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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 1-13165
CRYOLIFE, INC.
(Exact name of registrant as specified in its charter)
Florida 59-2417093
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1655 Roberts Boulevard N.W., Kennesaw, GA 30144
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code (770) 419-3355
Securities registered pursuant to Section
12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
Common Stock, $.01 par value New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [ X ] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K Section 229.405 of this chapter is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ X ] Yes [ ] No
As of June 30, 2002, the aggregate market value of the voting stock of the
Registrant held by non-affiliates of the registrant was $272,880,824 computed
using the closing price of $16.06 per share of Common Stock on June 28, 2002,
the last trading day of the registrant's most recently completed second fiscal
quarter, as reported by NYSE, based on the assumption that directors and
executive officers are affiliates.
As of February 24, 2003 the number of outstanding shares of Common Stock of the
registrant was 19,573,970.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Portions of Registrant's Proxy Statement relating to the Annual
Meeting of Shareholders to be filed not later than April 30, 2003.
PART I
ITEM 1. BUSINESS.
OVERVIEW
CryoLife, Inc. ("CryoLife" or the "Company"), incorporated January 19, 1984 in
Florida, is a leader in the preservation of human tissues for cardiovascular and
vascular transplant applications. The Company also develops and commercializes
implantable medical devices, including BioGlue(R) Surgical Adhesive,
glutaraldehyde-fixed stentless porcine heart valves, and SynerGraft(R) processed
bovine vascular grafts. The Company uses its expertise in biochemistry, cell
biology, immunology, and protein chemistry and its understanding of the needs of
the cardiovascular, vascular, and orthopaedic surgery medical specialties, to
continue expansion of its core preservation and surgical adhesive businesses and
to develop or acquire complementary implantable products and technologies for
these surgical specialties. For detailed financial information on CryoLife's
operating segments, see Note 20 of Notes to the Consolidated Financial
Statements.
CryoLife processes and distributes for transplantation preserved human
cardiovascular and vascular tissue. Management believes that cryopreserved human
heart valves and conduits offer specific advantages over mechanical, synthetic,
and animal-derived alternatives. Depending on the alternative, these advantages
include a more natural hemodynamic functionality, the elimination of a long-term
need for anti-coagulation drug therapy, a reduced incidence of reoperation, and
a reduced risk of catastrophic failure, thromboembolism (stroke), or
calcification. The Company has applied its proprietary SynerGraft antigen
reduction technology to enhance the performance of certain human cardiovascular
and vascular tissues. (See "Recent Events" below). The Company estimates that
the potential U.S. market for implantable products targeting indications
addressed by the preserved tissues processed by the Company, including
orthopaedic tissue, the processing of which had been suspended due to factors
discussed below, was in excess of $1 billion in 2001. However, supply
constraints of human tissue limit market share potential. Although the Company
estimates that it provided in excess of 70% of the preserved human heart valve
tissue implanted in the U.S. in 2001, as a result of the adverse effects from
the U.S. Food and Drug Administration ("FDA") Order, reported tissue infections,
and the resulting adverse publicity, as discussed below, the Company's market
share declined in 2002. The Company seeks to expand the availability of human
tissue through its established relationships with approximately 84 tissue banks
and organ procurement agencies nationwide.
Historically, CryoLife has been a leader in the preservation of human tissues
for orthopaedic transplant applications. The Company has provided preservation
services for surgical replacements for the meniscus and the anterior and
posterior cruciate ligaments, which are critical to the proper function of the
human knee, as well as osteochondral grafts used for the repair of cartilage
defects in the knee. The Company processed orthopaedic tissue until August of
2002 when the Company received a recall order from the FDA (see further
discussions below at "FDA Order on Human Tissue Preservation"). The Company
resumed processing orthopaedic tissue in late February 2003. The Company has
historically relied on independent orthopaedic sales representatives to market
its preservation services and intends to continue using independent sales
representatives once it resumes processing orthopaedic tissue.
CryoLife has developed implantable biomaterials for use as surgical adhesives
and sealants. The Company's proprietary BioGlue Surgical Adhesive, designed for
cardiovascular, vascular, pulmonary, and general surgical applications, is a
polymer based on bovine serum albumin and a cross-linking agent. The Company
received a Conformite Europeene ("CE") Mark (product certification) in 1997 for
use of its BioGlue Surgical Adhesive in vascular applications and began
marketing this product in April 1998 in the European Economic Area ("EEA"). In
March 1999 the Company was awarded a second CE Mark allowing the use of BioGlue
in pulmonary indications, including the repair of air leaks in lungs. In
December 1999 the Company received FDA approval to distribute BioGlue Surgical
Adhesive under a Humanitarian Device Exemption ("HDE") for use as an adjunct in
the repair of acute thoracic aortic dissections and immediately began marketing
this product in the U.S. pursuant to the HDE. The Company received approval to
distribute BioGlue Surgical Adhesive for vascular and pulmonary repairs in
Canada and Australia in January 2000 and February 2001, respectively. In
December 2001 the Company received FDA approval for BioGlue as an adjunct to
sutures and staples for use in adult patients in open surgical repair of large
vessels. The Company estimates that the annual worldwide market for surgical
sutures and staples in 2002 was in excess of $2.5 billion. In January 2002
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BioGlue was awarded a third CE Mark for use in soft tissue repair procedures. An
additional six marketing approvals were granted in the Czech Republic, Colombia,
Mexico, Peru, South Korea and Singapore in 2002 for one or more of the various
indications discussed above. In February 2003 the Company received an expanded
approval in Canada for use of BioGlue in soft tissue repair procedures. This
approval expands the application of BioGlue, from vascular and pulmonary repair
only, to soft tissue repair.
CryoLife has developed and markets outside of the U.S. bioprosthetic
cardiovascular and vascular devices for implantation, consisting of a SynerGraft
processed bovine vascular graft and a glutaraldehyde-fixed stentless porcine
heart valve, the CryoLife-O'Brien(R) aortic heart valve. In August of 2001 the
Company received CE Mark approval for its SynerGraft Model 100 vascular graft
for dialysis access. SynerGraft involves the depopulation of cells leaving a
collagen matrix that has the potential to be repopulated with the recipient's
cells. This process is designed to increase graft longevity, and to improve the
biocompatibility and functionality of such tissue. The SynerGraft Model 100
vascular graft is produced from a bovine ureter in lengths of 25 and 50 cm and
can be stored at room temperature until use. The SynerGraft Model 100 vascular
graft is marketed in the EEA, Switzerland, and Israel. The Company's
Cryolife-O'Brien heart valve is a glutaraldehyde-fixed porcine heart valve,
which is often preferred by surgeons for procedures involving elderly patients
because they eliminate the risk of patient non-compliance with long-term
anti-coagulation drug therapy associated with mechanical valves, are less
expensive than human heart valves, and their shorter longevity is more
appropriately matched with these patients' life expectancies.
Glutaraldehyde-fixed porcine and bovine heart valves address a worldwide target
market estimated to have been $400 million in 2002. Unlike most other available
porcine heart valves, the Company's stentless porcine heart valves contain
minimal amounts of synthetic materials, which decreases the risk of
endocarditis, a debilitating and potentially fatal infection. The Company's
CryoLife-O'Brien heart valve, currently marketed in the EEA and certain other
territories outside the U.S., is a stentless porcine heart valve which contains
a matched composite leaflet design that approximates human heart valve blood
flow characteristics and requires only a single suture line for implantation.
For information regarding international revenues, see Note 20 of Notes to the
Consolidated Financial Statements.
Previously, the Company developed and marketed, outside of the U.S., SynerGraft
processed porcine heart valves. During 2002 the Company decided to cease future
expenditures on the development and commercialization of these valves. This
decision was made to allow the Company to maintain its focus on its preservation
services business and its BioGlue and SynerGraft bovine vascular graft product
lines.
In February 2001 the Company formed AuraZyme Pharmaceuticals, Inc. ("AuraZyme")
to foster the commercial development of its Activation Control Technology
("ACT"). The ACT is a reversible linker technology that has potential uses in
the areas of cancer therapy, fibrinolysis (blood clot dissolving), and other
drug delivery applications. Since 1998 management has been seeking to advance
the development of drug delivery therapies utilizing the ACT through grants,
research and development partnerships, joint ventures, and equity investments.
This strategy is designed to allow the Company to continue development of this
technology without incurring additional research and development expenditures,
other than through AuraZyme, and allow the Company to focus its resources on the
commercial development of its BioGlue Surgical Adhesive, SynerGraft technology,
and other products under development.
In the U.S. the Company markets its preservation services for human
cardiovascular and vascular tissue and its BioGlue Surgical Adhesive through its
direct technical service representatives. Internationally, preserved human
tissues, bioprosthetic cardiovascular and vascular devices, including
SynerGraft, and BioGlue Surgical Adhesive are distributed through independent
representatives located throughout Europe, the Middle East, Canada, South
America, Australia, and Asia. The Company also uses direct technical service
representatives in the United Kingdom to market its preservation services,
bioprosthetic devices, and BioGlue Surgical Adhesive.
RECENT EVENTS
On February 5, 2003 the Company announced that it had signed an exclusive
agreement with curasan AG, located in Germany, for U.S. distribution of
Cerasorb(R) Ortho, curasan's resorbable bone graft substitute. The five-year
agreement gives CryoLife exclusive rights to market Cerasorb Ortho for all
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non-spine, non-dental orthopaedic indications such as trauma, general, and
sports medicine. Cerasorb, a resorbable, beta-tricalcium phosphate bone
regeneration material, was first introduced in Germany in 1998 for dental use.
The product captured approximately 60% of the synthetic dental bone regeneration
market in Germany within four years. In 2001 curasan received CE Mark
certification for Cerasorb's use in general orthopaedics, and in 2002 received
FDA 510(k) approval for orthopaedic use. The Company anticipates that the U.S.
market for bone grafts and substitutes for which it can distribute Cerasorb is
approximately $140 million annually.
On February 20, 2003 the Company received a letter from the FDA that stated that
a 510(k) premarket notification should be filed for the Company's CryoValve SG
and that premarket approval marketing authorization should be obtained for the
Company's CryoVein SG when used for arteriovenous ("A-V") access. The agency's
position is that use of the SynerGraft technology in the processing of allograft
heart valves represents a modification to the Company's legally marketed
CryoValve allograft, and that femoral veins used for A-V access are medical
devices that require premarket approval. CryoLife will be providing the agency
with information to demonstrate that femoral veins used for A-V access should
continue to be regulated as human tissue under Parts 1270 and 1271 of the FDA's
regulations. The FDA letter did not question the safety or efficacy of the
SynerGraft process or the CryoVein A-V access implant.
The Company has advised the FDA that it will voluntarily suspend use of the
SynerGraft technology in the processing of allograft heart valves and vascular
tissue until the regulatory status of the CryoValve SG and CryoVein SG is
resolved. The FDA has not suggested that these tissues be recalled. Until such
time as the issues surrounding the SG tissue are resolved, the Company will
employ its traditional processing methods on these tissues. Distribution of
allograft heart valves and vascular tissue processed using the Company's
traditional processing protocols will continue.
FDA ORDER ON HUMAN TISSUE PRESERVATION
On August 13, 2002 the Company received an order from the Atlanta district
office of the FDA regarding the non-valved cardiac, vascular, and orthopaedic
tissue processed by the Company since October 3, 2001 (the "FDA Order"). The FDA
Order followed an April 2002 FDA Form 483 Notice of Observations ("FDA 483") and
an FDA Warning Letter dated June 17, 2002, ("Warning Letter"). Subsequently, the
Company responded to the Warning Letter. Revenue from human tissue preservation
services accounted for 78% of the Company's revenues for the six months ended
June 30, 2002, (the last period ending prior to the issuance of the FDA Order)
and of those revenues 67% or $26.9 million were derived from preservation of
tissues subject to the FDA Order. The FDA Order contains the following principal
provisions:
o The FDA alleges that, based on its inspection of the Company's
facility on March 25 through April 12, 2002, certain human tissue
processed and distributed by the Company may be in violation of 21
Code of Federal Regulations ("CFR") Part 1270. (Part 1270 requires
persons or entities engaged in the recovery, screening, testing,
processing, storage, or distribution of human tissue to perform
certain medical screening and testing on human tissue intended for
transplantation. The rule also imposes requirements regarding
procedures for the prevention of contamination or cross-contamination
of tissues during processing and the maintenance of certain records
related to these activities.)
o The FDA alleges that the Company has not validated procedures for the
prevention of infectious disease contamination or cross-contamination
of tissue during processing at least since October 3, 2001.
o Non-valved cardiac, vascular, and orthopaedic tissue processed by the
Company from October 3, 2001 to September 5, 2002 must be retained
until it is recalled, destroyed, the safety is confirmed, or an
agreement is reached with the FDA for its proper disposition under the
supervision of an authorized official of the FDA.
o The FDA strongly recommends that the Company perform a retrospective
review of all tissue in inventory (i.e. currently in storage at the
Company) that is not referenced in the FDA Order to assure that it was
recovered, processed, stored, and distributed in conformance with 21
CFR 1270.
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o The Center for Devices and Radiological Health ("CDRH"), a division of
the FDA, is evaluating whether there are similar risks that may be
posed by the Company's allograft heart valves, and will take further
regulatory action if appropriate.
Pursuant to the FDA Order, the Company placed non-valved cardiac, vascular, and
orthopaedic tissue subject to the FDA Order on quality assurance quarantine and
recalled the non-valved cardiac, vascular, and orthopaedic tissues subject to
the FDA Order (i.e. processed since October 3, 2001) that had been distributed
but not implanted. In addition, the Company ceased processing non-valved
cardiac, vascular, and orthopaedic tissues. The Company appealed the FDA Order
on August 14, 2002 and requested a hearing with the FDA, which was originally
set for December 12, 2002. Due to the Agreement discussed below, the Company
withdrew its request for a hearing with the FDA. After the FDA issued its order
regarding the recall, Health Canada also issued a recall on the same types of
tissue and other countries have inquired about the circumstances surrounding the
FDA Order.
After receiving the FDA Order, the Company met with representatives of the FDA's
CDRH division regarding CDRH's review of the Company's processed allograft heart
valves, which are not subject to the FDA Order. On August 21, 2002 the FDA
publicly stated that allograft heart valves have not been included in the FDA
Order as these devices are essential for the correction of congenital cardiac
lesions in neonate and pediatric patients and no satisfactory alternative device
exists. However, the FDA also publicly stated that it then still had serious
concerns regarding the Company's processing and handling of allograft heart
valves. The FDA also recommended that surgeons carefully consider using
processed allografts from alternative sources, that surgeons inform prospective
patients of the FDA's concerns regarding the Company's allograft heart valves,
and that patients be carefully monitored for both fungal and bacterial
infections.
On September 5, 2002 the Company reached an agreement with the FDA (the
"Agreement") that supplements the FDA Order and allows the tissues subject to
recall (processed between October 3, 2001 and September 5, 2002) to be released
for distribution after the Company completes steps to assure that the tissue is
used for approved purposes and that patients are notified of risks associated
with tissue use. Specifically, the Company must obtain physician prescriptions,
and tissue packaging must contain specified warning labels. The Agreement calls
for the Company to undertake to identify third-party records of donor tissue
testing, and to destroy tissue from donors in whom microorganisms associated
with an infection are found. The Agreement allowing distribution of tissues
subject to the recall had a 45-business day term and was renewed on November 8,
2002 and on January 8, 2003. This most recent renewal expires on March 20, 2003.
The Company is unable to predict if the FDA will grant further renewals of the
Agreement. In addition, pursuant to the Agreement, the Company agreed to perform
additional procedures in the processing of non-valved cardiac and vascular
tissues and subsequently resumed processing these tissues. The Agreement
contained the requirement that tissues subject to the FDA Order be replaced with
tissues processed under validated methods. The Company also agreed to establish
a corrective action plan within 30 days from September 5, 2002 with steps to
validate processing procedures. The corrective action plan was submitted on
October 5, 2002.
As a result of the adverse publicity surrounding the FDA Warning Letter, FDA
Order, and the reported tissue infections, the Company's procurement of cardiac
tissues, from which heart valves and non-valved cardiac tissues are processed,
decreased 25% in the fourth quarter of 2002 as compared to the fourth quarter of
2001. Although the Company expects to be able to maintain the current level of
cardiac tissue procurement, there is no guarantee that sufficient tissue will be
available. The Company has continued to process and distribute heart valves
since the receipt of the FDA Order, as these tissues are not subject to the FDA
Order.
On September 17, 2002 the Company resumed the procurement and processing of
vascular tissues. The Company limited its vascular procurement until it
addressed the observations detailed in the FDA 483 and had fully evaluated the
demand for the vascular tissues. The Company's procurement of vascular tissue
decreased 65% in the fourth quarter of 2002 as compared to the fourth quarter of
2001. The Company expects that vascular procurement will increase significantly
following the close out of the FDA 483.
On December 31, 2002 the FDA clarified the Agreement noting that non-valved
cardiac and vascular tissues processed since September 5, 2002 are not subject
to the FDA Order. Specifically, for non-valved cardiac and vascular tissue
processed since September 5, 2002, the Company is not required to obtain
physician prescriptions, label the tissue as subject to a recall, or require
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special steps regarding procurement agency records of donor screening and
testing beyond those required for all processors of human tissue. A renewal of
the Agreement that expires on March 20, 2003 is therefore not needed in order
for the Company to continue to distribute non-valved cardiovascular and vascular
tissues processed since September 5, 2002.
On February 14, 2003 the FDA confirmed that the Company has completed the
corrective actions necessary to close out the April 2002 FDA 483 Notice of
Observations that preceded the Warning Letter and FDA Order. The close out of
the 483 followed a two-week inspection of the Company's processing operations.
As a result of the close out of the 483, the Company believes it can resume
processing and distributing orthopaedic tissues but has not received
confirmation of this from the FDA. The Company resumed processing orthopaedic
tissues in late February 2003. Prior to shipment of orthopaedic tissues, the
Company will confirm with the FDA that they do not disagree with the Company
regarding its interpretation of the close out of the FDA 483. The Company will
continue to process vascular tissues on a limited basis until it can fully
evaluate the demand level for its vascular tissue preservation services.
A new FDA 483 Notice of Observations was issued in connection with the
inspection, but corrective action was implemented on most of its observations
during the inspection. The Company believes the observations, most of which
focus on the Company's systems for handling complaints, will not materially
affect the Company's operations.
As a result of the FDA Order, the Company recorded a reduction to pretax income
of $12.6 million in the quarter ended June 30, 2002. The reduction was comprised
of a net $8.9 million increase to cost of human tissue preservation services, a
$2.4 million reduction to revenues (and accounts receivable) for the estimated
return of the tissues subject to recall by the FDA Order, and a $1.3 million
accrual recorded in general, administrative, and marketing expenses for
retention levels under the Company's product liability and directors' and
officers' insurance policies of $1.2 million (see Note 9), and for estimated
expenses of $75,000 for packaging and handling for the return of affected
tissues under the FDA Order. The net increase of $8.9 million to cost of
preservation services was comprised of a $10.0 million write-down of deferred
preservation costs for tissues subject to the FDA Order, offset by a $1.1
million decrease in cost of preservation services due to the estimated tissue
returns resulting from the FDA Order (the costs of such recalled tissue are
included in the $10.0 million write-down). The Company evaluated many factors in
determining the magnitude of impairment to deferred preservation costs as of
June 30, 2002, including the impact of the FDA Order, the possibility of
continuing action by the FDA or other U.S. and foreign government agencies, and
the possibility of unfavorable actions by physicians, customers, procurement
organizations, and others. As a result of this evaluation, management believed
that since all non-valved cardiac, vascular, and orthopaedic allograft tissues
processed since October 3, 2001 were under recall pursuant to the FDA Order, and
since the Company did not know if it would obtain a favorable resolution of its
appeal and request for modification of the FDA Order, the deferred preservation
costs for tissues subject to the FDA Order had been significantly impaired. The
Company estimated that this impairment approximated the full balance of the
deferred preservation costs of the tissues subject to the FDA Order, which
included the tissues stored by the Company and the tissues to be returned to the
Company, and therefore recorded a write-down of $10.0 million for these assets.
In the quarter ended September 30, 2002 the Company recorded a reduction to
pretax income of $24.6 million as a result of the FDA Order. The reduction was
comprised of a net $22.2 million increase to cost of human tissue preservation
services, a $1.4 million write-down of goodwill, and a $1.0 million reduction to
revenues (and accounts receivable) for the estimated return of the tissues
shipped during the third quarter subject to recall by the FDA Order. The net
$22.2 million increase to cost of preservation services was comprised of a $22.7
million write-down of deferred preservation costs, offset by a $0.5 million
decrease in cost of preservation services due to the estimated and actual tissue
returns resulting from the FDA Order (the costs of such recalled tissue are
included in the $22.7 million write-down).
The Company evaluated multiple factors in determining the magnitude of
impairment to deferred preservation costs at September 30, 2002, including the
impact of the FDA Order, the possibility of continuing action by the FDA or
other U.S. and foreign government agencies, the possibility of unfavorable
actions by physicians, customers, procurement organizations, and others, the
progress made to date on the corrective action plan, and the requirement in the
Agreement that tissues subject to the FDA Order be replaced with tissues
processed under validated methods. As a result of this evaluation, management
believed that all tissues subject to the FDA Order, as well as the majority of
tissues processed prior to October 3, 2001, including heart valves, which were
not subject to the FDA Order, were fully impaired. Management believed that most
of the Company's customers would only order tissues processed after the
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September 5, 2002 Agreement or tissues processed under future procedures
approved by the FDA once those tissues were available. The Company anticipated
that the tissues processed under the Agreement would be available early to
mid-November. Thus, the Company recorded a write-down of deferred preservation
costs for processed tissues in excess of the supply required to meet demand
prior to the release of these interim processed tissues. The Company did not
record any further write-downs of deferred preservation costs in the fourth
quarter of 2002. As of December 31, 2002 the balance of deferred preservation
costs were $2.0 million for allograft heart valve tissues, $620,000 for
non-valved cardiac tissues, $1.7 million for vascular tissues, and zero for
orthopaedic tissues.
As a result of the write-down of deferred preservation costs, the Company
recorded $6.3 million in income tax receivables and $4.5 million in deferred tax
assets. Upon destruction or shipment of the remaining tissues associated with
the deferred preservation costs write-down, the deferred tax asset will become
deductible in the Company's tax return. An expected refund of approximately $8.5
million will be generated through a carry back of operating losses and
write-downs of deferred preservation costs. In addition, the Company recorded
$2.5 million in income tax receivables related to estimated tax payments for
2002. The Company received payment of the $2.5 million in January of 2003.
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), requires the
write-down of a long-lived asset to be held and used if the carrying value of
the asset or the asset group to which the asset belongs is not recoverable. The
carrying value of the asset or asset group is not recoverable if it exceeds the
sum of the undiscounted future cash flows expected to result from the use and
eventual disposition of the asset or asset group. As of September 30, 2002, in
applying SFAS 144, the Company determined that the asset groups consisted of the
long-lived assets related to the Company's two reporting segments, as these
asset groups represent the lowest level at which identifiable cash flows are
largely independent of the cash flows of other assets and liabilities. The
Company used a fourteen-year period for the undiscounted future cash flows. This
period of time was selected based upon the remaining life of the primary assets
of the asset groups, which are leasehold improvements. The undiscounted future
cash flows related to these asset groups exceeded their carrying values as of
September 30, 2002 and December 31, 2002 and therefore management has concluded
that there is not an impairment of the Company's long-lived intangible assets,
except for goodwill as discussed below, and tangible assets related to the
tissue preservation business or medical device business. However, depending on
the Company's ability to rebuild demand for its tissue preservation services,
the outcome of discussions with the FDA regarding the shipping of orthopaedic
tissues, and the future effects of adverse publicity surrounding the FDA Order
and reported infections on preservation revenues, these assets may become
impaired. Management will continue to evaluate the recoverability of these
assets in accordance with SFAS 144.
Beginning with the Company's adoption of Statement of Financial Accounting
Standards ("SFAS") No. 142,"Goodwill and Other Intangible Assets" ("SFAS 142")
on January 1, 2002 the goodwill resulting from business acquisitions is not
amortized, but is instead subject to periodic impairment testing in accordance
with SFAS 142. Patent costs are amortized over the expected useful lives of the
patents (primarily 17 years) using the straight-line method. Other intangibles,
which consist primarily of manufacturing rights and agreements, are amortized
over the expected useful lives of the related assets (primarily five years). As
a result of the FDA Order, the Company determined that an evaluation of the
possible impairment of intangible assets under SFAS 142 was necessary. The
Company engaged an independent valuation expert to perform the valuation using a
discounted cash flow methodology, and as a result of this analysis, the Company
determined that goodwill related to its tissue processing reporting unit was
fully impaired as of September 30, 2002. Therefore, the Company recorded a
write-down of $1.4 million in goodwill during the quarter ended September 30,
2002. Management does not believe an impairment exists related to the other
intangible assets that were assessed in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144").
On September 3, 2002 the Company announced a reduction in employee force of
approximately 105 employees. In the third quarter of 2002 the Company recorded
accrued restructuring costs of approximately $690,000, for severance and related
costs of the employee force reduction. The expense was recorded in general,
administrative, and marketing expenses and was included as a component of
accrued expenses and other current liabilities on the Consolidated Balance
Sheet. During the year ended December 31, 2002 the Company utilized $580,000 of
the accrued restructuring costs, including $505,000 for salary and severance
payments, $64,000 for placement services for affected employees, and $11,000 in
other related costs. As of December 31, 2002 the remaining balance of accrued
restructuring costs was $110,000.
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See Part I, Item 3 "Legal Proceedings" for a discussion of certain material
legal proceedings.
STRATEGY
The Company's primary objective is to consistently grow revenue and
profitability. The Company's strategy to generate revenue growth is based on
increasing the use of cryopreserved tissues as an alternative to mechanical and
synthetic implantable products, developing new markets for existing products and
technologies and developing new products and technologies for new and existing
markets. The Company also selectively considers strategic acquisitions of
complementary technologies and businesses to supplement its internal growth. The
key elements of the Company's business and growth strategy are to:
o Continue Preservation of Cardiovascular Tissue. The Company intends to
increase the market penetration of its CryoLife preserved human heart
valves and conduits by (i) expanding awareness of clinical advantages
of cryopreserved human tissues through continuing educational efforts
directed to physicians, prospective heart valve and conduit
recipients, and tissue procurement agencies, (ii) expanding its
relationships with the approximately 84 tissue banks and organ
procurement agencies across the U.S. which have recovered and sent
tissue to the Company for preservation, (iii) expanding its physician
training activities, and (iv) resuming the application of its
SynerGraft technology to human heart valves and conduits for antigen
reduction properties with the potential for recipient cell
repopulation.
o Expand Distribution of Preserved Human Vascular Tissue and Resume
Distribution of Orthopaedic Tissue. Using the same strategy it has
successfully employed to expand its preservation services for
cardiovascular tissue, the Company intends to increase its
preservation revenues from human vascular tissue and to resume
orthopaedic tissue distribution by (i) continuing educational efforts
directed to surgeons about the clinical advantages of preserved
tissue, (ii) expanding its relationships with tissue banks and organ
procurement agencies, (iii) expanding its programs for training
physicians in the use of tissue preserved by the Company, and (iv)
resuming and expanding its product offerings by applying its
SynerGraft technology to human grafts for antigen reduction properties
with the potential for recipient cell repopulation.
o Broaden Application of Preservation Services. The Company will
continue to collect, monitor, and evaluate implant data to (i) develop
expanded uses for the human tissues currently cryopreserved by the
Company and (ii) identify new human tissues as candidates for
preservation. In 1997 the Company began providing cryopreserved human
vascular tissue to be used as dialysis access replacement grafts for
patients undergoing chronic dialysis, and separately, as venous valve
replacements for patients suffering from chronic venous insufficiency.
In 1997 and 1998 in addition to patellar and Achilles tendons, the
Company began providing semi-t/gracilis tendons and cryopreserved
posterior and anterior tibialis tendons, respectively, for use in knee
repairs, and in 1999 began providing preserved human osteochondral
grafts to repair articular defects and aortoiliac grafts to replace
infected abdominal aortic grafts. The Company is also investigating
the use of other orthopaedic tissues in various surgical applications.
As discussed in the section on the FDA Order on Human Tissue
Preservation, the Company resumed orthopaedic processing in late
February 2003.
o Expand Distribution of Biomaterials for Surgical Adhesive and Sealant
Applications. The Company began commercial marketing of its
proprietary BioGlue Surgical Adhesive in the EEA through its
independent representatives for vascular and pulmonary applications
upon receipt of a CE Mark in 1997 and 1999, respectively. The Company
has since been successful in broadening the scope for approved uses
and the number of countries that accept it. The Company continues to
seek additional marketing approvals in other countries. In addition to
these adhesive and sealant applications of BioGlue, the Company
intends to pursue, either directly or through strategic alliances,
additional indications for BioGlue technology, including replacement
for spinal disc nuclei. The Company also intends to pursue additional
approvals for hernia repair and dura mater sealing in the U.S.
8
o Develop and Commercialize Bioprosthetic SynerGraft Vascular Devices.
The Company intends to leverage its expertise with human vascular
grafts and bioprosthetic devices as a platform for the development and
commercialization of its SynerGraft processed bovine vascular grafts.
In July of 2001 the Company received CE Mark approval for its
SynerGraft Model 100 vascular graft that is presently being marketed
for dialysis access.
o Develop and Commercialize Bioprosthetic Cardiovascular Devices. The
Company intends to leverage its expertise with stentless human heart
valves to expand commercialization of its stentless porcine heart
valve.
o Develop and Commercialize Other Technologies. The Company intends to
leverage its current distribution channel and its expertise in the
cardiovascular and orthopaedic medical specialties by selectively
pursuing the potential distribution or licensing of additional
technologies that compliment existing services and products, such as
Cerasorb.
SERVICES AND PRODUCTS
Preservation of Human Tissue for Transplant
The Company's proprietary preservation process involves the recovery of tissue
from deceased human donors by tissue bank and organ procurement organizations,
the timely and controlled delivery of such tissue to the Company, the screening,
dissection, disinfection, and preservation of the tissue by the Company, the
storage and shipment of the cryopreserved tissue, and the controlled thawing of
the tissue. Thereafter, the tissue is surgically implanted into a human
recipient.
The transplant of human tissue that has not been preserved must be accomplished
within extremely short time limits (not to exceed eight hours for transplants of
the human heart). Prior to the advent of human tissue cryopreservation, these
time constraints resulted in the inability to use much of the tissue donated for
transplantation. The application of the Company's cryopreservation technologies
to donated tissue expands the amount of human tissue available to physicians for
transplantation. Cryopreservation also expands the treatment options available
to physicians and their patients by offering alternatives to implantable
mechanical, synthetic, and animal-derived devices. The tissues presently
cryopreserved by the Company include human heart valves, non-valved conduits,
and vascular tissue. In addition, the Company has historically preserved
orthopaedic tissue and resumed processing orthopaedic tissue in late February
2003.
CryoLife maintains and collects clinical data on the use and effectiveness of
implanted human tissues that it has preserved, and shares this data with
implanting physicians and the procurement organizations from which it receives
tissue. The Company also uses this data to help direct its continuing efforts to
improve its preservation services through ongoing research and development. Its
clinical research staff and technical representatives assist physicians by
providing educational materials, seminars, and clinics on methods for handling
and implanting the tissue cryopreserved by the Company and the clinical
advantages, indications, and applications for those tissues. The Company has
ongoing efforts to train and educate physicians on the indications for and uses
of the human tissues cryopreserved by the Company, as well as its programs
whereby surgeons train other surgeons in best-demonstrated techniques. The
Company also assists organ procurement agencies and tissue banks through
training and development of protocols and provides materials to improve their
tissue recovery techniques and thereby increase the efficiency and the yield of
usable tissue.
Human Cardiovascular Tissue. The human heart valves and conduits cryopreserved
by the Company are used in reconstructive heart valve replacement surgery.
CryoLife shipped approximately 55,400 cryopreserved human heart valves and
conduits from 1984 through 2002. Revenues from human heart valve and conduit
preservation services accounted for 39%, 33%, and 30% of total revenues,
respectively, in 2000, 2001, and 2002. Based on CryoLife's records of documented
implants, management believes that the Company's success in the allograft heart
valve market is due in part to physicians' recognition of the longevity and
natural functionality of the Company's cryopreserved human tissues, the
Company's documented clinical data, and the Company's technical representation.
Management believes the Company offers advantages in these areas as compared to
9
other allograft processors and that the Company's cryopreserved tissues offer
advantages in certain areas over mechanical, porcine, and bovine heart valve
alternatives. The Company currently applies its preservation services to human
aortic and pulmonary heart valves for implantation by cardiac surgeons. In
addition, the Company provides cryopreserved non-valved conduit and patch tissue
to surgeons who wish to perform certain specialized cardiac repair procedures.
Each of these human heart valves, non-valved conduits and patches maintains a
tissue structure which more closely resembles and performs like the patient's
own tissue than non-human tissue alternatives.
In February 2000 the Company began distributing in the U.S. depopulated
cryopreserved human heart valves and conduits utilizing its SynerGraft antigen
reduction technology, which effectively removes cells from the heart valve
leaving the collagen matrix intact. The CryoValve(R) SG valve is especially
designed to benefit patients, both children and adults, who have had a minor
immune response to transplanted tissues. Early clinical data indicates that the
new SynerGraft processing method mitigates the increase of panel reactive
antibodies ("PRA") experienced by some of the patients who receive allograft
heart valves. The absence of a significant immunologic response to the
decellularized allograft has the potential of improved long-term function of the
allograft heart valves. Animal studies and explants from human recipients have
documented that allograft heart valves treated with the SynerGraft process have
repopulated in vivo with the recipient's own cells. The Company's data shows a
majority of the cardiac allografts processed with standard cryopreservation
methods do not repopulate in vivo. As discussed at "Recent Events", the Company
has suspended the use of SynerGraft technology in the processing of allograft
heart valves and vascular tissue until the regulatory status of the CryoValve-SG
and CryoVein-SG is resolved.
The Company estimates that the total heart valve and non-valved conduit
replacement market in the U.S. in 2002 was approximately $400 million.
Management believes that approximately 80,000 heart valve and non-valved conduit
surgeries were conducted in the U.S. in 2002. Of the total number of heart valve
and conduit surgeries, approximately 27,000, or 34%, involved mechanical heart
valves, and approximately 53,000, or 66%, involved tissue heart valves or
conduits, including porcine, bovine, and cryopreserved human tissues.
Approximately 3,800 human heart valves and conduits cryopreserved by the Company
were shipped for implantation in 2002.
Management believes cryopreserved human heart valves and non-valved conduits
have characteristics that make them the preferred replacement option for many
patients. Specifically, human heart valves, such as those cryopreserved by the
Company, allow for more normal blood flow and provide higher cardiac output than
porcine, bovine, and mechanical heart valves. Human heart valves are not as
susceptible to progressive calcification, or hardening, as are
glutaraldehyde-fixed porcine and bovine heart valves, and do not require
anti-coagulation drug therapy, as do mechanical valves. The synthetic sewing
rings contained in mechanical and stented porcine and bovine valves may harbor
bacteria leading to endocarditis. Furthermore, prosthetic valve endocarditis can
be difficult to treat with antibiotics, and this usually necessitates the
surgical removal of these valves at considerable cost, morbidity, and risk of
mortality. Consequently, for many physicians, human heart valves are the
preferred alternative to mechanical and stented porcine valves for patients who
have, or are at risk to contract, endocarditis.
The following table sets forth the characteristics of alternative heart valve
implants that management believes make cryopreserved human heart valves the
preferred replacement for most patients:
10
PORCINE
----------------------------------
PRESERVED BOVINE
HUMAN STENTED STENTLESS(1) MECHANICAL PERICARDIUM
--------------- ---------------- --------------- ---------------- ---------------
Materials: human tissue glutaraldehyde- glutaraldehyde- pyrolitic carbon glutaraldehyde-
fixed pig tissue fixed pig bi-leaflet and fixed cow tissue
and synthetic tissue synthetic sewing and synthetic
sewing ring ring sewing ring
Blood Flow Dynamics normal moderate elevation nearly normal high elevation high elevation
(Required Pressure):(2) (0-5) (10-20) (5-15) (10-25) (10-30)
Mode of Failure: gradual gradual expected to be catastrophic gradual
gradual
Longevity: 15-20 years 10-15 years expected to 15-20 years 10-15 years
exceed stented
porcine
valves
Increased Risk of
Bleeding or
Thromboembolic Events
(strokes or other
clotting): no occasional occasional yes occasional
Anti-Coagulation Drug
Therapy Required: none short-term short-term chronic short-term
Responsiveness to
Antibiotic
Treatment of
Endocarditis: high low low low low
Average Estimated Valve
Cost in U.S.: $7,300 $4,700 $5,500 $4,000(3) $4,700
- -------------
(1) Limited long-term clinical data is available since stentless porcine heart
valves only recently became commercially available.
(2) Pressure measured in mmHg.
(3) Mechanical valves also require chronic anti-coagulation drug therapy at a
cost of approximately $450 per year.
While the clinical benefits of cryopreserved human heart valves discussed above
are relevant to all patients, they are particularly important for (i) pediatric
patients (newborn to 17 years) who are prone to calcification of porcine tissue,
(ii) young or otherwise active patients who face an increased risk of severe
blood loss or even death due to side effects associated with the
anti-coagulation drug therapy required with mechanical valves, and (iii) women
in their childbearing years for whom anti-coagulation drug therapy is
contraindicated.
Human Vascular Tissues. The Company cryopreserves human saphenous veins for use
in peripheral vascular surgeries that require small diameter conduits (3mm to
6mm), such as coronary bypass surgery and peripheral vascular reconstructions.
