e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
|
|
|
þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
OR
|
|
|
o |
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 000-51567
NxStage Medical, Inc.
(Exact Name of Registrant as Specified in Its Charter)
|
|
|
Delaware
(State or Other Jurisdiction of Incorporation or
Organization)
|
|
04-3454702
(I.R.S. Employer Identification No.) |
|
|
|
439 S. Union St., 5th Floor, Lawrence, MA
(Address of Principal Executive Offices)
|
|
01843
(Zip Code) |
(978) 687-4700
(Registrants Telephone Number, Including Area Code)
(Former Name, Former Address, and Former Fiscal year, If Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ
No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes
þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
|
|
|
|
|
|
|
Large accelerated filer o
|
|
Accelerated filer þ
|
|
Non-accelerated filer o
|
|
Smaller reporting company o |
|
|
|
|
(Do not check if a smaller reporting company) |
|
|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
There
were 55,201,471 shares of the registrants common stock outstanding as of the close of
business on October 28, 2011.
NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2011
TABLE OF CONTENTS
2
PART I FINANCIAL INFORMATION
|
|
|
Item 1. |
|
Financial Statements (unaudited) |
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2011 |
|
|
2010 |
|
|
|
(In thousands, except share data) |
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
101,247 |
|
|
$ |
104,339 |
|
Accounts receivable, net |
|
|
17,497 |
|
|
|
14,107 |
|
Inventory |
|
|
35,563 |
|
|
|
34,950 |
|
Prepaid expenses and other current assets |
|
|
3,104 |
|
|
|
2,084 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
157,411 |
|
|
|
155,480 |
|
Property and equipment, net |
|
|
14,276 |
|
|
|
8,290 |
|
Field equipment, net |
|
|
12,718 |
|
|
|
13,660 |
|
Deferred cost of revenues |
|
|
41,355 |
|
|
|
40,081 |
|
Intangible assets, net |
|
|
23,314 |
|
|
|
25,412 |
|
Goodwill |
|
|
42,698 |
|
|
|
42,698 |
|
Other assets |
|
|
1,497 |
|
|
|
473 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
293,269 |
|
|
$ |
286,094 |
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
19,195 |
|
|
$ |
16,811 |
|
Accrued expenses |
|
|
16,265 |
|
|
|
19,537 |
|
Current portion of long-term debt |
|
|
|
|
|
|
43 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
35,460 |
|
|
|
36,391 |
|
Deferred revenues |
|
|
56,682 |
|
|
|
55,366 |
|
Long-term debt |
|
|
42,521 |
|
|
|
40,454 |
|
Other long-term liabilities |
|
|
6,994 |
|
|
|
1,754 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
141,657 |
|
|
|
133,965 |
|
Commitments and contingencies (Note 10) |
|
|
|
|
|
|
|
|
Stockholders equity: |
|
|
|
|
|
|
|
|
Undesignated preferred stock: par value
$0.001, 5,000,000 shares authorized; no
shares issued and outstanding as of
September 30, 2011 and December 31, 2010 |
|
|
|
|
|
|
|
|
Common stock: par value $0.001,
100,000,000 shares authorized; 55,617,552
and 54,043,317 shares issued as of
September 30, 2011 and December 31, 2010,
respectively |
|
|
55 |
|
|
|
53 |
|
Additional paid-in capital |
|
|
485,191 |
|
|
|
465,642 |
|
Accumulated deficit |
|
|
(325,264 |
) |
|
|
(308,426 |
) |
Accumulated other comprehensive income |
|
|
146 |
|
|
|
85 |
|
Treasury stock, at cost: 480,923 and
325,104 shares as of September 30, 2011
and December 31, 2010, respectively |
|
|
(8,516 |
) |
|
|
(5,225 |
) |
|
|
|
|
|
|
|
Total stockholders equity |
|
|
151,612 |
|
|
|
152,129 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
293,269 |
|
|
$ |
286,094 |
|
|
|
|
|
|
|
|
See accompanying notes to these condensed consolidated financial statements.
3
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
|
|
|
|
|
|
(In thousands, except per share data) |
|
|
|
|
|
Revenues |
|
$ |
55,903 |
|
|
$ |
45,033 |
|
|
$ |
160,235 |
|
|
$ |
129,449 |
|
Cost of revenues |
|
|
36,363 |
|
|
|
30,073 |
|
|
|
103,797 |
|
|
|
88,914 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
19,540 |
|
|
|
14,960 |
|
|
|
56,438 |
|
|
|
40,535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing |
|
|
9,446 |
|
|
|
8,452 |
|
|
|
28,025 |
|
|
|
25,034 |
|
Research and development |
|
|
3,388 |
|
|
|
3,132 |
|
|
|
10,694 |
|
|
|
9,369 |
|
Distribution |
|
|
4,709 |
|
|
|
3,788 |
|
|
|
13,298 |
|
|
|
10,831 |
|
General and administrative |
|
|
5,708 |
|
|
|
6,023 |
|
|
|
16,750 |
|
|
|
16,604 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
23,251 |
|
|
|
21,395 |
|
|
|
68,767 |
|
|
|
61,838 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(3,711 |
) |
|
|
(6,435 |
) |
|
|
(12,329 |
) |
|
|
(21,303 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
|
(1,186 |
) |
|
|
(1,176 |
) |
|
|
(3,513 |
) |
|
|
(3,432 |
) |
Other (expense), net |
|
|
(146 |
) |
|
|
(341 |
) |
|
|
(342 |
) |
|
|
(128 |
) |
|
|
|
(1,332 |
) |
|
|
(1,517 |
) |
|
|
(3,855 |
) |
|
|
(3,560 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss before income taxes |
|
|
(5,043 |
) |
|
|
(7,952 |
) |
|
|
(16,184 |
) |
|
|
(24,863 |
) |
Provision for income taxes |
|
|
235 |
|
|
|
212 |
|
|
|
654 |
|
|
|
556 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(5,278 |
) |
|
$ |
(8,164 |
) |
|
$ |
(16,838 |
) |
|
$ |
(25,419 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share, basic and diluted |
|
$ |
(0.10 |
) |
|
$ |
(0.17 |
) |
|
$ |
(0.31 |
) |
|
$ |
(0.54 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding,
basic and diluted |
|
|
54,428 |
|
|
|
48,049 |
|
|
|
53,953 |
|
|
|
47,501 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to these condensed consolidated financial statements.
4
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
|
(In thousands) |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(16,838 |
) |
|
$ |
(25,419 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
17,415 |
|
|
|
16,879 |
|
Stock-based compensation |
|
|
10,166 |
|
|
|
10,985 |
|
Other |
|
|
2,387 |
|
|
|
1,750 |
|
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(3,414 |
) |
|
|
(303 |
) |
Inventory |
|
|
(15,196 |
) |
|
|
(20,504 |
) |
Prepaid expenses and other assets |
|
|
(2,067 |
) |
|
|
(327 |
) |
Accounts payable |
|
|
2,296 |
|
|
|
(3,376 |
) |
Accrued expenses and other liabilities |
|
|
195 |
|
|
|
3,980 |
|
Deferred revenues |
|
|
1,316 |
|
|
|
14,087 |
|
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(3,740 |
) |
|
|
(2,248 |
) |
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Purchases of property and equipment |
|
|
(3,330 |
) |
|
|
(981 |
) |
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(3,330 |
) |
|
|
(981 |
) |
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Proceeds from stock option and purchase plans |
|
|
6,471 |
|
|
|
5,552 |
|
Purchase of treasury stock |
|
|
(2,533 |
) |
|
|
(1,741 |
) |
Repayments on loans and lines of credit |
|
|
(46 |
) |
|
|
(42 |
) |
Net cash provided by financing activities |
|
|
3,892 |
|
|
|
3,769 |
|
|
|
|
|
|
|
|
Foreign exchange effect on cash and cash equivalents |
|
|
86 |
|
|
|
(286 |
) |
|
|
|
|
|
|
|
(Decrease) increase in cash and cash equivalents |
|
|
(3,092 |
) |
|
|
254 |
|
Cash and cash equivalents, beginning of period |
|
|
104,339 |
|
|
|
21,720 |
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
101,247 |
|
|
$ |
21,974 |
|
|
|
|
|
|
|
|
Noncash Investing Activities |
|
|
|
|
|
|
|
|
Transfers from inventory to field equipment |
|
$ |
13,432 |
|
|
$ |
15,612 |
|
|
|
|
|
|
|
|
Transfers from field equipment to deferred cost of revenues |
|
$ |
9,663 |
|
|
$ |
15,999 |
|
|
|
|
|
|
|
|
See accompanying notes to these condensed consolidated financial statements.
5
NXSTAGE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Nature of Operations
We are a medical device company that develops, manufactures and markets innovative products
for the treatment of kidney failure, fluid overload and related blood treatments and procedures.
Our primary product, the NxStage System One, or System One, was designed to satisfy an unmet
clinical need for a system that can deliver the therapeutic flexibility and clinical benefits
associated with traditional dialysis machines in a smaller, portable, easy-to-use form that can be
used by healthcare professionals and trained lay users alike in a variety of settings, including
patient homes, as well as more traditional care settings such as hospitals and dialysis clinics.
Given its design, the System One is particularly well-suited for home hemodialysis and a range of
dialysis therapies including more frequent, or daily, dialysis, which clinical literature
suggests provides patients better clinical outcomes and improved quality of life. The System One is
cleared or approved for commercial sale in the United States, Europe, Canada and other select
markets for the treatment of acute and chronic kidney failure and fluid overload. The System One
is cleared specifically by the United States Food and Drug Administration, or FDA, for home
hemodialysis as well as therapeutic plasma exchange, or TPE, in a clinical environment. We also
sell needles and blood tubing sets primarily to dialysis clinics for the treatment of end-stage
renal disease, or ESRD. These products are cleared or approved for commercial sale in the United
States, Europe, Canada and other select markets. We believe our largest future product market
opportunity is for our System One used in the home hemodialysis market for the treatment of ESRD.
Over the past several years we have improved our cash flows from operating activities and
continue to work towards our long-term goal of sustained positive cash flows from operating
activities. However, we expect cash flows from operating activities in the near term to fluctuate
between negative and positive on a quarterly basis, primarily due to changes in working capital.
There can be no assurance that we will be able to continue to improve cash flows from operating
activities or whether we will be able to generate positive cash flows from operating activities in
the future. We believe, based on current projections and the current nature of our business, that
we have the required resources to fund our ongoing operating requirements. Our ability to and the
rate at which we continue to improve cash flows from operating activities will depend on many
factors, including growing revenues, continued improvements in gross profits, leverage of our
operating infrastructure and continued sale versus rental of a significant percentage of our System
One equipment.
Basis of Presentation
The accompanying condensed consolidated financial statements as of September 30, 2011 and for
the three and nine months then ended, and related notes, are unaudited but, in the opinion of our
management, include all adjustments, consisting of normal recurring adjustments that are necessary
for fair statement of the interim periods presented. Our unaudited condensed consolidated financial
statements have been prepared following the requirements of the Securities and Exchange Commission,
or SEC, for interim reporting. As permitted under these rules, we have condensed or omitted certain
footnotes and other financial information that are normally required by U.S. generally accepted
accounting principles, or GAAP. Our accounting policies are described in the notes to the
consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2010 and updated, as necessary, in this Quarterly Report on Form 10-Q. Operating
results for the three and nine months ended September 30, 2011 are not necessarily indicative of
results for the entire fiscal year or future periods. The December 31, 2010 condensed consolidated
balance sheet contained herein was derived from audited financial statements, but does not include
all disclosures required by GAAP. For further information, refer to the consolidated financial
statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2010.
2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of NxStage
Medical, Inc. and our wholly-owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation.
Use of Estimates
The preparation of our condensed consolidated financial statements in conformity with GAAP
requires our management to make estimates and assumptions that affect reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
6
Revenue Recognition
We recognize revenue from product sales and services when earned. Revenues are recognized
when: (a) there is persuasive evidence of an arrangement, (b) the product has been shipped or
services and supplies have been provided to the customer, (c) the sales price is fixed or
determinable and (d) collection is reasonably assured.
