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Osteotech, Inc. (OSTE) makes no bones about its business -- well, yes, that's exactly what it does. The company uses donated tissue from deceased humans to make bone products for the orthopedic, neurological, oral/maxillofacial, dental, and general surgery markets around the globe. Its Demineralized Bone Matrix [DBM] products, marketed under the Grafton brand name, fill in bone defects and can induce bones to grow. The firm's Base Tissue segment makes weight-bearing structures [Graftech] used in spinal fusion procedures. Additionally, Osteotech processes bovine tissue for use as a substitute for bone grafts.

A couple of things to note right up front: this is a small company with a market cap of only $100 million. Market cap, that's the number of shares [17.3 million] times the price of the stock [$6]. Earnings have been erratic: in 2001, they were 7 cents a share. In 2002, they dropped to a negative 9 cents a share. In 2003, they rebounded to 62 cents a share, only to go down for the next 2 years to a negative 31 cents and then a negative $1.23. With earnings going up and down like that, there's no way the stock could be stable. And it wasn't, going from a low of $2.10 in 2001 to a high of $16.30 in 2003, only to drop to $2.40 in 2005.

OSTE 5-yr chart
OSTE 5 yr chart

So this is a small stock with lots of volatility. Not for widows and orphans. Or most investors for that matter. But there's a story here as well.

The first part of the story has to do with earnings. They're back in the black. Analysts are looking for 9 cents a share this year. Next year the forecast is for 15 cents. The reason: improved operating margins, coming from cutting costs and improving efficiencies. With its existing product line, profits should continue to grow. And there are new products being introduced in the first half of 2007 and into 2008.

The first is called Plexus, a line of bio-composites which has done well in animal studies. The second is an enhanced version of the current product Demineralized Bone Matrix [DBM]. With renewed earnings and new products, the company will most likely turn its attention to hiring new salespeople.

Analysts expect the company to spend about $4 million to improve its sales and distribution channels over the next 12 months, with much of that money going in to hiring and training 20 new salespeople. However, don't expect immediate sales gains from the new hires. It takes time to hire, train and book sales. The benefit from the new sales group should show up some time in 2008. Of course, that means higher expenses in the SG&A department for 2007 without offsetting revenues. Even with that, earnings are expected to grow 66% next year [9 cents this year to 15 cents].

Here are a few other numbers to ponder: Officers and directors own about 14% of the stock, a little over 30% is owned by 4 institutions. Current assets are over 4 times current liabilities. Debt is only 17% of the balance sheet. Revenues were $93.3 million last year, should be about $98.2 million this year and go to $105 million next year.

If this stock appeals, remember this is a small one, has had erratic earnings, and the stock price is very volatile [up 30% since September]. But it's a company working in a niche that will only grow as demographics show the aging of America. More people will need bone work. There's no disputing that. The question is whether Osteotech is just beginning to reap the benefits of this demographic certainty or are the erratic earnings of the past going to be repeated?

Disclosure: Author has no position in OSTE

Source: Osteotech Is Boning Up For An Aging America