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 September 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
October 28, 2002 was 19,573,970.
Part I - FINANCIAL INFORMATION
Item 1. Financial statements
CRYOLIFE, INC. AND SUBSIDIARIES
SUMMARY CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
(Unaudited) (Unaudited)
Revenues:
Human tissue preservation services, net $ 11,300 $ 19,737 $ 49,074 $ 57,069
Products 5,354 2,600 15,892 8,029
Distribution and grant 235 230 658 598
------------------------------- ------------------------------
16,889 22,567 65,624 65,696
Costs and expenses:
Human tissue preservation services
(including write-down of $22,691
and $32,715 in the three and nine
months ended September 30, 2002) 27,978 8,188 53,244 23,558
Products 4,739 1,196 8,817 4,051
General, administrative, and marketing 11,193 8,290 32,118 24,569
Research and development 1,347 1,232 3,696 3,604
Goodwill impairment 1,399 -- 1,399 --
Interest expense 155 37 543 53
Interest income (188) (449) (725) (1,587)
Other expense (income), net 35 114 (37) 856
------------------------------- ------------------------------
46,658 18,608 99,055 55,104
------------------------------- ------------------------------
(Loss) income before income taxes (29,769) 3,959 (33,431) 10,592
Income tax (benefit) expense (10,123) 1,267 (11,367) 3,390
------------------------------- ------------------------------
Net (loss) income $ (19,646) $ 2,692 $ (22,064) $ 7,202
=============================== ==============================
Net (loss) earnings per share:
Basic $ (1.01) $ 0.14 $ (1.14) $ 0.38
=============================== ==============================
Diluted $ (1.01) $ 0.14 $ (1.14) $ 0.37
=============================== ==============================
Weighted average shares outstanding:
Basic 19,526 18,832 19,388 18,785
=============================== ==============================
Diluted 19,526 19,771 19,388 19,635
=============================== ==============================
See accompanying notes to summary consolidated financial statements.
2
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, December 31,
2002 2001
-----------------------------------
ASSETS (Unaudited)
Current Assets:
Cash and cash equivalents $ 12,227 $ 7,204
Marketable securities, at market 15,926 26,483
Trade receivables, net 5,851 13,305
Other receivables, net 5,095 2,820
Note receivable, net -- 1,169
Deferred preservation costs, net 1,662 24,199
Inventories 4,659 6,259
Prepaid expenses and other assets 3,650 2,341
Deferred income taxes 12,292 688
-----------------------------------
Total current assets 61,362 84,468
-----------------------------------
Property and equipment, net 39,448 39,246
Goodwill -- 1,399
Patents, net 5,500 2,919
Other, net 1,128 1,278
-----------------------------------
TOTAL ASSETS $ 107,438 $ 129,310
===================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,782 $ 555
Accrued expenses and other current liabilities 2,739 1,491
Accrued compensation 762 2,560
Accrued procurement fees 6,153 6,592
Current maturities of capital lease obligations 640 609
Current maturities of long-term debt 6,000 1,600
Convertible debenture -- 4,393
-----------------------------------
Total current liabilities 18,076 17,800
-----------------------------------
Capital lease obligations, less current maturities 2,655 3,140
Bank loan, less current maturities -- 5,600
Deferred income taxes 433 449
Other long-term liabilities 1,049 882
-----------------------------------
Total liabilities 22,213 27,871
-----------------------------------
Shareholders' equity:
Preferred stock -- --
Common stock (issued 20,879 shares in 2002 and
20,172 shares in 2001) 208 202
Additional paid-in capital 73,550 66,828
Retained earnings 18,483 40,547
Deferred compensation (24) (33)
Accumulated other comprehensive income (loss) 172 (145)
Less: Treasury stock at cost (1,377 shares in 2002 and
1,286 shares in 2001) (7,164) (5,960)
-----------------------------------
Total shareholders' equity 85,225 101,439
-----------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 107,438 $ 129,310
===================================
See accompanying notes to summary consolidated financial statements.
3
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Nine Months Ended
September 30,
-----------------------------------
2002 2001
-----------------------------------
(Unaudited)
Net cash from operating activities:
Net (loss) income $ (22,064) $ 7,202
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Loss on sale of marketable equity securities 240 --
Depreciation and amortization 3,926 3,294
Provision for doubtful accounts 72 72
Write-down of deferred preservation costs and inventories 35,816 --
Other non-cash adjustments to income 1,399 748
Deferred income taxes (11,674) (85)
Tax effect of nonqualified option exercises 481 179
Changes in operating assets and liabilities:
Receivables 8,190 (2,821)
Income taxes (3,083) (97)
Deferred preservation costs and inventories (11,679) (3,746)
Prepaid expenses and other assets (1,309) (800)
Accounts payable, accrued expenses, and other liabilities 321 671
-----------------------------------
Net cash flows provided by operating activities 636 4,617
-----------------------------------
Net cash flows from investing activities:
Capital expenditures (3,877) (9,531)
Other assets (2,575) (1,281)
Purchases of marketable securities (10,025) (20,254)
Sales and maturities of marketable securities 20,496 16,489
Proceeds from note receivable 1,169 1,846
-----------------------------------
Net cash flows provided by (used in) investing activities 5,188 (12,731)
-----------------------------------
Net cash flows from financing activities:
Principal payments of debt (1,200) (650)
Proceeds from debt issuance -- 1,165
Payment of obligations under capital leases (454) (128)
Proceeds from exercise of stock options and
issuance of common stock 1,313 1,166
Purchase of treasury stock (663) --
-----------------------------------
Net cash (used in) provided by financing activities (1,004) 1,553
-----------------------------------
Increase (decrease) in cash 4,820 (6,561)
Effect of exchange rate changes on cash 203 52
Cash and cash equivalents, beginning of period 7,204 17,480
-----------------------------------
Cash and cash equivalents, end of period $ 12,227 $ 10,971
===================================
See accompanying notes to summary consolidated financial statements.
