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 March 31, 2005
Commission File Number 1-13165
CRYOLIFE, INC.
(Exact name of registrant as specified in its charter)
_________________
| Florida | 59-2417093 |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
1655 Roberts Boulevard,
NW
Kennesaw, Georgia 30144
(Address of principal executive offices)
(zip code)
(770) 419-3355
(Registrant’s telephone number, including area code)
Not Applicable
Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X] NO [_]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [_]
The number of shares of common stock, par value $0.01 per share, outstanding on May 2, 2005 was 23,714,340.
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 March 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2005 |
2004 | |||||||
| (Unaudited) | ||||||||
| Revenues: | ||||||||
| Products | $ | 10,127 | $ | 8,859 | ||||
| Human tissue preservation services | 7,538 | 6,225 | ||||||
| Research grants | -- | 2 | ||||||
| Total revenues | 17,665 | 15,086 | ||||||
| Costs and expenses: | ||||||||
| Products | 2,116 | 1,947 | ||||||
| Human tissue preservation services | 5,899 | 9,103 | ||||||
| (Including write-down of $280 in 2005 | ||||||||
| and $3,650 in 2004) | ||||||||
| General, administrative, and marketing | 10,056 | 10,148 | ||||||
| Research and development | 921 | 921 | ||||||
| Interest expense | 55 | 43 | ||||||
| Interest income | (75 | ) | (66 | ) | ||||
| Change in valuation of derivative | (118 | ) | -- | |||||
| Other expense, net | 130 | 16 | ||||||
| Total costs and expenses | 18,984 | 22,112 | ||||||
| Loss before income taxes | (1,319 | ) | (7,026 | ) | ||||
| Income tax benefit | 38 | -- | ||||||
| Net loss | $ | (1,357 | ) | $ | (7,026 | ) | ||
| Effect of preferred stock | (46 | ) | -- | |||||
| Net loss applicable to common shares | $ | (1,403 | ) | $ | (7,026 | ) | ||
| Loss per common share: | ||||||||
| Basic | $ | (0.06 | ) | $ | (0.32 | ) | ||
| Diluted | $ | (0.06 | ) | $ | (0.32 | ) | ||
| Weighted average common shares outstanding: | ||||||||
| Basic | 23,440 | 22,241 | ||||||
| Diluted | 23,908 | 22,241 | ||||||
See accompanying notes to summary consolidated financial statements.
2
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
| March 31, 2005 |
December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| ASSETS | (Unaudited) | |||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 22,404 | $ | 4,713 | ||||
| Marketable securities, at market | 3,159 | 3,956 | ||||||
| Restricted cash and securities | 565 | 563 | ||||||
| Trade receivables, net | 9,238 | 8,293 | ||||||
| Other receivables | 8,091 | 3,957 | ||||||
| Deferred preservation costs, net | 9,402 | 8,822 | ||||||
| Inventories | 4,716 | 4,767 | ||||||
| Prepaid expenses and other assets | 1,897 | 2,590 | ||||||
| Total current assets | 59,472 | 37,661 | ||||||
| Property and equipment, net | 27,762 | 28,724 | ||||||
| Patents, net | 4,964 | 4,978 | ||||||
| Other | 2,410 | 1,898 | ||||||
| TOTAL ASSETS | $ | 94,608 | $ | 73,261 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | 4,075 | $ | 2,569 | ||||
| Accrued expenses and other current liabilities | 12,839 | 9,615 | ||||||
| Accrued compensation | 1,508 | 1,835 | ||||||
| Accrued procurement fees | 2,660 | 2,634 | ||||||
| Derivative liability | 868 | -- | ||||||
| Current maturities of capital lease obligations | 1,201 | 1,319 | ||||||
| Total current liabilities | 23,151 | 17,972 | ||||||
| Capital lease obligations, less current maturities | 457 | 530 | ||||||
| Other long-term liabilities | 5,273 | 5,099 | ||||||
| Total liabilities | 28,881 | 23,601 | ||||||
| Shareholders' Equity: | ||||||||
| Preferred stock (397 issued shares in 2005) | 4 | -- | ||||||
| Common stock (24,854 issued shares in 2005 and | ||||||||
| 24,805 shares in 2004) | 248 | 248 | ||||||
| Additional paid-in capital | 112,291 | 94,846 | ||||||
| Retained deficit | (39,614 | ) | (38,257 | ) | ||||
| Deferred compensation | (162 | ) | (222 | ) | ||||
| Accumulated other comprehensive income | 278 | 361 | ||||||
| Treasury stock at cost (1,390 shares in 2005 and | ||||||||
| 1,390 shares in 2004) | (7,318 | ) | (7,316 | ) | ||||
| Total shareholders' equity | 65,727 | 49,660 | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 94,608 | $ | 73,261 | ||||
See accompanying notes to summary consolidated financial statements.
