approximates the expected pattern of product distribution based on the distribution agreement's contractual annual minimum purchase requirements. On May 14, 2007, the Company entered into an exclusive distribution agreement with Zimmer with an initial term of ten years, relating to certain new bone graft substitutes implants. As part of the agreement, Zimmer made payments to the Company totaling $5,000 for the aforementioned exclusive distribution rights, and has to maintain certain minimum order volumes through the duration of the contract. The $5,000 exclusivity payment has been deferred and is being recognized as other revenue on a straight-line basis over the initial term of the contract. The contract provides for repayment, on a pro rata basis, of the exclusivity payments during the initial contract term for specific events of non-performance, as defined in the agreement. The agreement also includes automatic two-year renewal terms, as well as buy-out provisions by both parties upon proper notice of cancellation. The Company's aforementioned revenue recognition methods related to the Zimmer and Davol distribution agreements do not result in the deferral of revenue less than amounts that would be refundable in the event the agreements were to be terminated in future periods. Additionally, the Company evaluates the appropriateness of the aforementioned revenue recognition methods on an ongoing basis. The Company records estimated distribution returns, discounts, rebates and other distribution incentives as a reduction of revenue in the same period revenue is recognized. Estimates of distribution returns are recorded for anticipated distribution returns based on historical distributions and returns information. Estimates of discounts, rebates and other distribution incentives are recorded based on contractual terms, historical experience and trend analysis. Other Revenues--Other revenues consists of tissue recovery fees, biomedical laboratory fees, recognition of previously deferred revenues, shipping fees, distribution of reproductions of our allografts to distributors for demonstration purposes, and restocking fees. Stock-Based Compensation Plans--The Company accounts for its stock-based compensation plans in accordance with FASB ASC 718, Accounting for Stock Compensation. FASB ASC 718 requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including employee stock options and restricted stock. Under the provisions of FASB ASC 718, and U.S. Securities and Exchange Commission Staff, Accounting Bulletin No. 107, stock-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense on a straight-line basis over the requisite service period of the entire award (generally the vesting period of the award). The Company elected to use the modified prospective transition method as permitted by ASC 718 and, therefore, financial results for periods prior to 2006 were not restated. Under this transition method, stock-based compensation expense for the years ended December 31, 2011, 2010 and 2009 includes expense for all equity awards granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of ASC 718. Since the adoption of ASC 718, there have been no changes to the Company's stock compensation plans or modifications to outstanding stock-based awards which would 54 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 58/77 4/1/12 Form 10-K Table of Contents increase the value of any awards outstanding. Compensation expense for all stock-based compensation awards granted subsequent to January 1, 2006 was based on the grant-date fair value determined in accordance with the provisions of ASC 718. Income Taxes--The Company uses the asset and liability method of accounting for income taxes. Deferred income taxes are recorded to reflect the tax consequences on future years for differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to amounts which are more likely than not to be realized. Earnings Per Share--Basic earnings per share ("EPS") is computed by dividing earnings attributable to common stockholders by the weighted-average number of common shares outstanding for the periods. Diluted EPS reflects the potential dilution of securities that could share in the earnings. A reconciliation of the number of common shares used in the calculation of basic and diluted EPS is presented below: 2011 Year Ended December 31, 2010 2009 Basic shares Effect of dilutive securities: Stock options Diluted shares 55,150,886 54,729,608 54,349,391 203,789 -- 423,098 55,354,675 54,729,608 54,772,489 Options to purchase 5,636,892 shares of common stock at prices ranging from $1.76 to $14.95 per share which were outstanding as of December 31, 2011 were included in the computation of diluted EPS because dilutive shares are factored into the calculation of EPS when a profit from continuing operations is reported. Options to purchase 6,308,182 shares of common stock at prices ranging from $1.76 to $14.95 per share which were outstanding as of December 31, 2010 were not included in the computation of diluted EPS because dilutive shares are not factored into the calculation of EPS when a loss from continuing operations is reported as they would be anti-dilutive. Options to purchase 6,259,952 shares of common stock at prices ranging from $1.76 to $14.95 per share which were outstanding as of December 31, 2009 were included in the computation of diluted EPS because dilutive shares are factored into the calculation of EPS when a profit from continuing operations is reported. Presentation of Comprehensive (Loss) Income--In June 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-05, Comprehensive (Loss) Income (Topic 220)--Presentation of Comprehensive (Loss) Income (ASU 2011-05), to require an entity to present the total of comprehensive (loss) income, the components of net (loss) income, and the components of other comprehensive (loss) income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive (loss) income as part of the statement of equity. ASU 2011-05 is effective for us in our first quarter of fiscal 2012 and should be applied retrospectively. Comprehensive (loss) income includes cumulative foreign currency translation adjustments. 3. Stock-Based Compensation The Company has five stock-based compensation plans under which employees, consultants and outside directors have received stock options and restricted stock awards. Stock options are granted with an exercise price equal to 100% of the market value of a share of common stock on the date of the grant, generally have ten-year contractual terms, and vest over a one to five year period from the date of grant. Restricted stock awards are granted with a fair value equal to 100% of the market value of a share of common stock on the date of the grant, and vest over one to three year periods. 