UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2004
Commission File Number 1-13165
CRYOLIFE, INC.
(Exact name of registrant as specified in its charter)
--------------------
Florida 59-2417093
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1655 Roberts Boulevard, NW
Kennesaw, Georgia 30144
(Address of principal executive offices)
(zip code)
(770) 419-3355
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO ____
----
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
October 29, 2004 was 23,332,773.
Part I - FINANCIAL INFORMATION
Item 1. Financial statements.
CRYOLIFE, INC. AND SUBSIDIARIES
SUMMARY CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2004 2003 2004 2003
------------------------------- ------------------------------
(Unaudited) (Unaudited)
Revenues:
Products $ 9,151 $ 6,831 $ 27,213 $ 20,362
Human tissue preservation services 6,955 8,097 19,234 25,842
Research grants 12 169 71 526
------------------------------- ------------------------------
Total revenues 16,118 15,097 46,518 46,730
Costs and expenses:
Products 1,998 1,782 5,839 5,429
Human tissue preservation services
(Including write-downs of $1,236
for the three months and $6,394
for the nine months ended
September 30, 2004
and $1,752 for the three months
and $3,180 for the nine months
ended September 30, 2003) 7,124 7,481 23,770 15,084
General, administrative, and marketing 12,127 10,575 31,968 45,706
Research and development 904 823 2,716 2,828
Interest expense 54 87 156 366
Interest income (71) (101) (201) (348)
Other (income) expense, net (10) (94) 27 46
-------------------------------- ------------------------------
Total costs and expenses 22,126 20,553 64,275 69,111
------------------------------- ------------------------------
Loss before income taxes (6,008) (5,456) (17,757) (22,381)
Income tax (benefit) expense -- (761) (1,371) 2,669
-------------------------------- ------------------------------
Net loss $ (6,008) $ (4,695) $(16,386) $(25,050)
================================ ==============================
Net loss per share:
Basic $ (0.26) $ (0.24) $ (0.72) $ (1.27)
=============================== ==============================
Diluted (0.26) $ (0.24) $ (0.72) $ (1.27)
=============================== ==============================
Weighted average shares outstanding:
Basic 23,287 19,701 22,928 19,669
=============================== ==============================
Diluted 23,287 19,701 22,928 19,669
=============================== ==============================
See accompanying notes to summary consolidated financial statements.
2
Item 1. Financial Statements.
CRYOLIFE, INC.
SUMMARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, December 31,
2004 2003
---------------------------------
ASSETS (Unaudited)
-
Current Assets:
Cash and cash equivalents $ 11,427 $ 5,672
Marketable securities, at market 3,206 5,272
Restricted cash and securities 560 972
Trade receivables, net 8,938 6,377
Other receivables 1,505 1,865
Deferred preservation costs, net 8,038 8,811
Inventories 4,829 4,450
Prepaid expenses and other assets 3,395 2,344
---------------------------------
Total current assets 41,898 35,763
---------------------------------
Property and equipment, net 29,719 32,886
Patents, net 5,010 5,244
Other 1,898 1,134
---------------------------------
TOTAL ASSETS $ 78,525 $ 75,027
=================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 2,663 $ 2,171
Accrued expenses and other current liabilities 11,756 11,570
Accrued compensation 1,400 1,136
Accrued procurement fees 2,687 4,358
Notes payable 1,197 --
Current maturities of capital lease obligations 1,435 1,738
---------------------------------
Total current liabilities 21,138 20,973
---------------------------------
Capital lease obligations, less current maturities 601 751
Other long-term liabilities 5,166 4,965
---------------------------------
Total liabilities 26,905 26,689
---------------------------------
Shareholders' Equity:
Preferred stock -- --
Common stock (24,696 issued shares in 2004 and
21,130 shares in 2003) 247 211
Additional paid-in capital 94,269 74,460
Retained deficit (35,894) (19,508)
Deferred compensation -- (9)
Accumulated other comprehensive income 257 365
Less: Treasury stock at cost (1,382 shares in
2004 and 1,371 shares in 2003) (7,259) (7,181)
----------------------------------
Total shareholders' equity 51,620 48,338
---------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 78,525 $ 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)
Nine Months Ended
September 30,
-----------------------------------
2004 2003
-----------------------------------
(Unaudited)
Net cash from operating activities:
Net loss $ (16,386) $ (25,050)
Adjustments to reconcile net loss to net cash
from operating activities:
Gain on sale of marketable equity securities -- (19)
Loss (Gain) on sale of assets 24 (80)
Depreciation and amortization 4,121 4,136
Provision for doubtful accounts 72 72
Write-down of deferred preservation costs and inventory 6,575 3,180
Other non-cash adjustments to income 8 328
Deferred income taxes -- 5,708
Tax effect of nonqualified option exercises 54 19
Changes in operating assets and liabilities:
Receivables (5,106) (334)
Income taxes 2,404 8,320
Deferred preservation costs and inventories (6,181) (8,864)
Prepaid expenses and other assets 1,599 1,379
Accounts payable, accrued expenses, and other liabilities 893 10,860
-----------------------------------
Net cash used in operating activities (11,923) (345)
-----------------------------------
Net cash from investing activities:
Capital expenditures (697) (456)
Net proceeds from sale of assets -- 1,080
Other assets 2 188
Purchases of marketable securities (560) --
Sales and maturities of marketable securities 2,000 4,699
-----------------------------------
Net cash provided by investing activities 745 5,511
-----------------------------------
Net cash from financing activities:
Principal payments of debt -- (5,600)
Payment of obligations under capital leases (530) (485)
Principal payments on short-term note payable (2,188) (1,642)
Proceeds from exercise of stock options and
issuance of common stock 349 475
Proceeds from equity offering 19,364 --
-----------------------------------
Net cash provided by (used in) financing activities 16,995 (7,252)
-----------------------------------
Increase (Decrease) in cash and cash equivalents 5,817 (2,086)
Effect of exchange rate changes on cash (62) (12)
Cash and cash equivalents, beginning of period 5,672 10,277
-----------------------------------
Cash and cash equivalents, end of period $ 11,427 $ 8,179
===================================
See accompanying notes to summary consolidated financial statements.
4
CRYOLIFE, INC. AND SUBSIDIARIES
NOTES TO SUMMARY CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited 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 nine months ended September 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 services revenues as compared to
preservation revenues prior to the FDA Order, subsequent FDA activity,
and related events (discussed in Note 2),
o The high cost of human tissue preservation services as a percent of
revenue, as compared to the period prior to the FDA Order, as a result
of lower tissue processing volumes and changes in processing methods,
which have increased the cost of processing human tissue and have
decreased yields of implantable tissue per donor,
o An expected use of cash related to the defense and resolution of
lawsuits and claims (discussed in Note 12), and
o The legal and professional costs related to ongoing FDA compliance.
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 September 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 by
improving yields and increasing prices,
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 and any other similar claims
(discussed in Note 12), and
o The outcome of other litigation against the Company (discussed in Note
12).
If the Company is unable to address these issues and continues to experience
negative cash flows, the Company anticipates that it will require additional
financing or seek to raise additional funds through bank facilities, debt or
equity offerings, or other sources of capital to meet liquidity and capital
requirements beyond September 30, 2005. The Company may elect to obtain
financing prior to that time depending on the availability and terms of the
financing agreement. 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.
NOTE 2 - FDA ORDER ON HUMAN TISSUE PRESERVATION AND OTHER FDA CORRESPONDENCE AND
NOTICES
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
5
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.
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, and executed thereafter. The corrective actions
taken have been reviewed by the FDA during three subsequent inspections as
discussed in "Other FDA Correspondence and Notices" below.
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
6
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.
