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ARNALL GOLDEN GREGORY LLP
171 17TH STREET NW, SUITE 2100
ATLANTA, GEORGIA 30363-1031
Direct phone: 404.873.8622
Direct fax: 404.873.8623
E-mail: clark.fitzgerald@agg.com
www.agg.com
January 3, 2006
VIA FEDERAL EXPRESS AND EDGAR
Mr. Jim B. Rosenberg
Senior Assistant Chief Accountant
Division of Corporation Finance
100 F Street N.E.
Washington, D.C. 20549
RE: CRYOLIFE, INC.
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2004
FILED MARCH 3, 2005
FILE NO. 001-13165
Dear Mr. Rosenberg:
On behalf of CryoLife, Inc. ("CryoLife"), we transmit for filing CryoLife's
responses to the Staff's letter of comment dated December 16, 2005. For your
convenience, the comments contained in that letter are reprinted below in
italics. Unless otherwise indicated, all page references are to the Form 10-K
for the year ended December 31, 2004.
CryoLife's responses are as follows:
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION, PAGE F-9
1. Please provide us, in disclosure-type format your revenue
recognition policy related to grant revenue. We noted that you
received funds from the Department of Defense for the development
of BioFoam in the third quarter and you will begin recording
revenues related to this grant in the fourth quarter of 2005.
RESPONSE:
In the third quarter of 2005, CryoLife received $231,500 from the
Department of Defense ("DOD") for the development of BioFoam. As
of September 30, 2005, CryoLife had not incurred any expenses
related to this grant. In accordance with CryoLife's revenue
recognition policy as stated on page F-9 of its Form 10-K,
"Revenues from research grants are recognized in the period the
associated costs are incurred", CryoLife will recognize the
revenues as the related expenses are incurred which CryoLife
anticipates to begin during the fourth quarter of 2005 and
continue throughout 2006. Terms of the DOD grant require the
Company to use the grant proceeds to fund the development of
BioFoam.
Mr. Jim B. Rosenberg
January 3, 2006
Page 2
DEFERRED PRESERVATION COSTS, PAGE F-10
2. With regards to your accounting policy for preservation costs,
please provide us, additional discussion in disclosure-type
format, that explains the reason it is appropriate to defer
the costs until revenue is recognized upon shipment.
RESPONSE:
By federal law, human tissues cannot be bought or sold.
Therefore, the tissues CryoLife preserves and further
processes cannot be held as inventory. Tissue is procured from
deceased human donors by organ and tissue procurement
agencies, which consign the tissue to the Company for
processing and preservation. Although the Company cannot own
human tissue, the preservation process is a typical
manufacturing process that is accounted for based on guidance
provided in Accounting Research Bulletin #43 ("ARB 43")
Chapter 4, Inventory Pricing. Preservation costs related to
tissue held by the Company are deferred until revenue is
recognized upon shipment of the tissue to the implanting
facilities. Deferred preservation costs consist primarily of
direct labor and materials including laboratory expenses,
tissue procurement fees, freight-in charges and fringe
benefits, and indirect costs including allocations of costs
from departments that support processing activities and
facility allocations. Deferred preservation costs are stated
on a first-in, first-out basis.
Additionally, we refer to a similar comment (#7) issued in a
previous SEC comment letter dated February 6, 2002. That
comment was "Your policy states the preservation costs related
to tissue held by the Company are deferred until shipment to
the implanting hospital. You also say that you recognize
revenue as services are performed. It appears that you may be
recognizing revenue in advance of expensing the related costs.
Please tell us your basis under GAAP for deferring the
preservation costs."
Our response in a letter dated February 18, 2002 was as
follows, "By federal law, human tissues cannot be bought or
sold. Therefore, the tissues CryoLife preserves and further
processes cannot be held as inventory. However, both the
accumulation of the costs to process the tissues which are
recorded "deferred preservation costs" on the balance sheet
and the expensing of these costs as "cost of preservation
services" at the time of shipment closely mirrors inventory
and cost of sales as seen in a typical manufacturing
environment.
... [Revenues from] CryoLife's preservation services are
recognized when services are complete which is when the tissue
is shipped to the customer. The deferred preservation costs
and revenues associated with the tissue are recognized
together at the time of shipment. This policy of matching
revenues and expenses is consistent with Statement of
Financial Accounting Concepts #5 paragraph 86a."
3. Please tell us why it is appropriate to defer the preservation
costs since it appears based on the repeated write-offs that
you are unable to make reasonable estimates. We noted the
write-down for December 31, 2004 was $6.6 million and $1.3
million for the nine months ending September 30, 2005. In
addition, your disclosure on page 54 states "management
believes that its estimates approximate the actual costs of
these services." This appears to conflict with the explanation
provided on the same page that states "These charges reflect
the write-down of the value of certain deferred tissue
preservation costs that exceeded management's estimates of the
tissue's market value..." Please reconcile these statements.
RESPONSE:
As discussed in #2 above, the Company follows the accounting
guidance issued in ARB43. The write-down for December 31, 2004
of $6.6 million and for the nine months ending September 30,
Mr. Jim B. Rosenberg
January 3, 2006
Page 3
2005 of $1.3 million primarily reflected current period tissue
processing costs that exceeded current average service fees.