Failure to bypass or revascularize an obstruction in such cases may result in
death or the loss of a limb. The Company also cryopreserves femoral veins and
arteries for dialysis access and aortoiliac arteries for the reconstruction of
infected abdominal synthetic grafts. The Company shipped approximately 33,300
human vascular tissues from 1986 through 2002, which includes 4,400 shipments in
2002. Revenues from human vascular preservation services accounted for 28%, 28%,
and 23% of total revenues, respectively, in 2000, 2001, and 2002.
A surgeon's first choice for replacing diseased or damaged vascular tissue is
generally the patient's own tissue. However, in cases of advanced vascular
disease, the patient's tissue is often unusable, and the surgeon may consider
using synthetic grafts or transplanted human vascular tissue. Small diameter
synthetic vascular grafts are generally not suitable for below-the-knee
surgeries because they have a tendency to occlude since the synthetic materials
in these products attract cellular material from the blood stream, which in turn
closes off the vessel to normal blood flow. Cryopreserved vascular tissues tend
to remain open longer and as such are used in indications where synthetics fail.
The Company's cryopreserved human vascular tissues are used for coronary artery
bypass surgeries, peripheral vascular reconstruction, dialysis access graft
replacement, venous valve transplantation, and infected abdominal aortic graft
replacement.
11
In 1986 the Company began a program to cryopreserve saphenous veins for use in
coronary artery bypass surgeries. The Company estimates there were approximately
450,000 to 500,000 coronary artery bypass procedures performed in the U.S. in
2002. The Company estimates that approximately 30% of these are re-operations,
which may require the use of preserved vascular tissue.
In 1989 the Company began a program to cryopreserve long segment saphenous veins
for use in peripheral vascular reconstruction. In cases of peripheral
arteriosclerosis, a cryopreserved saphenous vein can be implanted as a bypass
graft for the diseased artery in order to improve blood flow and maintain a
functional lower limb. Analysis of the Company's data on file of approximately
425 implants has shown that approximately 72% of patients receiving CryoLife's
preserved vascular tissues in this type of surgical procedure still have the use
of the affected leg four years after surgery. The only alternative for many of
these patients was amputation. The Company estimates that in 2002 approximately
78,000 peripheral vascular reconstruction surgeries were performed in the U.S.
in which its cryopreserved human vascular tissues could have been used.
In 1997 the Company began a program for the preservation of human superficial
femoral veins and arteries for use in dialysis access graft replacement as an
alternative for synthetic grafts, which have a higher risk of infection and
thrombosis than human tissue. The Company estimates that in 2002 there were
approximately 300,000 end stage renal failure patients receiving dialysis in the
U.S., and a majority of these patients rely on hemo-dialysis requiring either a
native fistula or synthetic graft for arterial-venous access. There are
approximately 87,000 synthetic grafts placed annually for arterial-venous
access.
Human Orthopaedic Tissue. As discussed at "FDA Order on Human Tissue
Preservation", the Company suspended processing orthopaedic tissues between
August 2002 and late February 2003. The Company has historically provided
preservation services for surgical replacements for the meniscus and the
anterior and posterior cruciate ligaments, which are critical to the proper
operation of the human knee, as well as osteochondral grafts used for the repair
of cartilage defects in the knee. CryoLife shipped approximately 27,500 human
connective tissues for the knee through the end of 2002, which includes 4,200
shipments in 2002. Revenues from human orthopaedic preservation services
accounted for 21%, 26%, and 18% of total revenues, respectively, in 2000, 2001,
and 2002.
Human menisci, historically cryopreserved by the Company prior to the issuance
of the FDA Order, provide orthopaedic surgeons with an alternative treatment in
cases where a patient's meniscus has been completely removed. When a patient has
a damaged meniscus, the current surgical alternatives are to repair, partially
remove or completely remove the patient's meniscus, with partial removal being
the most common procedure. Meniscal removal increases the risk of premature knee
degeneration and arthritis and typically results in the need for knee
replacement surgery at some point during the patient's life. Management believes
that there are no synthetic total menisci on the market. The Company estimates
that in 2002 approximately 725,000 U.S. patients underwent partial or total
meniscectomies. The Company believes up to 25% of these patients could become
candidates for meniscal replacement within five years.
Tendons, historically cryopreserved by the Company prior to the issuance of the
FDA Order, are primarily used for the reconstruction of the anterior and
posterior cruciate ligaments in cases where the patient's ligaments are
irreparably damaged. Surgeons have traditionally removed a portion of the
patient's patellar tendon from the patient's undamaged knee for use in repairing
a damaged anterior cruciate ligament. Cryopreserved tendons provide an
alternative to this procedure. Because surgeries using cryopreserved tissue do
not involve the removal of any of the patient's own patellar tendon, the patient
recovery period is typically shorter. The Company estimates that in 2002
approximately 200,000 cruciate ligament reconstruction surgeries were performed
in the U.S.
In 1999 the Company began preserving osteochondral grafts used to aid in the
repair of damaged knee cartilage. Prior to the FDA Order, the orthopaedic
surgical community had accepted these grafts, which are preserved and maintained
in a living state. The success of transplanted osteochondral grafts is
attributed to the presence of viable chondrocytes (cells of the cartilage). The
Company estimates that in 2002 approximately 450,000 articular cartilage repair
procedures were performed in the U.S. and that approximately 10-15% of these
repairs will be amenable to fresh osteochondral (OA) resurfacing replacement
within 5 years.
12
Implantable Biomaterials for Use as Surgical Adhesives and Sealants
The effective closure of internal wounds following surgical procedures is
critical to the restoration of the function of tissue and to the ultimate
success of the surgical procedure. Failure to effectively seal surgical wounds
can result in leakage of air in lung surgeries, cerebral spinal fluids in
neurosurgeries, blood in cardiovascular surgeries, and gastrointestinal contents
in abdominal surgeries. Air and fluid leaks resulting from surgical procedures
can lead to significant post-operative morbidity resulting in prolonged
hospitalization, higher levels of post-operative pain, and a higher mortality
rate.
Sutures and staples facilitate healing by joining wound edges and allowing the
body to heal naturally. However, because sutures and staples do not have
inherent sealing capabilities, they cannot consistently eliminate air and fluid
leakage at the wound site. This is particularly the case when sutures and
staples are used to close tissues containing air or fluids under pressure, such
as the lobes of the lung, the dural membrane surrounding the brain and spinal
cord, blood vessels, and the gastrointestinal tract. In addition, in minimally
invasive surgical procedures where the physician must operate through small
access devices, it can be difficult and time consuming for the physician to
apply sutures and staples. The Company believes that the use of surgical
adhesives and sealants with or without sutures and staples could enhance the
efficacy of these procedures through more effective and rapid wound closure.
In order to address the inherent limitations of sutures and staples, the Company
has developed and commercialized its BioGlue Surgical Adhesive. BioGlue Surgical
Adhesive is a polymeric surgical bioadhesive based on a derivative of an animal
blood protein and a cross-linking agent. BioGlue Surgical Adhesive has a tensile
strength that is four to five times that of fibrin sealants. Word wide clinical
applications for BioGlue Surgical Adhesive include cardiovascular, vascular,
pulmonary, and soft tissue repair. Other potential applications for BioGlue
Surgical Adhesive in the U.S. include hernia repair and dura mater sealing.
BioGlue also has the potential to be used as a replacement for spinal disc
nuclei. A derivative of the BioGlue technology is BioLastic(TM), an implantable
biomaterial under development, which is capable of exchanging oxygen and carbon
dioxide. BioLastic is being investigated for use in reinforcing or patching
vascular tissue, reducing adhesions, repairing air leaks in lungs, and sealing
holes in or replacing dura mater.
The Company estimates that the worldwide market for surgical sutures and staples
in 2002 was in excess of $2.5 billion. The Company began shipping BioGlue
Surgical Adhesive for distribution in the EEA in the second quarter of 1998 for
use in vascular applications and in the first quarter of 1999 for use in
pulmonary applications. In December 1999 the Company began shipping BioGlue
Surgical Adhesive in the U.S. pursuant to an HDE for use as an adjunct in repair
of acute thoracic aortic dissections. The Company received approval to
distribute BioGlue Surgical Adhesive for vascular and pulmonary repair in Canada
and Australia in January 2000 and February 2001, respectively. In December 2001
the Company received FDA approval to distribute BioGlue for use as an adjunct to
sutures and staples for use in adult patients in open surgical repair of large
vessels. In January 2002 the Company received a third CE Mark for BioGlue for
use in soft tissue repair procedures. In February 2003 the Company received an
expanded approval in Canada for use of BioGlue in soft tissue repair procedures.
This approval expands the application of BioGlue in Canada from vascular and
pulmonary repair only to soft tissue repair. Revenues from BioGlue Surgical
Adhesive represented 8%, 12%, and 27% of total revenues, respectively, in 2000,
2001, and 2002.
Bioprosthetic Cardiovascular and Vascular Devices
The Company is developing bioprosthetic cardiovascular and vascular devices
based on its experience with cryopreserved human tissue implants. Like human
heart valves, the Company's porcine heart valve is stentless with the valve
opening, or annulus, retaining a more natural flexibility. Stented porcine,
bovine, and mechanical heart valves are typically fitted with synthetic sewing
rings that are rigid and can impede normal blood flow. Unlike most other
available porcine heart valves, the Company's stentless porcine heart valve has
minimal synthetic materials, which decrease the risk of endocarditis, a
debilitating and potentially deadly infection. Revenues from bioprosthetic
cardiovascular and vascular devices represented 1% of total revenues in 2000,
2001, and 2002.
Glutaraldehyde-fixed porcine and bovine heart valves are often preferred by
surgeons for procedures involving elderly patients because they eliminate the
risk of patient non-compliance with anti-coagulation drug therapy associated
with mechanical valves, they are less expensive than allograft valves, and their
13
shorter longevity is more appropriately matched with these patients' life
expectancies. Glutaraldehyde-fixed porcine and bovine heart valves address a
worldwide target market estimated to have been $400 million in 2002.
The CryoLife-O'Brien aortic valve is a stentless porcine valve with design
features which management believes provides significant advantages over other
stentless porcine and bovine heart valves. CryoLife began exclusive worldwide
distribution of this valve in 1992 and acquired all rights to the underlying
technology in 1995. The Company's CryoLife-O'Brien aortic heart valve, currently
marketed in the EEA and certain other territories outside the U.S., contains a
matched composite leaflet design that approximates human heart valve blood flow
characteristics and requires only a single suture line for surgical
implantation.
The Company's SynerGraft technology involves the removal of cells from the
structure of animal or human tissue, leaving a collagen matrix that has the
potential to repopulate in vivo with the recipient's own cells. Animal studies
and explants from human recipients have documented that allograft heart valves
treated with the SynerGraft process have repopulated themselves in vivo with the
recipient's own cells. This process is designed to increase allograft longevity,
and more generally to improve the biocompatibility and functionality of such
tissue. In July 2001 the Company received CE Mark approval for its SynerGraft
Model 100 vascular graft for dialysis access. The SynerGraft Model 100 vascular
graft is produced from a bovine ureter in lengths between 25 and 50 cm in 5 cm
increments. The SynerGraft Model 100 vascular graft can be stored at room
temperature until use.
Other Implantable Devices
On February 5, 2003 the Company announced that it has signed an exclusive
agreement with curasan AG, located in Germany, for U.S. distribution on
Cerasorb(R) Ortho, curasan's resorbable bone graft substitute. The five-year
agreement gives CryoLife exclusive rights to market Cerasorb Ortho for all
non-spine, non-dental orthopaedic indications such as trauma, general, and
sports medicine. Cerasorb, a resorbable, beta-tricalcium phosphate bone
regeneration material, was first introduced in Germany in 1998 for dental use.
The product captured approximately 60% of the synthetic dental bone regeneration
market in Germany within four years. In 2001 curasan received CE Mark
certification for Cerasorb's use in general orthopaedics, and in 2002 received
FDA 510(k) approval for orthopaedic use. The Company anticipates that the U.S.
market for bone grafts and substitutes for which it can distribute Cerasorb is
approximately $140 million.
Single-Use Medical Devices
On October 9, 2000 the Company sold substantially all of the remaining assets of
Ideas for Medicine, Inc. ("IFM") to Horizon Medical Products, Inc. See Note 3 of
Notes to the Consolidated Financial Statements for a more detailed discussion.
SALES, DISTRIBUTION AND MARKETING
Preservation Services
CryoLife markets its preservation services to tissue procurement agencies,
implanting physicians, and prospective tissue recipients. The Company works with
tissue banks and organ procurement agencies to ensure consistent and continued
availability of donated human tissue for transplant and educates physicians and
prospective tissue recipients with respect to the benefits of cryopreserved
human tissues.
Procurement of Tissue. Donated human tissue is procured from deceased human
donors by organ procurement agencies and tissue banks. After procurement, the
tissue is packed and shipped, together with certain information about the tissue
and its donor, to the Company in accordance with the Company's protocols. The
tissue is transported to the Company's laboratory facilities via commercial
airlines pursuant to arrangements with qualified courier services. Timely
receipt of procured tissue is important, as tissue that is not received promptly
cannot be cryopreserved successfully. The procurement agency is reimbursed by
the Company for the costs associated with these procurement services. The
procurement fee and related shipping costs, together with the charges for the
preservation services of the Company, are ultimately paid to the Company by the
hospital with which the implanting physician is associated. The Company has
developed relationships with approximately 84 tissue banks and organ procurement
14
agencies throughout the U.S. Management believes these relationships are
critical for a growing business in the preservation services industry and that
the breadth of these existing relationships provides the Company a significant
advantage over potential new entrants to this market. The Company employs
approximately 20 individuals to work with organ procurement agencies and tissue
banks, eight of which are employed as procurement relations managers and are
stationed throughout the country. The Company's central office for procurement
relations is staffed 24 hours per day, 365 days per year.
Preservation of Tissue. Upon receiving tissue, a Company technician completes
the documentation control for the tissue prepared by the procurement agency and
gives it a control number. The documentation identifies, among other things,
donor age and cause of death. A trained technician then removes the portion or
portions of the delivered tissue that will be processed. These procedures are
conducted under aseptic conditions in clean rooms. At the same time, samples are
taken from the donated tissue and subjected to the Company's comprehensive
quality assurance program. This program may identify characteristics which would
disqualify the tissue for preservation or implantation.
Cardiovascular, vascular, and orthopaedic tissue, except osteochondral grafts,
are cryopreserved in a proprietary freezing process conducted according to
strict Company protocols. After the preservation process, the tissues are
transferred to liquid nitrogen freezers for long-term storage at temperatures
below -135(Degree)C. Prior to the issuance of the FDA Order, osteochondral
grafts were refrigerated in proprietary solutions from 2(Degree)C to 8(Degree)C
for up to 45 days. The entire preservation process is rigidly controlled by
guidelines established by the Company.
Distribution of Tissue to Implanting Physicians. After preservation, tissue is
stored by the Company or is delivered directly to hospitals at the implanting
physician's request. Cryopreserved tissue must be transported under stringent
handling conditions and maintained within specific temperature tolerances at all
times. Cryopreserved tissue is packaged for shipment using the Company's
proprietary processes. At the hospital the tissue is held in a liquid nitrogen
freezer according to Company protocols pending implantation. The Company
provides a detailed protocol for thawing the cryopreserved tissue. The Company
also makes its technical personnel available by phone or in person to answer
questions. After the Company transports the tissue to the hospital, the Company
invoices the institution for its services, the procurement fee, and
transportation costs.
The Company provides Company-owned liquid nitrogen freezers to certain client
hospitals without charge. The Company has currently installed more than 350 of
these freezers. Participating hospitals generally pay the cost of liquid
nitrogen and regular maintenance. The availability of on-site freezers makes it
easier for a hospital's physicians to utilize the Company's preservation
services by making the cryopreserved tissue more readily available. Because fees
for the Company's preservation services become due upon the delivery of tissue
to the hospital, the use of such on-site freezers also reduces the Company's
working capital needs.
Marketing, Educational and Technical Support. The Company has record of over
4,000 cardiovascular, vascular, and orthopaedic surgeons who have implanted
tissues cryopreserved by the Company during the past twelve months. The Company
works to maintain relationships with and market to surgeons within these medical
specialties. Because the Company markets its preservation services directly to
physicians, an important aspect of increasing the distribution of the Company's
preservation services is educating physicians on the use of cryopreserved human
tissue and on proper implantation techniques. Trained field support personnel
provide support to implanting institutions and surgeons. The Company currently
employs approximately 35 persons as technical service representatives who deal
primarily with cardiovascular and vascular surgeons and provide field support.
These representatives receive a base salary with a performance bonus. The
Company has over 150 independent technical service representatives and
sub-representatives who are employed by distributor groups who deal primarily
with orthopaedic surgeons and who are paid on a commission basis. The Company
has retained the majority of these distributor groups and added a few groups in
anticipation of resuming orthopaedic processing and distribution.
The Company sponsors physician training seminars where leading physicians teach
other physicians the proper technique for handling and implanting cryopreserved
human tissue. The Company also produces educational videotapes for physicians
and coordinates live surgery demonstrations at various medical schools. The
Company also coordinates laboratory sessions that utilize animal tissue to
demonstrate the surgical techniques. Members of the Company's Medical Advisory
Board often lead the surgery demonstrations and laboratory sessions. Management
15
believes that these activities improve the medical community's acceptance of the
cryopreserved human tissue processed by the Company and help to differentiate
the Company from other allograft processors.
To assist procurement agencies and tissue banks, the Company provides
educational materials and training on procurement, dissection, packaging, and
shipping techniques. The Company also produces educational videotapes and
coordinates laboratory sessions on procurement techniques for procurement agency
personnel. To supplement its educational activities, the Company employs
in-house technical specialists that provide technical information and assistance
and maintains a staff 24 hours per day, 365 days per year for customer support.
Backlog. The limited supply of tissue that is donated and available for
processing results in a backlog of orders in the Company's human tissue
business. The amount of backlog fluctuates based on the tissues available for
shipment and varies based on the surgical needs of specific cases. The Company's
backlog is generally not considered firm and must be confirmed with the customer
before shipment. The Company currently does not have a backlog of BioGlue or
SynerGraft bovine vascular grafts.
European Distribution
In September 1999 the Company established its European subsidiary, CryoLife
Europa, Ltd. ("Europa"), to provide distribution and technical services to the
Company's network of European representatives, customers, and surgeons. In
February 2000 Europa officially opened its headquarters located near London,
England. The Company's European, Middle East, and African sales, marketing, and
distribution activities directed through Europa are channeled through
approximately 30 independent distributors located throughout Europe, the Middle
East, and South Africa. Since 2002 Europa has employed approximately four
persons as direct technical representatives who also provide field support for
the United Kingdom. Marketing efforts are directed almost exclusively toward
cardiovascular, vascular, thoracic, and general surgeons.
BioGlue Surgical Adhesive
The Company markets and distributes its BioGlue Surgical Adhesive in the U.S.
through its existing direct technical representatives. The Company markets and
distributes its BioGlue Surgical Adhesive in international markets, excluding
Japan, through Europa and other existing independent representatives. The
Company conducts training sessions for doctors with respect to the application
and administration of BioGlue Surgical Adhesive.
During 1998 the Company signed a five-year exclusive agreement with Century
Medical, Inc. for the introduction and distribution of BioGlue in Japan. Under
the terms of the agreement, Century Medical will be responsible for applications
and clearances with the Japanese Ministry of Health and Welfare.
Bioprosthetic Cardiovascular Devices
The Company markets the CryoLife-O'Brien stentless porcine heart valve in
Europe, the Middle East, Africa, and Canada. The Company commenced marketing the
SynerGraft Model 100 vascular graft in Europe, Switzerland, and Israel during
the third quarter of 2001. Marketing efforts are primarily directed toward
vascular surgeons to educate them with respect to the uses and benefits of the
Company's bovine vascular grafts.
RESEARCH AND DEVELOPMENT
The Company uses its expertise in immunology, biochemistry, and cell biology,
and its understanding of the needs of the cardiovascular, vascular, and
orthopaedic surgery medical specialties, to continue to expand its core
preservation and surgical adhesive businesses in the U.S. and to develop or
acquire implantable products and technologies for these specialties. The Company
seeks to identify market areas that can benefit from preserved living tissues
and other related technologies, to develop innovative techniques and products
within these areas, to secure their commercial protection, to establish their
efficacy and then to market these techniques and products. The Company employs
approximately 18 people in its research and development department, including
six PhDs with specialties in the fields of immunology, molecular biology,
protein chemistry, organic chemistry, and biochemistry.
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In order to expand the Company's service and product offerings, the Company is
currently in the process of developing or investigating several technologies and
products, including additional applications of its SynerGraft technology, its
Protein Hydrogel Technology ("PHT") (of which BioGlue is the first PHT product
to be introduced) and its ACT. PHT is based on a bovine protein that mirrors an
array of amino acids that perform complex functions in the human body that
together with glutaraldehyde forms a hydrogel, a water based biomaterial similar
to human tissue. Materials and implantable replacement devices created with PHT
have the potential to provide structure, form, and function of human body
tissue. Because of its versatility and ease of application, PHT is being
developed for application in hernia repair and dura mater sealing in the U.S.,
in the repair of denucleated intervertebral discs, and for the delivery of bone
material for orthopaedic bone repair. The Company is also currently
investigating certain drug delivery applications for its ACT, such as
administering antibiotics and attaching chemotherapy drugs to tumors. To the
extent the Company identifies additional applications for these products, the
Company may attempt to license these products to corporate partners for further
development of such applications or seek funding from outside sources to
continue the commercial development of such technologies. The Company's research
and development strategy is to allocate available resources among the Company's
core market areas of preservation services, bioprosthetic cardiovascular
devices, and implantable biomaterials, based on the size of the potential market
for any specific product candidate and the estimated development time and cost
required to bring the product to market.
Research on these and other projects is conducted in the Company's research and
development laboratory or at universities or clinics where the Company sponsors
research projects. In 2000, 2001, and 2002, the Company spent approximately $5.2
million, $4.7 million, and $ 4.6 million, respectively, on research and
development activities on new and existing products. These amounts represented
approximately 7%, 5%, and 6% of the Company's revenues for those respective
years. The Company's research and development program is overseen by its medical
and scientific advisory boards. The Company's pre-clinical studies are conducted
at universities and other locations outside the Company's facilities by third
parties under contract with the Company. In addition to these efforts, the
Company may pursue other research and development activities.
MANUFACTURING AND OPERATIONS
During 2001 the Company completed a 100,000 square foot addition to its
corporate headquarters and laboratory facilities located on a 21.5-acre
campus-style setting in suburban Atlanta, Georgia. The new addition is to
accommodate growth and development of the Company's BioGlue Surgical Adhesive
and the SynerGraft family of biologic implantable devices. The total Company
U.S. facilities consist of three separate locations totaling approximately
243,000 square feet of leased manufacturing, administrative, laboratory, and
warehouse space. Approximately 24,000 square feet are dedicated to forty-five
class 10,000 clean rooms. An additional 5,500 square feet are dedicated as class
100,000 clean rooms. The extensive clean room environment provides a controlled
environment for tissue dissection, processing, manufacturing, and packaging.
Approximately 40 liquid nitrogen storage units maintain cryopreserved tissue at
- -196(Degree)C. Three back-up emergency generators assure continuity of all
Company operations. Additionally, the Company's corporate complex has a 3,600
square foot Learning Center which includes a 225 seat auditorium and a 1,500
square foot training lab, both equipped with closed-circuit and satellite
television broadcast capability allowing live surgery broadcasts from and to
anywhere in the world. The Learning Center provides visiting cardiovascular,
vascular, and orthopaedic surgeons with a hands-on training environment for
surgical and implantation techniques for the Company's technology platforms.
Human Tissue Processing
The human tissue processing laboratory is responsible for the processing and
preservation of human cardiovascular, vascular, and orthopaedic tissue for
transplant. This laboratory contains approximately 15,600 square feet with a
suite of eight clean rooms. Currently there are approximately 23 technicians
employed in this area, and the laboratory is staffed for two shifts, 365 days
per year. In 2002 the laboratory processed approximately 16,400 human allografts
for distribution and transplant. The current processing level is estimated to be
at about one-third of total capacity. Increasing this processing level could be
accomplished by increasing employees and expanding to three shifts.
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BioGlue Surgical Adhesives
BioGlue Surgical Adhesive is presently manufactured at the Company's
headquarters facility, which has an annual capacity of approximately 2 million
units. The current processing level is about one-twentieth of total capacity.
This laboratory contains approximately 13,500 square feet, including a suite of
six clean rooms. Currently, there are twelve technicians employed in this area.
Bioprosthetic Cardiovascular and Vascular Devices
The bioprosthesis laboratory, which was relocated to the expanded corporate
headquarters in 2001, is responsible for the manufacturing of the
CryoLife-O'Brien stentless porcine heart valve and the SynerGraft bovine
vascular graft. This laboratory is approximately 20,000 square feet with a suite
of six clean rooms for tissue processing. Currently, this laboratory employs six
technicians.
Other facilities
The Company maintains two separate facilities, located in Marietta, Georgia,
that total 31,000 square feet. One facility is approximately 20,000 square feet,
with about 2,100 square feet of laboratory space and a suite of six clean rooms.
The other facility contains approximately 11,000 square feet, including 4,000
square feet of laboratory space and a suite of eight clean rooms. The Company is
currently seeking to sublease these facilities.
QUALITY ASSURANCE
The Company's operations encompass the provision of preservation services and
the manufacturing of bioprosthetics and bioadhesives. In all of its facilities,
the Company is subject to regulatory standards for good manufacturing practices,
including current Quality System Regulations, which are FDA regulatory
requirements for medical device manufacturers. The FDA periodically inspects
Company facilities to ensure Company compliance with these regulations. The
Company also operates according to ISO 9001 Quality System Requirements, an
internationally recognized voluntary system of quality management for companies
that design, develop, manufacture, distribute and service products. The Company
maintains a Certification of Approval to the ISO 9001, as well as EN46001 and
ANSI/ISO/ASQC/Q9001, the European and U.S. versions of the international
standard, respectively. This approval is issued by Lloyd's Register Quality
Assurance Limited ("LRQA"). LRQA is a Notified Body officially recognized by the
EEA to perform assessments of compliance with ISO 9001 and its derivative
standards. LRQA performs semi-annual on-site inspections of the Company's
quality systems. The Company expects to be in compliance with ISO 13485 quality
system requirements by the end of 2003. The ISO 13485 requirements are intended
to be an enhancement to current quality management systems.
The Company's quality assurance staff is comprised primarily of experienced
professionals from the medical device and pharmaceutical manufacturing
industries. The quality assurance department, in conjunction with the Company's
research and development department and select university research staffs,
routinely evaluates the Company's processes and procedures.
Preservation Services
The Company employs a comprehensive quality assurance program in all of its
tissue processing activities. The Company is subject to Quality System
Regulations, additional FDA regulations, and ISO 9001 requirements. The
Company's quality assurance program begins with the development and
implementation of training courses for the employees of procurement agencies. To
assure uniformity of procurement practices among the tissue recovery teams, the
Company provides procurement protocols, transport packages, and tissue transport
liquids to the donor sites.
Upon receipt by the Company, each tissue is assigned a unique control number
that provides traceability of tissue from procurement through the processing and
preservation processes, and ultimately to the tissue recipient. Blood samples
from each tissue donor are subjected to a variety of tests to screen for
serologic infectious diseases. Samples of some tissues are also sent to
independent laboratories for pathology testing. Following dissection of the
tissue to be cryopreserved, a separate procedure is begun in which the dissected
tissue is treated with proprietary antimicrobial solutions.
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The materials and solutions used by the Company in processing tissue are
pre-screened to determine if they meet strict quality standards as defined by
Company protocols. Only materials and solutions that meet the Company's
requirements are approved by quality assurance personnel for use in processing.
Throughout tissue processing, detailed records are maintained and reviewed by
quality assurance personnel.
The Company's tissue processing facilities are annually licensed by the States
of Georgia, New York, Florida, and California as facilities that process, store,
and distribute human tissue for implantation. The regulatory bodies of these
states perform inspections of the facilities to ensure compliance with state law
and regulations. In addition, the Company's human heart valve processing
operations are additionally regulated by the FDA and periodically inspected for
compliance to Quality System Regulations. Other human tissue processed by the
Company is periodically inspected for compliance with the 'CFR Part 1270. CFR
1270 is an FDA regulation which sets forth the requirements with which the
Company must comply in determining the suitability of human tissue for
implantation.
Bioprosthetic and Bioadhesive Manufacturing
The Company employs a comprehensive quality assurance program in all of its
manufacturing activities. The Company is subject to Quality System Regulations,
additional FDA regulations, and ISO 9001 and ISO 13485 requirements.
All materials and components utilized in the production of the Company's
products are received and thoroughly inspected by trained quality control
personnel, according to written specifications and standard operating
procedures. Only materials and components found to comply with Company
procedures are accepted by quality control and utilized in production.
All materials, components and resulting sub-assemblies are traced throughout the
manufacturing process to assure that appropriate corrective actions can be
implemented, if necessary. Each process is documented along with all inspection
results, including final finished product inspection and acceptance. Records are
maintained as to the consignee of product to facilitate product removals or
corrections, if necessary. All processes in manufacturing are validated by
quality engineers to assure that they are capable of consistently producing
product meeting the Company's specifications. The Company maintains a rigorous
quality assurance program of measuring devices used for manufacturing and
inspection to ensure appropriate accuracy and precision.
Each manufacturing facility is subject to periodic inspection by the FDA and
LRQA to independently assure the Company's compliance with its systems and
regulatory requirements.
PATENTS, LICENSES AND OTHER PROPRIETARY RIGHTS
The Company relies on a combination of patents, trade secrets, trademarks, and
confidentiality agreements to protect its proprietary products, processing
technology, and know-how. The Company believes that its patents, trade secrets,
trademarks, and technology licensing rights provide it with important
competitive advantages. The Company owns or has licensed rights to 39 U.S.
patents and 53 foreign patents, including patents relating to its technology for
human cardiovascular, vascular, and orthopaedic tissue preservation; tissue
revitalization prior to freezing; tissue transport; BioGlue Surgical Adhesive;
ACT; organ storage solution; and packaging. The Company has 23 pending U.S.
patent applications and in excess of 97 pending foreign applications that relate
to areas including heart valve and tissue processing technology and delivery of
bioadhesives for anastomosis and other uses. The Company sold the patents
related to the IFM product line to Horizon in 1998. There can be no assurance
that any patents pending will result in issued patents. The Company also has
exclusive licensing rights for technology relating to light-sensitive enzyme
inhibitors. The remaining duration of the Company's issued patents ranges from 6
months to 17 years. The Company has licensed from third parties certain
technologies used in the development of its ACT and other technologies in
licenses that call for the payment of both development milestones and royalties
based on product sales, when and if such products are approved for marketing.
The loss of these licenses could adversely affect the Company's ability to
successfully develop its ACT or other technologies.
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There can be no assurance that the claims allowed in any of the Company's
existing or future patents will provide competitive advantages for the Company's
products, processes, and technologies or will not be successfully challenged or
circumvented by competitors. To the extent that any of the Company's products
are not patent protected, the Company's business, financial condition, and
results of operations could be materially adversely affected. Under current law,
patent applications in the U.S. and patent applications in foreign countries are
maintained in secrecy for a period after filing. The right to a patent in the
U.S. is attributable to the first to invent, not the first to file a patent
application. The Company cannot be sure that its products or technologies do not
infringe patents that may be granted in the future pursuant to pending patent
applications or that its products do not infringe any patents or proprietary
rights of third parties. The Company may incur substantial legal fees in
defending against a patent infringement claim or in asserting claims against
third parties. In the event that any relevant claims of third-party patents are
upheld as valid and enforceable, the Company could be prevented from selling
certain of its products or could be required to obtain licenses from the owners
of such patents or be required to redesign its products to avoid infringement.
There can be no assurance that such licenses would be available or, if
available, would be on terms acceptable to the Company or that the Company would
be successful in any attempt to redesign its products or processes to avoid
infringement. The Company's failure to obtain these licenses or to redesign its
products could have a material adverse effect on the Company's business,
financial condition, and results of operations.
On August 7, 2002 the Company announced the settlement of its ongoing litigation
with Colorado State University Research Foundation ("CSURF") over the ownership
of the Company's SynerGraft technology. The settlement resolved all disputes
between the parties and extinguished all CSURF ownership claims to any aspect of
the Company's SynerGraft technology. The settlement includes an unconditional
assignment to the Company of CSURF tissue engineering patents, trade secrets,
and know-how relating to tissue decellularization and recellularization. The
technology assignment supercedes the 1996 technology license, which was
terminated by the terms of the settlement. Payment terms include a nonrefundable
advance of $400,000 paid by the Company to CSURF that will be applied to earned
royalties as they accrue through March 2011. The Company recorded these amounts
as prepaid royalties and will expense the amounts as the royalties accrue. The
earned royalty rate is a maximum of 0.75% of net revenues from products or
tissue services utilizing the SynerGraft technology.
The Company has entered into confidentiality agreements with all of its
employees and several of its consultants and third-party vendors to maintain the
confidentiality of trade secrets and proprietary information. There can be no
assurance that the obligations of employees of the Company and third parties
with whom the Company has entered into confidentiality agreements will
effectively prevent disclosure of the Company's confidential information or
provide meaningful protection for the Company's confidential information if
there is unauthorized use or disclosure, or that the Company's trade secrets or
proprietary information will not be independently developed by the Company's
competitors. Litigation may be necessary to defend against claims of
infringement, to enforce patents and trademarks of the Company, or to protect
trade secrets and could result in substantial cost to, and diversion of effort
by, the Company. There can be no assurance that the Company would prevail in any
such litigation. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights to the same extent, as do the laws of the U.S.
COMPETITION
Cryopreserved Human Tissues and Bioprosthetic Cardiovascular Devices
The Company faces competition from at least one for-profit company and a number
of non-profit tissue banks that cryopreserve and distribute human tissue, as
well as from companies that market mechanical, porcine, and bovine heart valves,
and synthetic vascular grafts for implantation. Many established companies, some
with resources greater than those of the Company, are engaged in manufacturing,
marketing, and selling alternatives to cryopreserved human tissue. Management
believes that it competes favorably with other entities that cryopreserve human
tissue on the basis of technology, customer service, and quality assurance. As a
result of the decrease in the Company's procurement and processing of human
tissue, the decrease in cardiovascular and vascular tissue shipments, and the
lack of orthopaedic tissue shipments, the Company's competitors have been
favorably impacted. This interruption in the Company's services may make it
difficult for the Company to regain its level of revenues reported prior to the
FDA Order.
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As compared to mechanical, porcine, and bovine heart valves, management believes
that the human heart valves cryopreserved by the Company compete on the factors
set forth above, as well as by providing a tissue that is the preferred
replacement alternative with respect to certain medical conditions, such as
pediatric cardiac reconstruction, valve replacements for women in their
child-bearing years, and valve replacements for patients with endocarditis.
Although human tissue cryopreserved by the Company is initially higher priced
than are mechanical alternatives, these alternatives typically require that the
patient take anti-coagulation drug therapy for the lifetime of the implant. As a
result of the costs associated with anti-coagulants, mechanical valves are
generally, over the life of the implant, more expensive than tissue
cryopreserved by the Company. Notwithstanding the foregoing, management believes
that, to date, price has not been a significant competitive factor.
Generally, for each procedure that may utilize vascular or orthopaedic human
tissue that the Company cryopreserves, there are alternative treatments. Often,
as in the case of veins and ligaments, these alternatives include the repair,
partial removal or complete removal of the damaged tissue and may utilize other
tissues from the patients themselves or synthetic products. The selection of
treatment choices is made by the attending physician in consultation with the
patient. Any newly developed treatments will also compete with the use of tissue
cryopreserved by the Company.
Human and Stentless Porcine Heart Valves. Alternatives to human heart valves
cryopreserved by the Company include mechanical valves, porcine valves, and
valves constructed from bovine pericardium. St. Jude Medical, Inc. is the
leading supplier of mechanical heart valves, and has a marketing and
distribution arrangement with a non-profit tissue bank for supplies of
cryopreserved human heart valves. Edwards Life Sciences, Inc. is the leading
supplier of bovine heart valves. In addition, management believes that at least
four tissue banks offer preservation services for human heart valves in
competition with the Company. The Company presently distributes its stentless
porcine heart valve only outside the U.S. This stentless porcine heart valve
competes with mechanical valves, stented and stentless porcine valves, human
heart valves, and processed bovine pericardium heart valves. The Company is
aware of at least three other companies that offer stentless porcine heart
valves.
Human Vascular Tissue. Synthetic alternatives to veins cryopreserved by the
Company are available primarily in medium and large diameters. Currently,
management believes that there are at least four other providers of
cryopreserved human vascular tissue in competition with the Company. Companies
offering either synthetic or allograft products may enter this market in the
future.
Human Orthopaedic Tissue. As discussed at "FDA Order on Human Tissue
Preservation", the Company ceased processing orthopaedic tissue in August 2002.
The Company resumed processing orthopaedic tissue in late February 2003. The
Company's historic competition in the area of orthopaedic tissue has varied
according to the tissue involved. When transplantation is indicated, the
historic principal competition for human tissues cryopreserved by the Company
has been freeze-dried and fresh frozen human connective tissues. These
alternative allografts are distributed by Muscoskeletal Transplant Foundation,
Lifenet, and others. Prior to the issuance of the FDA Order, tendons
cryopreserved by the Company constituted the principal treatment options for
injuries that required anterior cruciate ligament reconstruction.
Implantable Biomedical Devices for Use as Surgical Adhesives and Sealants
The Company competes with many domestic and foreign medical device,
pharmaceutical, and biopharmaceutical companies. In the surgical adhesive and
surgical sealant area, the Company will compete with existing methodologies,
including traditional wound closure products such as sutures and staples,
marketed by companies such as Johnson & Johnson, Tyco Healthcare Corporation,
and others. Other competitors in the surgical sealant market include Baxter
Healthcare International, Inc., Angiotech Pharmaceuticals, Inc., and Genzyme
Biosurgery. Competitive products may also be under development by other large
medical device, pharmaceutical and biopharmaceutical companies, including 3M and
Confluent Surgical, Inc. Many of the Company's current and potential competitors
have substantially greater financial, technological, research and development,
regulatory and clinical, manufacturing, marketing and sales, and personnel
resources than the Company. BioGlue Surgical Adhesive is the only FDA approved
product with an arterial surgical glue product code designation (MUQ- glue,
surgical, arteries).
