UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly
Period Ended June 30, 2004
Commission File Number
1-13165
CRYOLIFE, INC.
(Exact name of
registrant as specified in its charter)
_________________
| Florida | 59-2417093 |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
1655 Roberts Boulevard,
NW
Kennesaw, Georgia 30144
(Address of principal
executive offices)
(zip code)
(770) 419-3355
(Registrant’s
telephone number, including area code)
Not Applicable
(Former
name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES X NO
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
YES X NO
The number of shares of common stock, par value $0.01 per share, outstanding on August 4, 2004 was 23,282,547.
Part I — FINANCIAL INFORMATION
Item 1. Financial statements
CRYOLIFE, INC. AND
SUBSIDIARIES
SUMMARY CONSOLIDATED
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
| Three Months Ended June 30, |
Six Months Ended June 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2004 |
2003 | |||||||||||
| (Unaudited) |
(Unaudited) | |||||||||||||
| Revenues: | ||||||||||||||
| Products | $ | 9,203 | $ | 6,932 | $ | 18,062 | $ | 13,531 | ||||||
| Human tissue preservation services | 6,054 | 8,615 | 12,279 | 17,745 | ||||||||||
| Research grants | 57 | 166 | 59 | 357 | ||||||||||
| Total revenues | 15,314 | 15,713 | 30,400 | 31,633 | ||||||||||
| Costs and expenses: | ||||||||||||||
| Products | 1,894 | 2,006 | 3,841 | 3,647 | ||||||||||
| Human tissue preservation services | ||||||||||||||
| (Including write-downs of $1,508 for the | ||||||||||||||
| three months and $5,158 for the six months | ||||||||||||||
| ended June 30, 2004 and $1,131 for the | ||||||||||||||
| three months and $1,428 for the six months | ||||||||||||||
| ended June 30, 2003) | 7,543 | 5,160 | 16,646 | 7,603 | ||||||||||
| General, administrative, and marketing | 9,693 | 23,539 | 19,841 | 35,131 | ||||||||||
| Research and development | 891 | 1,088 | 1,812 | 2,005 | ||||||||||
| Interest expense | 59 | 147 | 102 | 279 | ||||||||||
| Interest income | (64 | ) | (116 | ) | (130 | ) | (247 | ) | ||||||
| Other expense, net | 21 | 166 | 37 | 140 | ||||||||||
| Total costs and expenses | 20,037 | 31,990 | 42,149 | 48,558 | ||||||||||
| Loss before income taxes | (4,723 | ) | (16,277 | ) | (11,749 | ) | (16,925 | ) | ||||||
| Income tax (benefit) expense | (1,371 | ) | 3,644 | (1,371 | ) | 3,430 | ||||||||
| Net loss | $ | (3,352 | ) | $ | (19,921 | ) | $ | (10,378 | ) | $ | (20,355 | ) | ||
| Net loss per share: | ||||||||||||||
| Basic | $ | (0.14 | ) | $ | (1.01 | ) | $ | (0.46 | ) | $ | (1.04 | ) | ||
| Diluted | $ | (0.14 | ) | $ | (1.01 | ) | $ | (0.46 | ) | $ | (1.04 | ) | ||
| Weighted average shares outstanding: | ||||||||||||||
| Basic | 23,252 | 19,675 | 22,747 | 19,654 | ||||||||||
| Diluted | 23,252 | 19,675 | 22,747 | 19,654 | ||||||||||
See accompanying notes to summary consolidated financial statements.