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. On September 24, 2004 CryoLife received an inquiry from the FDA Atlanta
District Office seeking additional information on four items submitted by
CryoLife in response to the February 2004 483. CryoLife has been in discussion
with the agency regarding this request and will submit its response in the
fourth quarter of 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(R) SG
and that premarket approval marketing authorization should be obtained for the
Company's CryoVein(R) SG when marketed or labeled as an arteriovenous ("A-V")
access graft. The agency's position is that use of the SynerGraft(R) 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. On August 24, 2004, the Company submitted an amendment to
its original 510(k) submission providing clarification and additional
information to address the issues raised by the FDA. The FDA may still 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 CryoValve SG. On September 14, 2004, the
Company met with the FDA to discuss the data to be used to support a Request for
Designation ("RFD") filing for SynerGraft processed cardiovascular tissue,
including the CryoVein SG. The Company submitted the RFD on October 5, 2004. 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 has 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 September 30,
2004 the Company had no additional deferred preservation costs related to
SynerGraft processed tissues on its Summary Consolidated Balance Sheet.
NOTE 3 - CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company maintains cash equivalents, which consist primarily of highly liquid
investments with maturity dates of 90 days or less at the time of acquisition,
and marketable securities in several large, well-capitalized financial
institutions. The Company's policy disallows investment in any securities rated
less than "investment-grade" by national rating services.
7
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. As of December 31,
2003 all marketable securities were designated as available-for-sale. As of
September 30, 2004 $3.2 million of marketable securities were designated as
available-for-sale and $560,000 of marketable securities were designated as
held-to-maturity. These securities were designated held-to-maturity due to a
contractual commitment to hold the security as pledged collateral relating to
one of the Company's product liability insurance policies.
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.
The following is a summary of cash equivalents and marketable securities (in
thousands):
Unrealized Estimated
Holding Market
September 30, 2004 Cost Basis Gains/(Losses) Value
------------------------------------------------
(Unaudited)
Cash equivalents:
Money market funds $ 7,246 $ -- $ 7,246
Municipal obligations 775 -- 775
------------------------------------------------
$ 8,021 $ -- $ 8,021
================================================
Marketable securities:
Municipal obligations $ 3,140 $ 66 $ 3,206
================================================
Restricted Securities:
Debt securities $ 560 $ -- $ 560
================================================
Unrealized Estimated
Holding Market
December 31, 2003 Cost Basis Gains/(Losses) Value
------------------------------------------------
Cash equivalents:
Money market funds $ 1,079 $ -- $ 1,079
Municipal obligations 775 -- 775
------------------------------------------------
$ 1,854 $ -- $ 1,854
================================================
Marketable securities:
Municipal obligations $ 5,148 $ 124 $ 5,272
================================================
Gross realized gains on sales of available-for-sale securities totaled zero as
of September 30, 2004 and $19,000 as of December 31, 2003. Differences between
cost and market listed above, consisting of a net unrealized holding gain less
deferred taxes of $23,000 at September 30, 2004 and $42,000 at December 31,
2003, are included as a separate component of other comprehensive income in
shareholders' equity.
As of September 30, 2004 and December 31, 2003 approximately zero and $2.0
million, respectively, of marketable securities had a maturity date of less than
90 days, and approximately $3.2 million and $3.3 million, respectively, had a
maturity date between 1 and 5 years. The restricted securities mature on April
1, 2005.
8
NOTE 4 - INVENTORIES
Inventories are comprised of the following (in thousands):
September 30, December 31,
2004 2003
-------------------------------
(Unaudited)
Raw materials $ 2,998 $ 2,906
Work-in-process 303 229
Finished goods 1,528 1,315
-------------------------------
$ 4,829 $ 4,450
===============================
NOTE 5 -INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and tax return purposes. The Company generated deferred tax assets
beginning in 2002 primarily as a result of write-downs of deferred preservation
costs, accruals for product liability claims, and operating losses, reflecting
reductions in revenues and additional professional fees, as a result of the FDA
Order, subsequent FDA activity, and reported tissue infections. The Company
continued to generate deferred tax assets for the three and nine months ended
September 30, 2004 primarily as a result of operating losses. The Company
periodically assesses the recoverability of deferred tax assets and provides a
valuation allowance when management believes it is more likely than not that its
deferred tax assets will not be realized.
The Company evaluated several factors to determine if a valuation allowance
relative to its deferred tax assets was necessary during 2003. The Company
reviewed its historic operating results, including the reasons for its operating
losses in 2003 and 2002, uncertainties regarding projected future operating
results due to the effects of the adverse publicity resulting from the FDA
Order, subsequent FDA activity, and reported tissue infections, the changes in
processing methods resulting from the FDA Order, and the uncertainty of the
outcome of product liability claims. Based on the results of this analysis, the
Company determined that it was more likely than not that the Company's deferred
tax assets would not be realized. Therefore, during 2003 the Company recorded
valuation allowances totaling $13.7 million due to the effect of temporary
differences between book and tax income, the net deferred tax assets generated
in 2003, and the net deferred tax asset balance as of December 31, 2002. For the
three and nine months ended September 30, 2004 the Company did not experience
any changes that would materially affect the Company's analysis of and valuation
of its deferred tax assets. As of September 30, 2004 the Company had a total of
$21.2 million in valuation allowances against deferred tax assets and a net
deferred tax asset balance of zero.
During the quarter ended June 30, 2004, the Company received income tax refunds
of $2.4 million related to federal income tax losses from the year ended
December 31, 2003 that were carried back to prior years and $1.4 million related
to product liability expenses incurred in 2003. The Company did not record a
receivable for the $1.4 million carryback in prior periods due to uncertainty
regarding its realizability.
NOTE 6 - DEBT
On April 25, 2000 the Company entered into a loan agreement permitting the
Company to borrow up to $8.0 million under a line of credit. On June 1, 2001 the
line of credit was converted to a term loan (the "Term Loan") to be paid in 60
equal monthly installments of principal plus interest computed at Adjusted LIBOR
plus 1.5%. On August 15, 2003 the Company made a voluntary payment of $4.5
million to pay off the outstanding balance of the Term Loan. The Company also
paid approximately $11,000 to the lender in fees associated with the Term Loan
payoff. On August 15, 2003 in conjunction with the payoff of the outstanding
balance of the Term Loan, the Company paid $199,000 to terminate the swap
agreement related to the Term Loan. This $199,000 payment represented the
estimated fair value of the interest rate swap, as estimated by the lender based
on its internal valuation models, as of the day of the termination of the
agreement.
9
In the quarter ended June 30, 2003 the Company entered into two agreements to
finance $2.9 million in insurance premiums associated with the yearly renewal of
certain Company insurance policies. The amount financed accrued interest at a
3.75% rate and was payable in equal monthly payments through December 2003. As
of September 30, 2004 the outstanding balance of the agreements was zero and
there are no available borrowings under this agreement.
In April 2004 the Company entered into two agreements to finance approximately
$1.9 million and $1.5 million, respectively, in insurance premiums associated
with the yearly renewal of certain Company insurance policies. The amounts
financed accrue interest at a 3.25% rate and are payable in equal monthly
payments over a nine month period and an eight month period, respectively. As of
September 30, 2004 the aggregate outstanding balance under the agreements was
$1.2 million.
NOTE 7 - PRIVATE EQUITY PLACEMENT
On January 7, 2004 the Company's Board of Directors authorized an agreement with
a financial advisory company to sell shares of the Company's common stock in a
private investment in public equity transaction (the "PIPE"). The PIPE was
consummated on January 27, 2004, and resulted in the sale of approximately 3.4
million shares of stock at a price of $6.25 per share. The sale generated net
proceeds of approximately $19.4 million, after commissions, filing fees, late
registration fees, and other related charges for general corporate purposes. The
Company filed a registration statement on Form S-3 with the SEC covering the
resale of the shares sold in the PIPE by the investors. The Company paid a total
of $466,000 in late registration penalties to the investors through May 18,
2004, the date the registration statement was declared effective. This amount
was deducted from the PIPE proceeds in recording net proceeds from the PIPE in
shareholders' equity.
