UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2002
Commission File Number 1-13165
CRYOLIFE, INC.
(Exact name of registrant as specified in its charter)
---------
Florida 59-2417093
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1655 Roberts Boulevard, NW
Kennesaw, Georgia 30144
(Address of principal executive offices)
(zip code)
(770) 419-3355
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
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 X NO _____
The number of shares of common stock, par value $0.01 per share, outstanding on
August 30, 2002 was 19,502,371.
Part I - FINANCIAL INFORMATION
INFORMATION WITH RESPECT TO FINANCIAL STATEMENTS
On April 11, 2002 CryoLife, Inc. filed a Form 8-K, indicating that the Board of
Directors, upon the recommendation of the audit committee, had dismissed the
accounting firm Arthur Andersen LLP as the Company's independent auditors
effective April 9, 2002. On May 10, 2002 CryoLife, Inc. filed a Form 8-K,
indicating that the Board of Directors, upon the recommendation of the audit
committee, had appointed Deloitte & Touche LLP as the Company's independent
auditors effective May 7, 2002.
CryoLife, Inc.'s Form 10-Q for the quarterly period ended March 31, 2002 was
previously filed without a review of the financial statements for the quarterly
period ended March 31, 2002, by an independent public accountant in accordance
with Rule 10-01(d) of Regulation S-X promulgated by the Securities and Exchange
Commission. CryoLife, Inc. elected not to obtain such a review from its prior
auditor, Arthur Andersen LLP.
Deloitte & Touche LLP has subsequently reviewed the financial statements for the
quarterly period ended March 31, 2002 in accordance with Rule 10-01(d).
2
Item 1. Financial statements
CRYOLIFE, INC. AND SUBSIDIARIES
SUMMARY CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
(Unaudited) (Unaudited)
Revenues:
Human tissue preservation services, net $ 17,536 $ 18,765 $ 37,774 $ 37,331
Products 5,473 2,789 10,538 5,430
Distribution and grant 255 143 423 368
------------------------------- ------------------------------
23,264 21,697 48,735 43,129
Costs and expenses:
Human tissue preservation services
(including write-down of
$10,023 in 2002) 17,203 7,697 25,266 15,370
Products 1,843 1,423 4,078 2,855
General, administrative, and marketing 11,447 8,120 20,925 16,279
Research and development 1,196 1,286 2,349 2,372
Interest expense 196 16 388 16
Interest income (239) (576) (537) (1,138)
Other (income) expense, net (16) (5) (72) 742
-------------------------------- ------------------------------
31,630 17,961 52,397 36,496
------------------------------- ------------------------------
Income (loss) before income taxes (8,366) 3,736 (3,662) 6,633
Income tax (benefit) expense (2,844) 1,196 (1,244) 2,123
------------------------------- ------------------------------
Net (loss) income $ (5,522) $ 2,540 $ (2,418) $ 4,510
=============================== ==============================
Net (loss) earnings per share:
Basic $ (0.28) $ 0.14 $ (0.13) $ 0.24
=============================== ==============================
Diluted $ (0.28) $ 0.13 $ (0.13) $ 0.23
=============================== ==============================
Weighted average shares outstanding:
Basic 19,538 18,780 19,318 18,761
=============================== ==============================
Diluted 19,538 19,622 19,318 19,575
=============================== ==============================
See accompanying notes to summary consolidated financial statements.
3
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
June 30, December 31,
2002 2001
-----------------------------------
ASSETS (Unaudited)
---
Current Assets:
Cash and cash equivalents $ 12,290 $ 7,204
Marketable securities, at market 18,659 26,483
Trade receivables, net 13,800 13,305
Other receivables, net 3,727 2,820
Note receivable, net -- 1,169
Deferred preservation costs, net 21,039 24,199
Inventories 7,352 6,259
Prepaid expenses and other assets 2,976 2,341
Deferred income taxes 3,457 688
-----------------------------------
Total current assets 83,300 84,468
-----------------------------------
Property and equipment, net 39,574 39,246
Goodwill 1,399 1,399
Patents, net 4,998 2,919
Other, net 1,087 1,278
-----------------------------------
TOTAL ASSETS $ 130,358 $ 129,310
===================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,826 $ 555
Accrued expenses and other current liabilities 2,784 1,491
Accrued compensation 1,233 2,560
Accrued procurement fees 8,224 6,592
Current maturities of capital lease obligations 628 609
Current maturities of long-term debt 6,400 1,600
Convertible debenture -- 4,393
-----------------------------------
Total current liabilities 21,095 17,800
-----------------------------------
Capital lease obligations, less current maturities 2,821 3,140
Bank loan, less current maturities -- 5,600
Deferred income taxes 199 449
Other long-term liabilities 961 882
-----------------------------------
Total liabilities 25,076 27,871
-----------------------------------
Shareholders' equity:
Preferred stock -- --
Common stock (issued 20,864 shares in 2002 and
20,172 shares in 2001) 208 202
Additional paid-in capital 73,336 66,828
Retained earnings 38,129 40,547
Deferred compensation (27) (33)
Accumulated other comprehensive income (loss) 137 (145)
Less: Treasury stock at cost (1,309 shares in 2002 and
1,286 shares in 2001) (6,501) (5,960)
-----------------------------------
Total shareholders' equity 105,282 101,439
-----------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 130,358 $ 129,310
===================================
See accompanying notes to summary consolidated financial statements.
4
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Six Months Ended
June 30,
-----------------------------------
2002 2001
-----------------------------------
(Unaudited)
Net cash from operating activities:
Net (loss) income $ (2,418) $ 4,510
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Loss on sale of marketable equity securities 228 --
Depreciation and amortization 2,526 2,169
Provision for doubtful accounts 48 47
Write-down of deferred preservation costs 10,023 --
Other non-cash adjustments to income -- 748
Deferred income taxes (3,048) (578)
Tax effect of nonqualified option exercises 481 114
Changes in operating assets and liabilities:
Receivables 90 (1,645)
Income taxes (1,540) 926
Deferred preservation costs and inventories (7,956) (2,053)
Prepaid expenses and other assets (635) (814)
Accounts payable, accrued expenses, and other liabilities 2,951 889
-----------------------------------
Net cash flows provided by operating activities 750 4,313
-----------------------------------
Net cash flows from investing activities:
Capital expenditures (2,735) (9,072)
Other assets (1,980) (257)
Purchases of marketable securities (11,725) (9,307)
Sales and maturities of marketable securities 19,391 10,664
Proceeds from note receivable 1,169 1,605
-----------------------------------
Net cash flows provided by (used in) investing activities 4,120 (6,367)
-----------------------------------
Net cash flows from financing activities:
Principal payments of debt (800) (133)
Proceeds from debt issuance -- 1,165
Payment of obligations under capital leases (300) (85)
Proceeds from exercise of stock options and
issuance of common stock 1,099 540
-----------------------------------
Net cash (used in) provided by financing activities (1) 1,487
-----------------------------------
Increase (decrease) in cash 4,869 (567)
Effect of exchange rate changes on cash 217 (124)
Cash and cash equivalents, beginning of period 7,204 17,480
-----------------------------------
Cash and cash equivalents, end of period $ 12,290 $ 16,789
===================================
See accompanying notes to summary consolidated financial statements.
5
CRYOLIFE, INC. AND SUBSIDIARIES
NOTES TO SUMMARY CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with (i) accounting principles generally accepted in the
United States for interim financial information and (ii) the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X of the Securities and Exchange
Commission ("SEC"). Accordingly, they do not include all of the information and
disclosures required by accounting principles generally accepted in the United
States for a complete presentation of financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals and
estimated write-downs and accruals resulting from an order received from the
United States Food and Drug Administration ("FDA")) considered necessary for a
fair presentation have been included. Certain prior year balances have been
reclassified to conform to the 2002 presentation. CryoLife, Inc.'s ("CryoLife"
or the "Company") unaudited June 30, 2001 year to date results of operations
have been revised from the amounts previously reported in the Form 10-Q for the
quarter ended June 30, 2001, as indicated in Note 20 to the consolidated
financial statements included in the CryoLife, Inc Form 10-K for the year ended
December 31, 2001. Operating results for the three and six months ended June 30,
2002 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2002. For further information, refer to the
consolidated financial statements and notes thereto included in the CryoLife,
Inc. Form 10-K for the year ended December 31, 2001.
The Company anticipates that the FDA Order, defined in Note 2, will have
significant adverse effects on its financial position, results of operations and
cash flows. The Company expects its liquidity to decrease significantly over the
remainder of the year due to the anticipated significant decrease in revenues as
a result of the FDA Order and an expected use of cash due to the increased legal
and professional costs relating to the defense of lawsuits and to addressing the
FDA Order. As a result, the Company plans to reduce the number of personnel it
employs in several areas, as needed, based in part on the Company's success in
its efforts to appeal or obtain a modification of the FDA Order. On September 3,
2002 the Company announced a reduction in employee force of approximately 105
employees. The Company anticipates that severance and related costs will be
approximately $625,000, which will be recorded in the third quarter of 2002. As
a result of the employee reduction, management anticipates personnel costs will
be reduced by approximately $360,000 per month. The Company anticipates that
after it has reduced the number of employees in response to the reduction in
revenues, the savings in resources will enable the Company to meet its liquidity
needs through June 30, 2003. Even if the Company is able to obtain a favorable
outcome of its appeal or requested modification of the FDA Order, there is no
assurance that the Company would experience a return to the current level of
demand for its tissue services as a result of the adverse publicity or as a
result of customers and tissue banks switching to competitors.
