Overview

CryoLife, Inc. ("CryoLife," the "Company," "we," or "us"), incorporated January 19, 1984 in Florida, preserves and distributes human tissues for cardiac and vascular transplant applications and develops and commercializes medical devices. The human tissue distributed by the Company includes the CryoValve® SG pulmonary heart valve ("CryoValve SG"), processed using CryoLife's proprietary SynerGraft ® technology. The Company's medical devices include BioGlue® Surgical Adhesive ("BioGlue") and Hemostase, which the Company distributes for a third party, as well as other medical devices.

In January 2009 CryoLife achieved an industry milestone when it received tissue from its 100,000th individual donor. Since 1984, through the generosity of donor families and with the support of the organ and tissue procurement organizations, CryoLife has been able to provide more than 160,000 cryopreserved tissues for transplant. For the quarter ended March 31, 2009 CryoLife's revenues increased 4% over the prior year quarter. Also during the quarter, revenues from the sale of Hemostase exceeded the $1 million mark for the first time, increasing 38% over the fourth quarter of 2008. See the "Results of Operations" section below for additional analysis of the first quarter 2009 results.

Critical Accounting Policies

A summary of the Company's significant accounting policies is included in Part II, Item 8, Note 1 of the "Notes to Consolidated Financial Statements," contained in the Company's Form 10-K for the year ended December 31, 2008. 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 summary consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S. for interim financial information, which require the Company to make estimates and assumptions. The Company did not experience any significant changes during the quarter ended March 31, 2009 in its Critical Accounting Policies from those contained in the Company's Form 10-K for the year ended December 31, 2008.

New Accounting Pronouncements

The Company was required to adopt SFAS No. 141R, "Business Combinations" ("SFAS 141R"), on January 1, 2009. SFAS 141R establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The adoption of SFAS 141R did not have an effect on the financial position, profitability, or cash flows of the Company upon adoption.

Results of Operations

(Tables in thousands)

Revenues



                                                            Revenues as a Percentage of
                                   Revenues for the           Total Revenues for the
                                  Three Months Ended            Three Months Ended
                                      March 31,                      March 31,
                                   2009         2008           2009             2008

                                     (Unaudited)
  Preservation services:
  Cardiac tissue                $     5,592   $  6,238              21%              24%
  Vascular tissue                     7,871      6,859              30%              27%
  Orthopaedic tissue                     85        327               -%               1%

  Total preservation services        13,548     13,424              51%              52%


  Products:
  BioGlue                            11,764     11,887              44%              47%
  Hemostase                           1,110          -               4%               -%
  Other medical devices                  71         93               -%               -%

  Total products                     12,945     11,980              48%              47%

  Other                                 195        164               1%               1%

  Total                         $    26,688   $ 25,568             100%             100%

Revenues increased 4% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. A detailed discussion of the change in preservation services revenues for each of the major tissue types distributed by the Company, the change in BioGlue revenues, and the change in Hemostase revenues for the three months ended March 31, 2009 is presented below.

Cardiac Preservation Services

Revenues from cardiac preservation services decreased 10% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. This decrease was primarily due to the aggregate impact of a 20% decrease in unit shipments of cardiac tissues partially offset by the favorable effect of tissue mix, which together decreased revenues by 11%, partially offset by an increase in average service fees, which increased revenues by 1%.

The decrease in revenues from the net effect of volume and tissue mix for the three months ended March 31, 2009 was primarily due to a decrease in shipments of standard processed pulmonary valves. This decrease in standard processed pulmonary valve shipments was largely offset by an increase in shipments of the CryoValve SG pulmonary valve. The remaining cardiac volume decrease was primarily due to a decrease in shipments of non-valved cardiac tissues and aortic valves.

Management believes that there has not been a corresponding decrease in the number of procedures in which the Company's aortic and pulmonary valves could be utilized. However, management believes that due to the current economic conditions and their constraining effect on hospital budgets, hospitals are decreasing the number of valved cardiac tissues they keep on hand for urgent procedures. The decrease in shipments of non-valved cardiac tissues was primarily due to the timing of releases of these tissues, which are in high demand for pediatric surgeries. The increases in average service fees for the three months ended March 31, 2009 was primarily due to the routine expiration or renegotiation of fee contracts with certain customers.