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These competitors may also have greater experience in developing products,
conducting clinical trials, obtaining regulatory approvals, and manufacturing
and marketing such products. Certain of these competitors may obtain patent
protection, approval or clearance by the FDA or foreign countries, or product
commercialization earlier than the Company, any of which could materially
adversely affect the Company. Furthermore, if the Company commences significant
commercial sales of its products, it will also be competing with respect to
manufacturing efficiency and marketing capabilities.
Other recently developed technologies or procedures are, or may in the future
be, the basis of competitive products. There can be no assurance that the
Company's current competitors or other parties will not succeed in developing
alternative technologies and products that are more effective, easier to use, or
more economical than those which have been or are being developed by the Company
or that would render the Company's technology and products obsolete and
non-competitive in these fields. In such event, the Company's business,
financial condition, and results of operations could be materially adversely
affected. See "Risk Factors--Rapid Technological Change."
GOVERNMENT REGULATION
U.S. Federal Regulation of Medical Devices
Because human heart valves and BioGlue surgical bioadhesives are, and other
Company products may in the future be regulated as medical devices, the Company
and these products are subject to the provisions of the Federal Food, Drug and
Cosmetic Act ("FDCA") and implementing regulations. Pursuant to the FDCA, the
FDA regulates the manufacture, distribution, labeling, and promotion of medical
devices in the U.S. In addition, various foreign countries in which the
Company's products are or may be distributed impose additional regulatory
requirements.
The FDCA provides that, unless exempted by regulation, medical devices may not
be distributed in the U.S. unless they have been approved or cleared for
marketing by the FDA. There are two review procedures by which medical devices
can receive such approval or clearance. Some products may qualify for clearance
to be marketed under a Section 510(k) ("510(k)") procedure, in which the
manufacturer provides a premarket notification that it intends to begin
marketing the product, and shows that the product is substantially equivalent to
another legally marketed 510(k) product (i.e., that it has the same intended use
and that it is as safe and effective as a legally marketed 510(k) device and
does not raise different questions of safety and effectiveness than does a
legally marketed device). In some cases, the submission must include data from
clinical studies. Marketing may commence when the FDA issues a clearance letter
finding such substantial equivalence.
If the product does not qualify for the 510(k) procedure (either because it is
not substantially equivalent to a legally marketed 510(k) device or because it
is a Class III device required by the FDCA and implementing regulations to have
an approved application for premarket approval, known as a PMA) the FDA must
approve a PMA application before marketing can begin. PMA applications must
demonstrate, among other matters, that the medical device is safe and effective.
A PMA application is typically a complex submission, usually including the
results of human clinical studies, and preparing an application is a detailed
and time-consuming process. Once a PMA application has been submitted, the FDA's
review may be lengthy and may include requests for additional data. By statute
and regulation, the FDA may take 180 days to review a PMA application although
such time may be extended. Furthermore, there can be no assurance that a PMA
application will be reviewed within 180 days or that a PMA application will be
approved by the FDA.
The FDCA also provides for an investigational device exemption ("IDE") which
authorizes distribution for clinical evaluation of devices that lack a PMA or
510(k). Devices subject to an IDE are subject to various restrictions imposed by
the FDA. The number of patients that may be treated with the device is limited,
as are the number of institutions at which the device may be used. Patients must
give informed consent to be treated with an investigational device. The device
must be labeled that it is for investigational use and may not be advertised, or
otherwise promoted, and the price charged for the device may be limited.
Unexpected adverse experiences must be reported to the FDA.
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Under certain circumstances, the FDA may grant a Humanitarian Device Exemption
("HDE"). HDE's are granted by the FDA in an attempt to encourage the development
of medical devices for use in the treatment of rare conditions that affect small
patient populations. An approval by the FDA exempts such devices from full
compliance with clinical study requirements for premarket approval.
The FDCA requires all medical device manufacturers and distributors to register
with the FDA annually and to provide the FDA with a list of those medical
devices which they distribute commercially. The FDCA also requires manufacturers
of medical devices to comply with labeling requirements and to manufacture
devices in accordance with Quality System Regulations, which require that
companies manufacture their products and maintain their documents in a
prescribed manner with respect to good manufacturing practices, design, document
production, process, labeling and packaging controls, process validation, and
other quality control activities. The FDA's medical device reporting regulation
requires that a device manufacturer provide information to the FDA on death or
serious injuries alleged to have been associated with the use of its products,
as well as product malfunctions that would likely cause or contribute to death
or serious injury if the malfunction were to recur. The FDA's medical device
tracking regulation requires the adoption of a method of device tracking by
manufacturers of life-sustaining or implantable products, the failure of which
would be reasonably likely to have serious adverse health consequences, if the
FDA issues an order to do so. The manufacturer must adopt methods to ensure that
such devices can be traced from the manufacturing facility to the ultimate user,
the patient. The FDA further requires that certain medical devices not cleared
for marketing in the U.S. follow certain procedures before they are exported.
The FDA inspects medical device manufacturers and distributors and has authority
to seize noncomplying medical devices, to enjoin and/or to impose civil
penalties on manufacturers and distributors marketing non-complying medical
devices, to criminally prosecute violators, and to order recalls in certain
instances.
Human Heart Valves. The Company's human heart valves became subject to
regulation by the FDA in June 1991, when the FDA published a notice stating that
human heart valves were Class III medical devices under the FDCA. The June 1991
notice provided that distribution of human heart valves for transplantation
would violate the FDCA unless they were the subject of an approved PMA or IDE on
or before August 26, 1991.
On October 14, 1994, the FDA announced in the Federal Register that neither an
approved application for PMA nor an IDE is required for processors and
distributors who had marketed heart valve allografts before June 26, 1991. This
action by the FDA resulted in the allograft heart valves being classified as
Class II Medical Devices and has removed them from clinical trial status. It
also allows the Company to distribute such valves to cardiovascular surgeons
throughout the U.S.
Porcine Heart Valves. Porcine heart valves are Class III medical devices, and
FDA approval of a PMA is required prior to commercial distribution of such
valves in the U.S. The porcine heart valves currently marketed by the Company
have not been approved by the FDA for commercial distribution in the U.S. but
may be manufactured in the U.S. and exported to foreign countries if the valves
meet the specifications of the foreign purchaser, do not conflict with the laws
of and are approved by the country to which they will be exported, and the FDA
determines that their exportation is not contrary to the public health and
safety.
BioGlue Surgical Adhesive. BioGlue Surgical Adhesive is regulated as a Class III
medical device by the FDA. In December 2001 the Company received FDA approval
for BioGlue as an adjunct to sutures and staples for use in adult patients in
open surgical repair of large vessels. Prior to this approval, the Company
received a HDE in December 1999 for BioGlue Surgical Adhesive for use as an
adjunct in repair of acute thoracic aortic dissections. BioGlue Surgical
Adhesive is the only FDA approved product with an arterial surgical glue product
code designation (MUQ- glue, surgical, arteries).
U.S. Federal Regulation of Human Tissue
Other than human and porcine heart valves, BioGlue Surgical Adhesive, and
SynerGraft processed bovine vascular grafts, none of the Company's other tissue
services or tissue-based products are currently subject to regulation under the
FDCA or FDA regulation as medical devices. See "Recent Events" regarding
correspondence from the FDA about cardiovascular and vascular tissues processed
with the SynerGraft technology. Heart valves are one of a small number of
processed human tissues over which the FDA has asserted medical device
jurisdiction. Concerns with the transmission of HIV and Hepatitis B led the FDA
23
to issue an Interim Rule in December 1993 as an emergency measure to protect the
public from human tissue that had incomplete or no documentation ascertaining
its freedom from communicable diseases. The FDA modified the regulation and
reissued it as a new rule, effective January 1998. The 1998 Final Rule provided
clarification of certain provisions in the 1993 Interim Rule and focused on
donor screening and testing to prevent the introduction, transmission, and
spread of HIV-1 and -2 and Hepatitis B and C. The Final Rule set minimal
requirements to prevent the transmission of communicable diseases from human
tissue used for transplantation. The rule defines human tissue as any tissue
derived from a human body which is (i) intended for administration to another
human for the diagnosis, cure, mitigation, treatment, or prevention of any
condition or disease and (ii) recovered, processed, stored, or distributed by
methods not intended to change tissue function or characteristics. The FDA
definition excludes, among other things, tissue that currently is regulated as a
human drug, biological product, or medical device and excludes kidney, liver,
heart, lung, pancreas, or any other vascularized human organ. The FDA has
proposed and is refining three regulations covering registration, expanded donor
suitability and testing requirements, and the use of good tissue practices, akin
to good manufacturing practices required for medical device manufacturers. In
March 2002 the FDA issued a guidance document for implementation without seeking
prior comments titled, "Validation of Procedures for Processing of Human Tissues
Intended for Transplantation." This guidance represented the FDA's current
status on the topic of validation of procedures to prevent contamination during
processing of human tissues for transplantation. It is likely that the FDA will
expand its regulation of processed human tissue in the future. For example, in
November 2000 the FDA published a proposed rule for good tissue manufacturing
practices. Moreover, the FDA may determine that the vascular and orthopaedic
tissue that are processed by the Company are medical devices, or the FDA may
decide to regulate human heart valves as "human tissue" rather than medical
devices, but the FDA has not done so at this time. Complying with FDA regulatory
requirements or obtaining required FDA approvals or clearances may entail
significant time delays and expenses or may not be possible, any of which may
have a material adverse effect on the Company. In addition, the U.S. Congress is
expected to consider legislation that would regulate human tissue for transplant
or the FDA could impose a separate regulatory scheme for human tissue. Such
legislation or regulation could have a material adverse effect on the Company.
Possible Other FDA Regulation
Other products and processes under development by the Company are likely to be
subject to regulation by the FDA. Some may be classified as medical devices,
while others may be classified as drugs or biological products or subject to a
regulatory scheme for human tissue that the FDA may adopt in the future.
Regulation of drugs and biological products is substantially similar to
regulation of medical devices. Obtaining FDA approval to market these products
is likely to be a time consuming and expensive process, and there can be no
assurance that any of these products will ever receive FDA approval, if
required, to be marketed.
NOTA Regulation
The Company's activities in processing and transporting human hearts and certain
other organs are also subject to federal regulation under the National Organ
Transplant Act ("NOTA"), which makes it unlawful for any person to knowingly
acquire, receive, or otherwise transfer any human organ for valuable
consideration for use in human transplantation if the transfer affects
interstate commerce. NOTA excludes from the definition of "valuable
consideration" reasonable payments associated with the removal, transportation,
implantation, processing, preservation, quality control, and storage of a human
organ. The purpose of this statutory provision is to allow for compensation for
legitimate services. The Company believes that to the extent its activities are
subject to NOTA, it meets this statutory provision relating to the
reasonableness of its charges. There can be no assurance, however, that
restrictive interpretations of NOTA will not be adopted in the future that would
call into question one or more aspects of the Company's methods of charging for
its preservation services.
State Licensing Requirements
Some states have enacted statutes and regulations governing the processing,
transportation, and storage of human organs and tissue. The activities engaged
in by the Company require it to be licensed as a clinical laboratory and tissue
bank under Georgia, New York, California, and Florida law. The Company has such
licenses, and the Company believes it is in compliance with applicable state
laws and regulations relating to clinical laboratories and tissue banks which
store, process, and distribute human tissue designed to be used for medical
purposes in human beings. There can be no assurance, however, that more
24
restrictive state laws or regulations will not be adopted in the future that
could adversely affect the Company's operations. Certain employees of the
Company have obtained other required licenses.
Foreign Approval Requirements
Sales of medical devices and biological products outside the U.S. are subject to
foreign regulatory requirements that vary widely from country to country.
Approval of a product by comparable regulatory authorities of foreign countries
must be obtained prior to commercial distribution of the product in those
countries. The time required to obtain foreign approvals may be longer or
shorter than that required for FDA approval. The EEA recognizes a single
approval, called a CE Mark, which allows for distribution of an approved product
throughout the EEA (18 countries; 15 European Union (EU) countries and 3
European Free Trade Association (EFTA) countries) without additional general
applications in each country. However, individual EEA members reserve the right
to require additional labeling or information to address particular patient
safety issues prior to allowing marketing. For example, France and an increasing
number of EEA members require additional information for products containing
material of animal origin. The CE Mark is awarded by third parties called
Notified Bodies. These Notified Bodies are approved and subject to review by the
competent authorities of their respective countries. A number of countries
outside of the EEA accept the CE Mark in lieu of marketing submissions as an
addendum to that country's application process. The Company has been issued CE
Marks for its CryoLife-O'Brien porcine heart valve, BioGlue Surgical Adhesive,
and SynerGraft Model 100 vascular grafts. The Company's porcine heart valves may
be exported to specified developed nations, including countries in the EEA,
Australia, Canada, Israel, United Arab Emirates, and Switzerland. The Company's
SynerGraft Model 100 vascular graft may also be exported to Switzerland and
Israel.
ENVIRONMENTAL MATTERS
The Company's tissue processing activities generate some biomedical wastes
consisting primarily of human and animal pathological and biological wastes,
including human and animal tissue and body fluids removed during laboratory
procedures. The biomedical wastes generated by the Company are placed in
appropriately constructed and labeled containers and are segregated from other
wastes generated by the Company. The Company contracts with third parties for
transport, treatment, and disposal of biomedical waste. Although the Company
believes it is in compliance with applicable laws and regulations promulgated by
the U.S. Environmental Protection Agency and the Georgia Department of Natural
Resources, Environmental Protection Division, the failure by the Company to
comply fully with any such regulations could result in an imposition of
penalties, fines, or sanctions, which could have a material adverse effect on
the Company's business.
EMPLOYEES
As of February 19, 2003 the Company had approximately 274 employees. These
employees included ten persons with PhD degrees. None of the Company's employees
is represented by a labor organization or covered by a collective bargaining
agreement, and the Company has never experienced a work stoppage or interruption
due to labor disputes. Management believes its relations with its employees are
good.
AVAILABLE INFORMATION
It is the Company's policy to make all of its filings with the Securities and
Exchange Commission ("SEC"), including without limitation its annual report on
Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K,
available free of charge on the Company's website, www.cryolife.com, on the day
of filing. All of such filings made on or after November 15, 2002 have been made
available on the website.
25
RISK FACTORS
THE FDA ORDER ON HUMAN TISSUE-DEPENDENCE ON PRESERVATION OF HUMAN TISSUE HAS
ADVERSELY AFFECTED CRYOLIFE'S BUSINESS
On August 13, 2002 the Company received an order from the FDA calling for the
retention, recall, and/or destruction of all non-valved cardiac, vascular, and
orthopaedic tissue processed by the Company at its headquarters since at least
October 3, 2001 based upon allegations of FDA violations by the Company of its
handling of such tissue and alleged contamination through the Company's
processing of such tissue that resulted in 14 post-transplant infections
including one death. A significant portion of the Company's current revenues is
derived from the preservation of human tissues. Revenues of human tissue
preservation services for the six months ended June 30, 2002, the last period
ending prior to the issuance of the FDA Order, were 78% of the Company's
revenues. Of those revenues, $26.9 million or 67% were derived from preservation
of tissues subject to the FDA Order. Revenues for human tissue preservation
services for the year ended 2001 were 86% of the Company's revenues. Of those
revenues, 68% were derived from preservation of tissues subject to the FDA
Order. During the fourth quarter of 2002, revenues derived from the preservation
of tissues were $6.3 million, a 66% decrease in revenues from the fourth quarter
of 2001.
The FDA Order and resulting adverse publicity have had a material adverse effect
on the Company's business, financial condition, results of operations and cash
flows. As a result of the FDA Order, the Company has experienced, and expects to
continue to experience at least through the first half of 2003, decreases in
revenues and profits as compared to prior year periods and there is a
possibility that the Company may not generate sufficient cash from operations to
fund its operations over the long-term. Although the Agreement that supplements
the FDA Order has allowed the Company to ship vascular and non-valve cardiac
patch tissues subject to the FDA Order with certain restrictions, the Company
has continued to experience a reduced demand for such tissues and for tissues
processed since the September 5, 2002 Agreement due to the adverse publicity
generated from the recall and from decisions by implanting physicians' or risk
managers at implanting institutions to use human tissue from the Company's
competitors. Even though the FDA 483 letter that preceded the FDA Order was
closed out on February 14, 2003, demand for such tissue may continue to be
reduced by the adverse publicity generated from the FDA Order. Therefore, the
Company may still experience significant decreases in revenues and profits and
there is a possibility that the Company will not generate sufficient cash from
operations to fund its operations in the long-term. In addition, as a result of
the FDA Order, the time for processing human tissue and the costs of such
processing have increased and are likely to further increase, which could have a
material adverse effect on the Company's business, results of operations and
financial position.
The success of the Company depends upon, among other factors, the availability
of sufficient quantities of tissue from human donors. Any material reduction in
the supply of donated human tissue could restrict the Company's growth. The
Company relies primarily upon the efforts of third party procurement agencies
and tissue banks (most of which are not-for-profit) and others to educate the
public and foster a willingness to donate tissue. Because of the adverse
publicity associated with the FDA Order and uncertainty regarding future tissue
processing, some procurement agencies have ceased sending tissue to the Company
for processing. If the Company's relationships with procurement agencies
continue to be adversely affected or the Company is unable to obtain tissues
from procurement agencies that have ceased sending tissue to the Company for
processing, the Company may be unable to obtain adequate supplies of donated
tissues to operate profitably.
THE FDA ORDER HAS HAD AN ADVERSE IMPACT ON LIQUIDITY AND CAPITAL RESOURCES
Based upon the FDA Order, the Company anticipates a continued decrease in
liquidity. Based upon the present and anticipated decrease in revenues and
profits from the FDA Order and associated adverse publicity, the Company expects
that cash generated by operations will continue to decrease over the near term
and working capital could decrease. Although the Company has reduced its level
of operations and the number of personnel employed in response to the FDA Order,
there is a possibility that the Company may not have sufficient funds to fund
its primary capital requirements or to meet its operating and development needs
in the long-term.
26
DEMAND FOR OUR ORTHOPAEDIC TISSUE PRESERVATION SERVICES IS MINIMAL AND MAY NOT
RETURN
As a result of the FDA Order and related adverse publicity, the Company has
received only nominal revenue from the preservation of orthopaedic tissues since
August 14, 2002. Revenues since August 14, 2002 have been from shipments of
tissues that were processed prior to October 3, 2001. For the year ended
December 31, 2001, human tissue preservation services revenues for orthopaedic
tissues were $22.5 million, which represented 26% of the Company's revenues. For
the six months ended June 30, 2002, (the last period ending prior to the FDA
Order) revenues for preservation services for orthopaedic tissues were $11.9
million (prior to the reduction of estimated tissue recall returns), which
represented 23% of the Company's revenues. Because orthopaedic tissue is
generally not involved in life-saving or limb-saving procedures and due to the
adverse publicity, the demand for orthopaedic tissue from the Company may remain
minimal and may never return to the levels in existence before the FDA Order,
when the Company resumes processing. As a result, this portion of the Company's
business may have to be permanently discontinued or may only continue at an
extremely reduced level. Any of these occurrences would result in a significant
decrease in the Company's revenues and profitability in the future as compared
to historical results.
PHYSICIANS MAY BE RELUCTANT TO IMPLANT THE COMPANY'S PRESERVED TISSUES
Even though the April 2002 483 Notice that preceded the FDA's Warning Letter has
been closed out, there is a risk that physicians or implanting institutions will
be reluctant to choose the Company's preserved tissues for use in implantation,
due to a perception that they may not be safe or to a belief that the implanting
physician or hospital may be subject to a heightened liability risk if the
Company's tissues are used. In addition, for similar reasons, hospital risk
managers may forbid implanting surgeons to utilize the Company's tissues where
alternatives are available. If a significant number of implanting hospitals or
physicians refused to use tissues preserved by the Company, the Company's
revenues and profits would be materially adversely affected.
HEART VALVES PROCESSED BY THE COMPANY MAY ALSO BE RECALLED
On August 21, 2002 the FDA publicly stated that allograft heart valves have not
been included in the FDA recall order as these devices are essential for the
correction of congenital cardiac lesions in neonate and pediatric patients and
no satisfactory alternative device exists. However, the FDA also publicly stated
that it still has serious concerns regarding the processing and handling of
allograft heart valves. The FDA also recommended that surgeons carefully
consider using processed allografts from alternative sources, that surgeons
should inform prospective patients of the FDA's concerns with the Company's
allograft heart valves, and that patients should be carefully monitored for both
fungal and bacterial infections. Any adverse finding by the FDA regarding
allograft heart valves, including a recall, would cause further decreases in the
Company's revenue base and profits and significantly reduce the Company's
potential for growth. If such a recall occurs, the Company may also be required
to write-down all or a portion of the deferred preservation costs for allograft
heart valves, which could have a material adverse effect on the results of
operations and financial condition of the Company.
PRODUCTS NOT INCLUDED IN THE FDA RECALL MAY COME UNDER INCREASED SCRUTINY
Although the Company's BioGlue Surgical Adhesive and bioprosthetic devices were
not included in the FDA recall, the manufacturing facilities of these products
many come under increased scrutiny from the FDA as a result of their review of
the Company's tissue processing laboratories. A negative review from the FDA of
these manufacturing facilities could have a material adverse effect on the
Company's business, results of operations and financial position.
DEMAND FOR HEART VALVES PROCESSED BY THE COMPANY HAS DECREASED AND MAY CONTINUE
TO DECREASE
Possibly as a result of the FDA's public statement on August 21, 2002 regarding
allograft heart valves, and due to the adverse publicity associated with the FDA
Order and reported tissue infections, some physicians and implanting
institutions have been reluctant to choose the Company's allograft heart valves
for use in implantation, due to a perception that they may not be safe or to a
belief that the implanting institutions or hospitals may be subject to a
heightened liability risk if the Company's preserved tissues are used,
especially if alternatives are available. If adverse publicity continues and if
the FDA's public statement is not retracted, the demand for Company's allograft
heart valves could continue to decrease and may never return to the levels
27
exhibited before the FDA Order. In such an event, the Company's revenues and
profits would be materially adversely affected as compared to historical
results. Heart valve shipments decreased 33% in the fourth quarter of 2002 as
compared to the fourth quarter of 2001.
THE COSTS OF RECALL AND RELATED WRITE-DOWNS HAVE ADVERSELY AFFECTED THE COMPANY
The Company's financial statements reflect the estimated cost of recalling
tissue pursuant to the FDA Order. The Company recorded a write-down of $32.7
million of deferred preservation costs for tissues subject to the FDA Order.
While these estimates are based on the Company's best estimate of the costs
associated with the recall and the impairment of deferred preservation costs
subject to the FDA Order, there can be no assurance that these costs and
write-downs will be limited to the amount estimated.
ADVERSE PUBLICITY MAY REDUCE DEMAND FOR PRODUCTS NOT AFFECTED BY THE FDA RECALL
Even though the Company's BioGlue products and its porcine heart valve products
(which are not sold in the U.S.) are not included in the FDA Order, there is a
possibility that surgeons or risk managers at institutions that use such
products may be reluctant to use such products because of the adverse publicity
associated with the FDA Order. Decreased demand for such products, particularly
BioGlue, could have a material adverse effect on the Company's business, results
of operations and financial position.
WE MAY BE UNABLE TO ADDRESS THE CONCERNS RAISED BY THE FDA IN ITS FEBRUARY 2003
FORM 483 NOTICE OF OBSERVATIONS
In connection with closing out its April 2002 Form 483 Notice of Observations,
the FDA issued a new Form 483 Notice of Observations in February 2003. The
majority of the observations in the new letter focused on the Company's systems
for handling complaints. If the Company is unable to satisfactorily respond to
the FDA's observations contained in this notice, the FDA could take further
action, which could have a material adverse effect on the Company's business,
results of operations, financial position or cashflows.
THE FDA HAS NOTIFIED CRYOLIFE OF ITS BELIEF THAT MARKETING OF CRYOVALVE SG AND
CRYOVEIN SG REQUIRE ADDITIONAL REGULATORY SUBMISSIONS AND/OR APPROVALS
On February 20, 2003 CryoLife received a letter from the FDA stating that a
510(k) premarket notification for the CryoValve SG was required before the
product can be marketed. The letter also contended that a premarket approval
application was required in order to market the CryoVein SG when used for A-V
(arteriovenous) access. The agency position is that femoral veins used for A-V
access are medical devices that require premarket approval. If CryoLife is
unable to persuade the FDA that its assertions are incorrect, there can be no
guarantee that CryoLife will be able to obtain any required approvals on a
timely basis or without significant expenditures, if at all. Inability to market
either CryoValve or CryoVein could have a material adverse impact on the
Company's business, results of operations, financial position or cashflows.
REGULATORY ACTION OUTSIDE OF THE U.S. MAY ALSO AFFECT THE COMPANY'S BUSINESS
After the issuance of the FDA Order , Health Canada also issued a recall on the
same types of tissue. In addition, other countries have inquired as to the
tissues exported by the Company, although their inquiries are now, to the
Company's knowledge, complete. In addition, the Company has not shipped tissue
out of the U.S. without following the restrictions set forth in the FDA Order as
supplemented by the Agreement. In the event additional regulatory concerns are
raised by other countries, the Company may be unable to export tissues outside
of the U.S.
THE COMPANY'S COMMON STOCK IS POTENTIALLY AT RISK OF BEING DELISTED FROM THE NEW
YORK STOCK EXCHANGE
Because of the impact of the FDA Order and the recent trading price of the
Company's common stock, there is a possibility that the Company's common stock
could be delisted from the New York Stock Exchange. If the stock is delisted,
28
there is no guarantee that there will be a liquid market for the stock and the
trading price of the stock would likely be adversely affected.
THE COMPANY IS THE SUBJECT OF AN ONGOING SEC INVESTIGATION
The Company received notice from the Securities and Exchange Commission on
August 17, 2002 that it is the subject of an investigation with respect to
accounting issues and trades in the Company's stock related to the FDA Order.
The Company does not know any details of what the SEC is specifically
investigating, but believes that an adverse finding by the SEC could have a
material adverse effect on its business financial position, results of
operations, and cash flows. The staff of the SEC subsequently confirmed that its
investigation is informal in nature, and that it does not have subpoena power at
this time. At the present time, the Company is unable to predict the outcome of
this matter.
AS A RESULT OF THE FDA RECALL AND RESULTING FINANCIAL IMPACT, CRYOLIFE'S LENDER
HAS NOTIFIED IT THAT IT IS IN DEFAULT OF CERTAIN PROVISIONS OF THE COMPANY'S
CREDIT FACILITY
The Term Loan contains certain restrictive covenants including, but not limited
to, maintenance of certain financial ratios, a minimum tangible net worth
requirement, and the requirement that no materially adverse event has occurred.
The lender has determined that the FDA Order and resulting financial impact, as
described in Note 2 to the Summary Consolidated Financial Statements, and the
inquiries of the Securities and Exchange Commission, as described in Note 12 to
the Summary Consolidated Financial Statements, have had a material adverse
effect on the Company that constitutes an event of default. Additionally, as of
September 30 and December 31, 2002, the Company was in violation of the debt
coverage ratio and net worth financial covenants. The lender has advised the
Company that it is in default of certain provisions of the Term Loan; however,
as of February 24, 2003, the lender has elected not to pursue any of its various
remedies provided for in the Term Loan, but reserves the right to exercise any
such right under the terms of the Term Loan. There is no assurance the lender
will not exercise its rights, which could have a material adverse effect on the
Company's liquidity.
Due to cross default provisions included in the Company's debt agreements, as of
December 31, 2002 the Company was in default of certain capital lease agreements
maintained with the lender of the Term Loan. Therefore, all amounts due under
these capital leases are reflected as a current liability on the Consolidated
Balance Sheets as of December 31, 2002. There is no assurance the lender will
not exercise its rights under lease agreements, which could have a material
adverse effect on the Company's liquidity.
THE COMPANY'S INSURANCE COVERAGE MAY BE INSUFFICIENT TO COVER JUDGMENTS UNDER
EXISTING OR FUTURE CLAIMS
The Company's products are used by health care providers in connection with the
treatment of patients, who will, on occasion, sustain injury or die as a result
of their condition or medical treatment. As a result, the use of the Company's
products and human tissue processed by the Company involves the possibility of
adverse effects that could expose the Company to product liability claims,
including the lawsuits filed against the Company relating to implanted tissue
described below in Part I, Item 3 "Legal Proceedings." The FDA Order could
adversely influence the outcome of current product liability claims relating to
tissue processed by the Company. In addition, due to the publicity surrounding
the recent FDA Order, more product liability claims relating to tissue processed
by the Company could be filed.
In addition, a recent U.S. Supreme Court decision held that product liability
may exist despite FDA approval, and future court decisions may also increase the
Company's risk of product liability.
Whether or not the Company is ultimately determined to be liable for product
liability claims, the Company will incur significant legal expenses. In
addition, such litigation could damage the Company's reputation and therefore
impair its ability to market its products or obtain product liability insurance
and could cause the premiums for such insurance to increase. Although the
Company has incurred minimal losses due to product liability claims to date, the
Company may incur significant losses in the future. Management believes that the
coverage is adequate to cover any losses due to product claims that may be
incurred; however, there can be no assurance that such coverage will be
29
adequate. In addition, there can be no assurance that such coverage will
continue to be available on terms acceptable to the Company, especially in light
of the FDA Order and the number of product liability claims the Company has had
made against it. Furthermore, if any product liability claims are successful, it
could have a material adverse effect on the Company's business, financial
condition, results of operations, and cash flows.
INSURANCE COVERAGE MAY BE DIFFICULT OR IMPOSSIBLE TO OBTAIN IN THE FUTURE AND IF
OBTAINED, THE COST OF INSURANCE COVERAGE IS LIKELY TO BE MUCH MORE EXPENSIVE
THAN IN THE PAST
Because of the current litigation and the adverse publicity from the FDA Order,
the Company may be unable to obtain insurance coverage in the future, causing
the Company to be subject to additional future exposure from product liability
claims. Additionally, if insurance coverage is obtained, the insurance rates may
be significantly higher than in the past, which may adversely impact the
Company's profitability. The Company has received several notices of non-renewal
and/or notices of potential premium increases from its current insurance
companies. The Company is in the process of soliciting insurance for the coming
renewal period of April 1 and May 1, 2003.
INTENSE COMPETITION MAY AFFECT THE COMPANY'S ABILITY TO RECOVER FROM THE FDA
ORDER AND DEVELOP ITS SURGICAL ADHESIVE BUSINESS
The Company faces competition from other companies that cryopreserve human
tissue, as well as companies that market mechanical valves and synthetic and
animal tissue for implantation and companies that market wound closure products.
During the time that the Company has been restricted in its processing and
distribution of human tissue due to the FDA Order as supplemented by the
Agreement, tissue preservation service customers have been forced to obtain
tissue from the Company's competitors, which could lead to permanent
substitution.
Management believes that at least four tissue banks offer preservation services
for allograft heart valves and many companies offer processed porcine heart
valves and mechanical heart valves. A few companies dominate portions of the
mechanical and porcine heart valve markets, including St. Jude Medical, Inc.,
Medtronic, Inc. and Edwards Life Sciences. The Company is aware that several
companies have surgical adhesive products under development. Competitive
products may also be under development by other large medical device,
pharmaceutical and biopharmaceutical companies. Many of the Company's
competitors have greater financial, technical, manufacturing and marketing
resources than the Company and are well established in their markets.
There can be no assurance that the Company's products and services will be able
to compete successfully with the products of these or other companies. Any
products developed by the Company that gain regulatory clearance or approval
would have to compete for market acceptance and market share. Failure of the
Company to compete effectively could have a material adverse effect on the
Company's business, financial condition, results of operations and cash flows.
The FDA Order and related adverse publicity have had an adverse effect on the
Company's competitive position, which has had a material adverse effect on the
Company's results of operations. The FDA Order and related adverse publicity may
continue to have an adverse effect on the Company's competitive position, which
may continue to have a material adverse effect on the Company's results of
operations. As a result, the Company's competitors may gain competitive
advantages that may be difficult to overcome.
RAPID TECHNOLOGICAL CHANGE COULD CAUSE THE COMPANY'S SERVICES AND PRODUCTS TO
BECOME OBSOLETE
The technologies underlying the Company's products and services are subject to
rapid and profound technological change. The Company expects competition to
intensify as technical advances in each field are made and become more widely
known. There can be no assurance that others will not develop products or
processes with significant advantages over the products and processes that the
Company offers or is seeking to develop. Any such occurrence could have a
material adverse effect on the Company's business, financial condition, results
of operations, and cash flows.
PRODUCTS IN DEVELOPMENT MAY NOT BE SUCCESSFUL
The Company's growth and profitability will depend, in part, upon its ability to
complete development of and successfully introduce new products, including
additional applications of its BioGlue and SynerGraft technologies and its ACT.
The Company may be required to undertake time consuming and costly development
activities and seek regulatory clearance or approval for new products. The
Company has had minimal reduction in its development efforts since the receipt
30
of the FDA Order. The Company may have to further reduce its development efforts
in the future because of the impact of the FDA Order, reported tissue
infections, and adverse publicity on the Company's financial condition.
Although the Company has conducted pre-clinical studies on many of its products
under development which indicate that such products may be effective in a
particular application, there can be no assurance that the results obtained from
expanded clinical studies will be consistent with earlier trial results or be
sufficient for the Company to obtain any required regulatory approvals or
clearances. There can be no assurance that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of new products, that regulatory clearance or
approval of these or any new products will be granted on a timely basis, if
ever, or that the new products will adequately meet the requirements of the
applicable market or achieve market acceptance.
The completion of the development of any of the Company's products remains
subject to all of the risks associated with the commercialization of new
products based on innovative technologies, including unanticipated technical or
other problems, manufacturing difficulties and the possible insufficiency of the
funds allocated for the completion of such development. Consequently, the
Company's products under development may not be successfully developed or
manufactured or, if developed and manufactured, such products may not meet price
or performance objectives, be developed on a timely basis or prove to be as
effective as competing products.
The inability to complete successfully the development of a product or
application, or a determination by the Company, for financial, technical or
other reasons, not to complete development of any product or application,
particularly in instances in which the Company has made significant capital
expenditures, could have a material adverse effect on the Company's business,
financial condition, results of operations, and cash flows. The Company's
research and development efforts are time consuming and expensive and there can
be no assurance that these efforts will lead to commercially successful products
or services. Even the successful commercialization of a new service or product
in the medical industry can be characterized by slow growth and high costs
associated with marketing, under-utilized production capacity and continuing
research and development and education costs. The introduction of new human
tissue products may require significant physician training and years of clinical
evidence derived from follow-up studies on human implant recipients in order to
gain acceptance in the medical community.
INVESTMENTS IN NEW TECHNOLOGIES OR DISTRIBUTION RIGHTS MAY NOT BE SUCCESSFUL
The Company may invest in new technology licenses or distribution rights, such
as Cerasorb, and may be unable to meet the expected revenue forecast for the
licenses or rights. In addition, the Company may not be able to recover its
initial investment in the license, distribution right or purchase of initial
inventory, which may adversely impact the Company's profitability.
FUNDING FOR THE ACT TECHNOLOGY MAY NOT BE AVAILABLE
The ACT is a reversible linker technology that has potential uses in the areas
of cancer therapy, fibrinolysis (blood clot dissolving) and other drug delivery
applications. In February 2001 the Company formed AuraZyme, a wholly-owned
subsidiary, in order to seek a corporate collaboration or to complete a
potential private placement of equity or equity-oriented securities to fund the
commercial development of the ACT. The Company has been seeking such funding
since 1998.
This strategy is designed to allow the Company to continue development of this
technology without incurring additional research and development expenditures,
other than through AuraZyme. There can be no guarantee that such funding can be
obtained on acceptable terms, if at all, especially in light of the recent FDA
Order. If such funding is not obtained, the Company may be unable to effectively
test and develop the ACT, and may therefore be unable to determine its
effectiveness. Even if such financing is obtained, there is no guarantee that
the ACT will in fact prove to be effective in the above applications. Failure to
obtain the desired financing, or failure of the ACT to perform as anticipated in
future tests, could have a material adverse effect on the Company's future
expansion plans and could limit future growth.
31
UNCERTAINTIES REGARDING THE SYNERGRAFT TECHNOLOGY
The Company processes bovine tissues with the SynerGraft technology and
processed human tissues with the SynerGraft technology until February 22, 2003,
following the receipt of the informal February FDA letter (see "Recent Events').
In animal studies, explanted SynerGraft treated allograft heart valves have been
shown to repopulate with the hosts' cells. However, should SynerGraft-treated
tissues implanted in humans not consistently and adequately repopulate with the
human host cells, the SynerGraft-treated tissues may not have the improved
longevity over the CryoLife standard processing technology that the Company
currently expects. This could have a material adverse effect on future expansion
plans and could limit future growth.
EXTENSIVE GOVERNMENT REGULATION MAY RETARD THE COMPANY'S ABILITY TO DEVELOP AND
SELL PRODUCTS AND SERVICES
Government regulation in the U.S., the EEA and other jurisdictions can determine
the success of the Company's efforts to market and develop its products. The
allograft heart valves to which the Company applies its preservation services
are currently regulated as Class II medical devices by the FDA and are subject
to significant regulatory requirements, including Quality System Regulations and
record keeping requirements. Changes in regulatory treatment or the adoption of
new statutory or regulatory requirements are likely to occur, which could
adversely impact the marketing or development of these products or could
adversely affect market demand for these products. Other allograft tissues
processed and distributed by the Company are currently regulated as "human
tissue" under rules promulgated by the FDA pursuant to the Public Health
Services Act. These rules establish requirements for donor testing and screening
of human tissue and record keeping relating to these activities and impose
certain registration and product listing requirements on establishments that
process or distribute human tissue or cellular-based products. The FDA has
proposed and is refining a regulation that will improve good tissue practices,
akin to good manufacturing practices, followed by tissue banks and processors of
human tissue. It is anticipated that these good tissue practices regulations
when promulgated will enhance regulatory oversight of the Company and other
processors of human tissue. See "Risk Factor - The FDA Has Notified CryoLife of
Its Belief that Marketing of CryoValve SG and CryoVein SG Require Additional
Regulatory Submissions and/or Approvals".