4
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, the statements 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 and the
supplement to the 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
September 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 September 30,
2001, as indicated in Note 20 to the consolidated financial statements included
in the CryoLife Form 10-K for the year ended December 31, 2001. Operating
results for the three and nine months ended September 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 Form 10-K for the year
ended December 31, 2001.
In addition to the current effects of the FDA Order, defined in Note 2, the
Company anticipates that the FDA Order will have significant adverse effects on
its future financial position, results of operations, and cash flows as compared
to prior year periods. The Company expects its liquidity to decrease
significantly over the remainder of this year and next year due to the
anticipated significant decrease in revenues as compared to prior year 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 reduced its employee force by approximately
105 employees on September 3, 2002. Severance and related costs are
approximately $690,000 and were recorded in the third quarter of 2002 in general
and administrative expenses. As a result of the employee reduction, management
anticipates personnel costs will be reduced by approximately $385,000 per month.
The Company believes that anticipated revenue generation, expense management,
savings resulting from the reduction in the number of employees to reflect the
reduction in revenues, tax refunds expected to be in excess of $10 million, and
the Company's existing cash and marketable securities will enable the Company to
meet its liquidity needs through September 30, 2003. Even if the Company is able
to satisfactorily address the observations detailed in the FDA's Warning Letter
dated June 17, 2002 (the "Warning Letter"), as noted in Note 2, there is no
assurance that the Company will experience a return to the level of demand for
its tissue services that existed prior to the FDA Order because of the adverse
publicity or as a result of customers and tissue recovery organizations
switching to competitors.
The Company's long term liquidity and capital requirements will depend upon
numerous factors, including the Company's ability to address the observations
detailed in the FDA's Warning Letter, the extent of any future revenue
decreases, the costs associated with becoming compliant with the FDA
requirements as outlined in the FDA Warning Letter and 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 whether or not the Company can find suitable funding sources to
replace the funds no longer available due to the Company's inability to borrow
on its line of credit as described in Note 6. 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 September 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.
5
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 were 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 processed 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 the Company perform a retrospective
review of all tissue in inventory (i.e. currently in storage at the
Company) 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 the Company's allograft heart valves, and will take further
regulatory action if appropriate.
Pursuant to the FDA Order, the Company 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. The Company appealed the FDA Order on August 14,
2002 and requested a hearing with the FDA, which has been set for December 12,
2002. After the FDA issued its order regarding the recall, Health Canada also
issued a recall on the same types of tissue and other countries have inquired
about the circumstances surrounding the FDA Order.
On September 5, 2002, the Company reached an agreement with the FDA (the
"Agreement") that supplements the FDA Order and permits the Company to resume
processing and limited distribution of its life-saving and limb-saving
non-valved cardiac and vascular tissues. The Agreement allows the tissue to be
released for distribution after the Company completes steps to assure that the
tissue is used for approved purposes and that patients will be notified of risks
associated with tissue use. Specifically, the Company must obtain physician
prescriptions and tissue packaging must contain appropriate warning labels. The
Agreement also calls for the Company to undertake to identify third-party
records of donor tissue testing, and to destroy tissue from donors in whom
microorganisms associated with an infection are found. In addition, the
Agreement, which has a forty-five working-day term ending November 7, 2002,
specifies interim operating procedures to permit the Company to distribute
6
tissues processed during the term of the Agreement. The Company also agreed to
establish a corrective action plan within 30 days with steps to validate
processing procedures. The corrective action plan was submitted on October 5,
2002. The FDA will review records and other relevant information related to the
Company's release of tissue under the Agreement, as well as the status of the
Company's corrective action plan, before determining whether this Agreement
should be renewed or modified to provide for any further release of tissue
subject to the FDA Order.
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
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.
As a result of the FDA Order, the Company 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 as of
June 30, 2002, including the impact of the 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 believed 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 did not know if it would 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 had been
significantly impaired. The Company estimated that this impairment approximated
the full balance of the deferred preservation costs of the tissues subject to
the FDA Order, which included the tissues stored by the Company and the tissues
to be returned to the Company, and therefore recorded a write-down of $10.0
million for these assets.
In the quarter ended September 30, 2002, the Company recorded a reduction to
pretax income of $24.6 million as a result of the FDA Order. The reduction was
comprised of a net $22.2 million increase to cost of human tissue preservation
services, a $1.4 million write-down of goodwill, and a $1.0 million reduction to
revenues (and accounts receivable) for the estimated return of the tissues
shipped during the third quarter subject to recall by the FDA Order. The net
$22.2 million increase to cost of preservation services is comprised of a $22.7
million write-down of deferred preservation costs, offset by a $0.5 million
decrease in cost of preservation services due to the estimated and actual tissue
returns resulting from the FDA Order (the costs of such recalled tissue are
included in the $22.7 million write-down).
The Company evaluated multiple 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, the possibility of unfavorable actions
7
by physicians, customers, procurement organizations, and others, the progress
made to date on the corrective action plan, and the requirement in the Agreement
that tissues subject to the FDA Order be replaced with tissues processed under
validated methods. As a result of this evaluation, management believes that all
tissues subject to the FDA Order as well as the majority of tissues processed
prior to October 3, 2001, including heart valves which are not subject to the
FDA Order, are fully impaired. Management believes that most of the Company's
customers will only order tissues processed under the interim operating
procedures established under the Agreement or tissues processed under future
procedures approved by the FDA once these tissues are available. The Company
anticipates the tissues processed under the interim operating procedures
established under the Agreement will be available early to mid-November. Thus,
the Company has recorded a write-down of deferred preservation costs for
processed tissues in excess of the supply required to meet demand prior to the
release of these interim processed tissues. As of September 30, 2002 the balance
of the deferred preservation costs after the write-down was $545,000 of
allograft heart valves, $176,000 of non-valved cardiac tissues, $931,000 of
vascular tissues, and $10,000 of orthopaedic tissues.