55 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 59/77 4/1/12 Form 10-K Table of Contents 2010 Equity Incentive Plan--On April 20, 2010, the Company's stockholders approved and adopted the 2010 Equity Incentive Plan, (the "2010 Plan"). The 2010 Plan provides for the grant of incentive and nonqualified stock options and restricted stock to key employees, including officers and directors of the Company and consultants and advisors. The option price per share may not be less than 100% of the fair market value of such shares on the date granted. The 2010 Plan allows for up to 5,000,000 shares of common stock to be issued with respect to awards granted. 1998 Stock Option Plan and 2004 Equity Incentive Plan--The Company adopted equity incentive plans in 1998 (the "1998 Plan") and 2004 (the "2004 Plan"), which provide for the grant of incentive and nonqualified stock options and restricted stock to key employees, including officers and directors of the Company and consultants and advisors. The option price per share may not be less than 100% of the fair market value of such shares on the date granted. The 1998 and 2004 Plans allow for up to 4,406,400 and 2,000,000 shares, respectively, of common stock to be issued with respect to awards granted. New stock options may no longer be awarded under the 1998 Plan. TMI 1996 Stock Option Plan and TMI 2006 Incentive and Non-Statutory Stock Option Plan--In connection with the merger with TMI, the Company assumed the TMI 1996 Stock Option Plan and the TMI 2006 Incentive and Non-Statutory Stock Option Plan ("TMI Plans"). The TMI Plans allow for 4,880,000 and 1,830,000 shares of common stock, respectively, which may be issued with respect to stock options granted to former TMI employees or employees of the Company hired subsequent to the TMI acquisition. New stock options may no longer be awarded under the TMI 1996 Stock Option Plan. The Company uses the Black-Scholes model to value its stock option grants under FASB ASC 718 and expenses the related compensation cost using the straight-line method over the vesting period. The fair value of stock options is determined on the grant date using assumptions for the expected term, expected volatility, dividend yield, and the risk free interest rate. The term assumption is primarily based on the contractual vesting term of the option and historic data related to exercise and post-vesting cancellation history experienced by the Company. The Company uses the simplified method for estimating the expected term used to determine the fair value of options under FASB ASC 718. The expected term is determined separately for options issued to the Company's directors and to employees. The Company's anticipated volatility level is primarily based on the historic volatility of the Company's common stock. The Company's model includes a zero dividend yield assumption, as the Company has not historically paid nor does it anticipate paying dividends on its common stock. The risk free interest rate approximates recent U.S. Treasury note auction results with a similar life to that of the option. The Company's model does not include a discount for post-vesting restrictions, as the Company has not issued awards with such restrictions. The period expense is then determined based on the valuation of the options, and at that time an estimated forfeiture rate is used to reduce the expense recorded. The Company's estimate of pre-vesting forfeitures is primarily based on the recent historical experience of the Company, and is adjusted to reflect actual forfeitures as the options vest. The following weighted-average assumptions were used to determine the fair value of options under FASB ASC 718: Year Ended December 31, 2011 2010 2009 Expected term (years) Risk free interest rate Volatility factor Dividend yield Stock Options 6.50 2.72% 66.27% -- 6.29 3.13% 66.61% -- 6.27 2.25% 63.42% -- Outstanding options under all option plans vest over a one to five year period. Options expire ten years from the date of grant. 56 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 60/77 4/1/12 Form 10-K Table of Contents As of December 31, 2011, there was $3,052 of total unrecognized compensation cost related to nonvested stock options. That cost is expected to be recognized over a weighted-average period of 3.17 years. Stock options outstanding and exercisable at December 31, 2011 are summarized as follows: Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) Number of Shares Aggregate Intrinsic Value Outstanding at January 1, 2011 Granted Exercised Forfeited or expired Outstanding at December 31, 2011 Vested or expected to vest at December 31, 2011 Exercisable at December 31, 2011 Available for grant at Decembers31, 2011 6,308,182 641,000 (489,300) (822,990) 5,636,892 5,472,856 3,857,092 4,478,278 $ $ 5.79 2.69 2.29 9.52 5.19 5.07 4.97 3.64 $ 3,033 $ 2,836 $ 1,188 $ 5.25 $ 5.89 The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value. For the years ended December 31, 2011, 2010, and 2009, the Company recognized stock-based compensation as follows: Year Ended December 31, 2011 2010 2009 Stock-based compensation: Costs of processing and distribution Marketing, general and administrative Research and development Total $ 207 1,705 61 $1,973 $ 153 1,485 120 $1,758 $ 338 1,443 101 $1,882 For the years ended December 31, 2011, 2010, and 2009, the Company recognized total income tax benefits from stock- based compensation of $660, $477, and $470, respectively. Other information concerning stock options is as follows: Year Ended December 31, 2011 2010 2009 Weighted average fair value of options granted Aggregate intrinsic value of options exercised $1.71 926 $2.56 242 $1.83 857 The aggregate intrinsic value of options exercised in a year represents the cumulative difference between the fair market value of the underlying common stock and the option exercise prices, of the options exercised during the year. Restricted Stock Awards During 2011, the Company granted 272,283 shares of restricted stock with a weighted-average grant date fair value of $2.69 which vest over one and three year periods. As of December 31, 2011, there was $261 of total unrecognized compensation expense related to time-based, nonvested restricted stock. That expense is expected to be recognized on a straight-line basis over a period of 0.93 years. 57 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 61/77 4/1/12 Form 10-K Table of Contents 4. Inventories Inventories by stage of completion are as follows: December 31, 2011 2010 Unprocessed donor tissue Tissue in process Implantable donor tissue Supplies $24,365 26,251 24,266 1,716 $76,598 $27,774 30,688 27,092 1,724 $87,278 For the years ended December 31, 2011, 2010, and 2009, the Company had inventory write-downs of $4,840, $2,107, $1,940, respectively, relating primarily to product obsolescence. 