Business context and reporting period
Registrant: CryoLife, Inc. (the filing identifies the company as CryoLife, not Artivion). This unaudited Form 10-Q covers the quarter ended March 31, 2014, with comparisons to the quarter ended March 31, 2013. CryoLife develops and sells cardiac and vascular medical devices and preserves and distributes human tissues for transplantation.
Financial performance and liquidity
Amounts below are in millions of dollars except per-share data. Quarterly income and cash-flow figures are compared year over year; balance-sheet figures compare March 31, 2014 with December 31, 2013.
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Revenue | $35.7 | $35.5; up 1% |
| Gross margin | $22.5; 63% of revenue | $23.3; 65% of revenue |
| Operating income | $1.7 | $3.3 |
| Net income | $1.1 | $2.2 |
| Diluted earnings per share | $0.04 | $0.08 |
| Operating cash flow | $(2.0) | $(1.2) |
| Capital expenditures | $1.0 | $1.0 |
| Cash and cash equivalents | $32.8 | $37.6 at Dec. 31, 2013 |
| Restricted cash and securities | $5.7 | $5.4 at Dec. 31, 2013 |
| Current assets / current liabilities | $105.9 / $18.4 | $106.3 / $20.7 at Dec. 31, 2013 |
| Net working capital | $87.5 | $85.6 at Dec. 31, 2013 |
| Borrowings under GE credit facility | $0; $20.0 available | $0 at Dec. 31, 2013 |
Interest expense was $61,000 versus $50,000. The effective tax rate rose to approximately 39% from 28%, partly because the 2014 research and development tax credit had not been enacted by quarter-end. Cash declined $4.9 million during the quarter; financing activities used $1.1 million, including $772,000 in dividends. No cash was used for repurchases under the announced program in the quarter.
Material changes versus the prior comparable period
- Revenue growth was modest: preservation services rose 4% to $16.3 million, while product revenue fell 2% to $19.5 million. Cardiac tissue services rose 8%; vascular tissue services rose 1%.
- Product trends were mixed: HeRO Graft revenue increased 26% to $1.6 million and PerClot increased 6% to $0.9 million. BioGlue and BioFoam declined 1% to $15.2 million; revascularization technologies fell 23% to $1.7 million.
- Gross margin decreased 3% in dollars, as total costs of products and preservation services increased 8% to $13.3 million. Management cited lower manufacturing and tissue-processing throughput, higher material costs, and increased HeRO Graft unit manufacturing costs.
- Operating expenses increased 4% to $20.8 million. Research and development expense increased 26% to $2.5 million, primarily for PerClot clinical work and tissue processing. Operating income fell to $1.7 million from $3.3 million; net income declined to $1.1 million from $2.2 million.
- Operating cash use increased, with working capital affected by a $2.7 million increase in receivables, a $1.1 million cash outflow from payables and accruals, and an $821,000 increase in inventory and deferred preservation costs.
Outlook, management commentary, risks, and unusual items
- Outlook: Management expected 2014 PerClot and HeRO Graft revenues to increase from 2013, and cardiac preservation revenue to be comparable to 2013. It expected general, administrative, and marketing expense to increase and R&D spending to increase materially, including for PerClot trials. These are expectations, not quantified financial guidance.
- Product and commercial developments: The company established a Singapore-based Asia-Pacific subsidiary and obtained exclusive worldwide distribution rights for ProCol, with payments to Hancock Jaffe of up to $2.3 million during 2014. FDA approval of Hancock Jaffe’s manufacturing-facility supplement is needed for additional ProCol inventory. CryoLife planned to begin enrolling 324 patients in its pivotal U.S. PerClot trial in Q2 2014, with potential PMA by the end of 2015. FDA 510(k) clearance for PerClot Topical was received in April 2014, after quarter-end; launch was planned for Q2.
- FDA observations: Following a February–March inspection, CryoLife received a March 20, 2014 Form 483 citing observations involving validation, environmental monitoring, product controls and handling, corrective actions, and employee training. The company responded in April. It shortened the expiration dating of BioGlue 5 ml syringes from 24 to 18 months, and temporarily postponed certain tissue shipments while reviewing training. It reported an impairment to deferred preservation costs related to the review but did not state its amount clearly. Tissue shipments subsequently resumed. Further FDA action, including a recall or manufacturing hold, could materially harm results.
- Patent litigation: In April 2014, CryoLife filed a declaratory judgment action against Bard and affiliates concerning the alleged infringement of Bard’s patent by PerClot and related products. Management expected the litigation to be protracted and its 2014 costs to be material; an adverse outcome could restrict sales or result in damages or royalties.
- Liquidity and financing: Management believed cash, cash equivalents, and anticipated operating cash would meet operational liquidity needs for at least 12 months. The $20 million GE facility expires October 28, 2014; the company was covenant-compliant and had no borrowings at quarter-end. $5 million of cash was restricted as facility collateral. The company said future cash needs include clinical trials, litigation, ProCol, business development, dividends, and possible repurchases, and it may seek borrowing capacity or financing.
- Other exposures: CryoLife’s $2 million secured loan to ValveXchange may not be recoverable; the borrower was not selling products and required further funding. In April 2014, CryoLife waived prior loan defaults in exchange for 10% of Series B proceeds above $1.25 million. The company also disclosed $1.5 million of estimated unreported liability claims (with related insurance recoveries of $595,000); its actuarial estimate could be as high as $2.7 million including a statistical margin. A $2.1 million accrued CEO voluntary-retirement benefit was recorded.
- Contingent and contractual obligations: Reported contractual obligations totaled $37.9 million, including operating leases, purchase commitments, contingent payments, compensation, and research obligations. Separately, the filing cited $2.7 million of estimated uncertain tax positions, interest, and penalties whose timing and amount could not be reliably estimated.
Most important facts for investors to verify
- Whether the FDA accepts CryoLife’s corrective actions and whether the Form 483 or earlier Warning Letter leads to further restrictions, recalls, or costs; also quantify the deferred preservation-cost impairment if available.
- Progress, costs, and regulatory timing for the PerClot pivotal trial and PerClot Topical launch, including the outcome and expense of the Bard patent litigation.
- Whether lower manufacturing throughput and higher unit costs improve, and whether product and preservation-service revenue trends meet management’s 2014 expectations.
- Liquidity after planned clinical, litigation, ProCol, dividend, business-development, and repurchase spending, particularly as the GE credit facility approaches its October 2014 expiration.
- Collectability of the ValveXchange loan, realization of any Medafor contingent proceeds, and the timing and amount of contingent obligations.