Artivion Inc (AORT) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the CryoLife second quarter financial conference call. At this time, all participants are in listen-only mode, and the floor will be open for questions following the presentation. It is my pleasure to turn the floor over to your host, Mr. Steve Anderson, Chief Executive Officer. Sir, the floor is yours.

Good morning, everyone. This is Steve Anderson, the CEO of CryoLife. I would like to welcome you to CryoLife's second quarter and first half conference call. With me today is Ashley Lee, the company's Vice President of Finance and Chief Financial Officer; and Clinton Richardson, a partner with the company's legal counsel, Arnall Golden & Gregory.

This morning, we'll be commenting on the company's operating results for the second quarter and first half of '03. The agenda for today's call is as follows: first, Ashley will comment on this morning's press release, and will get into the detail of the numbers. Second, Mr. Richardson will comment on various litigation and insurance issues. Then I will follow Mr. Richardson with comments on international operations, BioGlue revenues, SynerGraft AV Access graft results, Allograft tissue revenues, and certain FDA matters relating to SynerGraft issues. After my comments, Ashley will give some financial guidance going forward. And after the guidance comments, we will then open up the conference call for questions. At this time, Ashley will comment on this morning's press release.

Thanks, Steve. First of all, I'd like to read the following statement. In order to comply with the Safe Harbor requirements of the Private Securities Litigation Reform Act of 1995, I'd like to make the following statement. Comments made in this call which look forward in time involve risks and uncertainties and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include statements made as to the company's or management's intentions, hopes, beliefs, expectations, or predictions of the future.

All statements made during this call that do not reflect historical results or information should be deemed to be forward-looking statements. It is important to note that the company's actual results could differ materially from those projected in such forward-looking statements. Additional information concerning risks and uncertainties is contained from time to time in the company's SEC filings, including the risk factor section of our form 10-K for the year ended December 31, 2002.

This presentation may contain information such as revenues prior to adjustment to estimated tissue recall returns and pro forma net loss per share that are deemed to be non-GAAP measures pursuant to regulation G promulgated by the SEC. A reconciliation of the measures to the most closely applicable GAAP measure is contained in the company's press release issued this morning which has been posted on the company's Web site.

This morning, CryoLife reported financial results for the second quarter and six months ended June 30, 2003. Revenues as reported for the three and six months period were 15.7 and 31.6 million, compared to 23.3 and 48.7 million in the corresponding periods in the prior year. Revenues as reported for the six months ended June 30, 2003 include $848,000 in favorable adjustments related to estimated tissue recall returns. Revenues as reported for the six months ended June 30, 2002, include 2.4 million in estimated tissue recall returns. Revenues excluding these items increased 4% in the second quarter of 2003 compared to the first quarter of 2003.

Reported net loss for the three and six months ended June 30, 2003, were $22.3 million or $1.14 per share and $22.8 million or $1.16 per share. This compares to losses of 5.5 million, or $28 cents per share, and $2.4 million, or $13 cents per share, in the corresponding periods in the prior year. The above amounts including the following items recorded in 2002. One, a recall reserve of 2.4 million recorded in the second quarter of 2002. Two, the write-off of a net of $8.9 million of tissues associated with the recall in the second quarter of 2002.

The numbers also include the following items recorded in 2003: an adjustment to the recall reserve of $848,000, which effectively increased revenue in the first quarter of 2003; two, the effects of the shipment of tissues previously written off in 2002 of $3.4 million; three, the personal injury loss accrual of 12.5 million in the second quarter of 2003; and four, the valuation allowance against deferred tax assets of 11.4 million in the second quarter of 2003.

Reported cost of human tissue preservation services as a percentage of reported human tissue preservation service revenues were 60% for the three months ended June 30, 2003, compared to 98.8% for the three months ended June 30, 2002, and were 43% for the six months ended June 30, 2003, as compared to 600 -- 67%, excuse me, for the six months ended June 30, 2002.

Cost of human tissue preservation services as reported for the three and six months ended June 30, 2003, include an increase to costs of preservation services related to lower of cost or market write-downs of 1.1 million and 1.4 million, respectively. And it includes the favorable effect of shipments of tissue with a zero cost basis of 1 million and 3.4 million, respectively. Cost of human tissue preservation services revenues as reported for the three and six months ended June 30, 2002, include a $10 million-write-down of deferred preservation costs offset by $1.1 million-decrease in cost to preservation services due to estimated tissue returns.