5. Prepaid and Other Current Assets Prepaid and other current assets are as follows: December 31, 2011 2010 Exclusivity fees receivable Other $ -- 4,883 $4,883 $4,000 3,646 $7,646 6. Property, Plant and Equipment Property, plant and equipment are as follows: December 31, 2011 2010 Land Buildings and improvements Processing equipment Office equipment, furniture and fixtures Computer equipment and software Construction in process Equipment under capital leases: Processing equipment Computer equipment Less accumulated depreciation $ 1,789 43,219 27,677 2,182 3,870 6,127 $ 1,816 42,992 27,376 2,025 3,881 258 396 744 86,004 (41,472) $ 44,532 285 744 79,377 (36,031) $ 43,346 Depreciation expense for the years ended December 31, 2011, 2010, and 2009 was $6,039, $5,798, and $5,632, respectively. 58 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 62/77 4/1/12 Form 10-K Table of Contents 7. Other Intangible Assets Other intangible assets are as follows: December 31, 2011 Gross Carrying Accumulated Amount Amortization December 31, 2010 Gross Carrying Accumulated Amount Amortization Patents Acquired exclusivity rights Acquired licensing rights Marketing and procurement intangible assets Total $ 4,425 2,941 10,850 2,944 $21,160 $ $ 1,266 2,043 2,904 1,293 7,506 $ 4,392 2,941 10,850 2,964 $21,147 $ $ 1,032 1,671 1,692 1,141 5,536 On September 10, 2010, the Company entered into an Exclusive License Agreement with Athersys, Inc. ("Athersys"), pursuant to which Athersys will provide the Company access to its Multipotent Adult Progenitor Cell ("MAPC") technologies to develop and commercialize MAPC technology-based biologic implants for certain orthopedic applications. In consideration for the Exclusive License, the Company agreed to pay Athersys the following: 1) a non-refundable $3,000 license fee, payable in three time-based $1,000 installments, the last of which was paid in the first quarter of 2011, 2) payment of $2,000 contingent upon successful achievement of certain development milestones which the Company has recorded in accrued expenses, and 3) up to $32,500 contingent upon achievement of certain cumulative revenue milestones in future years. On November 24, 2008, the Company entered into a License Agreement with LifeNet Health, Inc. ("LifeNet") to license from LifeNet certain intellectual property rights to be used in the Company's tissue processing efforts. The term of the License Agreement is for seven years or the remaining life of any patent covered by the License Agreement, whichever is longer. Total monetary consideration for the License Agreement is $4,900, to be paid in five annual installments of $980 from November 2008 to 2012. During the year ended December 31, 2006, the Company and Medtronic ("Medtronic") entered into an amended distribution agreement which allows the Company, among other things, the ability to distribute spinal allografts through other distributors. In conjunction with the amendment, the Company paid Medtronic $3,000 to buyout exclusivity provisions under the former distribution agreement. Of this payment, $2,444 relates to the acquired exclusivity rights and was recorded as an intangible asset and the remaining $556 reduced deferred revenue. On December 15, 2006 the Company recorded $2,908 in marketing and procurement intangibles related to CryoLife's orthopedic sports medicine business which are recorded in other intangible assets. Patents are amortized on the straight-line method over the shorter of the remaining protection period or estimated useful life of between 8 and 16 years. The acquired exclusivity rights are being amortized over eight years, the remaining term of the amended distribution agreement. Acquired licensing rights and marketing and procurement intangible assets are amortized over estimated useful lives of between 5 to 25 years. Amortization expense for the years ended December 31, 2011, 2010, and 2009 was $1,987, $1,700, and $1,507, respectively. At December 31, 2011, management's estimates of amortization expense for the next five years are as follows: Amortization Expense 2012 2013 2014 2015 2016 $ 59 2,100 2,100 1,800 1,500 1,000 8,500 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 63/77 4/1/12 Form 10-K Table of Contents 8. Other Assets Other assets are as follows: December 31, 2011 2010 Debt issuance costs Other Less accumulated amortization $ 54 442 496 (36) $460 $ 194 590 784 (154) $ 630 The Company recognized interest expense associated with the amortization of its debt issuance costs for the years ended December 31, 2011, 2010, and 2009 of $22, $82 and $72, respectively. 9. Accrued Expenses Accrued expenses are as follows: December 31, 2011 2010 Accrued compensation Accrued donor recovery fees Accrued distributor fees and marketing commissions Accrued severance Accrued licensing fees Accrued taxes Accrued professional service fees Other $ 4,267 2,730 577 -- 3,131 4,332 310 4,031 $19,378 $ 3,372 1,535 429 40 3,354 161 544 4,905 $14,340 The Company accrues for the estimated recovery fees due to third party recovery agencies as tissue is received. 10. Short and Long-Term Obligations Short and long-term obligations are as follows: December 31, 2011 2010 Term loans Capital leases Less current portion Long-term portion $ 131 460 591 (448) $ 143 $ 2,307 690 2,997 (1,120) $ 1,877 The Company has two outstanding term loans with German banks. The first term loan of 63 Euro, or $82, maturing March 31, 2012 has an associated interest rate swap agreement. Under this agreement, the Company pays a fixed interest rate of 5.15% and payments or receipts on the agreement are recorded as adjustments to interest expense. Such adjustments have not been significant. The second term loan of 38 Euro, or $49, maturing September 30, 2012 has a fixed interest rate of 5.75%. 60 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 64/77 4/1/12 Form 10-K Table of Contents The Company has capital leases with interest rates ranging from 5.00% to 8.46% and maturity dates from May 2013 through December 2013. The Company has a total of four revolving credit facilities, one credit facility with a U.S. bank and three credit facilities with German banks. Total available credit on the Company's four revolving credit facilities at December 31, 2011 and December 31, 2010 was $17,106 and $13,709, respectively. As of December 31, 2011 and 2010, there were no amounts outstanding on any of the four revolving credit facilities. On July 21, 2010, the Company entered into a second amendment to its credit agreement with Mercantile Bank, a division of Toronto-Dominion Bank. Under the second amendment to the credit agreement, 1) the revolving U.S. credit facility was increased from $10,000 to $15,000, available based on levels of accounts receivable and inventories, 2) the revolving credit facility's maturity date was extended from February 3, 2011 to July 21, 2012, and 3) a $5,000 compensating balance