As a result of the write-down of deferred preservation costs, the Company has
recorded a deferred tax asset of $12.2 million. Upon destruction of the tissues
associated with the deferred preservation costs, the deferred tax asset will be
reclassed as an income tax receivable. An expected refund will be generated
through a carry back of losses resulting from the deferred preservation cost
write-downs. In addition, the Company has recorded $4.2 million in income tax
receivables related to $1.7 million of tax overpayments for 2001 and an
estimated $2.5 million of tax overpayments for 2002.
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), requires the
write-down of a long-lived asset to be held and used if the carrying value of
the asset or the asset group to which the asset belongs, is not recoverable and
exceeds its fair value. The asset or asset group is not recoverable if its
carrying value exceeds the sum of the undiscounted future cash flows expected to
result from the use and eventual disposition of the asset or asset group. In
applying SFAS 144, the Company determined that the asset groups consisted of the
long-lived assets related to the Company's two reporting segments, as these
represent the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities. The Company used
a fourteen-year period for the undiscounted future cash flows. This period of
time was selected based upon the remaining life of the primary assets of the
asset groups, which are leasehold improvements. Based on its analysis,
management does not believe an impairment of the Company's intangible and
tangible assets related to the tissue preservation business or medical device
business had occurred as of September 30, 2002. However, depending on the
Company's ability to address the observations detailed in the Warning Letter 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.
Goodwill resulting from business acquisitions is not amortized, but is instead
subject to periodic impairment testing in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"). As a result of the FDA
Order, the Company determined that an evaluation of the possible impairment of
intangible assets under SFAS 142 was necessary. The Company engaged an
independent valuation expert to perform the valuation using a discounted cash
flow methodology, and as a result of this analysis, the Company determined that
goodwill related to its tissue processing reportable unit was fully impaired as
of September 30, 2002. Therefore, the Company recorded a write-down of $1.4
million in goodwill during the quarter ended September 30, 2002. Management does
not believe an impairment exists related to the other intangible assets.
Management will continue to evaluate the recoverability of these intangible
assets.
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.
8
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 September 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
September 30, 2002 Cost Basis to Cost Basis Cost Basis Gains/(Losses) Value
-----------------------------------------------------------------------------------
Cash equivalents:
Money market funds $ 47 $ -- $ 47 $ -- $ 47
Municipal obligations 5,636 -- 5,636 -- 5,636
-----------------------------------------------------------------------------------
$ 5,683 $ -- $ 5,683 $ -- $ 5,683
===================================================================================
Marketable securities:
Municipal obligations $ 15,615 $ -- $ 15,615 $ 311 $ 15,926
===================================================================================
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 $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 $106,000 at
September 30, 2002 and $50,000 as of December 31, 2001, are included in the
accumulated other comprehensive income account of shareholders' equity.
The marketable securities of $15.9 million on September 30, 2002 and $26.5
million on December 31, 2001 had maturity dates as follows: approximately $1.3
million and zero, respectively, had a maturity date of less than 90 days,
approximately $3.2 million and $3.4 million, respectively, had a maturity date
between 90 days and 1 year, approximately $11.4 million and $14.5 million,
respectively, had a maturity date between 1 and 5 years, and approximately zero
and $8.6 million matured in more than 5 years or did not have a maturity date.
9
NOTE 4 - INVENTORIES
Inventories are comprised of the following (in thousands):
September 30, December 31,
2002 2001
---------------------------------
Raw materials $ 2,598 $ 1,987
Work-in-process 264 1,183
Finished goods 1,797 3,089
---------------------------------
$ 4,659 $ 6,259
=================================
In the third quarter of 2002, the Company recorded a $3.1 million write-down of
bioprosthetic valves, including SynerGraft(R) and non-SynerGraft treated porcine
heart valves, due to the Company's decision to stop future expenditures on the
development and marketing of these valves and to maintain its focus on its
preservation services business, and its BioGlue(R) and SynerGraft vascular graft
product lines.
NOTE 5 - EARNINGS/(LOSS) PER SHARE
The following table sets forth the computation of basic and diluted
earnings/(loss) per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Numerator for basic and diluted earnings
per share:
Net (loss) income available to common
shareholders $ (19,646) $ 2,692 $ (22,064) $ 7,202
=============================== ==============================
Denominator for basic earnings per share:
Weighted-average basis 19,526 18,832 19,388 18,785
Effect of dilutive stock options -- 939 -- 850
------------------------------- ------------------------------
Denominator for diluted earnings per share:
Adjusted weighted-average shares 19,526 19,771 19,388 19,635
=============================== ==============================
Net (loss) earnings per share:
Basic $ (1.01) $ 0.14 $ (1.14) $ 0.38
=============================== ==============================
Diluted $ (1.01) $ 0.14 $ (1.14) $ 0.37
=============================== ==============================
The effects of stock options of 791,000 and 975,000 shares for the three and
nine months ended September 30, 2002, respectively, were excluded from the
calculation because the amounts are antidilutive for the periods presented.
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 common stock for $663,000. No further purchases
are anticipated in the near term.
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
10
plus interest computed at Adjusted LIBOR plus 1.5% (3.32% at September 30,
2002). At September 30, 2002 the principal balance of the Term Loan was $6.0
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 11, have had a material
adverse effect on the Company that constitutes an event of default.
Additionally, as of September 30, 2002, the Company is in violation of the debt
coverage ratio and net worth financial covenants. As of October 28, 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 September 30, 2002 are reflected as a current
liability on the Summary Consolidated Balance Sheets.
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.
On July 30, 2002 the Company entered into a line of credit agreement with the
same lender as for the Term Loan, 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 September 30, 2002 no amounts
were 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.