The Company's long term liquidity and capital requirements will depend upon
numerous factors, including the resolution of the Company's appeal of the FDA
Order as described in Note 2, the extent of the anticipated revenue decreases,
the costs associated with becoming compliant with the FDA requirements as
outlined in the FDA Order, the outcome of litigation against the Company as
described in Note 11, the level of demand for tissue based on adverse publicity
in the event the FDA Order is resolved in a manner favorable to the Company, the
default on the Term Loan as described in Note 6, and the Company's inability to
borrow on its line of credit as described in Note 12. The Company may require
additional financing or seek to raise additional funds through bank facilities,
debt or equity offerings, or other sources of capital to meet liquidity and
capital requirements beyond June 30, 2003. Additional funds may not be available
when needed or on terms acceptable to the Company, which could have a material
adverse effect on the Company's business, financial condition, results of
operations, and cash flows. These are factors that indicate that the Company may
be unable to continue operations.
6
NOTE 2 - FDA ORDER ON HUMAN TISSUE PRESERVATION
On August 13, 2002 the Company received an order from the Atlanta district
office of the FDA regarding the non-valved cardiac, vascular, and orthopaedic
tissue processed by the Company since October 3, 2001 (the "FDA Order"). Revenue
from human tissue preservation services accounted for 78% of the Company's
revenues for the six months ended June 30, 2002, and of those revenues 67% or
$26.9 million are derived from preservation of tissues subject to the FDA Order.
The Company announced the receipt of the FDA Order in a press release dated
August 14, 2002. The FDA Order follows an FDA warning letter dated June 17,
2002, which the Company announced in a press release dated June 24, 2002.
Subsequently, the Company responded to the warning letter and requested a
meeting with the FDA. The FDA Order contains the following principal provisions:
o The FDA alleges that, based on its inspection of the Company's
facility on March 25 through April 12, 2002, certain human tissue
received and distributed by the Company may be in violation of 21 Code
of Federal Regulations ("CFR") Part 1270. (Part 1270 requires persons
or entities engaged in the recovery, screening, testing, processing,
storage, or distribution of human tissue to perform certain medical
screening and testing on human tissue intended for transplantation.
The rule also imposes requirements regarding procedures for the
prevention of contamination or cross-contamination of tissues during
processing and the maintenance of certain records related to these
activities.)
o The FDA alleges that the Company has not validated procedures for the
prevention of infectious disease contamination or cross-contamination
of tissue during processing at least since October 3, 2001.
o Non-valved cardiac, vascular, and orthopaedic tissue processed by the
Company since October 3, 2001 must be retained until it is recalled,
destroyed, the safety is confirmed, or an agreement is reached with
the FDA for its proper disposition under the supervision of an
authorized official of the FDA.
o The FDA strongly recommends that CryoLife perform a retrospective
review of all tissue in inventory (i.e. currently in storage at
CryoLife) that is not referenced in the FDA Order to assure that it
was recovered, processed, stored, and distributed in conformance with
21 CFR 1270
o The Center for Devices and Radiological Health ("CDRH"), a division of
the FDA, is evaluating whether there are similar risks that may be
posed by CryoLife's allograft heart valves, and will take further
regulatory action if appropriate.
Pursuant to the FDA Order, the Company has placed all non-valved cardiac,
vascular, and orthopaedic tissue subject to the FDA Order on quality assurance
quarantine and is recalling all non-valved cardiac, vascular, and orthopaedic
tissues subject to the FDA Order (i.e. processed since October 3, 2001) that
have been distributed but not implanted. After the FDA issued its order
regarding the recall, Health Canada also issued a recall on the same types of
tissue and the United Kingdom Department of Health has begun investigating
tissue exported by the Company.
The Company appealed the FDA Order on August 14, 2002 and requested a hearing
with the FDA. No dates have been set for the hearing. In addition, the Company
has requested a modification of the FDA Order to allow distribution of certain
non-valved cardiac tissues and vascular tissues which are used in life saving or
limb salvaging surgical procedures. The Company has met with the FDA and is
holding on-going discussions regarding its request for modification of the FDA
Order to accommodate distribution of non-valved cardiac and vascular tissue in
life saving and limb salvaging situations. The Company is unable to predict if
it will obtain a favorable outcome to its appeal or request for modification of
the FDA Order or the timing of the resolution of these matters.
After receiving the FDA Order, the Company met with representatives of the FDA's
CDRH division regarding CDRH's review of the Company's processed allograft heart
valves, which are not required to be recalled pursuant to the FDA Order. On
August 21, 2002 the FDA publicly stated that allograft heart valves have not
7
been included in the FDA recall order as these devices are essential for the
correction of congenital cardiac lesions in neonate and pediatric patients and
no satisfactory alternative device exists. However, the FDA also publicly stated
that it still has serious concerns regarding the processing and handling of
allograft heart valves. The FDA also recommended that surgeons carefully
consider using processed allografts from alternative sources, that surgeons
inform prospective patients of the FDA's concerns with the Company's allograft
heart valves, and that patients be carefully monitored for both fungal and
bacterial infections.
Management has determined that, with respect to tissue subject to the FDA Order,
product liability claims and shareholder litigation, the FDA Order received on
August 13, 2002 is a type one subsequent event, as defined by generally accepted
auditing standards in the United States, which requires adjustment to the second
quarter financial statements. A type one subsequent event provides additional
evidence about conditions which existed at the balance sheet date, and results
in changes to the estimates used to prepare the financial statements. Management
has made this determination because the FDA Order clarified the accounting
estimates surrounding the June 17, 2002 FDA warning letter, which stated a
recall was a possible course of action for the FDA if the warning letter issues
were not resolved promptly. The Company was working with the FDA to correct the
issues and did not believe a recall would be instated. Therefore, the Company
previously estimated that there was no material accounting impact from the FDA
warning letter. This estimate was revised due to the receipt of the FDA Order.
Management has determined that the negative implications of the FDA Order to its
revenues generated from tissue not subject to the FDA Order and any resulting
impairments of other assets or incurrence of liabilities do not represent a type
one subsequent event and therefore any necessary adjustments will be recorded in
future periods.
As a result of the FDA Order, the Company has recorded a reduction to pretax
income of $12.6 million, in the quarter ended June 30, 2002. The reduction was
comprised of a net $8.9 million increase to cost of human tissue preservation
services, a $2.4 million reduction to revenues (and accounts receivable) for the
estimated return of the tissues subject to recall by the FDA Order, and a $1.3
million accrual recorded in general, administrative, and marketing expenses for
retention levels under the Company's product liability and directors' and
officers' insurance policies of $1.2 million (see Note 11) and for estimated
expenses of $75,000 for packaging and handling for the return of affected
tissues under the FDA Order.
The net increase of $8.9 million to cost of preservation services is comprised
of a $10.0 million write-down of deferred preservation costs for tissues subject
to the FDA Order, offset by a $1.1 million decrease in cost of preservation
services due to the estimated tissue returns resulting from the FDA Order (the
costs of such recalled tissue are included in the $10.0 million write-down). The
Company evaluated many factors in determining the magnitude of impairment to
deferred preservation costs, including the impact of the current FDA Order, the
possibility of continuing action by the FDA or other United States and foreign
government agencies, and the possibility of unfavorable actions by physicians,
customers, procurement organizations, and others. As a result of this
evaluation, management believes that since all non-valved cardiac, vascular, and
orthopaedic allograft tissues processed since October 3, 2001 are under recall
pursuant to the FDA Order, and the Company does not know if it will obtain a
favorable resolution of its appeal and request for modification of the FDA
Order, the deferred preservation costs for tissues subject to the FDA Order have
been significantly impaired. The Company has estimated that this impairment
approximates the full balance of the deferred preservation costs of the tissues
subject to the FDA Order, which includes the tissues stored by the Company and
the tissues to be returned to the Company, and has therefore recorded a
write-down of $10.0 million for these assets.
As of June 30, 2002 deferred preservation costs of tissues not subject to the
FDA Order (i.e. tissue processed prior to October 3, 2001) were $829,000 for
non-valved cardiac tissues, $7.3 million for vascular tissues, and $4.7 million
for orthopaedic tissues. Deferred preservation costs for allograft heart valves,
which are not subject to the FDA Order, were $8.5 million as of June 30, 2002.
The Company is continuing to ship these tissues.
The Company evaluated many factors in determining the potential impairment of
the deferred preservation costs for non-valved cardiac, vascular, and
orthopaedic tissues processed prior to October 3, 2001 and all of the Company's
8
allograft heart valves, as these tissue populations are not subject to the FDA
Order. The allograft heart valve, non-valved cardiac, and vascular tissues are
principally used in life saving and limb salvaging surgical procedures and are
often used after all other avenues of treatment have been exhausted. Therefore,
the Company believes that non-valved cardiac tissues and vascular tissues
processed prior to October 3, 2001 and allograft heart valves will continue to
be in demand. Although management believes that the demand for non-valved
cardiac and vascular tissues processed prior to October 3, 2001 and all
allograft heart valves stored by the Company will be affected by the adverse
publicity surrounding the FDA Order, the Company cannot estimate the degree to
which these tissues have been impaired. The Company may determine in the future
that a write-down of the deferred preservation costs for these tissues is
necessary. Management will continue to monitor the Company's progress in
satisfying the FDA's requirements and the effect of the FDA Order and the
related adverse publicity on the demand for these tissues to determine if
additional write-downs of deferred preservation costs are required.
