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# CryoLife Inc. Message Board

• dlhild@ymail.com dlhild Nov 15, 2012 2:16 PM Flag

## Return on Invested Capital (ROIC):

The following analysis uses CY 2011 data. This analysis is a bit tricky, but I will attempt to do it in a way I consider reasonable.

ROIC is a commonly used financial profitability metric. A person can calculate the ROIC and directly get a sense as to how efficiently a company is using its capital (debt + equity). It is one of the best metrics for comparing companies across industry groups. Frequently ROIC is used in conjunction with the Weighted Average Cost of Capital (WACC). If a company is effectively using their capital based, the ROIC should be greater than their WACC.

Let’s do some analysis. Smart Money calculated CRY’s ROIC to be 5.78%. FINVIZ calculated CRY’s ROIC to be 5.96%. A fairly close CY 2011 calculation would divide after tax net income of \$7,371,000 by the 12/31/2012 total equity of \$121,538,000. This calculates a ROIC of 6%. So it is pretty well established that CRY’s ROIC (lumping all cost centers together) is close to 6%. The WACC is more complex, so I’m going to use an internet WACC calculator and then perhaps adjust that number to something I consider more reasonable. One calculator I found was thatswacc. This site calculated CRY’s WACC to be 10.6%. If I were making this calculation, I would have used a slightly lower risk free rate, a slightly lower market rate, and a beta of one. My guess at a pretty good WACC for CRY would be slightly lower, perhaps 8% in today’s market. In either case though, CRY’s ROIC is less than its WACC, meaning that CRY as a company (e.g. all cost centers lumped together) IS NOT USING ITS CAPITAL EFFICIENTLY.

IMO CRY should not be analyzed as one aggregate company. To keep it simple, yet get things pretty close, I divided CRY into three cost centers. Then I calculated the ROIC for each cost centers. Let’s break CRY into the following three cost centers: “Preservation Services”, “BioGlue”, and “Everything Else”.

The “Preservation Services” cost center appears to operate at a net after tax loss. Let’s keep it simple and say the after tax income was \$0. We know that, as of 12/31/2011, \$29 million in “Deferred Preservation Costs” were allocated to this cost center.

We know that the “Everything Else” cost center has roughly the following equity allocations: \$11 million to PerClot, \$22 million to Cardiogenesis, and \$4 million to ValveXchange. These numbers total \$37 million.
If we use a simple equity allocation method, we start with \$122 million in equity on 12/31/2012. If we subtract off \$29 for the “Preservation Services” cost center and \$37 million for the “Everything Else” cost center, we are left with \$56 million in unallocated equity (\$122 - \$29 - \$37 = \$56). If we divide \$56 million by 3 and allocate 1/3 to each cost center, we end up allocating \$19 million in unallocated equity to each of the three cost centers.

ROIC for the “Preservation Services” cost center then becomes \$0 divided by \$48 million, which equals 0%. In other words CRY has roughly \$50 million invested in a cost center that does not seem to make any money. This cost center has a potential liability tail too.

ROIC for the “BioGlue” cost center is \$7,371,000 divided by \$19 million equity = 39%. Note here that the ROIC of 39% greatly exceeds CRY’s 8% WACC. This means that capital is being very efficiently used at this cost center.

ROIC for the “Everything Else” cost center is 0%. The “Everything Else” cost center probably has \$0 net after tax income (I guessed at income based upon low sales numbers for these early stage products) divided by \$58 million equity (\$37 + \$19 = \$58). In fairness to CRY, it is still too early to determine whether these new products will ultimately generate an acceptable ROIC. It will take a year, perhaps two, in order to make this profitability determination.

Conclusion: The “Preservation Services” cost center seems to be a walking talking financial net operating income disaster. It inefficiently ties up approximately \$50 million in equity, yet the result still appears to be a net operating loss. Flash back to 2001 and the Lykins matter. For this reason, it is clear that this cost center still has a potentially liability tail. This cost center has tied up \$50 million in equity, has used an estimated 40% of employee time, has a potential liability tail, and the end result is still a “net operating loss”.

So Steve, what are your plans for the “Preservation Services” cost center? Are you going to sell it? Cannibalize it and then close it? Increase margins? Control operating expenses? Why do you expose CRY to liability risk when the cost center does not seem to make any money? How are you going to generate an acceptable ROIC from the “Preservation Services” cost center?

Give the above analysis some thought. Then ask yourself if the unprofitability of the “Preservation Services” cost center may not be at least part of the reason why CRY stock has not appreciated much in recent years.

Crunch your own numbers. You are responsible for doing your own due diligence.

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