Cost of preservation services, as a percentage of revenues, increased over historical levels primarily due to changes in processing methods and higher overhead cost allocations associated with the decreased volume of tissues processed. We believe that once the issues with the FDA are resolved, cost of human tissue preservation as a percentage of revenues will decrease as compared to current levels.

BioGlue revenues were 6.8 million and 13 .3 million for the three and six months ended June 30, 2003, compared to 5.3 and 10.1 million in the corresponding periods in 2002. BioGlue revenues in the second quarter of 2003 increased 30% over the second quarter of 2002, and 5% over the first quarter of 2003. Total tissue processing revenues were 8.6 million in the second quarter of 2003 compared to 8.3 million in the first quarter of 2003, excluding $848,000 in favorable adjustments to the recall reserve, and compares to 6.3 million in the fourth quarter of 2002.

Cardiac revenues were 5 million for the second quarter of 2003, compared to 4.6 million in the first quarter of 2003, excluding $92,000 in favorable adjustments to the estimated tissue recall returns, and compared to 3.3 million in the fourth quarter of 2002. Vascular revenues were 3.3 million for the second quarter of 2003, compared to 3.5 million in the first quarter 2003, excluding $711,000 in favorable adjustments to the estimated tissue recall returns, and compared to 2.9 million in the fourth quarter of 2002.

Orthopedic revenues were $280,000 for the second quarter of 2003, compared to $150,000 in the first quarter of 2003, which includes $45,000 in favorable adjustments to the estimated tissue recall returns and compared to 108,000 in the fourth quarter of 2002.

General administrative and marketing expenses increased to 23.5 million for the three months ended June 30, 2003, compared to 11.4 million for the three months ended June 30, 2002. This also compares to 11.6 million in the first quarter of 2003 and 15.4 million in the fourth quarter of 2002. The increase from the prior year was primarily due to an accrual of $9 million for the potential expense to resolve ongoing product liability claims in excess of insurance coverage and 3.9 million for unreported product liability claims related to services performed and products sold prior to June 30, 2003, and $150,000 for deductibles under our prior-year policies.

Additional increases in general and administrative expenses were due to an increase of approximately 1.3 million and 3.3 million, respectively, in professional fees due to increased litigation, litigation settlement costs, and issues surrounding the FDA order, and an increase of approximately 179,000 and 488,000, respectively, in insurance premiums.

We periodically assess the recoverability of deferred tax assets and provide a valuation allowance when management believes it is more likely than not that its deferred tax assets will not be realized. We evaluated several factors to determine if a valuation allowance relative to our deferred tax assets was necessary. Based on the results of this analysis, the company has determined that it's more likely than not that the company's deferred tax assets will not be realized and recorded a valuation allowance of $11.4 million against deferred tax assets as of June 30, 2003.

The company was notified by its bank that it intends to require the company to enter into a forbearance agreement which would increase the interest rate charged on our $4.5 million-term loan to live (ph) order plus 4% and accelerate the principal payments on the term loan by requiring a balloon payment to pay off the outstanding balance by October 31, 2003. The company has sufficient cash and cash equivalents to pay the remaining outstanding balance of the term loan.

Based on the analysis of the product liability cases now pending against the company, the company recorded a liability of 9 million for the estimated potential expense of resolving these cases and reflecting the estimated uninsured portion of the liability. These amounts do not reflect actual settlement arrangements or judgments against the company nor do they represent a cash reserve. The company engaged in independent actuarial firm to estimate the loss for product liability claims incurred and not reported during the 2002- 2003 policy year. Based on the review of the actuarial analysis, the company recorded an additional liability of $3.9 million to increase the total accrual to 7.5 million for estimated cost for unreported product claims related to services performed and products sold prior to June 30, 2003.

The company also engaged in independent actuarial firm to estimate the loss for product liability claims incurred and not reported during the 2003-2004 policy year. Based on the review of the actuarial analysis, the company believes that its 2003-2004 insurance coverage is adequate to defend against claims incurred and reported during the 2003-2004 insurance year. Now I'll turn it over to Clint Richardson for a summary of ongoing litigation.