Management has reviewed the current circumstances relating to orthopaedic
tissues not subject to the FDA order (i.e. processed prior to October 3, 2001),
including whether there were indications of impairment of deferred preservation
costs for such tissues as of June 30, 2002. Management has determined that the
demand for orthopaedic tissues had not been affected sufficiently as of June 30,
2002 to cause an impairment in the deferred preservation costs related to these
tissues (i.e., cost was not in excess of market). Accordingly, the Company has
not recorded a write-down in the deferred preservation costs related to the
orthopaedic tissue processed prior to October 3, 2001 in the June 30, 2002
financial statements. However, the adverse publicity following the FDA Order has
resulted in a significant decrease in orthopaedic tissue revenues since August
13, 2002. As a result, management believes that the deferred preservation costs
for orthopaedic tissues not subject to the FDA Order have been impaired in the
third quarter of 2002 and expects that it will record a substantial write-down
of such costs in the third quarter of 2002.
As noted above, the FDA Order strongly recommends that the Company perform a
retrospective review of all tissue in inventory not subject to the FDA Order.
The Company is having ongoing discussions with the FDA to establish the
procedures to be followed in the retrospective review and therefore is currently
unable to reasonably estimate the costs for such review. Once the Company and
the FDA agree on these procedures the Company will evaluate the costs associated
with performing the review and record an appropriate accrual for these costs.
The Company periodically evaluates the recoverability of noncurrent tangible and
intangible assets and measures the amount of impairment, if any. Management does
not believe an impairment of the Company's tangible and intangible assets
relating to the tissue preservation business had occurred as of June 30, 2002.
However, depending on the outcome of the FDA Order and the future effects of
adverse publicity surrounding the FDA Order and reported infections on
preservation revenues, these assets may become impaired. Management will
continue to evaluate the recoverability of these assets.
The Company anticipates that the FDA Order will also affect the financial
position, results of operations, and cash flows of the Company for the quarter
ended September 30, 2002. In addition to the anticipated write-down of deferred
preservation costs for orthopaedic tissue, the Company expects a $1.0 million
reversal of revenues recorded in July and August, due to the estimated returns
of tissues subject to the FDA Order, which were shipped in July and August. The
deferred preservation costs of tissues processed during the third quarter of
2002 that are subject to the FDA Order approximate $3.9 million as of August 14,
2002. The deferred preservation costs of these tissues processed during the
third quarter are anticipated to be fully impaired and the Company expects to
record a write-down approximating their full cost in the third quarter.
NOTE 3 - CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company maintains cash equivalents, which consist primarily of highly liquid
investments with maturity dates of 90 days or less at the time of acquisition,
and marketable securities in several large, well-capitalized financial
institutions, and the Company's policy disallows investment in any securities
rated less than "investment-grade" by national rating services.
9
Management determines the appropriate classification of debt securities at the
time of purchase and reevaluates such designations as of each balance sheet
date. Debt securities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost. Debt securities not
classified as held-to-maturity or trading and marketable equity securities not
classified as trading are classified as available-for-sale. At June 30, 2002 and
December 31, 2001, all marketable equity securities and debt securities were
designated as available-for-sale.
Available-for-sale securities are stated at their fair values, with the
unrealized gains and losses, net of tax, reported in a separate component of
shareholders' equity. Interest income, dividends, realized gains and losses, and
declines in value judged to be other than temporary are included in investment
income. The cost of securities sold is based on the specific identification
method.
The following is a summary of cash equivalents and marketable securities (in
thousands):
Unrealized Estimated
Adjustments Adjusted Holding Market
June 30, 2002 Cost Basis to Cost Basis Cost Basis Gains/(Losses) Value
-----------------------------------------------------------------------------------
Cash equivalents:
Money market funds $ 6,061 $ -- $ 6,061 $ -- $ 6,061
Municipal obligations 3,454 -- 3,454 -- 3,454
-----------------------------------------------------------------------------------
$ 9,515 $ -- $ 9,515 $ -- $ 9,515
===================================================================================
Marketable securities:
Municipal obligations $ 17,642 $ -- $ 17,642 $ 269 $ 17,911
Equity securities 1,075 (284) 791 (43) 748
-----------------------------------------------------------------------------------
$ 18,717 $ (284) $ 18,433 $ 226 $ 18,659
===================================================================================
Unrealized Estimated
Adjustments Adjusted Holding Market
December 31, 2001 Cost Basis to Cost Basis Cost Basis Gains/(Losses) Value
-----------------------------------------------------------------------------------
Cash equivalents:
Money market funds $ 1,301 $ -- $ 1,301 $ -- $ 1,301
Municipal obligations 500 -- 500 -- 500
-----------------------------------------------------------------------------------
$ 1,801 $ -- $ 1,801 $ -- $ 1,801
===================================================================================
Marketable securities:
Municipal obligations $ 17,696 $ -- $ 17,696 $ 147 $ 17,843
Debt securities 6,227 (1,217) 5,010 -- 5,010
Equity securities 3,900 (343) 3,557 10 3,567
Certificates of deposit 63 -- 63 -- 63
-----------------------------------------------------------------------------------
$ 27,886 $ (1,560) $ 26,326 $ 157 $ 26,483
===================================================================================
The Adjustments to Cost Basis column includes a $284,000 loss as of June 30,
2002 recorded for an other than temporary decline in the market value of equity
securities, and a $1.6 million loss as of December 31, 2001 recorded for an
other than temporary decline in the market value of debt and equity securities.
Differences between cost and market listed above, consisting of a net unrealized
holding gain less deferred taxes of $77,000 at June 30, 2002 and $50,000 as of
December 31, 2001, are included in the accumulated other comprehensive income
account of shareholders' equity.
At June 30, 2002 and December 31, 2001 approximately $2.0 million and $3.4
million, respectively, of marketable securities had a maturity date between 90
days and 1 year, approximately $4.6 million and $14.5 million, respectively of
marketable securities matured between 1 and 5 years, and approximately $12.1
million and $8.6 million of marketable securities matured in more than 5 years
or did not have a maturity date.
10
NOTE 4 - INVENTORIES
Inventories are comprised of the following (in thousands):
June 30, December 31,
2002 2001
---------------------------------
Raw materials $ 2,402 $ 1,987
Work-in-process 961 1,183
Finished goods 3,989 3,089
---------------------------------
$ 7,352 $ 6,259
=================================
NOTE 5 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Numerator for basic and diluted earnings
per share:
Net (loss) income available to common
shareholders $ (5,522) $ 2,540 $ (2,418) $ 4,510
=============================== ==============================
Denominator for basic earnings per share:
Weighted-average basis 19,538 18,780 19,318 18,761
Effect of dilutive stock options -- 842 -- 814
------------------------------- ------------------------------
Denominator for diluted earnings per share:
Adjusted weighted-average shares 19,538 19,622 19,318 19,575
=============================== ==============================
Net (loss) earnings per share:
Basic $ (0.28) $ 0.14 $ (0.13) $ 0.24
=============================== ==============================
Diluted $ (0.28) $ 0.13 $ (0.13) $ 0.23
=============================== ==============================
The effects of stock options of 674,000 and 692,000 shares for the three and six
months ended June 30, 2002, respectively, were excluded from the calculation
because the amounts are antidilutive for the period presented.
NOTE 6 - DEBT
On April 25, 2000 the Company entered into a loan agreement permitting the
Company to borrow up to $8 million under a line of credit during the expansion
of the Company's corporate headquarters and manufacturing facilities. Borrowings
under the line of credit accrued interest equal to Adjusted LIBOR plus 2%
adjusted monthly. On June 1, 2001, the line of credit was converted to a term
loan (the "Term Loan") to be paid in 60 equal monthly installments of principal
plus interest computed at Adjusted LIBOR plus 1.5% (3.34% at June 30, 2002). At
June 30, 2002 the principal balance of the Term Loan was $6.4 million. The Term
Loan is secured by substantially all of the Company's assets. The Term Loan
contains certain restrictive covenants including, but not limited to,
maintenance of certain financial ratios, a minimum tangible net worth
requirement, and the requirement that no materially adverse event has occurred.
The lender has notified the Company that the FDA Order, as described in Note 2,
and the inquiries of the SEC, as described in Note 12, have had a material
adverse effect on the Company that constitute an event of default. As of August
11
30, 2002 the lender has elected not to declare an event of default, but reserves
the right to exercise any such right under the terms of the Term Loan.
Therefore, all amounts due under the Term Loan as of June 30, 2002 are reflected
as a current liability on the Summary Consolidated Balance Sheet.
In March 1997 the Company issued a $5.0 million convertible debenture in
connection with the Ideas for Medicine, Inc. acquisition. The debenture accrued
interest at 7% and was convertible into common stock of the Company at any time
prior to the due date of March 5, 2002 at $8.05 per common share. On March 30,
1998 $607,000 of the convertible debenture was converted into 75,000 shares of
the Company's common stock, and on March 4, 2002 the remaining $4.4 million was
converted into 546,000 shares of the Company's common stock.
NOTE 7 - DERIVATIVES
The Company's Term Loan, which accrues interest computed at Adjusted LIBOR plus
1.5%, exposes the Company to changes in interest rates going forward. On March
16, 2000, the Company entered into a $4 million notional amount forward-starting
interest swap agreement, which took effect on June 1, 2001 and expires in 2006.
