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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 1-13165
CRYOLIFE, INC.
(Exact name of registrant as specified in its charter)
Florida 59-2417093
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1655 Roberts Boulevard N.W., Kennesaw, GA 30144
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code (770) 419-3355
Securities registered pursuant to Section
12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
Common Stock, $.01 par value New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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 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. [ X ] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K Section 229.405 of this chapter is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ X ] Yes [ ] No
As of June 30, 2002, the aggregate market value of the voting stock of the
Registrant held by non-affiliates of the registrant was $272,880,824 computed
using the closing price of $16.06 per share of Common Stock on June 28, 2002,
the last trading day of the registrant's most recently completed second fiscal
quarter, as reported by NYSE, based on the assumption that directors and
executive officers are affiliates.
As of February 24, 2003 the number of outstanding shares of Common Stock of the
registrant was 19,573,970.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Portions of Registrant's Proxy Statement relating to the Annual
Meeting of Shareholders to be filed not later than April 30, 2003.
PART I
ITEM 1. BUSINESS.
OVERVIEW
CryoLife, Inc. ("CryoLife" or the "Company"), incorporated January 19, 1984 in
Florida, is a leader in the preservation of human tissues for cardiovascular and
vascular transplant applications. The Company also develops and commercializes
implantable medical devices, including BioGlue(R) Surgical Adhesive,
glutaraldehyde-fixed stentless porcine heart valves, and SynerGraft(R) processed
bovine vascular grafts. The Company uses its expertise in biochemistry, cell
biology, immunology, and protein chemistry and its understanding of the needs of
the cardiovascular, vascular, and orthopaedic surgery medical specialties, to
continue expansion of its core preservation and surgical adhesive businesses and
to develop or acquire complementary implantable products and technologies for
these surgical specialties. For detailed financial information on CryoLife's
operating segments, see Note 20 of Notes to the Consolidated Financial
Statements.
CryoLife processes and distributes for transplantation preserved human
cardiovascular and vascular tissue. Management believes that cryopreserved human
heart valves and conduits offer specific advantages over mechanical, synthetic,
and animal-derived alternatives. Depending on the alternative, these advantages
include a more natural hemodynamic functionality, the elimination of a long-term
need for anti-coagulation drug therapy, a reduced incidence of reoperation, and
a reduced risk of catastrophic failure, thromboembolism (stroke), or
calcification. The Company has applied its proprietary SynerGraft antigen
reduction technology to enhance the performance of certain human cardiovascular
and vascular tissues. (See "Recent Events" below). The Company estimates that
the potential U.S. market for implantable products targeting indications
addressed by the preserved tissues processed by the Company, including
orthopaedic tissue, the processing of which had been suspended due to factors
discussed below, was in excess of $1 billion in 2001. However, supply
constraints of human tissue limit market share potential. Although the Company
estimates that it provided in excess of 70% of the preserved human heart valve
tissue implanted in the U.S. in 2001, as a result of the adverse effects from
the U.S. Food and Drug Administration ("FDA") Order, reported tissue infections,
and the resulting adverse publicity, as discussed below, the Company's market
share declined in 2002. The Company seeks to expand the availability of human
tissue through its established relationships with approximately 84 tissue banks
and organ procurement agencies nationwide.
Historically, CryoLife has been a leader in the preservation of human tissues
for orthopaedic transplant applications. The Company has provided preservation
services for surgical replacements for the meniscus and the anterior and
posterior cruciate ligaments, which are critical to the proper function of the
human knee, as well as osteochondral grafts used for the repair of cartilage
defects in the knee. The Company processed orthopaedic tissue until August of
2002 when the Company received a recall order from the FDA (see further
discussions below at "FDA Order on Human Tissue Preservation"). The Company
resumed processing orthopaedic tissue in late February 2003. The Company has
historically relied on independent orthopaedic sales representatives to market
its preservation services and intends to continue using independent sales
representatives once it resumes processing orthopaedic tissue.
CryoLife has developed implantable biomaterials for use as surgical adhesives
and sealants. The Company's proprietary BioGlue Surgical Adhesive, designed for
cardiovascular, vascular, pulmonary, and general surgical applications, is a
polymer based on bovine serum albumin and a cross-linking agent. The Company
received a Conformite Europeene ("CE") Mark (product certification) in 1997 for
use of its BioGlue Surgical Adhesive in vascular applications and began
marketing this product in April 1998 in the European Economic Area ("EEA"). In
March 1999 the Company was awarded a second CE Mark allowing the use of BioGlue
in pulmonary indications, including the repair of air leaks in lungs. In
December 1999 the Company received FDA approval to distribute BioGlue Surgical
Adhesive under a Humanitarian Device Exemption ("HDE") for use as an adjunct in
the repair of acute thoracic aortic dissections and immediately began marketing
this product in the U.S. pursuant to the HDE. The Company received approval to
distribute BioGlue Surgical Adhesive for vascular and pulmonary repairs in
Canada and Australia in January 2000 and February 2001, respectively. In
December 2001 the Company received FDA approval for BioGlue as an adjunct to
sutures and staples for use in adult patients in open surgical repair of large
vessels. The Company estimates that the annual worldwide market for surgical
sutures and staples in 2002 was in excess of $2.5 billion. In January 2002
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BioGlue was awarded a third CE Mark for use in soft tissue repair procedures. An
additional six marketing approvals were granted in the Czech Republic, Colombia,
Mexico, Peru, South Korea and Singapore in 2002 for one or more of the various
indications discussed above. In February 2003 the Company received an expanded
approval in Canada for use of BioGlue in soft tissue repair procedures. This
approval expands the application of BioGlue, from vascular and pulmonary repair
only, to soft tissue repair.
CryoLife has developed and markets outside of the U.S. bioprosthetic
cardiovascular and vascular devices for implantation, consisting of a SynerGraft
processed bovine vascular graft and a glutaraldehyde-fixed stentless porcine
heart valve, the CryoLife-O'Brien(R) aortic heart valve. In August of 2001 the
Company received CE Mark approval for its SynerGraft Model 100 vascular graft
for dialysis access. SynerGraft involves the depopulation of cells leaving a
collagen matrix that has the potential to be repopulated with the recipient's
cells. This process is designed to increase graft longevity, and to improve the
biocompatibility and functionality of such tissue. The SynerGraft Model 100
vascular graft is produced from a bovine ureter in lengths of 25 and 50 cm and
can be stored at room temperature until use. The SynerGraft Model 100 vascular
graft is marketed in the EEA, Switzerland, and Israel. The Company's
Cryolife-O'Brien heart valve is a glutaraldehyde-fixed porcine heart valve,
which is often preferred by surgeons for procedures involving elderly patients
because they eliminate the risk of patient non-compliance with long-term
anti-coagulation drug therapy associated with mechanical valves, are less
expensive than human heart valves, and their shorter longevity is more
appropriately matched with these patients' life expectancies.
Glutaraldehyde-fixed porcine and bovine heart valves address a worldwide target
market estimated to have been $400 million in 2002. Unlike most other available
porcine heart valves, the Company's stentless porcine heart valves contain
minimal amounts of synthetic materials, which decreases the risk of
endocarditis, a debilitating and potentially fatal infection. The Company's
CryoLife-O'Brien heart valve, currently marketed in the EEA and certain other
territories outside the U.S., is a stentless porcine heart valve which contains
a matched composite leaflet design that approximates human heart valve blood
flow characteristics and requires only a single suture line for implantation.
For information regarding international revenues, see Note 20 of Notes to the
Consolidated Financial Statements.
Previously, the Company developed and marketed, outside of the U.S., SynerGraft
processed porcine heart valves. During 2002 the Company decided to cease future
expenditures on the development and commercialization of these valves. This
decision was made to allow the Company to maintain its focus on its preservation
services business and its BioGlue and SynerGraft bovine vascular graft product
lines.
In February 2001 the Company formed AuraZyme Pharmaceuticals, Inc. ("AuraZyme")
to foster the commercial development of its Activation Control Technology
("ACT"). The ACT is a reversible linker technology that has potential uses in
the areas of cancer therapy, fibrinolysis (blood clot dissolving), and other
drug delivery applications. Since 1998 management has been seeking to advance
the development of drug delivery therapies utilizing the ACT through grants,
research and development partnerships, joint ventures, and equity investments.
This strategy is designed to allow the Company to continue development of this
technology without incurring additional research and development expenditures,
other than through AuraZyme, and allow the Company to focus its resources on the
commercial development of its BioGlue Surgical Adhesive, SynerGraft technology,
and other products under development.
In the U.S. the Company markets its preservation services for human
cardiovascular and vascular tissue and its BioGlue Surgical Adhesive through its
direct technical service representatives. Internationally, preserved human
tissues, bioprosthetic cardiovascular and vascular devices, including
SynerGraft, and BioGlue Surgical Adhesive are distributed through independent
representatives located throughout Europe, the Middle East, Canada, South
America, Australia, and Asia. The Company also uses direct technical service
representatives in the United Kingdom to market its preservation services,
bioprosthetic devices, and BioGlue Surgical Adhesive.
RECENT EVENTS
On February 5, 2003 the Company announced that it had signed an exclusive
agreement with curasan AG, located in Germany, for U.S. distribution of
Cerasorb(R) Ortho, curasan's resorbable bone graft substitute. The five-year
agreement gives CryoLife exclusive rights to market Cerasorb Ortho for all
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non-spine, non-dental orthopaedic indications such as trauma, general, and
sports medicine. Cerasorb, a resorbable, beta-tricalcium phosphate bone
regeneration material, was first introduced in Germany in 1998 for dental use.
The product captured approximately 60% of the synthetic dental bone regeneration
market in Germany within four years. In 2001 curasan received CE Mark
certification for Cerasorb's use in general orthopaedics, and in 2002 received
FDA 510(k) approval for orthopaedic use. The Company anticipates that the U.S.
market for bone grafts and substitutes for which it can distribute Cerasorb is
approximately $140 million annually.