The Company's procurement of cardiac tissues, from which heart valves and non-valved cardiac tissues are processed, decreased 21% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. As a part of the normal course of business, CryoLife routinely adjusts its criteria for accepting incoming tissue based on certain variables. These variables include the likelihood that certain tissues will pass the Company's quality controls and testing processes, changes in demand for certain types of tissues processed by the Company, changes in incoming tissue availability, and the level of tissues currently available for shipment. The decrease in cardiac procurement for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 was primarily the result of changes in tissue acceptance criteria made during 2008. If these changes remain in effect, the Company believes that cardiac procurement will continue at these reduced levels in 2009 as compared to prior year periods. However, the Company may continue to make changes in incoming tissue acceptance criteria, and as a result the Company's level of procurement may continue to vary from quarter-to-quarter and year-to-year. The Company

The Company may continue to experience a decrease in cardiac valve shipments in 2009 as compared to the prior year. The Company believes that the trend of decreasing cardiac valve shipments will reverse sometime during 2009 as hospitals begin to find it necessary to replenish on-hand tissues at these reduced levels. However, there can be no assurance that this trend will reverse. The Company believes that shipments of the CryoValve SG will continue to have a premium fee over the standard processed CryoValve. However, there can be no assurance that the CryoValve SG will continue to command premium fees or that shipments of the CryoValve SG will continue to occur at material levels.

Vascular Preservation Services

Revenues from vascular preservation services increased 15% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. This increase was primarily due to a 15% increase in unit shipments of vascular tissues.

The increase in vascular volume for the three months ended March 31, 2009 was due to increases in shipments of each of the types of vascular tissues processed by the Company. The largest volume increases were in saphenous veins, which increased due to the strong demand for these tissues, primarily for use in peripheral vascular reconstruction surgeries to avoid limb amputations.

The Company's procurement of vascular tissues decreased 19% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. As a part of the normal course of business, CryoLife routinely adjusts its criteria for accepting incoming tissue based on certain variables. These variables include the likelihood that certain tissues will pass the Company's quality controls and testing processes, changes in demand for certain types of tissues processed by the Company, changes in incoming tissue availability, and the level of tissues currently available for shipment. The decrease in vascular procurement in the three months ended March 31, 2009 as compared to the three months ended March 31, 2008, was primarily the result of changes in tissue acceptance criteria made during 2008. If these changes remain in effect, the Company believes that vascular procurement will continue at these reduced levels in 2009 as compared to the prior year periods. However, the Company may continue to make changes in incoming tissue acceptance criteria, and as a result the Company's level of procurement may continue to vary from quarter-to-quarter and year-to-year. The Company believes that its existing vascular tissues available for shipment and current procurement levels are sufficient to support anticipated future demand for vascular tissues for the reasonably foreseeable future.

BioGlue

Revenues from the sale of BioGlue decreased 1% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. This decrease was primarily due to the unfavorable impact of foreign exchange, which reduced revenues by 3%, and by the net unfavorable effect of BioGlue sales volume, which decreased revenues by 1%, partially offset by an increase in average selling prices, which increased revenues by 3%.

The unfavorable impact of foreign exchange for the three months ended March 31, 2009 was due to changes in the exchange rates between the U.S. Dollar and both the British Pound and the Euro in the first quarter of 2009 as compared to the first quarter of 2008. The Company's sales of BioGlue through its direct sales force to United Kingdom hospitals are denominated in British Pounds and its sales to German hospitals and certain distributors are denominated in Euros.

The net unfavorable effect of BioGlue sales volume for the three months ended March 31, 2009 was primarily due to a decrease in shipments of BioGlue in domestic markets, largely offset by an increase in BioGlue shipments in international markets. Overall, BioGlue milliliters shipped increased by 2%. However, since domestic BioGlue shipments have a higher per milliliter price point than international BioGlue shipments, the net impact was a 1% decrease in revenues.

The increase in average selling prices for the three months ended March 31, 2009 was primarily due to domestic list price increases on certain BioGlue products that went into effect in January 2009 and the routine expiration or renegotiation of pricing contracts with certain domestic customers.

Domestic revenues accounted for 72% of total BioGlue revenues in both of the three month periods ended March 31, 2009 and 2008. The majority of the Company's international BioGlue revenues are denominated in British Pounds and Euros, and as such are sensitive to changes in exchange rates. In addition, a portion of the Company's U.S. Dollar-denominated BioGlue sales are made to customers in other countries who must convert local currencies into U.S. Dollars in order to purchase BioGlue. As a result the Company's revenues in 2009 could continue to be negatively impacted by changes in exchange rates from the weighted

Hemostase

Revenues from the sale of Hemostase for the three months ended March 31, 2009 are a result of CryoLife's marketing and distribution of Hemostase, which began in the second quarter of 2008. Revenues from Hemostase could be adversely impacted by the Company's lawsuit with Medafor. See Part II, Item 1, "Legal Proceedings."

Other Revenues

Other revenues for the three months ended March 31, 2009 included revenues from research grants. Other revenues for the three months ended March 31, 2008 included revenues from research grants and revenues related to the licensing of the Company's technology to a third party.