requirement was eliminated. The revolving credit facility contains various restrictive covenants which limit, among other things, indebtedness and liens, and is secured by the Company's domestic accounts receivable, inventory and certain processing equipment. The current interest rate for this line of credit is 4.25%. Under the terms of the revolving credit facilities with three German banks, the Company may borrow up to 1,700 Euro, or approximately $2,311, for working capital needs. The 1,000 Euro revolving credit facility is secured by a mortgage on the Company's German facility. The 500 Euro revolving credit facility is secured by accounts receivable of the Company's German subsidiary. The 200 Euro revolving credit facility is unsecured. The current interest rates for these lines of credit vary from 3.30% to 6.18%. The Company was in compliance with all covenants related to its credit facilities and term loans as of December 31, 2011. As of December 31, 2011, contractual maturities of long-term obligations are as follows: Term Loans Capital Leases Total 2012 2013 2014 $ $ 131 -- -- 131 $ 317 135 8 $ 460 $448 135 8 $591 11. Income Taxes The Company's income tax provision consists of the following components: 2011 Year Ended December 31, 2010 2009 Current: Federal State International Total current Deferred: Federal State International Total deferred Total income tax provision 61 $ (842) (925) (2,965) (4,732) (20) 630 896 1,506 $(3,226) $ (162) -- (588) (750) (325) (241) (289) (855) $(1,605) $ (187) -- -- (187) (1,694) (205) (514) (2,413) $(2,600) www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 65/77 4/1/12 Form 10-K Table of Contents The components of the deferred tax assets and liabilities consisted of the following at: December 31, 2011 Deferred Income Tax Asset Liability December 31, 2010 Deferred Income Tax Asset Liability Current: International Allowance for bad debts Inventory Net operating losses Tax credits Accrued liabilities Deferred revenue Other Total current Noncurrent: Fixed assets Intangibles International Investments Deferred revenue Net operating losses Tax credits Other Valuation allowance Total noncurrent Total $ 59 98 5,257 -- 1,077 4,606 251 -- 11,348 -- 543 -- 2,025 7,941 677 2,604 -- (469) 13,321 $24,669 $ -- -- -- -- -- -- -- -- -- $ -- -- 6,914 3,299 1,680 3,860 -- 57 15,810 -- 321 -- 2,025 4,029 540 2,895 12 (469) 9,353 $25,163 $ (939) -- -- -- -- -- -- -- (939) (2,254) -- (249) -- -- -- -- -- -- (2,503) $(3,442) (1,621) -- (339) -- -- -- -- -- -- (1,960) $(1,960) Valuation allowances are established when necessary to reduce deferred tax assets to amounts which are more likely than not to be realized. As such, valuation allowances of $469 have been established at both December 31, 2011 and 2010, against a portion of the deferred tax assets relating to certain state net operating loss carryforwards. The Company recorded a tax benefit from the exercise of stock options in the amount of $313, $0, and $212 for the years ended December 31, 2011, 2010 and 2009, respectively. As of December 31, 2011, the Company has consumed all of its federal net operating loss carryforwards. The Company has state net operating loss carryforwards of $17,996 that will expire in the years 2018, 2020 to 2024 and 2027. As of December 31, 2011, the Company has research tax credit carryforwards of $4,410 that will expire in years 2023 through 2031. As of December 31, 2011, the Company has alternative minimum tax credit carryforwards of $544. The Company expects the domestic deferred tax assets of $22,989, net of the valuation allowance at December 31, 2011 of $469, to be realized through the generation of future taxable income and the reversal of existing taxable temporary differences. Valuation allowances have been recorded for certain state tax loss carryforwards as the Company does not believe that it will have future income in the state to utilize the loss carryforwards. 62 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 66/77 4/1/12 Form 10-K Table of Contents United States income taxes have not been provided on the undistributed earnings of the Company's German subsidiary. It is not practicable to estimate the amount of tax that might be payable. The Company's intention is to permanently reinvest earnings in its German subsidiary. Excluding the non-deductible goodwill impairment in 2010, over the previous three years the Company has improved its business model to produce predictable earnings through the following: o o o o o improved tissue availability renegotiated distributor agreements the acquisition of TMI increased diversification of product portfolio reduced concentration risk on independent distributors The Company considered the improvements in its operating performance, as well as the impact of recent losses resulting from the non-deductible goodwill impairment in 2010 as it relates to the realization of remaining net deferred tax assets, and based on the weight of evidence, among other facts and circumstances, management determined that it was more likely than not that such net deferred tax assets would be realized. At December 31, 2011 the Company had $1,674 of unrecognized tax benefits, of which $567 were recorded in other liabilities and $1,107 of unrecognized tax benefits were recorded net against deferred tax assets in the accompanying consolidated balance sheet. During 2011, the Internal Revenue Service provided safe harbor guidance to its Large Business & International examiners regarding the deductibility of transaction fees incurred as part of the Company's merger with TMI in 2008, and as a result the Company de-recognized an uncertain tax liability which reduced income tax expense in 2011 by $800. The Company's unrecognized tax benefits are summarized as follows: Year Ended December 31, 2011 2010 2009 Opening balance Additions based on tax positions related to the current year Additions for tax positions of prior years Reductions for tax positions of prior years Settlements $2,341 154 -- (821) -- $1,674 $1,269 210 862 -- -- $2,341 $ 897 240 493 (361) -- $1,269 The unrecognized tax benefits, if recognized, would favorably impact the Company's effective tax rate. The Company does not anticipate any significant changes to its unrecognized tax benefits in 2012. The Company's policy is to recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in the provision for income taxes. There were no interest and penalties recorded in 2011, 2010 and 2009 and no interest and penalties accrued at December 31, 2011 and 2010. The Company files income tax returns in the U.S. federal jurisdiction and various states. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations for years before 2008. 