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 HemoStaseTM, which the Company distributes for a third party, as well as other medical devices.

In June 2009 CryoLife announced that BioGlue has now been used in more than 500,000 surgical procedures throughout the world since its introduction into the international market in 1998 and in the U.S. in 2001. For the quarter ended June 30, 2009 CryoLife's revenues exceeded $28 million, a new quarterly record, increasing 6% over the first quarter of 2009 and 4% over the prior year quarter. Revenues in the second quarter of 2009 improved over the first quarter of 2009, due in large part to revenues from the distribution of cardiac tissues, which were $6.5 million, increasing 16% over the first quarter of 2009, and revenues from the sale of HemoStase, which were a record $1.5 million, increasing 32% over the first quarter of 2009. See the "Results of Operations" section below for additional analysis of the second 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 June 30, 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 Statement of Financial Accounting Standards ("SFAS") statement No. 165, "Subsequent Events" ("SFAS 165") as of June 30, 2009. This statement establishes general standards of accounting and disclosure for events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The adoption of SFAS 165 did not have an effect on the financial position, profitability, or cash flows of the Company upon adoption.

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
                                        June 30,                    June 30,
                                    2009         2008         2009             2008

   Preservation services:
   Cardiac tissue                $     6,470   $  6,348            23%              23%
   Vascular tissue                     7,577      7,080            27%              26%
   Orthopaedic tissue                     44        297             -%               1%

   Total preservation services        14,091     13,725            50%              50%

   Products:
   BioGlue                            12,379     12,972            44%              48%
   HemoStase                           1,467        177             5%               1%
   Other medical devices                  72        131             -%               -%

   Total products                     13,918     13,280            49%              49%

   Other                                 154        150             1%               1%

   Total                         $    28,163   $ 27,155           100%             100%

                                                          Revenues as a Percentage of
                                    Revenues for the        Total Revenues for the
                                    Six Months Ended           Six Months Ended
                                        June 30,                   June 30,
                                    2009        2008         2009             2008

    Preservation services:
    Cardiac tissue                $  12,062   $ 12,586            22%              24%
    Vascular tissue                  15,448     13,939            28%              26%
    Orthopaedic tissue                  129        624             -%               1%

    Total preservation services      27,639     27,149            50%              51%

    Products:
    BioGlue                          24,143     24,859            44%              47%
    HemoStase                         2,577        177             5%               -%
    Other medical devices               143        224             -%               1%

    Total products                   26,863     25,260            49%              48%

    Other                               349        314             1%               1%

    Total                         $  54,851   $ 52,723           100%             100%

Revenues increased 4% for the three and six months ended June 30, 2009 as compared to the three and six months ended June 30, 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 and six months ended June 30, 2009 is presented below.

Cardiac Preservation Services

Revenues from cardiac preservation services increased 2% for the three months ended June 30, 2009 as compared to the three months ended June 30, 2008. This increase was primarily due to the aggregate impact of a 2% increase in unit shipments of cardiac tissues and the favorable effect of tissue mix, which together increased revenues by 3%, partially offset by a decrease in average service fees, which decreased revenues by 1%.

Revenues from cardiac preservation services decreased 4% for the six months ended June 30, 2009 as compared to the six months ended June 30, 2008. This decrease was primarily due to the aggregate impact of a 9% decrease in unit shipments of cardiac tissues, partially offset by the favorable effect of tissue mix, which together decreased revenues by 4%.

The increase in revenues from the net effect of volume and tissue mix for the three months ended June 30, 2009 was primarily due to an increase in shipments of aortic valves and CryoValve SG pulmonary valves, and to a lesser extent, an increase in

The decrease in revenues from the net effect of volume and tissue mix for the six months ended June 30, 2009 was primarily due to a decrease in shipments of standard processed pulmonary valves, largely offset by an increase in shipments of the CryoValve SG pulmonary valve. The remaining decrease was due to a decrease in shipments of non-valved cardiac tissues, partially offset by an increase in shipments of aortic valves. The Company believes that this decrease was primarily due to the first quarter impact of hospitals decreasing the number of valved cardiac tissues they keep on hand for urgent procedures as a result of the current economic conditions and their constraining effect on hospital budgets, partially offset by increases in second quarter tissue shipments as discussed above.

The decrease in average service fees for the three months ended June 30, 2009 was primarily due to fee decreases on the Company's aortic and pulmonary valves, due to the negotiation 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 8% for the three months and 14% for the six months ended June 30, 2009 as compared to the three and six months ended June 30, 2008, respectively. 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 changes in demand for certain types of tissues processed by the Company, the level of tissues currently available for shipment, changes in incoming tissue availability, and the likelihood that certain tissues will pass the Company's quality controls and testing processes. The decrease in cardiac procurement for the three and six months ended June 30, 2009 was primarily the result of changes in tissue acceptance criteria made during 2008. Based on these changes and additional changes planned for the remainder of 2009, the Company believes that cardiac procurement will continue at a lower level for the remainder of 2009 than seen in comparable prior year periods and in the first half of 2009. 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 cardiac tissues available for shipment and current procurement levels are sufficient to support anticipated future demand for cardiac tissues for the reasonably foreseeable future.