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 $4.0 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.
In August 2002 the Company determined that changes in the derivative's fair
value could no longer be recorded in other comprehensive income, as a result of
the uncertainty of future cash payments on the Term Loan caused by the lender's
ability to declare an event of default as discussed in Note 6. Beginning in
August 2002 the Company is recording all changes in the fair value of the
derivative currently in other expense/income on the Summary Consolidated
11
Statements of Operation, and is amortizing the amounts previously recorded in
other comprehensive income into other expense/income over the remaining life of
the agreement. If the lender accelerates the payments due under the Term Loan by
declaring an event of default, any remaining balance in other comprehensive
income will be reclassed into other expense/income during that period.
At September 30, 2002 the notional amount of this swap agreement was $3.0
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 $305,000.
The fair value of the swap agreement is recorded as part of long-term
liabilities. For the three and nine months ended September 30, 2002 the Company
recorded a loss of $26,000 on the interest rate swap. The unamortized value of
the swap agreement, recorded in the accumulated other comprehensive income
account of shareholders' equity, was $279,000 at September 30, 2002.
NOTE 8 - COMPREHENSIVE INCOME/(LOSS)
Components of comprehensive income/(loss) consist of the following, net of tax
(in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Net (loss) income $ (19,646) $ 2,692 $ (22,064) $ 7,202
Unrealized gain/(loss) on investments 56 (45) 98 772
Change in fair value of interest rate swap
(including cumulative effect of adopting
SFAS 133 in 2001) (6) (67) 17 (225)
Translation adjustment (12) 176 205 52
------------------------------- ------------------------------
Comprehensive income $ (19,608) $ 2,756 $ (21,744) $ 7,801
=============================== ==============================
The tax effect on the change in unrealized gain/loss on investments is $29,000
and zero for the three months ended September 30, 2002 and 2001, respectively.
The tax effect for the nine months ended September 30, 2002 and 2001 is $56,000
and $398,000, respectively. The tax effect on the change in fair value of the
interest rate swap is $4,000 and $34,000 for the three months ended September
30, 2002 and 2001, respectively. The tax effect for the nine months ended
September 30, 2002 and 2001 is $2,000 and $115,000, 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 142 and 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. See Note 2 for a discussion of the impact
of these two statements on the current quarter results.
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 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 rescinds SFAS No. 4, 44
and 64, which required gains and losses from extinguishments of debt to be
12
classified as extraordinary items. SFAS 145 also amends SFAS No. 13 eliminating
inconsistencies in certain sale-leaseback transactions. The provisions of SFAS
145 are effective for fiscal years beginning after May 15, 2002. 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.
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 Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenue:
Human tissue preservation services, net a 11,300 19,737 49,074 57,069
Implantable medical devices 5,354 2,600 15,892 8,029
All other b 235 230 658 598
------------------------------- ------------------------------
$ 16,889 $ 22,567 $ 65,624 $ 65,696
------------------------------- ------------------------------
Cost of Preservation Services and Products:
Human tissue preservation services c 27,978 8,188 53,244 23,558
Implantable medical devices 4,739 1,196 8,817 4,051
All other b -- -- -- --
------------------------------- ------------------------------
32,717 9,384 62,061 27,609
------------------------------- ------------------------------
Gross Margin (Loss):
Human tissue preservation services (16,678) 11,549 (4,170) 33,511
Implantable medical devices 615 1,404 7,075 3,978
All other b 235 230 658 598
------------------------------- ------------------------------
$ (15,828) $ 13,183 $ 3,563 $ 38,087
------------------------------- ------------------------------
a Revenue from human tissue preservation services includes the estimated
effect of the return of tissues subject to recall by the FDA Order of $1.0
million and $3.5 million, respectively, in the three and nine months ended
September 30, 2002.
b The "All other" designation includes 1) grant revenue and 2) distribution
revenue.
13
c Cost of human tissue preservation services includes the write-down of
deferred preservation costs for tissues subject to the FDA Order of $22.7
and $32.7 million, respectively, in the three and nine months ended
September 30, 2002.
The following table summarizes net revenues by product (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenue:
Human tissue preservation services, net a:
Cardiovascular tissue $ 5,487 $ 8,209 $ 20,131 $ 22,307
Vascular tissue 3,260 6,192 14,918 18,617
Orthopaedic tissue 2,553 5,336 14,025 16,145
------------------------------- ------------------------------
Total preservation services 11,300 19,737 49,074 57,069
------------------------------- ------------------------------
BioGlue surgical adhesive 5,183 2,431 15,308 7,505
Bioprosthetic devices 171 169 584 524
Distribution and grant 235 230 658 598
------------------------------- ------------------------------
$ 16,889 $ 22,567 $ 65,624 $ 65,696
=============================== ==============================
a Revenue from tissue preservation services includes the estimated effect of
the return of tissues subject to recall by the FDA Order of $170,000 and
$510,000, respectively, in cardiovascular tissue, $833,000 and $2.5 million,
respectively, in vascular tissue, and $28,000 and $408,000, respectively, in
orthopaedic tissue, totaling $1.0 and $3.5 million, respectively, for the
three and nine months ended September 30, 2002.
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 October 28,
2002 fifteen cases had been filed against the Company between May 18, 2000 and
October 8, 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, one alleges product liability
claims arising out of the Company's allograft vascular 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 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 through September 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 there under, 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
14
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 received notice in October that a complaint had been filed
instituting a shareholder derivative action against the Company and Company
officers and directors Steven G. Anderson, Albert E. Heacox, John W. Cook,
Ronald C. Elkins, Virginia C. Lacy, Ronald D. McCall, Alexander C. Schwartz and
Bruce J. Van Dyne. The suit was filed in the Superior Court of Gwinnett County,
Georgia, by Rosemary Lichtenberger but has not been served on the defendants.