Thanks, Ashley. Clinton Richardson, the company's legal counsel, will now comment on various legal and insurance matters.

As of August 1, 2003, approximately 21 personal injury lawsuits were opened. Of the 21 open cases, two lawsuits were filed in the 2000-2001 insurance policy year. Four were filed in the 2001-2002 insurance policy year. 14 were filed in the 2002-2003 insurance policy year, and one was filed in the 2003-2004 policy year.

For the 2000-2001 and 2001-2002 insurance policy years, the company maintained claims made insurance policies, which management believes to be adequate to defend against the suits filed during those periods. For the 2002-2003 insurance policy year, the company maintained claims made insurance policies with three carriers. Two of the three insurance companies who issued policies for the 2002-2003 year have confirmed coverage for the first two layers of coverage totaling $15 million. However, most of this coverage has already been used to defend and settle lawsuits. A third insurance company covering the last $10 million of the remaining insurance has indicated that it intends to exclude 11 matters under its policy. The company is evaluating its alternatives in regards to resolving the issues with the third carrier.

The company filed a motion to dismiss the consolidated shareholders lawsuit, which the U.S. district court denied in part and granted in part. The discovery phase of the case commenced on July 16, 2003. The company carries directors' and officers' liability insurance policies, which the company believes to be adequate to defend this action. As you know, two lawsuits against the individual officers and directors have been filed by shareholders derivatively on behalf of the company.

Last year, the company's board of directors established an independent committee to investigate and report on the allegations made in those two lawsuits. The independent committee, which engaged independent experts and legal counsel to assist in its study, has now completed its extensive investigation and reported to the board of directors. The report concludes that no officer or director breached any fiduciary duty and recommends that the board of directors seek to have the lawsuits dismissed.

The company's total BioGlue revenues were 13.3 million for the first six months of 2003, up 32% over the first six months of last year. The majority of our international sales are BioGlue sales and international sales of BioGlue are up 35% year to year. BioGlue is approved in international markets for all vascular sealing and for the sealing of air leaks in lungs. It is also being increasingly used in Europe and Canada where it is approved for the sealing of dura mater in both spinal surgery and brain surgery.

A number of papers have been accepted for publication on the various uses of BioGlue, and the papers are positive. Particularly positive is a paper co-authored by professor Andrew Kay of Melbourne, Australia, documenting the successful use of BioGlue in 216 patients in a clinical study on dura sealing. There was also a recent paper published of our six-center IDE study of the use of BioGlue in 151 patients for the reduction of anastomotic bleeding, an approved indication in the U.S. and internationally. The study concluded that BioGlue is a safe and effective adjunct to standard repair methods, and reduces anastomotic site bleeding in cardiac and vascular repair patients.

Domestic BioGlue sales are up 31% year to year, and we continue our development efforts for other forms of BioGlue and BioGlue products. The foam version of the product is currently being evaluated as a means of controlling endoleaks in endovascular abdominal aortic grafts. We are also investigating the use of BioGlue in hernia repair. This hernia repair application, IDE application, is scheduled to be submitted to the FDA in late 2004.

Our Japanese distributor has completed the clinical trial of BioGlue, and the Japanese ministry of health continues to evaluate post clinical studies and the follow-up of the clinical trials. We don't know when BioGlue might be approved in Japan.

A number of papers have been published recently on the SynerGraft bovine ureter vascular graft for AV Access that is approved in the European union. We have now implanted about a hundred model-100 vascular grafts in humans with promising results. We are planning to submit an IDE for the model-100 vascular graft to the FDA in the second half of 2004.

Cardiovascular allograft tissues, both allograft valves and vascular grafts, continue their recovery from the effects of the August '02 recall. Excluding the $92,000-adjustment to the recall reserve in the first quarter of 2003, the second quarter revenues for cardiovascular allograft preservation are up 9% over the first quarter of '03, and 53% over the fourth quarter of '02. We are still discussing SynerGraft-processed allografts with the FDA. While they have not made their final decision, it appears that we will have to file either a 510K or an IDE for the SynerGraft-processed allografts heart valves. It appears to us right now that the SynerGraft-processed allograft vascular grafts will be classified as banked human tissue. Both of these assumptions may prove to be incorrect, however.