Certain agreements with distributors allow for product returns and credits. For shipment of
product sold to distributors, revenue is recognized at the time of sale if a reasonable estimate of
future returns or credit can be made. If a reasonable estimate of future returns or credit cannot
be made, we recognize revenue using the sell-through method. Under the sell-through method,
revenue and related costs of revenue is deferred until the final resale of such products to end
customers.
In addition to contractually determined volume discounts, in many agreements we offer rebates
based on sales to specific end customers and discounts for early payment. Rebates and discounts are
recorded as a reduction of sales and trade accounts receivable, based on our best estimate of the
amount of probable future rebate or discount on current sales.
We enter into multiple-element arrangements that may include a combination of equipment,
related disposables and services. Effective January 1, 2011, we adopted Accounting Standards
Update, or ASU, No. 2009-13, Multiple Deliverable Revenue Arrangements, as required, using the
prospective method as permitted under the guidance. Accordingly, this guidance is being applied to
all revenue arrangements entered into or materially modified on or after January 1, 2011. The
impact of adopting this amended guidance on our results of operations has been limited to products
sold internationally through distributors in the System One segment, which revenue has not been
significant in the current or historical periods. ASU No. 2009-13 amended the previous guidance
for multiple-element arrangements. Pursuant to the amended guidance in ASU 2009-13 our revenue
arrangements with multiple elements are divided into separate units of accounting if specified
criteria are met, including whether the delivered element has stand-alone value to the customer,
and the consideration received is allocated among the separate units based on their respective
selling price, and the applicable revenue recognition criteria are applied to each of the separate
units.
Under the amended guidance we determine selling price using vendor specific objective evidence
(VSOE), if it exists, otherwise third-party evidence of selling price is used. If neither VSOE
nor third-party evidence of selling price exists for a unit of accounting, we use best estimated
selling price (BESP). We generally expect that we will not be able to establish third-party
evidence due to the nature of our products and the markets in which we compete, and, as such, we
typically will determine selling price using VSOE or BESP.
We determine BESP for an individual element based on consideration of both market and
Company-specific factors, including the selling price and profit margin for similar products, the
cost to produce the deliverable and the anticipated margin on that deliverable and the
characteristics of the varying markets in which the deliverable is sold.
The adoption of the amended guidance did not change the accounting for arrangements entered
into prior to January 1, 2011. Therefore, these arrangements with multiple elements were divided
into separate units of accounting if there was objective and reliable evidence of fair value of the
undelivered items and if other criteria were met, including whether the delivered element had
stand-alone value to the customer. If either criteria were not met, the arrangement was accounted
for as a single unit of accounting and the fees received upon the completion of delivery of
equipment were deferred and are recognized as revenue on a straight-line basis over the expected
term of our remaining obligation and direct costs relating to the delivered equipment are amortized
over the same period as the related revenue, while disposable products revenue is recognized on a
monthly basis upon delivery. The adoption of the amended guidance did not have a material impact
on our revenues for the three and nine months ended September 30, 2011.
System One Segment
We derive revenue in the home market from the sales of hemodialysis therapy to customers in
which the customer either purchases or rents the System One and/or PureFlow SL hardware and
purchases a specified number of disposable products and service.
For customers that purchase the System One and PureFlow SL hardware, in the home U.S. market,
due to the depot service model whereby equipment requiring service is picked up and a replacement
device is shipped to the site of care, we recognize fees received from equipment sale as revenue on
a straight-line basis over the expected term of our remaining service obligation and direct costs
relating to the delivered equipment are deferred and amortized over the same expected period as the
related revenue. Disposable products revenue is recognized on a monthly basis upon delivery.
Under the rental arrangements revenue is recognized on a monthly basis in accordance with
agreed upon contract terms and pursuant to binding customer purchase orders and fixed payment
terms.
Our sales arrangements with our international distributors are structured as direct product
sales and have no significant post delivery obligations with the exception of standard warranty
obligations. However, under the previous guidance, for arrangements entered into prior to January
1, 2011 we determined that we could not account for the sale of equipment as a
separate unit of accounting and, therefore, the fees received upon the completion of delivery
of equipment were deferred and
7
recognized as revenue on a straight-line basis over the expected
term of our remaining service obligation and direct costs relating to the delivered equipment were
amortized over the same expected period as the related revenue. Under the amended guidance, for
arrangements entered into or materially modified on or after January 1, 2011, we will recognize
revenues and related direct costs upon delivery in accordance with contract terms. Disposable
product revenue is recognized on a monthly basis upon delivery under both the previous and amended
guidance.
In the critical care market, we structure sales of the System One and disposable products as
direct product sales and have no significant post delivery obligations with the exception of
standard warranty obligations. Revenue from direct product sales is recognized upon delivery in
accordance with contract terms. Certain of these arrangements provide for training, technical
support and extended warranty services to our customers. We recognize training and technical
support revenue when the related services are performed. In the case of extended warranty, the
service revenue is recognized ratably over the warranty period.
In-Center Segment
Our In-Center segment sales are structured as direct product sales primarily through
distributors, and we have no significant post delivery obligations with the exception of standard
warranty obligations. Revenue from direct product sales is recognized upon delivery in accordance
with contract terms. Some of our distribution contracts for the In-Center segment contain minimum
volume commitments with negotiated pricing discounts at different volume tiers. Each agreement may
be canceled upon a material breach, subject to certain curing rights, and in many instances minimum
volume commitments can be reduced or eliminated upon certain events.
Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable is primarily limited to
certain customers to whom we make substantial sales. One customer represented 22% and 23% of
accounts receivable at September 30, 2011 and December 31, 2010, respectively.
Warranty Costs
We accrue estimated costs that we may incur under our product warranty programs at the time
the product revenue is recognized, based on contractual rights and historical experience. Warranty
expense is included in cost of revenues in the consolidated statements of operations. The following
is a rollforward of our warranty accrual (in thousands):
|
|
|
|
|
Balance at December 31, 2010 |
|
$ |
268 |
|
Provision |
|
|
505 |
|
Usage |
|
|
(420 |
) |
|
|
|
|
Balance at September 30, 2011 |
|
$ |
353 |
|
Recent Accounting Pronouncements
In September 2011, the Financial Accounting Standards Board, or FASB, issued ASU No. 2011-08,
Intangibles Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This update allows
an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment
to determine whether it should calculate the fair value of a reporting unit. Under these
amendments, an entity would not be required to calculate the fair value of a reporting unit unless
the entity determines, based on a qualitative assessment, that it is more likely than not that its
fair value is less than its carrying amount. The amendments include a number of events and
circumstances for an entity to consider in conducting the qualitative assessment. The amendments
in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal
years beginning after December 15, 2011. Early adoption is permitted, including for annual and
interim goodwill impairment tests performed as of a date before September 15, 2011, if an entitys
financial statements for the most recent annual or interim period have not yet been issued. We do
not expect that adoption of this update will have a material impact on our financial position or
results of operations.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220). This newly
issued accounting standard (1) eliminates the option to present the components of other
comprehensive income as part of the statement of changes in stockholders equity; (2) requires the
consecutive presentation of the statement of net income and other comprehensive income; and (3)
requires an entity to present reclassification adjustments on the face of the financial statements
from other comprehensive income to net income. This update does not change the items that must be
reported in other comprehensive income or when an item of other comprehensive income must be
reclassified to net income nor does it affect how earnings per share is calculated or presented.
This update is required to be applied retrospectively and is effective for us for fiscal years and
interim periods within those years beginning January 1, 2012. As this update only requires
enhanced disclosure, the adoption of this update will not impact our financial position or results
of operations.
8
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments
to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This
update clarifies the application of certain existing fair value measurement guidance and expands
the disclosures for fair value measurements that are estimated using significant unobservable
(Level 3) inputs. This update is effective on a prospective basis for our annual and interim
reporting periods beginning on January 1, 2012. We do not expect that adoption of this standard
will have a material impact on our financial position or results of operations.
3. Inventory
Inventory includes material, labor and overhead, and is stated at lower of cost (first-in,
first-out) or market. The components of inventory are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2011 |
|
|
2010 |
|
Purchased components |
|
$ |
14,091 |
|
|
$ |
14,928 |
|
Work in process |
|
|
9,906 |
|
|
|
6,372 |
|
Finished goods |
|
|
11,566 |
|
|
|
13,650 |
|
|
|
|
|
|
|
|
|
|
$ |
35,563 |
|
|
$ |
34,950 |
|
|
|
|
|
|
|
|
4. Property and Equipment and Field Equipment
Accumulated depreciation on property and equipment was $14.4 million and $11.8 million at
September 30, 2011 and December 31, 2010, respectively. Accumulated depreciation on field
equipment was $32.8 million and $29.1 million at September 30, 2011 and December 31, 2010,
respectively.
At September 30, 2011, we had $5.2 million recorded in property and equipment and other
long-term liabilities related to construction of a new manufacturing facility in Germany pursuant
to the terms of our Dialyzer Production Agreement entered into in May 2009 with Asahi Kasei Kuraray
Medical, or Asahi. We are overseeing construction of this new facility and will operate the new
facility under a manufacturing agreement upon its completion. Asahi will fund construction costs
up to an original fixed amount; however, we will be responsible for any additional costs. If the
agreement is terminated during the construction period due to our breach, insolvency or bankruptcy,
Asahi has the option to require us to pay for all amounts expended for construction of the new
facility. If such event occurs we would take title to the land and any construction in process.
Subsequent to the completion of construction, if the agreement is terminated due to our breach,
insolvency or bankruptcy, or by us pursuant to certain terms of the agreement, Asahi has the option
to require us to purchase the new facility from them by paying one hundred percent of the then net
book value of the new facility, as calculated in accordance with GAAP. Given these options and our
involvement in the construction, we are considered the owner of the new facility for accounting
purposes and will therefore record its cost as construction-in-process and a corresponding
liability has been recorded for the construction cost funded by Asahi. The $5.2 million recorded
at September 30, 2011 reflects the construction costs incurred to date in connection with this
project.
5. Intangible Assets
Accumulated amortization on intangible assets was $11.2 million and $9.1 million at September
30, 2011 and December 31, 2010, respectively.
6. Comprehensive Loss
The following table presents the components of comprehensive loss (in thousands):
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
Net loss |
|
$ |
(5,278 |
) |
|
$ |
(8,164 |
) |
|
$ |
(16,838 |
) |
|
$ |
(25,419 |
) |
Foreign currency translation (loss) gain |
|
|
(249 |
) |
|
|
256 |
|
|
|
61 |
|
|
|
(321 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(5,527 |
) |
|
$ |
(7,908 |
) |
|
$ |
(16,777 |
) |
|
$ |
(25,740 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
7. Net Loss per Share
Basic net loss per share is computed by dividing loss available to common stockholders (the
numerator) by the weighted-average number of common shares outstanding (the denominator) for the
period. The computation of diluted loss per share is similar to basic loss per share, except that
the denominator is increased to include the number of additional common shares that would have been
outstanding if the potentially dilutive common shares had been issued.
The following potential common stock equivalents, as calculated using the treasury stock
method, were not included in the computation of diluted net loss per share as their effect would
have been anti-dilutive due to the net loss incurred (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
Options to purchase common stock |
|
|
2,752 |
|
|
|
3,268 |
|
|
|
3,187 |
|
|
|
2,817 |
|
Restricted stock |
|
|
843 |
|
|
|
748 |
|
|
|
747 |
|
|
|
716 |
|
Warrants to purchase common stock |
|
|
1,085 |
|
|
|
1,076 |
|
|
|
1,135 |
|
|
|
933 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
4,680 |
|
|
|
5,092 |
|
|
|
5,069 |
|
|
|
4,466 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8. Segment Disclosures
After an evaluation of the business activities regularly reviewed by our chief operating
decision maker for which separate discrete financial information is available, we determined that
we have two reporting segments, System One and In-Center. The accounting policies of the
reportable segments are the same as those described in Note 2 to the consolidated financial
statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
The profitability measure employed by us and our chief operating decision maker for making
decisions about allocating resources to segments and assessing segment performance is segment
profit (loss), which consists of revenues less cost of revenues, selling and marketing and
distribution expenses.
Our management measures are designed to assess performance of these operating segments,
excluding certain items. As a result, certain corporate expenses are excluded from the segment
operating performance measures, including research and development expenses and general and
administrative expenses, as they are managed centrally.