3
Item 1. Financial Statements
CRYOLIFE, INC.
SUMMARY CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
| Three Months Ended March 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2005 |
2004 | |||||||
| (Unaudited) | ||||||||
| Net cash from operating activities: | ||||||||
| Net loss | $ | (1,357 | ) | $ | (7,026 | ) | ||
| Adjustments to reconcile net loss to net cash | ||||||||
| from operating activities: | ||||||||
| Loss on sale of assets | 121 | -- | ||||||
| Depreciation and amortization | 1,306 | 1,349 | ||||||
| Provision for doubtful accounts | 24 | 24 | ||||||
| Write-down of deferred preservation costs | 280 | 3,650 | ||||||
| Other non-cash adjustments to income | -- | 4 | ||||||
| Non-cash employee compensation | 60 | -- | ||||||
| Change in valuation of derivative | (118 | ) | -- | |||||
| Changes in operating assets and liabilities: | ||||||||
| Receivables | (1,173 | ) | (3,180 | ) | ||||
| Income taxes | 142 | 41 | ||||||
| Deferred preservation costs and inventories | (809 | ) | (1,986 | ) | ||||
| Prepaid expenses and other assets | 242 | 1,054 | ||||||
| Accounts payable, accrued expenses, and other liabilities | (102 | ) | 729 | |||||
| Net cash used in operating activities | (1,384 | ) | (5,341 | ) | ||||
| Net cash from investing activities: | ||||||||
| Capital expenditures | (211 | ) | (119 | ) | ||||
| Other assets | (66 | ) | 182 | |||||
| Sales and maturities of marketable securities | 775 | 2,000 | ||||||
| Net cash provided by investing activities | 498 | 2,063 | ||||||
| Net cash from financing activities: | ||||||||
| Proceeds from debt issuance | 265 | -- | ||||||
| Principal payments of debt | (265 | ) | -- | |||||
| Payment of obligations under capital leases | (191 | ) | (170 | ) | ||||
| Proceeds from equity offerings | 18,711 | 19,891 | ||||||
| Proceeds from exercise of stock options and | ||||||||
| issuance of common stock | 134 | 100 | ||||||
| Net cash provided by financing activities | 18,654 | 19,821 | ||||||
| Increase in cash and cash equivalents | 17,768 | 16,543 | ||||||
| Effect of exchange rate changes on cash | (77 | ) | (66 | ) | ||||
| Cash and cash equivalents, beginning of period | 4,713 | 5,672 | ||||||
| Cash and cash equivalents, end of period | $ | 22,404 | $ | 22,149 | ||||
See accompanying notes to summary consolidated financial statements.
4
CRYOLIFE, INC. AND
SUBSIDIARIES
NOTES TO SUMMARY CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The accompanying unaudited summary consolidated financial statements have been prepared in accordance with (i) accounting principles generally accepted in the United States for interim financial information and (ii) the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the United States Securities and Exchange Commission (“SEC”). Accordingly, the statements do not include all of the information and disclosures required by accounting principles generally accepted in the United States for a complete presentation of financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004.