Dr. Hawkins of Salt Lake City recently published a paper in the "Journal of Thoracic and Cardiovascular Surgery" that discussed his experience with 14 SynerGraft-processed allografts, both heart valves and conduits, and compared the SynerGraft-processed allografts to a historical control group of 20 standard processed allografts. The results showed at one year that patients with standard processed allografts had average PRA levels. Now, PRA stands for panel reactive anti-bodies. They had an average PRA level of 73%, while patients receiving SynerGraft-processed allografts had PRA levels of only 8%. The significance of this data is that it appears that SynerGraft-processed allografts have a reduced antigenic response in comparison to standard processed allografts.

As you'll recollect, we began shipping non-boned ligaments and tendons to a limited number of our accounts in late February and early March of '03. I'm pleased to announce that we have notified our customers that we would begin shipping boned orthopedic tissues on August 1. Although it is too soon to comment on our effectiveness in re-entering the orthopedic allograft market, we remain optimistic. Our orthopedic technical and support management is in place, and we have about 105 independent orthopedic technical representatives who will be contacting accounts in the near future.

We also continue to re-staff the company since last year's recall and subsequent 105-person layoff in September of '02. During the first half of '03, we have re-staffed 30 positions throughout the company, many of whom were rehires of people employed prior to the layoff. We expect this trend to continue for the foreseeable future. We now have a total of 305 people working at CryoLife both in the United States and in international markets.

Procurement of tissues remains strong, and it is continuing to increase month to month. In the fourth quarter of '02, we averaged 286 hearts per month and 214 vascular tissues per month. During that quarter, we were not accepting any orthopedic tissues for processing. During the second quarter of '03 we averaged 307 hearts per month, and in the second quarter of '03 we averaged 411 vascular grafts per month. Our orthopedic procurement during the second quarter averaged 201 tissues per month. At this time, Ashley will give some guidance for the rest of the year.

We believe that we will be able to generate approximately 65 to 67 million in revenues during 2003. This is a revision from our previous forecast of approximately 70 million. The change is necessary due to delays in the resumption of shipping our full line of orthopedic tissues, delays in getting SynerGraft-processing issues resolved with the FDA and yield issues.

Gross margins in large part will be determined by allograft processing levels for the remainder of the year, future tissue yields, the number of shipments of tissues previously written off, and the percentage of revenues generated from the sale of BioGlue surgical adhesive. Currently, we are not able to project gross margins with a great degree of accuracy, but we expect they will be less than the gross margin percentages posted during the first half of the year,

Consistent with the previous guidance, we believe that SG&A expenses will be at the high end of the $42 million to $46 million range that was communicated in previous conference calls, excluding the charges in the second quarter of 12.5 million related to product liability accruals. The ultimate level of G&A expenses is highly dependent on the timing of the resolution of regulatory issues, legal issues, and other items. That concludes my comments, and I'll turn it back over to Steve.

At this time, we'd like to open up the conference call for questions.

Thank you. The floor is now open for questions. If you do have a question, press one followed by four on your touch-tone telephone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. Once again, that's one followed by four. On your touch tone telephone at this time. The first question comes from Tom Gunderson of Piper Jaffray. Please state your question.

Hi. Good morning. Just a little bit more on vascular sales and the changes in guidance. You did have some guidance for Q2 that fell a little short. It looks like it was mostly in vascular sales. Could you comment on that? Were there any assumptions on demand or procurement that proved to be wrong in Q2, or was there something else going on?

There were two issues, Tom, that led to the shortfall in vascular and the decrease compared to the first quarter of this year. First of all, in the first quarter of this year, we still had available a lot of prescription tissue. Those are tissues processed between October of '01 and August of '02 that were still available for us to ship. And by and large, we were depending upon those tissues to drive first quarter revenues.

On the surface, if you look at vascular procurement, which increased 53% during the second quarter, it would lead one to believe that the revenues would have increased sequentially. However, there were a couple of issues there. First of all, it takes us approximately 60 days to get tissues through our systems, so some of the increase that you saw in our vascular procurement will really help us in the third quarter of this year. The other issue, which is just a little bit out of our control at this point was the yield issue related to how much implantable issue we are able to get out of the procurement. We expect that once we get these issues resolved with the FDA that the yields will increase on all of our tissues across the board so that we'll be able to hopefully meet the projections that we have set forth for the remainder of the year.