As of March 31, 2009 CryoLife has been awarded a total of $5.4 million in funding allocated from U.S. Congress Defense Appropriations Conference Reports in 2005 through 2008, collectively the ("DOD Grants"), which includes $1.7 million awarded in March of 2009. The DOD Grants were awarded to CryoLife for the development of protein hydrogel technology, which the Company is currently developing for use in organ sealing. Grant revenues in 2009 and 2008 are related to funding under the DOD Grants.

Through March 31, 2009 CryoLife has received cash payments totaling $3.9 million for the DOD Grants and expects to receive the remaining $1.5 million in cash payments over the next 12 months. The Company had $2.0 million remaining in unspent cash advances recorded as cash and cash equivalents and deferred revenues on the Company's Summary Consolidated Balance Sheet as of March 31, 2009.

Costs and Expenses

Cost of Preservation Services



                                                                    Three Months Ended
                                                                        March 31,
                                                                     2009         2008

Cost of preservation services                                     $    7,491    $  7,318
Cost of preservation services as a percentage of preservation
services revenues                                                        55%         55%

Cost of preservation services increased 2% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. Cost of preservation services as a percentage of preservation services revenues for the three months ended March 31, 2009 was comparable to the three months ended March 31, 2008.

Cost of Products



                                                             Three Months Ended
                                                                 March 31,
                                                              2009         2008

    Cost of products                                       $    1,962    $  1,992
    Cost of products as a percentage of product revenues          15%         17%

Cost of products decreased 2% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. Cost of products for the three months ended March 31, 2008 was negatively impacted by the write-down of other implantable medical device inventory. The decrease in cost of products for the three months ended March 31, 2009 was primarily due to the absence of similar write-downs in the current year, largely offset by an increase in the cost of Hemostase sales, as a result of the Company's launch of that product in the second quarter of 2008.

Cost of products as a percentage of product revenues decreased for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008, primarily due to the effect of the write-down of other implantable medical device inventory in the prior year. This decrease was partially offset by a change in product mix during 2008, in which the Company launched Hemostase, a product with lower margins than BioGlue.

General, Administrative, and Marketing Expenses



                                                                   Three Months Ended
                                                                        March 31,
                                                                     2009       2008
General, administrative, and marketing expenses                  $     12,748   $ 12,067
General, administrative, and marketing expenses as a
percentage of total revenues                                              48%        47%

The increase in general, administrative, and marketing expenses for the three months ended March 31, 2009 was primarily due to increases in marketing expenses, including increased personnel costs, partially related to an increase in sales force, and increases in advertising, travel costs, and expenses related to tradeshows to support the Company's expanding tissue service and product offerings and revenue growth.

The Company's expenses related to the grant of stock options and restricted stock awards was $607,000 for the three months ended March 31, 2009, and $636,000 for the three months ended March 31, 2008.

Research and Development Expenses



                                                                        Three Months Ended
                                                                             March 31,
                                                                          2009       2008
Research and development expenses                                     $     1,026    $  1,445
Research and development expenses as a percentage of total revenues            4%          6%

The decrease in research and development expenses for the three months ended March 31, 2009 was primarily due to a decrease in spending on external research studies with third party research companies and academic organizations. Research and development spending in 2009 and 2008 was primarily focused on the Company's tissue preservation, SynerGraft products and tissues, and Protein Hydrogel Technologies ("PHT"). SynerGraft products and tissues include the Company's CryoValve SG pulmonary heart valve and xenograft SynerGraft tissue products. PHT includes BioGlue, BioFoam®, BioDisc®, and related products.

Other Costs and Expenses

Interest expense was $49,000 for the three months ended March 31, 2009, compared to $70,000 for the three months ended March 31, 2008. Interest expense for the three months ended March 31, 2009 and 2008 included interest incurred related to the Company's debt as discussed in Note 5 of the "Notes to Summary Consolidated Financial Statements", capital leases, and interest related to uncertain tax positions.

Interest income was $43,000 for the three months ended March 31, 2009, compared to $122,000 for the three months ended March 31, 2008. Interest income for the three months ended March 31, 2009 and 2008 was primarily due to interest earned on the Company's cash, cash equivalents, and marketable securities. The decrease in interest income was primarily due to a decline in interest rates paid on the Company's cash and cash equivalents and restricted securities, partially offset by an increase in the balance in these accounts.

The Company's income tax expense was $1.4 million for the three months ended March 31, 2009, compared to $115,000 for the three months ended March 31, 2008. Income tax expense for the three months ended March 31, 2009 was recorded at the Company's effective tax rate of 41%. Income tax expense for the three months ended March 31, 2008 was primarily due to estimated alternative minimum tax on the Company's U.S. taxable income that could not be offset by the Company's net operating loss carryforwards and estimated foreign taxes on income of the Company's wholly owned European subsidiary.