Within the System One segment, we derive revenues from the sale and rental of the System One
and PureFlow SL equipment and the sale of disposable products in the home and critical care
markets. The home market is devoted to the treatment of ESRD patients in the home, while the
critical care market is devoted to the treatment of hospital-based patients with acute kidney
failure or fluid overload. Within the System One segment, we sell a similar technology platform of
the System One with different features to the home and critical care markets. Some of our largest
customers in the home market provide outsourced renal dialysis services to some of our customers in
the critical care market. Sales of product to both markets are made primarily through dedicated
sales forces and distributed directly to the customer, or the patient, with certain products sold
through distributors internationally.
Within the In-Center segment, we sell blood tubing sets and needles for hemodialysis primarily
for the treatment of ESRD patients at dialysis centers and needles for apheresis. Nearly all
In-Center products are sold through national distributors.
Our reportable segments consist of the following (in thousands):
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System One |
|
In-Center |
|
Unallocated |
|
Total |
Three Months Ended September 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers |
|
$ |
36,388 |
|
|
$ |
19,515 |
|
|
$ |
|
|
|
$ |
55,903 |
|
Segment profit (loss) |
|
|
3,566 |
|
|
|
1,819 |
|
|
|
(9,096 |
) |
|
|
(3,711 |
) |
Segment assets |
|
|
88,547 |
|
|
|
18,586 |
|
|
|
186,136 |
|
|
|
293,269 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers |
|
$ |
29,163 |
|
|
$ |
15,870 |
|
|
$ |
|
|
|
$ |
45,033 |
|
Segment profit (loss) |
|
|
464 |
|
|
|
2,256 |
|
|
|
(9,155 |
) |
|
|
(6,435 |
) |
Segment assets |
|
|
84,053 |
|
|
|
15,316 |
|
|
|
101,773 |
|
|
|
201,142 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers |
|
$ |
105,475 |
|
|
$ |
54,760 |
|
|
$ |
|
|
|
$ |
160,235 |
|
Segment profit (loss) |
|
|
9,253 |
|
|
|
5,862 |
|
|
|
(27,444 |
) |
|
|
(12,329 |
) |
Segment assets |
|
|
88,547 |
|
|
|
18,586 |
|
|
|
186,136 |
|
|
|
293,269 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers |
|
$ |
81,732 |
|
|
$ |
47,717 |
|
|
$ |
|
|
|
$ |
129,449 |
|
Segment (loss) profit |
|
|
(1,626 |
) |
|
|
6,296 |
|
|
|
(25,973 |
) |
|
|
(21,303 |
) |
Segment assets |
|
|
84,053 |
|
|
|
15,316 |
|
|
|
101,773 |
|
|
|
201,142 |
|
Substantially all of our revenues are derived from the sale of the System One and related
products, which cannot be used with any other dialysis system, and from needles and blood tubing
sets to customers located in the United States.
The following table summarizes the number of customers who individually comprise greater than
10% of total revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
Customer A |
|
|
20 |
% |
|
|
22 |
% |
|
|
21 |
% |
|
|
22 |
% |
Customer B |
|
|
13 |
% |
|
|
16 |
% |
|
|
13 |
% |
|
|
17 |
% |
Customer C |
|
|
14 |
% |
|
|
12 |
% |
|
|
14 |
% |
|
|
13 |
% |
Sales to Customer A are primarily in the System One segment and sales to Customer B and
Customer C are to significant distributors in the In-Center segment. A portion of Customer Bs
sales of our products are to Customer A. All of Customer Cs sales of our products are to Customer
A.
The following table presents a reconciliation of the total segment assets to total assets (in
thousands):
11
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2011 |
|
|
2010 |
|
Total segment assets |
|
$ |
107,133 |
|
|
$ |
102,798 |
|
Corporate assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
|
101,247 |
|
|
|
104,339 |
|
Property and equipment, net |
|
|
14,276 |
|
|
|
8,290 |
|
Intangible assets, net |
|
|
23,314 |
|
|
|
25,412 |
|
Goodwill |
|
|
42,698 |
|
|
|
42,698 |
|
Prepaid expenses and other assets |
|
|
4,601 |
|
|
|
2,557 |
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
293,269 |
|
|
$ |
286,094 |
|
|
|
|
|
|
|
|
9. Income Taxes
The provision for income taxes of $0.2 million for the three months ended September 30, 2011
and 2010, respectively, and $0.7 million and $0.6 million for the nine months ended September 30,
2011 and 2010, respectively, relates to the profitable operations of certain foreign entities.
10. Commitments and Contingencies
In June 2011, we entered into a new lease agreement with 350 Riverwalk LLC. The lease is for a
new corporate headquarters to be located in Lawrence, MA. The term of the lease will begin on or
before June 1, 2012 and continue for an initial term of eleven years with an early termination
provision after seven years, subject to certain terms and conditions. We have two, five year
options to extend this lease on substantially the same terms and at rent equal to ninety-five
percent of the then fair market value. In addition, we are responsible for the real estate taxes
and operating expenses related to this facility. The landlord is providing us a $4.3 million
tenant improvement allowance pursuant to the agreement. The future minimum annual rental payments
under this agreement are estimated to be $0.8 million, $1.2 million, $1.4 million and $1.6 million,
during 2012, 2013, 2014 and 2015, respectively, and $14.6 million thereafter.
Other significant commitments and contingencies at September 30, 2011 are consistent with
those discussed in Note 11 to the consolidated financial statements in our Annual Report on Form
10-K for the fiscal year ended December 31, 2010.
11. Stock-Based Compensation
Stock-based Compensation Expense
The following table presents stock-based compensation expense included in the condensed
consolidated statements of operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
Cost of revenues |
|
$ |
498 |
|
|
$ |
629 |
|
|
$ |
1,532 |
|
|
$ |
1,644 |
|
Selling and marketing |
|
|
1,432 |
|
|
|
1,460 |
|
|
|
4,062 |
|
|
|
3,940 |
|
Research and development |
|
|
258 |
|
|
|
587 |
|
|
|
924 |
|
|
|
1,618 |
|
General and administrative |
|
|
1,277 |
|
|
|
1,434 |
|
|
|
3,648 |
|
|
|
3,783 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
3,465 |
|
|
$ |
4,110 |
|
|
$ |
10,166 |
|
|
$ |
10,985 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options and Restricted Stock Units
The Company granted options to purchase 12,544 and 55,000 shares of common stock during the
three months ended September 30, 2011 and 2010, respectively, and options to purchase 485,939 and
1,355,300 shares of common stock during the
12
nine months ended September 30, 2011 and 2010,
respectively. The weighted-average fair value of options granted during the nine months ended
September 30, 2011 and 2010 was $11.23 and $5.55 per option, respectively.
The Company awarded 20,270 and 122,509 restricted stock units during the three and nine months
ended September 30, 2011. The restricted stock units vest based on continued employment over a
period of two or four years. The weighted-average fair value of restricted stock units granted
during the nine months ended September 30, 2011 was $18.78 per unit.
Performance Based Plans
In May 2011, the Companys Compensation Committee of the Board of Directors, or the
Compensation Committee, approved the Companys 2011 Performance Share Plan in which it committed to
grant up to 285,670 restricted stock units to certain employees and executive officers based on the
achievement of certain Company financial performance metrics for the year ending December 31, 2011.
The restricted stock units, if awarded, vest over a requisite service period of three years. The
estimated expense under the 2011 Performance Share Plan is being recognized as stock-based
compensation expense over the requisite service period. Further, in March 2011, the Compensation
Committee approved the Companys 2011 Corporate Bonus Plan. Payout under the 2011 Corporate Bonus
Plan will be based on individual performance and the achievement of certain Company financial
performance metrics for the year ending December 31, 2011 and will be paid in shares of the
Companys common stock, or in cash, at the discretion of the Compensation Committee. The estimated
payout under the 2011 Corporate Bonus Plan is being recognized as compensation expense during 2011,
with nearly all of this compensation expense classified as stock-based compensation expense, and
has been classified as a liability on the Companys condensed consolidated balance sheet.
12. Stockholders Equity
We received 115,418 and 174,757 shares during the quarter ended March 31, 2011 and 2010,
respectively, that were surrendered by employees in payment for the minimum required withholding
taxes associated with awards under our Corporate Bonus and Performance Share Plans. We received
40,401 shares that were surrendered in payment for the exercise of stock options through the nine
months ended September 30, 2011. The settlement of $2.8 million and $1.6 million during the first
quarter of 2011 and 2010, respectively, of the Companys 2010 Corporate Bonus Plan obligation in
shares of our common stock represents a noncash financing activity.
13. Fair Value Measurements
At September 30, 2011, we had $84.8 million in money market funds, included in cash and cash
equivalents, measured at fair value on a recurring basis utilizing quoted prices (unadjusted) in
active markets for identical assets, also referred to as level 1 inputs.
The carrying amounts reflected in the condensed consolidated balance sheets for cash and cash
equivalents, accounts receivable, prepaid expenses and other current and non-current assets,
accounts payable and accrued expenses approximate fair value due to their short-term nature.
The carrying amount of our long-term debt approximates fair value at September 30, 2011. The
fair value of our long-term debt was estimated using inputs derived principally from market
observable data, including current rates offered to us for debt of the same or similar remaining
maturities. Within the hierarchy of fair value measurements, these are level 2 inputs.
13
|
|
|
Item 2. |
|
Managements Discussion and Analysis of Financial Condition and Results of Operations |
Special Note Regarding Forward Looking Statements
The following discussion should be read with our unaudited condensed consolidated financial
statements and notes included in Part I, Item 1 of this Quarterly Report for the three and nine
months ended September 30, 2011, as well as the audited financial statements and notes and
Managements Discussion and Analysis of Financial Condition and Results of Operations for the
fiscal year ended December 31, 2010, included in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission, or SEC.
This Quarterly Report contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 concerning our business, operations and financial
condition, including statements with respect to: the market adoption of our products in the United
States and internationally; the growth of the home, critical care and in-center dialysis markets in
general and the home hemodialysis market in particular; the development and commercialization of
our products; changes in the historical purchasing patterns and preferences of our key customers,
including DaVita Inc. and Fresenius Medical Care; the adequacy of our funding; our ability to
achieve and sustain positive cash flows; whether and when we might achieve improvements to our
gross profit as a percentage of revenues and operating expenses; expectations with respect to our
operating expenses and achieving our business plan; expectations with respect to achieving
profitable operations; expectations with respect to achieving improvements in product reliability;
the timing and success of the submission, acceptance and approval of regulatory filings and the
impact of any changes in the regulatory environment with respect to our products or business; the
scope of patent protection with respect to our products; expectations with respect to the clinical
findings of our FREEDOM study and other ongoing clinical studies evaluating home and/or daily
hemodialysis; expectations as to the continued availability of raw materials, components, and
finished goods from key single source suppliers; expectations with respect to our ability to supply
on a timely and uninterrupted basis all products ordered by our customers; and the impact of new
and future changes to reimbursement for chronic dialysis treatments. All statements other than
statements of historical facts included in this report regarding our strategies, prospects,
financial condition, costs, plans and objectives are forward-looking statements. When used in this
report, the words expect, anticipate, intend, plan, believe, seek, estimate,
potential, continue, predict, may, and similar expressions are intended to identify
forward-looking statements, although not all forward-looking statements contain these identifying
words. Because these forward-looking statements involve risks and uncertainties, actual results
could differ materially from those expressed or implied by these forward-looking statements.
Among the important factors that could cause actual results to differ materially from those
indicated by our forward-looking statements are those discussed under the heading Risk Factors in
Item 1A of Part II. We undertake no obligation to revise or update publicly any forward-looking
statement for any reason. Readers should carefully review the factors described under the heading
Risk Factors in Item 1A of Part II of this Quarterly Report and in Managements Discussion and
Analysis of Financial Condition and Results of Operations, as well as in other documents filed by
us with the SEC, as they may be amended from time to time, including our Annual Report on Form 10-K
and Quarterly Reports on Form 10-Q.
Introduction
We are a medical device company that develops, manufactures and markets innovative products
for the treatment of kidney failure, fluid overload and related blood treatments and procedures.