Are you able to explain a little bit more about yield and FDA?

I will say that we are working on several things with the FDA right now, a lot of which will probably affect yields going forward. I really don't want to comment in much detail about specifically what we're working on with the FDA.

Okay. And then as a bridge to the FDA, there's a lot of update here, but there are also a lot of people that you've got there that might be able to answer. Is there any new news as far as the February '03 notice with the FDA?

I don't have any new news on that, Tom. We have a meeting with the FDA on those issues August 7. We continue to work our way through those issues. And I would expect that some time in the fall, we will be re-inspected by them in regard to the 483 from February, but we never know when they're going to inspect us, and they never tell us in advance. So, I can't be more definite than that.

Okay. Just clarification, the meeting on 8/7, is that in Washington or Atlanta?

It's in Atlanta at the district office.

Okay. Then last question, BioGlue guidance is basically just doubling the first half. Is that a matter of being conservative, or is there a certain supply/demand wall that we have hit for this year and it will go up again next year?

The third quarter is particularly slow in Europe, and Europe accounts for roughly 20% of our sales right now because so many people are on vacation. If you look historically in the last year or two, revenues have not increased much sequentially in the third over the second quarter because of that very issue. Then seasonally just with the holidays and everything coming up in the fourth quarter, we are hopefully just being a little bit conservative. We don't really think it's any reflection on any slowdown in demand at all.

Good. Thank you.

Thank you. The next question is coming from Rob Holesy (ph) of Flack Rock Capital (ph). Please state your question.

Yes, thank you. Do you have any idea -- has it been indicated at all how many more lawsuits might be pending against the company or soon to be filed?

No. I don't think we -- this is Clint Richardson. We don't have any particular information we can share about that. We tried to be inclusive in our original comments.

In your -- the comments of one filed in the '03 to-'04 year, when does that year start? Is it mid year?

It started April 1.

April 1. So there's been one filed since April 1?

Yes. I will say that we have settled approximately five cases at this time, and four have been dismissed. Of the five that we have settled, it is our opinion that they --three of those five were -- some of them were serious cases that were facing the company.

So if you have settled five cases, and the insurance coverage so far has taken up about $12.5 million, are those the right numbers to use, as we think about kind of the magnitude?

That is correct.

Those numbers also include the cost of defense.

It does include the cost of defense?

Yes.

Ok. That was my main question. In one other question, you mentioned 60 days to work through your process so you did expect some of those vascular issue that was procured in the second quarter to go through in the third quarter. Do you normally see a seasonal slowdown of tissue sales in the third quarter with vacations and stuff?

No. You actually see the opposite, especially as it relates to cardiac tissues, because a lot of the congenital surgery, pediatric surgery, is done during the summer months when the kids are out of school, so you would typically expect to see cardiac revenues increase. We really don't see much seasonality as it relates to vascular tissues and orthopedic tissues.

Great. One final question. It's actually escaping me right now. I'll get back in queue if I think of it. Thanks.

We have time left for one last question from Song Yi (ph) of Janney Montgomery Scott. Please state your question.

Yes. On July 25th of this year, California sixth court of appeal's decision on (inaudible) liability against you, the appeal court favored all of the rules to you, and on page 12 of the court decision, it mentions it might be possible that national law might be concerned with that. And my question to you is what kind of precedent can this ruling apply to the other jurisdictions?

I don't have that in front of me, but I think what you are referring to is a reference to an appellate court case in another jurisdiction other than California that cited-- what that court found is a general statement of law around the country which is that the issue of strict liability would not apply to a service company, instead service companies are measured against a standard of negligence -- you know, doctors are measured by a negligence standard called malpractice. So I think that's what you're referring to, the statement of that court that that's a general rule throughout the country. And that certainly, from our perspective, is good news. Not unexpected, but good news.

Thank you.

I'm sorry. We do not have any time left. I'd like to turn the floor back to the speakers.

Thank you very much for joining us. And we will talk you to in about 90 days.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.