Although cardiac tissue shipments increased for the three months ended June 30, 2009 as compared to the prior year period, the Company's cardiac tissue shipments may be negatively impacted by current economic conditions and their constraining effect on hospital budgets in the second half of 2009.

Vascular Preservation Services

Revenues from vascular preservation services increased 7% for the three months ended June 30, 2009 as compared to the three months ended June 30, 2008. This increase was primarily due to a 7% increase in unit shipments of vascular tissues.

Revenues from vascular preservation services increased 11% for the six months ended June 30, 2009 as compared to the six months ended June 30, 2008. This increase was primarily due to an 11% increase in unit shipments of vascular tissues.

The increase in vascular volume for the three and six months ended June 30, 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, and aortoiliac grafts, primarily for use in treating abdominal aortic infection.

The Company's procurement of vascular tissues decreased 23% for the three months and 21% for the six months ended June 30, 2009 as compared to the three and six months ended June 30, 2008, respectively. 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 changes in demand for certain types of tissues processed by the Company, the level of tissues currently available for shipment, changes in incoming tissue availability, and the likelihood that certain tissues will pass the Company's quality controls and testing processes. The decrease in vascular procurement for the three and six months ended June 30, 2009, was primarily the result of changes in tissue acceptance criteria made during 2008 and 2009. Based on these changes and additional changes planned for the remainder of 2009, the Company believes that vascular procurement will continue at a lower level for the remainder of 2009 than seen in comparable prior year periods and in the first half of 2009. 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-

BioGlue

Revenues from the sale of BioGlue decreased 5% for the three months ended June 30, 2009 as compared to the three months ended June 30, 2008. This decrease was primarily due to a 5% decrease in the volume of BioGlue milliliters sold, which decreased revenues by 6% and the unfavorable impact of foreign exchange, which reduced revenues by 3%, partially offset by an increase in average selling prices, which increased revenues by 4%.

Revenues from the sale of BioGlue decreased 3% for the six months ended June 30, 2009 as compared to the six months ended June 30, 2008. This decrease was primarily due to a 2% decrease in the volume of BioGlue milliliters sold, which decreased revenues by 4% and the unfavorable impact of foreign exchange, which reduced revenues by 3%, partially offset by an increase in average selling prices, which increased revenues by 4%.

The decrease in BioGlue sales volume for the three and six months ended June 30, 2009 was primarily due to a decrease in shipments of BioGlue in domestic markets, as a result of the current economic conditions and their constraining effect on hospital budgets. Management believes that hospitals are attempting to control costs by reducing spending on items, such as BioGlue, that are consumed during surgical procedures.

The unfavorable impact of foreign exchange for the three and six months ended June 30, 2009 was due to changes in the exchange rates between the U.S. Dollar and both the British Pound and the Euro in the three and six months ended June 30, 2009 as compared to the same period in 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 increase in average selling prices for the three and six months ended June 30, 2009 was primarily due to list price increases on certain BioGlue products that went into effect during 2009 and the negotiation of pricing contracts with certain customers.

Domestic revenues accounted for 68% and 70% of total BioGlue revenues in the three months ended June 30, 2009 and 2008, respectively. Domestic revenues accounted for 70% and 71% of total BioGlue revenues in the six months ended June 30, 2009 and 2008, respectively.

The Company believes that domestic hospital cost cutting practices are likely to continue in the second half of 2009. Should these attempts to control costs continue, BioGlue revenues could be materially adversely affected.

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. If these exchange rates decrease in the second half of 2009 when compared to the weighted average exchange rates experienced by the Company in the prior year periods, the Company's revenues could be materially adversely affected. 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. The Company's revenues in 2009 could be materially adversely affected by declining demand from foreign customers who may be impacted by the higher price of BioGlue in their native currencies caused by the changes in exchange rates.

HemoStase

Revenues from the sale of HemoStase for the three and six months ended June 30, 2009 are a result of CryoLife's marketing and distribution of HemoStase, which began in the second quarter of 2008. The Company believes that HemoStase revenues will increase in the second half of 2009 as compared to the second half of 2008, as this product is in an early growth phase associated with the recent launch of distribution efforts for this product. However, revenues from HemoStase could be adversely impacted by the Company's lawsuit with Medafor. See

Other Revenues

Other revenues for the three and six months ended June 30, 2009 and the three months ended June 30, 2008 included revenues from research grants. Other revenues for the six months ended June 30, 2008 included revenues from research grants and revenues related to the licensing of the Company's technology to a third party.

Through June 30, 2009 CryoLife has received cash payments totaling $4.6 million for the DOD Grants and expects to receive the remaining $849,000 in cash payments over the next 12 months. The Company had $2.5 million remaining in unspent cash advances recorded as cash and cash equivalents and deferred income on the Company's Summary Consolidated Balance Sheet as of June 30, 2009.