".
BioGlue Surgical Adhesive is regulated as a Class III medical device and the
Company believes that its ACT may be regulated as a biologic or drug by the FDA.
The ACT has not been approved for commercial distribution in the U.S. or
elsewhere. Fixed porcine heart valve products are classified as Class III
medical devices. There can be no assurance that the Company will be able to
obtain the FDA approval required to distribute its porcine heart valve products
in the U.S. Distribution of these products within the EC is dependent upon the
Company maintaining its CE Mark ISO 9001, and ISO 13485 certifications, of which
there can be no assurance.
Most of the Company's products and services in development, if successfully
developed, will require regulatory approvals from the FDA and perhaps other
regulatory authorities before they may be commercially distributed. The process
of obtaining required regulatory approvals from the FDA normally involves
clinical trials and the preparation of an extensive premarket approval ("PMA")
application and often takes many years. The process is expensive and can vary
significantly based on the type, complexity and novelty of the product. There
can be no assurance that any products developed by the Company, independently or
in collaboration with others, will receive the required approvals for
manufacturing and marketing.
Delays in obtaining U.S. or foreign approvals could result in substantial
additional cost to the Company and adversely affect the Company's competitive
position. The FDA may also place conditions on product approvals that could
restrict commercial applications of such products. Product marketing approvals
or clearances may be withdrawn if compliance with regulatory standards is not
maintained or if problems occur following initial marketing. Delays imposed by
the governmental clearance process may materially reduce the period during which
the Company has the exclusive right to commercialize patented products.
Also, delays or rejections may be encountered during any stage of the regulatory
approval process based upon the failure of the clinical or other data to
demonstrate compliance with, or upon the failure of the product to meet, the
regulatory agency's requirements for safety, efficacy and quality, and those
requirements may become more stringent due to changes in applicable law,
regulatory agency policy or the adoption of new regulations. Clinical trials may
also be delayed due to unanticipated side effects, inability to locate, recruit
32
and qualify sufficient numbers of patients, lack of funding, the inability to
locate or recruit clinical investigators, the redesign of clinical trial
programs, the inability to manufacture or acquire sufficient quantities of the
particular product or any other components required for clinical trials, changes
in the Company's or its collaborative partners' development focus and disclosure
of trial results by competitors.
Even if regulatory approval is obtained for any of the Company's products or
services, the scope of the approval may significantly limit the indicated usage
for which such products or services may be marketed. Products or services
marketed by the Company pursuant to FDA or foreign oversight or approvals are
subject to continuing regulation. In the U.S., devices and biologics must be
manufactured in registered establishments (and, in the case of biologics,
licensed establishments) and must be produced in accordance with Quality System
Regulations. Manufacturing facilities and processes are subject to periodic FDA
inspection. Labeling and promotional activities are also subject to scrutiny by
the FDA and, in certain instances, by the Federal Trade Commission. The export
of devices and biologics is also subject to regulation and may require FDA
approval. From time to time, the FDA may modify such regulations, imposing
additional or different requirements. Failure to comply with applicable FDA
requirements, which may be ambiguous, could result in civil and criminal
enforcement actions, warnings, citations, product recalls or detentions and
other penalties and could have a material adverse effect on the Company's
business, financial condition, results of operations, and cash flows. As noted
above, the FDA Order has had, and may continue to have such an effect.
In addition, The National Organ Transplant Act ("NOTA") prohibits the
acquisition or transfer of human organs for "valuable consideration" for use in
human transplantation. NOTA permits the payment of reasonable expenses
associated with the removal, transportation, processing, preservation, quality
control and storage of human organs. There can be no assurance that restrictive
interpretations of NOTA will not be adopted in the future that will challenge
one or more aspects of the Company's methods of charging for its preservation
services. The Company's laboratory operations are subject to the U.S. Department
of Labor, Occupational Safety and Health Administration and Environmental
Protection Agency requirements for prevention of occupational exposure to
infectious agents and hazardous chemicals and protection of the environment.
Some states have enacted statutes and regulations governing the processing,
transportation and storage of human organs and tissue.
More restrictive state laws or regulations may be adopted in the future and they
could have a material adverse effect on the Company's business, financial
condition, results of operations and cash flows.
UNCERTAINTIES RELATED TO PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY MAY
AFFECT THE VALUE OF OUR INTELLECTUAL PROPERTY
The Company owns several patents, patent applications and licenses relating to
its technologies, which it believes provide important competitive advantages.
There can be no assurance that the Company's pending patent applications will
issue as patents or that challenges will not be instituted concerning the
validity or enforceability of any patent owned by the Company, or, if
instituted, that such challenges will not be successful. The cost of litigation
to uphold the validity and prevent infringement of a patent could be
substantial. Furthermore, there can be no assurance that competitors will not
independently develop similar technologies or duplicate the Company's
technologies or design around the patented aspects of the Company's
technologies. There can be no assurance that the Company's proposed technologies
will not infringe patents or other rights owned by others.
In addition, under certain of the Company's license agreements, if the Company
fails to meet certain contractual obligations, including the payment of minimum
royalty amounts, such licenses may become nonexclusive or terminable by the
licensor, which could have a material adverse effect on the Company's business,
financial condition, results of operations, and cash flows. Additionally, the
Company protects its proprietary technologies and processes in part by
confidentiality agreements with its collaborative partners, employees and
consultants. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any breach or that
the Company's trade secrets will not otherwise become known or independently
discovered by competitors, any of which could have a material adverse effect on
the Company's business, financial condition, results of operations, and cash
flows.
33
UNCERTAINTIES REGARDING FUTURE HEALTH CARE REIMBURSEMENT MAY AFFECT THE AMOUNT
AND TIMING OF THE COMPANY'S REVENUES
Even though the Company does not receive payments directly from third-party
health care payors, their reimbursement methods and policies impact demand for
the Company's cryopreserved tissue and other services and products. The
Company's preservation services with respect to its cardiac, vascular, and
orthopaedic tissues may be particularly susceptible to third-party cost
containment measures. For example, the initial cost of a cryopreserved allograft
heart valve generally exceeds the cost of a mechanical, synthetic or
animal-derived valve. The Company is unable to predict what changes will be made
in the reimbursement methods and policies utilized by third-party health care
payors or their effect on the Company.
Changes in the reimbursement methods and policies utilized by third-party health
care payors, including Medicare, with respect to cryopreserved tissues provided
for implant by the Company and other Company services and products, could have a
material adverse effect on the Company. Significant uncertainty exists as to the
reimbursement status of newly approved health care products and services and
there can be no assurance that adequate third-party coverage will be available
for the Company to maintain price levels sufficient for realization of an
appropriate return on its investment in developing new products.
Government, hospitals, and other third-party payors are increasingly attempting
to contain health care costs by limiting both coverage and the level of
reimbursement for new products approved for marketing by the FDA and by refusing
in some cases to provide any coverage for uses of approved products for
indications for which the FDA has not granted marketing approval. If adequate
coverage and reimbursement levels are not provided by government and other
third-party payors for uses of the Company's new products and services, market
acceptance of these products would be adversely affected, which could have a
material adverse effect on the Company's business, financial condition, results
of operations and cash flows.
CRYOLIFE IS DEPENDENT ON ITS KEY PERSONNEL
The Company's business and future operating results depend in significant part
upon the continued contributions of its key technical personnel and senior
management, many of who would be difficult to replace. The Company's business
and future operating results also depend in significant part upon its ability to
attract and retain qualified management, processing, technical, marketing, sales
and support personnel for its operation. Competition for such personnel is
intense and there can be no assurance that the Company will be successful in
attracting and retaining such personnel. The loss of key employees, the failure
of any key employee to perform adequately or the Company's inability to attract
and retain skilled employees as needed could have a material adverse effect on
the Company's business, financial condition, results of operations and cash
flows.
OUR CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE TWO YEARS ENDED DECEMBER
31, 2001 AND 2000 INCLUDED IN THIS FORM 10-K WERE AUDITED BY ARTHUR ANDERSEN
LLP, WHICH HAS BEEN FOUND GUILTY OF OBSTRUCTION OF JUSTICE AND MAY BE THE
SUBJECT OF ADDITIONAL LITIGATION.
Arthur Andersen LLP has been found guilty of obstruction of justice with respect
to its activities in connection with Enron Corp. and may be the subject of
additional litigation. Arthur Andersen LLP has also agreed to cease practicing
before the SEC. Arthur Andersen LLP may seek to have the conviction overturned,
may dissolve or liquidate, may merge with or have its assets sold to a third
party and has lost critical personnel. In the event that Arthur Andersen LLP
dissolves, liquidates or does not otherwise continue in business, Arthur
Andersen LLP may have insufficient assets to satisfy any claims that may be made
by investors with respect to the financial statements as of and for the two
years ended December 31, 2001 and 2000 included in this Form 10-K.
In addition, Arthur Andersen LLP has not consented to the inclusion of their
report dated March 27, 2002 in this Form 10-K, and as a result, only a copy of
such report has been included. Because Arthur Andersen LLP has not consented to
the inclusion of their report in this Form 10-K, you may not be able to recover
against Arthur Andersen LLP for any untrue statements of a material fact
contained in the financial statements audited by Arthur Andersen LLP or any
omissions to state a material fact required to be stated therein.
34
VOLATILITY OF SECURITIES PRICES
The trading price of the Company's common stock has been subject to wide
fluctuations recently and may continue to be subject to such volatility in the
future. Trading price fluctuations can be caused by a variety of factors,
including regulatory actions such as the FDA Order, recent product liability
claims, quarter to quarter variations in operating results, announcement of
technological innovations or new products by the Company or its competitors,
governmental regulatory acts, developments with respect to patents or
proprietary rights, general conditions in the medical device or service
industries, actions taken by government regulators, changes in earnings
estimates by securities analysts or other events or factors, many of which are
beyond the Company's control. If the Company's revenues or operating results in
future quarters fall below the expectations of securities analysts and
investors, the price of the Company's common stock would likely decline further,
perhaps substantially. Changes in the trading price of the Company's common
stock may bear no relation to the Company's actual operational or financial
results. If the Company's share prices do not meet the requirements of the New
York Stock Exchange, the Company's shares may be delisted. The Company's closing
stock price in the period January 1, 2002 to February 24, 2003 has ranged from a
high of $31.31 to a low of $1.89.
ANTI-TAKEOVER PROVISIONS
The Company's Articles of Incorporation and Bylaws contain provisions that may
discourage or make more difficult any attempt by a person or group to obtain
control of the Company, including provisions authorizing the issuance of
preferred stock without shareholder approval, restricting the persons who may
call a special meeting of the shareholders and prohibiting shareholders from
taking action by written consent. In addition, the Company is subject to certain
provisions of Florida law that may discourage or make more difficult takeover
attempts or acquisitions of substantial amounts of the Company's common stock.
Further, pursuant to the terms of a shareholder rights plan adopted in 1995,
each outstanding share of common stock has one attached right. The rights will
cause substantial dilution of the ownership of a person or group that attempts
to acquire the Company on terms not approved by the Board of Directors and may
have the effect of deterring hostile takeover attempts.
ABSENCE OF DIVIDENDS
The Company has not paid, and does not presently intend to pay, cash dividends.
The Company's major credit agreement contains, and future credit agreements may
contain, financial covenants, including covenants to maintain certain levels of
net worth and certain leverage ratios, which could have the effect of
restricting the amount of dividends that the Company may pay. It is not likely
that any cash dividends will be paid in the foreseeable future.
35
FORWARD-LOOKING STATEMENTS
This Form 10-K includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and the Private Securities Litigation Reform Act of 1995.
All statements, other than statements of historical facts, included herein that
address activities, events or developments that the Company expects or
anticipates will or may occur in the future, including statements regarding the
impact of recent accounting pronouncements, adequacy of product liability
insurance to defend against lawsuits, the outcome of lawsuits filed against the
Company, the impact of the FDA Order and related Agreement on future revenues,
profits and business operations, the effect of the FDA Order on sales of
BioGlue, future tissue procurement levels resulting from the FDA Order, ,
expected future impact of BioGlue on revenues, the estimates underlying the
charges recorded in the second and third quarter due to the FDA Order, the
impact of the February 2003 FDA 483, the estimates of the amounts accrued for
the retention levels under the Company's product liability and directors' and
officers' insurance policies, the estimates of the amounts accrued for product
loss claims incurred but not reported at December 31, 2002, future costs of
human tissue preservation services, changes in liquidity and capital resources
as a result of the FDA Order, the outcome of the FDA letter regarding the
SynerGraft processed cardiovascular and vascular tissues, the outcome of any
evaluation of allograft heart valves by the FDA, the possible adverse outcome of
the SEC investigation referenced in the SEC Letter, future product development
plans as a result of the FDA Order, the Company's competitive position, the
successful development of the Company's SynerGraft porcine heart valves, funding
available to continue development of the ACT, estimated dates relating to the
Company's proposed regulatory submissions, the Company's expectations regarding
the adequacy of current financing arrangements, product demand and market
growth, the potential of the ACT for use in cancer therapies, fibrinolysis
(blood clot dissolving), and other drug delivery applications, the outcome of
litigation, the impact on the Company of adverse results of surgery utilizing
tissue processed by it, and other statements regarding future plans and
strategies, anticipated events or trends, and similar expressions concerning
matters that are not historical facts are forward-looking statements.
These statements are based on certain assumptions and analyses made by the
Company in light of its experience and its perception of historical trends,
current conditions, and expected future developments as well as other factors it
believes are appropriate in the circumstances. However, whether actual results
and developments will conform with the Company's expectations and predictions is
subject to a number of risks and uncertainties which could cause actual results
to differ materially from the Company's expectations, including the risk factors
discussed in this Form 10-K and other factors, many of which are beyond the
control of the Company. Consequently, all of the forward-looking statements made
in this Form 10-K are qualified by these cautionary statements and there can be
no assurance that the actual results or developments anticipated by the Company
will be realized or, even if substantially realized, that they will have the
expected consequences to or effects on the Company or its business or
operations. The Company assumes no obligation to update publicly any such
forward-looking statements, whether as a result of new information, future
events, or otherwise.
ITEM 2. PROPERTIES.
The Company's facilities are located in suburban Atlanta, Georgia, and in
Fareham, United Kingdom. The Atlanta facility consists of three separate
locations totaling approximately 243,000 square feet of leased office,
manufacturing, laboratory and warehouse space. Approximately 30,000 square feet
are dedicated to clean room work areas. The primary facility has five main
laboratory facilities: human tissue processing, BioGlue manufacturing,
bioprosthesis manufacturing, research and development, and microbiology. Each of
these areas consists of a general technician work area and adjoining "clean
rooms" for work with human tissue and for aseptic processing. The clean rooms
are supplied with highly filtered air which provides a near-sterile environment.
The human tissue processing laboratory contains approximately 13,500 square feet
with a suite of eight clean rooms. The BioGlue manufacturing laboratory contains
approximately 13,500 square feet with a suite of six clean rooms. The
bioprosthesis manufacturing laboratory contains approximately 20,000 square feet
with a suite of six clean rooms. The research and development laboratory is
approximately 14,500 square feet with a suite of eight clean rooms. The
microbiology laboratory is approximately 6,600 square feet with a suite of three
clean rooms. Two additional facilities contain approximately 11,000 square feet,
including approximately 4,000 square feet of laboratory space with a suite of
eight clean rooms and approximately 20,000 square feet, with about 2,100 square
feet of laboratory space and a suite of six clean rooms. The Europa facility
located in Fareham, United Kingdom contains approximately 5,600 square feet of
office, warehousing and training laboratory space. Subsequent to the sale of the
IFM assets, the Company continues to lease the 30,000 square foot IFM facility
in St. Petersburg, Florida from the former principal shareholder of IFM. A
wholly-owned subsidiary of Vascutech, Inc. currently subleases the IFM facility
from the Company. The Company's lease and sublease on its IFM facility expires
in 2007.
36
ITEM 3. LEGAL PROCEEDINGS.
In the normal course of business as a medical device and services company the
Company has product liability complaints filed against it. As of February 24,
2003 21 cases had been filed against the Company between May 18, 2000 and
January 30, 2003. The cases are currently in the pre-discovery or discovery
stages. Of these cases, 14 allege product liability claims arising out of the
Company's orthopaedic tissue services, six allege product liability claims
arising out of the Company's allograft heart valve tissue services, and one
alleges product liability claims arising out of the non-tissue products made by
Ideas for Medicine, when it was a subsidiary of the Company.
Included in these cases is the complaint filed against the Company in the
Superior Court of Cobb County, Georgia, on July 12, 2002 by Steve Lykins, as
Trustee for the benefit of next of kin of Brian Lykins. This complaint alleges
strict liability, negligence, professional negligence, and breach of warranties
related to tissue implanted in November of 2001. The plaintiff seeks unspecified
compensatory and punitive damages.
The Company maintains claims-made insurance policies, which the Company believes
to be adequate to defend against these suits. The Company's insurance company
has been notified of these actions. The Company intends to vigorously defend
against these claims. Nonetheless, an adverse judgment or judgments imposing
aggregate liabilities in excess of the Company's insurance coverage could have a
material adverse effect on the Company's financial position, results of
operations, and cash flows.
Claims-made insurance policies 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 represent a transfer of risk for claims and
incidents that have been incurred but not reported to the insurance carrier. 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. As of December 31, 2002
the Company accrued $3.6 million in estimated costs for unreported product
liability claims related to services performed and products sold during 2002 and
prior years. The expense was recorded in general, administrative, and marketing
expenses and was included as a component of accrued expenses and other current
liabilities on the Consolidated Balance Sheets.
Several putative class action lawsuits were filed in July through September 2002
against the Company and certain officers of the Company alleging that the
defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated there under. During the third quarter of 2002
the U.S. District Court for the Northern District of Georgia consolidated the
suits, and on November 14 2002, lead plaintiffs were named. A consolidated
complaint was filed on January 15, 2003, seeking the Court's certification of
the litigation as a class action on behalf of all purchasers of the Company's
stock between April 2, 2001 and August 14, 2002. The consolidated complaint also
seeks recovery of compensatory damages in an unspecified amount and various fees
and expenses of litigation, including attorneys' fees. The principal allegations
of the consolidated complaint are that the Company failed to disclose its
alleged lack of compliance with certain FDA regulations regarding the handling
and processing of certain tissues and other product safety matters. Although the
Company considers all of the claims in the consolidated complaint to be without
merit and intends to defend against them vigorously, the Company is unable to
predict at this time the final outcome of these claims. The Company carries
directors' and officers' liability insurance policies, which the Company
currently believes should be adequate to address these claims. Nonetheless, an
adverse judgment in excess of the Company's insurance coverage could have a
material adverse effect on the Company's financial position, results of
operations, and cash flows.
The Company received notice in October 2002 that a complaint had been filed
instituting a shareholder derivative action against the Company and Company
officers and directors Steven G. Anderson, Albert E. Heacox, John W. Cook,
Ronald C. Elkins, Virginia C. Lacy, Ronald D. McCall, Alexander C. Schwartz, and
Bruce J. Van Dyne. The suit was filed in the Superior Court of Gwinnett County,
37
Georgia, by Rosemary Lichtenberger. The suit alleges the individual defendants
breached their fiduciary duties to the Company by causing or allowing the
Company to engage in practices that caused the Company to suffer damages by
being out of compliance with FDA guidelines, and by causing the Company to issue
press releases that erroneously portrayed CryoLife's products, operations,
financial results, and future prospects. The complainant seeks undisclosed
damages, costs and attorney's fees, punitive damages, and prejudgment interest
against the individual defendants derivatively on behalf of the Company as a
nominal defendant. By an order entered on January 21, 2003, the lawsuit was
stayed until discovery commences in the consolidated complaint of the class
action lawsuit. In January 2003 the Company received notice that another
shareholder derivative lawsuit was filed in the Superior Court of Fulton County,
Georgia by Robert F. Frailey against the Company as a nominal defendant, and
Company officers and directors Steven G. Anderson, Bruce J. Van Dyne, John W.
Cook, Ronald D. McCall, Ronald C. Elkins, Virginia C. Lacy, and Alexander C.
Schwartz. The complaint asserts claims for breach of fiduciary duty, abuse of
control, gross mismanagement, and waste of corporate assets. As in the
Lichtenberger action, the Frailey action alleges that the defendant officers and
directors caused the Company to suffer damages by not being in compliance with
FDA guidelines, and by causing the Company to issue press releases that
erroneously portrayed CryoLife's products, operations, financial results, and
future prospects. The complaint also alleges improper insider trading by certain
Company officers and directors. The complainant seeks declaratory relief,
damages of unspecified amount, litigation expenses including attorneys' and
experts' fees, and unspecified equitable or injunctive relief against the
individual defendants derivatively on behalf of the Company as a nominal
defendant.
The Company's Board of Directors has established a committee that is independent
of management to investigate the claims asserted in the Lichtenberger and
Frailey complaints and report back to the Board with its recommendations for
action in response to the shareholders' demands. The independent committee has
engaged independent legal counsel to assist in the investigation. The committee
is in the process of its investigation of the claims.
The Company has concluded that it is probable that it will incur losses relating
to claims and litigation of at least $1.2 million, which represents the
aggregate amount of the Company's deductibles under its product liability and
directors' and officers' insurance policies. Therefore the Company has recorded
an accrual of $1.2 million as of December 31, 2002.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
Inapplicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
Each of the executive officers of the Registrant was elected by the Board of
Directors to serve until the Board of Directors' meeting immediately following
the next annual meeting of shareholders or until his earlier removal by the
Board of Directors or his resignation. The following table lists the executive
officers of the Registrant and their ages, positions with the Registrant, and
the dates from which they have continually served in their present positions
with the Registrant.
38
DATE FIRST ELECTED TO
NAME AGE POSITION PRESENT OFFICE
- ----------------------------- ------- ----------------------------------- ----------------------
Steven G. Anderson 64 President, Chief Executive Officer, February, 1984
and Chairman
Sidney B. Ashmore 44 Vice President, Marketing March, 2001
Kirby S. Black, PhD 48 Senior Vice President, Research July, 1995
and Development
David M. Fronk 39 Vice President, Clinical Research December, 1998
Albert E. Heacox, PhD 52 Senior Vice President, Laboratory June, 1989
Operations
D. Ashley Lee, CPA 38 Vice President Finance, Chief December, 2002
Financial Officer, and Treasurer
James C. Vander Wyk, PhD 58 Vice President, Product Integrity December, 2002
STEVEN G. ANDERSON, a founder of the Company, has served as the Company's
President, Chief Executive Officer, and Chairman since its inception. Mr.
Anderson has more than 30 years of experience in the implantable medical device
industry. Prior to joining the Company, Mr. Anderson was Senior Executive Vice
President and Vice President, Marketing, from 1976 until 1983 of Intermedics,
Inc. (now Guidant, Inc.), a manufacturer and distributor of pacemakers and other
medical devices. Mr. Anderson received his BA from the University of Minnesota.
SIDNEY B. ASHMORE has served as Vice President of Marketing since March 2001 and
has been with the Company since September 1996 as Director of Marketing. Mr.
Ashmore is responsible for developing and implementing the Company's sales and
marketing plans and supervising all tissue procurement activities. Prior to
joining the Company, Mr. Ashmore held senior marketing positions with Baxter
Healthcare from 1991 until 1996, and general management positions with Amorient
Aquafarms from 1985 until 1989. Mr. Ashmore received his BA from Vanderbilt
University in 1981, his MS from the University of Hawaii in 1985, and his MBA
from Northwestern University in 1991.
KIRBY S. BLACK, PHD, has served as Vice President of Research and Development
since July 1995. Dr. Black was promoted to Senior Vice President in December of
2000. Dr. Black is responsible for the continued development of the Company's
current products as well as the evaluation of new technologies. Dr. Black is
listed on six patents and has authored over 130 publications. Prior to joining
the Company, Dr. Black was Director, Medical Information and Project Leader from
July 1993 until July 1994 at Advanced Tissue Sciences, LaJolla, California. Dr.
Black has also held a number of positions at the University of California at
Irvine, including Director, Transplantation and Immunology Laboratories,
Department of Surgery. Dr. Black received his BSME degree from the University of
California, Los Angeles, and his PhD degree in immunology from the University of
California at Irvine.
DAVID M. FRONK was appointed to the position of Vice President of Clinical
Research in December 1998 and has been with the Company since 1992, serving as
Director of Clinical Research from December 1997 until December 1998. Mr. Fronk
is responsible for managing the pre-clinical and clinical investigations for all
products, as well as monitoring product performance. Prior to joining the
Company, Mr. Fronk held engineering positions with Zimmer Inc. from 1986 until
1988 and Baxter Healthcare Corporation from 1988 until 1991. Mr. Fronk served as
a market manager with Baxter Healthcare Corporation from 1991 until 1992. Mr.
Fronk received his BS in Mechanical Engineering from Ohio State University in
1985 and his MS in Biomedical Engineering from Ohio State University in 1986.
ALBERT E. HEACOX, PHD, has served as Vice President of Laboratory Operations
since June 1989 and has been with the Company since June 1985. Dr. Heacox was
promoted to Senior Vice President in December of 2000. Dr. Heacox has been
responsible for developing protocols and procedures for both cardiovascular and
connective tissues, implementing upgrades in procedures in conjunction with the
Company's quality assurance programs, and overseeing all production activities
of the Company's laboratories. Prior to joining the Company, Dr. Heacox worked
as a researcher with the U.S. Department of Agriculture and North Dakota State
University, developing methods for the preservation of cells and animal germ
plasma storage. Dr. Heacox received a BA and an MS in Biology from Adelphi
University, received his PhD in Biology from Washington State University and
completed his post-doctorate training in cell biology at the University of
Cologne, West Germany.
39
D. ASHLEY LEE, CPA, has served as Vice President of Finance and Chief Financial
Officer of the Company since April 2000 and as Vice President of Finance, Chief
Financial Officer, and Treasurer since December 2002. Mr. Lee previously served
as controller of the Company from December 1994 until April 2000. Mr. Lee is
responsible for the financial affairs of the Company, as well as information
technology, human resources, and purchasing. From 1993 to 1994, Mr. Lee served
as the Assistant Director of Finance for Compass Retail Inc, a wholly-owned
subsidiary of Equitable Real Estate. From 1987 to 1993, Mr. Lee was employed as
a certified public accountant with Ernst & Young, LLP. Mr. Lee received his BS
in Accounting from the University of Mississippi.
JAMES C. VANDER WYK, PHD, has served as Vice President, Product Integrity since
December 2002 and had previously served as Vice President, Regulatory Affairs
and Quality Assurance of the Company since February 1996. Prior to joining the
Company, Dr. Vander Wyk held senior management positions at Schneider (USA),
Inc. from 1993 until 1996, Pharmacia Deltec, Inc. from 1985 until 1993, Delmed,
Inc. from 1980 until 1985 and Pharmaco, Inc. from 1975 to 1979, gaining 20 years
of experience in Regulatory Affairs and Quality Assurance. Dr. Vander Wyk
received his BS in Pharmacy from the Massachusetts College of Pharmacy and his
PhD in Microbiology from the University of Massachusetts. Dr. Vander Wyk
performed his NIH Postdoctoral Fellowship at the University of Illinois.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market Price of Common Stock
The Company's Common Stock is traded on the New York Stock Exchange under the
symbol "CRY." The following table sets forth, for the periods indicated, the
intra-day high and low sale prices per share of Common Stock on the NYSE.
2002 High Low
- -----------------------------------------------------------------------
First quarter 30.74 20.05
Second quarter 32.00 14.90
Third quarter 16.06 1.40
Fourth quarter 7.92 2.12
- -----------------------------------------------------------------------
2001 High Low
- -----------------------------------------------------------------------
First quarter 30.25 20.00
Second quarter 42.00 23.80
Third quarter 44.82 29.00
Fourth quarter 40.32 23.00
- -----------------------------------------------------------------------
The Company has never declared or paid any cash dividends on its Common Stock.
The Company currently intends to retain any future earnings for funding growth
and, therefore, does not anticipate paying any cash dividends on its Common
Stock in the foreseeable future. The holders of any shares of Preferred Stock
issued by the Company will have a preference as to the payment of dividends over
the holders of shares of Common Stock. No shares of Preferred Stock are
currently issued and outstanding. The Company's Credit Facility contains, and
future credit agreements may contain, financial covenants, including covenants
to maintain certain levels of net worth and certain leverage ratios, which have
the effect of restricting the amount of dividends that the Company can pay.
As of February 20, 2003 the Company had 408 shareholders of record.
40
ITEM 6. SELECTED FINANCIAL DATA.
The following Selected Consolidated Financial Data should be read in conjunction
with the Company's Consolidated Financial Statements and Notes thereto,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other financial information included elsewhere in this Report or
incorporated herein by reference. The selected data presented below for and as
of the end of the year ended December 31, 2002 are derived from the Company's
Consolidated Financial Statements that have been audited by Deloitte and Touche
LLP, independent auditors, and which are included elsewhere in this Report and
are qualified by reference to such Consolidated Financial Statements and Notes
thereto. The selected data presented below as of and for each of the years in
the three-year period ended December 31, 2001, are derived from the Company's
Consolidated Financial Statements that have been audited by Arthur Andersen LLP,
independent auditors. The data set forth below with respect to the Company's
Consolidated Balance Sheet and Statement of Operations as of and for the year
ended December 31, 1998 are derived from the Company's Consolidated Financial
Statements that have been audited by Ernst & Young LLP, independent auditors.
The historical results are not necessarily indicative of future results of
operations.
SELECTED FINANCIAL INFORMATION
(in thousands, except percentages and per share data)
DECEMBER 31,
OPERATIONS 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------
Revenues $ 77,795 $ 87,671 $ 77,096 $ 66,722 $ 60,691
Net (loss)/income (27,761) 9,166 7,817 4,451 6,486
Research and
development as a
percentage of revenues 5.9% 5.4% 6.8% 6.6% 7.8%
(LOSS)/EARNINGS PER SHARE1
- -----------------------------------------------------------------------------------------------------------
Basic $ (1.43) $ 0.49 $ 0.42 $ 0.24 $ 0.36
Diluted $ (1.43) $ 0.47 $ 0.41 $ 0.24 $ 0.35
YEAR-END FINANCIAL POSITION
- -------------------------------------------------------------------------------------------------------------------
Total assets $ 106,345 $ 129,310 $ 112,009 $ 94,025 $ 98,390
Working capital 37,816 66,668 69,063 59,597 62,310
Long Term Liabilities 2,752 10,071 12,192 6,177 8,577
Shareholder's equity 79,800 101,439 89,395 80,226 80,421
Current ratio2 3:1 5:1 8:1 9:1 8:1
Shareholders' equity
per diluted common share1 $ 4.11 $ 5.16 $ 4.65 $ 4.27 $ 4.38
1 Reflects adjustment for 3-to-2 stock split effected December 27, 2000.
2 Current assets less current liabilities.
41
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The Company was organized in 1984 to address market opportunities in the area of
biological implantable products and materials and today is a leader in
preservation of human tissues for cardiovascular and vascular transplant
applications. The Company was a leader in orthopaedic transplant applications
until it suspended processing orthopaedic tissue from August 2002 following the
receipt of the FDA Order until late February 2003. Additionally, the Company
develops and commercializes implantable medical devices, including BioGlue
Surgical Adhesive, SynerGraft processed bovine vascular grafts, and
glutaraldehyde-fixed stentless porcine heart valves. The Company's revenues are
primarily generated in the U.S. In 2002, 2001, and 2000, approximately 8%, 7%,
and 7%, respectively, of total revenues were derived from international sources.
Prior to December 2001 the Company sold BioGlue Surgical Adhesive in the U.S. as
an adjunct in the repair of acute thoracic aortic dissections pursuant to an
HDE. In December 2001 the Company received FDA approval for the use of BioGlue
in the U.S. as an adjunct to sutures and staples in open surgical repair of
large vessels for adult patients. As a result, the number of annual procedures
in the U.S. in which BioGlue could be potentially used increased from
approximately 4,000 procedures to in excess of 700,000 procedures. Due to this
approval, the composition of the Company's revenues is expected to change in
future years with the anticipated growth in shipments of BioGlue Surgical
Adhesive.
CRITICAL ACCOUNTING POLICIES
A summary of the Company's significant accounting policies is included in Note 1
to the consolidated financial statements. 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 U.S., 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.
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
laboratory expenses, tissue procurement fees, fringe benefits, facility
allocations, and freight-in charges, and are stated, net of reserve, on a
first-in, first-out basis.
As of December 31, 2002 the deferred preservation costs were $2.0 million for
allograft heart valve tissues, $620,000 for non-valved cardiac tissues, $1.7
million for vascular tissues, and zero for orthopaedic tissues. During 2002 the
Company recorded a write-down of deferred preservation costs of $8.7 million for
valved cardiac tissues, $2.9 million for non-valved cardiac tissues, $11.9
million for vascular tissues, and $9.2 million for orthopaedic tissue totaling
$32.7 million. These write-downs were recorded as a result of the FDA Order as
discussed at Item 1. Business. "FDA Order on Human Tissue Preservation". The
amount of these write-downs reflects management's estimate based on information
currently available to it. These estimates may prove inaccurate, as the scope
and impact of the FDA Order are determined. Management will continue to evaluate
the recoverability of these deferred preservation costs based on the factors
discussed in the Recent Events section and record additional write-downs if it
becomes clear that additional impairments have occurred. The write-down creates
a new cost basis which cannot be written back up if these tissues become
saleable. The cost of human tissue preservation services may be favorably
impacted depending on the future level of tissue shipments related to previously
written-down deferred preservation costs. The shipment levels of these
written-down tissues will be affected by the amount and timing of the release of
tissues processed after September 5, 2002, as a result of the Agreement with the
FDA, since, under the Agreement, written-down tissues may be shipped if tissues
processed after September 5, 2002 are not available for shipment.
42
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL: The Company assesses
the impairment of its long-lived, identifiable intangible assets and related
goodwill annually and whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors that management considers
important that could trigger an impairment review include the following:
o Significant underperformance relative to expected historical or
projected future operating results;
o Significant negative industry or economic trends;
o Significant decline in the Company's stock price for a sustained
period; and
o 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. As of September 30, 2002, in
applying SFAS 144, the Company determined that the asset groups consisted of the
long-lived assets related to the Company's two reporting segments, as these
asset groups represent the lowest level at which identifiable cash flows are
largely independent of the cash flows of other assets and liabilities. The
Company used a fourteen-year period for the undiscounted future cash flows. This
period of time was selected based upon the remaining life of the primary assets
of the asset groups, which are leasehold improvements. The undiscounted future
cash flows related to these asset groups exceeded their carrying values as of
September 30, 2002 and December 31, 2002 and therefore management has concluded
that there is not an impairment of the Company's long-lived intangible assets,
except for goodwill discussed below, and tangible assets related to the tissue
preservation business or medical device business. However, depending on the
Company's ability to rebuild demand for its tissue preservation services, the
outcome of discussions with the FDA regarding the shipping of orthopaedic
tissues, and the future effects of adverse publicity surrounding the FDA Order
and reported infections on preservation revenues, these assets may become
impaired. Management will continue to evaluate the recoverability of these
assets in accordance with SFAS 144.
Beginning with the Company's adoption of Statement of Financial Accounting
Standards ("SFAS") No. 142,"Goodwill and Other Intangible Assets" ("SFAS 142")
on January 1, 2002 the goodwill resulting from business acquisitions is not
amortized, but is instead subject to periodic impairment testing in accordance
with SFAS 142. Patent costs are amortized over the expected useful lives of the
patents (primarily 17 years) using the straight-line method. Other intangibles,
which consist primarily of manufacturing rights and agreements, are amortized
over the expected useful lives of the related assets (primarily five years). As
a result of the FDA Order, the Company determined that an evaluation of the
possible impairment of intangible assets under SFAS 142 was necessary. The
Company engaged an independent valuation expert to perform the valuation using a
discounted cash flow methodology, and as a result of this analysis, the Company
determined that goodwill related to its tissue processing reporting unit was
fully impaired as of September 30, 2002. Therefore, the Company recorded a
write-down of $1.4 million in goodwill during the quarter ended September 30,
2002. Management does not believe an impairment exists related to the other
intangible assets that were assessed in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144").
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. The Company maintains claims-made insurance policies to mitigate its
financial exposure to product liability claims. Claims-made insurance policies
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 represent a transfer of risk for claims and incidents that have been
incurred but not reported to the insurance carrier. 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. As of December 31, 2002 the Company
accrued $3.6 million in estimated costs for unreported product liability claims
related to services performed and products sold prior to December 31, 2002. The
Company engaged an independent actuarial firm to perform an analysis of the
unreported product claims as of December 31, 2002. The unreported product loss
liability was estimated using a frequency-severity approach, whereas, projected
losses were calculated by multiplying the estimated number of claims by the
43
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 emergence 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
expense was recorded in general, administrative, and marketing expenses and was
included as a component of accrued expenses and other current liabilities on the
Consolidated Balance Sheet.
NEW ACCOUNTING PRONOUNCEMENTS
The Company will be required to adopt SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143") on January 1, 2003. SFAS 143 addresses
accounting and reporting for retirement costs of long-lived assets resulting
from legal obligations associated with acquisition, construction, or development
transactions. The Company has determined that the adoption of SFAS 143 will not
have a material effect on the financial position, results of operations, and
cash flows of the Company, as the Company does not currently have any relevant
transactions.