This swap agreement was designated as a cash flow hedge to effectively convert a
portion of the Term Loan balance to a fixed rate basis, thus reducing the impact
of interest rate changes on future income. This agreement involves the receipt
of floating rate amounts in exchange for fixed rate interest payments over the
life of the agreement, without an exchange of the underlying principal amounts.
The differential to be paid or received is recognized in the period in which it
accrues as an adjustment to interest expense on the Term Loan.
On January 1, 2001 the Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") as amended. SFAS 133 requires
the Company to recognize all derivative instruments on the balance sheet at fair
value, and changes in the derivative's fair value must be recognized currently
in earnings or other comprehensive income, as applicable. The adoption of SFAS
133 impacts the accounting for the Company's forward-starting interest rate swap
agreement. Upon adoption of SFAS 133, the Company recorded an unrealized loss of
approximately $175,000 related to the interest rate swap, which was recorded as
part of long-term liabilities and accumulated other comprehensive income as the
cumulative effect of adopting SFAS 133 within the Statement of Shareholders'
Equity.
At June 30, 2002 the notional amount of this swap agreement was $3.2 million,
and the fair value of the interest rate swap agreement, as estimated by the bank
based on its internal valuation models, was a liability of $269,000. The fair
value of the swap agreement is recorded as part of long-term liabilities and is
recorded net of tax as part of accumulated other comprehensive income within
shareholders' equity.
NOTE 8 -COMPREHENSIVE INCOME
Components of comprehensive income consist of the following, net of tax (in
thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Net (loss) income $ (5,522) $ 2,540 $ (2,418) $ 4,510
Unrealized gain/(loss) on investments 128 115 42 817
Change in fair value of interest rate swap
(including cumulative effect of adopting
SFAS 133 in 2001) 15 5 23 (158)
Translation adjustment 250 (121) 217 (124)
-------------------------------- -------------------------------
Comprehensive income $ (5,129) $ 2,539 $ (2,136) $ 5,045
=============================== ==============================
12
The tax effect on the change in unrealized gain/loss on investments is $66,000
and $59,000 for the three months ended June 30, 2002 and 2001, respectively. The
tax effect for the six months ended June 30, 2002 and 2001 is $27,000 and
$398,000, respectively. The tax effect on the change in fair value of the
interest rate swap is $7,000 and $3,000 for the three months ended June 30, 2002
and 2001, respectively. The tax effect for the six months ended June 30, 2002
and 2001 is $2,000 and a tax benefit of $81,000, respectively. The translation
adjustment is not currently adjusted for income taxes as it relates to a
permanent investment in a foreign subsidiary.
NOTE 9 - ACCOUNTING PRONOUNCEMENTS
On January 1, 2002 the Company was required to adopt SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), and SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 142 specifies
that goodwill and certain other intangible assets will no longer be amortized
but instead will be subject to periodic impairment testing. SFAS 144 clarifies
accounting and reporting for assets held for sale, scheduled for abandonment or
other disposal, and recognition of impairment loss related to the carrying value
of long-lived assets. The Company has completed its impairment testing as
required by FAS 142, and has determined that the recognition of an impairment
loss on intangible assets is not required. The adoption of these statements did
not have a material effect on the consolidated financial statements of the
Company. However, the adoption of SFAS 142 will increase the Company's pretax
income by approximately $100,000 in 2002 due to the cessation of goodwill
amortization.
The Company will be required to adopt SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143") on January 1, 2003. SFAS 143 addresses
accounting and reporting for asset retirement costs of long-lived assets
resulting from legal obligations associated with acquisition, construction, or
development transactions. The Company has determined that the adoption of SFAS
143 will not have a material effect on the results of operations or financial
position of the Company.
The Company will be required to adopt SFAS No. 145, "Rescission of FASB
Statements 4, 44 and 64, Amendment to FASB Statement 13, and Technical
Corrections" ("SFAS 145") on January 1, 2003. SFAS 145 changes the accounting
for the classification of gains and losses from the extinguishment of debt. The
Company is currently evaluating the impact of this Statement.
The Company will be required to adopt SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146") on January 1, 2003.
SFAS 146 requires that costs associated with exit or disposal activities be
recorded at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
Company is currently evaluating the impact of this Statement.
NOTE 10 - SEGMENT INFORMATION
The Company has two reportable segments: Human Tissue Preservation Services and
Implantable Medical Devices. The Company's segments are organized according to
services and products.
The HUMAN TISSUE PRESERVATION SERVICES segment includes external revenue from
cryopreservation services of cardiac, vascular, and orthopaedic allograft
tissues. The IMPLANTABLE MEDICAL DEVICES segment includes external revenue from
product sales of BioGlue Surgical Adhesive and bioprosthetic devices, including
stentless porcine heart valves, SynerGraft treated porcine heart valves, and
SynerGraft treated bovine vascular grafts. There are no intersegment revenues.
The primary measure of segment performance, as viewed by the Company's
management, is segment gross margin, or net external revenues less cost of
preservation services and products. The Company does not segregate assets by
segment; therefore asset information is excluded from the segment disclosures
below.
13
The following table summarizes revenues, cost of preservation services and
products, and gross margins for the Company's operating segments (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenue:
Human tissue preservation services, net a 17,536 18,765 37,774 37,331
Implantable medical devices 5,473 2,789 10,538 5,430
All other b 255 143 423 368
------------------------------- ------------------------------
$ 23,264 $ 21,697 $ 48,735 $ 43,129
------------------------------- ------------------------------
Cost of Preservation Services and Products:
Human tissue preservation services c 17,203 7,697 25,266 15,370
Implantable medical devices 1,843 1,423 4,078 2,855
All other b -- -- -- --
------------------------------- ------------------------------
19,046 9,120 29,344 18,225
------------------------------- ------------------------------
Gross Margin (Loss):
Human tissue preservation services 333 11,068 12,508 21,961
Implantable medical devices 3,630 1,366 6,460 2,575
All other b 255 143 423 368
------------------------------- ------------------------------
$ 4,218 $ 12,577 $ 19,391 $ 24,904
------------------------------- ------------------------------
a Revenue from human tissue preservation services includes the estimated
effect of the return of tissues subject to recall by the FDA Order of $2.4
million in the three and six months ended June 30, 2002.
b The "All other" designation includes 1) grant revenue and 2) distribution
revenue.
c Cost of human tissue preservation services includes the write-down of
deferred preservation costs for tissues subject to the FDA Order of $10.0
million in the three and six months ended June 30, 2002.
The following table summarizes net revenues by product (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenue:
Human tissue preservation services, net a:
Cardiovascular tissue $ 7,336 $ 7,182 $ 14,644 $ 14,093
Vascular tissue 4,641 6,017 11,658 12,429
Orthopaedic tissue 5,559 5,566 11,472 10,809
------------------------------- ------------------------------
Total preservation services 17,536 18,765 37,774 37,331
------------------------------- ------------------------------
BioGlue surgical adhesive 5,251 2,631 10,124 5,074
Bioprosthetic devices 222 158 414 356
Distribution and grant 255 143 423 368
------------------------------- ------------------------------
$ 23,264 $ 21,697 $ 48,735 $ 43,129
=============================== ==============================
a Revenue from tissue preservation services includes the estimated effect of
the return of tissues subject to recall by the FDA Order of $340,000 in
cardiovascular tissue, $1.7 million in vascular tissue, and $380,000 in
orthopaedic tissue, totaling $2.4 million, for the three and six months
ended June 30, 2002.
14
NOTE 11 - COMMITMENTS AND CONTINGENCIES
In the normal course of business as a medical device and services company the
Company has product liability complaints filed against it. As of August 30, 2002
fifteen product liability cases had been filed against the Company between May
18, 2000 and August 15, 2002. The cases are currently in the pre-discovery or
discovery stages. Of these cases, nine allege product liability claims arising
out of the Company's orthopaedic tissue, four allege product liability claims
arising out of the Company's allograft heart valve tissue and one alleges
product liability claims arising out of the non-tissue products made by Ideas
for Medicine, when it was a subsidiary of the Company.
Included in these cases is the complaint filed against the Company in the
Superior Court of Cobb County, Georgia, on July 12, 2002 by Steve Lykins, as
Trustee for the benefit of next of kin of Brian Lykins. This complaint alleges
strict liability, negligence, professional negligence, and breach of warranties
related to tissue implanted in November of 2001. The plaintiff seeks unspecified
compensatory and punitive damages.
The Company maintains product liability insurance policies, which the Company
believes to be adequate to defend against these suits. The Company's insurance
company has been notified of these actions. The Company intends to vigorously
defend against these claims. Nonetheless, an adverse judgment in excess of the
Company's insurance coverage could have a material adverse effect on the
Company's financial position, results of operations, and cash flows.
Several putative class action lawsuits were filed in July 2002, one of which was
amended in August of 2002, against the Company and certain officers of the
Company alleging that the defendants violated Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, by
issuing a series of materially false and misleading statements to the market
throughout the Class Period of August of 2000 through August of 2002, which
statements had the effect of artificially inflating the market price of the
Company's securities. The principal allegations of the complaints are that the
Company failed to disclose its alleged lack of compliance with certain FDA
regulations regarding the handling and processing of certain tissues and other
product safety matters. The plaintiffs seek unspecified compensatory damages in
an amount to be proven at trial. The Company believes these cases will be
consolidated into one putative class action lawsuit. The Company believes the
claims made in the lawsuits are without merit and intends to vigorously defend
against these claims. Management has retained the services of the Atlanta based
law firm of King & Spalding to defend the Company. The Company carries
director's and officer's liability insurance which the Company believes to be
adequate to defend against these suits. Nonetheless, an adverse judgment in
excess of the Company's insurance coverage could have a material adverse effect
on the Company's financial position, results of operations, and cash flows.
