Net Income

                                         Three Months Ended                               Six Months Ended
                                              June 30,                                        June 30,
(dollars in thousands,                                          Percent                                        Percent
except per share amounts)    2008       2007       Change       Change        2008       2007      Change       Change
Net income                  $ 1,746     $ 855     $    891           104 %   $ 2,554     $ 207     $ 2,347        1,134 %
Earnings per share:
Basic                       $   .10     $ .05                                $   .14     $ .01
Diluted                     $   .10     $ .05                                $   .14     $ .01

The improvement in net income for the second quarter and first half of 2008, compared to the respective prior year periods, resulted from increased revenue and improved gross margin which were partially offset by higher operating expenses and a higher effective tax rate. Net income for the three and six months ended June 30, 2008 was also positively impacted by a gain of $1.0 million from the settlement of certain litigation.
The net income in the second quarter and first half of 2007 was generated from increased revenues, which resulted in improved gross profit contribution, partially offset by an increase in operating expenses. Net income for the six months ended June 30, 2007 was also negatively impacted by the first quarter charges of $1.1 million for the settlement of certain litigation.

Revenue
For the three and six months ended June 30, 2008, revenue increased 4% and 7%, respectively, from the same prior year periods. The products in the DBM and Hybrid/Synthetic Segments compose our primary product areas and are designated as such because they are the focus of our research and development initiatives and we believe they offer us the highest potential for revenue growth and profitability improvements. Revenue from these product lines increased 4% and 8% in the second quarter and first half of 2008, respectively, compared to the prior year periods. We plan to focus our strategic efforts on expanding the domestic and international markets for our current and future primary product lines.
The following table details the components of revenue for the three and six months ended June 30, 2008 and 2007:

                                       Three Months Ended                                    Six Months Ended
                                            June 30,                                             June 30,
                                                                Percent                                              Percent
(dollars in thousands)     2008         2007       Change       Change         2008         2007        Change       Change
DBM                      $ 16,575     $ 16,161     $   414             3 %   $ 33,541     $ 31,643     $  1,898             6 %
Hybrid/Synthetic              727          408         319            78 %      1,371          641          730           114 %
Traditional Tissue          5,250        4,558         692            15 %     10,360        9,169        1,191            13 %
Spinal Allograft            2,286        3,221        (935 )         -29 %      4,536        6,009       (1,473 )         -25 %
Client Services             2,397        1,944         453            23 %      4,821        3,872          949            25 %
Other                         318          178         140            79 %        555          353          202            57 %

                         $ 27,553     $ 26,470     $ 1,083             4 %   $ 55,184     $ 51,687     $  3,497             7 %

DBM Segment revenue, which consists of revenue from the sale of Grafton® DBM and Xpanse® Bone Inserts and revenue from the processing of two private label DBMs, increased 3% and 6% in the second quarter and first half of 2008, respectively, as compared to the same periods in 2007, primarily as a result of increased unit volumes. Revenue from Grafton® DBM, private label DBM tissue forms and Xpanse® Bone Inserts changed 6%, (27)% and 7%, respectively, in the second quarter of 2008 compared to the second quarter of 2007 and 7%, (8)% and 15% respectively in the first half of 2008 compared to 2007. We have been formally advised that one of our private label DBM customers does not intend to renew its current agreement with us upon its expiration in March 2009. We recognized $.5 million of revenue from this customer in the first quarter of 2008 and the customer has not made any purchases since. The decline in purchases by this customer is the primary reason for the decline in private label DBM revenue in the three and six months ended June 30, 2008.
Revenue in the Hybrid/Synthetic Segment, represented sales of our Plexur P™ Biocomposite and GraftCage® Spacers, increased 78% and 114% in the second quarter and the first half of 2008, respectively, as compared to the same periods of 2007 as a result of increased Plexur P™ revenue offsetting a decline in revenue from the GraftCage® Spacers. We do not anticipate revenue from the distribution of the GraftCage® Spacers to significantly contribute to our future revenue streams.
Traditional Tissue Segment revenue resulted from the worldwide distribution of allograft bone tissue grafts increased 15% and 13% in the three and six months ended June 30 of 2008, respectively, as compared to the same periods in 2007. The increase in 2008 traditional tissue revenues resulted from increased unit sales volume.
Revenue in the Spinal Allograft Segment declined 29% and 25% in the second quarter and first half of 2008, respectively, as compared to the same periods in 2007, primarily due to a decrease in unit sales volume.
Client Services Segment revenue, which is generated by the processing of allograft bone tissue for our clients, mainly the Musculoskeletal Transplant Foundation ("MTF"), increased 23% and 25% in the second quarter and first half of 2008, respectively, as compared to the same periods in 2007. We anticipate that revenue in the Client Services Segment will decline during the next two quarters as we process fewer donors for MTF. Our contractual agreements with MTF expire at the end of 2008 and, beginning in 2009, we expect revenue in this segment to be insignificant.
Other revenue consists mainly of sales commission revenue and revenue related to the international distribution of xenograft tissue grafts. During the second quarter and first half of 2008, other revenue increased 79% and 57%, respectively, compared to the same periods in 2007.
In the second quarter and first half of 2008, MTF accounted for $3.7 million and $7.7 million, respectively, of revenue. MTF accounted for $4.1 million of revenue for the three months ended June 30, 2007 and $8.6 million of revenue for the six months ended June 30, 2007.

