4. Hemosphere Acquisition

Overview

On May 16, 2012 CryoLife completed its acquisition of 100% of the outstanding equity of Hemosphere, a privately held company, for $17.0 million in cash, an additional $3.2 million to pay for cash acquired, and contingent consideration with a fair value estimated to be approximately $1.8 million at acquisition, for a total purchase price of approximately $22.0 million. CryoLife used cash on hand to fund the transaction and operates Hemosphere as a wholly owned subsidiary.

Hemosphere is the developer and marketer of the Hemodialysis Reliable Outflow Graft (“HeRO^® Graft”), a proprietary graft-based solution for end-stage renal disease hemodialysis patients with limited access options and central venous obstruction. CryoLife believes that the HeRO Graft will fit well into its product portfolio of medical devices for cardiac and vascular surgery and believes that there is a significant opportunity for CryoLife’s sales team to leverage their strong relationships with vascular surgeons to introduce and to expand utilization of the HeRO Graft in the U.S.

Contingent Consideration

As of the acquisition date, CryoLife recorded a contingent consideration liability of $1.8 million in long-term liabilities on its Summary Consolidated Balance Sheet, representing the estimated fair value of the contingent consideration expected to be paid to the former shareholders of Hemosphere upon the achievement of certain revenue-based milestones. The acquisition agreement provides for a maximum of $4.5 million in future consideration payments through December 2015 based on specified sales targets.

The fair value of the contingent consideration liability was estimated by discounting to present value the contingent payments expected to be made based on a probability-weighted scenario approach. The Company applied a risk-based estimate of the probability of achieving each scenario and then applied a cost of debt based discount rate of 8%. This fair value measurement is based on unobservable inputs, including management estimates and assumptions, and is, therefore, classified as Level 3 within the fair value hierarchy presented in Note 2 above. The Company will remeasure this liability at each reporting date and will record changes in the fair value of the contingent consideration in other expense (income) on the Company’s Summary Consolidated Statement of Operations and Comprehensive Income. Increases or decreases in the fair value of the contingent consideration liability can result from changes in discount periods and rates, as well as changes in the timing and amount of Company revenue estimates.

The Company recorded a loss of $37,000 and $62,000 for the three and nine months ended September 30, 2012, respectively, on the remeasurement of the contingent consideration liability. The balance of the contingent consideration liability was $1.9 million as of September 30, 2012.

Accounting for the Transaction

The Company has recorded a preliminary allocation of the $22.0 million purchase price to Hemosphere’s tangible and identifiable intangible assets acquired and liabilities assumed based on their fair values as of May 16, 2012. Goodwill has been recorded based on the amount by which the purchase price exceeds the fair value of the net assets acquired, and is not deductible for tax purposes. Goodwill from this transaction has been allocated to the Company’s medical devices segment. The preliminary purchase price allocation is as follows (in thousands):


	Opening
	Balance Sheet
Cash and cash equivalents	$	3,155
Receivables		653
Inventories		554
Intangible assets		5,790
Goodwill		7,080
Deferred tax assets, net		5,444
Other assets		331
Liabilities assumed		(972)
Total purchase price	$	22,035

The preliminary allocation of the purchase price to intangible assets is based on preliminary valuations performed to determine the fair value of such assets as of the acquisition date. The Company may adjust the amounts recorded as of September 30, 2012 to reflect any revised evaluations of the assets acquired or liabilities assumed.

CryoLife incurred transaction and integration costs related to the acquisition of approximately $702,000 for the three months and $1.7 million for the nine months ended September 30, 2012. These costs were expensed as incurred and were primarily recorded as general, administrative, and marketing expenses on the Company’s Summary Consolidated Statement of Operations and Comprehensive Income.

Pro Forma Results

Hemosphere’s revenues of $2.0 million from the date of acquisition for the nine months ended September 30, 2012 are included in the Summary Consolidated Statement of Operations and Comprehensive Income. The Company’s selected unaudited pro forma results of operations for the nine months ended September 30, 2012 and 2011, assuming the Hemosphere acquisition had occurred as of January 1, 2011 are presented for comparative purposes below. These amounts are based on available information of the results of operations of Hemosphere prior to the acquisition date and are not necessarily indicative of what the results of operations would have been had the acquisition been completed on January 1, 2011. This unaudited pro forma information does not project operating results post acquisition. This pro forma information is as follows (in thousands, except per share amounts):


	Nine Months Ended
	September 30,
	2012		2011
Total revenues	$	100,922	$	93,269
Net income		6,376		2,287

Pro forma income per common share - basic	$	0.23	$	0.08
Pro forma income per common share - diluted	$	0.23	$	0.08

Pro forma results for the nine months ended September 30, 2011 include the Company’s acquisition and integration related costs of approximately $1.7 million, on a pre-tax basis, and other costs as appropriate. Pro forma disclosures were calculated using a tax rate of approximately 38%.