63 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 67/77 4/1/12 Form 10-K Table of Contents The effective tax rate differs from the statutory federal income tax rate for the following reasons: 2011 Year Ended December 31, 2010 2009 Statutory federal rate State income taxes--net of federal tax benefit Impairment of goodwill Research tax credits Exercise of incentive stock options Unrecognized tax benefits Miscellaneous Effective tax rate 12. Stockholders' Equity 35.00% 1.95% -- (3.30%) -- (6.90%) 1.05% 27.80% 35.00% (0.12%) (36.89%) 0.48% -- -- 0.27% (1.26%) 34.00% 3.03% -- (11.03%) 2.85% 2.61% (0.71%) 30.75% Preferred Stock--The Company has 5,000,000 shares of preferred stock authorized under its Certificate of Incorporation, none of which currently is outstanding. These shares may be issued in one or more series having such terms as may be determined by the Company's Board of Directors. Common Stock--The Company has 150,000,000 shares of common stock authorized. The common stock's voting, dividend, and liquidation rights presently are not subject to or qualified by the rights of the holders of any outstanding shares of preferred stock, as the Company presently does not have any shares of preferred stock outstanding. Holders of common stock are entitled to one vote for each share held at all stockholder meetings. Shares of common stock do not have redemption rights. 13. Retirement Benefits The Company has a qualified 401(k) plan available to all United States employees who meet certain eligibility requirements. The 401(k) plan allows each employee to contribute up to the annual maximum allowed under the Internal Revenue Code. The Company has the discretion to make matching contributions up to 6% of the employee's earnings. For the years ended December 31, 2011, 2010 and 2009, the Company's contributions to the plan were $1,359, $1,358 and $1,343, respectively. 14. Concentrations of Risk Distribution--The Company's principal concentration of risk is related to its limited distribution channels. The Company's revenues include the distribution efforts of eleven independent companies with significant revenues coming from three of the distribution companies, Medtronic, Zimmer, and Davol. For years ended December 31, 2011, 2010 and 2009, the amount of revenues derived from Medtronic were approximately 19%, 18% and 22%, respectively. For year ended December 31, 2011, 2010 and 2009, the amount of revenues derived from Zimmer was approximately 12%, 15% and 22%, respectively. For years ended December 31, 2011, 2010 and 2009, the amount of revenues derived from Davol were approximately 11%, 9% and 9%, respectively. The Company's distribution agreements are subject to termination by either party for a variety of causes. No assurance can be given that such distribution agreements will be renewed beyond their expiration dates, continue in their current form or at similar rate structures. Any termination or interruption in the distribution of the Company's products through one of its major distributors could have a material adverse effect on the Company's operations. Tissue Supply--The Company's operations are dependent on the availability of tissue from human donors. For the majority of the tissue recoveries, the Company relies on the efforts of independent procurement agencies 64 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 68/77 4/1/12 Form 10-K Table of Contents to educate the public and increase the willingness to donate bone tissue. These procurement agencies may not be able to obtain sufficient tissue to meet present or future demands. Any interruption in the supply of tissue from these procurement agencies could have a material adverse effect on the Company's operations. 15. Supplemental Disclosure of Cash Flow and Non-Cash Investing and Financing Activities Selected cash payments, receipts, and noncash activities are as follows: Year Ended December 31, 2011 2010 2009 Cash paid for interest Income taxes paid Purchases of property, plant, and equipment financed through capital leases Change in accrual for purchases of property, plant and equipment Payable for aquired licensing rights Excess income tax benefit from stock option exercises 16. Commitments and Contingencies $ 128 410 111 1,056 -- 283 $ 453 652 743 311 3,000 -- $472 505 -- 175 950 186 Potential Value Added Tax (VAT) Assessment--In 2008, the Company was audited by the German value added tax ("VAT") authorities and received potential cumulative assessments of 1,669 Euro, or $2,212 as of December 31, 2010. The Company had not accrued a liability for this contingency as it did not believe that it was probable that it would ultimately be required to pay the assessment to the German VAT authorities. During the fourth quarter of 2011, the Company successfully resolved the issue with the German VAT authorities and the favorable resolution resulted in no impact to the Company's financial statements. Distribution Agreement with Zimmer--On September 3, 2010, the Company and Zimmer Dental Inc. ("Zimmer"), a subsidiary of Zimmer, Inc., entered into a new exclusive distribution agreement (the "Agreement"), with an effective date of September 30, 2010. The Agreement has an initial term of ten years. Under the terms of the Agreement, the Company has agreed to supply sterilized allograft and xenograft implants at an agreed upon transfer price, and Zimmer has agreed to be the exclusive distributor of the implants for dental and oral applications worldwide (except the Ukraine), subject to certain Company obligations under an existing distribution agreement with a third party with respect to certain implants for the dental market. In consideration for Zimmer's exclusive distribution rights, Zimmer agreed to the following: 1) payment to the Company of $13,000 within ten days of the effective date ("the Upfront Payment"), 2) annual exclusivity fees ("Annual Exclusivity Fees") paid annually for the term of the contract to be paid at the beginning of each calendar year, and, 3) escalating annual purchase minimums to maintain exclusivity. Upon occurrence of an event that materially and adversely affects Zimmer's ability to distribute the Implants, Zimmer may be entitled to certain refund rights with respect to the Upfront Payment and the then current Annual Exclusivity Fee, where such refund would be in an amount limited by a formula specified in the Agreement that is based substantially on the number of days from the occurrence of such event to the date that it is cured by the Company to the satisfaction of Zimmer. The Upfront Payment and the Annual Exclusivity Fees are deferred as received and will be recognized as other revenues over the term of the Agreement based on the expected contractual escalating annual purchase minimums relative to the total contractual minimum purchase requirements in the Agreement. Additionally, the Company has considered the potential impact of the Agreement's contractual refund provisions and does not expect these provisions to impact future