NOTE 8 - COMPREHENSIVE LOSS
Components of comprehensive loss consist of the following, net of tax (in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ----------------------------
2004 2003 2004 2003
------------------------------- ----------------------------
(Unaudited) (Unaudited)
Net loss $ (6,008) $ (4,695) $ (16,386) $ (25,050)
Unrealized loss on investments (6) (23) (38) (84)
Change in fair value of interest rate swap -- -- -- 172
Translation adjustment (20) 9 (70) (22)
------------------------------- ----------------------------
Comprehensive loss $ (6,034) $ (4,709) $ (16,494) $ (24,984)
=============================== ============================
The tax effect on the change in unrealized gain/loss on investments is a benefit
of $3,000 and $14,000 for the three months ended September 30, 2004 and
September 30, 2003, respectively. The tax effect on the change in unrealized
gain/loss on investments is a benefit of $20,000 and $48,000 for the nine months
ended September 30, 2004 and September 30, 2003, respectively. The tax effect on
the change in fair value of the interest rate swap is zero for both the three
months ended September 30, 2004 and September 30, 2003. The tax effect on the
change in fair value of the interest rate swap is zero and $88,000 for the nine
months ended September 30, 2004 and September 30, 2003, respectively. The tax
effect on the translation adjustment is zero for both the three months ended
September 30, 2004 and September 30, 2003. The tax effect on the translation
adjustment is zero and $110,000 for the nine months ended September 30, 2004 and
September 30, 2003, respectively.
10
Components of accumulated other comprehensive income consist of the following,
net of tax (in thousands):
September 30, December 31,
2004 2003
-------------------------------
(Unaudited)
Unrealized gain on investments $ 47 $ 85
Translation adjustment 210 280
-------------------------------
Total accumulated other comprehensive income $ 257 $ 365
===============================
NOTE 9 - LOSS PER SHARE
The following table sets forth the computation of basic and diluted loss per
share (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2004 2003 2004 2003
------------------------------- ------------------------------
(Unaudited) (Unaudited)
Numerator for basic and diluted loss
per share - loss available to common
shareholders $ (6,008) $ (4,695) $ (16,386) $ (25,050)
Denominator for basic loss per share -
weighted-average basis 23,287 19,701 22,928 19,669
Effect of dilutive stock options -- -- -- --
------------------------------- ------------------------------
Denominator for diluted loss per share -
adjusted weighted-average shares 23,287 19,701 22,928 19,669
=============================== ==============================
Net loss per share:
Basic $ (0.26) $ (0.24) $ (0.72) $ (1.27)
=============================== ==============================
Diluted $ (0.26) $ (0.24) $ (0.72) $ (1.27)
=============================== ==============================
Since the Company had a net loss for the three and nine month periods ended
September 30, 2004 and September 30, 2003, all potentially dilutive securities
are anti-dilutive for those periods. During those periods, the Company had
outstanding stock options that are considered potentially dilutive securities
and would have resulted in additional dilutive shares of 325,000 and 419,000 for
the three months ended September 30, 2004 and September 30, 2003, respectively,
and 353,000 and 438,000 for the nine months ended September 30, 2004 and
September 30, 2003, respectively, pursuant to the provisions of SFAS 128.
NOTE 10 - STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations ("APB
25") in accounting for its employee stock options because, as discussed below,
the alternative fair value accounting provided for under SFAS No. 123,
"Accounting for Stock-Based Compensation" as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure" requires
use of option valuation models that were not developed for use in valuing
employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of the grant, no compensation expense is recognized.
Pro forma information regarding net loss and net loss per share is required by
SFAS 148 and SFAS 123. The fair values for these options were estimated at the
dates of grant using a Black-Scholes option-pricing model with the following
weighted-average assumptions:
11
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2004 2003 2004 2003
------------------------------- ------------------------------
(Unaudited) (Unaudited)
Expected dividend yield 0% 0% 0% 0%
Expected stock price volatility .589 .589 .600 .611
Risk-free interest rate 3.13% 2.36% 3.54% 2.40%
Expected life of options 3.7 Years 3.1 Years 4.4 Years 3.8 Years
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair values of the options
are amortized to expense over the options' vesting periods. The Company's pro
forma information follows (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2004 2003 2004 2003
------------------------------- ------------------------------
(Unaudited) (Unaudited)
Net loss--as reported $ (6,008) $ (4,695) $ (16,386) $ (25,050)
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all
awards, net of tax 189 204 1,195 1,109
------------------------------- ------------------------------
Net loss--pro forma $ (6,197) $ (4,899) $ (17,581) $ (26,159)
=============================== ==============================
Loss per share--as reported:
Basic $ (0.26) $ (0.24) $ (0.72) $ (1.27)
=============================== ==============================
Diluted $ (0.26) $ (0.24) $ (0.72) $ (1.27)
=============================== ==============================
Loss per share--proforma
Basic $ (0.27) $ (0.25) $ (0.77) $ (1.33)
=============================== ==============================
Diluted $ (0.27) $ (0.25) $ (0.77) $ (1.33)
=============================== ==============================
NOTE 11 - SEGMENT INFORMATION
The Company has two reportable segments: Implantable Medical Devices and Human
Tissue Preservation Services. The Company's segments are organized according to
services and products.
The Implantable Medical Devices segment includes external revenue from product
sales of BioGlue(R) Surgical Adhesive, bioprosthetic devices, including
stentless porcine heart valves and SynerGraft treated bovine vascular grafts.
The Human Tissue Preservation Services segment includes external revenue from
cryopreservation services of cardiac, vascular, and orthopaedic allograft
tissues. There are no intersegment revenues.
The primary measure of segment performance, as viewed by the Company's
management, is segment gross margin, or net external revenues less cost of
products and preservation services. The Company does not segregate assets by
segment, therefore, asset information is excluded from the segment disclosures
below.
12
The following table summarizes revenues, cost of preservation services and
products, and gross margins for the Company's operating segments (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2004 2003 2004 2003
------------------------------- ------------------------------
(Unaudited) (Unaudited)
Revenue:
Implantable medical devices 9,151 6,831 27,213 20,362
Human tissue preservation services 6,955 8,097 19,234 25,842
All other a 12 169 71 526
------------------------------- ------------------------------
$ 16,118 $ 15,097 $ 46,518 $ 46,730
=============================== ==============================
Cost of Products and Preservation Services:
Implantable medical devices 1,998 1,782 5,839 5,429
Human tissue preservation services 7,124 7,481 23,770 15,084
All other a -- -- -- --
------------------------------- ------------------------------
9,122 9,263 29,609 20,513
=============================== ==============================
Gross Margin (Loss):
Implantable medical devices 7,153 5,049 21,374 14,933
Human tissue preservation services (169) 616 (4,536) 10,758
All other a 12 169 71 526
------------------------------- ------------------------------
$ 6,996 $ 5,834 $ 16,909 $ 26,217
a The "All other" designation includes grant revenue.