Current average service fees are used as a basis to determine
net realizable value of the tissues in accordance with ARB43.
(Human tissues cannot be bought or sold, so the terminology
average "service" fees is used rather than average sales price
that would typically be found in a manufacturing environment.)
The current period tissue processing costs exceeded market
value for certain tissues primarily due to lower throughput
and lower yields resulting from processing changes many of
which were initiated as a result of FDA notices of
observations, as discussed in Note 2 to the December 31, 2004
Form 10-K. CryoLife's continuing process improvement efforts
have resulted in increased yields since the low point in mid
2003 and early 2004, thus resulting in lower write-offs in
2005 as compared to 2004. Additionally, CryoLife has increased
its average service fees in 2005 and 2004, which has also
contributed to the lower write-off in 2005 as compared to
2004. We refer you to the December 31, 2004 Form 10-K pages 56
- 59 for the discussion of the effect of price increases by
product and page 60 under the header "Cost of Human Tissue
Preservation Services" for a discussion of causes for the
write-down and future anticipated effects of increases in the
amount of tissues processed, in increases in yields of
implantable tissue per donor, and in increases in average
service fees due to prices increases implemented in July 2004
and January 2005. Similar discussions are presented on pages
28-32 of the September 30, 2005 Form 10-Q.
Our disclosure on page 54 "Management believes that its
estimates approximate the actual costs of these services, ..."
refers to the timing differences of raw materials and services
related to deferred preservation costs that have been
received, but not invoiced as of the close of the reporting
period. In our disclosure "These charges reflect the
write-down of the value of certain deferred tissue
preservation costs that exceeded management's estimates of the
tissue's market value based on recent average service fees,"
we used the word "estimate" to reflect that we are using
current average service fees to reasonably predict future
anticipated market value of these tissues to determine if an
impairment exists under ARB43. As discussed above, the
write-downs are primarily due to current period processing
costs exceeding market value and not due to changes in
estimates. The 2005 10-K will clarify that the write-downs are
primarily due to excess current tissue processing costs that
exceed market value based on recent average service fees.
4. In addition, please refer to page 54. With regards to your
yield estimates, provide for us, in disclosure type format,
the change in estimates for the periods presented and the
reasons for the changes. If you deem these changes to be
immaterial, so state and tell us your basis for determining
materiality.
RESPONSE:
As the disclosure on page 54 states, "The Company applies a
yield estimate to all tissues in process and in quarantine to
estimate the portion of tissues that will ultimately become
implantable." Yield estimates are reviewed and determined
monthly. Tissue yields are derived from several factors, some
of which remain relatively constant over a period of time and
some of which are subject to more variation due to a variety
of factors.
Factors that are relatively constant include physical
anomalies of tissues, donor attributes, and results of
serological testing on blood samples. The Company uses
long-term historical data to determine an estimate of the
percentage of tissues that will be rejected related to these
factors.
The primary factor that is subject to more variability is
tissue rejections due to microbial contamination testing. From
2002 to 2005, the Company implemented several changes to its
processing procedures, some of which were a result of the FDA
Order and subsequent FDA activities as discussed in Note 2 of
the December 31, 2004 Form 10-K, and some of which were a
result of the Company's own processing improvement
initiatives. As a result of these changes, there was great
Mr. Jim B. Rosenberg
January 3, 2006
Page 4
variability in the percentage of tissues rejected, which
affects tissue yields, due to microbial contamination testing
during the period. Results of microbial testing are generally
received within 14-21 days. Therefore, at the end of each
reporting period, an estimate for tissue rejections related to
microbial contamination is made for those tissues processed
within 14-21 days of period end based on recent data of
microbial testing results.
Tissue yields resulting from the factors mentioned above in
2005, 2004, and 2003 were 52%, 46% and 41%, respectively. The
Company does not disclose yield factors in detail as they are
only one of many interrelated factors in the total
determination of deferred preservation costs. Other factors
include direct labor and materials including laboratory
expenses, tissue procurement fees, freight-in charges and
fringe benefits, and indirect costs including allocations of
costs from departments that support processing activities and
facility allocations, as disclosed on page F-11 of the
December 31, 2004 Form 10-K. See page 60 of the December 31,
2004 Form 10-K and page 32 of the September 30, 2005 Form 10-Q
under the header "Cost of Human Tissue Preservation Services"
for a discussion of the effect of implementation of process
changes and improvements in the Company's tissue processing
yields on cost of human tissue preservation services.
CryoLife acknowledges that:
o it is responsible for the adequacy and accuracy of the disclosure
in the filings;
o staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission from taking any action
with respect to the filings; and
o it may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal
securities laws of the United States.
If you have any questions, please do not hesitate to contact me at (404)
873-8622.
Very truly yours,
ARNALL GOLDEN GREGORY LLP
/s/ T. Clark Fitzgerald III
T. Clark Fitzgerald III
cc: Sasha Parikh, Staff Accountant
Mary Mast, Review Accountant
Steven G. Anderson