Gross Profit Margin

                                     Three Months Ended          Six Months Ended
                                          June 30,                   June 30,
          (dollars in thousands)      2008          2007         2008         2007

In both the second quarter and first half of 2008, gross margin improved over gross margin levels in the comparable 2007 periods, primarily due to increased unit processing volumes to support the increase in revenue and better management of inventory risk exposures, such as obsolescence. Operating Expenses

                                          Three Months Ended                                       Six Months Ended
                                               June 30,                                                June 30,
                                                                    Percent                                                 Percent
(dollars in thousands)      2008          2007        Change        Change          2008          2007        Change        Change
Marketing, selling and
general and
administrative            $ 11,323      $ 10,434      $   889              9 %    $ 23,003      $ 22,124      $   879              4 %
Research and
development                  1,774         1,281          493             38 %       3,534         2,445        1,089             45 %

Total                     $ 13,097      $ 11,715      $ 1,382             12 %    $ 26,537      $ 24,569      $ 1,968              8 %

Marketing, selling and general and administrative expenses increased $.9 million in each of the three and six months ended June 30, 2008 as compared to the same periods in 2007. In the second quarter of 2008, we had higher non-cash stock compensation costs and marketing and selling expenses, compared to the prior year. In the six months ended June 30, 2008, we had higher non-cash stock compensation costs and selling expenses compared to the prior year period. In the six months ended June 30, 2007, we incurred $1.1 million in costs associated with the settlement of and legal fees incurred in connection with certain litigation.
In the second quarter and first half of 2008, research and development expenses increased 38% and 45%, respectively, as compared to the same periods in 2007, primarily due to the costs incurred for basic research, studies, product development and process development activities to support the technologies and products we are working on.

Operating Income (Loss) By Segment

                                       Three Months Ended                                    Six Months Ended
                                            June 30,                                             June 30,
                                                                Percent                                               Percent
(dollars in thousands)     2008         2007       Change       Change         2008          2007         Change       Change
DBM                      $  5,102     $  4,532     $   570            13 %   $  11,083     $   7,639     $  3,444           45 %
Hybrid/Synthetic               66          (43 )       109           253 %        (106 )           3         (109 )      -3633 %
Traditional Tissue            670          536         134            25 %       1,526         1,942         (416 )        -21 %
Spinal Allografts             254          711        (457 )         -64 %          16         1,040       (1,024 )        -98 %
Client Services             1,617        1,427         190            13 %       3,046         3,005           41            1 %
Other                         230           40         190           475 %         462           178          284          160 %

                            7,939        7,203         736            10 %      16,027        13,807        2,220           16 %
Corporate                  (6,534 )     (6,128 )       406            -7 %     (13,820 )     (13,269 )        551           -4 %

Operating income         $  1,405     $  1,075     $   330            31 %   $   2,207     $     538     $  1,669          310 %

Total product segment operating income for the second quarter and first half of 2008 increased 10% and 16%, respectively, as compared to comparable 2007 periods due to improved gross margin, partially offset by higher operating expenses. In both the three and six months ended June 30, 2008, product segment operating income, as a percent of revenue, increased to 29% compared to 27% in 2007. We are focusing our efforts on our key products, which are included in the DBM and Hybrid/Synthetic Segments. In doing so, more resources are being allocated to these segments resulting in lower costs and expenses being allocated to other products.
Costs and expenses associated with Corporate increased 7% and 4% in the three and six months ended June 30, 2008, respectively, compared to the same periods last year, primarily due to higher research and development expenses. Other Income (Expense)
Other income in the second quarter of 2008 of $.7 million is principally the result of proceeds from a litigation settlement of $1.0 million and interest income of $.1 million on invested cash balances, partially offset by $.4 million in interest expense associated with our capital lease obligation. In the second quarter of 2007, other expense primarily represented interest expense of $.4 million related to our capital lease obligation and foreign exchange losses of $.1 million, which were partially offset by interest income of $.3 million. Other income in the first half of 2008 of $.7 million is primarily the result of the litigation settlement of $1.0 million, interest income of $.3 million and foreign exchange gains of $.2 million, principally on intercompany debt, which were partially offset by interest expense of $.8 million. In the first half of 2007, interest expenses of $.8 million associated with our capital lease obligation and foreign exchange losses of $.1 million were only partially offset by interest income of $.5 million and a $.1 million gain from a contingent consideration payment related to the sale in 2002 of a foreign subsidiary. Income Tax Provision
For the six months ended June 30, 2008, after the application of available net operating loss carryforwards, we provided for Federal taxes based on the alternative minimum tax method, certain state taxes on alternative bases and a charge related to the assessment of uncertain tax positions as a result of the ongoing Federal and state tax audits. We continue not to recognize any Federal, state and certain foreign tax benefits, which were subject to full valuation allowances in accordance with the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standard ("SFAS") No. 109, "Accounting for Income Taxes." We intend to maintain the valuation allowances until sufficient positive evidence exists to support the reversal of a valuation allowance that we have established. We evaluate our position with respect to the valuation allowances each quarter taking into consideration numerous factors, including, but not limited to: past, present and forecasted results; the impact in each jurisdiction of operating activities; and the effects of our strategic plan. Should we continue to meet our financial expectations, the potential exists that certain valuation allowances may be reversed in 2008, although there can be no assurance that such action will take place.
We file U.S., state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2003 through 2007 tax years generally remain subject to examination by Federal, foreign and most state authorities including, but not limited to, the United States, France, Bulgaria and the State of New Jersey. Our 2003 through 2005 Federal tax returns are currently under examination by the U.S. Internal Revenue Service ("IRS") and the State of New Jersey is examining certain of our 2003 to 2007 state tax filings.