The Company has concluded that it is probable that it will incur losses relating
to claims and litigation of at least $1.2 million; which represents the
aggregate amount of the Company's deductibles under its product liability and
directors and officer's insurance policies. Therefore the Company has recorded
an accrual of $1.2 million as of June 30, 2002.
NOTE 12 - SUBSEQUENT EVENTS
On July 23, 2002 the Company's Board of Directors authorized the purchase of up
to $10 million of its Common Stock. As of August 13, 2002 the Company had
repurchased 68,000 shares of its Company stock for $666,000. No further
purchases are anticipated in the near term.
On July 30, 2002 the Company entered into a line of credit agreement with the
lender that made the Term Loan, as discussed in Note 6, permitting the Company
to borrow up to $10 million. Borrowings under the line of credit agreement
accrue interest equal to Adjusted LIBOR plus 1.25% adjusted monthly. This loan
is secured by substantially all of the Company's assets. As of August 30, 2002
$6,900 has been drawn on the line of credit. As a result of the FDA Order, as
discussed in Note 2, the Company is not in compliance with the lender's
requirements for advances of funds under the line of credit. On August 21, 2002
the lender notified the Company that it was not entitled to any further advances
under the line of credit.
15
On August 7, 2002 the Company announced the settlement of its ongoing litigation
with Colorado State University Foundation ("CSURF") over the ownership of the
Company's SynerGraft technology. The settlement resolves all disputes between
the parties and extinguishes all CSURF ownership claims to any aspect of
CryoLife's SynerGraft technology. The settlement includes an unconditional
assignment to CryoLife of CSURF tissue engineering patents, trade secrets and
know-how relating to tissue decellularization and recellularization. The
technology assignment supercedes the 1996 technology license, which was
terminated by the terms of the settlement. Payment terms include a nonrefundable
advance of $400,000 paid by the Company to CSURF that will be applied to earned
royalties as they accrue through March 2011. The Company will record these
amounts as prepaid royalties and will expense the amounts as the royalties
accrue. The earned royalty rate is a maximum of 0.75% of net revenues from
products or tissue services utilizing the SynerGraft technology. Royalties
earned under the agreement for revenues through June 30, 2002 were approximately
$27,000.
On August 14, 2002 the compensation committee determined to pay bonuses to
Steven G. Anderson, Chairman, President and CEO, of $225,000 and Sidney B.
Ashmore, Vice President Marketing, of $15,000. On August 16, 2002 the
compensation committee determined to pay a bonus to James Vander Wyk, Vice
President Regulatory Affairs and Quality Assurance, of $60,000. In each case the
compensation committee determined to grant the mid-year bonus in recognition of
the officer's efforts on behalf of the Company in addressing important Company
issues in difficult times, the officer's long term service to the Company, and
to accommodate the economic needs of the officers arising from their desire to
retain Company shares rather than permit them to be sold pursuant to margin
calls. These officers now have no margin loans against their shares.
On Saturday, August 17, 2002 the Company received a letter from the United
States Securities and Exchange Commission (the "SEC Letter") that stated that
the Company was subject to an investigation related to the Company's August 14,
2002 announcement of the FDA Order and requesting information from the Company
from the period between September 1, 2001 through the date of the Company's
response to the SEC Letter. The SEC Letter stated, in part, that "We are trying
to determine whether there have been any violations of the federal securities
laws. The investigation and the subpoena do not mean that we have concluded that
anyone has broken the law. Also, the investigation does not mean that we have a
negative opinion of any person, entity or security." The staff of the SEC
subsequently confirmed that its investigation is informal in nature, and that it
does not have subpoena power at this time. At the present time, the Company is
unable to predict the outcome of this matter.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
RECENT EVENTS
On August 13, 2002 the Company received an order from the Atlanta district
office of the FDA regarding the non-valved cardiac, vascular, and orthopaedic
tissue processed by the Company since October 3, 2001 (the "FDA Order"). Revenue
from human tissue preservation services accounted for 78% of the Company's
revenues for the six months ended June 30, 2002, and of those revenues 67% or
$26.9 million are derived from preservation of tissues subject to the FDA Order.
The Company announced the receipt of the FDA Order in a press release dated
August 14, 2002. The FDA Order follows an FDA warning letter dated June 17,
2002, which the Company announced in a press release dated June 24, 2002.
Subsequently, the Company responded to the warning letter and requested a
meeting with the FDA. The FDA Order contains the following principal provisions:
o The FDA alleges that, based on its inspection of the Company's
facility on March 25 through April 12, 2002, certain human tissue
received and distributed by the Company may be in violation of 21 Code
of Federal Regulations ("CFR") 1270. Code 21, 1270 (PROVIDE A BRIEF
DESCRIPTION OF WHAT THIS IS)
o The FDA alleges that the Company has not validated procedures for the
prevention of infectious disease contamination or cross-contamination
of tissue during processing at least since October 3, 2001.
o Non-valved cardiac, vascular, and orthopaedic tissue processed by the
Company since October 3, 2001 must be retained until it is recalled,
destroyed, the safety is confirmed, or an agreement is reached with
the FDA for its proper disposition under the supervision of an
authorized official of the FDA.
o The FDA strongly recommends that CryoLife perform a retrospective
review of all tissue in inventory that is not referenced in the FDA
Order to assure that it was recovered, processed, stored, and
distributed in conformance with 21 CFR 1270
o The Center for Devices and Radiological Health ("CDRH") is evaluating
whether there are similar risks that may be posed by CryoLife's
allograft heart valves, and will take further regulatory action if
appropriate.
Pursuant to the FDA Order, the Company has placed all non-valved cardiac,
vascular, and orthopaedic tissue subject to the FDA Order on quality assurance
quarantine and is recalling all non-valved cardiac, vascular, and orthopaedic
tissues subject to the FDA Order that have been distributed but not implanted.
After the FDA issued its order regarding the recall, Health Canada also issued a
recall on the same types of tissue and the United Kingdom Department of Health
has begun investigating tissue exported by the Company.
The Company appealed the FDA Order on August 14, 2002 and requested a hearing
with the FDA. No dates have been set for the hearing. In addition, the Company
has requested a modification of the FDA Order to allow distribution of certain
non-valved cardiac tissues and vascular tissues which are used in life saving or
limb salvaging surgical procedures. The Company has met with the FDA and is
holding on-going discussions regarding its request for modification of the FDA
Order to accommodate distribution of non-valved cardiac and vascular tissue in
life saving and limb salvaging situations. The Company is unable to predict if
it will obtain a favorable outcome to its appeal or request for modification of
the FDA Order or the timing of the resolution of these matters.
After receiving the FDA Order, the Company met with representatives of the FDA's
CDRH division regarding CDRH's review of the Company's processed allograft heart
valves, which are not required to be recalled pursuant to the FDA Order. On
August 21, 2002 the FDA publicly stated that allograft heart valves have not
17
been included in the FDA recall order as these devices are essential for the
correction of congenital cardiac lesions in neonate and pediatric patients and
no satisfactory alternative device exists. However, the FDA also publicly stated
that it still has serious concerns regarding the processing and handling of
allograft heart valves. The FDA also recommended that surgeons carefully
consider using processed allografts from alternative sources, that surgeons
inform prospective patients of the FDA's concerns with the Company's allograft
heart valves, and that patients be carefully monitored for both fungal and
bacterial infections.
Management has determined that, with respect to tissue subject to the FDA Order,
product liability claims and shareholder litigation, the FDA Order received on
August 13, 2002 is a type one subsequent event, as defined by generally accepted
auditing standards in the United States, which requires adjustment to the second
quarter financial statements. A type one subsequent event provides additional
evidence about conditions which existed at the balance sheet date, and results
in changes to the estimates used to prepare the financial statements. Management
has made this determination because the FDA Order clarified the accounting
estimates surrounding the June 17, 2002 FDA warning letter, which stated a
recall was a possible course of action for the FDA if the warning letter issues
were not resolved promptly. The Company was working with the FDA to correct the
issues and did not believe a recall would be instated. Therefore, the Company
previously estimated that there was no material accounting impact from the FDA
warning letter. This estimate was revised due to the receipt of the FDA Order.
Management has determined that the negative implications of the FDA Order to the
tissue revenues not subject to the FDA Order and any resulting impairments of
other assets or incurrence of liabilities do not represent a type one subsequent
event and therefore any necessary adjustments will be recorded in future
periods.
As a result of the FDA Order, the Company has recorded a reduction to pretax
income of $12.6 million, in the quarter ended June 30, 2002. The reduction was
comprised of a net $8.9 million increase to cost of human tissue preservation
services, a $2.4 million reduction to revenues (and accounts receivable) for the
estimated return of the tissues subject to recall by the FDA Order, and a $1.3
million accrual recorded in general, administrative, and marketing expenses for
retention levels under the Company's product liability and directors' and
officers' insurance policies of $1.2 million (see Note 11) and for estimated
expenses of $75,000 for packaging and handling for the return of affected
tissues under the FDA Order.