Our primary product, the NxStage System One, or System One, was designed to satisfy an unmet
clinical need for a system that can deliver the therapeutic flexibility and clinical benefits
associated with traditional dialysis machines in a smaller, portable, easy-to-use form that can be
used by healthcare professionals and trained lay users alike in a variety of settings, including
patient homes, as well as more traditional care settings such as hospitals and dialysis clinics.
Given its design, the System One is particularly well-suited for home hemodialysis and a range of
dialysis therapies including more frequent, or daily, dialysis, which clinical literature
suggests provides patients better clinical outcomes and improved quality of life. The System One is
cleared or approved for commercial sale in the United States, Europe, Canada and other select
markets for the treatment of acute and chronic kidney failure and fluid overload. The System One
is cleared specifically by the United States Food and Drug Administration, or FDA, for home
hemodialysis as well as therapeutic plasma exchange, or TPE, in a clinical environment. We also
sell needles and blood tubing sets primarily to dialysis clinics for the treatment of end-stage
renal disease, or ESRD. These products are cleared or approved for commercial sale in the United
States, Europe, Canada and other select markets. We believe our largest future product market
opportunity is for our System One used in the home hemodialysis market for the treatment of ESRD.
We report the results of our operations in two segments: System One and In-Center. We
distribute our products in three markets: home, critical care and in-center. In the System One
segment we derive our revenues from the sale and rental of the System One and PureFlow SL equipment
and the sale of disposable products in the home and critical care markets. The home market is
devoted to the treatment of ESRD patients in the home, while the critical care market is devoted to
the treatment of hospital-based patients with acute kidney failure or fluid overload. In the
In-Center segment, we derive our revenues from the
14
sale of blood tubing sets and needles for hemodialysis primarily for the treatment of ESRD
patients at dialysis centers and needles for apheresis, which is referred to as the in-center
market.
Segment and Market Highlights
Our customers in the System One segment are highly consolidated. Fresenius Medical Care, or
Fresenius, and DaVita Inc., or DaVita, own and operate the two largest chains of dialysis clinics
in the United States and collectively provide treatment to approximately two-thirds of United
States dialysis patients. DaVita is our most significant customer for the System One segment. Sales
to DaVita represented approximately 31% and 33% of our System One segment revenues for the three
and nine months ended September 30, 2011 and 2010, respectively. Further, DaVita is our largest
customer in the home market, constituting over 40% of our home hemodialysis patients. A growing
percentage of our sales are to Fresenius, which is our second largest customer in the System One
segment, with nearly all of those sales in the home market. Increased sales to DaVita and Fresenius
have driven a large portion of our historical revenue growth and will be important to future
growth. If the purchasing patterns of either of these customers adversely change, our business
could be negatively affected.
Our In-Center segment revenues are highly concentrated in several significant purchasers.
Revenues from Henry Schein, Inc., or Henry Schein, a significant distributor, represented
approximately 40% and 45% of our In-Center segment revenues during the three and nine months ended
September 30, 2011 and 2010, respectively. Our other largest distributor is Gambro Renal Products,
Inc., or Gambro. Revenues from Gambro represented approximately 40% and 35% of our In-Center
segment revenues during the three and nine months ended September 30, 2011 and 2010, respectively.
DaVita is also a significant customer in the in-center market. Sales of our products through
distributors to DaVita accounted for approximately half of In-Center segment revenues for both the
three and nine months ended September 30, 2011 and 2010. DaVita has contractual purchase
commitments under two agreements: one with us for needles and one with Gambro for blood tubing
sets. DaVitas purchase obligations with respect to needles will expire under an agreement with us
in January 2013. Gambros long term product supply agreement with DaVita, entered into in
connection with the sale of Gambros United States dialysis clinic business to DaVita, obligates
DaVita to purchase a significant majority of its blood tubing set requirements from Gambro. Our
distribution agreement with Gambro, which expires in June 2014, contractually obligates Gambro to
exclusively supply our blood tubing sets, including our ReadySet and the Streamline product lines,
to DaVita.
We offer certain customers rebates based on sales to specific end users and discounts for
early payment. Our revenues are presented net of these rebates and discounts. As of September 30,
2011, we had $1.8 million and $0.5 million reserved against trade accounts receivable for future
rebates and discounts for customers in our In-Center and System One segments, respectively. We
recorded $1.8 million and $1.0 million during the three months ended September 30, 2011 and 2010,
respectively, and $4.8 million and $3.9 million during the nine months ended September 30, 2011 and
2010, respectively, as a reduction of In-Center segment revenues in connection with rebates and
discounts. For the System One segment, we recorded $0.8 million and $0.2 million during the three
months ended September 30, 2011 and 2010, respectively, and $1.5 million and $0.5 million during
the nine months ended September 30, 2011 and 2010, respectively, in connection with rebates and
discounts.
As an alternative to a cash-based rebate, we issued to DaVita a warrant that may vest and
become exercisable to purchase up to 5.5 million shares of our common stock based upon the
achievement of certain System One home patient growth targets at June 30, 2011, 2012 and 2013.
This warrant-based rebate structure preserves our cash, and provides for the issuance of shares
upon the exercise of any warrants earned only if patient access to home hemodialysis with the
System One is materially expanded. The warrants have an exercise price of $14.22 per share, expire
during 2013, are non-transferable and must be exercised in cash. The accounting for these warrants
is similar to the accounting for cash-based rebates. Specifically, the warrants are measured at
fair value through their date of vesting and recognized as a reduction of revenues, based on the
number of warrants expected to vest over the same expected period as the related expected product
revenues, which is 7 to 10 years. Estimates of the number of warrants expected to vest and the fair
value of the warrants will be revised each reporting period through the date of vesting. For the
period ended June 30, 2011, DaVita achieved System One home patient growth targets that entitled
DaVita to become vested in warrants to purchase 250,000 shares of our common stock. The reduction
of revenues recorded in connection with these warrants was not significant during the three or nine
months ended September 30, 2011.
Financial Performance
During the three and nine months ended September 30, 2011, we grew our revenues by 24% to
$55.9 million and $160.2 million, respectively, with growth occurring in each market: home,
critical care and in-center. Home revenues drove the growth, increasing $4.9 million, or 22%, and
$18.1 million, or 29%, for the three and nine months ended September 30, 2011, respectively, versus
the prior year comparable period, due primarily to an increase in the number of patients prescribed
to use and centers offering the System One, including the continued adoption of System One
internationally. We expect to see
continued growth in our revenues, primarily driven by the System One segment as we further
penetrate the markets, and expand internationally.
15
We continue to see improvements in our financial performance below the revenue line. We have
not yet achieved profitable operating margins, but we have made improvements to gross profit as a
percentage of revenues. Gross profit as a percentage of revenues increased to 35% for the three
and nine months ended September 30, 2011, respectively, from 33% and 31% for the prior year
comparable periods. The improvement in gross profit as a percentage of revenues for both periods
was mainly attributable to lower product and service costs, partially offset by unfavorable foreign
exchange rates versus the U.S. dollar and costs incurred by our In-Center segment related to the
transition of manufacturing of certain blood tubing sets from a contract manufacturer to our own
manufacturing facility beginning in the second quarter of 2011. While we expect to continue to
improve gross profit as a percentage of revenues as a result of various initiatives including the
consolidation of our manufacturing network, these improvements will continue to be offset in the
short-term by unfavorable foreign exchange rates versus the U.S. dollar and costs to transition
certain blood tubing sets from a contract manufacturer to our own manufacturing facility.
Over the long-term, we expect to see continued improvements to our cash flows from operating
activities, driven in meaningful part through continued improvement in our gross profit. However,
in the near term, we expect cash flows from operating activities on a quarterly basis to fluctuate
between negative and positive, primarily due to changes in working capital.
We are encouraged by the improvements to our operating margins and are continuing to work hard
toward our long-term goal of achieving profitable operating margins. However, there can be no
assurance that we will be able to continue to improve our operating margins or achieve positive
operating margins. Our ability to become profitable and its timing and sustainability, depends
principally upon continued improvements in gross profit, growing revenues, and leverage of our
operating infrastructure. including the effects of any investment in selling and marketing or
research and development activities.
Comparison of the Three and Nine Months Ended September 30, 2011 and 2010
Revenues
Our revenues for the three and nine months ended September 30, 2011 and 2010 were as follows
(in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
System One segment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Home |
|
$ |
27,218 |
|
|
|
49 |
% |
|
$ |
22,346 |
|
|
|
50 |
% |
|
$ |
80,276 |
|
|
|
50 |
% |
|
$ |
62,204 |
|
|
|
48 |
% |
Critical Care |
|
|
9,170 |
|
|
|
16 |
% |
|
|
6,817 |
|
|
|
15 |
% |
|
|
25,199 |
|
|
|
16 |
% |
|
|
19,528 |
|
|
|
15 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total System One segment |
|
|
36,388 |
|
|
|
65 |
% |
|
|
29,163 |
|
|
|
65 |
% |
|
|
105,475 |
|
|
|
66 |
% |
|
|
81,732 |
|
|
|
63 |
% |
In-Center segment |
|
|
19,515 |
|
|
|
35 |
% |
|
|
15,870 |
|
|
|
35 |
% |
|
|
54,760 |
|
|
|
34 |
% |
|
|
47,717 |
|
|
|
37 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
55,903 |
|
|
|
100 |
% |
|
$ |
45,033 |
|
|
|
100 |
% |
|
$ |
160,235 |
|
|
|
100 |
% |
|
$ |
129,449 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in revenues over the comparable prior year periods was mainly attributable to
increased sales and rentals of the System One and related disposables in both the home and critical
care markets, primarily as a result of the growing number of patients using the System One as we
continue to penetrate these markets, including the continued adoption of the System One
internationally.
In the home market, revenues increased $4.9 million, or 22%, and $18.1 million, or 29%, for
the three and nine months ended September 30, 2011, respectively, versus the prior year comparable
periods, primarily due to an increase in the number of patients prescribed to use and centers
offering the System One and, to a lesser extent, the impact of adopting a new accounting standard
which effected revenue recognition for sales to our international distributors. In the U.S. we
have increased the average number of patients at existing centers and the number of total centers
offering the System One through new and existing relationships with service providers, including
DaVita and Fresenius. Critical care market revenues increased $2.4 million, or 35%, and $5.7
million, or 29%, for the three and nine months ended September 30, 2011, respectively, versus the
prior year comparable periods, due to increased sales of disposables from our growing number of
System One equipment placed within hospitals and increased sales of our System One equipment.
Future demand for our products and revenue growth in both the home and critical care markets is
expected to remain strong as we further penetrate these markets, expand internationally, and
leverage the annuity nature of our business. As our international business grows our System One
revenue may be susceptible to fluctuations in international equipment
sales and changes in inventory levels at our international distributors.
Our two largest customers in the home market, DaVita and Fresenius, will be important to that
growth, specifically in the U.S. market. If the purchasing patterns of either of these customers
adversely change, our business could be negatively affected.
In-Center segment revenues increased $3.6 million, or 23%, and $7.0 million, or 15%, for the
three and nine months ended September 30, 2011, respectively, versus the prior year comparable
periods, due to higher sales volumes of our blood tubing
16
sets, primarily Streamline, driven by
increased end user demand and changes in distributor inventory levels. While quarterly revenues
continue to be susceptible to fluctuations in inventory levels at our distributors, end user demand
of both our blood tubing sets and our needle products continues to grow. We expect future revenues
will continue to be susceptible to fluctuation, especially in the near term, due to the transition
of our major distributors and customers to our next generation Streamline blood tubing set and,
longer-term, as a result of increased competition and variations in inventory management policies
with both our distributors and end users.