2
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
| June 30, 2004 |
December 31, 2003 | |||||||
|---|---|---|---|---|---|---|---|---|
| ASSETS | (Unaudited) | |||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 19,966 | $ | 5,672 | ||||
| Marketable securities, at market | 3,217 | 5,272 | ||||||
| Restricted cash and securities | 558 | 972 | ||||||
| Trade receivables, net | 7,625 | 6,377 | ||||||
| Other receivables | 2,231 | 1,865 | ||||||
| Deferred preservation costs, net | 7,382 | 8,811 | ||||||
| Inventories | 4,572 | 4,450 | ||||||
| Prepaid expenses and other assets | 4,494 | 2,344 | ||||||
| Total current assets | 50,045 | 35,763 | ||||||
| Property and equipment, net | 30,739 | 32,886 | ||||||
| Patents, net | 4,968 | 5,244 | ||||||
| Other | 1,999 | 1,134 | ||||||
| TOTAL ASSETS | $ | 87,751 | $ | 75,027 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | 3,616 | $ | 2,171 | ||||
| Accrued expenses and other current liabilities | 11,985 | 11,570 | ||||||
| Accrued compensation | 1,699 | 1,136 | ||||||
| Accrued procurement fees | 3,387 | 4,358 | ||||||
| Note payable | 2,385 | -- | ||||||
| Current maturities of capital lease obligations | 1,513 | 1,738 | ||||||
| Total current liabilities | 24,585 | 20,973 | ||||||
| Capital lease obligations, less current maturities | 634 | 751 | ||||||
| Other long-term liabilities | 5,032 | 4,965 | ||||||
| Total liabilities | 30,251 | 26,689 | ||||||
| Shareholders' Equity: | ||||||||
| Preferred stock | -- | -- | ||||||
| Common stock (24,637 issued shares in 2004 and | ||||||||
| 21,130 shares in 2003) | 246 | 211 | ||||||
| Additional paid-in capital | 94,052 | 74,460 | ||||||
| Retained deficit | (29,886 | ) | (19,508 | ) | ||||
| Deferred compensation | (3 | ) | (9 | ) | ||||
| Accumulated other comprehensive income | 283 | 365 | ||||||
| Less: Treasury stock at cost (1,372 shares in 2004 and | ||||||||
| 1,371 shares in 2003) | (7,192 | ) | (7,181 | ) | ||||
| Total shareholders' equity | 57,500 | 48,338 | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 87,751 | $ | 75,027 | ||||
See accompanying notes to summary consolidated financial statements.
3
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
| Six Months Ended June 30, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||
| (Unaudited) | ||||||||
| Net cash from operating activities: | ||||||||
| Net loss | $ | (10,378 | ) | $ | (20,355 | ) | ||
| Adjustments to reconcile net loss to net cash | ||||||||
| from operating activities: | ||||||||
| Gain on sale of marketable equity securities | -- | (19 | ) | |||||
| Loss on sale of assets | 19 | -- | ||||||
| Depreciation and amortization | 2,711 | 2,774 | ||||||
| Provision for doubtful accounts | 48 | 48 | ||||||
| Write-down of deferred preservation costs | 5,158 | 1,428 | ||||||
| Other non-cash adjustments to income | 6 | 307 | ||||||
| Deferred income taxes | -- | 4,410 | ||||||
| Tax effect of nonqualified option exercises | 11 | 19 | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Receivables | (1,795 | ) | 9,250 | |||||
| Deferred preservation costs and inventories | (3,851 | ) | (6,605 | ) | ||||
| Prepaid expenses and other assets | 1,287 | 856 | ||||||
| Accounts payable, accrued expenses, and other liabilities | 1,741 | 10,862 | ||||||
| Net cash (used in) provided by operating activities | (5,043 | ) | 2,975 | |||||
| Net cash from investing activities: | ||||||||
| Capital expenditures | (439 | ) | (333 | ) | ||||
| Other assets | 125 | 173 | ||||||
| Purchases of marketable securities | (558 | ) | -- | |||||
| Sales and maturities of marketable securities | 2,000 | 4,708 | ||||||
| Net cash provided by investing activities | 1,128 | 4,548 | ||||||
| Net cash from financing activities: | ||||||||
| Principal payments of debt | -- | (800 | ) | |||||
| Payment of obligations under capital leases | (342 | ) | (320 | ) | ||||
| Principal payments on short-term note payable | (1,000 | ) | (827 | ) | ||||
| Proceeds from exercise of stock options and | ||||||||
| issuance of common stock | 241 | 325 | ||||||
| Proceeds from private equity offering | 19,364 | -- | ||||||
| Net cash provided by (used in) financing activities | 18,263 | (1,622 | ) | |||||
| Increase in cash and cash equivalents | 14,348 | 5,901 | ||||||
| Effect of exchange rate changes on cash | (54 | ) | (31 | ) | ||||
| Cash and cash equivalents, beginning of period | 5,672 | 10,277 | ||||||
| Cash and cash equivalents, end of period | $ | 19,966 | $ | 16,147 | ||||
See accompanying notes to summary consolidated financial statements.
4
CRYOLIFE, INC. AND SUBSIDIARIES
NOTES TO SUMMARY
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The accompanying unaudited summary consolidated financial statements have been prepared in accordance with (i) accounting principles generally accepted in the United States for interim financial information and (ii) the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the United States Securities and Exchange Commission (“SEC”). Accordingly, the statements do not include all of the information and disclosures required by accounting principles generally accepted in the United States for a complete presentation of financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and notes thereto included in the CryoLife Form 10-K for the year ended December 31, 2003.
