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CRY > SEC Filings for CRY > Form 10-Q on 30-Apr-2014All Recent SEC Filings

Show all filings for CRYOLIFE INC

Form 10-Q for CRYOLIFE INC


30-Apr-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

CryoLife, Inc. ("CryoLife," the "Company," "we," or "us") develops, manufactures, and commercializes medical devices for cardiac and vascular applications and preserves and distributes human tissues for transplantation. CryoLife's surgical sealants and hemostats include BioGlue® Surgical Adhesive ("BioGlue"), BioFoam® Surgical Matrix ("BioFoam"), and PerClot®, a powdered hemostat, which the Company distributes internationally for Starch Medical, Inc. ("SMI"). CryoLife's subsidiary, Cardiogenesis Corporation ("Cardiogenesis"), specializes in the treatment of coronary artery disease using a laser console system and single-use, fiber-optic handpieces to treat patients with severe angina. CryoLife and its subsidiary, Hemosphere, Inc. ("Hemosphere"), market the Hemodialysis Reliable Outflow Graft ("HeRO® Graft"), which is a solution for end-stage renal disease ("ESRD") in certain hemodialysis patients. The cardiac and vascular human tissues distributed by CryoLife include the CryoValve® SG pulmonary heart valve ("CryoValve SGPV") and the CryoPatch® SG pulmonary cardiac patch tissue ("CryoPatch SG"), both of which are processed using CryoLife's proprietary SynerGraft®technology.

During or shortly after the quarter ended March 31, 2014 CryoLife reported several new business developments, which are expected to help drive the future growth of the Company's medical device business. In February 2014 CryoLife announced the establishment of a new entity, CryoLife Asia Pacific Pte. Ltd. ("CryoLife Asia Pacific"), to expand the Company's presence in the rapidly growing Asia-Pacific medical device market. In March 2014 CryoLife entered into an exclusive agreement to distribute ProCol® Vascular Bioprosthesis ("ProCol"), a bioprosthetic vascular graft used to treat ESRD. Also in March 2014 CryoLife received from the U.S. Food and Drug Administration ("FDA") approval of its investigational device exemption ("IDE") for PerClot, which will allow the Company to begin enrollment in its pivotal U.S. PerClot clinical trial. In April 2014 CryoLife received 510(k) clearance from the FDA to market PerClot Topical, which CryoLife intends to launch in the second quarter of 2014 for use initially in ear, nose, and throat ("ENT") procedures. Each of these developments is discussed further in Recent Events below. In addition, the Company hosted its third Central Venous Pathology Summit from March 25 through 27, 2014. The event examined treatment strategies for durable hemodialysis access in cases of central venous pathology, with an emphasis on treatment algorithms to both preserve and salvage central veins and a hands-on practicum. This summit underscores CryoLife's continuing commitment to the treatment of patients with ESRD.

Also during the quarter ended March 31, 2014 the Company received a Form 483, Notice of Inspectional Observations, from the FDA that included observations regarding design and process validations, environmental monitoring, product controls and handling, and employee training. See the "Regulatory Activity" section below for further details.

For the quarter ended March 31, 2014 CryoLife reported record first quarter revenues of $35.7 million, a 1% increase over the quarter ended March 31, 2013. This increase was primarily due to an increase in cardiac tissue preservation services revenues, largely offset by a decrease in revascularization technologies revenues.

See the "Results of Operations" section below for additional analysis of the three months ended March 31, 2014.

Recent Events

CryoLife Asia Pacific

In February 2014 CryoLife announced the establishment of CryoLife Asia Pacific, a wholly owned subsidiary of CryoLife, to expand the Company's presence in the rapidly growing Asia-Pacific medical device market. To support this new subsidiary, CryoLife relocated Mr. Rich Gridley, Vice President Sales, Canada, Asia-Pacific, and The Americas, to a new regional headquarters in Singapore. In addition to his previous responsibilities, Mr. Gridley assumed the position of general manager, CryoLife Asia Pacific. He will manage CryoLife's sales expansion, product registrations, and new product introductions in the Company's Asia-Pacific distribution network, including Japan and China.