expected revenue related to the Agreement. Exclusive License Agreement with Athersys--On September 10, 2010, the Company entered into an Exclusive License Agreement with Athersys, Inc. ("Athersys"), pursuant to which Athersys will provide RTI access to its Multipotent Adult Progenitor Cell ("MAPC") technologies to develop and commercialize MAPC technology-based biologic implants for certain orthopedic applications. In consideration for the Exclusive License, the Company agreed to pay Athersys the following: 1) a non-refundable $3,000 license fee, payable in three time-based $1,000 installments, the last of which was paid in the first quarter of 2011, 2) payment of 65 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 69/77 4/1/12 Form 10-K Table of Contents $2,000 contingent upon successful achievement of certain development milestones which the Company has recorded in accrued expenses, and 3) up to $32,500 contingent upon achievement of certain cumulative revenue milestones in future years. In addition, the Company will pay Athersys royalties from the distribution of implants under a tiered royalty structure based on achievement of certain cumulative revenue milestones. The term of the Exclusive License Agreement is the longer of five years, or the remaining life of any patent or trade secret. These acquired licensing rights are being amortized to expense on a straight-line basis over the expected life of the asset. Distribution Agreement with Davol--On July 13, 2009, the Company and Davol amended their previous distribution agreement with TMI for human dermis implants. Under the amended agreement, 1) Davol paid the Company $8,000 in non- refundable fees for exclusive distribution rights for the distribution to the breast reconstruction market until July 13, 2019, 2) the exclusive worldwide distribution agreement related to the hernia market was extended to July 13, 2019, and 3) Davol agreed to pay the Company certain additional exclusive distribution rights fees contingent upon the achievement of certain revenue milestones by Davol during the duration of the contract. In the fourth quarter of 2010, Davol paid the first revenue milestone payment of $3,500. The $8,000 and $3,500 exclusivity payments have been deferred and are being recognized as other revenues on a straight-line basis over the initial term of the amended contract of ten years, and the remaining term of the amended contract, respectively. The straight-line method approximates the expected pattern of product distribution based on the distribution agreement's contractual annual minimum purchase requirements. Distribution Agreement with Zimmer--On May 14, 2007, the Company entered into an exclusive distribution agreement with Zimmer with an initial term of ten years, relating to certain new bone graft substitutes implants. As part of the agreement, Zimmer made payments to the Company totaling $5,000 for the aforementioned exclusive distribution rights, and has to maintain certain minimum order volumes through the duration of the contract. The $5,000 exclusivity payment has been deferred and is being recognized as other revenue on a straight-line basis over the initial term of the contract. The contract provides for repayment, on a pro rata basis, of the exclusivity payments during the initial contract term for specific events of non-performance, as defined in the agreement. The agreement also includes automatic two-year renewal terms, as well as buy-out provisions by both parties upon proper notice of cancellation. The Company's aforementioned revenue recognition methods related to the Zimmer and Davol distribution agreements do not result in the deferral of revenue less than amounts that would be refundable in the event the agreements were to be terminated in future periods. Additionally, the Company evaluates the appropriateness of the aforementioned revenue recognition methods on an ongoing basis. Leases--The Company leases certain facilities, items of office equipment and vehicles under non-cancelable operating lease arrangements expiring on various dates through 2016. The facility leases generally contain renewal options and escalation clauses based upon increases in the lessors' operating expenses and other charges. The Company anticipates that most of these leases will be renewed or replaced upon expiration. At December 31, 2011, the aggregate future minimum lease payments under all non-cancelable lease agreements were as follows: Future minimum lease commitments under non-cancelable operating leases as of December 31, 2011 are as follows: Operating Leases 2012 2013 2014 2015 2016 $ 1,312 714 165 79 79 $ 2,349 66 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 70/77 4/1/12 Form 10-K Table of Contents Rent expense for the years ended December 31, 2011, 2010, and 2009 was $1,041, $1,019, and $1,222, respectively, and is included as a component of marketing, general and administrative expenses. 17. Legal and Regulatory Actions The Company is, from time to time, involved in litigation relating to claims arising out of its operations in the ordinary course of business. The Company believes that none of these claims that were outstanding as of December 31, 2011 will have a material adverse impact on its financial position or results of operations. Medtronic Sofamor Danek, USA, Inc.--The Company and Medtronic Sofamor Danek, USA, Inc. ("MSD"), a subsidiary of Medtronic, Inc., ("Medtronic"), have filed claims against each other with the American Arbitration Association related to events stemming from the actions of Biomedical Tissue Services, Ltd. ("BTS"), an unaffiliated company recovery agency, and the subsequent voluntary recall of allografts processed by the Company from tissue originating from BTS (the "Allografts"). MSD seeks indemnification from the Company for its legal fees, costs and expenses allegedly incurred during the defense of cases brought by recipients of Allografts. The Company denies that it is obligated to indemnify MSD in respect of the Allografts. In the same proceeding, the Company is seeking damages from MSD due to actions taken by MSD during the recall process. Among other allegations, the Company alleges that MSD's actions were negligent and in breach of the contractual agreements between the Company and MSD. As of the filing date, hearings have concluded on the matter and post-hearing briefs are being prepared for submission to the arbitrator. Final resolution of the matter is anticipated to occur in the first quarter of 2012. The probability of a favorable or unfavorable outcome to the Company is unknown and a range of loss, if any, cannot be estimated at this time. However, while the Company believes its defenses and counterclaims are meritorious, the ultimate resolution of the matters, which is expected to occur within three months, could adversely impact the Company's business, financial condition or results of operations. This claim is not covered by insurance. Biomedical Tissue Service, Ltd.