The following table summarizes net revenues by product (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
-------------------------------- -------------------------------
(Unaudited) (Unaudited)
Revenue:
BioGlue surgical adhesive $ 8,914 $ 6,694 $ 26,519 $ 20,027
Other implantable medical devices 237 137 694 335
Human tissue preservation services:
Cardiovascular tissue 3,476 4,547 9,737 14,308
Vascular tissue 2,636 3,083 7,771 10,637
Orthopaedic tissue 843 467 1,726 897
-------------------------------- ------------------------------
Total preservation services 6,955 8,097 19,234 25,842
-------------------------------- -------------------------------
Research grants 12 169 71 526
-------------------------------- -------------------------------
$ 16,118 $ 15,097 $ 46,518 $ 46,730
================================ ===============================
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Product Liability Claims
In the normal course of business as a medical device and services company, the
Company has product liability complaints filed against it. Following the FDA
Order, a greater number of lawsuits than has historically been experienced have
been filed. As of November 3, 2004 the Company was aware of ten pending product
liability lawsuits. The lawsuits are currently in the pre-discovery or discovery
stages. Of these lawsuits, four allege product liability claims arising out of
13
the Company's orthopaedic tissue services, four allege product liability claims
arising out of the Company's allograft heart valve tissue services, one alleges
product liability claims arising from BioGlue, and one alleges product liability
claims arising out of the non-tissue products made by Ideas for Medicine, Inc.
when it was a subsidiary of the Company.
Of the ten open lawsuits a total of four are covered by the Company's insurance
coverage as follows: two lawsuits by the 2000/2001 insurance policy, one by the
2003/2004 insurance policy and one by the 2004/2005 insurance policy. For the
2000/2001 insurance policy year the Company maintained claims-made insurance
policies which the Company believes to be adequate to defend against the two
remaining suits filed during this period. As of September 30, 2004 the Company
has an accrual of $100,000 for the remaining retention levels related to the
2000/2001 insurance policy year. The Company believes its 2003/2004 and
2004/2005 insurance policies to be adequate to defend against the covered suit
filed during each of these time periods.
Of the ten open lawsuits the remaining six are not covered by the Company's
insurance policies as either these lawsuits relate to the 2002/2003 insurance
policy year for which the Company has used all of its insurance coverage,
aggregating $25 million, or they were asserted in periods after the coverage in
the related incident year had lapsed. Other product liability claims have been
asserted against the Company that have not resulted in lawsuits. The Company is
monitoring these claims.
The Company performed an analysis as of September 30, 2004 of the pending
product liability claims based on settlement negotiations to date and advice
from counsel. As of September 30, 2004 the Company had accrued a total of $1.8
million for pending product liability claims and recorded zero representing
amounts to be recovered from the Company's insurance carriers. The $1.8 million
accrual is included as a component of accrued expenses and other current
liabilities on the September 30, 2004 Summary Consolidated Balance Sheet. This
amount represents the Company's estimate of the probable losses related to six
of the ten pending product liability claims. The Company has not recorded an
accrual for the remaining four product liability claims because management has
concluded that either a loss is remote or that, although a loss is reasonably
possible or probable, a reasonable estimate of that loss or the range of losses
cannot be made at this time. The amount recorded as a liability is reflective of
estimated legal fees and settlement costs related to these claims and does not
reflect actual settlement arrangements, actual judgments, including punitive
damages, which may be assessed by the courts, or cash set aside for the purpose
of making payments. Prior to 2004, the Company recorded accruals for the
uninsured portion of product liability claims for which the amount of probable
loss was reasonably estimable. Had the Company recorded the total amounts of the
reasonably estimable probable losses as a liability and recorded an asset for
the estimated amount recoverable from the insurance carrier, the impact on the
financial statements as of December 31, 2003 would not have been material. The
Company's product liability insurance policies do not include coverage for any
punitive damages, which may be assessed at trial. The Company is currently
unable to reasonably estimate the maximum amount of the possible loss related to
these claims, as many of the claims do not specify the damages sought and the
Company does not have a reasonable method for estimating the amount of
compensatory or punitive damages that could be assessed by a trial jury.
Additionally, if the Company is unable to settle the outstanding claims for
amounts within its ability to pay or one or more of the product liability claims
in which the Company is a defendant should be tried with a substantial verdict
rendered in favor of the plaintiff(s), there can be no assurance that such
verdict(s) would not exceed the Company's available insurance coverage and
liquid assets. Failure by the Company to meet required future cash payments to
resolve the outstanding product liability claims would have a material adverse
effect on the financial position, results of operations, and cash flows of the
Company.
On April 1, 2004 the Company bound coverage for the 2004/2005 insurance policy
year. This policy is a two-year claims made insurance policy, i.e. claims
incurred during the period April 1, 2003 through March 31, 2005 and reported
during the period April 1, 2004 through March 31, 2005 are covered by this
policy. Claims incurred prior to April 1, 2003 that have not been reported are
uninsured.
The Company maintains claims-made insurance policies to mitigate its financial
exposure to product liability claims. Claims-made insurance policies generally
cover only those asserted claims and incidents that are reported to the
insurance carrier while the policy is in effect. Thus, a claims-made policy does
not generally represent a transfer of risk for claims and incidents that have
been incurred but not reported to the insurance carrier during the policy
period. The Company periodically evaluates its exposure to unreported product
liability claims and records accruals as necessary for the estimated cost of
unreported claims related to services performed and products sold. In July 2004,
14
the Company retained an independent actuarial firm to perform revised estimates
of the unreported claims as of June 30, 2004 and December 31, 2004. The
independent firm estimated the unreported product loss liability using a
frequency-severity approach, whereby projected losses were calculated by
multiplying the estimated number of claims by the estimated average cost per
claim. The estimated claims were calculated based on the reported claim
development method and the Bornhuetter-Ferguson method using a blend of the
Company's historical claim experience and industry data. The estimated cost per
claim was calculated using a lognormal claims model blending the Company's
historical average cost per claim with industry claims data. The independent
actuarial firm used a number of assumptions in order to estimate the unreported
product loss liability including:
o A ceiling of $5 million was selected for actuarial purposes in
determining the liability per claim given the uncertainty in
projecting claim losses in excess of $5 million,
o The future claim reporting lag time would be a blend of the Company's
experiences and industry data,
o The frequency of unreported claims for accident years 2001 through
2004 would be lower than the Company experienced during the 2002/2003
policy year, but higher than the Company's historical claim frequency
in prior policy years,
o The average cost per claim would be lower than the Company experienced
during the 2002/2003 policy year, but higher than the Company's
historical cost per claim in prior policy years,
o The average cost per BioGlue claim would be consistent with the
Company's overall historical exposures until adequate historical data
is available on this product line, and
o The number of BioGlue claims per million dollars of BioGlue revenue
would be 10% lower than non-BioGlue claims per million dollars to
adjust for the increase of BioGlue revenue as a percentage of total
revenues since 2002 and the BioGlue claims history to date.
The Company believes that these assumptions provide a reasonable basis for the
calculation of the unreported product liability loss, but actual developments
could differ materially from the assumptions above. The accuracy of the
actuarial firm's estimates is limited by the general uncertainty that exists for
any estimate of future activity and uncertainties surrounding the assumptions
used and due to Company specific conditions including the FDA Order, the
Company's recent levels of litigation activity, the Company's low volume of
historical claims, and the scarcity of industry data directly relevant to the
Company's business activities. Due to these factors actual results may differ
significantly from the amounts accrued.
Beginning April 1, 2004 and concurrent with signing the claims-made insurance
policy for the policy year from April 1, 2004 to March 31, 2005, the Company
implemented the provisions of Emerging Issues Task Force Issue 03-8, Accounting
for Claims-Made Insurance and Retroactive Contracts by the Insured Entity ("EITF
03-8"). Pursuant to EITF 03-8, the Company continues to record an estimated
liability for unreported product liability claims and has begun to record a
related recoverable from insurance. Prior to the effective date of EITF 03-8,
the Company did not record a recoverable from insurance related to the
unreported product liability claims.