The Company's income tax expense is expected to continue to be significantly higher for the remainder of 2009 as compared to 2008, as the Company records income tax expense based on its estimated combined federal, state, and foreign effective tax rate. The Company did not record income tax expense based on its effective tax rate in 2008 due to the valuation allowance on the Company's deferred tax assets during that year. Due to the Company's federal and state net operating loss carryforwards, the Company expects that cash paid for taxes will continue to be significantly less than the tax expense recorded during 2009.

The demand for the Company's cardiac preservation services has historically been seasonal, with peak demand generally occurring in the second and third quarters. Management believes this trend for cardiac preservation services is primarily due to the high number of surgeries scheduled during the summer months for school aged patients, who drive the demand for a large percentage of cardiac tissues processed by CryoLife. In recent years due to the growth rate of the Company's cardiac business coupled with the deterioration in recent quarters in the U.S. and global economies, the seasonal nature of the Company's cardiac preservation service business has been obscured.

The demand for the Company's human vascular preservation services does not appear to be seasonal.

The demand for BioGlue appears to be seasonal, with a slight decline in demand generally occurring in the third quarter followed by stronger demand in the fourth quarter. Management believes that this trend for BioGlue may be due to the summer holiday season in Europe and fewer surgeries being performed on adult patients in the summer months in the U.S.

The Company is uncertain whether demand for Hemostase will be seasonal. As Hemostase is in a growth phase generally associated with a recently introduced product that has not fully penetrated the marketplace, the nature of any seasonal trends in Hemostase sales may be obscured.

Liquidity and Capital Resources

Net Working Capital

At March 31, 2009 net working capital (current assets of $83.3 million less current liabilities of $19.5 million) was $63.8 million, with a current ratio (current assets divided by current liabilities) of 4 to 1, compared to net working capital of $59.4 million, with a current ratio of 4 to 1 at December 31, 2008.

Overall Liquidity and Capital Resources

The Company's primary cash requirements for the three months ended March 31, 2009 arose out of general working capital needs, including the annual payment of bonuses accrued in the prior year, capital expenditures for facilities and equipment, and funding of research and development projects. The Company funded its cash requirements primarily through its operating activities, which generated cash during the period.

In March of 2008 CryoLife entered into a credit facility with GE Capital, which provides for up to $15.0 million in revolving credit for working capital, acquisitions, and other corporate purposes. If the current global financial and credit liquidity crisis continues, GE may be unable or unwilling to lend money pursuant to this agreement. As of March 31, 2009 the outstanding balance under this agreement was $315,000. As required under the terms of the GE Credit Agreement, the Company is maintaining cash and cash equivalents of at least $5.0 million in accounts in which GE Capital has a first priority perfected lien. As a result these funds will not be available to meet the Company's liquidity needs during the term of the GE Credit Agreement, and as such have been recorded as the long-term asset restricted money market funds on the Company's Summary Consolidated Balance Sheet.

The Company's cash equivalents include advance funding received under the DOD Grants for the continued development of protein hydrogel technology. As of March 31, 2009 $2.0 million of cash equivalents were recorded on the Company's Summary Consolidated Balance Sheet related to the DOD Grants. These funds must be used for the specified purposes.

As of March 31, 2009 approximately $17.4 million of the Company's money market funds and restricted money market funds were guaranteed under the U.S. Treasury's Temporary Guarantee Program for Money Market Funds. In this program the U.S. Treasury guarantees that the value of the participating money market fund shares will not fall below $1 per share through September 18, 2009 for shares held as of close of business on September 19, 2008.

The Company believes that its anticipated cash from operations, existing cash, cash equivalents, and marketable securities will enable the Company to meet its operational liquidity needs for at least the next twelve months.

Liability Claims

As of March 31, 2009 the Company had a $330,000 accrual for a pending tissue processing liability lawsuit. The timing and amount of actual future payments with respect to tissue processing and product liability claims is dependent on when and if judgments are rendered and/or settlements are reached. Should payments be required, the Company's portion of these monies

As of March 31, 2009 the Company had accrued a total $4.5 million for the estimated costs of unreported tissue processing and product liability claims related to services performed and products sold prior to March 31, 2009 and had recorded a receivable of $1.6 million representing estimated amounts to be recoverable from the Company's insurance carriers with respect to such accrued liability. Further analysis indicated that the liability could be estimated to be as high as $9.5 million, after including a reasonable margin for statistical fluctuations calculated based on actuarial simulation techniques. The $4.5 million accrual does not represent cash set aside. The timing of future payments related to the accrual is dependent on when and if claims are asserted, judgments are rendered, and/or settlements are reached. Should payments related to the accrual be required, these monies would have to be paid from insurance proceeds and liquid assets. Since the amount accrued is based on actuarial estimates, actual amounts required could vary significantly from this estimate.

Net Cash from Operating Activities

. . .