On February 20, 2003 the Company received a letter from the FDA that stated that
a 510(k) premarket notification should be filed for the Company's CryoValve SG
and that premarket approval marketing authorization should be obtained for the
Company's CryoVein SG when used for arteriovenous ("A-V") access. The agency's
position is that use of the SynerGraft technology in the processing of allograft
heart valves represents a modification to the Company's legally marketed
CryoValve allograft, and that femoral veins used for A-V access are medical
devices that require premarket approval. CryoLife will be providing the agency
with information to demonstrate that femoral veins used for A-V access should
continue to be regulated as human tissue under Parts 1270 and 1271 of the FDA's
regulations. The FDA letter did not question the safety or efficacy of the
SynerGraft process or the CryoVein A-V access implant.
The Company has advised the FDA that it will voluntarily suspend use of the
SynerGraft technology in the processing of allograft heart valves and vascular
tissue until the regulatory status of the CryoValve SG and CryoVein SG is
resolved. The FDA has not suggested that these tissues be recalled. Until such
time as the issues surrounding the SG tissue are resolved, the Company will
employ its traditional processing methods on these tissues. Distribution of
allograft heart valves and vascular tissue processed using the Company's
traditional processing protocols will continue.
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"). The FDA
Order followed an April 2002 FDA Form 483 Notice of Observations ("FDA 483") and
an FDA Warning Letter dated June 17, 2002, ("Warning Letter"). Subsequently, the
Company responded to the Warning Letter. Revenue from human tissue preservation
services accounted for 78% of the Company's revenues for the six months ended
June 30, 2002, (the last period ending prior to the issuance of the FDA Order)
and of those revenues 67% or $26.9 million were derived from preservation of
tissues subject to the FDA Order. 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 from October 3, 2001 to September 5, 2002 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.
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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 non-valved cardiac, vascular, and
orthopaedic tissue subject to the FDA Order on quality assurance quarantine and
recalled the non-valved cardiac, vascular, and orthopaedic tissues subject to
the FDA Order (i.e. processed since October 3, 2001) that had been distributed
but not implanted. In addition, the Company ceased processing non-valved
cardiac, vascular, and orthopaedic tissues. The Company appealed the FDA Order
on August 14, 2002 and requested a hearing with the FDA, which was originally
set for December 12, 2002. Due to the Agreement discussed below, the Company
withdrew its request for a hearing with the FDA. 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.
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 subject to the FDA Order. On August 21, 2002 the FDA
publicly stated that allograft heart valves have not been included in the FDA
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 then still had serious
concerns regarding the Company's 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 regarding the Company's allograft heart valves,
and that patients be carefully monitored for both fungal and bacterial
infections.
On September 5, 2002 the Company reached an agreement with the FDA (the
"Agreement") that supplements the FDA Order and allows the tissues subject to
recall (processed between October 3, 2001 and September 5, 2002) to be released
for distribution after the Company completes steps to assure that the tissue is
used for approved purposes and that patients are notified of risks associated
with tissue use. Specifically, the Company must obtain physician prescriptions,
and tissue packaging must contain specified warning labels. The Agreement 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. The Agreement allowing distribution of tissues
subject to the recall had a 45-business day term and was renewed on November 8,
2002 and on January 8, 2003. This most recent renewal expires on March 20, 2003.
The Company is unable to predict if the FDA will grant further renewals of the
Agreement. In addition, pursuant to the Agreement, the Company agreed to perform
additional procedures in the processing of non-valved cardiac and vascular
tissues and subsequently resumed processing these tissues. The Agreement
contained the requirement that tissues subject to the FDA Order be replaced with
tissues processed under validated methods. The Company also agreed to establish
a corrective action plan within 30 days from September 5, 2002 with steps to
validate processing procedures. The corrective action plan was submitted on
October 5, 2002.
As a result of the adverse publicity surrounding the FDA Warning Letter, FDA
Order, and the reported tissue infections, the Company's procurement of cardiac
tissues, from which heart valves and non-valved cardiac tissues are processed,
decreased 25% in the fourth quarter of 2002 as compared to the fourth quarter of
2001. Although the Company expects to be able to maintain the current level of
cardiac tissue procurement, 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.
On September 17, 2002 the Company resumed the procurement and processing of
vascular tissues. The Company limited its vascular procurement until it
addressed the observations detailed in the FDA 483 and had fully evaluated the
demand for the vascular tissues. The Company's procurement of vascular tissue
decreased 65% in the fourth quarter of 2002 as compared to the fourth quarter of
2001. The Company expects that vascular procurement will increase significantly
following the close out of the FDA 483.
On December 31, 2002 the FDA clarified the Agreement noting that non-valved
cardiac and vascular tissues processed since September 5, 2002 are not subject
to the FDA Order. Specifically, for non-valved cardiac and vascular tissue
processed since September 5, 2002, the Company is not required to obtain
physician prescriptions, label the tissue as subject to a recall, or require
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special steps regarding procurement agency records of donor screening and
testing beyond those required for all processors of human tissue. A renewal of
the Agreement that expires on March 20, 2003 is therefore not needed in order
for the Company to continue to distribute non-valved cardiovascular and vascular
tissues processed since September 5, 2002.
On February 14, 2003 the FDA confirmed that the Company has completed the
corrective actions necessary to close out the April 2002 FDA 483 Notice of
Observations that preceded the Warning Letter and FDA Order. The close out of
the 483 followed a two-week inspection of the Company's processing operations.
As a result of the close out of the 483, the Company believes it can resume
processing and distributing orthopaedic tissues but has not received
confirmation of this from the FDA. The Company resumed processing orthopaedic
tissues in late February 2003. Prior to shipment of orthopaedic tissues, the
Company will confirm with the FDA that they do not disagree with the Company
regarding its interpretation of the close out of the FDA 483. The Company will
continue to process vascular tissues on a limited basis until it can fully
evaluate the demand level for its vascular tissue preservation services.
A new FDA 483 Notice of Observations was issued in connection with the
inspection, but corrective action was implemented on most of its observations
during the inspection. The Company believes the observations, most of which
focus on the Company's systems for handling complaints, will not materially
affect the Company's operations.
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 9), 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 was 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 U.S. 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 were under recall pursuant to the FDA Order, and
since 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 was 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 at September 30, 2002, including the
impact of the FDA Order, the possibility of continuing action by the FDA or
other U.S. 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
believed 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 were
not subject to the FDA Order, were fully impaired. Management believed that most
of the Company's customers would only order tissues processed after the
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September 5, 2002 Agreement or tissues processed under future procedures
approved by the FDA once those tissues were available. The Company anticipated
that the tissues processed under the Agreement would be available early to
mid-November. Thus, the Company 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. The Company did not
record any further write-downs of deferred preservation costs in the fourth
quarter of 2002. As of December 31, 2002 the balance of deferred preservation
costs were $2.0 million for allograft heart valve tissues, $620,000 for
non-valved cardiac tissues, $1.7 million for vascular tissues, and zero for
orthopaedic tissues.
As a result of the write-down of deferred preservation costs, the Company
recorded $6.3 million in income tax receivables and $4.5 million in deferred tax
assets. Upon destruction or shipment of the remaining tissues associated with
the deferred preservation costs write-down, the deferred tax asset will become
deductible in the Company's tax return. An expected refund of approximately $8.5
million will be generated through a carry back of operating losses and
write-downs of deferred preservation costs. In addition, the Company recorded
$2.5 million in income tax receivables related to estimated tax payments for
2002. The Company received payment of the $2.5 million in January of 2003.
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. The
carrying value of the asset or asset group is not recoverable if it exceeds the
sum of the undiscounted future cash flows expected to result from the use and
eventual disposition of the asset or asset group. As of September 30, 2002, 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
asset groups represent the lowest level at 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. The undiscounted future
cash flows related to these asset groups exceeded their carrying values as of
September 30, 2002 and December 31, 2002 and therefore management has concluded
that there is not an impairment of the Company's long-lived intangible assets,
except for goodwill as discussed below, and tangible assets related to the
tissue preservation business or medical device business. However, depending on
the Company's ability to rebuild demand for its tissue preservation services,
the outcome of discussions with the FDA regarding the shipping of orthopaedic
tissues, 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 in accordance with SFAS 144.
Beginning with the Company's adoption of Statement of Financial Accounting
Standards ("SFAS") No. 142,"Goodwill and Other Intangible Assets" ("SFAS 142")
on January 1, 2002 the goodwill resulting from business acquisitions is not
amortized, but is instead subject to periodic impairment testing in accordance
with 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 reporting 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 that were assessed in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144").
On September 3, 2002 the Company announced a reduction in employee force of
approximately 105 employees. In the third quarter of 2002 the Company recorded
accrued restructuring costs of approximately $690,000, for severance and related
costs of the employee force reduction. The expense was recorded in general,
administrative, and marketing expenses and was included as a component of
accrued expenses and other current liabilities on the Consolidated Balance
Sheet. During the year ended December 31, 2002 the Company utilized $580,000 of
the accrued restructuring costs, including $505,000 for salary and severance
payments, $64,000 for placement services for affected employees, and $11,000 in
other related costs. As of December 31, 2002 the remaining balance of accrued
restructuring costs was $110,000.
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See Part I, Item 3 "Legal Proceedings" for a discussion of certain material
legal proceedings.