Gross Profit
Our gross profit and gross profit as a percentage of revenues for the three and nine months
ended September 30, 2011 and 2010 were as follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
System One segment |
|
$ |
15,412 |
|
|
|
42 |
% |
|
$ |
10,978 |
|
|
|
38 |
% |
|
$ |
44,351 |
|
|
|
42 |
% |
|
$ |
29,373 |
|
|
|
36 |
% |
In-Center segment |
|
|
4,128 |
|
|
|
21 |
% |
|
|
3,982 |
|
|
|
25 |
% |
|
|
12,087 |
|
|
|
22 |
% |
|
|
11,162 |
|
|
|
23 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
$ |
19,540 |
|
|
|
35 |
% |
|
$ |
14,960 |
|
|
|
33 |
% |
|
$ |
56,438 |
|
|
|
35 |
% |
|
$ |
40,535 |
|
|
|
31 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit increased $4.6 million, or 31%, and $15.9 million, or 39%, for the three and nine
months ended September 30, 2011, respectively, versus the prior year comparable periods, driven by
the System One segment. Gross profit for the System One segment increased $4.4 million, or 40%,
and $15.0 million, or 51%, for the three and nine months ended September 30, 2011, respectively,
versus the prior year comparable periods, due to increased revenues and improvement in gross profit
as a percentage of revenues. The improvement in gross profit as a percentage of revenues for both
periods was attributable to several factors, including lower product manufacturing and service
costs driven by continued leveraging of our manufacturing infrastructure, certain cost saving
initiatives and improvements in product design and reliability, and lower depreciation expense on
our field equipment assets resulting from the change in the useful life of certain of these assets
from five to seven years during the fourth quarter of 2010. These favorable changes were partially
offset by unfavorable impact of changes in foreign exchange rates versus the U.S. dollar.
Gross profit for the In-Center segment for the three and nine months ended September 30, 2011
increased slightly in absolute dollars and decreased as a percentage of revenues versus the prior
year comparable period. Gross profit changes in the three and nine month periods were driven by
increased revenues offset by the unfavorable impact of changes in foreign currency rates versus the
U.S. dollar, costs incurred relating to the transition of certain blood tubing sets from a contract
manufacturer to our own manufacturing facility, increased freight costs and increased resin costs
as a result of higher oil prices.
We expect gross profit as a percentage of revenues will continue to improve in the long-term
for three general reasons, all of which we expect will reduce costs in the future. First, we expect
to introduce additional process improvements and product design changes that have inherently lower
costs than the costs associated with our current products. Second, we anticipate that increased
sales volume, rationalization and consolidation of our manufacturing operations and rationalization
of our supply chain, and realization of economies of scale will lead to lower costs and better
purchasing terms and prices. Finally, we expect to continue to improve product reliability, which
would reduce unit service costs. However, there is no certainty that our expectations or the
projected timing associated with our expectations will be achieved with respect to these cost
reduction plans. Further, these improvements in gross profit as a percentage of revenues may be
offset in the short-term for five general reasons, all of which could negatively impact gross
profit. First, we manufacture a large majority of our products internationally and purchase
products from foreign companies in other than U.S. dollars and, therefore, our product costs are
subject to fluctuations due to changes in foreign currency exchange rates. Any unfavorable
fluctuations in foreign exchange rates versus the U.S. dollar would negatively impact our gross
profit as a percentage of revenues. Second, we expect that we will continue to incur higher
transportation costs driven in large part by increased prices from carriers and changes in fuel
prices. Third, we may see an increase in the cost of certain raw materials, due to increases in
the cost of commodities, particularly resin. Fourth, we expect future demand for our products to
continue to grow; however, higher relative sales of lower margin products and certain pricing
strategies would have a negative impact on gross profit as a percentage of revenues. Finally,
rationalization and consolidation of our manufacturing operations, in an effort to drive long-term
gross margin improvement, will require us to incur additional costs in the short-term.
Selling and Marketing
Our selling and marketing expenses and selling and marketing as a percent of revenues for the
three and nine months ended September 30, 2011 and 2010 were as follows (in thousands, except
percentages):
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
System One segment |
|
$ |
8,085 |
|
|
|
22 |
% |
|
$ |
7,185 |
|
|
|
25 |
% |
|
$ |
24,088 |
|
|
|
23 |
% |
|
$ |
21,505 |
|
|
|
26 |
% |
In-Center segment |
|
|
1,361 |
|
|
|
7 |
% |
|
|
1,267 |
|
|
|
8 |
% |
|
|
3,937 |
|
|
|
7 |
% |
|
|
3,529 |
|
|
|
7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Selling and marketing |
|
$ |
9,446 |
|
|
|
17 |
% |
|
$ |
8,452 |
|
|
|
19 |
% |
|
$ |
28,025 |
|
|
|
17 |
% |
|
$ |
25,034 |
|
|
|
19 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing expenses increased $1.0 million, or 12%, and $3.0 million, or 12%, for
the three and nine months ended September 30, 2011, respectively, versus the prior year comparable
periods, but decreased as a percentage of revenues. The increases in both periods were primarily
due to increased personnel and personnel-related costs, and increased spending due to expanded
marketing programs within both segments. Selling and marketing expenses for the System One segment
decreased as a percentage of revenues for both the three and nine months ended September 30, 2011,
versus the prior year comparable periods, due to our initiative to continue to leverage our
infrastructure. Selling and marketing expenses for the In-Center segment decreased slightly as a
percentage of revenues for the three months ended September 30, 2011, and remained consistent as a
percentage of revenues for the nine months ended September 30, 2011, versus the prior year
comparable periods, as we continue to broaden our marketing programs. We anticipate that selling
and marketing expenses will continue to increase in absolute dollars but continue to decline as a
percentage of revenues as we broaden our marketing initiatives to increase public awareness of the
System One in the home market and to support growth in international markets.
Research and Development
Our research and development expenses and research and development as a percent of revenues
for the three and nine months ended September 30, 2011 and 2010 were as follows (in thousands,
except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
Research and development |
|
$ |
3,388 |
|
|
|
6 |
% |
|
$ |
3,132 |
|
|
|
7 |
% |
|
$ |
10,694 |
|
|
|
7 |
% |
|
$ |
9,369 |
|
|
|
7 |
% |
Research and development expenses increased $0.3 million, or 8%, and $1.3 million, or 14%, for
the three and nine months ended September 30, 2011, respectively, versus the prior year comparable
periods, decreased slightly as a percentage of revenues for the three months ended September 30,
2011, and remained consistent as a percentage of revenues for the nine months ended September 30,
2011. The increase in research and development expenses for the three months ended September 30,
2011, was primarily due to increased project related spending. The increase in research and
development expenses for the nine months ended September 30, 2011, was primarily due to increased
personnel and personnel-related costs and increased project related spending. For the near term, we
expect research and development expenses will increase as we seek to further develop and enhance
our System One and related products.
Distribution
Our distribution expenses and distribution as a percent of revenues for the three and nine
months ended September 30, 2011 and 2010 were as follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
System One segment |
|
$ |
3,761 |
|
|
|
10 |
% |
|
$ |
3,329 |
|
|
|
11 |
% |
|
$ |
11,010 |
|
|
|
10 |
% |
|
$ |
9,494 |
|
|
|
12 |
% |
In-Center segment |
|
|
948 |
|
|
|
5 |
% |
|
|
459 |
|
|
|
3 |
% |
|
|
2,288 |
|
|
|
4 |
% |
|
|
1,337 |
|
|
|
3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Distribution |
|
$ |
4,709 |
|
|
|
8 |
% |
|
$ |
3,788 |
|
|
|
8 |
% |
|
$ |
13,298 |
|
|
|
8 |
% |
|
$ |
10,831 |
|
|
|
8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution expenses increased $0.9 million, or 24%, and $2.5 million, or 23%, for the three
and nine months ended September 30, 2011, respectively, versus the prior year comparable periods,
due primarily to increased business volumes. Distribution expenses remained consistent as a
percentage of revenues for the three and nine months ended September 30, 2011. Distribution
expenses for the System One segment decreased slightly as a percentage of revenues for both the
three and nine
months ended September 30, 2011 versus the prior year comparable periods, due to efficiencies
gained from economies of scale resulting from increased business volume, improved product
reliability of our System One and PureFlow SL hardware and efficiencies in our distribution
network. Distribution expenses for the In-Center segment increased as a percentage of revenues
18
for
both the three and nine months ended September 30, 2011 versus the prior year comparable periods,
due primarily to overall increased fuel prices and increased costs associated with shipping certain
of our products from our international manufacturing locations to our customers. We expect that
distribution expenses will increase at a lower rate than revenues due to expected efficiencies
gained from increased business volume and improved reliability of System One equipment. However,
these favorable impacts may be offset by overall increases in fuel costs.
General and Administrative
Our general and administrative expenses and general and administrative expenses as a percent
of revenues for the three and nine months ended September 30, 2011 and 2010 were as follows (in
thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
|
2011 |
|
|
2010 |
|
General and administrative |
|
$ |
5,708 |
|
|
|
10 |
% |
|
$ |
6,023 |
|
|
|
13 |
% |
|
$ |
16,750 |
|
|
|
10 |
% |
|
$ |
16,604 |
|
|
|
13 |
% |
General and administrative expenses decreased $0.3 million, or 5%, and decreased as a
percentage of revenue to 10% versus 13% for the three months ended September 30, 2011 versus the
prior year comparable period as a result of lower non-cash stock based compensation expenses. For
the nine months ended September 30, 2011, general and administrative expenses increased $0.1
million, or 1%, and decreased as a percentage of revenue to 10% from 13% for the prior year
comparable period as a result of increased personnel and personnel-related costs and other
infrastructure related costs. We expect that general and administrative expenses will decrease as a
percentage of revenues over time as we continue to leverage our existing infrastructure.
Other Expense
Interest expense increased 1% and 2% for the three and nine months ended September 30, 2011,
versus the prior year comparable periods, due primarily to fees and amortization of debt issuance
costs associated with our loan and security agreement with Silicon Valley Bank, or SVB, which was
entered into in March 2010. We have no debt outstanding under this facility.
The change in other expense during both periods is derived primarily by foreign currency gains
and losses.
Provision for Income Taxes
The provision for income taxes of $0.2 million for the three months ended September 30, 2011
and 2010, and $0.7 million and $0.6 million for the nine months ended September 30, 2011 and 2010,
respectively, relates to the profitable operations of certain foreign entities.
Liquidity and Capital Resources
We have operated at a loss since our inception in 1998. As of September 30, 2011, our
accumulated deficit was $325.3 million and we had cash and cash equivalents of $101.2 million and
working capital of $122.0 million.
Our primary ongoing cash requirements will be to fund operating activities, product
development and debt service. Our primary sources of liquidity are cash on hand and ongoing
revenues.
Over the past several years we have improved our cash flows from operating activities and
continue to work towards our long-term goal of sustained positive cash flows from operating
activities. However, we expect cash flows from operating activities in the near term to fluctuate
between negative and positive on a quarterly basis, primarily due to changes in working capital.
There can be no assurance that we will be able to continue to improve cash flows from operating
activities or whether we will be able to generate positive cash flows from operating activities in
the future. We believe, based on current projections and the current nature of our business, that
we have the required resources to fund our ongoing operating requirements. Our ability to and the
rate at which we continue to improve cash flows from operating activities will depend on many
factors, including growing revenues, continued improvements in gross profit, leverage of our
operating infrastructure and continued sale versus rental of a significant percentage of our System
One equipment.
Historically, our business was fairly capital intensive due to the manner in which we placed
our System One equipment in the home market. However, over the past several years there has been
an increase in the number of customers who choose to
purchase rather than rent their System One equipment, which has been important to our
historical cash flow improvements. Shifting our customers to an equipment purchase versus rental
model allows us to recover the cost of our products upon initial sale rather than over an extended
period of time, thereby reducing our working capital requirements. A majority of our home
19
market
customers, have committed to purchase, rather than rent, the significant majority of their future
System One equipment requirements. While currently approximately 75% of patients use purchased
rather than rented System One equipment, there can be no assurance that we will be able to continue
to expand or sustain the percentage of our equipment placements that are purchased rather than
rented.
Another important factor that has affected our historical improvements in our cash flows is
our effective management of our field equipment assets, including those rented by customers and our
service pool equipment, which is equipment owned and maintained by us that is swapped for
equipment owned or rented by our customers that needs repair or maintenance. Any excess equipment,
unused equipment or material defects or write-offs of equipment would negatively impact our working
capital requirements.
We have two material debt instruments: the term loan and security agreement with Asahi and the
loan and security agreement with SVB.
In May 2009, we entered into a term loan and security agreement with Asahi. The $40.0 million
term loan bears interest at a rate of 8% per annum, with fifty percent of such interest being
deferred until the maturity date on May 31, 2013. Principal is payable in one balloon payment at
maturity. The term loan is secured by substantially all of our assets. In the event the term loan
reaches maturity, Asahi may require that all of the principal and interest on the term loan that is
unpaid as of the maturity date be converted into shares of our common stock, with the number of
shares to be determined based upon the average closing price of our common stock during the thirty
business days preceding the maturity date, subject to certain conditions.