The suit alleges the individual defendants breached their fiduciary duties to
the Company by causing or allowing the Company to engage in practices that
caused the Company to suffer damages by being out of compliance with FDA
guidelines, and by causing the Company to issue press releases that erroneously
portrayed CryoLife's products, operations, financial results and future
prospects. The complainant seeks undisclosed damages, costs and attorney's fees,
punitive damages and prejudgment interest against the individual defendants
derivatively on behalf of the Company as a nominal defendant. Filing of the
complaint was preceded by a demand letter on behalf of the complainant dated one
day prior to the filing of the suit. Another derivative demand letter of similar
import was received on behalf of complainant Robert F. Fraley; however, to the
Company's knowledge, no suit has yet been filed by Mr. Fraley. The Company's
Board of Directors has established an independent committee to investigate the
claims asserted in the Lichtenberger complaint and the demands made in the
Fraley letter and report back to the Board with its recommendations for action
in response to the shareholders' demands. The independent committee has engaged
independent legal counsel to assist in the investigation.
On August 7, 2002 the Company announced the settlement of its ongoing litigation
with Colorado State University Research 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
the Company's SynerGraft technology. The settlement includes an unconditional
assignment to the Company 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 recorded 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 September 30, 2002 were approximately $33,000.
On 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.
15
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 officers' insurance policies. Therefore the Company has recorded
an accrual of $1.2 million as of June 30, 2002.
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 were 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 processed 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 the Company perform a retrospective
review of all tissue in inventory (i.e. currently in storage at the
Company) 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 the Company's allograft heart valves, and will take further
regulatory action if appropriate.
Pursuant to the FDA Order, the Company 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. The Company appealed the FDA Order on August 14,
2002 and requested a hearing with the FDA, which has been set for December 12,
2002. After the FDA issued its order regarding the recall, Health Canada also
issued a recall on the same types of tissue and other countries have inquired
about the circumstances surrounding the FDA Order.
On September 5, 2002, the Company reached an agreement with the FDA (the
"Agreement") that supplements the FDA Order and permits the Company to resume
processing and limited distribution of its life-saving and limb-saving
non-valved cardiac and vascular tissues. The Agreement allows the tissue to be
released for distribution after the Company completes steps to assure that the
tissue is used for approved purposes and that patients will be notified of risks
associated with tissue use. Specifically, the Company must obtain physician
prescriptions and tissue packaging must contain appropriate warning labels. The
Agreement also calls for the Company to undertake to identify third-party
records of donor tissue testing, and to destroy tissue from donors in whom
microorganisms associated with an infection are found. In addition, the
Agreement, which has a forty-five working-day term ending November 7, 2002,
17
specifies interim operating procedures to permit the Company to distribute
tissues processed during the term of the Agreement. The Company also agreed to
establish a corrective action plan within 30 days with steps to validate
processing procedures. The corrective action plan was submitted on October 5,
2002. The FDA will review records and other relevant information related to the
Company's release of tissue under the Agreement, as well as the status of the
Company's corrective action plan, before determining whether this Agreement
should be renewed or modified to provide for any further release of tissue
subject to the FDA Order.
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
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.
As a result of the adverse publicity surrounding the FDA Warning Letter, the
Company's procurement of cardiac tissues, from which heart valves and non-valved
cardiac tissues are processed, decreased 15% in September 2002 as compared to
September 2001. Although, the Company expects to be able to maintain the current
level of cardiac tissue procurement if it continues to make progress in
addressing the observations detailed in the Warning Letter, there is no
guarantee that sufficient tissue will be available. The Company has continued to
process and distribute heart valves since the receipt of the FDA Order, as these
tissues are not subject to the FDA Order. The Company reduced the level of
processing for non-valved cardiac tissue to minimum levels after the receipt of
the FDA Order. After the Agreement, the Company resumed processing of non-valved
cardiac tissues under the interim operating procedures.
Upon receipt of the FDA Order, the Company ceased the procurement and processing
of vascular tissues until it entered into the Agreement allowing for interim
processing and distribution of vascular tissues. On September 17, 2002 the
Company resumed the procurement and processing of vascular tissues under the
interim operating procedures. The Company anticipates it will procure and
process vascular tissues at reduced levels as compared to prior year periods at
least until it addresses the observations detailed in the Warning Letter and
evaluates the demand for the vascular tissues.
Upon receipt of the FDA Order, the Company ceased the procurement and processing
of orthopaedic tissues. The Company does not anticipate procuring and processing
additional orthopaedic tissues until after it has satisfied the observations
detailed in the Warning Letter.
As a result of the FDA Order, the Company 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 as of
June 30, 2002, including the impact of the 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 believed that since all non-valved cardiac, vascular, and orthopaedic
allograft tissues processed since October 3, 2001 are under recall pursuant to
18
the FDA Order, and the Company did not know if it would 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 had been
significantly impaired. The Company estimated that this impairment approximated
the full balance of the deferred preservation costs of the tissues subject to
the FDA Order, which included the tissues stored by the Company and the tissues
to be returned to the Company, and therefore recorded a write-down of $10.0
million for these assets.
In the quarter ended September 30, 2002, the Company recorded a reduction to
pretax income of $24.6 million as a result of the FDA Order. The reduction was
comprised of a net $22.2 million increase to cost of human tissue preservation
services, a $1.4 million write-down of goodwill, and a $1.0 million reduction to
revenues (and accounts receivable) for the estimated return of the tissues
shipped during the third quarter subject to recall by the FDA Order. The net
$22.2 million increase to cost of preservation services is comprised of a $22.7
million write-down of deferred preservation costs, offset by a $0.5 million
decrease in cost of preservation services due to the estimated and actual tissue
returns resulting from the FDA Order (the costs of such recalled tissue are
included in the $22.7 million write-down).