ProCol Distribution Agreement

In March 2014 CryoLife acquired the exclusive worldwide distribution rights for ProCol, from Hancock Jaffe Laboratories, Inc. ("Hancock Jaffe"). The agreement between CryoLife and Hancock Jaffe (the "HJ Agreement") has an initial three-year term and is renewable for two one-year periods at CryoLife's option. Per the terms of the HJ Agreement, CryoLife has the option to acquire the ProCol product line from Hancock Jaffe beginning in March 2016.


ProCol, which is approved for sale in the U.S., is a biological graft derived from a bovine mesenteric vein that provides vascular access for ESRD hemodialysis patients. It is intended for the creation of a bridge graft for vascular access subsequent to at least one previously failed prosthetic access graft. ProCol is complementary to CryoLife's HeRO Graft, which also serves patients with ESRD. ProCol provides vascular access for earlier-stage ESRD patients, while HeRO Graft is designed for patients with limited access options and central venous obstruction.

CryoLife will make payments to Hancock Jaffe of up to $2.3 million during 2014, with no more than $650,000 payable in any quarter. The first payment of $430,000 was made in the first quarter of 2014. In exchange for these payments, CryoLife will receive a designated amount of ProCol inventory for resale, including a small amount of existing commercially salable inventory and additional inventory as it is manufactured and after Hancock Jaffe receives FDA approval of the Premarket Approval ("PMA") Supplement associated with its new manufacturing facilities. Subsequent to this initial inventory purchase, CryoLife can purchase additional units from Hancock Jaffe at an agreed upon transfer price.

PerClot

In March 2014 CryoLife received approval of its IDE for PerClot from the FDA. This approval allows the Company to begin its pivotal clinical trial to gain approval to commercialize PerClot in the U.S. The Company plans to begin enrollment in the trial in the second quarter of 2014 and could potentially receive PMA from the FDA by the end of 2015.

The PerClot IDE is a prospective, multicenter, multidisciplinary, controlled clinical investigation. The study will include 324 patients across cardiac, general, and urological surgical specialties. The primary objective of this investigation will be to collect clinical data concerning the safety and efficacy of PerClot versus C.R. Bard, Inc.'s ("Bard") Arista MPH Hemostat in multiple surgical disciplines when used as an adjunct to conventional means of achieving hemostasis such as pressure or ligature. The primary efficacy endpoint of this investigation will be achievement of hemostasis at the site of application at five minutes following application of the prescribed hemostatic agent. The secondary efficacy endpoint for this investigation will be hemostasis at the site of application evaluated at two minutes. Safety endpoints will include, but are not limited to, the incidence of reoperation due to bleeding, total hospitalization and procedure time, and the incidence of procedure complications and/or adverse events through final patient follow-up at three months.

In April 2014 CryoLife received 510(k) clearance from the FDA to market PerClot Topical in the U.S. PerClot Topical is a version of the Company's PerClot product, which will be manufactured by the Company at its headquarters and labeled for use in certain topical indications. CryoLife intends to launch PerClot Topical in the second quarter of 2014 initially for use in ENT procedures. PerClot Topical is a hemostat composed of absorbable polysaccharide granules and is intended for use as a topical dressing for the temporary treatment of mildly bleeding wounds such as surgical wounds, including post-operative, donor sites, and dermatological, cuts and lacerations, and for the treatment of mild bleeding from topical ENT surgical wounds and nosebleeds. It is also indicated for control of bleeding from the skin at percutaneous needle access, vascular access, and percutaneous catheter access sites.

As discussed in Part II, Item 1, Legal Proceedings of this Form 10-Q, in April 2014, the Company filed a declaratory judgment action against Bard and certain of its subsidiaries, including Medafor, Inc., in federal court, requesting that the court confirm that CryoLife's anticipated sales of PerClot, when it is approved by the FDA, and certain of its derivative products, such as PerClot Topical, which has been cleared by the FDA, will not infringe upon the patent held by Bard and/or that the Bard patent is invalid.

Regulatory Activity

In January 2013 CryoLife received a warning letter ("Warning Letter") from the FDA. The Warning Letter followed a Form 483, Notice of Inspectional Observations, from the FDA ("2012 CryoLife Form 483"), related to a routine quality system inspection of the Company's facilities by the FDA in September and October 2012.