The term loan and security agreement with Asahi includes certain affirmative covenants,
including requirements to make timely filings and limitations on contingent debt obligations and
sales of assets. At September 30, 2011, we were in compliance with these covenants. The term loan
and security agreement also contains customary events of default, including nonpayment,
misrepresentation, breach of covenants, material adverse effect and bankruptcy. In the event we
fail to satisfy our covenants, or otherwise go into default, Asahi has a number of remedies,
including sale of our assets and acceleration of all outstanding indebtedness, subject to the
rights of SVBs senior security interest. Any of these remedies would likely have a material
adverse effect on our business.
We have the flexibility under our term loan with Asahi to seek up to $40.0 million in
additional debt at market interest rates. In March 2010, we entered into a loan and security
agreement with SVB for a $15.0 million revolving line of credit with a maturity date of April 1,
2012. The agreement was amended in March 2011 to reduce the interest rate on borrowings, fees on
unused revolving line of credit and monthly reporting requirements. The agreement is secured by
all or substantially all of our assets. In connection with the agreement, we amended our term loan
and security agreement with Asahi to provide for certain amendments, including granting to Asahi
junior liens on certain of our assets for so long as the agreement with SVB remains outstanding.
Upon termination of all obligations under that facility, Asahis security will revert to a security
in all assets other than cash, bank accounts, accounts receivable, field equipment and inventory.
Borrowings under the agreement, as amended, bear interest at a floating rate per annum equal to
0.5% percentage points above the prime rate (initial prime rate of 4.00%). Pursuant to the
agreement, we have agreed to certain financial covenants relating to liquidity requirements and
adjusted EBITDA, as defined in the agreement with SVB. The agreement contains events of default
customary for transactions of this type, including nonpayment, misrepresentation, breach of
covenants, material adverse effect and bankruptcy. At September 30, 2011, we were in compliance
with the covenants, and there were no outstanding borrowings against the credit commitment. We
have nearly all of the $15 million of the credit commitment available for borrowing.
We have begun construction of a new manufacturing facility in Germany pursuant to the terms of
our Dialyzer Production Agreement entered into in May 2009 with Asahi. We are overseeing
construction of this new facility and will operate the new facility under a manufacturing agreement
upon its completion. Asahi will fund construction costs up to an original fixed amount; however,
we will be responsible for any additional costs. If the agreement is terminated during the
construction period due to our breach, insolvency or bankruptcy, Asahi has the option to require us
to pay for all amounts expended for construction of the new facility. If such event occurs we
would take title to the land and any construction in process. Subsequent to the completion of
construction, if the agreement is terminated due to our breach, insolvency or bankruptcy or by us
pursuant to certain terms of the agreement, Asahi has the option to require us to purchase the new
facility from them by paying one hundred percent of the then net book value of the new facility, as
calculated in accordance with GAAP. Given these options and our involvement in the construction,
we are considered the owner of the new facility for accounting purposes and will therefore record
its cost as construction-in-process and a corresponding liability has been recorded for the
construction cost funded by Asahi. The $5.2 million recorded at September 30, 2011 reflects the
construction costs incurred to date in connection with this project.
We maintain postemployment benefit plans for employees in certain foreign subsidiaries. The
plans provide lump sum benefits, payable based on statutory regulations for voluntary or
involuntary termination. Where required, we obtain an annual actuarial valuation of the benefit
plans. We have recorded a liability of $1.6 million as other long-term liabilities at
20
September 30,
2011 for costs associated with these plans. The expense recorded in connection with these plans was
not significant during 2011 or 2010.
The following table sets forth the components of our cash flows for the periods indicated (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2011 |
|
|
2010 |
|
Net cash used in operating activities |
|
$ |
(3,740 |
) |
|
$ |
(2,248 |
) |
Net cash used in investing activities |
|
|
(3,330 |
) |
|
|
(981 |
) |
Net cash provided in financing activities |
|
|
3,892 |
|
|
|
3,769 |
|
Effect of exchange rate changes on cash |
|
|
86 |
|
|
|
(286 |
) |
|
|
|
|
|
|
|
Net cash flow |
|
$ |
(3,092 |
) |
|
$ |
254 |
|
|
|
|
|
|
|
|
Net Cash Used in Operating Activities. Net cash used in operating activities increased by
$1.5 million during the nine months ended September 30, 2011, versus the prior year comparable
period. Net loss after adjustments for non-cash charges, such as depreciation, amortization and
stock-based compensation expense, had a favorable impact on cash flows increasing to a positive
$13.1 million during the nine months ended September 30, 2011 versus a positive $4.2 million for
the prior year comparable period. This improvement in cash flows was offset by an increase in
working capital requirements driven in part by lower sales of previously rented equipment and a
$4.3 million one-time customer prepayment on first quarter 2011 orders received by us during the
fourth quarter of 2010, partially offset by an increase in accounts payable related to increased
inventory levels. We expect working capital to fluctuate from quarter to quarter due to various
factors including inventory requirements and timing of payments from our customers and to our
vendors. Deferred revenues decreased $12.8 million to $1.3 million during the nine months ended
September 30, 2011 versus $14.1 million for the prior year comparable period, due to lower sales of
previously rented equipment, the change in accounting for equipment sales to our international
distributors and an increase in amortization of deferred revenues into revenues. During the nine
months ended September 30, 2011 and 2010, we recognized $11.7 million and $8.1 million,
respectively, of deferred revenues into revenues.
Non-cash transfers from inventory to field equipment for the placement of units with our
customers decreased $2.2 million during the nine months ended September 30, 2011 versus the prior
year comparable period. This activity fluctuates due to the timing of home market patient
additions and the equipment levels required in our service pool. Non-cash transfers from field
equipment to deferred costs of revenues decreased $6.3 million during the nine months ended
September 30, 2011 versus the prior year comparable period due, in part, to lower purchases of
previously rented equipment.
Net Cash Used in Investing Activities. For each of the periods above, net cash used in
investing activities reflected purchases of property and equipment, primarily for manufacturing
operations and capital improvements for our facilities and research and development and information
technology. The increase of $2.3 million in purchases of property and equipment was driven by
capital improvements to and expansion of certain of our manufacturing facilities to accommodate the
increased demand for our Streamline blood tubing sets and the transition of manufacturing of
certain of our blood tubing sets from our contract manufacturer to our own manufacturing facility.
Net Cash Provided in Financing Activities. During the nine months ended September 30, 2011
and 2010 we received $6.5 million and $5.6 million, respectively, of proceeds from stock option and
stock purchase plans due to an increase in the number of stock options exercised. This cash inflow
was offset by $2.5 million and $1.7 million during the nine months ended September 30, 2011 and
2010, respectively, of cash used to repurchase shares of our common stock that were surrendered by
employees in payment for the minimum required withholding taxes associated with awards under our
annual Bonus and Performance Share Plans.
Contractual Obligations
The following table summarizes our contractual commitments as of September 30, 2011 and the
effect those commitments are expected to have on liquidity and cash flows in the future periods (in
thousands):
21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less Than |
|
|
|
|
|
|
|
|
|
|
More Than |
|
|
|
Total |
|
|
One Year |
|
|
1-3 Years |
|
|
3-5 Years |
|
|
5 Years |
|
Debt obligations |
|
$ |
50,774 |
|
|
$ |
1,627 |
|
|
$ |
49,147 |
|
|
$ |
|
|
|
$ |
|
|
Operating leases |
|
|
20,564 |
|
|
|
1,278 |
|
|
|
2,695 |
|
|
|
3,286 |
|
|
|
13,305 |
|
Purchase obligations |
|
|
51,355 |
|
|
|
34,277 |
|
|
|
13,514 |
|
|
|
3,168 |
|
|
|
396 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
122,693 |
|
|
$ |
37,182 |
|
|
$ |
65,356 |
|
|
$ |
6,454 |
|
|
$ |
13,701 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt obligations include the aggregate outstanding principal amount under our $40.0
million term loan with Asahi and related deferred interest and estimated interest payments.
Our purchase obligations include purchase commitments for System One components, primarily for
equipment, blood tubing sets, needles, and fluids pursuant to contractual agreements with several
of our suppliers that are in the normal course of business. Certain of these commitments may be
extended and/or canceled at our option.
Summary of Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States, GAAP. The preparation of these consolidated
financial statements requires us to make significant estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. These items are regularly monitored
and analyzed by management for changes in facts and circumstances, and material changes in these
estimates could occur in the future. Changes in estimates are recorded in the period in which they
become known. We base our estimates on historical experience and various other assumptions that we
believe to be reasonable under the circumstances. Actual results may differ substantially from our
estimates.
The accounting policies and estimates that we believe are most critical to fully understanding
and evaluating our financial results are described in Item 7 in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2010. There were no new accounting pronouncements adopted
during the nine months ended September 30, 2011 that had a material impact on our financial
statements.
Revenue Recognition
We recognize revenue from product sales and services when earned. Revenues are recognized
when: (a) there is persuasive evidence of an arrangement; (b) the product has been shipped or
services and supplies have been provided to the customer, (c) the sales price is fixed or
determinable; and (d) collection is reasonably assured.
Certain agreements with distributors allow for product returns and credits. For shipment of
product sold to distributors, revenue is recognized at the time of sale if a reasonable estimate of
future returns or credit can be made. If a reasonable estimate of future returns or credit cannot
be made, we recognize revenue using the sell-through method. Under the sell-through method,
revenue and related costs of revenue is deferred until the final resale of such products to end
customers.
In addition to contractually determined volume discounts, in many agreements we offer rebates
based on sales to specific end customers and discounts for early payment. Rebates and discounts are
recorded as a reduction of sales and trade accounts receivable, based on our best estimate of the
amount of probable future rebate or discount on current sales.
We enter into multiple-element arrangements that may include a combination of equipment,
related disposables and services. Effective January 1, 2011, we adopted Accounting Standards
Update, or ASU, No. 2009-13, Multiple Deliverable Revenue Arrangements, as required, using the
prospective method as permitted under the guidance. Accordingly, this guidance is being applied to
all revenue arrangements entered into or materially modified on or after January 1, 2011. The
impact of adopting this amended guidance on our results of operations has been limited to products
sold internationally through distributors in the System One segment, which revenue has not been
significant in the current or historical periods. ASU No. 2009-13 amended the previous guidance
for multiple-element arrangements. Pursuant to the amended guidance in ASU 2009-13 our revenue
arrangements with multiple elements are divided into separate units of accounting if specified
criteria are met, including whether the delivered element has stand-alone value to the customer,
and the consideration received is allocated among the separate units based on their respective
selling price, and the applicable revenue recognition criteria are applied to each of the separate
units.
22
Under the amended guidance we determine selling price using vendor specific objective evidence
(VSOE), if it exists, otherwise third-party evidence of selling price is used. If neither VSOE
nor third-party evidence of selling price exists for a unit of accounting, we use best estimated
selling price (BESP). We generally expect that we will not be able to establish third-party
evidence due to the nature of our products and the markets in which we compete, and, as such, we
typically will determine selling price using VSOE or BESP.
We determine BESP for an individual element based on consideration of both market and
Company-specific factors, including the selling price and profit margin for similar products, the
cost to produce the deliverable and the anticipated margin on that deliverable, and the
characteristics of the varying markets in which the deliverable is sold.
The adoption of the amended guidance did not change the accounting for arrangements entered
into prior to January 1, 2011. Therefore, these arrangements with multiple elements were divided
into separate units of accounting if there was objective and reliable evidence of fair value of the
undelivered items and if other criteria were met, including whether the delivered element had
stand-alone value to the customer. If either criteria were not met, the arrangement was accounted
for as a single unit of accounting and the fees received upon the completion of delivery of
equipment were deferred and are recognized as revenue on a straight-line basis over the expected
term of our remaining obligation and direct costs relating to the delivered equipment are amortized
over the same period as the related revenue, while disposable products revenue is recognized on a
monthly basis upon delivery.
System One Segment
We derive revenue in the home market from the sales of hemodialysis therapy to customers in
which the customer either purchases or rents the System One and/or PureFlow SL hardware and
purchases a specified number of disposable products and service.