The Company evaluated multiple 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, the possibility of unfavorable actions
by physicians, customers, procurement organizations, and others, the progress
made to date on the corrective action plan, and the requirement in the Agreement
that tissues subject to the FDA Order be replaced with tissues processed under
validated methods. As a result of this evaluation, management believes that all
tissues subject to the FDA Order as well as the majority of tissues processed
prior to October 3, 2001, including heart valves which are not subject to the
FDA Order, are fully impaired. Management believes that most of the Company's
customers will only order tissues processed under the interim operating
procedures established under the Agreement or tissues processed under future
procedures approved by the FDA once these tissues are available. The Company
anticipates the tissues processed under the interim operating procedures
established under the Agreement will be available early to mid-November. Thus,
the Company has recorded a write-down of deferred preservation costs for
processed tissues in excess of the supply required to meet demand prior to the
release of these interim processed tissues. As of September 30, 2002 the balance
of the deferred preservation costs after the write-down was $545,000 of
allograft heart valves, $176,000 of non-valved cardiac tissues, $931,000 of
vascular tissues, and $10,000 of orthopaedic tissues.
As a result of the write-down of deferred preservation costs, the Company has
recorded a deferred tax asset of $12.2 million. Upon destruction of the tissues
associated with the deferred preservation costs, the deferred tax asset will be
reclassed as an income tax receivable. An expected refund will be generated
through a carry back of losses resulting from the deferred preservation cost
write-downs. In addition, the Company has recorded $4.2 million in income tax
receivables related to $1.7 million of tax overpayments for 2001 and an
estimated $2.5 million of tax overpayments for 2002.
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), requires the
write-down of a long-lived asset to be held and used if the carrying value of
the asset or the asset group to which the asset belongs, is not recoverable and
exceeds its fair value. The asset or asset group is not recoverable if its
carrying value exceeds the sum of the undiscounted future cash flows expected to
result from the use and eventual disposition of the asset or asset group. In
applying SFAS 144, the Company determined that the asset groups consisted of the
long-lived assets related to the Company's two reporting segments, as these
represent the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities. The Company used
a fourteen-year period for the undiscounted future cash flows. This period of
time was selected based upon the remaining life of the primary assets of the
asset groups, which are leasehold improvements. Based on its analysis,
management does not believe an impairment of the Company's intangible and
tangible assets related to the tissue preservation business or medical device
business had occurred as of September 30, 2002. However, depending on the
Company's ability to address the observations detailed in the Warning Letter 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.
19
Goodwill resulting from business acquisitions is not amortized, but is instead
subject to periodic impairment testing in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"). As a result of the FDA
Order, the Company determined that an evaluation of the possible impairment of
intangible assets under SFAS 142 was necessary. The Company engaged an
independent valuation expert to perform the valuation using a discounted cash
flow methodology, and as a result of this analysis, the Company determined that
goodwill related to its tissue processing reportable unit was fully impaired as
of September 30, 2002. Therefore, the Company recorded a write-down of $1.4
million in goodwill during the quarter ended September 30, 2002. Management does
not believe an impairment exists related to the other intangible assets.
Management will continue to evaluate the recoverability of these intangible
assets.
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 $690,000, which was recorded in the third quarter of
2002. As a result of the employee reduction, management anticipates personnel
costs will be reduced by approximately $385,000 per month.
See Part II, Item 1 "Legal Proceedings" for a discussion of certain material
legal proceedings.
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
original shipment if certain quality criteria are maintained. 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 and tissue procurement agencies, 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 September 30, 2002 the deferred preservation costs were $545,000 for
allograft heart valve tissues, $176,000 for non-valved cardiac tissues, $931,000
for vascular tissues, and $10,000 for orthopaedic tissues. For the three and
20
nine months ended September 30, 2002, respectively, the Company recorded a
write-down of deferred preservation costs of $8.7 million and $8.7 million for
valved cardiac tissues, $1.3 million and $2.9 million for non-valved cardiac
tissues, $6.9 million and $11.9 million for vascular tissues, and $5.8 million
and $9.2 million for orthopaedic tissue totaling $22.7 and $32.7 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.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL: The Company assesses
the impairment of its long-lived, identifiable intangible assets and related
goodwill whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Factors that management considers important that
could trigger an impairment review include the following:
o significant underperformance relative to expected historical or projected
future operating results;
o significant negative industry or economic trends;
o significant decline in the Company's stock price for a sustained period;
and
o the Company's market capitalization relative to net book value.
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), requires the
write-down of a long-lived asset to be held and used if the carrying value of
the asset or the asset group to which the asset belongs, is not recoverable and
exceeds its fair value. The asset or asset group is not recoverable if its
carrying value exceeds the sum of the undiscounted future cash flows expected to
result from the use and eventual disposition of the asset or asset group. In
applying SFAS 144, the Company determined that the asset groups consisted of the
long-lived assets related to the Company's two reporting segments, as these
represent the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities. The Company used
a fourteen-year period for the undiscounted future cash flows. This period of
time was selected based upon the remaining life of the primary assets of the
asset groups, which are leasehold improvements. Based on its analysis,
management does not believe an impairment of the Company's intangible and
tangible assets related to the tissue preservation business or medical device
business had occurred as of September 30, 2002. However, depending on the
Company's ability to address the observations detailed in the Warning Letter 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.
Goodwill resulting from business acquisitions is not amortized, but is instead
subject to periodic impairment testing in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 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). As a result of the FDA
Order, the Company determined that an evaluation of the possible impairment of
intangible assets under SFAS 142 was necessary. The Company engaged an
independent valuation expert to perform the valuation using a discounted cash
flow methodology, and as a result of this analysis, the Company determined that
goodwill related to its tissue processing reportable unit was fully impaired as
of September 30, 2002. Therefore, the Company recorded a write-down of $1.4
million in goodwill during the quarter ended September 30, 2002. Management does
not believe an impairment exists related to the other intangible assets.