--The Company has been named as a party, along with a number of other processor defendants, in lawsuits relating to the tissue recovery practices of Biomedical Tissue Service, Ltd., an unaffiliated recovery agency ("BTS"). As of December 31, 2011, there are 79 lawsuits pending against the Company related to the misconduct of BTS and BTS's owner, Michael Mastromarino, as well as several funeral homes and their owners with which BTS conducted its affairs. These lawsuits generally allege that the Company was negligent in not discovering deficiencies in recovery practices at BTS. The Company denies the allegations and, due at least in part to the favorable law currently in place in the states where such cases are pending, i.e. New York, New Jersey, and Pennsylvania, the Company does not anticipate a materially adverse event arising from this litigation. However, reactions of juries cannot be predicted with reasonable reliability, and currently favorable laws in the jurisdictions may be subject to change. In addition to the favorable law, the Company believes it has meritorious factual defenses to these claims, and will defend them vigorously. The Company has $2 million in answerable indemnity insurance, with non-eroding defense limits. Of the pending cases, however, our insurer has disclaimed coverage on approximately 33 of the cases. The Company believes this disclaimer is improper, and has brought a declaratory action against the insurer to obtain coverage on these disclaimed cases. Pending resolution of the declaratory action, or if the declaratory action is not resolved in the Company's favor, the Company will be responsible for paying both the legal fees and any indemnification that may be owed in connection with those disclaimed cases. The probability of an unfavorable outcome to the Company is unknown and a range of loss, if any, cannot be estimated at this time. However, while we believe our defenses are meritorious, the ultimate resolution of the matters could adversely impact our business, financial condition or results of operations. The Company's accounting policy is to accrue for legal costs as they are incurred. 67 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 71/77 4/1/12 Form 10-K Table of Contents 18. Segment Data The Company processes human and bovine animal tissue and distributes the tissue through various distribution channels. The Company's lines of business are comprised primarily of five implant categories: sports medicine, spine, dental, surgical specialties, BGS and general orthopedic. The following table presents revenues from tissue distribution, and other revenues and percentage of total revenues for the years ended December 31, 2011, 2010 and 2009: 2011 Year Ended December 31, 2010 2009 Fees from tissue distribution: Sports medicine Spine Surgical specialties BGS and general orthopedic Dental Other revenues Total revenues Domestic revenues International revenues Total revenues $ 48,122 39,722 30,328 26,291 18,392 6,461 $169,316 28.4% 23.5% 17.9% 15.5% 10.9% 3.8% 100.0% $ 45,065 33,906 26,871 25,413 29,746 5,170 $166,171 27.1% 20.4% 16.2% 15.3% 17.9% 3.1% 100.0% $ 39,533 41,087 26,278 23,161 29,985 4,483 $164,527 24.0% 25.0% 16.0% 14.1% 18.2% 2.7% 100.0% $148,315 87.6% $147,943 89.0% $141,275 85.9% 21,001 12.4% 18,228 11.0% 23,252 14.1% $169,316 100.0% $166,171 100.0% $164,527 100.0% For the years ended December 31, 2011, 2010 and 2009, the Company derived approximately 19%, 18% and 22%, respectively, of its total revenues from Medtronic. For the years ended December 31, 2011, 2010 and 2009, the Company derived approximately 12%, 15% and 22% respectively, of its total revenues from Zimmer. For the years ended December 31, 2011, 2010 and 2009, the Company derived approximately 11%, 9% and 9%, respectively, of its total revenues from Davol. For the years ended December 31, 2011, 2010 and 2009, the Company derived approximately 12%, 11% and 14%, respectively, of its total revenues from foreign distribution. As of December 31, 2011, the Company had $31,532 of net property, plant and equipment located domestically, and $13,000 of net property, plant and equipment located at its processing facility in Germany. 19. Quarterly Results of Operations (Unaudited) The following table sets forth the results of operations for the periods indicated: March 31, 2011 June 30, 2011 September 30, 2011 December 31, 2011 Quarter Ended: Revenues Gross profit Net income Net income per common share: Basic Diluted 68 $40,646 18,337 1,248 $ 0.02 0.02 $43,482 19,719 2,018 $ 0.04 0.04 $ $ 42,257 19,323 2,742 0.05 0.05 $ 42,931 19,709 2,370 $ 0.04 0.04 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 72/77 4/1/12 Form 10-K Table of Contents During 2011, the Company experienced an increase in fees from tissue distribution in the sports medicine, spine, surgical specialties and BGS and general orthopedic implant categories and a decrease in its dental implant category. Sports medicine and BGS and general orthopedic implant categories were positively impacted by increases in unit volumes, favorable product distribution mixes and increased market penetration through our direct distribution force both domestically and internationally. The unit volume of the Company's spine implant category normalized during 2011 after a $6,000 inventory reduction from our largest spine distributor in the first half of 2010. The Company's dental implant category was affected by a new exclusive distribution agreement with our exclusive dental distributor, effective September 30, 2010, which changed distributions from a marketing fee structure to a transfer fee structure. In addition, the Company experienced an increase in the other revenues category during 2011. The increase in the other revenues category was affected by higher deferred revenue amortization resulting from exclusivity payments from our dental and surgical specialties distributors received in the fourth quarter of 2010, which favorably impacted gross profit. The following table sets forth the results of operations for the periods indicated: March 31, 2010 June 30, 2010 September 30, 2010 December 31, 2010 Quarter Ended: Revenues Gross profit Net (loss) income Net income (loss) per common share: Basic Diluted $37,779 17,057 (54) $ -- -- $41,180 18,858 948 $ 0.02 0.02 $ 41,836 19,886 (133,059) $ (2.43) (2.43) $ 45,376 20,202 2,766 $ 0.05 0.05 During 2010, the Company experienced an increase in fees from tissue distribution in the sports medicine and BGS and general orthopedic implant categories and a decrease in its spine and dental implant categories. Sports medicine and BGS and general orthopedic implant categories were positively impacted by increases in unit volumes, favorable product distribution mixes and increased market penetration through our direct distribution force both domestically and internationally. The Company's dental implant category was affected by a new exclusive distribution agreement with our exclusive dental distributor which changed distributions from a marketing fee structure to a transfer fee structure. The Company's spine implant category was negatively impacted by a $6,000 inventory reduction from our largest spine distributor in the first half of 2010. In addition, the Company experienced an increase in the other revenues category during 2010. The increase in the other revenues category was affected by higher deferred revenue amortization resulting from exclusivity payments from our dental and surgical specialties distributors received in the fourth quarter of 2010, which favorably impacted gross profit. During the third quarter of 2010, the Company recorded a goodwill impairment of $134,681. 