Based on the actuarial valuation performed in July 2004 as of June 30, 2004 and
December 31, 2004, the Company estimated that its liability for unreported
product liability claims was $8.0 million as of June 30, 2004 and would be $8.7
million as of December 31, 2004. In accordance with EITF 03-8, the Company has
accrued a prorated amount of $8.4 million, representing the Company's best
estimate of the total liability for unreported product liability claims related
to services performed and products sold prior to September 30, 2004. The $8.4
million balance is included as a component of accrued expenses and other current
liabilities of $4.3 million and other long-term liabilities of $4.1 million on
the September 30, 2004 Summary Consolidated Balance Sheet. Further analysis
indicated that the liability could be estimated to be as high as $14.6 million,
after including a reasonable margin for statistical fluctuations calculated
based on actuarial simulation techniques. Based on the actuarial valuation, the
Company estimated that as of September 30, 2004, $1.8 million of the accrual for
unreported liability claims would be recoverable under the Company's insurance
policies. The $1.8 million insurance recoverable is included as a component of
other receivables of $700,000 and other assets of $1.1 million on the September
30, 2004 Summary Consolidated Balance Sheet. These amounts represent
management's estimate of the probable losses and anticipated recoveries related
to unreported product liability claims related to services performed and
products sold prior to September 30, 2004. Actual results may differ from this
estimate.
15
Class Action Lawsuit
Several putative class action lawsuits were filed in July through September 2002
against the Company and certain officers of the Company, alleging violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 based on a
series of purportedly materially false and misleading statements to the market.
The suits were consolidated, and a consolidated amended complaint filed, that
principally alleges that the Company made misrepresentations and omissions
relating to product safety and the Company did not comply with certain FDA
regulations regarding the handling and processing of certain tissues and other
product safety matters. The consolidated complaint seeks certification of a
class of purchasers between April 2, 2001 and August 14, 2002, compensatory
damages, and other expenses of litigation. The Company and the other defendants
filed a motion to dismiss the consolidated complaint on February 28, 2003, which
motion the U.S. District Court for the Northern District of Georgia denied in
part and granted in part on May 27, 2003. The discovery phase of the case
commenced on July 16, 2003. On December 16, 2003, the Court certified a class of
individuals and entities who purchased or otherwise acquired CryoLife stock from
April 2, 2001 through August 14, 2002. At present, the case is in the expert
discovery phase. Although the Company carries directors' and officers' liability
insurance policies, the directors' and officers' liability insurance carriers
have issued reservation of rights letters reserving their rights to deny or
rescind coverage under the policies. An adverse judgment in excess of the
Company's available insurance coverage could have a material adverse effect on
the Company's financial position, results of operations, and cash flows. At this
time, the Company is unable to predict the outcome of this litigation.
Therefore, the Company has not recorded any accruals for future expenses related
to this case, as the Company is currently unable to estimate these amounts. As
of September 30, 2004 the Company had accrued $571,000 for legal fees incurred
but unpaid related to this case and recorded an asset of $571,000 representing
the anticipated recovery of these fees from the Company's insurance carrier. The
$571,000 accrual is included as a component of accrued expenses and other
current liabilities and the $571,000 insurance receivable is included as a
component of other receivables, net on the September 30, 2004 Summary
Consolidated Balance Sheet. The Company believes that the receivable will be
fully collectible.
Shareholder Derivative Action
On August 30, 2002 a purported shareholder derivative action was filed by
Rosemary Lichtenberger against Steven G. Anderson, Albert E. Heacox, John W.
Cook, Ronald C. Elkins, Virginia C. Lacy, Ronald D. McCall, Alexander C.
Schwartz, and Bruce J. Van Dyne in the Superior Court of Gwinnett County,
Georgia. The suit, which names the Company as a nominal defendant, alleges that
the individual defendants breached their fiduciary duties to the Company by
causing or allowing the Company to engage in certain inappropriate practices
that caused the Company to suffer damages. The complaint was preceded by one day
by a letter written on behalf of Ms. Lichtenberger demanding that the Company's
Board of Directors take certain actions in response to her allegations. On
January 16, 2003 another purported derivative suit alleging claims similar to
those of the Lichtenberger suit was filed in the Superior Court of Fulton County
by complainant Robert F. Frailey. As in the Lichtenberger suit, the filing of
the complaint in the Frailey action was preceded by a demand letter sent on
Frailey's behalf to the Company's Board of Directors. Both complaints seek
undisclosed damages, costs and attorney's fees, punitive damages, and
prejudgment interest against the individual defendants derivatively on behalf of
the Company. As previously disclosed, the Company's Board of Directors has
established an independent committee to investigate the allegations of Ms.
Lichtenberger and Mr. Frailey. The independent committee engaged independent
legal counsel to assist in the investigation, which culminated in a report by
the committee concluding that no officer or director breached any fiduciary
duty. In October 2003 the two derivative suits were consolidated into one action
in the Superior Court of Fulton County, and a consolidated amended complaint was
filed. The independent committee, along with its independent legal counsel,
evaluated the consolidated amended complaint and concluded that its prior report
and determination addressed the material allegations contained in the
consolidated amended complaint. The committee reiterated its previous
conclusions and determinations, including that maintaining the derivative
litigation is not in the best interests of the Company. Based on the report of
the independent committee, the Company moved to dismiss the derivative
litigation in May 2004. That motion remains pending. At this time, the Company
is unable to predict the outcome of this litigation. Although the derivative
suit is brought nominally on behalf of the Company, the Company expects to
continue to incur defense costs and other expenses in connection with the
derivative litigation.
16
SEC Investigation
On August 19, 2002 the Company issued a press release announcing that on August
17, 2002, the Company received a letter from the Atlanta District Office of the
SEC inquiring regarding certain matters relating to the Company's August 14,
2002 announcement of the recall order issued by the FDA. The SEC notified the
Company in July 2003 that the inquiry became a formal investigation in June
2003. CryoLife has cooperated with this investigation both before and after
issuance of the formal order of investigation in June 2003 and intends to
continue doing so. CryoLife voluntarily reported the names of six employees and
former employees to the SEC in December 2002 after discovering they had
apparently sold CryoLife shares on August 14, 2002, before trading was halted
pending CryoLife's press release reporting the FDA Order. These individuals were
not and are not executive officers of CryoLife. The formal order of
investigation indicates that the SEC's scope includes whether, during 2002,
among other things, CryoLife or others may have traded while in possession of
material nonpublic information, made (or caused to be made) false or misleading
statements or omissions in press releases and SEC filings, and failed to
maintain accurate records and adequate controls. The investigation could also
encompass matters not specifically identified in the formal order. As of the
date hereof, the SEC has had no discussions with CryoLife representatives as to
whether or against whom it will seek relief, or the nature of any relief that
may be sought. At present, CryoLife is unable to predict the ultimate focus or
outcome of the investigation, or when it will be completed. An unfavorable
outcome could have a material adverse effect on CryoLife's reputation, business,
financial position, results of operations, and cash flows.