The Company will be required to adopt SFAS No. 145, "Rescission of FASB
Statements 4, 44 and 64, Amendment to FASB Statement 13, and Technical
Corrections" ("SFAS 145") on January 1, 2003. SFAS 145 rescinds SFAS No. 4, 44,
and 64, which required gains and losses from extinguishments of debt to be
classified as extraordinary items. SFAS 145 also amends SFAS No. 13 eliminating
inconsistencies in certain sale-leaseback transactions. The provisions of SFAS
145 are effective for fiscal years beginning after May 15, 2002. The Company has
determined that the adoption of SFAS 145 will not have a material effect on the
financial position, results of operations, and cash flows of the Company, as the
Company does not currently have any relevant transactions.
The Company will be required to adopt SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146") on January 1, 2003.
SFAS 146 requires that costs associated with exit or disposal activities be
recorded at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
Company will adopt SFAS 146 for restructuring plans entered into after December
31, 2002.
RESULTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
REVENUES
Three Months Ended Twelve Months Ended
December 31, December 31,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 12,171 $ 21,975 $ 77,795 $ 87,671
Reduction in revenues due to
estimated tissue recall returns -- -- 3,466 --
-------------- ------------- ------------- ------------
Revenues prior to reduction for
estimated tissue recall returns1 $ 12,171 $ 21,975 $ 81,261 $ 87,671
============== ============= ============= =============
Revenues prior to the reduction for the estimated effect of tissue returns as a
result of the FDA Order decreased 45% and 7%, respectively, for the three and
twelve months ended December 31, 2002. This decrease in revenues for the three
and twelve months ended December 31, 2002, respectively, was primarily due to a
66% and 22% decrease in human tissue preservation service revenues as a result
of the FDA Order's restriction on shipments of certain tissues, the Company's
- --------
1 Management has included this information to show the revenue effect of tissue
returns resulting from the recall instituted by the FDA Order.
44
cessation of orthopaedic processing, and decreased demand as a result of the
adverse publicity surrounding the FDA Order, partially offset by an 81% and 97%
increase in BioGlue(R) Surgical Adhesive revenues for the three and twelve
months ended December 31, 2002, respectively. The BioGlue increases were
primarily attributable to the receipt of FDA approval in December 2001 for the
use of BioGlue in the U.S. as an adjunct to sutures and staples in open surgical
repair of large vessels for adult patients.
Revenues as reported decreased 11% for the twelve months ended December 31,
2002. Revenues were adversely impacted by the estimated effect of the return of
tissues subject to recall by the FDA Order, which resulted in an estimated
decrease of $3.5 million in preservation service revenues during the twelve
months ended December 31, 2002. As discussed below, the estimated amount of
recall returns includes credits for tissues actually returned to the Company to
date and the expected credits for future tissues to be returned to the Company
as a result of the FDA Order. No adjustments have been made to the original
estimate of recall returns as actual returns to date have approximated the
original estimate of recall returns. The Company expects the final recall
returns to be received in the first quarter of 2003, at which time the estimate
may change depending on final actual recall returns.
Management believes that a decrease in revenues as compared to prior periods
will continue at least through the first half of 2003, although, the close out
of the April 2002 FDA 483 should assist the Company in rebuilding demand for its
preservation services. In the event the Company is not successful in rebuilding
demand for its preservation services, future revenues can be expected to
decrease significantly as compared to prior year periods. As discussed at Item
1, Business "Recent Events", the outcome of the discussions with the FDA
regarding the use of the SynerGraft process on human tissue could result in a
reduction in SynerGraft processed cardiovascular and vascular tissue which would
reduce revenue and the gross margins with respect to cardiovascular and vascular
tissues.
BIOGLUE SURGICAL ADHESIVE
Three Months Ended Twelve Months Ended
December 31, December 31,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 5,590 $ 3,090 $ 20,898 $ 10,595
Percentage of total revenue as reported 46% 14% 27% 12%
Percentage of total revenue prior to
reduction for estimated tissue recall returns 46% 14% 26% 12%
Revenues from the sale of BioGlue Surgical Adhesive increased 81% and 97%,
respectively, for the three and twelve months ended December 31, 2002. The
increase in revenues for the three and twelve month periods ended December 31,
2002 was due to an increase in the milliliters of BioGlue shipped of 56% and
75%, respectively, and a 15% and 12%, respectively, increase in the average
selling price of the BioGlue shipped. The increase in shipments was primarily
due to the receipt of FDA approval in December 2001 for the use of BioGlue in
the U.S. as an adjunct to sutures and staples in open surgical repair of large
vessels for adult patients. Domestic revenues accounted for 81% and 65% of total
BioGlue revenues for the three months ended December 31, 2002 and 2001,
respectively. Domestic revenues accounted for 79% and 66% of total BioGlue
revenues for the twelve months ended December 31, 2002 and 2001, respectively.
Although BioGlue revenue increased as compared to the prior year and BioGlue was
not included in the FDA Order, future sales of BioGlue could be adversely
affected due to the adverse publicity surrounding the FDA's review of and
correspondence with the Company. Additionally, there is a possibility the
Company's BioGlue manufacturing operations could come under increased scrutiny
from the FDA as a result of their review of the Company's tissue processing
laboratories.
45
CARDIOVASCULAR PRESERVATION SERVICES
Three Months Ended Twelve Months Ended
December 31, December 31,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 3,283 $ 6,304 $ 23,413 $ 28,606
Percentage of total revenue as reported 27% 29% 30% 33%
Revenues prior to reduction for
estimated tissue recall returns $ 3,283 $ 6,304 $ 23,924 $ 28,606
Percentage of total revenue prior to
reduction for estimated tissue recall returns 27% 29% 29% 33%
Revenues from cardiovascular preservation services prior to the reduction for
estimated returns of tissue subject to the FDA Order decreased 48% and 16%,
respectively, for the three and twelve months ended December 31, 2002. This
decrease in revenues for the three and twelve month periods ended December 31,
2002 was primarily due to a decline in customer demand due to the adverse
publicity surrounding the FDA Order, the FDA Letter posted on its website,
certain reported tissue infections and the related adverse publicity, and the
restrictions on shipments of certain tissues subject to the FDA Order.
Revenues as reported from cardiovascular preservation services decreased 18% for
the twelve months ended December 31, 2002. In addition to the factors discussed
above, the revenues as reported from cardiovascular preservation services were
adversely impacted by the estimated effect of the non-valved cardiac tissues
returned subject to recall by the FDA Order, which resulted in an estimated
decrease of $511,000 in service revenues during the twelve months ended December
31, 2002.
The Company anticipates a future decrease in cardiovascular preservation
revenues as compared to prior year periods for at least the first half of 2003
as a result of the FDA Warning Letter, the FDA Order, the FDA letter posted on
its website, certain reported tissue infections, and the related adverse
publicity. The Company anticipates that the clarification received from the FDA
on December 31, 2002 that non-valve conduit tissues processed after September 5,
2002 are not subject to the FDA Order and that the Company is able to ship these
tissues without obtaining physician prescriptions, labeling the tissue as
subject to a recall, or requiring special steps regarding procurement agency
records of donor screening and testing beyond those required for all processors
of human tissue will enable the Company to increase its shipments of non-valve
conduit tissue as compared to the fourth quarter of 2002. If the Company is
unable to rebuild demand for its preservation services for these tissues, future
non-valved cardiac preservation revenue could continue to decrease. The
clarification from the FDA does not affect heart valve tissues, as these tissues
are not subject to the FDA Order.
VASCULAR PRESERVATION SERVICES
Three Months Ended Twelve Months Ended
December 31, December 31,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 2,908 $ 5,865 $ 17,826 $ 24,488
Percentage of total revenues as reported 24% 27% 23% 28%
Revenues prior to reduction for
estimated tissue recall returns $ 2,908 $ 5,865 $ 20,373 $ 24,488
Percentage of total revenue prior to
reduction for estimated tissue recall returns 24% 27% 25% 28%
Revenues from human vascular tissue preservation services prior to reduction for
estimated returns of tissue subject to the FDA Order decreased 50% and 17%,
respectively, for the three and twelve months ended December 31, 2002. This
decrease in revenues for the three and twelve month periods ended December 31,
46
2002 was primarily due to a decline in customer demand due to the adverse
publicity surrounding the FDA Order, certain reported tissue infections, and the
restrictions on shipments of certain tissues subject to the FDA Order.
Revenues as reported from human vascular tissue preservation services decreased
27% for the twelve months ended December 31, 2002. In addition to the factors
discussed above, the revenues as reported from vascular tissue preservation
services were adversely impacted by the estimated effect of the return of
tissues subject to recall by the FDA Order, which resulted in an estimated
decrease of $2.5 million in vascular preservation service revenues during the
twelve months ended December 31, 2002.
The Company anticipates a future decrease in vascular preservation revenues as
compared to prior year periods for at least the first half of 2003 as a result
of the adverse publicity surrounding the FDA Warning Letter, FDA Order, and
certain reported tissue infections. The Company anticipates that the
clarification received from the FDA on December 31, 2002 that vascular tissues
processed after September 5, 2002 are not subject to the FDA Order and that the
Company is able to ship these tissues without obtaining physician prescriptions,
labeling the tissue as subject to a recall, or requiring special steps regarding
procurement agency records of donor screening and testing beyond those required
for all processors of human tissue will enable the Company to increase its
shipments of vascular tissue as compared to the fourth quarter of 2002. If the
Company is unable to rebuild demand for its preservation services for these
tissues, future vascular preservation revenue could continue to decrease.
ORTHOPAEDIC PRESERVATION SERVICES
Three Months Ended Twelve Months Ended
December 31, December 31,
------------------------------- ------------------------------
2002 2001 2002 2001
------------------------------- ------------------------------
Revenues as reported $ 108 $ 6,314 $ 14,134 $ 22,458
Percentage of total revenue as reported 1% 29% 18% 26%
Revenues prior to reduction for
estimated tissue recall returns $ 108 $ 6,314 $ 14,542 $ 22,458
Percentage of total revenue prior to
reduction for estimated tissue recall returns 1% 29% 18% 26%
Revenues from human orthopaedic tissue preservation services prior to reduction
for estimated returns of tissue subject to the FDA Order decreased 98% and 35%
for the three and twelve months ended December 31, 2002. This decrease in
revenues for the three and twelve month periods ended December 31, 2002 was
primarily due to a decline in customer demand due to the adverse publicity
surrounding the FDA Order, certain reported tissue infections, cessation of
processing of orthopaedic tissue, and the restrictions on shipments of tissues
subject to the FDA Order. Revenues since August 14, 2002 have been from
shipments of orthopaedic tissues that were processed prior to October 3, 2001.
Revenues as reported from human orthopaedic tissue preservation services
decreased 37% for the twelve months ended December 31, 2002. In addition to the
factors discussed above, the revenues as reported from orthopaedic tissue
preservation services were adversely impacted by the estimated effect of the
return of tissues subject to recall by the FDA Order, which resulted in an
estimated decrease of $408,000 in orthopaedic preservation service revenues
during the twelve months ended December 31, 2002.
The Company anticipates a substantial decrease in the orthopaedic preservation
revenues as compared to prior year periods for at least the first half of 2003
due to the Company's inability to ship orthopaedic grafts processed between
October 3, 2001 and September 5, 2002 pursuant to the FDA Order, the adverse
publicity resulting from the FDA Warning Letter and FDA Order, and the reported
infections in some orthopaedic allograft recipients. The Company resumed
processing orthopaedic tissues in late February 2003 following the close out of
the April FDA 483 as discussed in Item 1. Business - "FDA Order on Human Tissue
Preservation Services". If the Company is unable to rebuild demand for its
preservation services for orthopaedic tissues or if it is unable to confirm that
the FDA does not disagree with the Company's interpretation that following the
close out of the April 2002 FDA 483 the Company can resume distribution of
orthopaedic tissue, future orthopaedic preservation revenue, if any, may be
minimal.
47
BIOPROSTHETIC DEVICES
Revenues from bioprosthetic cardiovascular devices increased 31% to $699,000 in
2002 from $535,000 in 2001, representing 1% of total revenues during such
periods. This increase in revenues was primarily due to an increase in the
demand for the Company's SynerGraft bovine vascular grafts which received CE
Mark approval in August 2001.
DISTRIBUTION AND GRANT REVENUES
Grant revenues decreased to $348,000 in 2002 from $985,000 in 2001. Grant
revenues in both years were primarily attributable to the SynerGraft research
and development programs. Distribution revenues increased to $477,000 in 2002
from $4,000 in 2001. Distribution revenues are for commissions received for the
distribution of orthopaedic tissues for another processor.
COSTS AND EXPENSES
Cost of human tissue preservation services aggregated $55.4 million in 2002
compared to $31.2 million in 2001, representing 100% and 41%, respectively, of
total human tissue preservation service revenues during each period. Cost of
human tissue preservation services aggregated $2.1 million in fourth quarter of
2002 compared to $7.6 million in 2001, representing 34% and 41%, respectively,
of total human tissue preservation service revenues during each period. The
increase in the full year 2002 cost of preservation was due to the $32.7 million
write-down of deferred preservation costs recorded in the second and third
quarters of 2002 related to the FDA Order (See Item 1. Business. "FDA Order on
Human Tissue Preservation"). The decrease in the fourth quarter cost of
preservation was due to decreased demand and shipments of tissue for which
approximately $1.4 million of deferred preservation costs that were written-off
in the second and third quarter of 2002. The Company anticipates a reduction in
the cost of human tissue preservation services due to a reduction in shipments
of tissues as a result of the FDA Order; however, the cost of human tissue
preservation services as a percent of revenue is likely to increase as a result
of lower tissue processing volumes, especially if the decline in demand
continues. Additionally, the cost of human tissue preservation services may be
favorably impacted, depending on the future level of tissue shipments related to
previously written-down deferred preservation costs, because the write-down
creates a new cost basis which cannot be written back up if these tissues become
saleable. The shipment levels of these written-down tissues will be affected by
the amount and timing of the release of tissues processed after September 5,
2002, pursuant to the Agreement with the FDA, since written-down tissues may be
shipped if tissues processed after the Agreement are not available for shipment
Cost of products aggregated $10.3 million in 2002 compared to $5.5 million in
2001, representing 48% and 49%, respectively, of total product revenues during
such periods. Cost of products aggregated $1.5 million in the fourth quarter of
2002 compared to $1.4 million in the fourth quarter of 2001, representing 25%
and 46%, respectively, of total product revenues during such periods. The 2002
cost of products includes a $3.1 million write-down of bioprosthetic valves,
including SynerGraft and non-SynerGraft treated porcine valves, in the third
quarter of 2002 due to the Company's decision to stop future expenditures on the
development and marketing of these valves and to maintain its focus on its
preservation services business, and its BioGlue and SynerGraft vascular graft
product lines. The decrease in the fourth quarter 2002 cost of products as a
percentage of total product revenues is due to a favorable product mix that was
impacted by the increase in revenues from BioGlue Surgical Adhesive, which
carries higher gross margins than bioprosthetic devices.
General, administrative, and marketing expenses increased 40% to $47.5 million
in 2002, compared to $33.8 million in 2001, representing 61% and 39%,
respectively, of total revenues during such periods. The increase in
expenditures for the twelve months ended December 31, 2002 was primarily due to
increased overhead costs in connection with the expansion of the corporate
headquarters and manufacturing facility, which was substantially completed in
the first quarter of 2002, a $3.6 million accrual for estimated product loss
claims that have been incurred but not reported as of December 31, 2002, an
increase of $1.1 million in insurance premiums, an increase of $1.7 million in
legal and accounting costs due to the response to the FDA Order and increased
litigation, a $1.2 million accrual for retention levels under the Company's
liability and directors' and officers' insurance policies (see Legal Proceedings
at Part I, Item 3), additional professional fees of $1.5 million required to
address the observations detailed in the Warning Letter and severance and
48
related costs of approximately $690,000 due to the reduction in employee force
of approximately 105 employees. The Company expects to continue to incur
significant legal costs and professional fees to defend the lawsuits filed
against the Company and to address FDA compliance requirements. Additional
marketing expenses may also be incurred to address the effects of the adverse
publicity surrounding the FDA Order
Research and development expenses decreased 3% to $4.6 million in 2002, compared
to $4.7 million in 2001, representing 6% and 5%, respectively, of total revenues
during such periods. Research and development spending in 2002 was primarily
focused on the Company's SynerGraft and Protein Hydrogel Technologies.
As discussed in New Accounting Pronouncements, the Company recorded a $1.4
million write-down of its goodwill, which is shown as a separate line on the
Consolidated Income Statements for the twelve months ended December 31, 2002.
Interest income, net of interest expense, was $203,000 for the twelve months
ended December 31, 2002 as compared to $1.9 million for the twelve months ended
December 31, 2001. The 2002 decrease in net interest income was due to reduced
interest rates in 2002 as compared to 2001, a reduction in the principal debt
amount outstanding due to scheduled payments, and the lack of interest expense
capitalized in 2002 in connection with the expansion of the corporate
headquarters and manufacturing facility, which was substantially completed in
the first quarter of 2002.
The effective income tax rate was 33% and 32% for the years ended December 31,
2002 and 2001, respectively.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
REVENUES
Revenues increased 14% to $87.7 million in 2001 from $77.1 million in 2000. The
increase in revenues was primarily due to increased sales of BioGlue Surgical
Adhesive and growth in the Company's human vascular and orthopaedic tissue
preservation services. The increases were primarily attributable to a greater
acceptance of these products by the surgical community and the Company's ability
to procure greater amounts of tissue. These increases in revenues have been
offset by decreases in other revenues. Year over year statistics presented for
tissues procured and processed for human tissue preservation services are from
the period beginning in November of the prior year through October of the
current year, as such procurement and processing of tissues received during this
time period is the primary generator of calendar year revenues.
BIOGLUE SURGICAL ADHESIVE
Twelve Months Ended
December 31,
2001 2000
-----------------------------
Revenues $ 10,595 $ 6,405
Percentage of total revenue 12% 8%
Revenues from the sale of BioGlue Surgical Adhesive increased 65% for the year
ended December 31, 2001. The increase in revenues was due to a 56% increase in
the number of milliliter shipments of BioGlue. The increase in shipments was
primarily due to increased acceptance of BioGlue since its introduction in
domestic markets in January of 2000 pursuant to a HDE and its introduction in
international markets in April 1998. Additionally, BioGlue shipments increased
in 2001 as a result of subsequent domestic and international regulatory
approvals for use of BioGlue for certain indications. Domestic revenues were 66%
and 59% of total BioGlue revenues in 2001 and 2000, respectively.
49
CARDIOVASCULAR PRESERVATION SERVICES
Twelve Months Ended
December 31,
2001 2000
-----------------------------
Revenues $ 28,606 $ 29,685
Percentage of total revenue 33% 39%
Revenues from cardiovascular preservation services decreased 4% for the year
ended December 31, 2001. This decrease in revenues resulted from a 4% decrease
in the number of cardiovascular allograft shipments as a result of a 4% decrease
in cardiovascular tissues procured and processed year over year. Although
cardiovascular tissues procured and processed decreased year over year,
cardiovascular tissues procured and processed improved during the course of 2001
resulting in a 5% increase in cardiovascular tissue processed during the fourth
quarter of 2001 as compared to fourth quarter of 2000.
VASCULAR PRESERVATION SERVICES
Twelve Months Ended
December 31,
2001 2000
-----------------------------
Revenues $ 24,488 $ 21,279
Percentage of total revenue 28% 28%
Revenues from human vascular tissue preservation services increased 15% for the
year ended December 31, 2001. This increase in revenues was primarily due to a
17% increase in the number of vascular allograft shipments resulting from an 11%
increase in vascular tissues procured and processed year over year and an
increase in demand for all vascular tissue types.
ORTHOPAEDIC PRESERVATION SERVICES
Twelve Months Ended
December 31,
2001 2000
-----------------------------
Revenues $ 22,458 $ 16,132
Percentage of total revenue 26% 21%
Revenues from human orthopaedic tissue preservation services increased 39% for
the year ended December 31, 2001. This increase in revenues was primarily due to
a 27% increase in the number of allograft shipments. The increase in orthopaedic
shipments, primarily osteochondral grafts and non-bone tendons, was due to a 14%
increase in orthopaedic allograft tissues procured and processed year over year
and an increasing acceptance of these tissues in the orthopaedic surgeon
community. Shipments of non-bone tendons and osteochondral grafts increased 51%
and 80%, respectively, in 2001 resulting in a $4.9 million and $1.5 million
increase, respectively, in revenues in 2001 as compared to 2000. Additional
increases in revenues were due to a more favorable product mix, with increased
shipments of osteochondral grafts, which carry higher average selling prices
than other orthopaedic tissues. These increases were partially offset by a
decrease in boned tendon shipments resulting in a $900,000 decrease in revenues
in 2001 as compared to 2000.
BIOPROSTHETIC DEVICES
Revenues from bioprosthetic cardiovascular devices decreased 31% to $535,000 in
2001 from $771,000 in 2000, representing 1% of total revenues during such
periods. This decrease in revenues was primarily due to the Company's on-going
50
focus on development and start-up of production of the Company's SynerGraft line
of bioprosthetic heart valves and vascular grafts which adversely impacted its
ability to manufacture other bioprosthetic cardiovascular devices during the
first half of 2001.
SINGLE USE MEDICAL DEVICES
Revenues from single use medical devices manufactured by the Company's former
wholly-owned subsidiary Ideas for Medicine, Inc. ("IFM") decreased to zero in
2001 from $2.2 million in 2000. The decrease in revenues was due to the October
9, 2000 sale of substantially all of the remaining assets of IFM to Horizon
Medical Products, Inc. ("HMP"). See further discussion of the sale of the IFM
assets in Note 3 to the consolidated financial statements.
DISTRIBUTION AND GRANT REVENUES
Grant revenues increased to $989,000 in 2001 from $616,000 in 2000. Grant
revenues in both years are primarily attributable to the SynerGraft research and
development programs.
COSTS AND EXPENSES
Cost of human tissue preservation services aggregated $31.2 million in 2001
compared to $27.5 million in 2000, representing 41% of total human tissue
preservation service revenues during each period. Cost of products aggregated
$5.5 million in 2001 compared to $5.8 million in 2000, representing 49% and 62%,
respectively, of total product revenues during such periods. The decrease in the
2001 cost of products as a percentage of total product revenues was due to a
more favorable product mix during 2001. The product mix was impacted by an
increase in revenues from BioGlue Surgical Adhesive, which carries higher gross
margins than bioprosthetic devices, and the termination of the IFM OEM contract
with HMP, which had significantly lower margins than BioGlue Surgical Adhesive.
General, administrative, and marketing expenses increased 18% to $33.8 million
in 2001, compared to $28.7 million in 2000, representing 39% and 37%,
respectively, of total revenues during such periods. The increase in
expenditures in 2001 was primarily due to an increase of $500,000 resulting from
a full year of operations of CryoLife Europa, Ltd., the Company's European
headquarters established in early 2000, an increase in marketing and general
expenses to support revenue growth, and $684,000 of non-recurring charges. The
non-recurring charges consist primarily of $375,000 associated with the
termination of certain international distributor agreements and $160,000 of
costs previously capitalized in connection with uncompleted licensing
transactions.
Research and development expenses decreased 9% to $4.7 million in 2001, compared
to $5.2 million in 2000, representing 5% and 7%, respectively, of total revenues
during such periods. Research and development spending in 2001 related
principally to the Company's human clinical trials for its BioGlue Surgical
Adhesive and to its focus on its SynerGraft and Protein Hydrogel Technologies.
Total research and development expenses decreased in 2001 due to the wrap-up of
the BioGlue clinical trial and the lack of active enrollment expenses from this
trial in 2001 as compared to 2000.
Interest income, net of interest expense, was $1.9 million and $1.7 million in
2001 and 2000, respectively. The 2001 increase in net interest income and
expense was due primarily to the interest expense capitalized in 2001 in
connection with the expansion of the corporate headquarters and manufacturing
facility.
Other expense was $852,000 in 2001 as compared to other income of $169,000 in
2000. Other expense in 2001 primarily consisted of a $1.6 million loss related
to an other than temporary decline in the market value of marketable securities
previously recorded in comprehensive income as a component of shareholder's
equity, partially offset by a non-recurring gain of $713,000 related to the
reversal of the previously established reserve against the note receivable from
the sale of the IFM assets and product line.
The effective income tax rate was 32% and 33% for the years ended December 31,
2001 and 2000, respectively.
51
SEASONALITY
The demand for the Company's cardiovascular tissue preservation services is
seasonal, with peak demand generally occurring in the second and third quarters.
Management believes this trend for cardiovascular tissue preservation services
is primarily due to the high number of surgeries scheduled during the summer
months when younger patients are out of school for the summer break and also due
to a greater availability of tissue as donation is often higher in the summer
months. However, the demand for the Company's human vascular and orthopaedic
tissue preservation services, BioGlue Surgical Adhesive, and bioprosthetic
cardiovascular and vascular devices does not appear to experience seasonal
trends.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2002 net working capital (current assets less current
liabilities) was $37.8 million, with a current ratio (current assets divided by
current liabilities) of 3 to 1, compared to $66.7 million at December 31, 2001.
The Company's primary capital requirements historically arose out of general
working capital needs, capital expenditures for facilities and equipment, and
funding of research and development projects. The Company funded these
requirements through cash generated by operations, equity offerings, and bank
credit facilities. Based on the decrease in revenues resulting from the FDA
Order and associated adverse publicity, the Company expects that its cash
generated by operations will decrease significantly over the near term, and that
net working capital will decrease. It is possible that the Company will not have
sufficient funds to meet its primary capital requirements over the long term.
Net cash used in operating activities was $2.1 million in 2002, as compared to
cash provided of $6.5 million in 2001. The $2.1 million of cash used in 2002 was
primarily due to an increase in working capital requirements, which resulted in
a $12.2 million decrease in cash, partially offset by $10.1 million in net
income before depreciation, taxes, and excluding non-cash items. Working capital
needs were largely driven by a $12.8 million increase in deferred preservation
costs, excluding the effect of the non-cash write-down. Non-cash adjustments to
net income for 2002 include a $32.7 million write-down for the impairment of
deferred preservation costs resulting from the FDA Order as discussed in Recent
Events, a $3.1 million write-down for the impairment of inventory as discussed
in Costs and Expenses, and a $1.4 million write-down of goodwill as discussed in
Critical Accounting Policies.
Net cash provided by investing activities was $6.3 million for 2002, as compared
to cash used of $18.1 million for 2001. The $6.3 million in current year cash
provided was primarily due to a net $11.8 million increase in cash from sales
and maturities of marketable securities, primarily due to the maturity of debt
securities, and $1.2 million in proceeds from notes receivable, partially offset
by a $4.1 million decrease due to capital expenditures in 2002, as the expansion
and renovation of the Company's corporate headquarters and manufacturing
facilities approached completion, and a decrease due to spending on patents of
$2.6 million, primarily relating to costs incurred to defend the SynerGraft
technology patents.
Net cash used in financing activities was $1.4 million for 2002, as compared to
cash provided of $1.3 million for 2001. The $1.4 million in cash used in 2002
was primarily due to $1.6 million in principal payments on the Term Loan,
$663,000 for the purchase of treasury stock, and $609,000 in principal payments
on capital leases, offset by a $1.5 million increase due to proceeds from stock
option exercises.
Scheduled contractual obligations and the related future payments are as follows
(in thousands):
Total 2003 2004 2005 Thereafter
----------- ----------- ----------- ----------- -----------
Debt $ 5,600 $ 1,600 $ 1,600 $ 1,600 $ 800
Capital Lease Obligations 3,637 843 843 843 1,108
Operating Leases 27,280 2,294 2,115 2,091 20,780
Purchase Commitments 650 300 350 -- --
----------- ----------- ----------- ----------- -----------
Total Contractual Obligations $ 37,167 $ 5,037 $ 4,908 $ 4,534 $ 22,688
=========== =========== =========== =========== ===========
On March 4, 2002 the $4.4 million convertible debenture due on March 5, 2002 was
converted into approximately 546,000 shares of common stock at $8.05 per common
share.
52
The Company's Term Loan, of which the principal balance was $5.3 million as of
February 24, 2003, contains certain restrictive covenants including, but not
limited to, maintenance of certain financial ratios and a minimum tangible net
worth requirement, and the requirement that no materially adverse event has
occurred. The lender has determined that the FDA Order, as described in Note 2
to the Consolidated Financial Statements, and the inquiries of the Securities
and Exchange Commission, as described in Note 9 to the Consolidated Financial
Statements, have a material adverse effect on the Company that constitutes an
event of default. Additionally, as of December 31, 2002, the Company is in
violation of the debt coverage ratio and net worth financial covenants. As of
February 24, 2003 the lender has elected not to declare an event of default, but
reserves the right to exercise any such right under the terms of the Term Loan.
Therefore, all amounts due under the Term Loan as of December 31, 2002 are
reflected as a current liability on the Consolidated Balance Sheet. In the event
the lender calls the Term Loan, the Company at present has adequate funds to pay
the principal amount outstanding. The Term Loan is secured by substantially all
of the Company's assets. Due to cross default provisions included in the
Company's debt agreements, as of December 31, 2002 the Company was in default of
certain capital lease agreements maintained with the lender of the Term Loan.
Therefore, all amounts due under these capital leases are reflected as a current
liability on the Consolidated Balance Sheets as of December 31, 2002.
The Company's Term Loan, which accrues interest computed at Adjusted LIBOR plus
1.5%, exposes the Company to changes in interest rates going forward. On March
16, 2000, the Company entered into a $4 million notional amount forward-starting
interest swap agreement, which took effect on June 1, 2001 and expires in 2006.
This swap agreement was designated as a cash flow hedge to effectively convert a
portion of the Term Loan balance to a fixed rate basis, thus reducing the impact
of interest rate changes on future income. This agreement involves the receipt
of floating rate amounts in exchange for fixed rate interest payments over the
life of the agreement, without an exchange of the underlying principal amounts.
The differential to be paid or received is recognized in the period in which it
accrues as an adjustment to interest expense on the Term Loan.
On January 1, 2001 the Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") as amended. SFAS 133 requires
the Company to recognize all derivative instruments on the balance sheet at fair
value, and changes in the derivative's fair value must be recognized currently
in earnings or other comprehensive income, as applicable. The adoption of SFAS
133 impacts the accounting for the Company's forward-starting interest rate swap
agreement. Upon adoption of SFAS 133, the Company recorded an unrealized loss of
approximately $175,000 related to the interest rate swap, which was recorded as
part of long-term liabilities and accumulated other comprehensive income within
the Statement of Shareholders' Equity.
In August 2002 the Company determined that changes in the derivative's fair
value could no longer be recorded in other comprehensive income, as a result of
the uncertainty of future cash payments on the Term Loan caused by the lender's
ability to declare an event of default as discussed in Note 6. Beginning in
August 2002 the Company began recording all changes in the fair value of the
derivative into other expense/income on the Consolidated Income Statements, and
is amortizing the amounts previously recorded in other comprehensive income of
$292,000 into other expense/income over the remaining life of the agreement
through June 2006. If the lender accelerates the payments due under the term
loan by declaring an event of default, any remaining balance in other
comprehensive income will be reclassed into other expense/income during that
period.
On December 31, 2002 the notional amount of this swap agreement was $2.8
million, and the fair value of the interest rate swap agreement, as estimated by
the bank based on its internal valuation models, was a liability of $280,000.
The fair value of the swap agreement is recorded as part of long-term
liabilities. The Company recorded a loss of $20,000 on the interest rate swap in
2002. The unamortized value of the swap agreement, recorded in the accumulated
other comprehensive income account of shareholders' equity, was $260,000 at
December 31, 2002.
On July 18, 2002 the Company's Board of Directors authorized the purchase of up
to $10 million of its common stock. As of August 13, 2002 the Company had
repurchased 68,000 shares of its common stock for $663,000. No further purchases
have been made or are anticipated in the near term.
On July 30, 2002 the Company entered into a line of credit agreement with the
lender that made the Term Loan, permitting the Company to borrow up to $10
million. Any borrowings under the line of credit agreement would accrue interest
equal to Adjusted LIBOR plus 1.25% adjusted monthly. This loan is secured by
substantially all of the Company's assets. As a result of the financial impact
53
of the FDA Order, see Item 1, Business - FDA Order on Human Tissue Preservation,
the Company is not in compliance with the lender's requirements for advances of
funds under the line of credit. On August 21, 2002 the lender notified the
Company that it was not entitled to any further advances under the line of
credit. On November 27, 2002 the lender notified the Company that it had
cancelled the unfunded commitment of the line of credit, as the Company was in
default of certain provisions and financial covenants of the line of credit
agreement. The Company had no outstanding borrowings on the line of credit at
the time of cancellation.
Since October 1998 management has been seeking to enter into a corporate
collaboration or to complete a potential private placement of equity or
equity-oriented securities to fund the commercial development of its Activation
Control Technology ("ACT"). This technology is now held by the Company's wholly
owned subsidiary AuraZyme Pharmaceutical, Inc.(R), ("AuraZyme") which was formed
on February 26, 2001. This strategy, if successful, will allow an affiliated
entity to fund the ACT and should expedite the commercial development of its
oncology, fibrinolysis (blood clot dissolving), and surgical sealant product
applications without additional research and development expenditures by the
Company (other than through the affiliated company). This strategy could
favorably impact the Company's liquidity going forward. However, if the Company
is unable to obtain funds for the commercial development of the ACT and/or if
the Company decides to fund the technology itself, the expenses required to fund
the ACT could adversely impact the Company's liquidity going forward. The
Company has reduced its efforts to fund the commercial development of ACT in the
near term until it has resolved the financial impact of the recent FDA Order.
The Company expects that its capital expenditures in 2003 will be less than its
expenditures in 2002, which were approximately $4.1 million. The Company expects
to have the flexibility to increase or decrease the majority of its planned
capital expenditures depending on its ability to resume normal operating levels
once it has addressed the observations in the FDA Warning Letter. The Company
does not currently anticipate any major purchase of equipment as a result of the
FDA re-inspection of its facilities.
Century Medical, Inc. has completed the Japanese BioGlue clinical trial and is
performing a post clinical trial follow up of patients who have received the
product. The Company does not know when to expect a final decision on the
approval of the BioGlue application from the Japanese Ministry of Health and
Welfare. If approval is received, the Company believes it could have a positive
impact on its BioGlue business.
On February 14, 2003 the FDA confirmed that the Company has completed the
corrective actions necessary to close out the April 2002 FDA 483 Notice of
Observations that preceded the Warning Letter and FDA Order. The close out of
the 483 followed a two-week inspection of the Company's processing operations.
As a result of the close out of the 483, the Company believes it can resume
processing and distributing orthopaedic tissues but has not received
confirmation of this from the FDA. The Company resumed processing orthopaedic
tissues in late February 2003. Prior to shipment of orthopaedic tissues, the
Company will confirm with the FDA that they do not disagree with the Company
regarding its interpretation of the close out of the April 2002 FDA 483.
A new FDA 483 Notice of Observations was issued in connection with the
inspection, but corrective action was implemented on most of its observations
during the inspection. The Company believes the observations, most of which
focus on the Company's systems for handling complaints, will not materially
affect the Company's operations. If the Company is unable to satisfactorily
respond to the FDA's observations contained in this notice, the FDA could take
further action, which could have a material adverse effect on the Company's
business, results of operations, financial position or cashflows.
On February 20, 2003 the Company received a letter from the FDA that stated that
a 510(k) premarket notification should be filed for the Company's CryoValve SG
and that premarket approval marketing authorization should be obtained for the
Company's CryoVein SG when used for arteriovenous ("A-V") access. The agency's
position is that use of the SynerGraft technology in the processing of allograft
heart valves represents a modification to the Company's legally marketed
CryoValve allograft, and that femoral veins used for A-V access are medical
devices that require premarket approval. CryoLife will be providing the agency
with information to demonstrate that femoral veins used for A-V access should
continue to be regulated as human tissue under Parts 1270 and 1271 of the FDA's
regulations. The FDA letter did not question the safety or efficacy of the
SynerGraft process or the CryoVein A-V access implant.
54
The Company has advised the FDA that it will voluntarily suspend use of the
SynerGraft technology in the processing of allograft heart valves and vascular
tissue until the regulatory status of the CryoValve SG and CryoVein SG is
resolved. The FDA has not suggested that these tissues be recalled. Until such
time as the issues surrounding the SG tissue are resolved, the Company will
employ its traditional processing methods on these tissues. Distribution of
allograft heart valves and vascular tissue processed using the Company's
traditional processing protocols will continue. The outcome of the discussions
with the FDA regarding the use of the SynerGraft process on human tissue could
result in a reduction in SynerGraft processed cardiovascular and vascular tissue
which would reduce the revenues and gross margins with respect to cardiovascular
and vascular tissues. Considering additional costs associated with processing
SynerGraft cardiac and vascular tissues, the potential net financial impact from
not utilizing the SynerGraft technology in cardiac and vascular tissue
processing is estimated to be approximately 10% of the cardiac and vascular
revenues derived from SynerGraft processing.
The Company expects its liquidity to decrease significantly over the next year
due to the anticipated significant decrease in revenues throughout at least the
first half of 2003 as compared to the prior year period, as a result of the FDA
Order and associated adverse publicity, and an expected decrease in cash due to
the anticipated increased legal and professional costs relating to the defense
of lawsuits and the FDA Order. On September 3, 2002 the Company announced a
reduction in employee force of approximately 105 employees. Severance and
related costs were approximately $690,000 and were recorded in the third quarter
of 2002. As a result of the employee reduction, management anticipated personnel
costs would be reduced by approximately $385,000 per month. Although the Company
has rehired certain employees, due to other turnover, the net change has
remained approximately 105 employees as of mid-February 2003 and the savings per
month has approximated that expected. The Company intends to increase its hiring
in 2003 as a result of receiving the close out of the April 2002 FDA 483. The
Company believes that anticipated revenue generation, expense management
including the cessation of the development of the bioprosthetic valves, savings
resulting from the reduction in the number of employees to reflect the reduction
in revenues, tax refunds expected to be at least $11 million ($2.5 million of
estimated tax payments remitted for the 2002 tax year that were refunded to the
Company in January of 2003, and approximately $8.5 million of loss carrybacks
generated from operating losses and write-downs of deferred preservation costs
and inventory), and the Company's existing cash and cash equivalents and
marketable securities will enable the Company to meet its liquidity needs
through at least December 31, 2003, even if the term loan is called in its
entirety. There is no assurance that the Company will be able to return to the
level of demand for its tissue services that existed prior to the FDA Order as a
result of the adverse publicity or as a result of customers and tissue banks
switching to competitors. Failure of the Company to maintain sufficient demand
for its services, would have a material adverse effect on the Company's
business, financial condition, results of operations, and cash flows.