For customers that purchase the System One and PureFlow SL hardware in the home U.S. market,
due to the depot service model whereby equipment requiring service is picked up and a replacement
device is shipped to the site of care, we recognize fees received from equipment sale as revenue on
a straight-line basis over the expected term of our remaining service obligation and direct costs
relating to the delivered equipment are deferred and amortized over the same expected period as the
related revenue. Disposable products revenue is recognized on a monthly basis upon delivery.
Under the rental arrangements revenue is recognized on a monthly basis in accordance with
agreed upon contract terms and pursuant to binding customer purchase orders and fixed payment
terms.
Our sales arrangements with our international distributors are structured as direct product
sales and have no significant post delivery obligations with the exception of standard warranty
obligations. Under the previous guidance, for arrangements entered into prior to January 1, 2011
we determined that we could not account for the sale of equipment as a separate unit of accounting
and, therefore, the fees received upon the completion of delivery of equipment were deferred and
recognized as revenue on a straight-line basis over the expected term of our remaining service
obligation and direct costs relating to the delivered equipment were amortized over the same
expected period as the related revenue. Under the amended guidance, for arrangements entered into
or materially modified on or after January 1, 2011, we will recognize revenues and related direct
costs upon delivery in accordance with contract terms. Disposable product revenue is recognized on
a monthly basis upon delivery under both the previous and amended guidance.
In the critical care market, we structure sales of the System One and disposable products as
direct product sales and have no significant post delivery obligations with the exception of
standard warranty obligations. Revenue from direct product sales is recognized upon delivery in
accordance with contract terms. Certain of these arrangements provide for training, technical
support and extended warranty services to our customers. We recognize training and technical
support revenue when the related services are performed. In the case of extended warranty, the
service revenue is recognized ratably over the warranty period.
In-Center Segment
Our In-Center segment sales are structured as direct product sales primarily through
distributors, and we have no significant post delivery obligations with the exception of standard
warranty obligations. Revenue from direct product sales is recognized upon delivery in accordance
with contract terms. Some of our distribution contracts for the In-Center segment contain minimum
volume commitments with negotiated pricing discounts at different volume tiers. Each agreement may
be canceled upon a material breach, subject to certain curing rights, and in many instances minimum
volume commitments can be reduced or eliminated upon certain events.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements is included in Note 2 to the consolidated
financial statements included in our Annual Report on Form 10-K for the fiscal year ended December
31, 2010 and updated as necessary in Note 2 to the
condensed consolidated financial statements included in this quarterly report on Form 10-Q.
23
|
|
|
Item 3. |
|
Quantitative and Qualitative Disclosures About Market Risk |
We are subject to market risks in the normal course of our business, including changes in
interest rates and exchange rates. For quantitative and qualitative disclosures about market risk
affecting us, see Item 7A, Quantitative and Qualitative Disclosures About Market Risk, of our
Annual Report on Form 10-K for the fiscal year ended December 31, 2010. There have been no material
changes to the market risks described in our Annual Report on Form 10-K for December 31, 2010.
|
|
|
Item 4. |
|
Controls and Procedures |
Our management, with the participation of our chief executive officer and chief financial
officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30,
2011. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, or the Exchange Act, means controls and other procedures
of a company that are designed to ensure that information required to be disclosed by a company in
the reports that it files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SECs rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to ensure that information
required to be disclosed by a company in the reports that it files or submits under the Exchange
Act is accumulated and communicated to the companys management, including its principal executive
and principal financial officers, as appropriate to allow timely decisions regarding required
disclosure. Our management recognizes that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. Based on the evaluation of our disclosure controls and procedures as of September
30, 2011, our chief executive officer and chief financial officer concluded that, as of such date,
our disclosure controls and procedures were effective to achieve their stated purpose.
No change in our internal control over financial reporting (as defined in Rule 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2011 that
has materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
24
PART II OTHER INFORMATION
In addition to the factors discussed in Managements Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this report, the following are some of the
important risk factors that could cause our actual results to differ materially from those
projected in any forward-looking statements.
Risks Related to our Business
We expect to derive a significant percentage of our future revenues from the rental or sale of our
System One and the related products used with the System One and a limited number of other
products.
Since our inception, we have devoted a substantial amount of our efforts to the development of
the System One and the related products used with the System One. We commenced marketing the System
One and the related disposable products to the critical care market in February 2003. We commenced
marketing the System One for chronic hemodialysis treatment in September 2004. Prior to the
acquisition of the Medisystems Corporation and certain affiliated entities, or the Medisystems
Acquisition, on October 1, 2007, nearly 100% of our revenues were derived from the rental or sale
of our System One and the sale of related disposables. Although the Medisystems Acquisition
broadened our product offerings, we expect that in 2011 and in the foreseeable future, we will
continue to derive a significant percentage of our revenues from the System One, and that we will
derive the remainder of our revenues from the sale of a few key disposable products acquired in the
Medisystems Acquisition, including blood tubing sets and needles. To the extent that any of our
primary products are not commercially successful or are withdrawn from the market for any reason,
our revenues will be adversely impacted and we do not have other significant products in
development that could readily replace these revenues.
We cannot accurately predict the size of the home hemodialysis market, and it may be smaller, and
may develop more slowly than we expect.
We believe our largest future product market opportunity is the home hemodialysis market.
However, this market is presently very small and adoption of the home hemodialysis treatment
options has been limited. The most widely adopted form of dialysis therapy used in a setting other
than a dialysis clinic is peritoneal dialysis. Based on the most recently available data from the
United States Renal Data System, or USRDS, less than 10% of all United States patients receiving
dialysis treatment for ESRD receive either peritoneal dialysis or home hemodialysis. Because the
adoption of home hemodialysis has been limited to date, the number of patients and their partners
who desire to, and are capable of, administering hemodialysis treatment with a system such as the
System One is unknown and there is limited data upon which to make estimates. In addition, many
dialysis clinics do not presently have the infrastructure in place to support home hemodialysis and
most do not have the infrastructure in place to support a significant home hemodialysis patient
population. Our long-term growth will depend on the number of patients who adopt home-based
hemodialysis and how quickly they adopt it, which in turn is driven by the number of physicians
willing to prescribe home hemodialysis and the number of dialysis clinics able or willing to
establish and support home hemodialysis therapies.
Because nearly all our home hemodialysis patients are also receiving more frequent dialysis,
meaning dialysis delivered five or more times a week, the market adoption of our System One for
home hemodialysis is also dependent upon the penetration and market acceptance of more frequent
hemodialysis. Given the increased provider supply costs associated with providing more frequent
dialysis versus conventional three-times per week dialysis, market acceptance will be impacted,
especially for U.S. Medicare patients, by whether dialysis clinics are able to obtain reimbursement
for additional dialysis treatments provided in excess of three times a week. Based on analysis of
historical Medicare payment files and customer reports, those delivering and billing for more
frequent dialysis receive reimbursement, on average, for more than three treatments per week.
However, providing medical justification for treatments beyond three times per week increases
administrative burden, and some customers may not receive additional reimbursement in all cases.
Although access to home daily hemodialysis continues to grow, we believe that current Medicare
reimbursement leads to adoption rates lower than rates commensurate with the percentage of patients
experts believe can perform and medically benefit from this therapy. More certain Medicare
reimbursement with less administrative burden would allow adoption of more frequent home
hemodialysis at rates more consistent with those believed to be appropriate by the expert medical
community.
New regulations particularly impacting home hemodialysis technologies can also negatively
impact the rate and extent of any further market expansion of our System One for home hemodialysis.
We saw the impact of such regulations in 2008, when the Centers for Medicare and Medicaid
Services, or CMS, released new Conditions for Coverage applicable to our customers. These
Conditions for Coverage impose water testing requirements on our patients using our PureFlow SL
product. These water testing requirements increase the burden of our therapy for our patients and
may impair market adoption, especially for our PureFlow SL product. To the extent additional
regulations are introduced unique to the home environment, market adoption could be even further
impaired.
25
We are in a developing market and we will need to continue to devote significant resources to
developing the home market. We cannot be certain that this market will develop, how quickly it will
develop or how large it will be.
Current Medicare reimbursement rates, at three times per week, limit the price at which we can
market our home products, and adverse changes to reimbursement would likely negatively affect the
adoption or continued sale of our home products.
Our ability to attain profitability will be driven in part by our ability to set or maintain
adequate pricing for our products. As a result of legislation passed by the United States Congress
more than 30 years ago, Medicare provides broad and well-established reimbursement in the United
States for ESRD. With approximately 75% of United States ESRD patients covered by Medicare, the
reimbursement rate is an important factor in a potential customers decision to use the System One
or our other products and limits the fee for which we can sell or rent our products. Additionally,
current CMS rules limit the number of hemodialysis treatments paid for by Medicare to three times a
week, unless there is medical justification provided by the dialysis facility based on information
from the patients physician for additional treatments. Most patients using the System One in the
home treat themselves, with the help of a partner, up to six times per week. To the extent that
Medicare contractors elect not to pay for the additional treatments, adoption of the System One
would likely be impaired. The determination of medical justification must be made at the local
Medicare contractor level on a case-by-case basis, based on documentation provided by our
customers. If daily therapy is prescribed, a clinics decision as to how much it is willing to
spend on dialysis equipment and services will be at least partly dependent on whether Medicare will
reimburse more than three treatments per week for the clinics patients. Medicare is switching from
intermediaries to Medicare administrative contractors. This change in the reviewing entity for
Medicare claims could lead to a change in whether a customer receives Medicare reimbursement for
additional treatments. If an adverse change to historical payment practices occurs, market adoption
of our System One in the home market may be impaired. Based on analysis of historical Medicare
payment files and customers, those delivering and billing for more frequent dialysis receive
reimbursement, on average, for more than three treatments per week. However, providing medical
justification for treatments beyond three times per week increases administrative burden, and some
customers may not receive additional reimbursement in all cases. Although access to home daily
hemodialysis continues to grow, we believe that current Medicare reimbursement leads to adoption
rates lower than rates commensurate with the percentage of patients experts believe can perform and
medically benefit from this therapy. More certain Medicare reimbursement with less administrative
burden would allow adoption of more frequent home hemodialysis at rates more consistent with those
believed to be appropriate by the expert medical community.
CMS published, on August 12, 2010, the final rule for implementation of the new prospective
payment system for dialysis treatment effective January 1, 2011. Under this new ESRD prospective
payment system, CMS makes a single bundled payment to the dialysis facility for each dialysis
treatment that covers all renal dialysis services and home dialysis and includes certain drugs
(including erythropoiesis stimulating agents, or ESAs, iron, and Vitamin D). It has replaced the
former system which paid facilities a composite rate for a defined set of items and services, while
paying separately for drugs, laboratory tests, or other services that were not included in the
composite rate. The prospective payment system still limits the number of hemodialysis treatments
paid by Medicare to three times a week, unless there is medical justification provided by the
patients physician for additional treatments. In addition, in 2014 CMS is expected to expand the
prospective payment systems single bundled payment to include oral medications. Although a stated
goal of the prospective payment system is to encourage home dialysis, and the inclusion of drugs
into the prospective rate and the retention of a home patient training payment adjustment with a
modest update from current levels are intended to support this goal, it is not possible at this
time to determine what impact the new payment system or healthcare legislation will have on the
adoption of home and/or daily hemodialysis or the price for which we can sell our products.
We have limited operating experience, a history of net losses and an accumulated deficit of $325.3
million at September 30, 2011. We cannot guarantee if, when and the extent to which we will become
profitable, or that we will be able to maintain profitability if it is achieved.
Since inception, we have incurred negative operating margins and losses every quarter. At
September 30, 2011, we had an accumulated deficit of approximately $325.3 million. We expect our
operating expenses to continue to increase as we grow our business. While we have achieved positive
gross profit for our products, in aggregate, since the fourth quarter of 2007, we cannot provide
assurance that our gross profit as a percentage of revenues will improve or, if they do improve,
the rate at which they will improve. We cannot provide assurance that we will achieve
profitability, when we will become profitable, the sustainability of profitability, should it
occur, or the extent to which we will be profitable.
Our customers in the System One and In-Center segments are highly consolidated, with concentrated
buying power.