STRATEGY
The Company's primary objective is to consistently grow revenue and
profitability. The Company's strategy to generate revenue growth is based on
increasing the use of cryopreserved tissues as an alternative to mechanical and
synthetic implantable products, developing new markets for existing products and
technologies and developing new products and technologies for new and existing
markets. The Company also selectively considers strategic acquisitions of
complementary technologies and businesses to supplement its internal growth. The
key elements of the Company's business and growth strategy are to:
o Continue Preservation of Cardiovascular Tissue. The Company intends to
increase the market penetration of its CryoLife preserved human heart
valves and conduits by (i) expanding awareness of clinical advantages
of cryopreserved human tissues through continuing educational efforts
directed to physicians, prospective heart valve and conduit
recipients, and tissue procurement agencies, (ii) expanding its
relationships with the approximately 84 tissue banks and organ
procurement agencies across the U.S. which have recovered and sent
tissue to the Company for preservation, (iii) expanding its physician
training activities, and (iv) resuming the application of its
SynerGraft technology to human heart valves and conduits for antigen
reduction properties with the potential for recipient cell
repopulation.
o Expand Distribution of Preserved Human Vascular Tissue and Resume
Distribution of Orthopaedic Tissue. Using the same strategy it has
successfully employed to expand its preservation services for
cardiovascular tissue, the Company intends to increase its
preservation revenues from human vascular tissue and to resume
orthopaedic tissue distribution by (i) continuing educational efforts
directed to surgeons about the clinical advantages of preserved
tissue, (ii) expanding its relationships with tissue banks and organ
procurement agencies, (iii) expanding its programs for training
physicians in the use of tissue preserved by the Company, and (iv)
resuming and expanding its product offerings by applying its
SynerGraft technology to human grafts for antigen reduction properties
with the potential for recipient cell repopulation.
o Broaden Application of Preservation Services. The Company will
continue to collect, monitor, and evaluate implant data to (i) develop
expanded uses for the human tissues currently cryopreserved by the
Company and (ii) identify new human tissues as candidates for
preservation. In 1997 the Company began providing cryopreserved human
vascular tissue to be used as dialysis access replacement grafts for
patients undergoing chronic dialysis, and separately, as venous valve
replacements for patients suffering from chronic venous insufficiency.
In 1997 and 1998 in addition to patellar and Achilles tendons, the
Company began providing semi-t/gracilis tendons and cryopreserved
posterior and anterior tibialis tendons, respectively, for use in knee
repairs, and in 1999 began providing preserved human osteochondral
grafts to repair articular defects and aortoiliac grafts to replace
infected abdominal aortic grafts. The Company is also investigating
the use of other orthopaedic tissues in various surgical applications.
As discussed in the section on the FDA Order on Human Tissue
Preservation, the Company resumed orthopaedic processing in late
February 2003.
o Expand Distribution of Biomaterials for Surgical Adhesive and Sealant
Applications. The Company began commercial marketing of its
proprietary BioGlue Surgical Adhesive in the EEA through its
independent representatives for vascular and pulmonary applications
upon receipt of a CE Mark in 1997 and 1999, respectively. The Company
has since been successful in broadening the scope for approved uses
and the number of countries that accept it. The Company continues to
seek additional marketing approvals in other countries. In addition to
these adhesive and sealant applications of BioGlue, the Company
intends to pursue, either directly or through strategic alliances,
additional indications for BioGlue technology, including replacement
for spinal disc nuclei. The Company also intends to pursue additional
approvals for hernia repair and dura mater sealing in the U.S.
8
o Develop and Commercialize Bioprosthetic SynerGraft Vascular Devices.
The Company intends to leverage its expertise with human vascular
grafts and bioprosthetic devices as a platform for the development and
commercialization of its SynerGraft processed bovine vascular grafts.
In July of 2001 the Company received CE Mark approval for its
SynerGraft Model 100 vascular graft that is presently being marketed
for dialysis access.
o Develop and Commercialize Bioprosthetic Cardiovascular Devices. The
Company intends to leverage its expertise with stentless human heart
valves to expand commercialization of its stentless porcine heart
valve.
o Develop and Commercialize Other Technologies. The Company intends to
leverage its current distribution channel and its expertise in the
cardiovascular and orthopaedic medical specialties by selectively
pursuing the potential distribution or licensing of additional
technologies that compliment existing services and products, such as
Cerasorb.
SERVICES AND PRODUCTS
Preservation of Human Tissue for Transplant
The Company's proprietary preservation process involves the recovery of tissue
from deceased human donors by tissue bank and organ procurement organizations,
the timely and controlled delivery of such tissue to the Company, the screening,
dissection, disinfection, and preservation of the tissue by the Company, the
storage and shipment of the cryopreserved tissue, and the controlled thawing of
the tissue. Thereafter, the tissue is surgically implanted into a human
recipient.
The transplant of human tissue that has not been preserved must be accomplished
within extremely short time limits (not to exceed eight hours for transplants of
the human heart). Prior to the advent of human tissue cryopreservation, these
time constraints resulted in the inability to use much of the tissue donated for
transplantation. The application of the Company's cryopreservation technologies
to donated tissue expands the amount of human tissue available to physicians for
transplantation. Cryopreservation also expands the treatment options available
to physicians and their patients by offering alternatives to implantable
mechanical, synthetic, and animal-derived devices. The tissues presently
cryopreserved by the Company include human heart valves, non-valved conduits,
and vascular tissue. In addition, the Company has historically preserved
orthopaedic tissue and resumed processing orthopaedic tissue in late February
2003.
CryoLife maintains and collects clinical data on the use and effectiveness of
implanted human tissues that it has preserved, and shares this data with
implanting physicians and the procurement organizations from which it receives
tissue. The Company also uses this data to help direct its continuing efforts to
improve its preservation services through ongoing research and development. Its
clinical research staff and technical representatives assist physicians by
providing educational materials, seminars, and clinics on methods for handling
and implanting the tissue cryopreserved by the Company and the clinical
advantages, indications, and applications for those tissues. The Company has
ongoing efforts to train and educate physicians on the indications for and uses
of the human tissues cryopreserved by the Company, as well as its programs
whereby surgeons train other surgeons in best-demonstrated techniques. The
Company also assists organ procurement agencies and tissue banks through
training and development of protocols and provides materials to improve their
tissue recovery techniques and thereby increase the efficiency and the yield of
usable tissue.
Human Cardiovascular Tissue. The human heart valves and conduits cryopreserved
by the Company are used in reconstructive heart valve replacement surgery.
CryoLife shipped approximately 55,400 cryopreserved human heart valves and
conduits from 1984 through 2002. Revenues from human heart valve and conduit
preservation services accounted for 39%, 33%, and 30% of total revenues,
respectively, in 2000, 2001, and 2002. Based on CryoLife's records of documented
implants, management believes that the Company's success in the allograft heart
valve market is due in part to physicians' recognition of the longevity and
natural functionality of the Company's cryopreserved human tissues, the
Company's documented clinical data, and the Company's technical representation.
Management believes the Company offers advantages in these areas as compared to
9
other allograft processors and that the Company's cryopreserved tissues offer
advantages in certain areas over mechanical, porcine, and bovine heart valve
alternatives. The Company currently applies its preservation services to human
aortic and pulmonary heart valves for implantation by cardiac surgeons. In
addition, the Company provides cryopreserved non-valved conduit and patch tissue
to surgeons who wish to perform certain specialized cardiac repair procedures.
Each of these human heart valves, non-valved conduits and patches maintains a
tissue structure which more closely resembles and performs like the patient's
own tissue than non-human tissue alternatives.
In February 2000 the Company began distributing in the U.S. depopulated
cryopreserved human heart valves and conduits utilizing its SynerGraft antigen
reduction technology, which effectively removes cells from the heart valve
leaving the collagen matrix intact. The CryoValve(R) SG valve is especially
designed to benefit patients, both children and adults, who have had a minor
immune response to transplanted tissues. Early clinical data indicates that the
new SynerGraft processing method mitigates the increase of panel reactive
antibodies ("PRA") experienced by some of the patients who receive allograft
heart valves. The absence of a significant immunologic response to the
decellularized allograft has the potential of improved long-term function of the
allograft heart valves. Animal studies and explants from human recipients have
documented that allograft heart valves treated with the SynerGraft process have
repopulated in vivo with the recipient's own cells. The Company's data shows a
majority of the cardiac allografts processed with standard cryopreservation
methods do not repopulate in vivo. As discussed at "Recent Events", the Company
has suspended the use of SynerGraft technology in the processing of allograft
heart valves and vascular tissue until the regulatory status of the CryoValve-SG
and CryoVein-SG is resolved.
The Company estimates that the total heart valve and non-valved conduit
replacement market in the U.S. in 2002 was approximately $400 million.
Management believes that approximately 80,000 heart valve and non-valved conduit
surgeries were conducted in the U.S. in 2002. Of the total number of heart valve
and conduit surgeries, approximately 27,000, or 34%, involved mechanical heart
valves, and approximately 53,000, or 66%, involved tissue heart valves or
conduits, including porcine, bovine, and cryopreserved human tissues.
Approximately 3,800 human heart valves and conduits cryopreserved by the Company
were shipped for implantation in 2002.
Management believes cryopreserved human heart valves and non-valved conduits
have characteristics that make them the preferred replacement option for many
patients. Specifically, human heart valves, such as those cryopreserved by the
Company, allow for more normal blood flow and provide higher cardiac output than
porcine, bovine, and mechanical heart valves. Human heart valves are not as
susceptible to progressive calcification, or hardening, as are
glutaraldehyde-fixed porcine and bovine heart valves, and do not require
anti-coagulation drug therapy, as do mechanical valves. The synthetic sewing
rings contained in mechanical and stented porcine and bovine valves may harbor
bacteria leading to endocarditis. Furthermore, prosthetic valve endocarditis can
be difficult to treat with antibiotics, and this usually necessitates the
surgical removal of these valves at considerable cost, morbidity, and risk of
mortality. Consequently, for many physicians, human heart valves are the
preferred alternative to mechanical and stented porcine valves for patients who
have, or are at risk to contract, endocarditis.
The following table sets forth the characteristics of alternative heart valve
implants that management believes make cryopreserved human heart valves the
preferred replacement for most patients:
10
PORCINE
----------------------------------
PRESERVED BOVINE
HUMAN STENTED STENTLESS(1) MECHANICAL PERICARDIUM
--------------- ---------------- --------------- ---------------- ---------------
Materials: human tissue glutaraldehyde- glutaraldehyde- pyrolitic carbon glutaraldehyde-
fixed pig tissue fixed pig bi-leaflet and fixed cow tissue
and synthetic tissue synthetic sewing and synthetic
sewing ring ring sewing ring
Blood Flow Dynamics normal moderate elevation nearly normal high elevation high elevation
(Required Pressure):(2) (0-5) (10-20) (5-15) (10-25) (10-30)
Mode of Failure: gradual gradual expected to be catastrophic gradual
gradual
Longevity: 15-20 years 10-15 years expected to 15-20 years 10-15 years
exceed stented
porcine
valves
Increased Risk of
Bleeding or
Thromboembolic Events
(strokes or other
clotting): no occasional occasional yes occasional
Anti-Coagulation Drug
Therapy Required: none short-term short-term chronic short-term
Responsiveness to
Antibiotic
Treatment of
Endocarditis: high low low low low
Average Estimated Valve
Cost in U.S.: $7,300 $4,700 $5,500 $4,000(3) $4,700
- -------------
(1) Limited long-term clinical data is available since stentless porcine heart
valves only recently became commercially available.