Other Litigation
In October 2003 an action was filed against multiple defendants, including
the Company, titled Donald Payne and Candace Payne v. Community Blood Center, et
al., in the Circuit Court of the State of Oregon, County of Multnomah, seeking
noneconomic damages of $9.0 million and other damages of $4.7 million. The suit
alleged that Mr. Payne received a tissue implant processed by one of the other
defendants, and that he was subsequently diagnosed with an infection attributed
to the implant. The claim against the Company asserted that CryoLife had
processed tissue from the same donor and been notified that a recipient of that
tissue had contracted the same virus, and further that the Company had a duty to
notify governmental authorities and the other defendants. A second action,
titled L.L.R. and W.C.R. v. Community Blood Center, et al., was filed in October
2003 in the same court as the Payne case, against the same defendants, seeking
the same amounts of damages. In this case the plaintiffs alleged the recipient
received an implant processed by the same co-defendant tissue processor, from
the same donor as Mr. Payne, and contracted an infection. In late July 2004 a
third action was filed against multiple defendants, including the Company,
titled Anthony F. Spadaro v. Community Blood Center, et al., in the same court
as the other two cases, seeking noneconomic damages of $6.0 million, $1.7
million in economic damages, and punitive and exemplary damages. This suit
alleged that Mr. Spadaro received a tissue implant processed by the same
defendant tissue processor that was named in the other two suits, and that he
was subsequently diagnosed with an infection attributed to the implant. This
claim also asserted that the Company had processed tissue from the same donor
and been notified that a recipient of the tissue had contracted the same virus,
and that the Company had a duty to notify governmental authorities and the other
defendants.
The trial for the Payne and L.L.R. cases began on October 18, 2004.
CryoLife reached a settlement agreement with the plaintiffs on October 25, 2004
concerning the Payne, L.L.R. and Spadaro cases totaling $3.0 million in the
aggregate, which CryoLife agreed to pay no later than November 5, 2004. The
Company did not have insurance coverage for these claims. The $3.0 million is
included in the Company's general, administrative and marketing expenses for the
three months ended September 30, 2004. A cross-claim for indemnification by
another defendant was dismissed earlier in the lawsuit because the claim is
subject to a contractual obligation to arbitrate. As of the date of this filing,
the arbitration clause has not been invoked by either party. Although the
Company believes there are defenses it can assert against such a claim and would
defend it vigorously, such a claim, if successfully brought, would not be
insured and could have a material impact on the Company's liquidity and
financial condition.
17
PART I - FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
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
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.
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, and executed thereafter. The corrective actions
taken have been reviewed by the FDA during three subsequent inspections as
discussed in "Other FDA Correspondence and Notices" below.
OTHER FDA CORRESPONDENCE AND NOTICES
FDA Form 483 Notices of Observations 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. On September 24, 2004 CryoLife received an inquiry from the FDA Atlanta
District Office seeking additional information on four items submitted by
CryoLife in response to the February 2004 483. CryoLife has been in discussion
with the agency regarding this request and will submit its response in the
fourth quarter of 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(R) SG
and that premarket approval marketing authorization should be obtained for the
Company's CryoVein(R) SG when marketed or labeled as an arteriovenous ("A-V")
access graft. The agency's position is that use of the SynerGraft(R) 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
18
additional information be provided to support the 510(k) premarket notification
for the CryoValve SG. On August 24, 2004, the Company submitted an amendment to
its original 510(k) submission providing clarification and additional
information to address the issues raised by the FDA. The FDA may still 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 CryoValve SG. On September 14, 2004, the
Company met with the FDA to discuss the data to be used to support a Request for
Designation ("RFD") filing for SynerGraft processed cardiovascular tissue,
including the CryoVein SG. The Company submitted the RFD on October 5, 2004. 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 has 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 September 30, 2004, the Company wrote down
$353,000 in SynerGraft processed cardiovascular and vascular tissues. As of
September 30, 2004 the Company has no additional deferred preservation costs
related to SynerGraft processed tissues on its Summary Consolidated Balance
Sheet.
CRITICAL ACCOUNTING POLICIES
A summary of the Company's significant accounting policies is included in Note 1
to the consolidated financial statements, as filed in the Form 10-K for the
fiscal year ended December 31, 2003. Management believes that the consistent
application of these policies enables the Company to provide users of the
financial statements with useful and reliable information about the Company's
operating results and financial condition. The consolidated financial statements
are prepared in accordance with accounting principles generally accepted in the
United States, which require the Company to make estimates and assumptions. The
following are accounting policies that management believes are most important to
the portrayal of the Company's financial condition and results and may involve a
higher degree of judgment and complexity.
PRODUCT LIABILITY CLAIMS: In the normal course of business as a medical device
and services company, the Company has product liability complaints filed against
it. Following the FDA Order, a greater number of lawsuits than has historically
been experienced have been filed. As of November 3, 2004 the Company was aware
of ten pending product liability lawsuits. The lawsuits are currently in the
pre-discovery or discovery stages. Of these lawsuits, four allege product
liability claims arising out of the Company's orthopaedic tissue services, four
allege product liability claims arising out of the Company's allograft heart
valve tissue services, one alleges product liability claims arising from
BioGlue, and one alleges product liability claims arising out of the non-tissue
products made by Ideas for Medicine, Inc. when it was a subsidiary of the
Company.
Of the ten open lawsuits a total of four are covered by the Company's insurance
coverage as follows: two lawsuits by the 2000/2001 insurance policy, one by the
2003/2004 insurance policy and one by the 2004/2005 insurance policy. For the
2000/2001 insurance policy year the Company maintained claims-made insurance
policies which the Company believes to be adequate to defend against the suits
filed during this period. As of September 30, 2004 the Company had an accrual of
$100,000 for the remaining retention levels related to the 2000/2001 insurance
policy year. The Company believes its 2003/2004 and 2004/2005 insurance policies
to be adequate to defend against the covered suit filed during each of these
time periods.
Of the ten open lawsuits the remaining six are not covered by the Company's
insurance policies as either these lawsuits relate to the 2002/2003 insurance
policy year for which the Company has used all of its insurance coverage,
aggregating $25 million, or they were asserted in periods after the coverage in
the related incident year had lapsed. Other product liability claims have been
asserted against the Company that have not resulted in lawsuits. The Company is
monitoring these claims.
19
The Company performed an analysis as of September 30, 2004 of the pending
product liability claims based on settlement negotiations to date and advice
from counsel. As of September 30, 2004 the Company had accrued a total of $1.8
million for pending product liability claims and recorded zero representing
amounts to be recovered from the Company's insurance carriers. The $1.8 million
accrual is included as a component of accrued expenses and other current
liabilities on the September 30, 2004 Summary Consolidated Balance Sheet. This
amount represents the Company's estimate of the probable losses and anticipated
recoveries related to six of the ten pending product liability claims. The
Company has not recorded an accrual for the remaining four product liability
claims because management has concluded that either a loss is remote or that,
although a loss is reasonably possible or probable, a reasonable estimate of
that loss or the range of losses cannot be made at this time. The amount
recorded as a liability is reflective of estimated legal fees and settlement
costs related to these claims and does not reflect actual settlement
arrangements, actual judgments, including punitive damages, which may be
assessed by the courts, or cash set aside for the purpose of making payments.
Prior to 2004, the Company recorded accruals for the uninsured portion of
product liability claims for which the amount of probable loss was reasonably
estimable. Had the Company recorded the total amounts of the reasonably
estimable probable losses as a liability and recorded an asset for the estimated
amount recoverable from the insurance carrier, the impact on the financial
statements as of December 31, 2003 would not have been material. The Company's
product liability insurance policies do not include coverage for any punitive
damages, which may be assessed at trial. The Company is currently unable to
reasonably estimate the maximum amount of the possible loss related to these
claims, as many of the claims do not specify the damages sought and the Company
does not have a reasonable method for estimating the amount of compensatory or
punitive damages that could be assessed by a trial jury. Additionally, if the
Company is unable to settle the outstanding claims for amounts within its
ability to pay or one or more of the product liability claims in which the
Company is a defendant should be tried with a substantial verdict rendered in
favor of the plaintiff(s), there can be no assurance that such verdict(s) would
not exceed the Company's available insurance coverage and liquid assets. Failure
by the Company to meet required future cash payments to resolve the outstanding
product liability claims would have a material adverse effect on the financial
position, results of operations, and cash flows of the Company.