In February and March 2014 the FDA re-inspected the Company to review the Company's actions and responses to the Warning Letter and to conduct a quality system inspection. Following this re-inspection, on March 20, 2014 CryoLife received a Form 483, Notice of Inspectional Observations, from the FDA ("2014 CryoLife Form 483"). The 2014 CryoLife Form 483 included observations concerning design and process validations, environmental monitoring, product controls and handling, corrective and preventive actions, and employee training.

The Company responded timely to the 2014 CryoLife Form 483 on April 10, 2014, and communications with the FDA related to these observations are ongoing. As part of the Company's response to the 2014 CryoLife Form 483, the Company voluntarily changed the expiration dating of its BioGlue 5 ml syringe from 24 months to 18 months. The Company will re-label BioGlue 5 ml product that has not reached the 18-month expiration and will replace BioGlue 5 ml product that has exceeded the 18-month expiration. The Company temporarily postponed shipments of certain cardiac and vascular tissues while it performed a voluntary review of its internal training programs.


The Company recorded an impairment to its deferred preservation costs in the first quarter of 2014 related to this review and has subsequently resumed shipments of tissues in accordance with its procedures. The Company does not believe that any of these actions will have a material impact on the Company's financial statements.

The Company believes that the changes it has implemented, and will implement, will adequately address the FDA's observations; however, it is possible that the Company may not be able to do so in a manner satisfactory to the FDA, and the FDA could issue a warning letter or take other enforcement or regulatory actions, including requiring a recall or manufacturing hold. Although the Company currently believes that the 2014 CryoLife Form 483 will not have a material effect on the Company, it is nonetheless possible that actions it may be required to take in response to the 2014 CryoLife Form 483 could materially, adversely affect the Company's revenues, financial condition, profitability, or cash flows.

Critical Accounting Policies

A summary of the Company's significant accounting policies is included in Note 1 of the "Notes to Consolidated Financial Statements," contained in the Company's Form 10-K for the year ended December 31, 2013. 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., which require the Company to make estimates and assumptions. The Company did not experience any significant changes during the quarter ended March 31, 2014 in any of its Critical Accounting Policies from those contained in the Company's Form 10-K for the year ended December 31, 2013.

New Accounting Pronouncements

There were no new accounting pronouncements relevant to the Company that management anticipates implementing during the year ending December 31, 2014.


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,

                                            2014                   2013                 2014                   2013

Products:
BioGlue and BioFoam                    $       15,240        $        15,464                  43%                    44%
PerClot                                           916                    864                   2%                     2%
Revascularization technologies                  1,684                  2,191                   5%                     6%
HeRO Graft                                      1,615                  1,277                   4%                     4%

Total products                                 19,455                 19,796                  54%                    56%

Preservation services:
Cardiac tissue                                  7,190                  6,645                  20%                    19%
Vascular tissue                                 9,086                  9,032                  26%                    25%

Total preservation services                    16,276                 15,677                  46%                    44%

Other                                              --                     63                  --%                    --%

Total                                  $       35,731        $        35,536                 100%                   100%

Revenues increased 1% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. A detailed discussion of the changes in product revenues and preservation services revenues for the three months ended March 31, 2014 is presented below.

Products

Revenues from products decreased 2% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. The decrease was primarily due to a decrease in revascularization technologies revenues. A detailed discussion of the changes in product revenues for BioGlue and BioFoam; PerClot; revascularization technologies; and HeRO Graft is presented below.

The Company's sales of products through its direct sales force to U.K. hospitals are denominated in British Pounds, and its sales to German, Austrian, and Irish hospitals and certain distributors are denominated in Euros and are, therefore, subject to changes in foreign exchange rates. If the exchange rates between the U.S. Dollar and the British Pound and/or Euro decline materially in the future, this would have a material, adverse effect on the Company's revenues denominated in these currencies.

BioGlue and BioFoam

Revenues from the sale of surgical sealants, consisting of BioGlue and BioFoam, decreased 1% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. This decrease was primarily due to a 4% decrease in the volume of milliliters sold, which decreased revenues by 3%, partially offset by an increase in average sales prices, which increased revenues by 1%, and the favorable effect of foreign currency exchange, which increased revenues less than 1%.