The components of our unrecognized tax benefits ("UTBs") are substantially comprised of deferred tax assets which are subject to a full valuation allowance. To the extent we prevail in matters for which either a receivable or a liability for a UTB has been established, are required to pay an amount or utilize net operating loss carryforwards to settle a tax liability, or estimates a change to a specific UTB, our effective tax rate in a given financial reporting period may be affected.
During six months ended June 30, 2008, the total amount of our UTBs declined approximately $1.6 million to $2.1 million. It is expected that the amount of UTBs may change in the next twelve months due to our filing of amended Federal and state tax returns, resolution of the revenue authority examinations and expiring statutes of limitation and audit activity. Liquidity and Capital Resources
At June 30, 2008, we had cash and cash equivalents of $19.1 million compared to $22.8 million at December 31, 2007. Working capital declined to $56.2 million at June 30, 2008 compared to $57.9 million at December 31, 2007. The decline in working capital in 2008 resulted primarily from the use of a portion of available cash to invest in additional long-term bone tissue inventories and capital expenditures.
Net cash used by operating activities was $.1 million in the first half of 2008 compares to $2.2 million provided by operating activities in the first half of 2007. The change resulted primarily from increases in accounts receivable related primarily to larger orders from customers who generally have longer payment terms and an increased investment in unprocessed tissue of $5.1 million, partially offset by an aggregate $1.6 million decline in work-in-process and finished goods.
Net cash used in investing activities was $3.6 million and $1.2 million for the six months ended June 30, 2008 and 2007, respectively, and principally relates to funding of capital expenditures and intellectual property. Net cash used by financing activities in the first half of 2008 relates primarily to principal payments on our capital lease obligation partially offset by proceeds from the exercise of stock options and the sale of common stock pursuant to our employee stock purchase plan. In the first half of 2007, proceeds received from the exercise of stock options and the sale of common stock pursuant to our employee stock purchase plan were partially offset by payments on our capital lease obligation resulting in net cash provided by financing activities of $.4 million.
Based on our current projections, we believe that our currently available cash and cash equivalents and anticipated future cash flow from operations will be sufficient to meet our forecasted cash needs for the next twelve months. We may seek additional funding to meet the needs of our long-term strategic plans. We can provide no assurance that such additional funds will be available, or if available, that such funds will be available on favorable terms. Recent Accounting Developments
On January 1, 2008, we adopted the effective provisions of FASB SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 applies under a number of other accounting pronouncements that require or permit fair value measurements. Certain provisions of SFAS No. 157, as they relate to non-financial assets and liabilities, are effective for us beginning in January 1, 2009.
Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
• Level 1 - Quoted prices in active markets for identical assets or liabilities.

• Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

• Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

We adopted SFAS No. 157 for financial assets and liabilities. The adoption of SFAS No. 157 had no impact on our consolidated results of operations and financial condition. We hold certain investments in money market funds which are valued in accordance with Level 1 and are included in cash and cash equivalents. In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133" ("SFAS No. 161"). SFAS No. 161 is effective for us beginning January 1, 2009 and changes the disclosure requirements for derivative instruments and hedging activities. We presently do not have derivative instruments nor do we participate in hedging activities.
Contractual Obligations
As of June 30, 2008, there were no material changes in our contractual obligations from that disclosed in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2007.
Impact of Inflation and Foreign Currency Exchange Fluctuations Results of operations for the periods discussed above have not been materially affected by inflation or foreign currency fluctuations related to the translation of financial statements denominated in foreign currency to U.S. dollars. For additional discussion, see Footnote 10 to condensed consolidated financial statements elsewhere in this Quarterly Report on Form 10-Q. Litigation
We are involved in various legal proceedings. For a discussion of these matters, see Note 14 of "Notes to Consolidated Financial Statements" and ITEM 3. LEGAL PROCEEDINGS both of which are in our Annual Report on Form 10-K for the year ended December 31, 2007. There were no material developments that occurred during the six months ended June 30, 2008 in the lawsuits reported in the Company's Annual Report on Form 10-K for the year ended December 31, 2007. We are not aware of any other material matters or legal proceedings initiated against us during the first six months of 2008.
It is possible that our results of operations or liquidity and capital resources could be adversely affected by the ultimate outcome of pending litigation or as a result of the costs of contesting such lawsuits.