The net increase of $8.9 million to cost of preservation services is comprised
of a $10.0 million write-down of deferred preservation costs for tissues subject
to the FDA Order, offset by a $1.1 million decrease in cost of preservation
services due to the estimated tissue returns resulting from the FDA Order. The
Company evaluated many factors in determining the magnitude of impairment to
deferred preservation costs, including the impact of the current FDA Order, the
possibility of continuing action by the FDA or other United States and foreign
government agencies, and the possibility of unfavorable actions by physicians,
customers, procurement organizations, and others. As a result of this
evaluation, management believes that since all non-valved cardiac, vascular, and
orthopaedic allograft tissues processed since October 3, 2001 are under recall
pursuant to the FDA Order, and the Company does not know if it will obtain a
favorable resolution of its appeal and request for modification of the FDA
Order, the deferred preservation costs for tissues subject to the FDA Order have
been significantly impaired. The Company has estimated that this impairment
approximates the full balance of the deferred preservation costs of the tissues
subject to the FDA Order, which includes the tissues stored by the Company and
the tissues to be returned to the Company, and has therefore recorded a
write-down of $10.0 million for these assets.
As of June 30, 2002 deferred preservation costs of tissues not subject to the
FDA Order (i.e. tissue processed prior to October 3, 2001) were $829,000 for
non-valved cardiac tissues, $7.3 million for vascular tissues, and $4.7 million
for orthopaedic tissues. Deferred preservation costs for allograft heart valves,
which are not subject to the FDA Order, were $8.5 million as of June 30, 2002.
The Company is continuing to ship these tissues.
The Company evaluated many factors in determining the potential impairment of
the deferred preservation costs for non-valved cardiac, vascular, and
orthopaedic tissues processed prior to October 3, 2001 and all of the Company's
allograft heart valves, as these tissue populations are not subject to the FDA
18
Order. The allograft heart valve, non-valved cardiac, and vascular tissues are
principally used in life saving and limb salvaging surgical procedures and are
often used after all other avenues of treatment have been exhausted. Therefore,
the Company believes that non-valved cardiac tissues and vascular tissues
processed prior to October 3, 2001 and allograft heart valves will continue to
be in demand. Although management believes that the demand for non-valved
cardiac and vascular tissues processed prior to October 3, 2001 and all
allograft heart valves stored by the Company will be affected by the adverse
publicity surrounding the FDA Order, the Company cannot estimate the degree to
which these tissues have been impaired. The Company may determine in the future
that a write-down of the deferred preservation costs for these tissues is
necessary. Management will continue to monitor the Company's progress in
satisfying the FDA's requirements and the effect of the FDA Order and the
related adverse publicity on the demand for these tissues to determine if
additional write-downs of deferred preservation costs are required.
Management has reviewed the current circumstances relating to orthopaedic
tissues not subject to the FDA order (i.e. processed prior to October 3, 2001),
including whether there were indications of impairment of deferred preservation
costs for such tissues as of June 30, 2002. Management has determined that the
demand for orthopaedic tissues had not been affected sufficiently as of June 30,
2002 to cause an impairment in the deferred preservation costs related to these
tissues (i.e., cost was not in excess of market). Accordingly, the Company has
not recorded a write-down in the deferred preservation costs related to the
orthopaedic tissue processed prior to October 3, 2001 in the June 30, 2002
financial statements. However, the adverse publicity following the FDA Order has
resulted in a significant decrease in orthopaedic tissue revenues since August
13, 2002. As a result, management believes that the deferred preservation costs
for orthopaedic tissues not subject to the FDA Order have been impaired in the
third quarter of 2002 and expects that it will record a substantial write-down
of such costs in the third quarter of 2002.
As noted above, the FDA Order strongly recommends that the Company perform a
retrospective review of all tissue in inventory not subject to the FDA Order.
The Company is having ongoing discussions with the FDA to establish the
procedures to be followed in the retrospective review and therefore is currently
unable to reasonably estimate the costs for such review. Once the Company and
the FDA agree on these procedures the Company will evaluate the costs associated
with performing the review and record an appropriate accrual for these costs.
The Company periodically evaluates the recoverability of noncurrent tangible and
intangible assets and measures the amount of impairment, if any. Management does
not believe an impairment of the Company's tangible and intangible assets
relating to the tissue preservation business has occurred as of June 30, 2002.
However, depending on the outcome of the FDA Order and the future effects of
adverse publicity surrounding the FDA Order and reported infections on
preservation revenues, these assets may become impaired. Management will
continue to evaluate the recoverability of these assets.
The Company anticipates that the FDA Order will also affect the financial
position, results of operations, and cash flows of the Company for the quarter
ended September 30, 2002. In addition to the anticipated write-down of deferred
preservation costs for orthopaedic tissue, the Company expects a $1.0 million
reversal of revenues recorded in July and August, due to the estimated returns
of tissues subject to the FDA Order, which were shipped in July and August. The
deferred preservation costs of tissues processed during the third quarter of
2002 that are subject to the FDA Order approximate $3.9 million as of August 14,
2002. The deferred preservation costs of these tissues processed during the
third quarter are anticipated to be fully impaired and the Company expects to
record a write-down approximating their full cost in the third quarter.
On July 23, 2002 the Company's Board of Directors authorized the purchase of up
to $10 million of its Common Stock. As of August 13, 2002 the Company had
repurchased 68,000 shares of its Company stock for $666,000. No further
purchases are anticipated in the near term.
On August 7, 2002 the Company announced the settlement of its ongoing litigation
with Colorado State University Foundation ("CSURF") over the ownership of the
Company's SynerGraft technology. The settlement resolves all disputes between
the parties and extinguishes all CSURF ownership claims to any aspect of
CryoLife's SynerGraft technology. The settlement includes an unconditional
assignment to CryoLife of CSURF tissue engineering patents, trade secrets and
19
know-how relating to tissue decellularization and recellularization. The
technology assignment supercedes the 1996 technology license, which was
terminated by the terms of the settlement. Payment terms include a nonrefundable
advance of $400,000 paid by the Company to CSURF that will be applied to earned
royalties as they accrue through March 2011. The Company will record these
amounts as prepaid royalties and will expense the amounts as the royalties
accrue. The earned royalty rate is a maximum of 0.75% of net revenues from
products or tissue services utilizing the SynerGraft technology. Royalties
earned under the agreement for revenues through June 30, 2002 were approximately
$27,000.
On August 14, 2002 the compensation committee determined to pay bonuses to
Steven G. Anderson, Chairman, President and CEO, of $225,000 and Sidney B.
Ashmore, Vice President Marketing, of$15,000. On August 16, 2002 the
compensation committee determined to pay a bonus to James Vander Wyk, Vice
President Regulatory Affairs and Quality Assurance, of $60,000. In each case the
compensation committee determined to grant the mid-year bonus in recognition of
the officer's efforts on behalf of the Company in addressing important Company
issues in difficult times, the officer's long term service to the Company, and
to accommodate the economic needs of the officers arising from their desire to
retain Company shares rather than permit them to be sold pursuant to margin
calls. The officers now have no margin loans against their shares.
On Saturday, August 17, 2002 the Company received a letter from the United
States Securities and Exchange Commission (the "SEC Letter") that stated that
the Company was subject to an investigation related to the Company's August 14,
2002 announcement of the FDA Order and requesting information from the Company
from the period between September 1, 2001 through the date of the Company's
response to the SEC Letter. The SEC Letter stated, in part, that "We are trying
to determine whether there have been any violations of the federal securities
laws. The investigation and the subpoena do not mean that we have concluded that
anyone has broken the law. Also, the investigation does not mean that we have a
negative opinion of any person, entity or security." The staff of the SEC
subsequently confirmed that the investigation is informal in nature, and that it
does not have subpoena poser at this time. At the present time, the Company is
unable to predict the outcome of this matter.
On September 3, 2002 the Company announced a reduction in employee force of
approximately 105 employees. The Company anticipates that severance and related
costs will be approximately $625,000, which will be recorded in the third
quarter of 2002. As a result of the employee reduction, management anticipates
personnel costs will be reduced by approximately $360,000 per month.
CRITICAL ACCOUNTING POLICIES
A summary of the Company's significant accounting policies is included in Note 1
to the consolidated financial statements, as filed in the Form 10-K for the
fiscal year ended December 31, 2001. Management believes that the consistent
application of these policies enables the Company to provide users of the
financial statements with useful and reliable information about the Company's
operating results and financial condition. The consolidated financial statements
are prepared in accordance with accounting principles generally accepted in the
United States, which require the Company to make estimates and assumptions. The
following are accounting policies that management believes are most important to
the portrayal of the Company's financial condition and results and may involve a
higher degree of judgment and complexity.
REVENUE RECOGNITION: The Company recognizes revenue in accordance with SEC Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"), which provides guidance on applying generally accepted accounting
principles to revenue recognition issues. Revenues for human tissue preservation
services are recognized when services are completed and tissue is delivered to
the customer. The Company accepts returned human tissue within 72 hours of
20
original shipment. The Company has recorded the estimated revenues of tissues to
be recalled pursuant to the FDA Order as a service revenue return. Revenues for
products are recognized at the time the product is shipped, at which time title
passes to the customer. There are no further performance obligations and
delivery occurs upon shipment. Revenues from research grants are recognized in
the period the associated costs are incurred. The Company assesses the
likelihood of collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the customer.