The Company's long term liquidity and capital requirements will depend upon
numerous factors, including continued acceptance of BioGlue, the ability to
extend the Agreement with the FDA, the extent of the anticipated revenue
decreases, the costs associated with compliance with FDA requirements, the
outcome of litigation against the Company as described in Part I Item 3 of this
Form 10-K, the level of demand for cardiovascular and vascular tissue, the
continuing effect of adverse publicity, the Company's ability to resolve the
February 2003 FDA 483 and the informal February FDA letter, the ability to
regain orthopaedic demand, the actual outcomes of product liability claims that
have been incurred but not reported as of December 31, 2002 of which $3.6
million has been accrued, the timing of the Company's receipt of FDA approvals
to begin clinical trials for its products currently in development, the
availability of resources required to further develop its marketing and sales
capabilities if and when those products gain approval, the extent to which the
Company's products generate market acceptance and demand, and the resolution of
the "Risk Factors" discussed in Item 1 above. There can be no assurance the
Company will not require additional financing or will not be required to seek to
raise additional funds through bank facilities, debt or equity offerings, or
other sources of capital to meet future requirements. 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.
FORWARD LOOKING STATEMENTS
The Company's statements addressing events or developments which will or may
occur in the future, including those regarding the Company's competitive
position, successful development of its SynerGraft bioprosthetic devices,
funding to continue development of the ACT, expectations regarding the adequacy
55
of financing, expectations regarding the outcome of the February 2003 FDA 483
and informal February FDA letter, product demand and market growth, and other
statements regarding future plans and strategies, anticipated events or trends
and similar expressions concerning matters that are not historical facts are
forward-looking statements. These statements are based on assumptions and
analyses made by the Company in light of historical trends, current conditions
and expected future developments as well as other factors it considers
appropriate. However, whether actual developments will conform with the
Company's expectations and predictions is subject to a number of risks and
uncertainties, including the "Risk Factors" discussed in Item 1 to this Form
10-K and other factors, many of which are beyond the control of the Company, and
which could cause actual results to differ materially from the Company's
expectations. All of the forward-looking statements made in this Form 10-K are
qualified by these cautionary statements and there can be no assurance that the
actual results or developments anticipated by the Company will be realized or
that they will have the expected results. The Company assumes no obligation to
update publicly any such forward-looking statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's interest income and expense are sensitive to changes in the
general level of U.S. interest rates. In this regard, changes in U.S. interest
rates affect the interest earned on the Company's cash and cash equivalents of
$10.3 million and short-term investments in municipal obligations of $14.6
million as of December 31, 2002, as well as interest paid on its debt. A 10%
adverse change in interest rates affecting the Company's cash equivalents and
short-term investments would not have a material impact on the Company's
financial position, results of operations, and cash flows for 2002.
The Company manages interest rate risk through the use of fixed debt and an
interest rate swap agreement. At December 31, 2002 approximately $2.8 million of
the Company's $5.6 million in debt charged interest at a fixed rate. This fixed
rate debt includes a portion of the Company's outstanding term loan balance that
has been effectively converted to fixed rate debt through an interest rate swap
agreement. A 10% increase in interest rates affecting the Company's variable
rate debt, net of the effect of the interest rate swap agreement, would not have
a material increase in the Company's financial position, results of operations,
and cash flows for 2002.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Our financial statements and supplementary data required by this item are
submitted as a separate section of this annual report on Form 10-K. See
"Financial Statements" commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Information concerning a change in accountants is included in the Company's Form
8-K dated April 11, 2002.
56
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The response to Item 10, applicable to the Directors of the Company, is
incorporated herein by reference to the information set forth under the caption
"Election of Directors" in the Proxy Statement for the Annual Meeting of
Shareholders to be filed with the Commission not later than April 30, 2003.
Information concerning executive officers is included in Part I, Item 4A of this
Form 10-K.
The response to Item 10, applicable to Section 16(a) of the Securities Exchange
Act of 1934, as amended, is incorporated herein by reference to the information
set forth under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement for the Annual Meeting of Shareholders to be
filed with the Commission not later than April 30, 2003.
ITEM 11. EXECUTIVE COMPENSATION.
The response to Item 11 is incorporated herein by reference to the information
set forth under the caption "Executive Compensation" in the Proxy Statement for
the Annual Meeting of Shareholders to be filed with the Commission not later
than April 30, 2003.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The response to Item 12 is incorporated herein by reference to the information
set forth under the captions "Executive Compensation", "Ownership of Principal
Shareholders and Certain Executive Officers", and "Election of Directors" in the
Proxy Statement for the Annual Meeting of Shareholders to be filed with the
Commission not later than April 30, 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The response to Item 13 is incorporated herein by reference to the information
set forth under the caption "Executive Compensation" in the Proxy Statement for
the Annual Meeting of Stockholders to be filed with the Commission not later
than April 30, 2003.
ITEM 14. CONTROLS AND PROCEDURES.
With the participation of management, the Company's President and Chief
Executive Officer along with the Company's Vice President of Finance and Chief
Financial Officer evaluated the Company's disclosure controls and procedures
within 90 days of the filing date of this annual report. Based upon this
evaluation, the Company's President and Chief Executive Officer along with the
Company's Vice President of Finance and Chief Financial Officer concluded that
the Company's disclosure controls and procedures are effective in ensuring that
material information required to be disclosed is included on a timely basis in
the reports that it files with the Securities and Exchange Commission.
There have been no significant changes in the Company's internal controls or, to
the knowledge of the management of the Company, in other factors that could
significantly affect these controls subsequent to the evaluation date.
57
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
The following are filed as part of this report:
(a) 1. Financial Statements
Independent Auditors' Report-Deloitte & Touche LLP, Report of
Independent Public Accountants-Arthur Andersen LLP, Copy of Report of
Independent Public Accountants, Consolidated Balance Sheets as of
December 31, 2002 and 2001, Consolidated Statements of Operations as of
December 31, 2002, 2001 and 2000, Consolidated Statements of Cash Flows
as of December 31, 2002, 2001 and 2000, Consolidated Statements of
Shareholders' Equity for the years ended December 31, 2002, 2001, 2000,
and 1999, and Notes to Consolidated Financial Statements.
2. Financial Statement Schedule
Independent Auditors' Report on Schedule II
Schedule II--Valuation and Qualifying Accounts
All other financial statement schedules not listed above are omitted, as the
required information is not applicable or the information is presented in the
consolidated financial statements or related notes.
3. A. Exhibits
The following exhibits are filed herewith or incorporated herein by reference:
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1 Asset Purchase Agreement among the Company and United Cryopreservation
Foundation, Inc., United Transplant Foundation, Inc. and QV, Inc.
dated September 11, 1996. (Incorporated by reference to Exhibit 2.2 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996.)
2.2 Agreement and Plan of Merger dated as of March 5, 1997 among Ideas for
Medicine, Inc., J. Crayton Pruitt, Sr., M.D., Thomas Benham, Thomas
Alexandris, Tom Judge, Natalie Judge, Helen Wallace, J. Crayton
Pruitt, Jr., M.D., and Johanna Pruitt, and CryoLife, Inc. and CryoLife
Acquisition Corporation. (Incorporated by reference to Exhibit 2.1 to
the Registrant's Current Report on Form 8-K filed on March 19, 1997.)
2.3 Asset Purchase Agreement by and between Horizon Medical Products, Inc.
and Ideas for Medicine, Inc. dated September 30, 1998. (Incorporated
by reference to Exhibit 2 to Horizon Medical Products, Inc.'s Current
Report on Form 8-K filed with the Securities and Exchange Commission
on October 14, 1998.)
2.4+ Asset Purchase Agreement, dated October 9, 2000, by and between
Horizon and IFM. (Incorporated by reference to Exhibit 2.4 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 2000.)
3.1 Restated Certificate of Incorporation of the Company. (Incorporated by
reference to Exhibit 3.1 to the Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 1999.)
3.2 ByLaws of the Company, as amended. (Incorporated by reference to
Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995.)
58
3.3 Articles of Amendment to the Articles of Incorporation of the Company.
(Incorporated by reference to Exhibit 3.3 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000).
4.1 Form of Certificate for the Company's Common Stock. (Incorporated by
reference to Exhibit 4.1 to the Registrant's Registration Statement on
Form S-1 (No. 33-56388).
4.2 Form of Certificate for the Company's Common Stock. (Incorporated by
reference to Exhibit 4.2 to the Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 1997.)
10.1 Lease, by and between New Market Partners III, Laing Properties, Inc.,
General Partner, as Landlord, and the Company, as Tenant, dated
February 13, 1986, as amended by that Amendment to Lease, by and
between the parties, dated April 7, 1986, as amended by that Amendment
to Lease, by and between the parties, dated May 15, 1987, as amended
by that Second Amendment to Lease, by and between the parties, dated
June 22, 1988, as amended by that Third Amendment to Lease, by and
between the parties, dated April 4, 1989, as amended by that Fourth
Amendment to Lease, by and between the parties, dated April 4, 1989 as
amended by that Fifth Amendment to Lease, by and between the parties,
dated October 15, 1990. (Incorporated by reference to Exhibit 10.1 to
the Registrant's Registration Statement on Form S-1 (No. 33-56388).)
10.1(a) Seventh Amendment to Lease dated February 13, 1986, by and between New
Market Partners III, Laing Properties, Inc., General Partner, as
Landlord, and the Company as tenant, dated May 15, 1996. (Incorporated
by reference to Exhibit 10.1(a) to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1996.)
10.1(b) Eighth Amendment to Lease dated February 13, 1986, by and between New
Market Partners III, Laing Properties, Inc., General Partner, as
Landlord, and the Company as tenant, dated November 18, 1998.
(Incorporated by reference to Exhibit 10.12 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002.)
10.1(c) Ninth Amendment to Lease dated February 13, 1986, by and between New
Market Partners III, Laing Properties, Inc., General Partner, as
Landlord, and the Company as tenant, dated July 25, 2001.
(Incorporated by reference to Exhibit 10.13 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002.)
10.1(d) Tenth Amendment to Lease dated February 13, 1986, by and between New
Market Partners III, Laing Properties, Inc., General Partner, as
Landlord, and the Company as tenant, dated June 25, 2002.
(Incorporated by reference to Exhibit 10.42 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002.)
10.2 Lease by and between Newmarket Partners I, Laing Properties, Inc. and
Laing Management Company, General Partner, as Landlord, and the
Company as Tenant, dated July 23, 1993. (Incorporated by reference to
Exhibit 10.2 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993.)
10.2(a) First Amendment to Lease dated July 23, 1993, by and between Newmarket
Partners I, Laing Properties, Inc. and Laing Management Company,
General Partner, as Landlord, and the Company as Tenant dated June 9,
1994. (Incorporated by reference to Exhibit 10.15 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002.)
10.2(b) Second Amendment to Lease dated July 23, 1993, by and between
Newmarket Partners I, Laing Properties, Inc. and Laing Management
Company, General Partner, as Landlord, and the Company as Tenant dated
June 6, 1998. (Incorporated by reference to Exhibit 10.16 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
59
10.2(c) Third Amendment to Lease dated July 23, 1993, by and between Newmarket
Partners I, Laing Properties, Inc. and Laing Management Company,
General Partner, as Landlord, and the Company as Tenant dated August
3, 2001. (Incorporated by reference to Exhibit 10.17 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.2(d) Fourth Amendment to Lease dated July 23, 1993, by and between
Newmarket Partners I, Laing Properties, Inc. and Laing Management
Company, General Partner, as Landlord, and the Company as Tenant dated
June 25, 2002. (Incorporated by reference to Exhibit 10.18 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.3 1993 Employee Stock Incentive Plan adopted on July 6, 1993.
(Incorporated by reference to Exhibit 10.3 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1993.)
10.4 1989 Incentive Stock Option Plan for the Company, adopted on March 23,
1989. (Incorporated by reference to Exhibit 10.2 to the Registrant's
Registration Statement on Form S-1 (No. 33-56388).)
10.5 Incentive Stock Option Plan, dated as of April 5, 1984. (Incorporated
by reference to Exhibit 10.3 to the Registrant's Registration
Statement on Form S-1 (No. 33-56388).)
10.6 Form of Stock Option Agreement and Grant under the Incentive Stock
Option and Employee Stock Incentive Plans. (Incorporated by reference
to Exhibit 10.4 to the Registrant's Registration Statement on Form S-1
(No. 33-56388).)
10.7 CryoLife, Inc. Profit Sharing 401(k) Plan, as adopted on December 17,
1991. (Incorporated by reference to Exhibit 10.5 to the Registrant's
Registration Statement on Form S-1 (No. 33-56388).)
10.8 Form of Supplemental Retirement Plan, by and between the Company and
its Officers -- Parties to Supplemental Retirement Plans: Steven G.
Anderson, David M. Fronk, Sidney B. Ashmore, James C. Vander Wyk,
Albert E. Heacox, Kirby S. Black, and David Ashley Lee. (Incorporated
by reference to Exhibit 10.6 to the Registrant's Registration
Statement on Form S-1 (No. 33-56388).)
10.9(a) Employment Agreement, by and between the Company and Steven G.
Anderson. (Incorporated by reference to Exhibit 10.9(a) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1998.)
10.9(b) Employment Agreement, by and between the Company and Albert E. Heacox.
(Incorporated by reference to Exhibit 10.7(c) to the Registrant's
Registration Statement on Form S-1 (No. 33-56388).)
10.9(c) Employment Agreement, by and between the Company and D. Ashley Lee,
dated December 12, 1994. (Incorporated by reference to Exhibit 10.9(c)
to the Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2000.)
10.9(d) Employment Agreement, by and between the Company and James C. Vander
Wyk, Ph.D. (Incorporated by reference to Exhibit 10.9(f) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995.)
10.9(e) Employment Agreement, by and between the Company and Kirby S. Black,
Ph.D. (Incorporated by reference to Exhibit 10.9(g) to the
Registrant's Annual Report on Form 10-K/A for the fiscal year ended
December 31, 1996.)
10.9(f) Employment Agreement, by and between the Company and David M. Fronk.
(Incorporated by reference to Exhibit 10.9(g) to the Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31,
1998.)
60
10.9(g) Employment Agreement, by and between the Company and Sidney B.
Ashmore. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended March
31, 2001.)
10.9(h) Employment Agreement, by and between the Company and D. Ashley Lee,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.4 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.9(i) Employment Agreement, by and between the Company and Sidney B.
Ashmore, dated September 3, 2002. (Incorporated by reference to
Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002.)
10.9(j) Employment Agreement, by and between the Company and Kirby S. Black,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.6 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.9(k) Employment Agreement, by and between the Company and Albert E. Heacox,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.7 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.9(l) Employment Agreement, by and between the Company and David M. Fronk,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.8 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.9(m) Employment Agreement, by and between the Company and James C. Vander
Wyk, dated September 3, 2002. (Incorporated by reference to Exhibit
10.9 to the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002.)
10.9(n) Employment Agreement, by and between the Company and Steven G.
Anderson, dated September 3, 2002. (Incorporated by reference to
Exhibit 10.10 to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2002.)
10.10 Form of Secrecy and Noncompete Agreement, by and between the Company
and it's Officers. (Incorporated by reference to Exhibit 10.9 to the
Registrant's Registration Statement on Form S-1 (No. 33-56388).)
10.11 Terms of Agreement Between Bruce J. Van Dyne, M.D. and CryoLife, Inc.
dated November 1, 1999. (Incorporated by reference to Exhibit 10.11 to
the Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1999.)
10.12 Technology Acquisition Agreement between the Company and Nicholas
Kowanko, Ph.D., dated March 14, 1996. (Incorporated by reference to
Exhibit 10.14 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995.)
10.13 Option Agreement, by and between the Company and Duke University,
dated July 9, 1990, as amended by that Option Agreement Extension, by
and between the parties, dated July 9, 1991. (Incorporated by
reference to Exhibit 10.20 to the Registrant's Registration Statement
on Form S-1 (No. 33-56388).)
10.14 Research and License Agreement by and between Medical University of
South Carolina and CryoLife dated November 15, 1985, as amended by
Amendment to the Research and License Agreement dated February 25,
1986 by and between the parties and an Addendum to Research and
License Agreement by and between the parties, dated March 4, 1986.
(Incorporated by reference to Exhibit 10.23 to the Registrant's
Registration Statement on Form S-1 (No. 33-56388).)
61
10.15 CryoLife, Inc. Non-Employee Directors Stock Option Plan, as amended.
(Incorporated by reference to Appendix 2 to the Registrant's
Definitive Proxy Statement filed with the Securities and Exchange
Commission on April 17, 1998.)
10.16 Lease Agreement between the Company and Amli Land Development--I
Limited Partnership, dated April 18, 1995. (Incorporated by reference
to Exhibit 10.26 to the Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995.)
10.16(a) First Amendment to Lease Agreement, dated April 18, 1995, between the
Company and Amli Land Development--I Limited Partnership dated August
6, 1999. (Incorporated by reference to Exhibit 10.16(a) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1999.)
10.16(b) Restatement and Amendment to Funding Agreement between the Company and
Amli Land Development- I Limited Partnership, dated August 6, 1999.
(Incorporated by reference to Exhibit 10.16(b) to the Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31,
2000.)
10.18 CryoLife, Inc. Employee Stock Purchase Plan (Incorporated by reference
to Exhibit "A" of the Registrant's Definitive Proxy Statement filed
with the Securities and Exchange Commission on April 10, 1996.)
10.19 Noncompetition Agreement between the Company and United
Cryopreservation Foundation, Inc. dated September 11,1996.
(Incorporated by reference to Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.)
10.20 Noncompetition Agreement between the Company and QV, Inc. dated
September 11, 1996. (Incorporated by reference to Exhibit 10.3 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996.)
10.21 Revolving Term Loan Facility between the Company and NationsBank N.A.,
dated August 30, 1996. (Incorporated by reference to Exhibit 10.4 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996.)
10.22 Technology License Agreement between the Company and Colorado State
University Research Foundation dated March 28, 1996. (Incorporated by
reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1996.)
10.23 Noncompetition Agreement between the Company and United Transplant
Foundation, Inc. dated September 11, 1996. (Incorporated by reference
to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1996.)
10.24(a) First Amendment of Third Amended and Restated Loan Agreement between
CryoLife, Inc., as Borrower and NationsBank, N.A. (South), as Lender,
dated April 14, 1997. (Incorporated by reference to Exhibit 10.1 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997.)
10.24(b) Second Modification of Third Amended and Restated Loan Agreement dated
December 16, 1997 by and between the Registrant and NationsBank, N.A.
(Incorporated by reference to Exhibit 4.2 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997.)
10.24(c) Fourth Modification of Third Amended and Restated Loan Agreement dated
December 16, 1997 by and between the Company and Bank of America, N.A.
and First Modification of Revolving Note dated December 31, 1999.
(Incorporated by reference to Exhibit 10.24 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999)
10.25 Reserved.
62
10.26 CryoLife, Inc. 1998 Long-Term Incentive Plan. (Incorporated by
reference to Appendix 2 to the Registrant's Definitive Proxy Statement
filed with the Securities and Exchange Commission on April 17, 1998.)
10.27 Consulting Agreement dated March 5, 1997 between CryoLife Acquisition
Corporation and J. Crayton Pruitt, Sr., M.D. (Incorporated by
reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997.)
10.28 Subordinated Convertible Debenture dated March 5, 1997 between the
Company and J. Crayton Pruitt, Sr., M.D. (Incorporated by reference to
Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997.)
10.29 Lease Agreement dated March 5, 1997 between the Company and J. Crayton
Pruitt, Sr., M.D. (Incorporated by reference to Exhibit 10.4 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended March
31, 1997.)
10.30 Lease Guaranty dated March 5, 1997 between J. Crayton Pruitt Family
Trust U/T/A and CryoLife, Inc., as Guarantor for CryoLife Acquisition
Corporation. (Incorporated by reference to Exhibit 10.5 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended March
31, 1997.)
10.31 Form of Non-Competition Agreement dated March 5, 1997 between the
Company and J. Crayton Pruitt, Sr., M.D., Thomas Benham, Thomas
Alexandris, Tom Judge, Natalie Judge, Helen Wallace, J. Crayton
Pruitt, Jr., M.D., and Johanna Pruitt. (Incorporated by reference to
Exhibit 10.6 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997.)
10.32 Standard Form of Agreements Between Owner and Design/Builder by and
between the Company and Choate Design and Build Company dated January
19, 2000. (Incorporated by reference to Exhibit 10.32 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1999)
10.33 Construction Loan and Permanent Financing Agreement with Bank of
America dated April 25, 2000. (Incorporated by reference to Exhibit
10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000.)
10.33(a) Second Amendment to Construction Loan and Permanent Financing
Agreement, dated July 30, 2002 by and between the Company and Bank of
America. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.33(b) Promissory Note by and between the Company and Bank of America, dated
July 30, 2002. (Incorporated by reference to Exhibit 10.2 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.34 Sublease Agreement between Horizon and IFM, dated October 9, 2000.
(Incorporated by reference to Exhibit 10.34 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000.)
10.35 Terms of Agreement between Ronald C. Elkins, MD and CryoLife, Inc.,
dated November 7, 2000. (Incorporated by reference to Exhibit 10.35 to
the Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 2000.)
10.36 Rights Agreement between the Company and Chemical Mellon Shareholder
Services, L.L.C., as Rights Agent, dated as of November 27, 1995.
(Incorporated by reference to Exhibit 10.36 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000.)
10.37 International Distribution Agreement, dated September 17, 1998,
between the Company and Century Medical, Inc. (Incorporated by
reference to Exhibit 10.37 to the Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 2000.)
63
10.38 Assignment and Assumption Agreement, dated March 30, 2001, by and
among Horizon, Vascutech and IFM. (Incorporated by reference to
Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2001.)
10.39 Assignment of Sublease, dated March 30, 2001, by and among Horizon,
Vascutech, and IFM. (Incorporated by reference to Exhibit 10.3 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended March
31, 2001.)
10.40 Security Agreement, dated March 30, 2001, by Vascutech in favor of
IFM. (Incorporated by reference to Exhibit 10.4 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2001.)
10.41 2002 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1
to the Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002.)
10.42 Settlement and Release Agreement, dated August 2, 2002, by and between
Colorado State University Research Foundation, the Company and Dr. E.
Christopher Orton. (Incorporated by reference to Exhibit 10.3 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.)
10.43 Letter Agreement between the Company and FDA, dated September 5, 2002.
(Incorporated by reference to Exhibit 10.38 to the registrant's report
on Form 8-K filed on September 6, 2002).
10.44* Letter Agreement between the Company and FDA, dated November 8, 2002.
10.45* Letter Agreement between the Company and FDA, dated January 8, 2003.
21.1* Subsidiaries of CryoLife, Inc.
23.1* Consent of Deloitte & Touche LLP.
23.2* Notice regarding consent of Arthur Andersen LLP.
99.1* Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant
To Section 906 Of The Sarbanes-Oxley Act Of 2002.
* Filed herewith.
+ In accordance with Item 601(b)(2) of Regulation S-K, the schedules and certain
exhibits to this exhibit have been omitted and a list of the schedules and
exhibits has been placed at the end of the Exhibit. The Registrant will furnish
supplementally a copy of any omitted schedule or exhibit to the Commission upon
request.
64
3.B. Executive Compensation Plans and Arrangements.
1. 1993 Employee Stock Incentive Plan adopted on July 6, 1993. (Exhibit 10.2
to the Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994.)
2. 1989 Incentive Stock Option Plan for the Company, adopted on March 23, 1989
(Exhibit 10.2 to the Registrant's Registration Statement on Form S-1 (No.
33-56388).)
3. Incentive Stock Option Plan, dated as of April 5, 1984 (Exhibit 10.3 to the
Registrant's Registration Statement on Form S-1 (No. 33-56388).)
4. Form of Stock Option Agreement and Grant under the Incentive Stock Option
and Employee Stock Incentive Plans (Exhibit 10.4 to the Registrant's
Registration Statement on Form S-1 (No. 33-56388).)
5. CryoLife, Inc. Profit Sharing 401(k) Plan, as adopted on December 17, 1991
(Exhibit 10.5 to the Registrant's Registration Statement on Form S-1 (No.
33-56388).)
6. Form of Supplemental Retirement Plan, by and between the Company and its
Officers -- Parties to Supplemental Retirement Plans: Steven G. Anderson,
David M. Fronk, Sidney B. Ashmore, James C. Vander Wyk, Albert E. Heacox,
Kirby S. Black and David Ashley Lee. (Exhibit 10.6 to the Registrant's
Registration Statement on Form S-1 (No. 33-56388).)
7. Employment Agreement, by and between the Company and Steven G. Anderson.
(Incorporated by reference to Exhibit 10.9(a) to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998.)
8. Employment Agreement, by and between the Company and David M. Fronk.
(Incorporated by reference to Exhibit 10.9(g) to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1998.)
9. Employment Agreement, by and between the Company and Albert E. Heacox.
(Incorporated by reference to Exhibit 10.7(c) to the Registrant's
Registration Statement on Form S-1 (No. 33-56388).)
10. Reserved.
11. Employment Agreement, by and between the Company and James C. Vander Wyk,
Ph.D. (Incorporated by reference to Exhibit 10.9(f) to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1995.)
12. Employment Agreement, by and between the Company and D. Ashley Lee.
(Incorporated by reference to Exhibit 10.9(c) to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2000.)
13. Employment Agreement, by and between the Company and Sidney B. Ashmore.
(Incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2001.)
14. CryoLife, Inc. Non-Employee Directors Stock Option Plan, as amended.
(Incorporated by reference to Appendix 2 to the Registrant's Definitive
Proxy Statement filed with the Securities and Exchange Commission on April
17, 1998.)
15. CryoLife, Inc. Employee Stock Purchase Plan. (Incorporated by reference to
Exhibit "A" of the Registrant's Definitive Proxy Statement filed with the
Securities and Exchange Commission on April 10, 1996.)
16. Employment Agreement by and between the Company and Kirby S. Black
(Incorporated by reference to Exhibit 10.9(g) to the Registrant's Annual
Report on Form 10-K/A for the fiscal year ended December 31, 1996.)
17. CryoLife, Inc. 1998 Long-Term Incentive Plan. (Incorporated by reference to
Appendix 2 to the Registrant's Definitive Proxy Statement filed with the
Securities and Exchange Commission on April 17, 1998.)
65
18. Terms of Agreement Between Bruce J. Van Dyne, M.D. and CryoLife, Inc.,
dated November 1, 1999. (Incorporated by reference to Exhibit 10.11 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended December
31, 1999.)
19. Terms of Agreement between Ronald C. Elkins, MD and CryoLife, Inc., dated
November 7, 2000. (Incorporated by reference to Exhibit 10.35 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended December
31, 2000.)
20. 2002 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
2002.)
21. Employment Agreement, by and between the Company and D. Ashley Lee, dated
September 3, 2002. (Incorporated by reference to Exhibit 10.4 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 2002.)
22. Employment Agreement, by and between the Company and Sidney B. Ashmore,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.5 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 2002.)
23. Employment Agreement, by and between the Company and Kirby S. Black, dated
September 3, 2002. (Incorporated by reference to Exhibit 10.6 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 2002.)
24. Employment Agreement, by and between the Company and Albert E. Heacox,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.7 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 2002.)
25. Employment Agreement, by and between the Company and David M. Fronk, dated
September 3, 2002. (Incorporated by reference to Exhibit 10.8 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 2002.)
26. Employment Agreement, by and between the Company and James C. Vander Wyk,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.9 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 2002.)
27. Employment Agreement, by and between the Company and Steven G. Anderson,
dated September 3, 2002. (Incorporated by reference to Exhibit 10.10 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 2002.)
(b) Reports on Form 8-K
1. NONE.
66
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CRYOLIFE, INC.
February 26, 2003
By /S/ STEVEN G. ANDERSON
----------------------------------------
Steven G. Anderson,
President, Chief Executive
Officer and Chairman of
the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ STEVEN G. ANDERSON President, Chief Executive Officer, February 26, 2003
----------------------- and Chairman of the Board of
STEVEN G. ANDERSON Directors (Principal Executive
Officer)
/s/ D. ASHLEY LEE Vice President, Treasurer, and Chief February 26, 2003
------------------ Financial Officer (Principal
D. ASHLEY LEE Financial and Accounting Officer)
/s/ JOHN M. COOK Director February 26, 2003
----------------
JOHN M. COOK
/s/ RONALD CHARLES ELKINS, M.D. Director February 26, 2003
- -------------------------------
RONALD CHARLES ELKINS, M.D.
/s/ VIRGINIA C. LACY Director February 26, 2003
---------------------
VIRGINIA C. LACY
/s/ RONALD D. MCCALL Director February 26, 2003
---------------------
RONALD D. MCCALL
/s/ Bruce J. Van Dyne, M.D. Director February 26, 2003
---------------------------
BRUCE J. VAN DYNE, M.D.
67
CERTIFICATIONS
I, Steven G. Anderson, Chairman, President, and Chief Executive Officer, certify
that:
1. I have reviewed this annual report on Form 10-K of CryoLife, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 26, 2003 /s/STEVEN G. ANDERSON
------------------------------------
Chairman, President, and Chief
Executive Officer
68
I, David Ashley Lee, Vice President, Treasurer, and Chief Financial Officer,
certify that:
1. I have reviewed this annual report on Form 10-K of CryoLife, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 26, 2003 /s/DAVID ASHLEY LEE
---------------------------------
Vice President , Treasurer, and
Chief Financial Officer
69
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
CryoLife, Inc.
We have audited, the accompanying consolidated balance sheet of CRYOLIFE, INC.
(a Florida corporation) AND SUBSIDIARIES ("the Company") as of December 31, 2002
and the related consolidated statement of operations, shareholders' equity, and
cash flows for the year ended December 31, 2002. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit. The financial
statements of the Company as of December 31, 2001 and for each of the two years
then ended were audited by other auditors who have ceased operations. Those
auditors expressed an unqualified opinion on those financial statements in their
report dated March 27, 2002.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December 31,
2002 and the results of their operations and their cash flows for the year ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for goodwill and other intangible assets to
conform to Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets", which was adopted by the Company as of January 1,
2002.
/s/ Deloitte & Touche LLP
Atlanta, Georgia
February 24, 2003
F-1
The following report of Arthur Andersen LLP ("Andersen") is a copy of the report
previously issued by Andersen on March 27, 2002. The report of Andersen is
included in this annual report on Form 10-K pursuant to rule 2-02(e) of
regulation S-X. The Company has not been able to obtain a reissued report from
Andersen. Andersen has not consented to the inclusion of its report in this
annual report on Form 10-K. Because Andersen has not consented to the inclusion
of its report in this annual report, it may be difficult to seek remedies
against Andersen, and the ability to seek relief against Andersen may be
impaired.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To CryoLife, Inc.
We have audited, the accompanying consolidated balance sheets of CYROLIFE, INC.
(a Florida corporation) AND SUBSIDIARIES as of December 31, 2001 and 2000 and
the related consolidated statements of income, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CryoLife, Inc. and subsidiaries
as of December 31, 2001 and 2000 and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Atlanta, Georgia
March 27, 2002
F-2
CryoLife, Inc.
Consolidated Balance Sheets
(in thousands, except per share data)
ASSETS
December 31, 2002 2001
- ----------------------------------------------------------------------------------------------------------
Current assets:
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents $ 10,277 $ 7,204
Marketable securities, at market 14,583 26,483
Receivables:
Trade accounts, less allowance for doubtful accounts
of $75 in 2002 and $100 in 2001 6,930 13,305
Note receivable, less allowance of $250 in 2001 -- 1,169
Income taxes 11,312 1,557
Other 512 1,263
- ----------------------------------------------------------------------------------------------------------
Total receivables 18,754 17,294
- ----------------------------------------------------------------------------------------------------------
Deferred preservation costs, net 4,332 24,199
Inventories 4,585 6,259
Prepaid expenses 2,413 2,341
Deferred income taxes 6,734 688
- ----------------------------------------------------------------------------------------------------------
Total current assets 61,678 84,468
- ----------------------------------------------------------------------------------------------------------
Property and equipment:
- ----------------------------------------------------------------------------------------------------------
Land 1,009 1,009
Equipment 22,403 18,998
Furniture and fixtures 5,275 5,347
Leasehold improvements 32,971 24,990
Construction in progress 189 7,767
- ----------------------------------------------------------------------------------------------------------
61,847 58,111
Less accumulated depreciation and amortization 23,717 18,865
- ----------------------------------------------------------------------------------------------------------
Net property and equipment 38,130 39,246
- ----------------------------------------------------------------------------------------------------------
Other assets:
- ----------------------------------------------------------------------------------------------------------
Goodwill, less accumulated amortization of $501 in 2001 -- 1,399
Patents, less accumulated amortization
of $1,014 in 2002 and $1,102 in 2001 5,324 2,919
Other, less accumulated amortization
of $397 in 2002 and $135 in 2001 1,282 1,278
- ----------------------------------------------------------------------------------------------------------
Total assets $ 106,414 $ 129,310
- ----------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-3
CryoLife, Inc.
Consolidated Balance Sheets
(in thousands, except per share data)
LIABILITIES AND SHAREHOLDERS' EQUITY
December 31, 2002 2001
- ----------------------------------------------------------------------------------------------------------
Current liabilities:
- ----------------------------------------------------------------------------------------------------------
Accounts payable $ 3,874 $ 555
Accrued expenses and other current liabilities 6,823 1,491
Accrued compensation 1,627 2,560
Accrued procurement fees 3,769 6,592
Current maturities of capital lease obligation 2,169 609
Current maturities of long-term debt 5,600 1,600
Convertible debenture -- 4,393
- ----------------------------------------------------------------------------------------------------------
Total current liabilities 23,862 17,800
- ----------------------------------------------------------------------------------------------------------
Capital lease obligations, less current maturities 971 3,140
Bank line of credit, less current maturities -- 5,600
Deferred income taxes 986 449
Other long-term liabilities 795 882
- ----------------------------------------------------------------------------------------------------------
Total liabilities 26,614 27,871
- ----------------------------------------------------------------------------------------------------------
Shareholders' equity:
- ----------------------------------------------------------------------------------------------------------
Preferred stock $.01 par value per share; authorized 5,000 shares
including 2,000 shares of series A junior participating preferred stock;
no shares issued -- --
Common stock $.01 par value per share; authorized 75,000 shares;
issued 20,935 in 2002 and 20,172 shares in 2001 209 202
Additional paid-in capital 73,630 66,828
Retained earnings 12,786 40,547
Deferred compensation (21) (33)
Accumulated other comprehensive income, net of tax 282 (145)
Treasury stock; 1,361 shares in 2002 and
1,286 shares in 2001, at cost (7,086) (5,960)
- ---------- -----------------------------------------------------------------------------------------------
Total shareholders' equity 79,800 101,439
- ----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 106,414 $ 129,310
- ----------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-4
CryoLife, Inc.
Consolidated Statements of Operations
(in thousands, except per share data)
Year Ended
December 31, 2002 2001 2000
- --------------------------------------------------------------------------------------------------------
Revenues:
- --------------------------------------------------------------------------------------------------------
Human tissue preservation services $ 55,373 $ 75,552 $ 67,096
(including write-down of $32,715 in 2002)
Products 21,597 11,130 9,384
Research grants and distribution revenue 825 989 616
- --------------------------------------------------------------------------------------------------------
Total revenues 77,795 87,671 77,096
- --------------------------------------------------------------------------------------------------------
Costs and expenses:
- --------------------------------------------------------------------------------------------------------
Human tissue preservation services 55,363 31,165 27,500
Products 10,270 5,464 5,847
General, administrative, and marketing 47,530 33,844 28,731
Research and development 4,597 4,737 5,207
Nonrecurring charges 1,399 -- --
Interest expense 692 96 299
Interest income (895) (1,967) (1,952)
Other expense (income), net 273 852 (169)
- ---------------------------------------------------------------------------------------------------------
Total costs and expenses 119,229 74,191 65,463
- --------------------------------------------------------------------------------------------------------
(Loss) income before income taxes (41,434) 13,480 11,633
Income tax (benefit) expense (13,673) 4,314 3,816
- --------------------------------------------------------------------------------------------------------
Net (loss) income $ (27,761) $ 9,166 $ 7,817
- --------------------------------------------------------------------------------------------------------
(Loss) earnings per share:
- --------------------------------------------------------------------------------------------------------
Basic $ (1.43) $ 0.49 $ 0.42
- --------------------------------------------------------------------------------------------------------
Diluted $ (1.43) $ 0.47 $ 0.41
- --------------------------------------------------------------------------------------------------------
Weighted average shares outstanding:
- --------------------------------------------------------------------------------------------------------
Basic 19,432 18,808 18,541
- --------------------------------------------------------------------------------------------------------
Diluted 19,432 19,660 19,229
- --------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-5
CryoLife, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------------------------------
Net cash flows from operating activities:
- --------------------------------------------------------------------------------------------------------
Net (loss) income $ (27,761) $ 9,166 $ 7,817
Adjustments to reconcile net (loss) income to net cash
flows (used by) provided by operating activities:
Loss (gain) on sale of marketable equity securities 240 (9) --
Depreciation of property and equipment 5,222 4,203 3,023
Amortization 201 404 199
Provision for doubtful accounts 50 304 21
Write-down of deferred preservation costs and inventories 35,816 -- --
Other non-cash adjustments to income 1,419 348 --
Deferred income taxes (5,568) 624 1,658
Tax effect of non-qualified option exercises 481 421 595
Changes in operating assets and liabilities:
Trade and other receivables 7,076 (2,707) 469
Income taxes (9,755) (983) (543)
Deferred preservation costs (12,848) (3,888) (2,659)
Inventories (1,427) (2,265) (1,433)
Prepaid expenses and other assets (59) (1,121) 234
Accounts payable 3,313 (1,814) 535
Accrued expenses and other liabilities 1,489 3,796 367
- --------------------------------------------------------------------------------------------------------
Net cash flows (used by) provided by operating activities (2,111) 6,479 10,283
- --------------------------------------------------------------------------------------------------------
Net cash flows from investing activities:
- --------------------------------------------------------------------------------------------------------
Capital expenditures (4,100) (14,329) (9,491)
Other assets (2,598) (689) 39
Purchases of marketable securities (9,970) (29,336) (5,729)
Sales and maturities of marketable securities 21,780 24,235 8,542
Proceeds from notes receivable 1,169 2,020 360
- --------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) investing activities 6,281 (18,099) (6,279)
- ---------------------------------------------------------------------------------------------------------
Net cash flows from financing activities:
- --------------------------------------------------------------------------------------------------------
Principal payments of debt (1,600) (1,050) (287)
Proceeds from debt issuance -- 1,165 6,835
Principal payments on obligations under capital leases (609) (291) (180)
Proceeds from exercise of options and issuance of stock 1,472 1,502 1,660
Purchase of treasury stock (663) -- (612)
- --------------------------------------------------------------------------------------------------------
Net cash flows (used in) provided by financing activities (1,400) 1,326 7,416
- --------------------------------------------------------------------------------------------------------
Increase (decrease) in cash 2,770 (10,294) 11,420
Effect of exchange rate changes on cash 303 18 (68)
Cash and cash equivalents, beginning of year 7,204 17,480 6,128
- --------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 10,277 $ 7,204 $ 17,480
- --------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information - cash paid during the year for:
- --------------------------------------------------------------------------------------------------------
Interest $ 636 $ 896 $ 471
Income taxes 2,874 4,996 2,215
- --------------------------------------------------------------------------------------------------------
Non-cash investing and financing activities:
- --------------------------------------------------------------------------------------------------------
Conversion of convertible debenture $ 4,393 $ -- $ --
Establishment of capital lease obligation $ -- $ 2,506 $ --
Purchase of property and equipment
in accounts payable and accrued expenses $ 6 $ 203 $ 844
- --------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-6
CryoLife, Inc.