The decrease in sales volume of surgical sealants for the three months ended March 31, 2014 was primarily due to a decrease in shipments of BioGlue in certain international markets, partially offset by an increase in the Company's domestic markets. The decrease in international sales of BioGlue was primarily due to decreased sales to Japan and to Latin America due to variability in ordering patterns from quarter-to-quarter.

Revenues from shipments to Japan were $1.6 million for the three months ended March 31, 2014, as compared to $2.4 million for the three months ended March 31, 2013. Management currently believes that BioGlue sales will be positively affected by increased shipments to Japan for the full year 2014, as compared to 2013, although this increase will be less than the increase experienced in 2013 over 2012. Management is currently seeking expanded indications for BioGlue in Japan and regulatory


approval for BioGlue in China and, if successful, believes this will provide additional international growth opportunities for BioGlue in future years.

Domestic revenues accounted for 56% and 52% of total BioGlue revenues for the three months ended March 31, 2014 and 2013, respectively. BioFoam sales accounted for less than 1% of surgical sealant sales for each of the three months ended March 31, 2014 and 2013. BioFoam is currently approved for sale in certain international markets.

PerClot

Revenues from the sale of PerClot increased 6% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. This increase was primarily due to a 19% increase in the volume of grams sold, which increased revenues by 10% and the favorable effect of foreign currency exchange, which increased revenues 2%, partially offset by a decrease in average selling prices, which decreased revenues 6%.

Revenues during these periods were for sales in certain international markets, as PerClot is not yet approved for domestic distribution, except as discussed below, or for widespread international distribution. These increases were primarily due to increased sales in the Company's markets in Europe, partially due to growth in both new geographies and new surgical indications. The Company expects that overall PerClot revenues will increase in 2014, as compared to 2013; however, revenues may show some variability from quarter-to-quarter.

In March 2014 CryoLife received approval of its IDE for PerClot from the FDA. This approval allows the Company to begin its pivotal clinical trial to gain approval to commercialize PerClot in the U.S. The Company plans to begin enrollment in the trial in the second quarter of 2014 and could potentially receive PMA from the FDA by the end of 2015.

In April 2014 CryoLife received 510(k) clearance for PerClot Topical from the FDA, which allows CryoLife to begin commercialization of PerClot Topical in the U.S. The Company plans to begin shipping PerClot Topical in the second quarter of 2014.

Revascularization Technologies

Revenues from revascularization technologies include revenues related primarily to the sale of handpieces and, in certain periods, revenues from the sale of laser consoles. Revenues from revascularization technologies decreased 23% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. Revenues from the sale of laser consoles were $57,000 and zero for the three months ended March 31, 2014 and 2013, respectively. Revenues from the sale of handpieces decreased 28% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013, primarily due to a 29% decrease in unit shipments of handpieces. Revenues from the sale of handpieces decreased 2% for the three months ended March 31, 2014, as compared to the three months ended December 31, 2013.

In June 2013 the FDA approved the Company's new handpiece design, and the Company made the decision to exclusively distribute the new handpiece beginning late in the second quarter of 2013. Following the rollout of the new handpiece, the Company's handpiece revenues decreased sequentially in the third and the fourth quarters of 2013, due to the slower than anticipated adoption of the new handpiece design. This decrease in handpiece revenues slowed in the first quarter of 2014. Management currently believes that handpiece sales will increase slightly in the second quarter of 2014, as compared to the first quarter of 2014, as the new handpiece becomes more widely used and adopted, but will decrease as compared to the second quarter of 2013.

The amount of revenues from laser console sales can vary significantly from quarter-to-quarter due to the long lead time required to generate sales of capital equipment.

HeRO Graft

Revenues from HeRO Grafts include revenues related to the sale of vascular grafts, venous outflow components, and accessories, which are generally sold together as a kit. HeRO Grafts are primarily distributed in domestic markets as a solution for ESRD in certain hemodialysis patients. HeRO Graft revenues for the three months ended March 31, 2014 increased 26%, as compared to the three months ended March 31, 2013, primarily due to an increase in the volume of kits sold as a result of an increase in procedure volume and an increase in the number of implanting physicians.