On April 1, 2004 the Company bound coverage for the 2004/2005 insurance policy
year. This policy is a two-year claims made insurance policy, i.e. claims
incurred during the period April 1, 2003 through March 31, 2005 and reported
during the period April 1, 2004 through March 31, 2005 are covered by this
policy. Claims incurred prior to April 1, 2003 that have not been reported are
uninsured.
The Company maintains claims-made insurance policies to mitigate its financial
exposure to product liability claims. Claims-made insurance policies generally
cover only those asserted claims and incidents that are reported to the
insurance carrier while the policy is in effect. Thus, a claims-made policy does
not generally represent a transfer of risk for claims and incidents that have
been incurred but not reported to the insurance carrier during the policy
period. The Company periodically evaluates its exposure to unreported product
liability claims, and records accruals as necessary for the estimated cost of
unreported claims related to services performed and products sold. In July 2004,
the Company retained an independent actuarial firm to perform revised estimates
of the unreported claims as of June 30, 2004 and December 31, 2004. The
independent firm estimated the unreported product loss liability using a
frequency-severity approach, whereby projected losses were calculated by
multiplying the estimated number of claims by the estimated average cost per
claim. The estimated claims were calculated based on the reported claim
development method and the Bornhuetter-Ferguson method using a blend of the
Company's historical claim experience and industry data. The estimated cost per
claim was calculated using a lognormal claims model blending the Company's
historical average cost per claim with industry claims data. The independent
actuarial firm used a number of assumptions in order to estimate the unreported
product loss liability including:
o A ceiling of $5 million was selected for actuarial purposes in
determining the liability per claim given the uncertainty in
projecting claim losses in excess of $5 million,
o The future claim reporting lag time would be a blend of the Company's
experiences and industry data,
o The frequency of unreported claims for accident years 2001 through
2004 would be lower than the Company experienced during the 2002/2003
policy year, but higher than the Company's historical claim frequency
in prior policy years,
o The average cost per claim would be lower than the Company experienced
during the 2002/2003 policy year, but higher than the Company's
historical cost per claim in prior policy years,
20
o The average cost per BioGlue claim would be consistent with the
Company's overall historical exposures until adequate historical data
is available on this product line, and
o The number of BioGlue claims per million dollars of BioGlue revenue
would be 10% lower than non-BioGlue claims per million dollars to
adjust for the increase of BioGlue revenue as a percentage of total
revenues since 2002 and the BioGlue claims history to date.
The Company believes that these assumptions provide a reasonable basis for the
calculation of the unreported product liability loss, but actual developments
could differ materially from the assumptions above. The accuracy of the
actuarial firm's estimates is limited by the general uncertainty that exists for
any estimate of future activity and uncertainties surrounding the assumptions
used and due to Company specific conditions including the FDA Order, the
Company's recent levels of litigation activity, the Company's low volume of
historical claims, and the scarcity of industry data directly relevant to the
Company's business activities. Due to these factors actual results may differ
significantly from the amounts accrued.
Beginning April 1, 2004 and concurrent with signing the claims-made insurance
policy for the policy year from April 1, 2004 to March 31, 2005, the Company
implemented the provisions of Emerging Issues Task Force Issue 03-8, Accounting
for Claims-Made Insurance and Retroactive Contracts by the Insured Entity ("EITF
03-8"). Pursuant to EITF 03-8, the Company continues to record an estimated
liability for unreported product liability claims and has begun to record a
related recoverable from insurance. Prior to the effective date of EITF 03-8,
the Company did not record a recoverable from insurance related to the
unreported product liability claims.
Based on the actuarial valuation performed in July 2004 as of June 30, 2004 and
December 31, 2004, the Company estimated that its liability for unreported
product liability claims was $8.0 million as of June 30, 2004 and would be $8.7
million as of December 31, 2004. In accordance with EITF 03-8, the Company has
accrued a prorated amount of $8.4 million, representing the Company's best
estimate of the total liability for unreported product liability claims related
to services performed and products sold prior to September 30, 2004. The $8.4
million balance is included as a component of accrued expenses and other current
liabilities of $4.3 million and other long-term liabilities of $4.1 million on
the September 30, 2004 Summary Consolidated Balance Sheet. Further analysis
indicated that the liability could be estimated to be as high as $14.6 million,
after including a reasonable margin for statistical fluctuations calculated
based on actuarial simulation techniques. Based on the actuarial valuation, the
Company estimated that as of September 30, 2004, $1.8 million of the accrual for
unreported liability claims would be recoverable under the Company's insurance
policies. The $1.8 million insurance recoverable is included as a component of
other receivables of $700,000 and other assets of $1.1 million on the September
30, 2004 Summary Consolidated Balance Sheet. These amounts represent
management's estimate of the probable losses and anticipated recoveries related
to unreported product liability claims related to services performed and
products sold prior to September 30, 2004. Actual results may differ from this
estimate.
DEFERRED PRESERVATION COSTS: Tissue is procured from deceased human donors by
organ and tissue procurement agencies, which consign the tissue to the Company
for processing and preservation. Preservation costs related to tissue held by
the Company are deferred until revenue is recognized upon shipment of the tissue
to the implanting facilities. Deferred preservation costs consist primarily of
direct labor and materials including laboratory expenses, tissue procurement
fees, freight-in charges, and fringe benefits, and indirect costs including
allocations of costs from departments that support processing activities and
facility allocations. Deferred preservation costs are stated, net of reserve, on
a first-in, first-out basis.
The calculation of deferred preservation costs includes a high degree of
judgment and complexity. The costs included in deferred preservation costs
contain several estimates due to the timing differences between the occurrence
of the cost and receipt of final bills for services. Costs that contain
estimates include tissue procurement fees, which are estimated based on the
Company's contracts with independent procurement agencies, and freight-in
charges, which are estimated based on the Company's prior experiences with these
charges. These costs are adjusted for differences between estimated and actual
fees when invoices for these services are received. Management believes that its
estimates approximate the actual costs of these services, but estimates could
differ from actual costs. Total deferred preservation costs are then allocated
among the different tissues processed during the period based on specific cost
drivers such as the number of donors and the number of tissues processed. At
each balance sheet date a portion of the deferred preservation costs relates to
tissues currently in active processing or held in quarantine pending release to
implantable status. The Company applies a yield estimate to all tissues in
process and in quarantine to estimate the portion of tissues that will
21
ultimately become implantable. Management determines this estimate of quarantine
yields based on its experience in prior periods and reevaluates this estimate
periodically. Due to the nature of this estimate and the length of the
processing times experienced by the Company, actual yields could differ from the
Company's estimates. A significant change in quarantine yields could materially
affect the deferred preservation costs per tissue, which could impact the value
of deferred preservation costs on the Company's balance sheet and the cost of
preservation services, including the lower of cost or market write-down, on the
Company's Summary Consolidated Statement of Operations.
During 2002 the Company recorded write-downs of deferred preservation costs
totaling $32.7 million. These write-downs were recorded as a result of the FDA
Order as discussed in "FDA Order on Human Tissue Preservation" above. The amount
of these write-downs reflected management's estimates based on information
available to it at the time the estimates were made and actual results did
differ from these estimates. The write-down created a new cost basis, which
cannot be written back up if these tissues become available for distribution.
The cost of human tissue preservation services has been favorably affected by
tissue shipments that were related to previously written-down deferred
preservation costs. The cost of human tissue preservation services may continue
to be favorably affected depending on the future level of tissue shipments
related to previously written-down deferred preservation costs, but such impact
is not expected to be material. Management continues to evaluate the
recoverability of the deferred preservation costs and will record additional
write-downs if it becomes clear that additional impairments have occurred.