(2) Pressure measured in mmHg.
(3) Mechanical valves also require chronic anti-coagulation drug therapy at a
cost of approximately $450 per year.
While the clinical benefits of cryopreserved human heart valves discussed above
are relevant to all patients, they are particularly important for (i) pediatric
patients (newborn to 17 years) who are prone to calcification of porcine tissue,
(ii) young or otherwise active patients who face an increased risk of severe
blood loss or even death due to side effects associated with the
anti-coagulation drug therapy required with mechanical valves, and (iii) women
in their childbearing years for whom anti-coagulation drug therapy is
contraindicated.
Human Vascular Tissues. The Company cryopreserves human saphenous veins for use
in peripheral vascular surgeries that require small diameter conduits (3mm to
6mm), such as coronary bypass surgery and peripheral vascular reconstructions.
Failure to bypass or revascularize an obstruction in such cases may result in
death or the loss of a limb. The Company also cryopreserves femoral veins and
arteries for dialysis access and aortoiliac arteries for the reconstruction of
infected abdominal synthetic grafts. The Company shipped approximately 33,300
human vascular tissues from 1986 through 2002, which includes 4,400 shipments in
2002. Revenues from human vascular preservation services accounted for 28%, 28%,
and 23% of total revenues, respectively, in 2000, 2001, and 2002.
A surgeon's first choice for replacing diseased or damaged vascular tissue is
generally the patient's own tissue. However, in cases of advanced vascular
disease, the patient's tissue is often unusable, and the surgeon may consider
using synthetic grafts or transplanted human vascular tissue. Small diameter
synthetic vascular grafts are generally not suitable for below-the-knee
surgeries because they have a tendency to occlude since the synthetic materials
in these products attract cellular material from the blood stream, which in turn
closes off the vessel to normal blood flow. Cryopreserved vascular tissues tend
to remain open longer and as such are used in indications where synthetics fail.
The Company's cryopreserved human vascular tissues are used for coronary artery
bypass surgeries, peripheral vascular reconstruction, dialysis access graft
replacement, venous valve transplantation, and infected abdominal aortic graft
replacement.
11
In 1986 the Company began a program to cryopreserve saphenous veins for use in
coronary artery bypass surgeries. The Company estimates there were approximately
450,000 to 500,000 coronary artery bypass procedures performed in the U.S. in
2002. The Company estimates that approximately 30% of these are re-operations,
which may require the use of preserved vascular tissue.
In 1989 the Company began a program to cryopreserve long segment saphenous veins
for use in peripheral vascular reconstruction. In cases of peripheral
arteriosclerosis, a cryopreserved saphenous vein can be implanted as a bypass
graft for the diseased artery in order to improve blood flow and maintain a
functional lower limb. Analysis of the Company's data on file of approximately
425 implants has shown that approximately 72% of patients receiving CryoLife's
preserved vascular tissues in this type of surgical procedure still have the use
of the affected leg four years after surgery. The only alternative for many of
these patients was amputation. The Company estimates that in 2002 approximately
78,000 peripheral vascular reconstruction surgeries were performed in the U.S.
in which its cryopreserved human vascular tissues could have been used.
In 1997 the Company began a program for the preservation of human superficial
femoral veins and arteries for use in dialysis access graft replacement as an
alternative for synthetic grafts, which have a higher risk of infection and
thrombosis than human tissue. The Company estimates that in 2002 there were
approximately 300,000 end stage renal failure patients receiving dialysis in the
U.S., and a majority of these patients rely on hemo-dialysis requiring either a
native fistula or synthetic graft for arterial-venous access. There are
approximately 87,000 synthetic grafts placed annually for arterial-venous
access.
Human Orthopaedic Tissue. As discussed at "FDA Order on Human Tissue
Preservation", the Company suspended processing orthopaedic tissues between
August 2002 and late February 2003. The Company has historically provided
preservation services for surgical replacements for the meniscus and the
anterior and posterior cruciate ligaments, which are critical to the proper
operation of the human knee, as well as osteochondral grafts used for the repair
of cartilage defects in the knee. CryoLife shipped approximately 27,500 human
connective tissues for the knee through the end of 2002, which includes 4,200
shipments in 2002. Revenues from human orthopaedic preservation services
accounted for 21%, 26%, and 18% of total revenues, respectively, in 2000, 2001,
and 2002.
Human menisci, historically cryopreserved by the Company prior to the issuance
of the FDA Order, provide orthopaedic surgeons with an alternative treatment in
cases where a patient's meniscus has been completely removed. When a patient has
a damaged meniscus, the current surgical alternatives are to repair, partially
remove or completely remove the patient's meniscus, with partial removal being
the most common procedure. Meniscal removal increases the risk of premature knee
degeneration and arthritis and typically results in the need for knee
replacement surgery at some point during the patient's life. Management believes
that there are no synthetic total menisci on the market. The Company estimates
that in 2002 approximately 725,000 U.S. patients underwent partial or total
meniscectomies. The Company believes up to 25% of these patients could become
candidates for meniscal replacement within five years.
Tendons, historically cryopreserved by the Company prior to the issuance of the
FDA Order, are primarily used for the reconstruction of the anterior and
posterior cruciate ligaments in cases where the patient's ligaments are
irreparably damaged. Surgeons have traditionally removed a portion of the
patient's patellar tendon from the patient's undamaged knee for use in repairing
a damaged anterior cruciate ligament. Cryopreserved tendons provide an
alternative to this procedure. Because surgeries using cryopreserved tissue do
not involve the removal of any of the patient's own patellar tendon, the patient
recovery period is typically shorter. The Company estimates that in 2002
approximately 200,000 cruciate ligament reconstruction surgeries were performed
in the U.S.
In 1999 the Company began preserving osteochondral grafts used to aid in the
repair of damaged knee cartilage. Prior to the FDA Order, the orthopaedic
surgical community had accepted these grafts, which are preserved and maintained
in a living state. The success of transplanted osteochondral grafts is
attributed to the presence of viable chondrocytes (cells of the cartilage). The
Company estimates that in 2002 approximately 450,000 articular cartilage repair
procedures were performed in the U.S. and that approximately 10-15% of these
repairs will be amenable to fresh osteochondral (OA) resurfacing replacement
within 5 years.
12
Implantable Biomaterials for Use as Surgical Adhesives and Sealants
The effective closure of internal wounds following surgical procedures is
critical to the restoration of the function of tissue and to the ultimate
success of the surgical procedure. Failure to effectively seal surgical wounds
can result in leakage of air in lung surgeries, cerebral spinal fluids in
neurosurgeries, blood in cardiovascular surgeries, and gastrointestinal contents
in abdominal surgeries. Air and fluid leaks resulting from surgical procedures
can lead to significant post-operative morbidity resulting in prolonged
hospitalization, higher levels of post-operative pain, and a higher mortality
rate.
Sutures and staples facilitate healing by joining wound edges and allowing the
body to heal naturally. However, because sutures and staples do not have
inherent sealing capabilities, they cannot consistently eliminate air and fluid
leakage at the wound site. This is particularly the case when sutures and
staples are used to close tissues containing air or fluids under pressure, such
as the lobes of the lung, the dural membrane surrounding the brain and spinal
cord, blood vessels, and the gastrointestinal tract. In addition, in minimally
invasive surgical procedures where the physician must operate through small
access devices, it can be difficult and time consuming for the physician to
apply sutures and staples. The Company believes that the use of surgical
adhesives and sealants with or without sutures and staples could enhance the
efficacy of these procedures through more effective and rapid wound closure.
In order to address the inherent limitations of sutures and staples, the Company
has developed and commercialized its BioGlue Surgical Adhesive. BioGlue Surgical
Adhesive is a polymeric surgical bioadhesive based on a derivative of an animal
blood protein and a cross-linking agent. BioGlue Surgical Adhesive has a tensile
strength that is four to five times that of fibrin sealants. Word wide clinical
applications for BioGlue Surgical Adhesive include cardiovascular, vascular,
pulmonary, and soft tissue repair. Other potential applications for BioGlue
Surgical Adhesive in the U.S. include hernia repair and dura mater sealing.
BioGlue also has the potential to be used as a replacement for spinal disc
nuclei. A derivative of the BioGlue technology is BioLastic(TM), an implantable
biomaterial under development, which is capable of exchanging oxygen and carbon
dioxide. BioLastic is being investigated for use in reinforcing or patching
vascular tissue, reducing adhesions, repairing air leaks in lungs, and sealing
holes in or replacing dura mater.
The Company estimates that the worldwide market for surgical sutures and staples
in 2002 was in excess of $2.5 billion. The Company began shipping BioGlue
Surgical Adhesive for distribution in the EEA in the second quarter of 1998 for
use in vascular applications and in the first quarter of 1999 for use in
pulmonary applications. In December 1999 the Company began shipping BioGlue
Surgical Adhesive in the U.S. pursuant to an HDE for use as an adjunct in repair
of acute thoracic aortic dissections. The Company received approval to
distribute BioGlue Surgical Adhesive for vascular and pulmonary repair in Canada
and Australia in January 2000 and February 2001, respectively. In December 2001
the Company received FDA approval to distribute BioGlue for use as an adjunct to
sutures and staples for use in adult patients in open surgical repair of large
vessels. In January 2002 the Company received a third CE Mark for BioGlue for
use in soft tissue repair procedures. In February 2003 the Company received an
expanded approval in Canada for use of BioGlue in soft tissue repair procedures.
This approval expands the application of BioGlue in Canada from vascular and
pulmonary repair only to soft tissue repair. Revenues from BioGlue Surgical
Adhesive represented 8%, 12%, and 27% of total revenues, respectively, in 2000,
2001, and 2002.