DEFERRED PRESERVATION COSTS: Tissue is procured from deceased human donors by
organ procurement agencies and tissue banks, which consign the tissue to the
Company for processing and preservation. Preservation costs related to tissue
held by the Company are deferred until revenue is recognized upon shipment of
the tissue to the implanting hospital. Deferred preservation costs consist
primarily of laboratory expenses, tissue procurement fees, fringe and facility
allocations, and freight-in charges, and are stated, net of reserve, on a
first-in, first-out basis. As of June 30, 2002 the deferred preservation costs
were $8.5 million for allograft heart valve tissues, $829,000 for non-valved
cardiac tissues, $7.3 million for vascular tissues, and $4.7 million for
orthopaedic tissues, excluding valuation allowances of $300,000. At June 30,
2002 the Company recorded a write-down of deferred preservation costs of $1.6
million for non-valved cardiac tissues, $5.0 million for vascular tissues, and
$3.4 million for orthopaedic tissue totaling $10.0 million. These write-downs
were recorded as a result of the FDA Order as discussed in the Recent Events
section. The amount of these write-downs reflects management's estimate based on
information currently available to it. These estimates may prove inaccurate, as
the scope and impact of the FDA Order are determined. Management will continue
to evaluate the recoverability of these deferred preservation costs based on the
factors discussed in the Recent Events section and record additional write-downs
if it becomes clear that additional impairments have occurred.
INTANGIBLE ASSETS: Goodwill resulting from business acquisitions is not
amortized, but is instead subject to periodic impairment testing in accordance
with FAS 142. Patent costs are amortized over the expected useful lives of the
patents (primarily 17 years) using the straight-line method. Other intangibles,
which consist primarily of manufacturing rights and agreements, are amortized
over the expected useful lives of the related assets (primarily five years). The
Company periodically evaluates the recoverability of noncurrent tangible and
intangible assets and measures the amount of impairment, if any. Management does
not believe an impairment exists to the intangible assets relating to the tissue
preservation business. However, depending on outcome of the FDA Order and the
future effects adverse publicity surrounding the FDA Order and reported
infections on preservation revenues, these assets may become impaired.
Management will continue to evaluate the recoverability of these intangible
assets.
NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2002 the Company was required to adopt SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), and SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 142 specifies
that goodwill and certain other intangible assets will no longer be amortized
but instead will be subject to periodic impairment testing. SFAS 144 clarifies
accounting and reporting for assets held for sale, scheduled for abandonment or
other disposal, and recognition of impairment loss related to the carrying value
of long-lived assets. The Company has completed its impairment testing as
required by FAS 142, and has determined that the recognition of an impairment
loss on intangible assets is not required. The adoption of these statements did
not have a material effect on the consolidated financial statements of the
Company. However, the adoption of SFAS 142 will increase the Company's pretax
income by approximately $100,000 in 2002 due to the cessation of goodwill
amortization.
The Company will be required to adopt SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143") on January 1, 2003. SFAS 143 addresses
accounting and reporting for asset retirement costs of long-lived assets
resulting from legal obligations associated with acquisition, construction, or
development transactions. The Company has determined that the adoption of SFAS
143 will not have a material effect on the financial position, results of
operations, and cash flows of the Company.
The Company will be required to adopt SFAS No. 145, "Rescission of FASB
Statements 4, 44 and 64, Amendment to FASB Statement 13, and Technical
Corrections" ("SFAS 145") on January 1, 2003. SFAS 145 changes the accounting
for the classification of gains and losses from the extinguishment of debt. The
Company is currently evaluating the impact of this Statement.
21
The Company will be required to adopt SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146") on January 1, 2003.
SFAS 146 requires that costs associated with exit or disposal activities be
recorded at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
Company is currently evaluating the impact of this Statement.
RESULTS OF OPERATIONS
REVENUES
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------ ------------------------------------------
2002 2001 2002 2001
------------------------------------------ ------------------------------------------
Revenues $ 23,264 $ 21,697 $ 48,735 $ 43,129
Revenues excluding recall $ 25,697 $ 21,697 $ 51,168 $ 43,129
Revenues increased 7% and 13%, respectively, for the three and six months ended
June 30, 2002. Revenues were adversely impacted by the estimated effect of the
return of tissues subject to recall by the FDA Order, which resulted in an
estimated decrease of $2.4 million in preservation service revenues during the
three and six months ended June 30, 2002.
Excluding the effect of the FDA Order, revenues increased 18% and 19%,
respectively, for the three and six months ended June 30, 2002. This increase in
revenues for the three month and six month periods ended June 30, 2002 was
primarily due to increased sales of BioGlue Surgical Adhesive and growth in the
Company's preservation businesses. The increases are primarily attributable to
the receipt of FDA approval for BioGlue in December 2001, a greater acceptance
of these products by the surgical community and the Company's ability to procure
greater amounts of tissue. Management currently believes the FDA Order will have
an adverse impact on these trends.
The Company has not yet determined the full impact of the FDA Order on future
revenues. In the event the Company is not successful in its appeal of the FDA
Order or is unable to reach a satisfactory agreement with the FDA, future
revenues can be expected to decrease significantly. Revenues from human tissue
preservation services accounted for 78% of the Company's revenues for the six
months ended June 30, 2002, and of those revenues 67% were derived from
preservation of tissues subject to the FDA Order. In 2001 revenues for human
tissue preservation services were 87% of the Company's revenues, or $75.6
million, and of those revenues 68%, or $51.6 million, were derived from
preservation of tissues subject to the FDA Order.
BIOGLUE SURGICAL ADHESIVE
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------ ------------------------------------
2002 2001 2002 2001
------------------------------------------ ------------------------------------
Revenues $ 5,251 $ 2,631 $ 10,124 $ 5,074
Percentage of total revenue 23% 12% 21% 12%
Percentage of total revenue excluding recall 20% 12% 20% 12%
Revenues from the sale of BioGlue Surgical Adhesive increased 100% for the three
and six month periods ended June 30, 2002. The increase in revenues for the
three month and six month periods ended June 30, 2002 was due to an increase in
22
the milliliters of BioGlue shipped of 81% and 79%, respectively, and an increase
in the average selling price of the BioGlue shipped. The increase in shipments
was primarily due to the receipt of FDA approval in December 2001 for the use of
BioGlue in the United States as an adjunct in open surgical repair of large
vessels for adult patients. Domestic revenues accounted for 77% and 64% of total
BioGlue revenues for the three months ended June 30, 2002 and 2001,
respectively. Domestic revenues accounted for 78% and 65% of total BioGlue
revenues for the six months ended June 30, 2002 and 2001, respectively.
Although BioGlue was not included in the FDA Order, future sales of BioGlue
could be adversely affected due to the adverse publicity surrounding the FDA's
review of and correspondence with the Company. Additionally, there is a
possibility the Company's BioGlue operations could come under increased scrutiny
from the FDA as a result of their review of the Company's tissue processing
laboratories.
PRESERVATION SERVICE REVENUES
Quarter over quarter statistics presented for tissues procured and processed for
human tissue preservation services are from the period February through April,
as such procurement and processing of tissues received during this time period
is the primary generator of second quarter revenues. Year-to-date over
year-to-date statistics presented for tissues procured and processed for human
tissue preservation services are from the period beginning in November of the
prior year through April of the year presented, as such procurement and
processing of tissues received during this time period is the primary generator
of year-to-date revenues. During the time period for which procurement
statistics are discussed, the Company benefited from significant increases in
procurement due to new relationships with tissue banks and competitive wins of
tissue bank contracts. Additionally, the Company changed certain tissue
acceptance guidelines, which resulted in an increase in tissues procured and
processed. Tissue acceptance and processing guidelines include donor age,
gender, manner of death, time of procurement, and other factors. These
guidelines are under constant review to allow the most recipients to benefit
from donated tissues, while preserving the quality of tissue procured and
processed. Tissue acceptance guidelines are changed periodically through the
general course of business based on the demand for certain types or sizes of
tissue and based on the scientific analysis of the viability of tissues procured
under the guidelines. More stringent guidelines have recently been implemented
for certain tissues.
The increases in procurement surpassed the Company's expectations during this
period. However, the Company expects that future procurement levels of all
tissues will decrease as a result of the uncertainties surrounding the Company's
inability to continue to ship non-valved cardiac, vascular and orthopaedic
grafts as a result of the FDA Order and due to the uncertainties as to whether
tissue banks will continue to send tissues to the Company to process as a result
of the adverse publicity surrounding the FDA's review and the FDA Order. As of
August 14, 2002 the Company reduced its acceptance of orthopaedic and vascular
tissues for processing to minimal levels until it receives resolution of its
request for modification or appeal of the FDA Order. The Company is continuing
to accept cardiac tissues for processing from tissue banks. As of August 30,
2002 the Company estimates approximately 50% of its cardiovascular procurement
has been suspended due to the FDA Order and the surrounding publicity.
Due to a variety of factors, primarily the FDA Order, but including the time
required to process the greater amounts of tissue, the increase in processing
time and complexity for tissues processed using the SynerGraft technology, the
focus of the Company on the marketing and rollout of BioGlue, and adverse
publicity resulting from certain tissue infections and lawsuits during this
period, the increases in tissues procured and processed did not translate into
equivalent increases in revenues from preservation services. As a result of this
increased procurement, the level of deferred preservation costs prior to
write-downs increased in all of the Company's main tissue service categories:
cardiac, vascular, and orthopaedic. These higher levels of deferred preservation
costs are expected to result in some revenue growth for allograft heart valve
tissues in the short term as the Company provides services related to the more
critical implant needs. The Company expects that the majority of this increase
in procurement will generate more modest increases in service revenues over a
longer period of time for cardiac tissues, as less critical need tissues and
tissues of various sizes are properly matched with recipients.