Management will continue to evaluate the recoverability of these intangible
assets.
21
NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2002 the Company was required to adopt SFAS 142 and SFAS 144. See
Critical Accounting policies for a discussion of the impact of these
pronouncements on current financial results.
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 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 rescinds SFAS No. 4, 44
and 64, which required gains and losses from extinguishments of debt to be
classified as extraordinary items. SFAS 145 also amends SFAS No. 13 eliminating
inconsistencies in certain sale-leaseback transactions. The provisions of SFAS
145 are effective for fiscal years beginning after May 15, 2002. 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.
RESULTS OF OPERATIONS
REVENUES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 16,889 $ 22,567 $ 65,624 $ 65,696
Reduction in revenues due to
estimated tissue returns 1,031 -- 3,464 --
-------------- ------------- ------------- ------------
Revenues prior to reduction for
estimated tissue returns $ 17,920 $ 22,567 $ 69,088 $ 65,696
============== ============= ============= =============
One Month Ended
September 30,
-------------------------------
2002 2001
-------------------------------
Revenues prior to reduction
for estimated tissue returns $ 3,632 $ 7,394
Revenues prior to the reduction for the estimated effect of tissue returns as a
result of the FDA Order decreased 51% and 21% and increased 5%, respectively,
for the one, three, and nine months ended September 30, 2002. This decrease in
revenues for the one and three months ended September 30, 2002, respectively,
was primarily due to a 72% and 38% decrease in human tissue preservation service
revenues as a result of the FDA Order's restriction on shipments of certain
tissues and decreased demand as a result of the adverse publicity surrounding
the FDA Order, partially offset by a 82% and 113% increase in BioGlue(R)
Surgical Adhesive revenues for the one and three months ended September 30,
2002. The increase in revenues for the nine month period ended September 30,
2002 was primarily due to a 104% increase in sales of BioGlue Surgical Adhesive,
22
partially offset by a 14% decrease in human tissue preservation service revenues
as a result of the FDA Order's restriction on shipments of certain tissues and
decreased demand as a result of the adverse publicity surrounding the FDA Order
and reported incidents of infection. The BioGlue increases are primarily
attributable to the receipt of FDA approval for BioGlue in December 2001.
Revenues as reported decreased 25% and less than 1%, respectively, for the three
and nine months ended September 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 $1.0 million and $3.5 million,
respectively, in preservation service revenues during the three and nine months
ended September 30, 2002. As discussed herein, the estimated effect of the
return of tissues subject to recall includes credits for tissues actually
returned to the Company to date and the expected credits for future tissues to
be returned to the Company as a result of the FDA Order.
Although the Company has not yet determined the full impact of the FDA Order on
future revenues, the September revenues for 2002 as compared to 2001 decreased
51% primarily as a result of the FDA Order and adverse publicity. Management
believes that a decrease in revenues as compared to prior periods will continue.
In the event the Company is not successful in addressing the issues detailed in
the Warning Letter as described in the recent events section or is unable to
reach a satisfactory agreement with the FDA, future revenues can be expected to
decrease significantly as compared to prior year periods.
BIOGLUE SURGICAL ADHESIVE
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 5,183 $ 2,431 $ 15,308 $ 7,505
Percentage of total revenue as reported 31% 11% 23% 11%
Percentage of total revenue prior to
reduction for estimated tissue returns 29% 11% 22% 11%
One Month Ended
September 30,
-------------------------------
2002 2001
-------------------------------
Revenues $ 1,786 $ 981
Percentage of total revenue 49% 13%
Revenues from the sale of BioGlue Surgical Adhesive increased 82%, 113% and
104%, respectively, for the one, three, and nine month periods ended September
30, 2002. The increase in revenues for the one, three, and nine month periods
ended September 30, 2002 was due to an increase in the milliliters of BioGlue
shipped of 56%, 89% and 82%, 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 78% and 69% of total BioGlue
revenues for the three months ended September 30, 2002 and 2001, respectively.
Domestic revenues accounted for 78% and 67% of total BioGlue revenues for the
nine months ended September 30, 2002 and 2001, respectively.
Although BioGlue revenue increased as compared to prior year and 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.
23
CARDIOVASCULAR PRESERVATION SERVICES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 5,487 $ 8,209 $ 20,131 $ 22,307
Percentage of total revenue as reported 32% 36% 31% 34%
Revenues prior to reduction for
estimated tissue returns $ 5,657 $ 8,209 $ 20,643 $ 22,307
Percentage of total revenue prior to
reduction for estimated tissue returns 32% 36% 30% 34%
One Month Ended
September 30,
-------------------------------
2002 2001
-------------------------------
Revenues prior to reduction
for estimated tissue returns $ 1,196 $ 2,487
Percentage of total revenue 33% 34%
Revenues from cardiovascular preservation services, prior to the reduction for
estimated returns of tissue subject to the FDA Order, decreased 52%, 31% and 7%,
respectively, for the one, three, and nine months ended September 30, 2002. This
decrease in revenues for the one, three, and nine month periods ended September
30, 2002 was primarily due to a decline in customer demand due to the adverse
publicity surrounding the FDA Order, certain reported tissue infections, and the
restrictions on shipments of certain tissues subject to the FDA Order.
Revenues as reported from cardiovascular preservation services decreased 33% and
10%, respectively, for the three and nine months ended September 30, 2002. The
revenues from cardiovascular preservation services were adversely impacted by
the estimated effect of the non-valved cardiac tissues returned subject to
recall by the FDA Order, which resulted in an estimated decrease of $170,000 and
$510,000 in service revenues during the three and nine months ended September
30, 2002.