20. Subsequent Events The Company evaluated subsequent events as of the issuance date of the financial statements, February 15, 2012, as defined by FASB ASC 855 Subsequent Events, and identified no subsequent events that require adjustment to, or disclosure of, in these financial statements except for the receipt of the Company's annual exclusivity payment of $3.0 million from Zimmer relating to the exclusive dental distribution agreement on January 24, 2012. 69 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 73/77 4/1/12 Form 10-K Table of Contents RTI BIOLOGICS, INC. AND SUBSIDIARIES Schedule II Valuation and Qualifying Accounts Years Ended December 31, 2011, 2010 and 2009 (Dollars in thousands) Balance at Beginning of Period Charged to Costs and Expenses Deductions- Write-offs, Payments Balance at End of Period Description For the year ended December 31, 2011: Allowance for doubtful accounts Allowance for product returns Allowance for obsolescence Deferred tax asset valuation allowance For the year ended December 31, 2010: Allowance for doubtful accounts Allowance for product returns Allowance for obsolescence Deferred tax asset valuation allowance For the year ended December 31, 2009: Allowance for doubtful accounts Allowance for product returns Allowance for obsolescence Deferred tax asset valuation allowance 70 $ 190 300 11,513 469 1,103 193 12,131 469 1,231 504 16,826 488 $ 133 317 4,840 -- $ 48 118 2,107 -- 92 117 1,940 -- $ -- 234 8,182 -- 961 11 2,726 -- 220 428 6,635 19 $ 323 383 8,171 469 190 300 11,513 469 1,103 193 12,131 469 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 74/77 4/1/12 Form 10-K Table of Contents SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. February 15, 2012 RTI BIOLOGICS, INC. By: /s/ Brian K. Hutchison Brian K. Hutchison President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/ Brian K. Hutchison Brian K. Hutchison /s/ Robert P. Jordheim Robert P. Jordheim /s/ Dean H. Bergy Dean H. Bergy /s/ Julianne M. Bowler Julianne M. Bowler /s/ Philip R. Chapman Philip R. Chapman /s/ Roy D. Crowninshield Roy D. Crowninshield /s/ Peter F. Gearen Peter F. Gearen /s/ Gregory P. Rainey Gregory P. Rainey /s/ Adrian J.R. Smith Adrian J.R. Smith President and Chief Executive Officer (Principal Executive Officer) Executive Vice President and Chief Financial Officer Chairman February 15, 2012 February 15, 2012 February 15, 2012 Director February 15, 2012 Director February 15, 2012 Director February 15, 2012 Director February 15, 2012 Director February 15, 2012 Director February 15, 2012 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 75/77 4/1/12 Form 10-K Table of Contents EXHIBIT INDEX Exhibit Number Description 3.1 3.2 4.3 10.1 * 10.2 * 10.3 * 10.4 * 10.5 * 10.6 10.7 10.8 10.9 * 10.10 10.11 10.12 * 23.1 31.1 31.2 32.1 Amended and Restated Certificate of Incorporation of RTI Biologics, Inc.1 Bylaws.2 Specimen Stock Certificate.3 Omnibus Stock Option Plan.3 Year 2000 Compensation Plan.3 RTI Biologics, Inc. 2004 Equity Incentive Plan.4 Form of Nonqualified Stock Option Grant Agreement.5 Form of Incentive Stock Option Grant Agreement.5 License Agreement, dated November 24, 2008, between RTI Biologics, Inc. and LifeNet Health, Inc.+ 6 Credit Agreement, dated January 28, 2008, between RTI Biologics, Inc. and Mercantile Bank.6 First Amendment to the Credit Agreement, dated June 11, 2009, between RTI Biologics, Inc. and Mercantile Bank.7 RTI Biologics, Inc. 2010 Equity Incentive Plan.8 Second Amendment to the Credit Agreement, dated July 21, 2010, between RTI Biologics, Inc. and Mercantile Bank.9 Exclusive Distribution Agreement between RTI Biologics, Inc. and Zimmer Dental Inc., dated as of September 3, 2010 and effective as of September 30, 2010.+ 10 RTI Biologics, Inc. Executive Nonqualified Excess Plan. Consent of Independent Registered Public Accounting Firm. Certification of Brian K. Hutchison, President and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Robert P. Jordheim, Executive Vice President and Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Brian K. Hutchison, President and Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, regarding the information contained in RTI Biologics, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2011. Certification of Robert P. Jordheim, Executive Vice President and Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, regarding the information contained in RTI Biologics, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2011. XBRL Instance Document XBRL Taxonomy Extension Schema Document XBRL Taxonomy Extension Calculation Linkbase Document XBRL Taxonomy Extension Definition Linkbase Document XBRL Taxonomy Extension Label Linkbase Document XBRL Taxonomy Extension Presentation Linkbase Document 72 32.2 101.INS** 101.SCH** 101.CAL** 101.DEF** 101.LAB** 101.PRE** www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 76/77 4/1/12 Form 10-K Table of Contents 1 2 3 4 5 6 7 8 9 10 + * ** Incorporated by reference to our Current Report on Form 8-K filed February 29, 2008. Incorporated by reference to our Current Report on Form 8-K filed August 4, 2008. Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-35756). Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2004. Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2008. Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2009. Incorporated by reference to our Proxy Statement on Form DEF 14A filed March 18, 2010 Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2010. Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010. Confidential treatment requested as to certain portions, which portions were omitted and filed separately with the Commission. Indicates a management contract or any compensatory plan, contract, or arrangement. XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections. 73 www.sec.gov/Archives/edgar/data/1100441/000119312512062168/d263785d10k.htm 77/77