The Company regularly evaluates its deferred preservation costs to determine if
the costs are appropriately recorded at the lower of cost or market value. The
Company recorded $1.2 million and $6.0 million, respectively, in the three and
nine months ended September 30, 2004 and $1.8 million and $3.2 million,
respectively, in the three and nine months ended September 30, 2003 as an
increase to cost of preservation services to write-down the value of certain
deferred tissue preservation costs from tissues that exceeded market value. The
amount of these write-downs reflects management's estimates of market value
based on recent average service fees. Actual results may differ from these
estimates.
As of September 30, 2004 deferred preservation costs were $2.6 million for
allograft heart valve tissues, $268,000 for non-valved cardiac tissues, $2.6
million for vascular tissues, and $2.5 million for orthopaedic tissues.
DEFERRED INCOME TAXES: Deferred income taxes reflect the net tax effect of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and tax return purposes. The Company generated
deferred tax assets beginning in 2002 primarily as a result of write-downs of
deferred preservation costs, accruals for product liability claims, and
operating losses, reflecting reductions in revenues and additional professional
fees, as a result of the FDA Order, subsequent FDA activity, and reported tissue
infections. The Company continued to generate deferred tax assets for the three
and nine months ended September 30, 2004 primarily as a result of operating
losses and expects to do so for the remainder of 2004. The Company periodically
assesses the recoverability of deferred tax assets and provides a valuation
allowance when management believes it is more likely than not that its deferred
tax assets will not be realized.
The Company evaluated several factors to determine if a valuation allowance
relative to its deferred tax assets was necessary during 2003. The Company
reviewed its historic operating results, including the reasons for its operating
losses in 2003 and 2002, uncertainties regarding projected future operating
results due to the effects of the adverse publicity resulting from the FDA
Order, subsequent FDA activity, and reported tissue infections, the changes in
processing methods resulting from the FDA Order, and the uncertainty of the
outcome of product liability claims. Based on the results of this analysis, the
Company determined that it was more likely than not that the Company's deferred
tax assets would not be realized. Therefore, during 2003 the Company recorded
valuation allowances totaling $13.7 million due to the effect of temporary
differences between book and tax income, the net deferred tax assets generated
in 2003, and the net deferred tax asset balance as of December 31, 2002. For the
three and nine months ended September 30, 2004 the Company did not experience
any changes that would materially affect the Company's analysis of and valuation
of its deferred tax assets. As of September 30, 2004 the Company had a total of
$21.2 million in valuation allowances against deferred tax assets and a net
deferred tax asset balance of zero.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS: The Company assesses the
impairment of its long-lived, identifiable intangible assets annually and
whenever events or changes in circumstances indicate that the carrying value may
22
not be recoverable. Factors that management considers important that could
trigger an impairment review include the following:
o Significant underperformance relative to expected historical or
projected future operating results,
o Significant negative industry or economic trends,
o Significant decline in the Company's stock price for a sustained
period, and
o Significant decline in the Company's market capitalization relative to
net book value.
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), requires the
write-down of a long-lived asset to be held and used if the carrying value of
the asset or the asset group to which the asset belongs is not recoverable. 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. In applying SFAS 144, the
Company defined the specific asset groups used to perform the cash flow
analysis. The Company defined the asset groups at the lowest level possible, by
identifying the cash flows from groups of assets that could be segregated from
the cash flows of other assets and liabilities. Using this methodology, the
Company determined that its asset groups consisted of the long-lived assets
related to the Company's two reporting segments. As the Company does not
segregate assets by segment, the Company allocated assets to the two reporting
segments based on factors including facility space and revenues. The Company
used an eleven-year period for the undiscounted future cash flows. This period
of time was selected based upon the approximate 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, 2004 and, therefore, management has concluded that there was
not an impairment of the Company's long-lived intangible assets 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 and the future effects of events surrounding the FDA
Order, these assets may become impaired. Management will continue to evaluate
the recoverability of these assets in accordance with SFAS 144.
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), requires goodwill resulting from business
acquisitions and other intangible assets be subject to periodic impairment
testing. The Company's intangible assets consist of patent costs, which are
amortized over the expected useful lives of the patents (primarily 17 years)
using the straight-line method, trademarks, which are non-amortizing, and other
intangibles, which consist primarily of manufacturing rights and agreements and
are amortized over the expected useful lives of the related assets (primarily
five years). As of September 30, 2004 the Company did not believe that an
impairment existed related to the other intangible assets that were assessed in
accordance with SFAS No. 144.
NEW ACCOUNTING PRONOUNCEMENTS
The Company was required to adopt EITF issue 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
("EITF 03-1"). The Company adopted the recognition and measurement guidance of
EITF 03-1 for the interim period ending September 30, 2004 and will adopt the
annual disclosure requirements for its year ended December 31, 2004. EITF 03-1
clarifies the definition of and accounting treatment for other-than-temporary
losses on debt and equity investments. The adoption of EITF 03-1 did not have a
material effect on the results of operations or financial position of the
Company.
23
RESULTS OF OPERATIONS
(IN THOUSANDS)
REVENUES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2004 2003 2004 2003
------------------------------- ------------------------------
Revenues $ 16,118 $ 15,097 $ 46,518 $ 46,730
Revenues increased 7% and 0%, respectively, for the three and nine months ended
September 30, 2004 as compared to the three and nine months ended September 30,
2003. The 7% increase in revenues for the three month period was primarily due
to an increase in revenues from sales of BioGlue Surgical Adhesive, partially
offset by decreases in cardiovascular and vascular tissue preservation service
revenues compared to the prior year quarter. Revenues for the nine month period
ended September 30, 2004 included an increase in revenues from sales of BioGlue
Surgical Adhesive and decreases in cardiovascular and vascular tissue
preservation service revenues compared to the prior year period.
Further discussion of the increase in BioGlue revenues and the decrease in
cryopreservation service revenues for each of the three major tissue types
processed by the Company continues in the detailed sections below.
BIOGLUE SURGICAL ADHESIVE
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2004 2003 2004 2003
------------------------------- ------------------------------
Revenues $ 8,914 $ 6,694 $ 26,519 $ 20,027
BioGlue revenues as a
percentage of total revenue 55% 44% 57% 43%
Revenues from the sale of BioGlue Surgical Adhesive increased 33% and 32%,
respectively, for the three and nine months ended September 30, 2004 as compared
to the three and nine months ended September 30, 2003. The 33% increase in
revenues for the three months ended September 30, 2004 was primarily due to an
increase in average selling prices which increased revenues by 24%, and an
increase in BioGlue sales volume as a result of an increase in foreign and
domestic demand which increased revenues by 9%. The 32% increase in revenues for
the nine months ended September 30, 2004 was primarily due to an increase in
average selling prices which increased revenues by 18%, and an increase in
BioGlue sales volume as a result of an increase in foreign and domestic demand
which increased revenues by 14%.
The Company experienced volume increases in the 2ml, 5ml, and 10ml sizes as well
as BioGlue applicator tips and delivery devices in the nine months ended
September 30, 2004The Company introduced a new BioGlue syringe product in the
second quarter of 2004, which resulted in volume growth in both the three and
nine months ended September 30, 2004. Price increases in the three and nine
months ended September 30, 2004 were largely due to list price increases for
BioGlue that went into effect on December 1, 2003 domestically and in early 2004
internationally. Domestic revenues accounted for 78% of total BioGlue revenues
for each of the three and nine month periods ended September 30, 2004, compared
to 75% and 77%, respectively, of total BioGlue revenues for the three and nine
months ended September 30, 2003.
The Company anticipates that revenues from BioGlue Surgical Adhesive will
continue to grow for the full year 2004 when compared to 2003 due to domestic
and foreign increases in sales volume and previously implemented price
increases.
24
CARDIOVASCULAR PRESERVATION SERVICES
Three Month