Bioprosthetic Cardiovascular and Vascular Devices
The Company is developing bioprosthetic cardiovascular and vascular devices
based on its experience with cryopreserved human tissue implants. Like human
heart valves, the Company's porcine heart valve is stentless with the valve
opening, or annulus, retaining a more natural flexibility. Stented porcine,
bovine, and mechanical heart valves are typically fitted with synthetic sewing
rings that are rigid and can impede normal blood flow. Unlike most other
available porcine heart valves, the Company's stentless porcine heart valve has
minimal synthetic materials, which decrease the risk of endocarditis, a
debilitating and potentially deadly infection. Revenues from bioprosthetic
cardiovascular and vascular devices represented 1% of total revenues in 2000,
2001, and 2002.
Glutaraldehyde-fixed porcine and bovine heart valves are often preferred by
surgeons for procedures involving elderly patients because they eliminate the
risk of patient non-compliance with anti-coagulation drug therapy associated
with mechanical valves, they are less expensive than allograft valves, and their
13
shorter longevity is more appropriately matched with these patients' life
expectancies. Glutaraldehyde-fixed porcine and bovine heart valves address a
worldwide target market estimated to have been $400 million in 2002.
The CryoLife-O'Brien aortic valve is a stentless porcine valve with design
features which management believes provides significant advantages over other
stentless porcine and bovine heart valves. CryoLife began exclusive worldwide
distribution of this valve in 1992 and acquired all rights to the underlying
technology in 1995. The Company's CryoLife-O'Brien aortic heart valve, currently
marketed in the EEA and certain other territories outside the U.S., contains a
matched composite leaflet design that approximates human heart valve blood flow
characteristics and requires only a single suture line for surgical
implantation.
The Company's SynerGraft technology involves the removal of cells from the
structure of animal or human tissue, leaving a collagen matrix that has the
potential to repopulate in vivo with the recipient's own cells. Animal studies
and explants from human recipients have documented that allograft heart valves
treated with the SynerGraft process have repopulated themselves in vivo with the
recipient's own cells. This process is designed to increase allograft longevity,
and more generally to improve the biocompatibility and functionality of such
tissue. In July 2001 the Company received CE Mark approval for its SynerGraft
Model 100 vascular graft for dialysis access. The SynerGraft Model 100 vascular
graft is produced from a bovine ureter in lengths between 25 and 50 cm in 5 cm
increments. The SynerGraft Model 100 vascular graft can be stored at room
temperature until use.
Other Implantable Devices
On February 5, 2003 the Company announced that it has signed an exclusive
agreement with curasan AG, located in Germany, for U.S. distribution on
Cerasorb(R) Ortho, curasan's resorbable bone graft substitute. The five-year
agreement gives CryoLife exclusive rights to market Cerasorb Ortho for all
non-spine, non-dental orthopaedic indications such as trauma, general, and
sports medicine. Cerasorb, a resorbable, beta-tricalcium phosphate bone
regeneration material, was first introduced in Germany in 1998 for dental use.
The product captured approximately 60% of the synthetic dental bone regeneration
market in Germany within four years. In 2001 curasan received CE Mark
certification for Cerasorb's use in general orthopaedics, and in 2002 received
FDA 510(k) approval for orthopaedic use. The Company anticipates that the U.S.
market for bone grafts and substitutes for which it can distribute Cerasorb is
approximately $140 million.
Single-Use Medical Devices
On October 9, 2000 the Company sold substantially all of the remaining assets of
Ideas for Medicine, Inc. ("IFM") to Horizon Medical Products, Inc. See Note 3 of
Notes to the Consolidated Financial Statements for a more detailed discussion.
SALES, DISTRIBUTION AND MARKETING
Preservation Services
CryoLife markets its preservation services to tissue procurement agencies,
implanting physicians, and prospective tissue recipients. The Company works with
tissue banks and organ procurement agencies to ensure consistent and continued
availability of donated human tissue for transplant and educates physicians and
prospective tissue recipients with respect to the benefits of cryopreserved
human tissues.
Procurement of Tissue. Donated human tissue is procured from deceased human
donors by organ procurement agencies and tissue banks. After procurement, the
tissue is packed and shipped, together with certain information about the tissue
and its donor, to the Company in accordance with the Company's protocols. The
tissue is transported to the Company's laboratory facilities via commercial
airlines pursuant to arrangements with qualified courier services. Timely
receipt of procured tissue is important, as tissue that is not received promptly
cannot be cryopreserved successfully. The procurement agency is reimbursed by
the Company for the costs associated with these procurement services. The
procurement fee and related shipping costs, together with the charges for the
preservation services of the Company, are ultimately paid to the Company by the
hospital with which the implanting physician is associated. The Company has
developed relationships with approximately 84 tissue banks and organ procurement
14
agencies throughout the U.S. Management believes these relationships are
critical for a growing business in the preservation services industry and that
the breadth of these existing relationships provides the Company a significant
advantage over potential new entrants to this market. The Company employs
approximately 20 individuals to work with organ procurement agencies and tissue
banks, eight of which are employed as procurement relations managers and are
stationed throughout the country. The Company's central office for procurement
relations is staffed 24 hours per day, 365 days per year.
Preservation of Tissue. Upon receiving tissue, a Company technician completes
the documentation control for the tissue prepared by the procurement agency and
gives it a control number. The documentation identifies, among other things,
donor age and cause of death. A trained technician then removes the portion or
portions of the delivered tissue that will be processed. These procedures are
conducted under aseptic conditions in clean rooms. At the same time, samples are
taken from the donated tissue and subjected to the Company's comprehensive
quality assurance program. This program may identify characteristics which would
disqualify the tissue for preservation or implantation.
Cardiovascular, vascular, and orthopaedic tissue, except osteochondral grafts,
are cryopreserved in a proprietary freezing process conducted according to
strict Company protocols. After the preservation process, the tissues are
transferred to liquid nitrogen freezers for long-term storage at temperatures
below -135(Degree)C. Prior to the issuance of the FDA Order, osteochondral
grafts were refrigerated in proprietary solutions from 2(Degree)C to 8(Degree)C
for up to 45 days. The entire preservation process is rigidly controlled by
guidelines established by the Company.
Distribution of Tissue to Implanting Physicians. After preservation, tissue is
stored by the Company or is delivered directly to hospitals at the implanting
physician's request. Cryopreserved tissue must be transported under stringent
handling conditions and maintained within specific temperature tolerances at all
times. Cryopreserved tissue is packaged for shipment using the Company's
proprietary processes. At the hospital the tissue is held in a liquid nitrogen
freezer according to Company protocols pending implantation. The Company
provides a detailed protocol for thawing the cryopreserved tissue. The Company
also makes its technical personnel available by phone or in person to answer
questions. After the Company transports the tissue to the hospital, the Company
invoices the institution for its services, the procurement fee, and
transportation costs.
The Company provides Company-owned liquid nitrogen freezers to certain client
hospitals without charge. The Company has currently installed more than 350 of
these freezers. Participating hospitals generally pay the cost of liquid
nitrogen and regular maintenance. The availability of on-site freezers makes it
easier for a hospital's physicians to utilize the Company's preservation
services by making the cryopreserved tissue more readily available. Because fees
for the Company's preservation services become due upon the delivery of tissue
to the hospital, the use of such on-site freezers also reduces the Company's
working capital needs.
Marketing, Educational and Technical Support. The Company has record of over
4,000 cardiovascular, vascular, and orthopaedic surgeons who have implanted
tissues cryopreserved by the Company during the past twelve months. The Company
works to maintain relationships with and market to surgeons within these medical
specialties. Because the Company markets its preservation services directly to
physicians, an important aspect of increasing the distribution of the Company's
preservation services is educating physicians on the use of cryopreserved human
tissue and on proper implantation techniques. Trained field support personnel
provide support to implanting institutions and surgeons. The Company currently
employs approximately 35 persons as technical service representatives who deal
primarily with cardiovascular and vascular surgeons and provide field support.
These representatives receive a base salary with a performance bonus. The
Company has over 150 independent technical service representatives and
sub-representatives who are employed by distributor groups who deal primarily
with orthopaedic surgeons and who are paid on a commission basis. The Company
has retained the majority of these distributor groups and added a few groups in
anticipation of resuming orthopaedic processing and distribution.
The Company sponsors physician training seminars where leading physicians teach
other physicians the proper technique for handling and implanting cryopreserved
human tissue. The Company also produces educational videotapes for physicians
and coordinates live surgery demonstrations at various medical schools. The
Company also coordinates laboratory sessions that utilize animal tissue to
demonstrate the surgical techniques. Members of the Company's Medical Advisory
Board often lead the surgery demonstrations and laboratory sessions. Management
15
believes that these activities improve the medical community's acceptance of the
cryopreserved human tissue processed by the Company and help to differentiate
the Company from other allograft processors.
To assist procurement agencies and tissue banks, the Company provides
educational materials and training on procurement, dissection, packaging, and
shipping techniques. The Company also produces educational videotapes and
coordinates laboratory sessions on procurement techniques for procurement agency
personnel. To supplement its educational activities, the Company employs
in-house technical specialists that provide technical information and assistance
and maintains a staff 24 hours per day, 365 days per year for customer support.
Backlog. The limited supply of tissue that is donated and available for
processing results in a backlog of orders in the Company's human tissue
business. The amount of backlog fluctuates based on the tissues available for
shipment and varies based on the surgical needs of specific cases. The Company's
backlog is generally not considered firm and must be confirmed with the customer
before shipment. The Company currently does not have a backlog of BioGlue or
SynerGraft bovine vascular grafts.
European Distribution
In September 1999 the Company established its European subsidiary, CryoLife
Europa, Ltd. ("Europa"), to provide distribution and technical services to the
Company's network of European representatives, customers, and surgeons. In
February 2000 Europa officially opened its headquarters located near London,
England. The Company's European, Middle East, and African sales, marketing, and
distribution activities directed through Europa are channeled through
approximately 30 independent distributors located throughout Europe, the Middle
East, and South Africa. Since 2002 Europa has employed approximately four
persons as direct technical representatives who also provide field support for
the United Kingdom. Marketing efforts are directed almost exclusively toward
cardiovascular, vascular, thoracic, and general surgeons.