Consolidated Statements of Shareholders' Equity
(in thousands)
Accumulated
Common Shares Additional Other Total
Outstanding Paid-In Retained Deferred Comprehensive Treasury Stock Shareholders'
Shares Amount Capital Earnings Compensation Income (Loss) Shares Amount Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 20,041 $200 $64,359 $23,564 $(57) $(785) (1,701) $(7,055) $80,226
- -----------------------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 7,817 -- -- -- -- 7,817
Other comprehensive loss,
net of taxes -- -- -- -- -- (303) -- -- (303)
--------------
Comprehensive income 7,514
Exercise of options 36 1 338 -- -- -- 356 1,389 1,728
Employee stock purchase plan -- -- 239 -- -- -- 67 288 527
Amortization of deferred
compensation -- -- -- -- 12 -- -- -- 12
Purchase of treasury stock -- -- -- -- -- -- (78) (612) (612)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 20,077 201 64,936 31,381 (45) (1,088) (1,356) (5,990) 89,395
- -----------------------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 9,166 -- -- -- -- 9,166
Other comprehensive income,
net of taxes -- -- -- -- -- 943 -- -- 943
--------------
Comprehensive income 10,109
Exercise of options 87 1 1,268 -- -- -- 46 (78) 1,191
Employee stock purchase plan 8 -- 624 -- -- -- 24 108 732
Amortization of deferred
compensation -- -- -- -- 12 -- -- -- 12
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 20,172 202 66,828 40,547 (33) (145) (1,286) (5,960) 101,439
===================================================================================================================================
Net loss -- -- -- (27,761) -- -- -- -- (27,761)
Other comprehensive income,
net of taxes -- -- -- -- -- 427 -- -- 427
--------------
Comprehensive loss (27,334)
Exercise of options 119 1 1,578 -- -- -- (23) (541) 1,038
Employee stock purchase plan 98 1 836 -- -- -- 16 78 915
Conversion of convertible
debenture 546 5 4,388 -- -- -- -- -- 4,393
Amortization of deferred
compensation -- -- -- -- 12 -- -- -- 12
Purchase of treasury stock -- -- -- -- -- -- (68) (663) (663)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 20,935 $209 $73,630 $12,786 $(21) $282 (1,361) $(7,086) $79,800
===================================================================================================================================
See accompanying notes to consolidated financial statements.
F-7
CRYOLIFE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Founded in 1984, CryoLife, Inc. (the "Company") is a leader in the development
and commercialization of implantable living human tissues for use in
cardiovascular and vascular surgeries throughout the U.S. and Canada.
Historically, the Company has been a leader in the development and
commercialization of implantable living human tissues for use in orthopaedic
surgeries throughout the U.S. and Canada. The Company suspended processing of
orthopaedic tissue from August 2002 until late February 2003 as a result of a
recall order from the FDA. (See Note 2 for further discussion). The Company's
human tissue cryopreservation services are marketed in North America, Europe,
South America, and Asia. The Company's BioGlue(R) Surgical Adhesive is FDA
approved in the U.S. as an adjunct to sutures and staples for use in adult
patients in open surgical repair of large vessels, is CE marked in the European
Community and is approved in Canada, Australia and certain countries within the
Middle East, South America, Asia, and South Africa for use in cardiovascular,
vascular, pulmonary, and soft tissue repair. The Company's bioprosthetic
implantable devices include stentless porcine heart valves marketed in Europe,
South America, the Middle East, Canada, and South Africa, and SynerGraft(R)
processed bovine vascular grafts, which are CE marked in the European Community.
Until October 9, 2000 the Company served as an original equipment manufacturer
for single-use medical devices for use in vascular surgical procedures.
In February 2001 the Company formed a wholly owned subsidiary, AuraZyme
Pharmaceuticals, Inc., to foster the commercial development of the Company's
light-activated drug delivery systems that have potential application in cancer
treatment and fibrinolysis (blood clot dissolving) and other drug delivery
applications.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany balances are
eliminated.
USE OF ESTIMATES
The preparation of the accompanying consolidated financial statements in
conformity with accounting principles generally accepted in the U.S. requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
Estimates and assumptions are used when accounting for depreciation, allowance
for doubtful accounts, write-downs of deferred preservation costs, valuation of
long-lived tangible and intangible assets, commitments and contingencies,
disclosure of the fair value of stock based compensation, and the related
pro-forma expense and income taxes.
REVENUE RECOGNITION
The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"), which
provides guidance on applying generally accepted accounting principles to
revenue recognition issues. Revenues for human tissue preservation services are
recognized when services are completed and tissue is delivered to the customer.
The Company has recorded the estimated amount of credits issued and to be issued
for tissues recalled pursuant to the FDA Order as a service revenue return.
Revenues for products are recognized at the time the product is shipped, at
which time title passes to the customer. There are no further performance
obligations and delivery occurs upon shipment. Revenues from research grants are
recognized in the period the associated costs are incurred. The Company assesses
the likelihood of collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the customer.
SHIPPING AND HANDLING CHARGES
Fees charged to customers for shipping and handling of preserved tissues and
products are included in human tissue preservation service revenues and product
F-8
revenues, respectively. The costs for shipping and handling of preserved human
tissues and products are included as a component of cost of human tissue
preservation services and cost of products, respectively.
CASH AND CASH EQUIVALENTS
Cash equivalents consist primarily of highly liquid investments with
insignificant interest rate risk and maturity dates of 90 days or less at the
time of acquisition. The carrying value of cash equivalents approximates fair
value.
MARKETABLE SECURITIES
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 debt securities at the
time of purchase and reevaluates such designations as of each balance sheet
date. Debt securities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost. Debt securities not
classified as held-to-maturity or trading and marketable equity securities not
classified as trading are classified as available-for-sale. At December 31, 2002
and 2001 all marketable equity securities and debt securities were designated as
available-for-sale.
Available-for-sale securities are stated at their fair values, with the
unrealized gains and losses, net of tax, reported in a separate component of
shareholders' equity. Interest income, dividends, realized gains and losses, and
declines in value judged to be other than temporary are included in investment
income. The cost of securities sold is based on the specific identification
method.
DEFERRED PRESERVATION COSTS
Tissue is procured from deceased human donors by organ and tissue procurement
agencies, which consign the tissue to the Company for processing and
preservation. Preservation costs related to tissue held by the Company are
deferred until revenue is recognized upon shipment of the tissue to the
implanting hospital. Deferred preservation costs consist primarily of laboratory
expenses, tissue procurement fees, fringe and facility allocations, and
freight-in charges, and are stated, net of reserve, on a first-in, first-out
basis.
As of December 31, 2002 the deferred preservation costs were $2.0 million for
allograft heart valve tissues, $620,000 for non-valved cardiac tissues, $1.7
million for vascular tissues, and zero for orthopaedic tissues. For the year
ended December 31, 2002, the Company recorded a write-down of deferred
preservation costs of $8.7 million for valved cardiac tissues, $2.9 million for
non-valved cardiac tissues, $11.9 million for vascular tissues, and $9.2 million
for orthopaedic tissue totaling $32.7 million. These write-downs were recorded
as a result of the matters discussed in Note 2, FDA Order on Human Tissue
Preservation. The amount of these write-downs reflects management's estimate
based on information currently available to it. These estimates may prove
inaccurate, as the scope and impact of the FDA Order are determined. Management
will continue to evaluate the recoverability of these deferred preservation
costs based on the factors discussed in Note 2 and record additional write-downs
if it becomes clear that additional impairments have occurred. The write-down
creates a new cost basis which cannot be written back up if these tissues become
saleable. The cost of human tissue preservation services may be favorably
impacted depending on the future level of tissue shipments related to previously
written-down deferred preservation costs. The shipment levels of these
written-down tissues will be affected by the amount and timing of the release of
tissues processed after September 5, 2002, as a result of the Agreement with the
FDA, since written-down tissues may be shipped if tissues processed after the
Agreement are not available for shipment.
INVENTORIES
Inventories are comprised of implantable surgical adhesives and bioprosthetic
products and are valued at the lower of cost (first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided over the
estimated useful lives of the assets, generally five to ten years, on a
straight-line basis. Leasehold improvements are amortized on a straight-line
basis over the lease term or the estimated useful lives of the assets, whichever
is shorter. Interest is capitalized in connection with the expansion of the
corporate headquarters and manufacturing facility.
F-9
INTANGIBLE ASSETS
Beginning with the Company's adoption of Statement of Financial Accounting
Standards ("SFAS") No. 142,"Goodwill and Other Intangible Assets" ("SFAS 142")
on January 1, 2002 the goodwill resulting from business acquisitions is not
amortized, but is instead subject to periodic impairment testing in accordance
with SFAS 142. Patent costs are amortized over the expected useful lives of the
patents (primarily 17 years) using the straight-line method. Other intangibles,
which consist primarily of manufacturing rights and agreements, are amortized
over the expected useful lives of the related assets (primarily five years). As
a result of the FDA Order, the Company determined that an evaluation of the
possible impairment of intangible assets under SFAS 142 was necessary. The
Company engaged an independent valuation expert to perform the valuation using a
discounted cash flow methodology, and as a result of this analysis, the Company
determined that goodwill related to its tissue processing reporting unit was
fully impaired as of September 30, 2002. Therefore, the Company recorded a
write-down of $1.4 million in goodwill during the quarter ended September 30,
2002. Management does not believe an impairment exists related to the other
intangible assets that were assessed in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). B
Scheduled amortization of intangible assets for the next five years is as
follows (in thousands):
2003 $ 180
2004 150
2005 150
2006 136
2007 109
-------------
$ 725
=============
LONG-LIVED ASSETS
SFAS 144 requires the write-down of a long-lived asset to be held and used if
the carrying value of the asset or the asset group to which the asset belongs is
not recoverable. The carrying value of the asset or asset group is not
recoverable if it exceeds the sum of the undiscounted future cash flows expected
to result from the use and eventual disposition of the asset or asset group. As
of September 30, 2002, in applying SFAS 144, the Company determined that the
asset groups consisted of the long-lived assets related to the Company's two
reporting segments, as these asset groups represent the lowest level at which
identifiable cash flows are largely independent of the cash flows of other
assets and liabilities. The Company used a fourteen-year period for the
undiscounted future cash flows. This period of time was selected based upon the
remaining life of the primary assets of the asset groups, which are leasehold
improvements. The undiscounted future cash flows related to these asset groups
exceeded their carrying values as of September 30, 2002 and December 31, 2002
and therefore management has concluded that there is not an impairment of the
Company's long-lived intangible, except for goodwill discussed above, and
tangible assets related to the tissue preservation business or medical device
business. However, depending on the Company's ability to rebuild demand for its
tissue preservation services, the outcome of discussions with the FDA regarding
the shipping of orthopaedic tissues, and the future effects of adverse publicity
surrounding the FDA Order and reported infections on preservation revenues,
these assets may become impaired. Management will continue to evaluate the
recoverability of these assets in accordance with SFAS 144.
ACCRUED PROCUREMENT FEES
Tissue is procured from deceased human donors by organ procurement agencies and
tissue banks ("Agencies"), which consign the tissue to the Company for
processing and preservation. The Company reimburses the Agencies for their costs
to recover the tissue and passes on these costs to the customer when the tissue
is shipped and the service is complete. The Company accrues the procurement fees
due to the Agencies at the time the tissue is received based on contractual
agreements between the Company and the Agencies.
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. The Company maintains
claims-made insurance policies to mitigate its financial exposure to product
liability claims. Claims-made insurance policies 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 represent a transfer of risk
for claims and incidents that have been incurred but not reported to the
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insurance carrier. 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. As of
December 31, 2002 the Company accrued $3.6 million in estimated costs for
unreported product liability claims related to services performed and products
sold prior to December 31, 2002. The Company engaged an independent actuarial
firm to perform an analysis of the unreported product claims as of December 31,
2002. The unreported product loss liability was estimated using a
frequency-severity approach; whereas, 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 emergence 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 expense was
recorded in general, administrative, and marketing expenses and was included as
a component of accrued expenses and other current liabilities on the
Consolidated Balance Sheet.
INCOME TAXES
Deferred income tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted income tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. A
valuation allowance is established when it is more likely than not that the full
value of a deferred tax asset will not be recovered.
EARNINGS PER SHARE
Earnings per share is computed on the basis of the weighted average number of
common shares outstanding plus the effect of outstanding stock options, computed
using the treasury stock method.
STOCK-BASED COMPENSATION
On December 31, 2002 the Company was required to adopt SFAS No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148
amends SFAS No. 123, "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for companies that voluntarily elect to adopt
the fair value recognition and measurement methodology prescribed by SFAS 123.
In addition, regardless of the method a company elects to account for
stock-based compensation arrangements, SFAS 148 requires additional disclosures
in the Summary of Significant Accounting Policies footnote of both interim and
annual financial statements regarding the method the company uses to account for
stock-based compensation and the effect of such method on the Company's reported
results. The Company has determined that the adoption of SFAS 148 will not have
a material effect on the financial position, results of operations, and cash
flows of the Company.
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 123 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 income and earnings per share is required by
SFAS 123, which requires that the information be determined as if the Company
has accounted for its employee stock options granted under the fair value method
of that statement. 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:
2002 2001 2000
------------- -------------- -------------
Expected dividend yield 0% 0% 0%
Expected stock price volatility .630 .600 .540
Risk-free interest rate 3.67% 4.73% 6.39%
Expected life of options 5.3 Years 4.2 Years 4.3 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
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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):
2002 2001 2000
------------- -------------- -------------
Net (loss) income--as reported $ (27,761) $ 9,166 $ 7,817
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all awards,
net of tax 1,287 2,232 1,183
------------- -------------- -------------
Net (loss) income--pro forma $ (29,048) $ 6,934 $ 6,634
============= ============== =============
(Loss) earnings per share--as reported:
Basic $ (1.43) $ 0.49 $ 0.42
Diluted $ (1.43) $ 0.47 $ 0.41
(Loss) earnings per share--pro forma:
Basic $ (1.49) $ 0.37 $ 0.36
Diluted $ (1.49) $ 0.35 $ 0.35
STOCK SPLIT
On November 27, 2000 the Board of Directors declared a three-for-two stock
split, effected in the form of a stock dividend, payable on December 27, 2000,
to shareholders of record on December 8, 2000. All share and per share
information in the accompanying consolidated financial statements has been
adjusted to reflect this split.
COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income" ("SFAS 130"), established
standards for the reporting and display of comprehensive income and its
components in a full set of comparative general-purpose financial statements.
The statement became effective for the Company in 1998. Comprehensive income is
defined in SFAS 130 as net income plus other comprehensive income, which, under
existing accounting standards, includes foreign currency items, minimum pension
liability adjustments and unrealized gains and losses on certain investments in
debt and equity securities.
TRANSLATION OF FOREIGN CURRENCIES
Assets and liabilities are translated at the exchange rate as of the balance
sheet date. All revenue and expense accounts are translated at a
weighted-average of exchange rates in effect during the year. Translation
adjustments are recorded as a separate component of other comprehensive income
in shareholders' equity.
NEW ACCOUNTING PRONOUNCEMENTS
The Company will be required to adopt SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143") on January 1, 2003. SFAS 143 addresses
accounting and reporting for retirement costs of long-lived assets resulting
from legal obligations associated with acquisition, construction, or development
transactions. The Company has determined that the adoption of SFAS 143 will not
have a material effect on the results of operations or financial position of the
Company, as the Company does not currently have any relevant transactions.
The Company will be required to adopt SFAS No. 145, "Rescission of FASB
Statements 4, 44 and 64, Amendment to FASB Statement 13, and Technical
Corrections" ("SFAS 145"), on January 1, 2003. SFAS 145 rescinds SFAS No. 4, 44
and 64, which required gains and losses from extinguishments of debt to be
classified as extraordinary items. SFAS 145 also amends SFAS No. 13 eliminating
inconsistencies in certain sale-leaseback transactions. The provisions of SFAS
145 are effective for fiscal years beginning after May 15, 2002. The Company has
determined that the adoption of SFAS 145 will not have a material effect on the
results of operations or financial position of the Company, as the Company does
not currently have any relevant transactions.
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The Company will be required to adopt SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146") on January 1, 2003.
SFAS 146 requires that costs associated with exit or disposal activities be
recorded at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
Company will adopt SFAS 146 for restructuring plans entered into after December
31, 2002.
2. FDA ORDER ON HUMAN TISSUE PRESERVATION
On August 13, 2002 the Company received an order from the Atlanta district
office of the FDA regarding the non-valved cardiac, vascular, and orthopaedic
tissue processed by the Company since October 3, 2001 (the "FDA Order"). The FDA
Order followed an April 2002 FDA Form 483 Notice of Observations ("FDA 483") and
an FDA Warning Letter dated June 17, 2002 (the "Warning Letter"). Subsequently,
the Company responded to the Warning Letter. Revenue from human tissue
preservation services accounted for 78% of the Company's revenues for the six
months ended June 30, 2002, and of those revenues 67% or $26.9 million was
derived from preservation of tissues subject to the FDA Order. The FDA Order
contains the following principal provisions:
o The FDA alleges that, based on its inspection of the Company's
facility on March 25 through April 12, 2002, certain human tissue
processed and distributed by the Company may be in violation of 21
Code of Federal Regulations ("CFR") Part 1270. (Part 1270 requires
persons or entities engaged in the recovery, screening, testing,
processing, storage, or distribution of human tissue to perform
certain medical screening and testing on human tissue intended for
transplantation. The rule also imposes requirements regarding
procedures for the prevention of contamination or cross-contamination
of tissues during processing and the maintenance of certain records
related to these activities.)
o The FDA alleges that the Company has not validated procedures for the
prevention of infectious disease contamination or cross-contamination
of tissue during processing at least since October 3, 2001.
o Non-valved cardiac, vascular, and orthopaedic tissue processed by the
Company from October 3, 2001 to September 5, 2002 must be retained
until it is recalled, destroyed, the safety is confirmed, or an
agreement is reached with the FDA for its proper disposition under the
supervision of an authorized official of the FDA.
o The FDA strongly recommends that the Company perform a retrospective
review of all tissue in inventory (i.e. currently in storage at the
Company) that is not referenced in the FDA Order to assure that it was
recovered, processed, stored, and distributed in conformance with 21
CFR 1270.
o The Center for Devices and Radiological Health ("CDRH"), a division of
the FDA, is evaluating whether there are similar risks that may be
posed by the Company's allograft heart valves, and will take further
regulatory action if appropriate.
Pursuant to the FDA Order, the Company placed non-valved cardiac, vascular, and
orthopaedic tissue subject to the FDA Order on quality assurance quarantine and
recalled the non-valved cardiac, vascular, and orthopaedic tissues subject to
the FDA Order (i.e. processed since October 3, 2001) that had been distributed
but not implanted. In addition, the Company ceased processing non-valved
cardiac, vascular, and orthopaedic tissues. The Company appealed the FDA Order
on August 14, 2002 and requested a hearing with the FDA, which was originally
set for December 12, 2002. Due to the Agreement discussed below, the Company
withdrew its request for a hearing with the FDA. After the FDA issued its order
regarding the recall, Health Canada also issued a recall on the same types of
tissue and other countries have inquired about the circumstances surrounding the
FDA Order.
After receiving the FDA Order, the Company met with representatives of the FDA's
CDRH division regarding CDRH's review of the Company's processed allograft heart
valves, which are not subject to the FDA Order. On August 21, 2002 the FDA
publicly stated that allograft heart valves have not been included in the FDA
Order as these devices are essential for the correction of congenital cardiac
lesions in neonate and pediatric patients and no satisfactory alternative device
exists. However, the FDA also publicly stated that it then still had serious
concerns regarding the Company's processing and handling of allograft heart
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valves. The FDA also recommended that surgeons carefully consider using
processed allografts from alternative sources, that surgeons inform prospective
patients of the FDA's concerns regarding the Company's allograft heart valves,
and that patients be carefully monitored for both fungal and bacterial
infections.
On September 5, 2002 the Company reached an agreement with the FDA (the
"Agreement") that supplements the FDA Order and allows the tissues subject to
recall (processed between October 3, 2001 and September 5, 2002) to be released
for distribution after the Company completes steps to assure that the tissue is
used for approved purposes and that patients are notified of risks associated
with tissue use. Specifically, the Company must obtain physician prescriptions,
and tissue packaging must contain specified warning labels. The Agreement calls
for the Company to undertake to identify third-party records of donor tissue
testing, and to destroy tissue from donors in whom microorganisms associated
with an infection are found. The Agreement allowing distribution of tissues
subject to the recall had a 45-business day term and was renewed on November 8,
2002 and on January 8, 2003. This most recent renewal expires on March 20, 2003.
The Company is unable to predict whether or not the FDA will grant further
renewals of the Agreement. In addition, pursuant to the Agreement, the Company
agreed to perform additional procedures in the processing of non-valved cardiac
and vascular tissues and subsequently resumed processing these tissues. The
Agreement contained the requirement that tissues subject to the FDA Order be
replaced with tissues processed under validated methods. The Company also agreed
to establish a corrective action plan within 30 days from September 5, 2002 with
steps to validate processing procedures. The corrective action plan was
submitted on October 5, 2002.
As a result of the adverse publicity surrounding the FDA Warning Letter and FDA
Order and related tissue infections, the Company's procurement of cardiac
tissues, from which heart valves and non-valved cardiac tissues are processed,
decreased 25% in the fourth quarter of 2002 as compared to the fourth quarter of
2001. Although the Company expects to be able to maintain the current level of
cardiac tissue procurement, there is no guarantee that sufficient tissue will be
available. The Company has continued to process and distribute heart valves
since the receipt of the FDA Order, as these tissues are not subject to the FDA
Order.
On September 17, 2002 the Company resumed the procurement and processing of
vascular tissues. The Company limited its vascular procurement until it
addressed the observations detailed in the FDA 483 and had fully evaluated the
demand for the vascular tissues. The Company's procurement of vascular tissue
decreased 65% in the fourth quarter of 2002 as compared to the fourth quarter of
2001. The Company expects that vascular procurement will increase significantly
following the close out of the FDA 483.
On December 31, 2002 the FDA clarified the Agreement noting that non-valved
cardiac and vascular tissues processed since September 5, 2002 are not subject
to the FDA Order. Specifically, for non-valved cardiac and vascular tissue
processed since September 5, 2002, the Company is not required to obtain
physician prescriptions, label the tissue as subject to a recall, or require
special steps regarding procurement agency records of donor screening and
testing beyond those required for all processors of human tissue. A renewal of
the Agreement that expires on March 20, 2003 is therefore not needed in order
for the Company to continue to distribute non-valved cardiovascular and vascular
tissues processed since September 5, 2002.
On February 14, 2003 the FDA confirmed that the Company has completed the
corrective actions necessary to close out the April 2002 FDA 483 that preceded
the Warning Letter and FDA Order. The close out of the 483 followed a two-week
inspection of the Company's processing operations. As a result of the close out
of the 483, the Company believes it can resume processing and distributing
orthopaedic tissues but has not received confirmation of this from the FDA. The
Company resumed processing orthopaedic tissues in late February 2003. Prior to
shipment of orthopaedic tissues, the Company will confirm with the FDA that they
do not disagree with the Company regarding its interpretation of the close out
of the FDA 483. The Company will continue to process vascular tissues on a
limited basis until it can fully evaluate the demand level for its vascular
tissue preservation services.
A new FDA 483 was issued in connection with the inspection, but corrective
action was implemented on most of its observations during the inspection. The
Company believes the observations, most of which focus on the Company's systems
for handling complaints, will not materially affect the Company's operations.
As a result of the FDA Order, the Company recorded a reduction to pretax income
of $12.6 million in the quarter ended June 30, 2002. The reduction was comprised
of a net $8.9 million increase to cost of human tissue preservation services, a
$2.4 million reduction to revenues (and accounts receivable) for the estimated
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return of the tissues subject to recall by the FDA Order, and a $1.3 million
accrual recorded in general, administrative, and marketing expenses for
retention levels under the Company's product liability and directors' and
officers' insurance policies of $1.2 million (see Note 9), and for estimated
expenses of $75,000 for packaging and handling for the return of affected
tissues under the FDA Order. The net increase of $8.9 million to cost of
preservation services was comprised of a $10.0 million write-down of deferred
preservation costs for tissues subject to the FDA Order, offset by a $1.1
million decrease in cost of preservation services due to the estimated tissue
returns resulting from the FDA Order (the costs of such recalled tissue are
included in the $10.0 million write-down). The Company evaluated many factors in
determining the magnitude of impairment to deferred preservation costs as of
June 30, 2002, including the impact of the FDA Order, the possibility of
continuing action by the FDA or other U.S. and foreign government agencies, and
the possibility of unfavorable actions by physicians, customers, procurement
organizations, and others. As a result of this evaluation, management believed
that since all non-valved cardiac, vascular, and orthopaedic allograft tissues
processed since October 3, 2001 were under recall pursuant to the FDA Order, and
since the Company did not know if it would obtain a favorable resolution of its
appeal and request for modification of the FDA Order, the deferred preservation
costs for tissues subject to the FDA Order had been significantly impaired. The
Company estimated that this impairment approximated the full balance of the
deferred preservation costs of the tissues subject to the FDA Order, which
included the tissues stored by the Company and the tissues to be returned to the
Company, and therefore recorded a write-down of $10.0 million for these assets.
In the quarter ended September 30, 2002 the Company recorded a reduction to
pretax income of $24.6 million as a result of the FDA Order. The reduction was
comprised of a net $22.2 million increase to cost of human tissue preservation
services, a $1.4 million write-down of goodwill, and a $1.0 million reduction to
revenues (and accounts receivable) for the estimated return of the tissues
shipped during the third quarter subject to recall by the FDA Order. The net
$22.2 million increase to cost of preservation services was comprised of a $22.7
million write-down of deferred preservation costs, offset by a $0.5 million
decrease in cost of preservation services due to the estimated and actual tissue
returns resulting from the FDA Order (the costs of such recalled tissue are
included in the $22.7 million write-down).
The Company evaluated multiple factors in determining the magnitude of
impairment to deferred preservation costs at September 30, 2002, including the
impact of the FDA Order, the possibility of continuing action by the FDA or
other U.S. and foreign government agencies, the possibility of unfavorable
actions by physicians, customers, procurement organizations, and others, the
progress made to date on the corrective action plan, and the requirement in the
Agreement that tissues subject to the FDA Order be replaced with tissues
processed under validated methods. As a result of this evaluation, management
believed that all tissues subject to the FDA Order, as well as the majority of
tissues processed prior to October 3, 2001, including heart valves, which were
not subject to the FDA Order, were fully impaired. Management believed that most
of the Company's customers would only order tissues processed after the
September 5, 2002 Agreement or tissues processed under future procedures
approved by the FDA once those tissues were available. The Company anticipated
that the tissues processed under the Agreement would be available early to
mid-November. Thus, the Company recorded a write-down of deferred preservation
costs for processed tissues in excess of the supply required to meet demand
prior to the release of these interim processed tissues. The Company did not
record any further write-downs of deferred preservation costs in the fourth
quarter of 2002. As of December 31, 2002 the balance of deferred preservation
costs were $2.0 million for allograft heart valve tissues, $620,000 for
non-valved cardiac tissues, $1.7 million for vascular tissues, and zero for
orthopaedic tissues.
As a result of the write-down of deferred preservation costs, the Company
recorded $6.3 million in income tax receivables and $4.5 million in deferred tax
assets. Upon destruction or shipment of the remaining tissues associated with
the deferred preservation costs write-down, the deferred tax asset will become
deductible in the Company's tax return. An expected refund of approximately $8.5
million will be generated through a carry back of operating losses and
write-downs of deferred preservation costs. In addition, the Company recorded
$2.5 million in income tax receivables related to estimated tax payments for
2002. The Company received payment of the $2.5 million in January of 2003.
On September 3, 2002 the Company announced a reduction in employee force of
approximately 105 employees. In the third quarter of 2002 the Company recorded
accrued restructuring costs of approximately $690,000, for severance and related
costs of the employee force reduction. The expense was recorded in general,
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administrative, and marketing expenses and was included as a component of
accrued expenses and other current liabilities on the Consolidated Balance
Sheet. During the year ended December 31, 2002 the Company utilized $580,000 of
the accrued restructuring costs, including $505,000 for salary and severance
payments, $64,000 for placement services for affected employees, and $11,000 in
other related costs. As of December 31, 2002, the remaining balance of accrued
restructuring costs was $110,000.
The Company expects its liquidity to decrease significantly over the next year
due to the anticipated significant decrease in revenues throughout at least the
first half of 2003 as compared to the prior year period, as a result of the
reported tissue infections, the FDA Order and associated adverse publicity, and
an expected decrease in cash due to the anticipated increased legal and
professional costs relating to the defense of lawsuits (discussed in Note 9) and
ongoing FDA compliance. The Company believes that anticipated revenue
generation, expense management including the cessation of the development of the
bioprosthetic valves, savings resulting from the reduction in the number of
employees to reflect the reduction in revenues, tax refunds expected to be at
least $11 million ($2.5 million of estimated tax payments remitted for the 2002
tax year which were received in January of 2003, and approximately $8.5 million
of loss carrybacks generated from operating losses and write-downs of deferred
preservation costs), and the Company's existing cash and marketable securities
will enable the Company to meet its liquidity needs through at least December
31, 2003, even if the term loan is called in its entirety. There is no assurance
that the Company will be able to return to the level of demand for its tissue
services that existed prior to the FDA Order due to the adverse publicity or as
a result of customers and to tissue banks switching to competitors. Failure of
the Company to maintain sufficient demand for its services, would have a
material adverse effect on the Company's business, financial condition, results
of operations, and cash flows.
3. CASH EQUIVALENTS AND MARKETABLE SECURITIES
The following is a summary of cash equivalents and marketable securities, all of
which are classified as available-for-sale (in thousands):
Unrealized Estimated
Adjustments Adjusted Holding Market
December 31, 2002 Cost Basis to Cost Basis Cost Basis Gains/(Losses) Value
------------- ------------- -------------- ------------- --------------
Cash equivalents:
Money market funds $ 52 $ -- $ 52 $ -- $ 52
Municipal obligations 7,175 -- 7,175 -- 7,175
------------- ------------- -------------- ------------- --------------
$ 7,227 $ -- $ 7,227 $ -- $ 7,227
============= ============= ============== ============= ==============
Marketable securities:
Municipal obligations $ 14,276 $ -- $ 14,276 $ 307 $ 14,583
============= ============= ============== ============= ==============
Unrealized Estimated
Adjustments Adjusted Holding Market
December 31, 2001 Cost Basis to Cost Basis Cost Basis Gains/(Losses) Value
------------- ------------- -------------- ------------- --------------
Cash equivalents:
Money market funds $ 1,301 $ -- $ 1,301 $ -- $ 1,301
Municipal obligations 500 -- 500 -- 500
------------- ------------- -------------- ------------- --------------
$ 1,801 -- $ 1,801 -- $ 1,801
============= ============= ============== ============= ==============
Marketable securities:
Municipal obligations 17,696 -- 17,696 147 17,843
Debt securities 6,227 (1,217) 5,010 -- 5,010
Equity securities 3,900 (343) 3,557 10 3,567
Certificates of deposit 63 -- 63 -- 63
------------- ------------- -------------- ------------- --------------
$ 27,886 (1,560) $ 26,326 $ 157 $ 26,483
============= ============= ============== ============= ==============
The Adjustments to Cost Basis column includes a $1.6 million loss recorded in
2001 for an other than temporary decline in the market value of debt and equity
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securities. Gross realized losses on sales of available-for-sale securities
totaled $240,000 in 2002 and gross realized gains on sales of available-for-sale
securities totaled $9,000 in 2001. Differences between cost and market listed
above, consisting of a net unrealized holding gain less deferred taxes of
$104,000 and $50,000, at December 31, 2002 and 2001, respectively, are included
as a separate component of other comprehensive income in shareholders' equity.
At December 31, 2002 and 2001 approximately $1.2 million and zero, respectively,
of marketable securities had a maturity date of less than 90 days, approximately
$8.0 million and $3.4 million, respectively, had a maturity date between 90 days
and 1 year, and approximately $5.4 million and $14.5 million, respectively, had
a maturity date between 1 and 5 years, and approximately zero and $8.6 million,
respectively, matured in more than 5 years or did not have a maturity date.
4. IDEAS FOR MEDICINE, INC.
On March 5, 1997 the Company acquired the stock of Ideas for Medicine, Inc.
("IFM"), a medical device company specializing in the manufacture and
distribution of single-use medical devices, for consideration of approximately
$4.5 million in cash and approximately $5.0 million in convertible debentures
plus related expenses. The acquisition was recorded under the purchase method of
accounting. The cash portion of the purchase price was financed by borrowings
under the Company's revolving term loan agreement. Pursuant to the purchase
agreement, an additional consideration of $700,000 was paid in January 2000. In
connection with this acquisition, the Company also entered into a consulting
agreement with the former majority shareholder of IFM requiring monthly payments
to such shareholder of approximately $17,000 until March 2002.
On September 30, 1998 the Company completed the sale of substantially all of the
IFM product line and certain related assets, consisting of inventory, equipment,
and intellectual property, to Horizon Medical Products, Inc. ("HMP") for $15
million in cash pursuant to an asset purchase agreement. Concurrently, IFM and
HMP signed a Manufacturing Agreement (the "Agreement") that provided for the
manufacture by IFM of specified minimum dollar amounts of IFM products to be
purchased exclusively by HMP over each of the four years following the sale.
Thereafter, responsibility for such manufacturing was to be assumed by HMP.
The Company recorded deferred income at the transaction date totaling $2.9
million, representing the selling price less the net book value of the assets
sold, which included $7.7 million of goodwill, net of accumulated amortization,
and the costs related to the sale. The income was deferred because the sale and
manufacturing agreements represented, in the aggregate, a single transaction for
which the related income should be recognized over the term of the manufacturing
agreement. Accordingly, the deferred income was reflected in cost of goods sold
during 1999 to maintain margins that would have been approximately equal over
the four-year period of the Agreement on the products manufactured and sold by
IFM to HMP. During 1999 amortization of deferred income totaled $1.2 million.
On June 22, 1999 IFM notified HMP that it was in default of certain provisions
of the Agreement. Specifically, HMP was in violation of the payment provisions
contained within the Agreement, which called for inventory purchases to be paid
for within 45 days of delivery. Additionally, HMP was in violation due to
nonpayment of interest related to such past due accounts receivable.
After notification of the default, HMP indicated to the Company that it would
not be able to meet and did not meet the minimum purchase requirements outlined
in the Agreement. At December 31, 1999, the Company determined that it had
incurred an impairment loss on its IFM assets due to the significant
uncertainties related to the Company's ability to realize its investment in IFM.
In calculating the amount of the impairment loss, management used its best
estimate to determine the realizable value of its increase in working capital
due to the HMP default and the recoverability of IFM's long-lived assets,
consisting primarily of leasehold improvements and equipment. As a result,
management recorded a $2.1 million impairment loss on working capital and a $2.6
million impairment loss on leasehold improvements. Additionally, the Company
offset the above charges with $2.5 million of deferred income recorded in
connection with the sale of the IFM product line to HMP. The net pretax effect
of the above nonrecurring charges was $2.2 million and has been included under
the caption "Nonrecurring charges" in the 1999 Consolidated Statement of
Operations.
F-17
On October 9, 2000 the Company sold substantially all of the remaining assets of
IFM to HMP. The assets consisted primarily of inventory, equipment and leasehold
improvements, which had a net book value of $2.4 million at the date of sale.
