It would seem that this management principle would lend itself to explanation, discussion and illustration at tomorrow’s Lazard Markets Conference.
The “preservation services” cost center, mainly cardiac and vascular tissue, is a great operational example of this principle. Let me explain.
I’m, guessing that some of you have seen a gerbil running on a spinning wheel. The gerbil runs in one direction, but the wheel spins at the same exact speed in the opposite direction. The faster the gerbil runs, the faster the wheel spins, with the same result. The gerbil always stays at the same place at the bottom of the spinning wheel.
Let's look at the “preservation services” cost center. Q3 2012 “preservation services” sales were $16,399,000 ($8,239,000 cardiac tissue plus $8,160,000 vascular tissue). Hence, this cost center represented 49% of total Q3 2012 sales (total “preservation services” sales of $16,399,000 divided by total sales $33,429,000). So total “preservation services” sales were $16,399,000 less related COGS of $9,005,000 (extracted directly from Q3 2012 earnings report) resulted in a gross margin for the “preservation services” cost center of $7,394,000. Total operating expense for the quarter was $18,362,000 (extracted directly from Q3 2012 earnings report). If we allocate 49% of total operating expenses (using the prorate allocation method) to the this cost center, we end up subtracting $8,997,000 in operating expenses from the $7,394,000 in “preservation services” gross margin, which results in a net operating loss of ($1,603,000). If we credit back taxes at 40%, arguably the net operating loss drops to ($962,000). I’m not sure the above analysis is correct, but it appears close enough for this purpose. Note: To date, nobody has ever numerically explained to me any flaw in the foregoing analysis.
So what’s the point? The point is that the “preservation services” cost center, at least on the surface, seems to be similar to a gerbil running on a spinning wheel. No matter what happens at the “preservation services” cost center, the margins are so low, and the related operating expenses so high, that the cost center seems to operate at a net operating loss no matter what happens. If sales go up, the cost center still seems to generate a net operating loss. Thus, the “preservation services” cost center is a metaphorical gerbil. The “preservation Services” cost center spins the wheel (higher sales with an equal offset in direct and operating costs), but stays in the same place (still doesn’t generate much, if any, net operating loss).
If the “preservation services” cost center does have net operating income number, it would likely be a very small net operating income number. Think of all those CRY employees sitting at their desks spinning the sales wheel faster and faster, but all the time going nowhere. Think too of how this negatively affects sales of other higher margin products. A salesperson gerbil has to meet tissue sales quotas ($0 net operating profit cost center), resulting in that salesperson gerbil having less time to sell high net operating income products like BioGlue.
If my math is somehow flawed, then someone should use CRY’s financial data numbers to explain to me what part of my analysis is flawed. Note too that if operating expenses are allocated differently, each dollar that is shifted way form the “preservation services” cost center then reduces the net operating income at a different cost center by the exact same amount (perhaps yet another example of “The Gerbil Principle”). Given this though, I don’t see how SA can explain away what appears evident. The fact that the “preservation services” cost center does not seem to generate much (if any) net operating income.
In addition, this cost center may have a liability tail too, making the situation even more difficult to comprehend.
Check the numbers yourself, as you all are responsible for doing your own due diligence.