Costs and Expenses

Cost of Preservation Services



                                                        Three Months Ended       Six Months Ended
                                                             June 30,                June 30,
                                                         2009         2008       2009        2008

Cost of preservation services                         $    8,027    $  7,449   $  15,518   $ 14,767
Cost of preservation services as a percentage of
preservation services revenues                               57%         54%         56%        54%

Cost of preservation services increased 8% for the three months and 5% for the six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, respectively.

The increase in cost of preservation services in the three and six months ended June 30, 2009 was primarily due to an increase in vascular tissues shipped as discussed above and due to an increase in the per unit costs of processing tissues. During the six months ended June 30, 2009 these increases were partially offset by a decrease in shipments of cardiac tissues.

The increase in cost of preservation services as a percentage of preservation services revenues for the three and six months ended June 30, 2009 was primarily due to the increase in the per unit costs of processing tissues. The Company expects this higher cost of preservation services as a percentage of preservation services revenues to continue for the remainder of 2009.

Cost of Products



                                                         Three Months Ended       Six Months Ended
                                                              June 30,                June 30,
                                                          2009         2008        2009       2008

Cost of products                                       $    2,241    $  1,840   $    4,203   $ 3,832
Cost of products as a percentage of product revenues          16%         14%          16%       15%

Cost of products increased 22% for the three months and 10% for the six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, respectively.

The increase in cost of products in the three and six months ended June 30, 2009 was primarily due to the increase in shipments of HemoStase, which the Company began distributing in the second quarter of 2008. Cost of products for the three and six months ended June 30, 2008 was negatively impacted by the write-down of other medical device inventory.

Cost of products as a percentage of product revenues increased for the three and six months ended June 30, 2009 as compared to the three and six months ended June 30, 2008, respectively. This increase was primarily due to the change in product mix during 2009, as HemoStase, a product with lower margins than BioGlue, comprises a larger percentage of product sales in 2009 than in the corresponding periods in 2008.

The Company expects that cost of products and cost of products as a percentage of product revenues will continue to be impacted by an increased volume of HemoStase revenues in the second half of 2009 when compared to the prior year periods.

General, Administrative, and Marketing Expenses



                                                        Three Months Ended       Six Months Ended
                                                             June 30,                June 30,
                                                         2009         2008       2009        2008

General, administrative, and marketing expenses       $    12,306   $ 12,358   $  25,054   $ 24,425
General, administrative, and marketing expenses as
a percentage of total revenues                                44%        46%         46%        46%

General, administrative, and marketing expenses were comparable for the three months and increased 3% for the six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, respectively.

The increase in general, administrative, and marketing expenses for the six months ended June 30, 2009 was primarily due to increases in marketing expenses, including increased personnel costs, partially related to an increase in sales force, and other marketing expenses to support the Company's efforts to increase its tissue preservation service and product offerings and current revenue growth.

The Company's expenses related to the grant of stock options and restricted stock awards were $579,000 and $702,000 and for the three months ended June 30, 2009 and 2008, respectively, and $1.1 million and $1.3 million for the six months ended June 30, 2009 and 2008, respectively. The Company's general, administrative, and marketing expenses included benefits for the reduction of tissue processing and product liability accruals of $495,000 and $610,000 for the three months ended June 30, 2009 and 2008, respectively, and $460,000 and $530,000 for the six months ended June 30, 2009 and 2008, respectively.

Research and Development Expenses



                                                         Three Months Ended       Six Months Ended
                                                              June 30,                June 30,
                                                          2009         2008        2009       2008

Research and development expenses                      $    1,367    $  1,307   $    2,393   $ 2,752
Research and development expenses as a percentage of
total revenues                                                 5%          5%           4%        5%

Research and development expenses for the three months ended June 30, 2009 were comparable to the three months ended June 30, 2008. The decrease in research and development expenses for the six months ended June 30, 2009 compared to the six months ended June 30, 2008 was primarily due to a decrease in spending on external research studies with third party research companies and academic organizations in the first quarter of 2009. 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 and aortic heart valves, CryoPatch SG non-valved cardiac tissues, and xenograft SynerGraft tissue products. PHT includes BioGlue, BioFoam®, BioDisc®, and related products.

Other Costs and Expenses

Interest expense was $61,000 and $69,000 for the three months ended June 30, 2009 and 2008, respectively, and $110,000 and $139,000 for the six months ended June 30, 2009 and 2008, respectively. Interest expense for the three and six months ended June 30, 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 $20,000 and $71,000 for the three months ended June 30, 2009 and 2008, respectively, and $63,000 and $193,000 for the six months ended June 30, 2009 and 2008, respectively. Interest income for the three and six months ended June 30, 2009 and 2008 was primarily due to interest earned on the Company's cash, cash equivalents, and marketable securities. The decrease in interest income in 2009 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 $1.7 million and $260,000 for the three months ended June 30, 2009 and 2008, respectively, and $3.1 million and $375,000 for the six months ended June 30, 2009 and 2008, respectively. Income tax expense during 2009 was recorded at the Company's effective tax rate of 41%. Income tax expense during 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.