BioGlue Surgical Adhesive
The Company markets and distributes its BioGlue Surgical Adhesive in the U.S.
through its existing direct technical representatives. The Company markets and
distributes its BioGlue Surgical Adhesive in international markets, excluding
Japan, through Europa and other existing independent representatives. The
Company conducts training sessions for doctors with respect to the application
and administration of BioGlue Surgical Adhesive.
During 1998 the Company signed a five-year exclusive agreement with Century
Medical, Inc. for the introduction and distribution of BioGlue in Japan. Under
the terms of the agreement, Century Medical will be responsible for applications
and clearances with the Japanese Ministry of Health and Welfare.
Bioprosthetic Cardiovascular Devices
The Company markets the CryoLife-O'Brien stentless porcine heart valve in
Europe, the Middle East, Africa, and Canada. The Company commenced marketing the
SynerGraft Model 100 vascular graft in Europe, Switzerland, and Israel during
the third quarter of 2001. Marketing efforts are primarily directed toward
vascular surgeons to educate them with respect to the uses and benefits of the
Company's bovine vascular grafts.
RESEARCH AND DEVELOPMENT
The Company uses its expertise in immunology, biochemistry, and cell biology,
and its understanding of the needs of the cardiovascular, vascular, and
orthopaedic surgery medical specialties, to continue to expand its core
preservation and surgical adhesive businesses in the U.S. and to develop or
acquire implantable products and technologies for these specialties. The Company
seeks to identify market areas that can benefit from preserved living tissues
and other related technologies, to develop innovative techniques and products
within these areas, to secure their commercial protection, to establish their
efficacy and then to market these techniques and products. The Company employs
approximately 18 people in its research and development department, including
six PhDs with specialties in the fields of immunology, molecular biology,
protein chemistry, organic chemistry, and biochemistry.
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In order to expand the Company's service and product offerings, the Company is
currently in the process of developing or investigating several technologies and
products, including additional applications of its SynerGraft technology, its
Protein Hydrogel Technology ("PHT") (of which BioGlue is the first PHT product
to be introduced) and its ACT. PHT is based on a bovine protein that mirrors an
array of amino acids that perform complex functions in the human body that
together with glutaraldehyde forms a hydrogel, a water based biomaterial similar
to human tissue. Materials and implantable replacement devices created with PHT
have the potential to provide structure, form, and function of human body
tissue. Because of its versatility and ease of application, PHT is being
developed for application in hernia repair and dura mater sealing in the U.S.,
in the repair of denucleated intervertebral discs, and for the delivery of bone
material for orthopaedic bone repair. The Company is also currently
investigating certain drug delivery applications for its ACT, such as
administering antibiotics and attaching chemotherapy drugs to tumors. To the
extent the Company identifies additional applications for these products, the
Company may attempt to license these products to corporate partners for further
development of such applications or seek funding from outside sources to
continue the commercial development of such technologies. The Company's research
and development strategy is to allocate available resources among the Company's
core market areas of preservation services, bioprosthetic cardiovascular
devices, and implantable biomaterials, based on the size of the potential market
for any specific product candidate and the estimated development time and cost
required to bring the product to market.
Research on these and other projects is conducted in the Company's research and
development laboratory or at universities or clinics where the Company sponsors
research projects. In 2000, 2001, and 2002, the Company spent approximately $5.2
million, $4.7 million, and $ 4.6 million, respectively, on research and
development activities on new and existing products. These amounts represented
approximately 7%, 5%, and 6% of the Company's revenues for those respective
years. The Company's research and development program is overseen by its medical
and scientific advisory boards. The Company's pre-clinical studies are conducted
at universities and other locations outside the Company's facilities by third
parties under contract with the Company. In addition to these efforts, the
Company may pursue other research and development activities.
MANUFACTURING AND OPERATIONS
During 2001 the Company completed a 100,000 square foot addition to its
corporate headquarters and laboratory facilities located on a 21.5-acre
campus-style setting in suburban Atlanta, Georgia. The new addition is to
accommodate growth and development of the Company's BioGlue Surgical Adhesive
and the SynerGraft family of biologic implantable devices. The total Company
U.S. facilities consist of three separate locations totaling approximately
243,000 square feet of leased manufacturing, administrative, laboratory, and
warehouse space. Approximately 24,000 square feet are dedicated to forty-five
class 10,000 clean rooms. An additional 5,500 square feet are dedicated as class
100,000 clean rooms. The extensive clean room environment provides a controlled
environment for tissue dissection, processing, manufacturing, and packaging.
Approximately 40 liquid nitrogen storage units maintain cryopreserved tissue at
- -196(Degree)C. Three back-up emergency generators assure continuity of all
Company operations. Additionally, the Company's corporate complex has a 3,600
square foot Learning Center which includes a 225 seat auditorium and a 1,500
square foot training lab, both equipped with closed-circuit and satellite
television broadcast capability allowing live surgery broadcasts from and to
anywhere in the world. The Learning Center provides visiting cardiovascular,
vascular, and orthopaedic surgeons with a hands-on training environment for
surgical and implantation techniques for the Company's technology platforms.
Human Tissue Processing
The human tissue processing laboratory is responsible for the processing and
preservation of human cardiovascular, vascular, and orthopaedic tissue for
transplant. This laboratory contains approximately 15,600 square feet with a
suite of eight clean rooms. Currently there are approximately 23 technicians
employed in this area, and the laboratory is staffed for two shifts, 365 days
per year. In 2002 the laboratory processed approximately 16,400 human allografts
for distribution and transplant. The current processing level is estimated to be
at about one-third of total capacity. Increasing this processing level could be
accomplished by increasing employees and expanding to three shifts.
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BioGlue Surgical Adhesives
BioGlue Surgical Adhesive is presently manufactured at the Company's
headquarters facility, which has an annual capacity of approximately 2 million
units. The current processing level is about one-twentieth of total capacity.
This laboratory contains approximately 13,500 square feet, including a suite of
six clean rooms. Currently, there are twelve technicians employed in this area.
Bioprosthetic Cardiovascular and Vascular Devices
The bioprosthesis laboratory, which was relocated to the expanded corporate
headquarters in 2001, is responsible for the manufacturing of the
CryoLife-O'Brien stentless porcine heart valve and the SynerGraft bovine
vascular graft. This laboratory is approximately 20,000 square feet with a suite
of six clean rooms for tissue processing. Currently, this laboratory employs six
technicians.
Other facilities
The Company maintains two separate facilities, located in Marietta, Georgia,
that total 31,000 square feet. One facility is approximately 20,000 square feet,
with about 2,100 square feet of laboratory space and a suite of six clean rooms.
The other facility contains approximately 11,000 square feet, including 4,000
square feet of laboratory space and a suite of eight clean rooms. The Company is
currently seeking to sublease these facilities.
QUALITY ASSURANCE
The Company's operations encompass the provision of preservation services and
the manufacturing of bioprosthetics and bioadhesives. In all of its facilities,
the Company is subject to regulatory standards for good manufacturing practices,
including current Quality System Regulations, which are FDA regulatory
requirements for medical device manufacturers. The FDA periodically inspects
Company facilities to ensure Company compliance with these regulations. The
Company also operates according to ISO 9001 Quality System Requirements, an
internationally recognized voluntary system of quality management for companies
that design, develop, manufacture, distribute and service products. The Company
maintains a Certification of Approval to the ISO 9001, as well as EN46001 and
ANSI/ISO/ASQC/Q9001, the European and U.S. versions of the international
standard, respectively. This approval is issued by Lloyd's Register Quality
Assurance Limited ("LRQA"). LRQA is a Notified Body officially recognized by the
EEA to perform assessments of compliance with ISO 9001 and its derivative
standards. LRQA performs semi-annual on-site inspections of the Company's
quality systems. The Company expects to be in compliance with ISO 13485 quality
system requirements by the end of 2003. The ISO 13485 requirements are intended
to be an enhancement to current quality management systems.
The Company's quality assurance staff is comprised primarily of experienced
professionals from the medical device and pharmaceutical manufacturing
industries. The quality assurance department, in conjunction with the Company's
research and development department and select university research staffs,
routinely evaluates the Company's processes and procedures.
Preservation Services
The Company employs a comprehensive quality assurance program in all of its
tissue processing activities. The Company is subject to Quality System
Regulations, additional FDA regulations, and ISO 9001 requirements. The
Company's quality assurance program begins with the development and
implementation of training courses for the employees of procurement agencies. To
assure uniformity of procurement practices among the tissue recovery teams, the
Company provides procurement protocols, transport packages, and tissue transport
liquids to the donor sites.
Upon receipt by the Company, each tissue is assigned a unique control number
that provides traceability of tissue from procurement through the processing and
preservation processes, and ultimately to the tissue recipient. Blood samples
from each tissue donor are subjected to a variety of tests to screen for
serologic infectious diseases. Samples of some tissues are also sent to
independent laboratories for pathology testing. Following dissection of the
tissue to be cryopreserved, a separate procedure is begun in which the dissected
tissue is treated with proprietary antimicrobial solutions.
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The materials and solutions used by the Company in processing tissue are
pre-screened to determine if they meet strict quality standards as defined by
Company protocols. Only materials and solutions that meet the Company's
requirements are approved by quality assurance personnel for use in processing.
Throughout tissue processing, detailed records are maintained and reviewed by
quality assurance personnel.
The Company's tissue processing facilities are annually licensed by the States
of Georgia, New York, Florida, and California as facilities that process, store,
and distribute human tissue for implantation. The regulatory bodies of these
states perform inspections of the facilities to ensure compliance with state law
and regulations. In addition, the Company's human heart valve processing
operations are additionally regulated by the FDA and periodically inspected for
compliance to Quality System Regulations. Other human tissue processed by the
Company is periodically inspected for compliance with the 'CFR Part 1270. CFR
1270 is an FDA regulation which sets forth the requirements with which the
Company must comply in determining the suitability of human tissue for
implantation.
Bioprosthetic and Bioadhesive Manufacturing
The Company employs a comprehensive quality assurance program in all of its
manufacturing activities. The Company is subject to Quality System Regulations,
additional FDA regulations, and ISO 9001 and ISO 13485 requirements.