The Company expects that the following factors will continue to have an adverse impact on cash flows during 2005:
| o | The anticipated lower preservation services revenues as compared to preservation revenues prior to the FDA Order, subsequent FDA activities, 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, although at levels expected to be lower than the levels seen in 2003 and 2004, and |
| o | The legal and professional costs related to ongoing FDA compliance. |
The Company believes the following factors should have a favorable impact on cash flow from operations during 2005, although there can be no assurance that the Company’s efforts will be successful:
| o | Expected increases in revenues due to increases in BioGlue list prices implemented in January 2005, |
| o | Expected increases in the service fees for cardiovascular and vascular tissues due to fee increases implemented in July 2004 and January 2005, to reflect the higher cost of processing these tissues, |
| o | Anticipated improvements in yields of implantable tissues per donor over the levels experienced in 2003 and 2004 through process changes and process directives, |
| o | Expected increases in procurement of human tissues for processing over the levels experienced in 2004, and |
| o | Anticipated decreases in cash payments related to insurance premiums. |
The Company believes that its existing cash, cash equivalents, marketable securities, and available borrowings under its credit agreement, discussed in Note 6, will enable the Company to meet its liquidity needs through at least March 31, 2006.
The Company’s long term liquidity and capital requirements will depend upon numerous factors, including:
5
| o | The success of BioGlue and other products using related technology, |
| o | The Company's ability to increase the level of tissue procurement and demand for its tissue preservation services, |
| 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 resolution of the remaining outstanding product liability lawsuits and other claims (see Note 13), |
| o | The outcome of other litigation against the Company (see Note 13), and |
| o | To a lesser degree, the Company’s success at resolving the issues with the FDA regarding SynerGraft processing of human tissue. |
If the Company is unable to address these issues and continues to experience negative cash flows, the Company anticipates that it may require additional financing or seek to raise additional funds through bank facilities, debt or equity offerings, or other sources of capital to meet liquidity and capital requirements beyond March 31, 2006. Additional funds may not be available when needed or on terms acceptable to the Company, which could have a material adverse effect on the Company’s business, financial condition, results of operations, and cash flows.
FDA Order
The FDA inspected the Company’s tissue processing operations in December 2001, after it was reported that a Minnesota man had died after receiving an implant of orthopaedic tissue processed by the Company. The FDA conducted another inspection in March 2002. In April 2002 the FDA issued a Form 483 Notice of Observations (“April 2002 483”) and an FDA Warning Letter was issued, dated June 17, 2002 (“Warning Letter”). 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”). 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 “FDA 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 FDA 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 FDA 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 FDA 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.
6
Other FDA Correspondence and Notices
FDA Form 483 Notices of Observations (“483”) were issued in connection with the FDA inspections of the Company’s facilities in February 2003, October 2003, and February 2004. The Company responded to the February 2003 483 in March 2003, responded to the October 2003 483 in October 2003, November 2003, and April 2004, and responded to the February 2004 483 in March 2004, April 2004, and June 2004. 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 to which CryoLife responded on November 8, 2004. In response to the Form 483 Notice of Observations, the Company has implemented new and revised existing processing, preservation, and testing procedures. The FDA may require the Company to implement additional corrective actions, perform additional validation testing, or supply additional information. 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 SynerGraft processed human cardiac tissues (“CryoValve® SG”) and that premarket approval marketing authorization should be obtained for the Company’s SynerGraft processed human vascular tissues (“CryoVein® SG”) when marketed or labeled as an arteriovenous (“A-V”) access graft. The agency’s position is that use of the SynerGraft® technology in the processing of allograft heart valves represents a modification to the Company’s legally marketed CryoValve allograft and that vascular allografts labeled for use as A-V access grafts are medical devices that require premarket approval.