The Company anticipates a future decrease in cardiovascular preservation
revenues as compared to prior year periods as a result of the adverse publicity
surrounding the FDA Warning Letter, FDA Order, and certain reported tissue
infections. If the Company is unable to address the observations detailed in the
Warning Letter, future non-valved cardiac preservation revenue, if any, may be
immaterial.
VASCULAR PRESERVATION SERVICES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 3,260 $ 6,192 $ 14,918 $ 18,617
Percentage of total revenue as reported 19% 27% 23% 28%
Revenues prior to reduction for
estimated tissue returns $ 4,093 $ 6,192 $ 17,464 $ 18,617
Percentage of total revenue prior to
reduction for estimated tissue returns 23% 27% 25% 28%
24
One Month Ended
September 30,
-------------------------------
2002 2001
-------------------------------
Revenues prior to reduction
for estimated tissue returns $ 573 $ 1,942
Percentage of total revenue 16% 26%
Revenues from human vascular tissue preservation services, prior to reduction
for estimated returns of tissue subject to the FDA Order, decreased 70%, 34% and
6%, respectively, for the one, three, and nine months ended September 30, 2002.
This decrease in revenues for the one, three, and nine month periods ended
September 30, 2002 was primarily due to a decline in customer demand due to the
adverse publicity surrounding the FDA Order, certain reported tissue infections,
and the restrictions on shipments of certain tissues subject to the FDA Order.
Revenues as reported from human vascular tissue preservation services decreased
47% and 20%, respectively, for the three and nine months ended September 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 $833,000 and $2.5
million, respectively, in vascular preservation service revenues during the
three and nine months ended September 30, 2002.
The Company anticipates a future decrease in vascular preservation revenues as
compared to prior year periods as a result of the adverse publicity surrounding
the FDA Warning Letter, FDA Order, and certain reported tissue infections. If
the Company is unable to address the observations detailed in the Warning
Letter, future vascular preservation revenues, if any, may be immaterial.
ORTHOPAEDIC PRESERVATION SERVICES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 2,553 $ 5,336 $ 14,025 $ 16,145
Percentage of total revenue as reported 15% 24% 21% 25%
Revenues prior to reduction for
estimated tissue returns $ 2,581 $ 5,336 $ 14,433 $ 16,145
Percentage of total revenue prior to
reduction for estimated tissue returns 14% 24% 21% 25%
One Month Ended
September 30,
-------------------------------
2002 2001
-------------------------------
(Credits) revenues prior to
reduction for estimated tissue returns $ (22) $ 1,870
Percentage of total revenue (1%) 25%
Revenues from human orthopaedic tissue preservation services, prior to reduction
for estimated returns of tissue subject to the FDA Order, decreased 101%, 52%
and 11% for the one, three, and nine months ended September 30, 2002. This
decrease in revenues for the one, three, and nine month periods ended September
30, 2002 was primarily due to a decline in customer demand due to the adverse
publicity surrounding the FDA Order, certain reported tissue infections, and the
restrictions on shipments of certain tissues subject to the FDA Order.
25
Revenues as reported from human orthopaedic tissue preservation services
decreased 52% and 13% for the three and nine months ended September 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 $28,000 and $408,000,
respectively, in orthopaedic preservation service revenues during the three and
nine months ended September 30, 2002.
The Company anticipates a substantial decrease in the orthopaedic preservation
revenues as compared to prior year periods due to the Company's inability to
ship orthopaedic grafts processed since October 3, 2001 pursuant to the FDA
Order, the adverse publicity resulting from the FDA Warning Letter and FDA
Order, and the reported infections in some orthopaedic allograft recipients. If
the Company is unable to address the observations detailed in the Warning Letter
to enable the Company to process and ship orthopaedic tissue, or if demand for
these tissues does not return after the observations are addressed, future
orthopaedic preservation revenue, if any, may be immaterial.
BIOPROSTHETIC DEVICES
Revenues from bioprosthetic cardiovascular devices increased 1% to $171,000 for
the three months ended September 30, 2002 from $169,000 for the three months
ended September 30, 2001, representing 1% of total revenues during each such
period. Revenues from bioprosthetic cardiovascular devices increased 11% to
$584,000 for the nine months ended September 30, 2002 from $524,000 for the nine
months ended September 30, 2001, representing 1% of total revenues during each
such period.
DISTRIBUTION AND GRANT REVENUES
Distribution and grant revenues increased to $235,000 for the three months ended
September 30, 2002 from $230,000 for the three months ended September 30, 2001.
Distribution and grant revenues increased to $658,000 for the nine months ended
September 30, 2002 from $598,000 for the nine months ended September 30, 2001.
Grant revenues of $77,000 and $230,000, for the three months ended September 30,
2002 and 2001, respectively, and $208,000 and $598,000, for the nine months
ended September 30, 2002 and 2001, respectively, are primarily attributable to
the SynerGraft(R) research and development programs. Distribution revenues of
$158,000 for the three months ended September 30, 2002 and $450,000 for the nine
months ended September 30, 2002 are for commissions received for the
distribution of orthopaedic tissues for another processor. Distribution revenues
for 2001 were zero.
COSTS AND EXPENSES
Cost of human tissue preservation services aggregated $28.0 million for the
three months ended September 30, 2002 as compared to $8.2 million for the three
months ended September 30, 2001, representing 248% and 41%, respectively, of
total human tissue preservation service revenues for each such period. Cost of
human tissue preservation services aggregated $53.2 million for the nine months
ended September 30, 2002 as compared to $23.6 million for the nine months ended
September 30, 2001, representing 108% and 41%, respectively of total human
tissue preservation service revenues for each period. The cost of human tissue
preservation services for the three and nine months ended September 30, 2002,
respectively, includes a $22.7 million and $32.7 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 current cost of human tissue preservation services as a
percent of revenue is likely to increase, especially if the decline in the
demand for the tissues continues.
Cost of products aggregated $4.7 million for the three months ended September
30, 2002 as compared to $