All materials and components utilized in the production of the Company's
products are received and thoroughly inspected by trained quality control
personnel, according to written specifications and standard operating
procedures. Only materials and components found to comply with Company
procedures are accepted by quality control and utilized in production.
All materials, components and resulting sub-assemblies are traced throughout the
manufacturing process to assure that appropriate corrective actions can be
implemented, if necessary. Each process is documented along with all inspection
results, including final finished product inspection and acceptance. Records are
maintained as to the consignee of product to facilitate product removals or
corrections, if necessary. All processes in manufacturing are validated by
quality engineers to assure that they are capable of consistently producing
product meeting the Company's specifications. The Company maintains a rigorous
quality assurance program of measuring devices used for manufacturing and
inspection to ensure appropriate accuracy and precision.
Each manufacturing facility is subject to periodic inspection by the FDA and
LRQA to independently assure the Company's compliance with its systems and
regulatory requirements.
PATENTS, LICENSES AND OTHER PROPRIETARY RIGHTS
The Company relies on a combination of patents, trade secrets, trademarks, and
confidentiality agreements to protect its proprietary products, processing
technology, and know-how. The Company believes that its patents, trade secrets,
trademarks, and technology licensing rights provide it with important
competitive advantages. The Company owns or has licensed rights to 39 U.S.
patents and 53 foreign patents, including patents relating to its technology for
human cardiovascular, vascular, and orthopaedic tissue preservation; tissue
revitalization prior to freezing; tissue transport; BioGlue Surgical Adhesive;
ACT; organ storage solution; and packaging. The Company has 23 pending U.S.
patent applications and in excess of 97 pending foreign applications that relate
to areas including heart valve and tissue processing technology and delivery of
bioadhesives for anastomosis and other uses. The Company sold the patents
related to the IFM product line to Horizon in 1998. There can be no assurance
that any patents pending will result in issued patents. The Company also has
exclusive licensing rights for technology relating to light-sensitive enzyme
inhibitors. The remaining duration of the Company's issued patents ranges from 6
months to 17 years. The Company has licensed from third parties certain
technologies used in the development of its ACT and other technologies in
licenses that call for the payment of both development milestones and royalties
based on product sales, when and if such products are approved for marketing.
The loss of these licenses could adversely affect the Company's ability to
successfully develop its ACT or other technologies.
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There can be no assurance that the claims allowed in any of the Company's
existing or future patents will provide competitive advantages for the Company's
products, processes, and technologies or will not be successfully challenged or
circumvented by competitors. To the extent that any of the Company's products
are not patent protected, the Company's business, financial condition, and
results of operations could be materially adversely affected. Under current law,
patent applications in the U.S. and patent applications in foreign countries are
maintained in secrecy for a period after filing. The right to a patent in the
U.S. is attributable to the first to invent, not the first to file a patent
application. The Company cannot be sure that its products or technologies do not
infringe patents that may be granted in the future pursuant to pending patent
applications or that its products do not infringe any patents or proprietary
rights of third parties. The Company may incur substantial legal fees in
defending against a patent infringement claim or in asserting claims against
third parties. In the event that any relevant claims of third-party patents are
upheld as valid and enforceable, the Company could be prevented from selling
certain of its products or could be required to obtain licenses from the owners
of such patents or be required to redesign its products to avoid infringement.
There can be no assurance that such licenses would be available or, if
available, would be on terms acceptable to the Company or that the Company would
be successful in any attempt to redesign its products or processes to avoid
infringement. The Company's failure to obtain these licenses or to redesign its
products could have a material adverse effect on the Company's business,
financial condition, and results of operations.
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 resolved all disputes
between the parties and extinguished 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.
The Company has entered into confidentiality agreements with all of its
employees and several of its consultants and third-party vendors to maintain the
confidentiality of trade secrets and proprietary information. There can be no
assurance that the obligations of employees of the Company and third parties
with whom the Company has entered into confidentiality agreements will
effectively prevent disclosure of the Company's confidential information or
provide meaningful protection for the Company's confidential information if
there is unauthorized use or disclosure, or that the Company's trade secrets or
proprietary information will not be independently developed by the Company's
competitors. Litigation may be necessary to defend against claims of
infringement, to enforce patents and trademarks of the Company, or to protect
trade secrets and could result in substantial cost to, and diversion of effort
by, the Company. There can be no assurance that the Company would prevail in any
such litigation. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights to the same extent, as do the laws of the U.S.
COMPETITION
Cryopreserved Human Tissues and Bioprosthetic Cardiovascular Devices
The Company faces competition from at least one for-profit company and a number
of non-profit tissue banks that cryopreserve and distribute human tissue, as
well as from companies that market mechanical, porcine, and bovine heart valves,
and synthetic vascular grafts for implantation. Many established companies, some
with resources greater than those of the Company, are engaged in manufacturing,
marketing, and selling alternatives to cryopreserved human tissue. Management
believes that it competes favorably with other entities that cryopreserve human
tissue on the basis of technology, customer service, and quality assurance. As a
result of the decrease in the Company's procurement and processing of human
tissue, the decrease in cardiovascular and vascular tissue shipments, and the
lack of orthopaedic tissue shipments, the Company's competitors have been
favorably impacted. This interruption in the Company's services may make it
difficult for the Company to regain its level of revenues reported prior to the
FDA Order.
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As compared to mechanical, porcine, and bovine heart valves, management believes
that the human heart valves cryopreserved by the Company compete on the factors
set forth above, as well as by providing a tissue that is the preferred
replacement alternative with respect to certain medical conditions, such as
pediatric cardiac reconstruction, valve replacements for women in their
child-bearing years, and valve replacements for patients with endocarditis.
Although human tissue cryopreserved by the Company is initially higher priced
than are mechanical alternatives, these alternatives typically require that the
patient take anti-coagulation drug therapy for the lifetime of the implant. As a
result of the costs associated with anti-coagulants, mechanical valves are
generally, over the life of the implant, more expensive than tissue
cryopreserved by the Company. Notwithstanding the foregoing, management believes
that, to date, price has not been a significant competitive factor.
Generally, for each procedure that may utilize vascular or orthopaedic human
tissue that the Company cryopreserves, there are alternative treatments. Often,
as in the case of veins and ligaments, these alternatives include the repair,
partial removal or complete removal of the damaged tissue and may utilize other
tissues from the patients themselves or synthetic products. The selection of
treatment choices is made by the attending physician in consultation with the
patient. Any newly developed treatments will also compete with the use of tissue
cryopreserved by the Company.
Human and Stentless Porcine Heart Valves. Alternatives to human heart valves
cryopreserved by the Company include mechanical valves, porcine valves, and
valves constructed from bovine pericardium. St. Jude Medical, Inc. is the
leading supplier of mechanical heart valves, and has a marketing and
distribution arrangement with a non-profit tissue bank for supplies of
cryopreserved human heart valves. Edwards Life Sciences, Inc. is the leading
supplier of bovine heart valves. In addition, management believes that at least
four tissue banks offer preservation services for human heart valves in
competition with the Company. The Company presently distributes its stentless
porcine heart valve only outside the U.S. This stentless porcine heart valve
competes with mechanical valves, stented and stentless porcine valves, human
heart valves, and processed bovine pericardium heart valves. The Company is
aware of at least three other companies that offer stentless porcine heart
valves.
Human Vascular Tissue. Synthetic alternatives to veins cryopreserved by the
Company are available primarily in medium and large diameters. Currently,
management believes that there are at least four other providers of
cryopreserved human vascular tissue in competition with the Company. Companies
offering either synthetic or allograft products may enter this market in the
future.
Human Orthopaedic Tissue. As discussed at "FDA Order on Human Tissue
Preservation", the Company ceased processing orthopaedic tissue in August 2002.
The Company resumed processing orthopaedic tissue in late February 2003. The
Company's historic competition in the area of orthopaedic tissue has varied
according to the tissue involved. When transplantation is indicated, the
historic principal competition for human tissues cryopreserved by the Company
has been freeze-dried and fresh frozen human connective tissues. These
alternative allografts are distributed by Muscoskeletal Transplant Foundation,
Lifenet, and others. Prior to the issuance of the FDA Order, tendons
cryopreserved by the Company constituted the principal treatment options for
injuries that required anterior cruciate ligament reconstruction.
Implantable Biomedical Devices for Use as Surgical Adhesives and Sealants
The Company competes with many domestic and foreign medical device,
pharmaceutical, and biopharmaceutical companies. In the surgical adhesive and
surgical sealant area, the Company will compete with existing methodologies,
including traditional wound closure products such as sutures and staples,
marketed by companies such as Johnson & Johnson, Tyco Healthcare Corporation,
and others. Other competitors in the surgical sealant market include Baxter
Healthcare International, Inc., Angiotech Pharmaceuticals, Inc., and Genzyme
Biosurgery. Competitive products may also be under development by other large
medical device, pharmaceutical and biopharmaceutical companies, including 3M and
Confluent Surgical, Inc. Many of the Company's current and potential competitors
have substantially greater financial, technological, research and development,
regulatory and clinical, manufacturing, marketing and sales, and personnel
resources than the Company. BioGlue Surgical Adhesive is the only FDA approved
product with an arterial surgical glue product code designation (MUQ- glue,
surgical, arteries).
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These competitors may also have greater experience in developing products,
conducting clinical trials, obtaining regulatory approvals, and manufacturing
and marketing such products. Certain of these competitors may obtain patent
protection, approval or clearance by the FDA or foreign countries, or product
commercialization earlier than the Company, any of which could materially
adversely affect the Company. Furthermore, if the Company commences significant
commercial sales of its products, it will also be competing with respect to
manufacturing efficiency and marketing capabilities.
Other recently developed technologies or procedures are, or may in the future
be, the basis of competitive products. There can be no assurance that the
Company's current competitors or other parties will not succeed in developing
alternative technologies and products that are more effective, easier to use, or
more economical than those which have been or are being developed by the Company
or that would render the Company's technology and products obsolete and
non-competitive in these fields. In such event, the Company's business,
financial condition, and results of operations could be materially adversely
affected. See "Risk Factors--Rapid Technological Change."