Management currently expects that overall HeRO Graft revenues will increase in 2014, as compared to 2013. As the HeRO Graft implant is currently performed by a relatively small number of physicians, HeRO Graft revenues are subject to variability quarter-to-quarter due to the timing of surgical cases. As the population of implanting physicians increases, the Company expects this variability in revenues will decrease.


Preservation Services

Revenues from preservation services increased 4% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. The increase in revenues for the three month period was primarily due to an increase in cardiac tissue service revenues during the period. A detailed discussion of the changes in cardiac and vascular preservation services revenues is presented below.

Preservation services revenues, particularly revenues for certain high demand tissues, can vary from quarter-to-quarter and year-to-year due to a variety of factors including: quantity and type of incoming tissues, yields of tissue through the preservation process, timing of receipt of donor information, timing of the release of tissues to an implantable status, demand for certain tissue types due to the number and type of procedures being performed, and pressures from competing products or services. See further discussion of any specific items affecting cardiac and vascular preservation services revenues for the three months ended March 31, 2014 below.

Cardiac Preservation Services

Revenues from cardiac preservation services, consisting of revenues from the distribution of heart valves and cardiac patch tissues, increased 8% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. This increase was primarily due to an increase in average service fees, which increased revenues by 6%, and a 4% increase in unit shipments of cardiac tissues, which increased revenues by 2%.

The increase in average service fees for the three months ended March 31, 2014 was primarily due to list price increases in domestic markets that took effect in July 2013 and due to the routine negotiation of pricing contracts with certain customers.

During the three months ended March 31, 2014 the Company's revenues from shipments of cardiac tissues into Europe were $148,000 as compared to $361,000 in the corresponding period in 2013. The Company ceased the distribution of tissues into Europe as of March 31, 2014.

Revenues from SynerGraft processed tissues, including the CryoValve SGPV and CryoPatch SG, accounted for 58% and 50% of total cardiac preservation services revenues for the three months ended March 31, 2014 and 2013, respectively. Domestic revenues accounted for 95% and 91% of total cardiac preservation services revenues for the three months ended March 31, 2014 and 2013, respectively.

The Company's cardiac valves are primarily used in cardiac replacement and reconstruction surgeries, including the Ross procedure, for patients with endocarditis or congenital heart defects.

The Company expects that overall cardiac preservation services revenues in 2014 will be comparable to the revenues in 2013, notwithstanding the cessation of shipments to Europe.

Vascular Preservation Services

Revenues from vascular preservation services increased 1% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. This increase was primarily due to an increase in average service fees, which increased revenues by 7%, largely offset by a 7% decrease in unit shipments of vascular tissues, which decreased revenues by 6%.

The increase in average service fees for the three months ended March 31, 2014 was primarily due to list fee increases in domestic markets that took effect in July 2013, fee differences due to physical characteristics of vascular tissues, and the routine negotiation of pricing contracts with certain customers.

The decrease in vascular volume for the three months ended March 31, 2014 was primarily due to decreases in shipments of saphenous veins and, to a lesser extent, femoral arteries. The Company believes that the decrease in unit shipments of veins was primarily due to the timing of tissue releases for shipments to domestic markets as compared to the prior year periods, which can vary as discussed above.

The majority of the Company's vascular preservation services revenues are related to shipments of saphenous veins, which are mainly used in peripheral vascular reconstruction surgeries to avoid limb amputations. These tissues are primarily distributed in domestic markets.


Cost of Products and Preservation Services

Cost of Products

Three Months Ended
March 31,
2014 2013

Cost of products $ 3,801 $ 3,465

Cost of products increased 10% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. Cost of products in 2014 and 2013 includes costs related to BioGlue, BioFoam, PerClot, revascularization technologies, and HeRO Grafts.

The increase in cost of products in the three months ended March 31, 2014 was primarily due to the increase in the per unit cost of manufacturing HeRO Grafts, as a result of the transfer of manufacturing to a new location and lower manufacturing throughput. To a lesser extent, the increase was due to an increase in the per unit costs of manufacturing BioGlue, partially offset by a decrease in the sales volume of revascularization technologies handpieces.

Cost of Preservation Services

Three Months Ended
March 31,
2014 2013

Cost of preservation services $ 9,457 $ 8,795

Cost of preservation services increased 8% for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. Cost of preservation services includes costs for cardiac and vascular tissue preservation services. . . .

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