On November 3, 2003 the Company filed a 510(k) premarket notification with the FDA for the CryoValve SG. On February 4, 2004 the Company received a letter from the FDA requesting additional information. On August 24, 2004, the Company submitted an amendment to its original 510(k) submission providing clarification and additional information. The FDA requested further additional information in November 2004. CryoLife anticipates responding to some of the additional requests and has initiated an appeal of others through administrative procedures. The FDA may still require that additional studies be undertaken and may never clear the 510(k) premarket notification. 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 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 September 14, 2004, the Company met with the FDA to discuss the data to be used to support a formal Request for Designation (“RFD”) filing for SynerGraft processed cardiovascular tissue, including the CryoVein SG. An RFD submission establishes the regulatory status of the tissue. The Company submitted the RFD on October 5, 2004. The FDA affirmed its original decision in letters received in December 2004. That decision is currently subject to an administrative appeal. Unless this appeal is successful, CryoLife will be unable to distribute tissues with the SynerGraft technology until further submissions and FDA clearances are granted. In the event that the Company is not successful in appealing the FDA’s decision to regulate SynerGraft vascular tissue as a medical device, the Company will evaluate whether it will file and seek a premarket approval for CryoVein SG or discontinue the CryoVein SG.
In 2003 the Company suspended the use of the SynerGraft technology in the processing of allograft tissue and the distribution of tissues on hand previously processed with the SynerGraft technology until the regulatory issues are resolved. Additionally, the Company discontinued labeling its vascular grafts for use as A-V access grafts. Until such time as the issues surrounding SynerGraft are resolved, the Company will employ its traditional processing methods on these tissues. During the year ended December 31, 2004, the Company wrote down $353,000 in SynerGraft processed cardiovascular and vascular tissues. As of March 31, 2005 the Company had no deferred preservation costs related to SynerGraft processed tissues on its Summary Consolidated Balance Sheet.
7
The Company maintains cash equivalents and investments in several large, well-capitalized financial institutions, and the Company’s policy disallows investment in any securities rated less than “investment-grade” by national rating services. Management determines the appropriate classification of its marketable securities at the time of purchase and reevaluates such designations quarterly.
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. Trading securities are securities that are acquired principally for the purpose of generating a profit from short-term fluctuations in price. Trading securities are stated at their fair values, with the realized and unrealized gains and losses, interest, and dividends included in investment income. Debt securities not classified as held-to-maturity or trading and marketable equity securities not classified as trading are classified as available-for-sale. Available-for-sale securities are stated at their fair values, with the unrealized gains and losses, net of applicable taxes, reported in a separate component of shareholders’ equity. Interest, 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.
As of March 31, 2005 $3.2 million of marketable securities were designated as available-for-sale, and $565,000 of marketable securities were designated as held-to-maturity. These securities were designated held-to-maturity due to a contractual commitment to hold the securities as pledged collateral relating to one of the Company’s product liability insurance policies, and are reported in the restricted cash and securities line of the March 31, 2005 Summary Consolidated Balance Sheet. As of December 31, 2004 $4.0 million of marketable securities were designated as available-for-sale, and $563,000 of marketable securities were designated as held-to-maturity.
The following is a summary of cash equivalents and marketable securities (in thousands):
| March 31, 2005 |
Cost Basis |
Unrealized Holding Gains |
Estimated Market Value | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Cash equivalents: | |||||||||||
| Money market funds | $ | 21,156 | $ | -- | $ | 21,156 | |||||
| Marketable securities: | |||||||||||
| Municipal obligations | $ | 3,136 | $ | 23 | $ | 3,159 | |||||
| Restricted securities: | |||||||||||
| Debt securities | $ | 565 | $ | -- | $ | 565 | |||||
| December 31, 2004 |
Cost Basis |
Unrealized Holding Gains |
Estimated Market Value | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Cash equivalents: | |||||||||||
| Money market funds | $ | 2,290 | $ | -- | $ | 2,290 | |||||
| Marketable securities: | |||||||||||
| Municipal obligations | $ | 3,913 | $ | 43 | $ | 3,956 | |||||
| Restricted securities: | |||||||||||