The Company expects that its operations will continue to generate negative cash flows throughout the remainder of 2004 due to:
| o | The anticipated lower preservation revenues as compared to preservation revenues prior to the FDA Order, subsequent FDA activity, and related events (discussed in Note 2), |
| o | The increase in cost of human tissue preservation services as a percent of revenue as a result of lower tissue processing volumes and changes in processing methods, and |
| o | An expected use of cash related to the defense and resolution of lawsuits (discussed in Note 12). |
The Company believes anticipated revenue generation, expense management, and the Company’s existing cash, cash equivalents, and marketable securities will enable the Company to meet its liquidity needs through at least June 30, 2005.
The Company’s long term liquidity and capital requirements will depend upon numerous factors, including:
| o | The Company’s ability to return to the level of demand for its tissue services that existed prior to the FDA Order, |
| o | The Company's ability to reestablish sufficient margins on its tissue preservation services in the face of increased processing costs, |
| o | The Company’s spending levels on its research and development activities, including research studies, to develop and support its service and product pipeline, |
| o | The amount and the timing of the resolution of the remaining outstanding product liability claims (discussed in Note 12), and |
| o | The outcome of other litigation against the Company (discussed in Note 12). |
The Company may require additional financing or seek to raise additional funds through bank facilities, debt or equity offerings, or other sources of capital to meet liquidity and capital requirements beyond June 30, 2005. Additional funds may not be available when needed or on terms acceptable to the Company, which could have a material adverse effect on the Company’s business, financial condition, results of operations, and cash flows.
FDA Order
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 tissues processed by the Company since October 3, 2001
(the “FDA Order”). The FDA Order followed an April 2002 FDA Form 483 Notice of
Observations (“April 2002 483”) and an FDA Warning Letter dated June 17, 2002,
(“Warning Letter”). Pursuant to the FDA Order, the Company placed non-valved
cardiac, vascular, and orthopaedic tissue subject to the FDA Order (i.e. processed since
October 3, 2001) on quality assurance quarantine and recalled the portion of those tissues
that had been distributed but not implanted. In addition, the Company ceased processing
non-valved cardiac, vascular, and orthopaedic tissues.
5
On September 5, 2002 the Company entered into an agreement with the FDA (the “Agreement”) that supplemented the FDA Order and allowed non-valved cardiac and vascular tissues subject to the recall (processed between October 3, 2001 and September 5, 2002) to be released for distribution after the Company had completed steps to ensure that the tissue was used for approved purposes and that patients were notified of risks associated with tissue use. The Agreement had a renewable 45-business day term and the final renewal expired on September 5, 2003. The Company is no longer shipping tissue subject to the recall (processed between October 3, 2001 and September 5, 2002). A renewal of the Agreement that expired on September 5, 2003 was not needed in order for the Company to continue to distribute non-valved cardiovascular, vascular, and orthopaedic tissues processed after September 5, 2002.
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 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.
Accounting Treatment
As a result of the FDA Order, the
Company evaluated multiple factors in determining the magnitude of impairment to deferred
preservation costs, 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 its evaluation in the quarter ended June 30, 2002, the Company recorded a
reduction to pretax income of $12.6 million 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), and a $1.3 million accrual recorded in general, administrative, and
marketing expenses. In the quarter ended September 30, 2002 the Company recorded a
reduction to pretax income of $24.6 million 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).
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 as of December 31, 2002. A refund of approximately $8.9 million related to 2002 federal income taxes was generated through a carry back of operating losses and write-downs of deferred preservation costs. The Company filed its 2002 federal income tax returns in April of 2003 and received its tax refund during the second quarter of 2003. In addition, estimated tax payments for 2002 of $2.5 million were recorded as a receivable by the Company as of December 31, 2002 and were received in January 2003.
On September 3, 2002 the Company announced a reduction in employee force of approximately 105 employees. In the third quarter of 2002 the Company accrued restructuring costs of approximately $690,000, for severance and related costs of the employee force reduction. During the quarter ended March 31, 2003 the Company utilized $64,000 of the accrued restructuring costs and reversed the remaining accrual of $46,000 in unused restructuring costs. The Company has not incurred and does not expect to incur any additional restructuring costs associated with the employee force reduction subsequent to March 31, 2003.