GOVERNMENT REGULATION
U.S. Federal Regulation of Medical Devices
Because human heart valves and BioGlue surgical bioadhesives are, and other
Company products may in the future be regulated as medical devices, the Company
and these products are subject to the provisions of the Federal Food, Drug and
Cosmetic Act ("FDCA") and implementing regulations. Pursuant to the FDCA, the
FDA regulates the manufacture, distribution, labeling, and promotion of medical
devices in the U.S. In addition, various foreign countries in which the
Company's products are or may be distributed impose additional regulatory
requirements.
The FDCA provides that, unless exempted by regulation, medical devices may not
be distributed in the U.S. unless they have been approved or cleared for
marketing by the FDA. There are two review procedures by which medical devices
can receive such approval or clearance. Some products may qualify for clearance
to be marketed under a Section 510(k) ("510(k)") procedure, in which the
manufacturer provides a premarket notification that it intends to begin
marketing the product, and shows that the product is substantially equivalent to
another legally marketed 510(k) product (i.e., that it has the same intended use
and that it is as safe and effective as a legally marketed 510(k) device and
does not raise different questions of safety and effectiveness than does a
legally marketed device). In some cases, the submission must include data from
clinical studies. Marketing may commence when the FDA issues a clearance letter
finding such substantial equivalence.
If the product does not qualify for the 510(k) procedure (either because it is
not substantially equivalent to a legally marketed 510(k) device or because it
is a Class III device required by the FDCA and implementing regulations to have
an approved application for premarket approval, known as a PMA) the FDA must
approve a PMA application before marketing can begin. PMA applications must
demonstrate, among other matters, that the medical device is safe and effective.
A PMA application is typically a complex submission, usually including the
results of human clinical studies, and preparing an application is a detailed
and time-consuming process. Once a PMA application has been submitted, the FDA's
review may be lengthy and may include requests for additional data. By statute
and regulation, the FDA may take 180 days to review a PMA application although
such time may be extended. Furthermore, there can be no assurance that a PMA
application will be reviewed within 180 days or that a PMA application will be
approved by the FDA.
The FDCA also provides for an investigational device exemption ("IDE") which
authorizes distribution for clinical evaluation of devices that lack a PMA or
510(k). Devices subject to an IDE are subject to various restrictions imposed by
the FDA. The number of patients that may be treated with the device is limited,
as are the number of institutions at which the device may be used. Patients must
give informed consent to be treated with an investigational device. The device
must be labeled that it is for investigational use and may not be advertised, or
otherwise promoted, and the price charged for the device may be limited.
Unexpected adverse experiences must be reported to the FDA.
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Under certain circumstances, the FDA may grant a Humanitarian Device Exemption
("HDE"). HDE's are granted by the FDA in an attempt to encourage the development
of medical devices for use in the treatment of rare conditions that affect small
patient populations. An approval by the FDA exempts such devices from full
compliance with clinical study requirements for premarket approval.
The FDCA requires all medical device manufacturers and distributors to register
with the FDA annually and to provide the FDA with a list of those medical
devices which they distribute commercially. The FDCA also requires manufacturers
of medical devices to comply with labeling requirements and to manufacture
devices in accordance with Quality System Regulations, which require that
companies manufacture their products and maintain their documents in a
prescribed manner with respect to good manufacturing practices, design, document
production, process, labeling and packaging controls, process validation, and
other quality control activities. The FDA's medical device reporting regulation
requires that a device manufacturer provide information to the FDA on death or
serious injuries alleged to have been associated with the use of its products,
as well as product malfunctions that would likely cause or contribute to death
or serious injury if the malfunction were to recur. The FDA's medical device
tracking regulation requires the adoption of a method of device tracking by
manufacturers of life-sustaining or implantable products, the failure of which
would be reasonably likely to have serious adverse health consequences, if the
FDA issues an order to do so. The manufacturer must adopt methods to ensure that
such devices can be traced from the manufacturing facility to the ultimate user,
the patient. The FDA further requires that certain medical devices not cleared
for marketing in the U.S. follow certain procedures before they are exported.
The FDA inspects medical device manufacturers and distributors and has authority
to seize noncomplying medical devices, to enjoin and/or to impose civil
penalties on manufacturers and distributors marketing non-complying medical
devices, to criminally prosecute violators, and to order recalls in certain
instances.
Human Heart Valves. The Company's human heart valves became subject to
regulation by the FDA in June 1991, when the FDA published a notice stating that
human heart valves were Class III medical devices under the FDCA. The June 1991
notice provided that distribution of human heart valves for transplantation
would violate the FDCA unless they were the subject of an approved PMA or IDE on
or before August 26, 1991.
On October 14, 1994, the FDA announced in the Federal Register that neither an
approved application for PMA nor an IDE is required for processors and
distributors who had marketed heart valve allografts before June 26, 1991. This
action by the FDA resulted in the allograft heart valves being classified as
Class II Medical Devices and has removed them from clinical trial status. It
also allows the Company to distribute such valves to cardiovascular surgeons
throughout the U.S.
Porcine Heart Valves. Porcine heart valves are Class III medical devices, and
FDA approval of a PMA is required prior to commercial distribution of such
valves in the U.S. The porcine heart valves currently marketed by the Company
have not been approved by the FDA for commercial distribution in the U.S. but
may be manufactured in the U.S. and exported to foreign countries if the valves
meet the specifications of the foreign purchaser, do not conflict with the laws
of and are approved by the country to which they will be exported, and the FDA
determines that their exportation is not contrary to the public health and
safety.
BioGlue Surgical Adhesive. BioGlue Surgical Adhesive is regulated as a Class III
medical device by the FDA. In December 2001 the Company received FDA approval
for BioGlue as an adjunct to sutures and staples for use in adult patients in
open surgical repair of large vessels. Prior to this approval, the Company
received a HDE in December 1999 for BioGlue Surgical Adhesive for use as an
adjunct in repair of acute thoracic aortic dissections. BioGlue Surgical
Adhesive is the only FDA approved product with an arterial surgical glue product
code designation (MUQ- glue, surgical, arteries).
U.S. Federal Regulation of Human Tissue
Other than human and porcine heart valves, BioGlue Surgical Adhesive, and
SynerGraft processed bovine vascular grafts, none of the Company's other tissue
services or tissue-based products are currently subject to regulation under the
FDCA or FDA regulation as medical devices. See "Recent Events" regarding
correspondence from the FDA about cardiovascular and vascular tissues processed
with the SynerGraft technology. Heart valves are one of a small number of
processed human tissues over which the FDA has asserted medical device
jurisdiction. Concerns with the transmission of HIV and Hepatitis B led the FDA
23
to issue an Interim Rule in December 1993 as an emergency measure to protect the
public from human tissue that had incomplete or no documentation ascertaining
its freedom from communicable diseases. The FDA modified the regulation and
reissued it as a new rule, effective January 1998. The 1998 Final Rule provided
clarification of certain provisions in the 1993 Interim Rule and focused on
donor screening and testing to prevent the introduction, transmission, and
spread of HIV-1 and -2 and Hepatitis B and C. The Final Rule set minimal
requirements to prevent the transmission of communicable diseases from human
tissue used for transplantation. The rule defines human tissue as any tissue
derived from a human body which is (i) intended for administration to another
human for the diagnosis, cure, mitigation, treatment, or prevention of any
condition or disease and (ii) recovered, processed, stored, or distributed by
methods not intended to change tissue function or characteristics. The FDA
definition excludes, among other things, tissue that currently is regulated as a
human drug, biological product, or medical device and excludes kidney, liver,
heart, lung, pancreas, or any other vascularized human organ. The FDA has
proposed and is refining three regulations covering registration, expanded donor
suitability and testing requirements, and the use of good tissue practices, akin
to good manufacturing practices required for medical device manufacturers. In
March 2002 the FDA issued a guidance document for implementation without seeking
prior comments titled, "Validation of Procedures for Processing of Human Tissues
Intended for Transplantation." This guidance represented the FDA's current
status on the topic of validation of procedures to prevent contamination during
processing of human tissues for transplantation. It is likely that the FDA will
expand its regulation of processed human tissue in the future. For example, in
November 2000 the FDA published a proposed rule for good tissue manufacturing
practices. Moreover, the FDA may determine that the vascular and orthopaedic
tissue that are processed by the Company are medical devices, or the FDA may
decide to regulate human heart valves as "human tissue" rather than medical
devices, but the FDA has not done so at this time. Complying with FDA regulatory
requirements or obtaining required FDA approvals or clearances may entail
significant time delays and expenses or may not be possible, any of which may
have a material adverse effect on the Company. In addition, the U.S. Congress is
expected to consider legislation that would regulate human tissue for transplant
or the FDA could impose a separate regulatory scheme for human tissue. Such
legislation or regulation could have a material adverse effect on the Company.
Possible Other FDA Regulation
Other products and processes under development by the Company are likely to be
subject to regulation by the FDA. Some may be classified as medical devices,
while others may be classified as drugs or biological products or subject to a
regulatory scheme for human tissue that the FDA may adopt in the future.
Regulation of drugs and biological products is substantially similar to
regulation of medical devices. Obtaining FDA approval to market these products
is likely to be a time consuming and expensive process, and there can be no
assurance that any of these products will ever receive FDA approval, if
required, to be marketed.
NOTA Regulation
The Company's activities in processing and transporting human hearts and certain
other organs are also subject to federal regulation under the National Organ
Transplant Act ("NOTA"), which makes it unlawful for any person to knowingly
acquire, receive, or otherwise transfer any human organ for valuable
consideration for use in human transplantation if the transfer affects
interstate commerce. NOTA excludes from the definition of "valuable
consideration" reasonable payments associated with the removal, transportation,
implantation, processing, preservation, quality control, and storage of a human
organ. The purpose of this statutory provision is to allow for compensation for
legitimate services. The Company believes that to the extent its activities are
subject to NOTA, it meets this statutory provision relating to the
reasonableness of its charges. There can be no assurance, however, that
restrictive interpretations of NOTA will not be adopted in the future that would
call into question one or more aspects of the Company's methods of ch