23
CARDIOVASCULAR PRESERVATION SERVICES
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------ ------------------------------------------
2002 2001 2002 2001
------------------------------------------ ------------------------------------------
Revenues $ 7,336 $ 7,182 $ 14,644 $ 14,093
Percentage of total revenue 32% 33% 30% 33%
Revenues excluding recall $ 7,676 $ 7,182 $ 14,984 $ 14,093
Percentage of total revenue 30% 33% 29% 33%
Revenues from cardiovascular preservation services increased 2% and 4%,
respectively, for the three and six months ended June 30, 2002. The revenues
from cardiovascular preservation services were adversely impacted by the
estimated effect of the tissues returned subject to the FDA Order on service
revenues for non-valved cardiac tissues, which resulted in an estimated decrease
of $340,000 in service revenues during the three and six months ended June 30,
2002. At June 30, 2002 $9.3 million of cardiac deferred preservation costs
related to tissue not subject to the FDA Order was available for shipment.
Excluding the effect of the FDA Order, revenues from cardiovascular preservation
services increased 7% and 6%, respectively, for the three and six months ended
June 30, 2002. This increase in revenues for the three month and six month
periods ended June 30, 2002 was in part due to an increase in the number of
cardiovascular allograft shipments of 3% in each such period as a result of a
20% and 23% increase in cardiovascular tissues procured and processed quarter
over quarter and year-to-date over year-to-date, respectively. Additionally,
average service fees were higher by 4% and 3%, during the three and six months
ended June 30, 2002, respectively, due to an increase in shipments during 2002
as compared to 2001 of SynerGraft processed cardiovascular grafts, which have
higher service fees than non-SynerGraft cardiovascular grafts.
The Company anticipates a future decrease in cardiovascular preservation
revenues as a result of the uncertainties regarding the Company's inability to
ship non-valved cardiac tissue processed since October 3, 2001 pursuant to the
FDA Order and the adverse publicity surrounding the FDA's review of and
correspondence with the Company.
VASCULAR PRESERVATION SERVICES
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------ ------------------------------------------
2002 2001 2002 2001
------------------------------------------ ------------------------------------------
Revenues $ 4,641 $ 6,017 $ 11,658 $ 12,429
Percentage of total revenue 20% 28% 24% 29%
Revenues excluding recall $ 6,354 $ 6,017 $ 13,371 $ 12,429
Percentage of total revenue 25% 28% 26% 29%
Revenues from human vascular tissue preservation services decreased 23% and 6%,
respectively, for the three and six months ended June 30, 2002. The revenues
from vascular tissue preservation services were adversely impacted by the
estimated effect of the return of tissues subject to recall by the FDA Order,
which resulted in an estimated decrease of $1.7 million in service revenues
during the three and six months ended June 30, 2002. At June 30, 2002 $7.3
million of vascular deferred preservation costs related to tissue not subject to
the FDA Order was available for shipment.
24
Excluding the effect of the FDA Order, revenues from human vascular tissue
preservation services increased 6% and 8%, respectively, for the three and six
months ended June 30, 2002. This increase in revenues for the three month and
six month periods ended June 30, 2002 was due to an increase in the number of
vascular allograft shipments of 8% and 3%, respectively, which resulted from a
17% increase in vascular tissues procured and processed year-to-date over
year-to-date.
The Company anticipates a future decrease in vascular preservation revenues due
to the Company's inability to ship vascular grafts processed subsequent to
October 2, 2001 pursuant to the FDA Order and the adverse publicity surrounding
the FDA's review of and correspondence with the Company. If the Company is
unable to obtain a favorable decision from its appeal or request for
modification of the FDA Order and/or to clear the issues as outlined in the
FDA's warning letter and the FDA Order, future vascular preservation revenues,
if any, may be immaterial.
ORTHOPAEDIC PRESERVATION SERVICES
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------ ------------------------------------------
2002 2001 2002 2001
------------------------------------------ ------------------------------------------
Revenues $ 5,559 $ 5,566 $ 11,472 $ 10,809
Percentage of total revenue 24% 26% 24% 25%
Revenues excluding recall $ 5,939 $ 5,566 $ 11,852 $ 10,809
Percentage of total revenue 23% 26% 23% 25%
Revenues from human orthopaedic tissue preservation services increased 0% and 6%
for the three and six months ended June 30, 2002. The revenues from orthopaedic
tissue preservation services were adversely impacted by the estimated effect of
the return of tissues subject to recall by the FDA Order, which resulted in an
estimated decrease of $380,000 in service revenues during the three and six
months ended June 30, 2002. At June 30, 2002 $4.7 million of orthopaedic
deferred preservation costs related to tissue not subject to the FDA Order was
available for shipment; see discussion of impairment of this asset in the Recent
Events section.
Excluding the effect of the FDA Order, revenues from human orthopaedic tissue
preservation services increased 7% and 10% for the three and six months ended
June 30, 2002. This increase in revenues for the three month and six month
periods ended June 30, 2002 was primarily due to an increase in the number of
allograft shipments of 6% and 8%, respectively. The increase in orthopaedic
shipments, primarily boned tendons, resulted from a 76% and 62% increase in
orthopaedic allograft tissues procured and processed quarter over quarter and
year-to-date over year-to-date, respectively, and an increasing acceptance of
these tissues in the orthopaedic surgeon community. Shipments of boned tendons
increased 42% and 52% in the three and six months ended June 30, 2002,
respectively, due to increased availability of these higher demand tissues,
which resulted in an increase of $400,000 and $1 million in revenues with
respect to these tissues for the three and six months ended June 2002 as
compared to the same periods in 2001, partially offset by a decrease in
shipments of non-boned tendons. Additional increases in revenues in the
six-month period were due to a more favorable product mix, with increased
shipments of hemi-osteochondral grafts, which carry higher average service fees
than other orthopaedic tissues. The increases in orthopaedic revenues were
smaller than anticipated, due to the effects of adverse publicity surrounding
the reports of infections in some orthopaedic allograft recipients.
The Company anticipates a substantial decrease in the orthopaedic preservation
revenues in the future due to the Company's inability to ship orthopaedic grafts
processed since October 3, 2001 pursuant to the FDA Order, the adverse publicity
surrounding the FDA's review of and correspondence with the Company, and the
reported infections in some orthopaedic allograft recipients. If the Company is
unable to clear the issues as outlined in the FDA's warning letter and FDA Order
or obtain a favorable appeal of the FDA Order, future orthopaedic preservation
revenue, if any, may be immaterial. These factors would be likely to result in a
substantial decrease of revenues from tissues preserved both prior to and since
October 3, 2001.
25
BIOPROSTHETIC DEVICES
Revenues from bioprosthetic cardiovascular devices increased 41% to $222,000 for
the three months ended June 30, 2002 from $158,000 for the three months ended
June 30, 2001, representing 1% of total revenues during each such period.
Revenues from bioprosthetic cardiovascular devices increased 16% to $414,000 for
the six months ended June 30, 2002 from $356,000 for the six months ended June
30, 2001, representing 1% of total revenues during each such period.
DISTRIBUTION AND GRANT REVENUES
Distribution and grant revenues increased to $255,000 for the three months ended
June 30, 2002 from $143,000 for the three months ended June 30, 2001.
Distribution and grant revenues increased to $423,000 for the six months ended
June 30, 2002 from $368,000 for the six months ended June 30, 2001. Grant
revenues of $104,000 and $143,000, for the three and six months ended June 30,
2002 and 2001, respectively, and $131,000 and $368,000, for the six months ended
June 30, 2002 and 2001, respectively, are primarily attributable to the
SynerGraft research and development programs.
COSTS AND EXPENSES
Cost of human tissue preservation services aggregated $17.2 million for the
three months ended June 30, 2002 as compared to $7.7 million for the three
months ended June 30, 2001, representing 98% and 41%, respectively, of total
human tissue preservation service revenues for each such period. Cost of human
tissue preservation services aggregated $25.3 million for the six months ended
June 30, 2002 as compared to $15.4 million for the six months ended June 30,
2001, representing 67% and 41%, respectively of total human tissue preservation
service revenues for each period. The cost of human tissue preservation services
for the three and six months ended June 30, 2002 includes a $10.0 million
write-down of deferred preservation costs related to the FDA Order, as discussed
in Recent Events. The Company anticipates a reduction in the cost of human
tissue preservation services due to a reduction in shipments of tissues as a
result of the FDA Order; however the cost of human tissue preservation services
as a percent of revenue may increase due to potential write-downs of deferred
preservation costs if the Company is unable to meet the requirements of the FDA
as outlined in the FDA Order and if there is a significant decline in the demand
for the tissues.
Cost of products aggregated $1.8 million for the three months ended June 30,
2002 as compared to $1.4 million for the three months ended June 30, 2001,
representing 34% and 51%, respectively, of product revenues for each such
period. Cost of products aggregated $4.1 million for the six months ended June
30, 2002 as compared to $2.9 million for the six months ended June 30, 2001,
representing 39% and 53%, respectively, of total product revenues for each
period. The decrease in the 2002 cost of products as a percentage of total
product revenues is due to a more favorable product mix during 2002. The product
mix was impacted by an increase in revenues from BioGlue Surgical Adhesive,
which carries higher gross margins than bioprosthetic devices.
General, administrative, and marketing expenses increased 41% to $11.4 million
for the three months ended June 30, 2002, compared to $8.1 million for the three
months ended June 30, 2001, representing 49% and 37%, respectively of total
revenues during each such period. General, administrative, and marketing
expenses increased 29% to $20.9 million for the six months ended June 30, 2002,
compared to $16.3 million for the six months ended June 30, 2001, representing
43% and 38%, respectively, of total revenues during each such period. The
incre