In the quarter ended March 31, 2003 the Company recorded a favorable adjustment of $848,000 to the estimated tissue recall returns due to lower actual tissue returns under the FDA Order than were originally estimated in 2002. The adjustment increased cardiac tissue revenues by $92,000, vascular tissue revenues by $711,000, and orthopaedic tissue revenues by $45,000 in the first quarter of 2003. In the quarter ended September 30, 2003 the Company recorded a favorable adjustment of $52,000 to reverse the remaining unused portion of the estimated tissue recall returns due to lower overall actual tissue returns under the FDA Order than were estimated. Although vascular and orthopaedic returns were lower than expected, cardiac returns were higher than expected. Therefore, the $52,000 adjustment decreased cardiac tissue revenues by $7,000 and increased vascular tissue revenues by $41,000 and orthopaedic tissue revenues by $18,000 in the third quarter of 2003. Management determined that no additional accruals were necessary for tissue returns under the FDA Order. Therefore, as of September 30, 2003 and in subsequent periods there was no accrual for estimated return of tissues subject to recall by the FDA Order.
6
Other FDA Correspondence
and Notices
FDA Form 483 Notices of Observations
(“483”) were issued in connection with the FDA inspections of the Company’s
facilities in February 2003, October 2003, and February 2004. The Company responded to the
February 2003 483 in March 2003, responded to the October 2003 483 in October 2003,
November 2003, and April 2004, and responded to the February 2004 483 in March 2004, April
2004, and June 2004. The Company continues to work with the FDA to review process
improvements and address any outstanding observations.
On February 20, 2003 the Company received a letter from the FDA stating 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 marketed or labeled as an arteriovenous (“A-V”) access graft. 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 vascular allografts labeled for use as A-V access grafts are medical devices that require premarket approval.
On November 3, 2003 the Company filed a 510(k) premarket notification with the FDA for the CryoValve SG. On December 8, 2003 the Company received a letter from the FDA stating that it was the agency’s position that cardiovascular tissues processed with the SynerGraft technology should be regulated as medical devices. On February 4, 2004 the Company received a letter from the FDA requesting that additional information be provided to support the 510(k) premarket notification for the CryoValve SG. The requested information may require that additional studies be undertaken. Clearance of the 510(k) premarket notification with the FDA will be required before the Company can resume distribution of SynerGraft processed cardiovascular tissue, including the CryoValve SG. The Company is still in discussions with the FDA regarding the type of submissions necessary for the CryoVein SG. The outcome of the discussions and filing with the FDA regarding the use of the SynerGraft process on human tissue, including the CryoValve SG and CryoVein SG, could result in an inability to distribute tissues with the SynerGraft technology until further submissions and FDA clearances are granted.
The Company suspended the use of the SynerGraft technology in the processing of allograft cardiovascular and vascular tissue and has suspended the distribution of tissues on hand that have been processed with the SynerGraft technology until the regulatory status of the CryoValve SG and CryoVein SG is resolved. Additionally, the Company discontinued labeling its vascular grafts for use as A-V access grafts. The FDA has not suggested that these tissues be recalled. Until such time as the issues surrounding the SynerGraft treated tissues 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. During the three months ended June 30, 2004, the Company wrote down $353,000 in SynerGraft processed cardiovascular and vascular tissues. As of June 30, 2004 the Company has no additional deferred preservation costs related to SynerGraft processed tissues on its Summary Consolidated Balance Sheet.
The Company maintains cash equivalents, which consist primarily of highly liquid investments with maturity dates of 90 days or less at the time of acquisition, and marketable securities in several large, well-capitalized financial institutions. The Company’s policy disallows investment in any securities rated less than “investment-grade” by national rating services.
Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designations as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity or trading and marketable equity securities not classified as trading are classified as available-for-sale. At December 31, 2003 all marketable securities were designated as available-for-sale. At June 30, 2004 $3.2 million of marketable securities were designated as available-for-sale and $558,000 of marketable securities were designated as held-to-maturity.
Available-for-sale securities are stated at their fair values, with the unrealized gains and losses, net of tax, reported in a separate component of shareholders’ equity. Interest income, dividends, realized gains and losses, and declines in value judged to be other than temporary are included in investment income. The cost of securities sold is based on the specific identification method. Held-to-maturity securities are stated at amortized cost due to a contractual commitment to hold the security as pledged collateral relating to the Company’s insurance product liability policy. The held-to-maturity securities mature on April 1, 2005 and are, therefore, classified as current assets.
7
The following is a summary of cash equivalents and marketable securities (in thousands):
| June 30, 2004 | Cost Basis |
Unrealized Holding Gains/(Losses) |
Estimated Market Value | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (Unaudited) | |||||||||||
| Cash equivalents: | |||||||||||
| Money market funds | $ | 13,684 | $ | -- | $ | ||||||