The terms of the transaction required HMP to pay the Company the sum of
approximately $5.9 million, payable in equal monthly installments of principal
and interest of $140,000. The note consists of a portion, approximately $3.8
million, which bears interest at 9% per year, and a non-interest-bearing portion
of approximately $2.1 million. The note also required an additional $1 million
principal payment at any time prior to April 3, 2001. If the $1 million payment
was made when due, and no other defaults existed under the note, then $1 million
of the non-interest-bearing portion of the note would be forgiven. In addition,
at such time as the principal balance has been paid down to $1.1 million and
there have been no defaults under the promissory note, the remainder of the note
will be forgiven and the note will be canceled. The Company had recorded as
notes receivable only the balances owed on the interest-bearing portion of the
note. Due to uncertainties regarding HMP's ability to pay the full amount of the
note, the Company also recorded reserves against these notes such that the gain
from the sale is deferred until the full amount of the note is deemed
collectible. In addition, the Company entered into a sublease agreement with HMP
under which HMP assumed responsibility for the IFM manufacturing facility. Also,
substantially all of the employees of IFM have become employees of HMP.
On March 30, 2001, HMP sold the IFM assets to a wholly owned subsidiary of
LeMaitre Vascular, Inc. ("LeMaitre"), and the remaining portion of the Company's
note receivable from HMP and the sublease agreement was assumed by the LeMaitre
subsidiary and the payment schedule was restructured. On April 2, 2001 the
Company received a scheduled $1 million principal payment from LeMaitre and, as
a result, $1 million of the non-interest-bearing portion of the note was
forgiven in accordance with the terms of the assumed note. At December 31, 2001
the Company reassessed the collectibility of the note receivable based on the
payment record and general creditworthiness of LeMaitre. As a result, the
Company reduced the reserve on the note receivable to $250,000 from $963,000,
and recorded a non-recurring pretax gain of $713,000 in the fourth quarter of
2001 that is included within Other Income in the Consolidated Statements of
Operations. During 2002, LeMaitre remitted payment for the remaining balance of
the note receivable. During 2002, the Company reduced the reserve on the note
receivable to zero, and recorded a $250,000 non-recurring pretax gain that is
included within Other Income in the Consolidated Statements of Operations.
5. INVENTORIES
Inventories at December 31 are comprised of the following (in thousands):
2002 2001
------------- --------------
Raw materials $ 2,341 $ 1,987
Work in process 306 1,183
Finished goods 1,938 3,089
------------- --------------
$ 4,585 $ 6,259
============= ==============
6. LONG-TERM DEBT
Long-term debt at December 31 consists of the following (in thousands):
2002 2001
------------- --------------
5-year term loan, bearing interest equal to the Adjusted LIBOR
plus 1.5%, to be adjusted monthly $ 5,600 $ 7,200
7% convertible debenture, due in March 2002 -- 4,393
------------- --------------
Total debt 5,600 11,593
Less current maturities 5,600 5,993
------------- --------------
Total long-term debt $ -- $ 5,600
============= ==============
On April 25, 2000 the Company entered into a loan agreement permitting the
Company to borrow up to $8 million under a line of credit during the expansion
of the Company's corporate headquarters and manufacturing facilities. Borrowings
under the line of credit accrued interest equal to Adjusted LIBOR plus 2%
F-18
adjusted monthly. On June 1, 2001, the line of credit was converted to a term
loan (the "Term Loan") to be paid in 60 equal monthly installments of principal
plus interest computed at Adjusted LIBOR plus 1.5% (2.94% at December 31, 2002).
At December 31, 2002 the principal balance of the Term Loan was $5.6 million.
The Term Loan is secured by substantially all of the Company's assets. The Term
Loan contains certain restrictive covenants including, but not limited to,
maintenance of certain financial ratios, a minimum tangible net worth
requirement, and the requirement that no materially adverse event has occurred.
The lender has notified the Company that the FDA Order, as described in Note 2,
and the inquiries of the SEC, as described in Note 9, have had a material
adverse effect on the Company that constitutes an event of default.
Additionally, as of December 31, 2002, the Company is in violation of the debt
coverage ratio and net worth financial covenants. As of February 24, 2003 the
lender has elected not to declare an event of default, but reserves the right to
exercise any such right under the terms of the Term Loan. Therefore, all amounts
due under the Term Loan as of December 31, 2002 are reflected as a current
liability on the Consolidated Balance Sheets.
In March 1997 the Company issued a $5.0 million convertible debenture in
connection with the Ideas for Medicine, Inc. acquisition. The debenture accrued
interest at 7% and was convertible into common stock of the Company at any time
prior to the due date of March 5, 2002 at $8.05 per common share. On March 30,
1998 $607,000 of the convertible debenture was converted into 75,000 shares of
the Company's common stock, and on March 4, 2002 the remaining $4.4 million was
converted into 546,000 shares of the Company's common stock.
On July 30, 2002 the Company entered into a line of credit agreement with the
same lender as for the Term Loan, permitting the Company to borrow up to $10
million. Borrowings under the line of credit agreement accrue interest equal to
Adjusted LIBOR plus 1.25% adjusted monthly. This loan is secured by
substantially all of the Company's assets. On August 21, 2002 the lender
notified the Company that, as a result of the FDA Order, as discussed in Note 2,
it was not entitled to any further advances under the line of credit. On
November 27, 2002 the lender notified the Company that it had cancelled the
unfunded commitment of the line of credit, as the Company was in default of
certain provisions and financial covenants of the line of credit agreement. The
Company had no outstanding borrowings on the line of credit at the time of
cancellation.
Scheduled maturities of long-term debt for the next five years are as follows
(in thousands):
2003 $ 1,600
2004 1,600
2005 1,600
2006 800
2007 --
Thereafter --
-------------
$ 5,600
=============
Total interest costs were $692,000, and $915,000, and $528,000, in 2002, and
2001, and 2000 which included zero, $819,000, and $229,000, respectively, of
interest capitalized in connection with the expansion of the corporate
headquarters and manufacturing facilities.
7. DERIVATIVES
The Company's Term Loan, which accrues interest computed at Adjusted LIBOR plus
1.5%, exposes the Company to changes in interest rates going forward. On March
16, 2000, the Company entered into a $4.0 million notional amount
forward-starting interest swap agreement, which took effect on June 1, 2001 and
expires in 2006. This swap agreement was designated as a cash flow hedge to
effectively convert a portion of the Term Loan balance to a fixed rate basis,
thus reducing the impact of interest rate changes on future income. This
agreement involves the receipt of floating rate amounts in exchange for fixed
rate interest payments over the life of the agreement, without an exchange of
the underlying principal amounts. The differential to be paid or received is
recognized in the period in which it accrues as an adjustment to interest
expense on the Term Loan.
On January 1, 2001 the Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") as amended. SFAS 133 requires
the Company to recognize all derivative instruments on the balance sheet at fair
F-19
value, and changes in the derivative's fair value must be recognized currently
in earnings or other comprehensive income, as applicable. The adoption of SFAS
133 impacts the accounting for the Company's forward-starting interest rate swap
agreement. Upon adoption of SFAS 133, the Company recorded an unrealized loss of
approximately $175,000 related to the interest rate swap, which was recorded as
part of long-term liabilities and accumulated other comprehensive income as the
cumulative effect of adopting SFAS 133 within the Statement of Shareholders'
Equity.
In August 2002 the Company determined that changes in the derivative's fair
value could no longer be recorded in other comprehensive income, as a result of
the uncertainty of future cash payments on the Term Loan caused by the lender's
ability to declare an event of default as discussed in Note 6. Beginning in
August 2002 the Company began recording all changes in the fair value of the
derivative into other expense/income on the Consolidated Statements of
Operations, and is amortizing the amounts previously recorded in other
comprehensive income of $292,000 into other expense/income over the remaining
life of the swap agreement through June 2006. If the lender accelerates the
payments due under the term loan by declaring an event of default, any remaining
balance in other comprehensive income will be reclassed into other
expense/income during that period.
At December 31, 2002 the notional amount of this swap agreement was $2.8
million, and the fair value of the interest rate swap agreement, as estimated by
the bank based on its internal valuation models, was a liability of $280,000.
The fair value of the swap agreement is recorded as part of short-term
liabilities. For the year ended December 31, 2002 the Company recorded a loss of
$20,000 on the interest rate swap. The unamortized value of the swap agreement,
recorded in the accumulated other comprehensive income account of shareholders'
equity, was $260,000 at December 31, 2002.
8. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", requires
the Company to disclose estimated fair values for its financial instruments. The
carrying amounts of receivables and accounts payable approximate their fair
values due to the short-term maturity of these instruments. The carrying value
of the Company's other financial instruments approximated fair value at December
31, 2002 and 2001.
9. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases equipment, furniture, office, and manufacturing space under
various leases with terms of up to 15 years. Commencing January 5, 1998 the
Company leased office and manufacturing facilities under a capital lease for
$24,125 per month with an interest rate at 8% per annum through January 2008
from the former majority shareholder of IFM. This lease is subject to a sublease
agreement as discussed in Note 4. Certain leases contain escalation clauses and
renewal options for additional periods. Rent expense is computed on the
straight-line method over the term of the lease with the offsetting accrual
recorded in other long-term liabilities. Future minimum lease payments under
noncancelable leases as of December 31, 2002 are as follows (in thousands):
Capitalized Operating
Leases Leases
--------------------------------------------------------------------------------------------------
2003 $ 843 $ 2,294
2004 843 2,115
2005 843 2,091
2006 843 1,943
2007 265 1,981
Thereafter -- 16,856
----------------------------------------------------------------------------------------------
Total minimum lease payments 3,637 $ 27,280
=============
Less amount representing interest 497
----------------------------------------------------------------
Present value of net minimum lease payments 3,140
Less current portion 2,169
----------------------------------------------------------------
Capital lease obligation, less current portion $ 971
================================================================
F-20
Property acquired under capital leases through December 31, 2002 consists of the
following (in thousands):
Equipment $ 403
Furniture and fixtures 890
Leasehold improvements 3,199
Accumulated depreciation (907)
---------------
$ 3,585
===============
Total rental expense for operating leases amounted to $2,470,000, $2,243,000,
and $1,478,000, for 2002, 2001, and 2000, respectively. Total rental income
under the sublease was $310,000 in 2002, $310,000 in 2001, and $95,000 in 2000.
Due to cross default provisions included in the Company's debt agreements, as of
December 31, 2002 the Company was in default of certain capital lease agreements
maintained with the lender of the Term Loan. Therefore, all amounts due under
these capital leases are reflected as a current liability on the Consolidated
Balance Sheets as of December 31, 2002.
LITIGATION, CLAIMS, AND ASSESSMENTS
In the normal course of business as a medical device and services company the
Company has product liability complaints filed against it. As of February 24,
2003 21 cases had been filed against the Company between May 18, 2000 and
January 30, 2003. The cases are currently in the pre-discovery or discovery
stages. Of these cases, 14 allege product liability claims arising out of the
Company's orthopaedic tissue services, six allege product liability claims
arising out of the Company's allograft heart valve tissue services, and one
alleges product liability claims arising out of the non-tissue products made by
Ideas for Medicine, when it was a subsidiary of the Company.
Included in these cases is the complaint filed against the Company in the
Superior Court of Cobb County, Georgia, on July 12, 2002 by Steve Lykins, as
Trustee for the benefit of next of kin of Brian Lykins. This complaint alleges
strict liability, negligence, professional negligence, and breach of warranties
related to tissue implanted in November of 2001. The plaintiff seeks unspecified
compensatory and punitive damages.
The Company maintains claims-made insurance policies, which the Company believes
to be adequate to defend against these suits. The Company's insurance company
has been notified of these actions. The Company intends to vigorously defend
against these claims. Nonetheless, an adverse judgment or judgments imposing
aggregate liabilities in excess of the Company's insurance coverage could have a
material adverse effect on the Company's financial position, results of
operations, and cash flows.
Claims-made insurance policies 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 represent a transfer of risk for claims and
incidents that have been incurred but not reported to the insurance carrier. 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. During the year ended
December 31, 2002 the Company accrued $3.6 million in estimated costs for
unreported product liability claims related to services performed and products
sold during 2002 and prior years. The expense was recorded in general,
administrative, and marketing expenses and was included as a component of
accrued expenses and other current liabilities on the Consolidated Balance
Sheets.
Several putative class action lawsuits were filed in July through September 2002
against the Company and certain officers of the Company alleging that the
defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated there under. During the third quarter of 2002
the U.S. District Court for the Northern District of Georgia consolidated the
suits, and on November 14, 2002 lead plaintiffs were named. A consolidated
complaint was filed on January 15, 2003, seeking the Court's certification of
the litigation as a class action on behalf of all purchasers of the Company's
stock between April 2, 2001 and August 14, 2002. The consolidated complaint also
seeks recovery of compensatory damages in an unspecified amount and various fees
F-21
and expenses of litigation, including attorneys' fees. The principal allegations
of the consolidated complaint are that the Company failed to disclose its
alleged lack of compliance with certain FDA regulations regarding the handling
and processing of certain tissues and other product safety matters. Although the
Company considers all of the claims in the consolidated complaint to be without
merit and intends to defend against them vigorously, the Company is unable to
predict at this time the final outcome of these claims. The Company carries
directors' and officers' liability insurance policies, which the Company
currently believes should be adequate to address these claims. Nonetheless, an
adverse judgment in excess of the Company's insurance coverage could have a
material adverse effect on the Company's financial position, results of
operations, and cash flows.
The Company received notice in October 2002 that a complaint had been filed
instituting a shareholder derivative action against the Company and Company
officers and directors Steven G. Anderson, Albert E. Heacox, John W. Cook,
Ronald C. Elkins, Virginia C. Lacy, Ronald D. McCall, Alexander C. Schwartz, and
Bruce J. Van Dyne. The suit was filed in the Superior Court of Gwinnett County,
Georgia, by Rosemary Lichtenberger. The suit alleges the individual defendants
breached their fiduciary duties to the Company by causing or allowing the
Company to engage in practices that caused the Company to suffer damages by
being out of compliance with FDA guidelines, and by causing the Company to issue
press releases that erroneously portrayed CryoLife's products, operations,
financial results, and future prospects. The complainant seeks undisclosed
damages, costs and attorney's fees, punitive damages, and prejudgment interest
against the individual defendants derivatively on behalf of the Company as a
nominal defendant. By an order entered on January 21, 2003, the lawsuit was
stayed until discovery commences in the consolidated complaint of the class
action lawsuit. In January 2003 the Company received notice that another
shareholder derivative lawsuit was filed in the Superior Court of Fulton County,
Georgia by Robert F. Frailey against the Company as a nominal defendant, and
Company officers and directors Steven G. Anderson, Bruce J. Van Dyne, John W.
Cook, Ronald D. McCall, Ronald C. Elkins, Virginia C. Lacy and Alexander C.
Schwartz. The complaint asserts claims for breach of fiduciary duty, abuse of
control, gross mismanagement, and waste of corporate assets. As in the
Lichtenberger action, the Frailey action alleges that the defendant officers and
directors caused the Company to suffer damages by being out of compliance with
FDA guidelines, and by causing the Company to issue press releases that
erroneously portrayed CryoLife's products, operations, financial results, and
future prospects. The complaint also alleges improper insider trading by certain
Company officers and directors. The complainant seeks declaratory relief,
damages of unspecified amount, litigation expenses including attorneys' and
experts' fees, and unspecified equitable or injunctive relief against the
individual defendants derivatively on behalf of the Company as a nominal
defendant. The Frailey complaint has not yet been served on any of the named
defendants.
The Company's Board of Directors has established a committee that is independent
of management to investigate the Claims asserted in the Lichtenberger and
Frailey complaints and report back to the Board with its recommendations for
action in response to the shareholders' demands. The independent committee has
engaged independent legal counsel to assist in the investigation. The committee
is in the process of its investigation.
On August 7, 2002 the Company announced the settlement of its ongoing litigation
with Colorado State University Research Foundation ("CSURF") over the ownership
of the Company's SynerGraft technology. The settlement resolves all disputes
between the parties and extinguishes all CSURF ownership claims to any aspect of
the Company's SynerGraft technology. The settlement includes an unconditional
assignment to the Company of CSURF tissue engineering patents, trade secrets and
know-how relating to tissue decellularization and recellularization. The
technology assignment supercedes the 1996 technology license, which was
terminated by the terms of the settlement. Payment terms include a nonrefundable
advance of $400,000 paid by the Company to CSURF that will be applied to earned
royalties as they accrue through March 2011. The Company recorded these amounts
as prepaid royalties and will expense the amounts as the royalties accrue. The
earned royalty rate is a maximum of 0.75% of net revenues from products or
tissue services utilizing the SynerGraft technology. Royalties earned under the
agreement for revenues through December 31, 2002 were approximately $37,000.
On August 17, 2002 the Company received a letter from the U.S. Securities and
Exchange Commission (the "SEC Letter") that stated that the Company was subject
to an investigation related to the Company's August 14, 2002 announcement of the
FDA Order and requesting information from the Company from the period between
September 1, 2001 through the date of the Company's response to the SEC Letter.
The SEC Letter stated, in part, that "We are trying to determine whether there
have been any violations of the federal securities laws. The investigation and
the subpoena do not mean that we have concluded that anyone has broken the law.
Also, the investigation does not mean that we have a negative opinion of any
F-22
person, entity or security." The staff of the SEC subsequently confirmed that
its investigation was informal in nature, and that it did not have subpoena
power. At the present time, the Company is unable to predict the outcome of this
matter.
The Company has concluded that it is probable that it will incur losses relating
to claims and litigation of at least $1.2 million, which represents the
aggregate amount of the Company's deductibles under its product liability and
directors' and officers' insurance policies. Therefore the Company has recorded
an accrual of $1.2 million as of December 31, 2002.
10. STOCK OPTION PLANS
The Company has stock option plans which provide for grants of options to
employees and directors to purchase shares of the Company's common stock at
exercise prices generally equal to the fair values of such stock at the dates of
grant, which generally become exercisable over a five-year vesting period and
expire within ten years of the grant dates. Under the 1993 Employee Incentive
Stock Option Plan, the 1998 Long-Term Incentive Plan, the 2002 Stock Incentive
Plan, and the amended and restated Nonemployee Director's Plan, the Company has
authorized the grant of options of up to 1,050,000, 900,000, 974,000, and
594,000 shares of common stock, respectively. As of December 31, 2002 and 2001,
there were 427,000 and 128,000, respectively, shares of common stock reserved
for future issuance under the Company's stock option plans. A summary of stock
option transactions under the plans follows:
Exercise Weighted Average
Shares Price Exercise Price
------------- ------------------ ------------------
Outstanding at December 31, 1999 1,519,000 $ 2.33-11.50 $ 7.67
Granted 492,000 11.50-29.15 13.99
Exercised (416,000) 2.33-9.00 3.85
Canceled (45,000) 6.83-9.00 8.64
-------------- ------------------ ------------------
Outstanding at December 31, 2000 1,550,000 $ 5.67-29.15 $ 10.67
Granted 370,000 23.68-34.10 30.02
Exercised (145,000) 5.67-11.63 7.68
Canceled (13,000) 8.50-29.15 16.38
-------------- ------------------ ------------------
Outstanding at December 31, 2001 1,762,000 $ 6.83-34.10 $ 14.94
Granted 1,133,000 2.20-29.25 9.94
Exercised (119,000) 6.83-11.63 9.21
Canceled (390,000) 2.20-34.10 19.55
-------------- ------------------ ------------------
Outstanding at December 31, 2002 2,386,000 $ 2.20-31.99 $ 12.10
============= ================== ==================
The following table summarizes information concerning currently outstanding and
exercisable options:
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------- ------------------------------
Weighted Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Price Outstanding Contract Life Exercise Price Exercisable Exercise Price
--------------- ------------- -------------- ------------- ------------- -------------
$ 2.20-2.20 644,000 5.02 $ 2.20 180,000 $ 2.20
6.59-8.50 551,000 3.14 7.75 269,000 8.22
9.00-11.63 635,000 2.45 11.38 466,000 11.32
12.92-30.86 425,000 4.34 27.65 157,000 27.04
31.99-31.99 131,000 3.48 31.99 103,000 31.99
--------------- ------------- -------------- ------------- ------------- -------------
$ 2.20-31.99 2,386,000 3.70 $ 12.10 1,175,000 $ 13.12
============= =============
In September 1999, the Company granted options to a nonemployee to purchase
18,000 shares of common stock at an exercise price of $8.21 per share. In
connection with the issuance of these options, the Company recognized $60,000 as
deferred compensation for the estimated fair value of the options. Deferred
compensation is amortized ratably over the vesting period of the options in
accordance with SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123").
F-23
Other information concerning stock options follows:
2002 2001 2000
------------- -------------- -------------
Weighted average fair value of options
granted during the year $ 4.23 $ 15.20 $ 6.97
Number of shares as to which options are
exercisable at end of year 1,175,000 915,000 791,000
11. SHAREHOLDER RIGHTS PLAN
On November 27, 1995 the Board of Directors adopted a shareholder rights plan to
protect long-term share value for the Company's shareholders. Under the plan,
the Board declared a distribution of one Right for each outstanding share of the
Company's Common Stock to shareholders of record on December 11, 1995.
Additionally, the Company has further authorized and directed the issuance of
one Right with respect to each Common Share that shall become outstanding
between December 11, 1995 and the earliest of the Right's exercise date or
expiration date. Each Right entitles the registered holder to purchase from the
Company one-thirtieth of a share of a newly created Series A Junior
Participating Preferred Stock at an exercise price of $100. The Rights, which
expire on November 27, 2005, may be exercised only if certain conditions are
met, such as the acquisition of 15% or more of the Company's Common Stock by a
person or affiliated group ("Acquiring Person").
In the event the Rights become exercisable, each Right will enable the owner,
other than the Acquiring Person, to purchase, at the Right's then current
exercise price, that number of shares of Common Stock with a market value equal
to twice the exercise price times the number of one-tenth's of a share of Series
A Junior Participating Preferred Stock for which the Right is then exercisable.
In addition, unless the Acquiring Person owns more than 50% of the outstanding
shares of Common Stock, the Board of Directors may elect to exchange all
outstanding Rights (other than those owned by such Acquiring Person) at an
exchange ratio of one share of Common Stock per Right appropriately adjusted to
reflect any stock split, stock dividend or similar transaction.
12. STOCK REPURCHASE
On July 18, 2002 the Company's Board of Directors authorized the purchase of up
to $10 million in shares of its common stock. The purchase of shares was to be
made from time-to-time in open market or privately negotiated transactions on
such terms as management deemed appropriate. As of December 31, 2002 the Company
had repurchased 68,000 shares of its common stock for an aggregate purchase
price of $663,000. No further purchases are anticipated in the near term.
On October 14, 1998 the Company's Board of Directors authorized the Company to
purchase up to 1.5 million shares of its common stock. As of December 31, 2001,
and 2000, the Company had purchased an aggregate of 1,159,000 and 1,159,000
shares, respectively, of its common stock for an aggregate purchase price of
$8,258,000 and $8,258,000, respectively. No further purchases are anticipated
under this authorization.
F-24
13. ACCUMULATED OTHER COMPREHENSIVE INCOME
Components of comprehensive income/(loss) consist of the following, net of tax
(in thousands):
December 31,
------------------------------
2002 2001
------------------------------
Net (loss) income $ (27,761) $ 9,166
Unrealized gain on investments 95 1,124
Change in fair value of interest rate swap (including
cumulative effect of adopting SFAS 133 in 2001) 30 (200)
Translation adjustment 303 18
------------------------------
Comprehensive income $ (27,333) $ 10,108
==============================
The tax effect on the change in unrealized gain/loss on investments is $55,000
and $575,000 for the years ended December 31, 2002 and 2001, respectively. The
tax effect on the change in fair value of the interest rate swap is $4,000 and
$93,000 for the years ended December 31, 2002 and 2001, respectively. The
translation adjustment is not currently adjusted for income taxes, as it relates
to a permanent investment in a foreign subsidiary.
14. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan (the "Plan") providing retirement benefits
to all employees who have completed at least three months of service. The
Company makes matching contributions of 50% of each participant's contribution
up to 5% of each participant's salary. Total company contributions approximated
$404,000, $384,000, and $355,000, for 2002, 2001, and 2000, respectively.
Additionally, the Company may make discretionary contributions to the Plan that
are allocated to each participant's account. No such discretionary contributions
were made in 2002, 2001, or 2000.
On May 16, 1996 the Company's shareholders approved the CryoLife, Inc. Employee
Stock Purchase Plan (the "ESPP"). The ESPP allows eligible employees the right
to purchase common stock on a quarterly basis at the lower of 85% of the market
price at the beginning or end of each three-month offering period. As of
December 31, 2002 and 2001 there were 543,000 and 657,000, respectively, shares
of common stock reserved under the ESPP and there had been 357,000 and 243,000,
respectively, shares issued under the plan.
15. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share data):
2002 2001 2000
-------------- ------------- --------------
Numerator for basic and diluted earnings per share:
(loss) income available to common shareholders $ (27,761) $ 9,166 $ 7,817
============== ============= ==============
Denominator for basic earnings per share:
weighted-average shares 19,432 18,808 18,541
Effect of dilutive stock options -- 852 688
-------------- ------------- --------------
Denominator for diluted earnings per share:
adjusted weighted-average shares 19,432 19,660 19,229
============== ============= ==============
(Loss) earnings per share:
Basic $ (1.43) $ 0.49 $ 0.42
============== ============= ==============
Diluted $ (1.43) $ 0.47 $ 0.41
============== ============= ==============
Since the Company has a net loss in the current year, all common stock
equivalents are anti-dilutive. For the year ended December 31, 2002 the Company
had stock options that are considered common stock equivalents and would have
resulted in 966,000 additional dilutive shares pursuant to the provisions of
SFAS 128.
F-25
On July 23, 2002 the Company's Board of Directors authorized the purchase of up
to $10 million of its common stock. As of February 24, 2003 the Company had
repurchased 68,000 shares of its common stock for $663,000. No further purchases
are anticipated in the near term.
16. INCOME TAXES
Income tax (benefit) expense consists of the following (in thousands):
2002 2001 2000
------------- ------------- -------------
Current:
Federal $ (8,000) $ 4,680 $ 2,272
State (164) 115 (114)
-------------- ------------- -------------
(8,164) 4,795 2,158
Deferred (5,509) (481) 1,658
-------------- ------------- -------------
$ (13,673) $ 4,314 $ 3,816
============== ============= =============
Such amounts differ from the amounts computed by applying the U.S. federal and
state income tax rate of 34% in 2002, 35% in 2001, and 34% in 2000 to pretax
income as a result of the following (in thousands):
2002 2001 2000
------------- ------------- -------------
Tax (benefit) expense at statutory rate $ (14,088) $ 4,718 $ 3,955
Increase (reduction) in income taxes
Resulting from:
Entertainment expenses 83 50 47
State income taxes, net of federal benefit (167) 108 231
Nontaxable interest income (202) (242) (264)
Research and development credits -- (200) (125)
Foreign sales corporation (27) (60) --
Other 728 (60) (28)
------------- ------------- -------------
$ (13,673) $ 4,314 $ 3,816
============= ============= =============
For the year ended December 31, 2002, the Company generated federal income tax
losses of approximately $27 million. These losses will be carried back to prior
years to offset income taxes paid and should result in approximately $8.5
million in refunds to the Company.
The tax effects of temporary differences which give rise to deferred tax
liabilities and assets at December 31 are as follows (in thousands):
2002 2001
------------- -------------
Long-term deferred tax (liabilities) assets:
Property $ (865) $ (550)
Intangible assets (210) 153
Impairment of IFM long-lived assets -- (52)
Other 89 --
------------- -------------
(986) (449)
Current deferred tax assets (liabilities):
Unrealized loss on interest rate swap 88 93
Unrealized loss on marketable securities (104) 449
Allowance for bad debts 26 32
Accrued expenses 1,875 13
Prepaid items (56) --
Deferred preservation costs and inventory reserves 4,845 96
Other 60 5
------------- -------------
6,734 688
------------- -------------
Net deferred tax assets $ 5,748 $ 239
============= =============
F-26
At December 31, 2002 the Company has recorded a net deferred tax asset of $5.7
million. If the temporary differences that generated the net deferred tax asset
become fully deductible in 2003, the Company will have sufficient pre-tax
earnings in 2001 to carryback these losses and realize the deferred tax asset.
If some of the temporary differences become deductible in future years, the
realization of the deferred tax asset may be dependent on generating sufficient
taxable income in future periods. Although realization is not ensured, the
Company believes that it is more likely than not that the deferred tax asset
will be realized.
17. EXECUTIVE INSURANCE PLAN
Pursuant to a supplemental life insurance program for certain executive officers
of the Company, the Company and the executives share in the premium payments and
ownership of insurance policies on the lives of such executives. Upon death of
the insured party, policy proceeds equal to the premium contribution are due to
the Company with the remaining proceeds due to the designated beneficiaries of
the insured party. The Company's aggregate premium contributions under this
program were $74,000, $75,000, and $53,000, for 2002, 2001, and 2000,
respectively.
18. EQUIPMENT ON LOAN TO IMPLANTING HOSPITALS
The Company consigns liquid nitrogen freezers with certain implanting hospitals
for tissue storage. The freezers are the property of the Company. At December
31, 2002 freezers with a total cost of approximately $2.3 million and related
accumulated depreciation of approximately $1.5 million were located at the
implanting hospitals' premises. Depreciation is provided over the estimated
useful lives of the freezers on a straight-line basis.
19. TRANSACTIONS WITH RELATED PARTIES
The Company expensed $90,000, $87,000, and $78,000 during 2002, 2001, and 2000,
respectively, relating to services performed by a law firm whose sole proprietor
is a member of the Company's Board of Directors and a shareholder of the
Company. The Company expensed $100,000, $100,000, and $102,000 in 2002, 2001 and
2000, respectively, relating to consulting services performed by a member of the
Company's Board of Directors and a shareholder of the Company. In addition, the
Company expensed $240,000, $473,000 and $44,000 in 2002, 2001, and 2000,
respectively, relating to research performed by the university where the same
Director and shareholder holds a significant position. The Company expensed
$4,500, zero, and zero in 2002, 2001 and 2000, respectively, relating to
consulting services performed by a member of the Company's Board of Directors
and a shareholder of the Company. The Company paid $35,000, $210,000 and
$210,000, in 2002, 2001, and 2000, respectively, relating to consulting services
performed by a shareholder of the Company.
20. SEGMENT AND GEOGRAPHIC INFORMATION
The Company has two reportable segments: Human Tissue Preservation Services and
Implantable Medical Devices. The Company's segments are organized according to
services and products.
The HUMAN TISSUE PRESERVATION SERVICES segment includes external revenue from
cryopreservation services of cardiovascular, vascular, and orthopaedic human
tissue. The IMPLANTABLE MEDICAL DEVICES segment includes external revenue from
product sales of BioGlue Surgical Adhesive and bioprosthetic devices, including
stentless porcine heart valves, SynerGraft treated porcine heart valves, and
SynerGraft treated bovine vascular grafts. There are no intersegment sales.
The primary measure of segment performance, as viewed by the Company's
management, is segment gross margin, or net external revenues less cost of
preservation services and products. The Company does not segregate assets by
segment; therefore asset information is excluded from the segment disclosures
below.
F-27
The following table summarizes revenues, cost of preservation services and
products, and gross margin for the Company's operating segments (in thousands):
Cost of Preservation Gross
2002: Revenue Services and Products Margin
------------- --------------------- --------------
Human Tissue Preservation Services $ 55,373 $ 55,363 $ 10
Implantable Medical Devices 21,597 10,270 11,327
All Other a 825 -- 825
------------- ------------- --------------
$ 77,795 $ 65,633 $ 12,162
============= ============= ==============
2001:
Human Tissue Preservation Services $ 75,552 $ 31,165 $ 44,387
Implantable Medical Devices 11,130 5,464 5,666
All Other a 989 -- 989
------------- ------------- --------------
$ 87,671 $ 36,629 $ 51,042
============= ============= ==============
2000:
Human Tissue Preservation Services $ 67,096 $ 27,500 $ 39,596
Implantable Medical Devices 7,176 4,068 3,108
All Other a 2,824 1,779 1,045
------------- ------------- --------------
$ 77,096 $ 33,347 $ 43,749
============= ============= ==============
a The All Other designation includes 1) grant revenue and 2) distribution
revenues and 3) revenues and cost of sales of IFM, a single-use medical device
business, through October 9, 2000, the date of the sale of substantially all of
the remaining assets of IFM.
Net revenues by product for the years ended December 31, 2002, 2001 and 2000
were as follows (in thousands):
Revenue 2002 2001 2000
------------- ------------- --------------
Human tissue preservation services:
Cardiovascular tissue $ 23,413 $ 28,606 $ 29,685
Vascular tissue 17,826 24,488 21,279
Orthopaedic tissue 14,134 22,458 16,132
------------- ------------- --------------
Total preservation services 55,373 75,552 67,096
BioGlue surgical adhesive 20,898 10,595 6,405
Bioprosthetic devices 699 535 771
Single-use medical devices -- 2,208
Grant and distribution revenue 825 989 616
------------- ------------- --------------
$ 77,795 $ 87,671 $ 77,096
------------- ------------- --------------
Net revenues by geographic location for the years ended December 31, 2002, 2001
and 2000 were as follows (in thousands):
Revenue b 2002 2001 2000
------------- ------------- -------------- -
U.S. $ 71,188 $ 81,657 $ 72,010
International 6,607 6,014 5,086
------------- ------------- --------------
$ 77,795 $ 87,671 $ 77,096
------------- ------------- --------------
b Net external revenues are attributed to countries based on the location of the
customer.
At December 31, 2002, 2001, and 2000, over 95% of the long-lived assets of the
Company were held in the U.S., where all Company manufacturing facilities and
the corporate headquarters are located.
F-28
20. SUBSEQUENT EVENTS
On February 20, 2003 the Company received a letter from the FDA that stated that
a 510(k) premarket notification should be filed for the Company's CryoValve SG
and that premarket approval marketing authorization should be obtained for the
Company's CryoVein SG when used for arteriovenous ("A-V") access. The agency's
position is that use of the SynerGraft technology in the processing of allograft
heart valves represents a modification to the Company's legally marketed
CryoValve allograft, and that femoral veins used for A-V access are medical
devices that require premarket approval. CryoLife will be providing the agency
with information to demonstrate that femoral veins used for A-V access should
continue to be regulated as human tissue under Parts 1270 and 1271 of the FDA's
regulations. The FDA letter did not question the safety or efficacy of the
SynerGraft process or the CryoVein A-V access implant.
The Company has advised the FDA that it will voluntarily suspend use of the
SynerGraft technology in the processing of allograft heart valves and vascular
tissue until the regulatory status of the CryoValve SG and CryoVein SG is
resolved. The FDA has not suggested that these tissues be recalled. Until such
time as the issues surrounding the SG tissue are resolved, the Company will
employ its traditional processing methods on these tissues. Distribution of
allograft heart valves and vascular tissue processed using the Company's
traditional processing protocols will continue. The outcome of the discussions
with the FDA regarding the use of the SynerGraft process on human tissue could
result in a reduction in SynerGraft processed cardiovascular and vascular tissue
which would reduce revenues and gross margins with respect to cardiovascular and
vascular tissues.
F-29
SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(In thousands except per share data)
First Second Third Fourth
REVENUE Year Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------------------------------
2002 $ 25,471 $ 23,264 $ 16,889 $ 12,171
2001 21,432 21,697 22,567 21,975
2000 19,623 19,454 19,524 18,495
NET INCOME (LOSS)
- --------------------------------------------------------------------------------------------------------
2002 $ 3,104 $ (5,522) $ (19,646) $ (5,697)
2001 1,970 2,540 2,692 1,964
2000 1,604 1,979 2,308 1,926
EARNINGS (LOSS) PER SHARE - DILUTED
- --------------------------------------------------------------------------------------------------------
2002 $ 0.16 $ (0.28) $ (1.01) $ (0.29)
2001 0.10 0.13 0.14 0.10
2000 0.09 0.10 0.12 0.10
F-30
INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of
CryoLife, Inc.
We have audited the consolidated financial statements of CryoLife, Inc. and
Subsidiaries as of and for the year ended December 31, 2002 and have issued our
report thereon dated February 24, 2003 which report includes an explanatory
paragraph because the Company changed its method of accounting for goodwill and
other intangible assets to conform to Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets", which was adopted by
the Company as of January 1, 2002; such report is included elsewhere in this
Form 10-K. Our audit also included the 2002 financial statement schedules of
CryoLife, Inc., listed in Item 14. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audit. The financial statements of the Company as of
December 31, 2001 and 2000 and for the years then ended were audited by other
auditors who have ceased operations. Those auditors expressed an unqualified
opinion on the 2001 and 2000 financial statements in their report dated March
29, 2002. Those auditors also audited the 2001 and 2000 financial statement
schedules listed in Item 14, and their report dated March 29, 2002 expressed an
unqualified opinion on those financial statement schedules.
In our opinion, such 2002 financial statement schedules, when considered in
relation to the basic 2002 financial statements taken as a whole, present fairly
in all material respects the information set forth therein.
/s/Deloitte & Touche LLP
Atlanta, Georgia
February 24, 2003
S-1
SCHEDULE II
CRYOLIFE, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
BALANCE BALANCE
BEGINNING END OF
DESCRIPTION OF PERIOD ADDITIONS DEDUCTIONS PERIOD
- ------------------------------------ ------------- ------------- ------------- -------------
Year ended December 31, 2002
Allowance for doubtful accounts $ 100,000 $ 53,000 $ 78,000 $ 75,000
Deferred preservation costs 300,000 320,000 570,000 50,000
Year ended December 31, 2001
Allowance for doubtful accounts $ 85,000 $ 338,000 $ 323,000 $ 100,000
Deferred preservation costs 229,000 280,000 209,000 300,000
Year ended December 31, 2000
Allowance for doubtful accounts $ 528,000 $ 21,000 $ 464,000 $ 85,000
Deferred preservation costs 151,000 230,000 152,000 229,000
S-2