Fresenius and DaVita own and operate the two largest chains of dialysis clinics in the United
States and collectively provide treatment to approximately two-thirds of United States dialysis
patients; and this percentage may continue to grow with further market consolidation. DaVita, for
example, recently announced its plans to acquire DSI Renal, Inc. More recently, Fresenius announced
its plans to acquire Liberty Dialysis Holdings, Inc., the holding company for Liberty Dialysis and
Renal Advantage. With less than 40% of United States dialysis patients cared for by independent
dialysis clinics, our market
26
adoption, at least within the United States, would be more constrained without the presence of
both DaVita and Fresenius as customers for our System One and In-Center products.
Additionally, Fresenius is not only a dialysis service provider, it is also the leading
manufacturer of dialysis equipment worldwide. On February 18, 2011 we learned that Fresenius
obtained clearance for its 2008K At Home hemodialysis system for use in home chronic therapy in
February 2011. DaVita does not manufacture dialysis equipment, but has certain dialysis supply
purchase obligations to Gambro, a dialysis equipment manufacturer, under a long-term preferred
supplier agreement. Fresenius may choose to offer its dialysis patients only the dialysis equipment
Fresenius manufactures, including its recently cleared home hemodialysis system. DaVita may choose
to offer their dialysis patients the equipment it contractually agreed to offer in its agreement
with Gambro. Fresenius and DaVita may also choose to otherwise limit access to the equipment
manufactured by competitors. DaVita is our most significant customer, and we expect it to continue
to be, at least for the foreseeable future. Our earlier agreement with DaVita contained certain
limited exclusivity rights which restricted our ability to sell the System One in certain markets
and to Fresenius. These restrictions do not exist under our July 2010 Amended and Restated National
Service Provider Agreement with DaVita and we have a growing percentage of our home market sales to
Fresenius, which is our second largest customer in the System One segment. Our Amended and
Restated National Service Provider Agreement with DaVita expires on December 31, 2013, which term
will be automatically extended on a month to month basis. Our agreements with DaVita and other
large home market customers are intended to support the continued expansion of patient access to
home hemodialysis with the System One, but like all our agreements with home market customers, our
agreements with DaVita and other large customers are not requirements contracts and they contain
no minimum purchase volumes. We have no assurance that our sales to DaVita, Fresenius or other
large customers will continue to grow, and we cannot predict what impact Fresenius recently
cleared home hemodialysis system will have on our sales to Fresenius in the home market or our
overall performance in the home market going forward. Given the significance of DaVita and
Fresenius as customers in the home market, any adverse change in either customers ordering or
clinical practices, as might be the case in periodic contract negotiations, would have a
significant adverse impact on our home market revenues, especially in the near term.
DaVita is a key customer for our System One and In-Center product lines. The partial or complete
loss of DaVita as a customer would materially impair our financial results, at least in the near
term.
DaVita is our most significant customer. Sales through distributors to DaVita of products
accounted for approximately half of In-Center segment revenues for the three and six months ended
September 30, 2011, and direct sales to DaVita accounted for approximately 31% of our System One
segment revenues during the same period. Further, DaVita is our largest customer in the home
market, constituting over 40% of our home hemodialysis patients. Although we expect that DaVita
will continue to be a significant customer in the home market, we cannot be certain that DaVita
will continue to purchase and/or rent the System One or add additional System One patients in the
future. Our contract for needles with DaVita, expiring in December 2013, includes certain minimum
order requirements; however, these can be reduced significantly under certain circumstances. Our
contract for blood tubing sets with DaVita expired in September 2009. However, in June 2009, we
entered into a five year distribution agreement in the United States with Gambro, pursuant to which
Gambro will exclusively supply our blood tubing sets, including our ReadySet and the Streamline
product lines, to DaVita. The partial or complete loss of DaVita as a customer for any of these
product lines would adversely affect our business, at least in the near term.
We entered into a $40.0 million term loan and security agreement with Asahi in May 2009. We are
obligated to pay 50% of the interest on the first day of November and May, beginning on November 1,
2009, and repay the remaining interest and principal upon maturity in May 2013. If we fail to
comply with all terms under this agreement, we may go into default, which could trigger, among
other things, the acceleration of all of our indebtedness there under or the sale of our assets.
In May 2009, we entered into a $40.0 million term loan, with Asahi. The four year term loan,
maturing in May 2013, bears interest at 8% annually, payable on the first day of November and May
beginning on November 1, 2009, with 50% of the interest deferred to maturity. The term loan is
secured by substantially all of our assets.
The term loan and security agreement includes certain affirmative covenants including timely
filings and limitations on contingent debt obligations and sales of assets. The term loan and
security agreement also contains customary events of default, including nonpayment,
misrepresentation, breach of covenants, material adverse effects and bankruptcy. In the event we
fail to satisfy our covenants, or otherwise go into default, Asahi has a number of remedies,
including sale of our assets and acceleration of all outstanding indebtedness, subject to the
rights of Silicon Valley Banks senior security interests. Any of these remedies would likely have
a material adverse effect on our business.
We entered into a two year Loan and Security Agreement, dated as of March 10, 2010, with Silicon
Valley Bank, or SVB. The terms of this agreement may restrict our current and future operations,
which could affect our ability to respond to changes in our business and to manage our operations.
On March 10, 2010, we entered into an agreement with SVB for a $15.0 million revolving line of
credit with a maturity date of April 1, 2012. The agreement is secured by all or substantially all
of our assets. In connection with this agreement, we amended our term loan and security agreement
with Asahi to provide for certain amendments, including granting to Asahi
27
junior liens on certain of our assets for so long as the agreement with SVB remains
outstanding. Upon termination of all obligations under that facility, Asahis security will revert
to a security in all assets other than cash, bank accounts, accounts receivable, field equipment
and inventory. Borrowings under the agreement, as amended, bear interest at a floating rate per
annum equal to 0.5% percentage points above the prime rate (initial prime rate of 4.00%). Pursuant
to the agreement, we have agreed to certain financial covenants relating to liquidity requirements
and adjusted EBITDA, as defined in our agreement with SVB. The agreement contains events of default
customary for transactions of this type, including nonpayment, misrepresentation, breach of
covenants, material adverse effect and bankruptcy.
As of the date hereof, we do not have an outstanding balance under the revolving line of
credit. However, were we to draw on the line of credit, in the event we fail to satisfy our
covenants, or otherwise go into default, SVB has a number of remedies, including sale of our assets
and acceleration of all outstanding indebtedness. Certain of these remedies would likely have a
material adverse effect on our business.
We compete against other dialysis equipment manufacturers with much greater financial resources and
established products and customer relationships, which may make it difficult for us to penetrate
the market and achieve significant sales of our products. Our competitors may also introduce new
products or features that could impair the competitiveness of our own product portfolio.
Our System One in the critical care market competes against Gambro AB, Fresenius Medical Care
AG, B. Braun and others. Our System One in the home market is currently the only portable system
specifically indicated for use in the home market in the United States. However, on February 18,
2011 we learned that Fresenius, our second largest customer in the System One segment, with nearly
all of those sales in the home market, obtained clearance for its 2008K At Home hemodialysis system
for use in home chronic therapy in February 2011. Our product lines in the in-center market compete
directly against products produced by Fresenius Medical Care AG, Gambro AB, Nipro, B. Braun, Baxter
International, JMS CO., LTD and others. Our competitors each market one or more FDA-cleared medical
devices for the treatment of acute or chronic kidney failure. Each of these competitors offers
products that have been in use for a longer time than our System One and are more widely recognized
by physicians, patients and providers. These competitors have significantly more financial and
human resources, more established sales, service and customer support infrastructures and spend
more on product development and marketing than we do. Many of our competitors also have established
relationships with the providers of dialysis therapy and, Fresenius owns and operates a chain of
dialysis clinics. The product lines of most of these companies are broader than ours, enabling them
to offer a broader bundle of products and have established sales forces and distribution channels
that may afford them a significant competitive advantage.
The market for our products is competitive, subject to change and affected by new product
introductions and other market activities of industry participants, including increased
consolidation of ownership of clinics by large dialysis chains. If we are successful, our
competitors are likely to develop products that offer features and functionality similar to our
products, including our System One. Improvements in existing competitive products or the
introduction of new competitive products may make it more difficult for us to compete for sales,
particularly if those competitive products demonstrate better reliability, convenience or
effectiveness or are offered at lower prices. In addition to the recent clearance of the Fresenius
2008K At Home for use in home chronic therapy, Baxter International has a research and development
collaboration with DEKA Research and Development Corporation and HHD, LLC, or DEKA, and has
recently indicated that it commenced an IDE clinical study seeking to support the clearance of
DEKAs new home hemodialysis in the US. Baxter International has publicly indicated that it
had temporarily suspended its U.S. IDE study shortly after the study commenced, and that it expects to
recommence the study later this year. Baxter International has indicated that it hopes to obtain regulatory
approval for DEKAs system in Europe in 2012, and to submit for regulatory approval for a nocturnal
indication in the U.S. in 2013. Other small companies are also working to develop products for this
market. We are unable to predict when, if ever, any of these products may attain regulatory
clearance and appear in the market, or how successful they may be should they be introduced, but if
additional viable products are introduced to the market, it could adversely affect our sales and
growth. We also are unable to predict what impact the recent clearance of a Fresenius home
hemodialysis systems will have on our sales to Fresenius or our overall home market performance.
Our ability to successfully market our products could also be adversely affected by pharmacological
and technological advances in preventing the progression of ESRD and/or in the treatment of acute
kidney failure or fluid overload. If we are unable to compete effectively against existing and
future competitors and existing and future alternative treatments and pharmacological and
technological advances, it will be difficult for us to penetrate the market and achieve significant
sales of our products.
Our continued growth is dependent on our development and successful commercialization of new and
improved products.
Our future success will depend in part on our timely development and introduction of new and
improved products that address changing market requirements. To the extent that we fail to
introduce new and innovative products or incremental product improvements, we may lose revenues or
market share to our competitors, which may be difficult to regain. Our inability, for
technological, regulatory or other reasons, to successfully develop and introduce new or improved
products could
28
reduce our growth rate or otherwise damage our business. We cannot assure you that our
developments will keep pace with the marketplace or that our new or improved products will
adequately meet the requirements of the marketplace.
The success and growth of our business will depend upon our ability to achieve expanded market
acceptance of our System One.
In the home market, we have to convince four distinct constituencies involved in the choice of
dialysis therapy, namely operators of dialysis clinics, nephrologists, dialysis nurses and
patients, that the System One provides an effective alternative to other existing dialysis
equipment. In the in-center market, we have to convince all of these constituencies, but to a
lesser degree, patients, that our blood tubing sets and needles provide an effective alternative to
other dialysis disposables. In the critical care market, we have to convince hospital purchasing
groups, hospitals, nephrologists, dialysis nurses and critical care nurses that our system provides
an effective alternative to other existing dialysis equipment. Each of these constituencies uses
different considerations in reaching their decision. Lack of acceptance by any of these
constituencies will make it difficult for us to grow our business. We may have difficulty gaining
widespread or rapid acceptance of any of our products, including the System One, for a number of
reasons including:
|
|
|
the failure by us to demonstrate to operators of dialysis clinics, hospitals,
nephrologists, dialysis nurses, patients and others that our products are equivalent or
superior to existing therapy options; |
|
|
|
competition from products sold by companies with longer operating histories and
greater financial resources, more recognizable brand names and better established
distribution networks and relationships with hospitals or dialysis clinics; |
|
|
|
the failure by us to continue to improve product reliability and the ease of use
of our products; |
|
|
|
limitations on the existing infrastructure in place to support home hemodialysis,
including without limitation, home hemodialysis training nurses, and the willingness,
cost associated with, and ability of dialysis clinics to build that infrastructure; |
|
|
|
the ownership and operation of some dialysis providers by companies that also
manufacture and sell competitive dialysis products; |
|
|
|
the introduction of competing products or treatments that may be more effective,
easier to use or less expensive than ours; |
|
|
|
regulations that impose additional burden on patients and their caregivers, such
as the recently adopted Medicare conditions for coverage which impose additional water
testing requirements in connection with the use of our PureFlow SL; |
|
|
|
the number of patients willing and able to perform therapy independently, outside
of a traditional dialysis clinic, may be smaller than we estimate; and |
|
|
|
the availability of satisfactory reimbursement from healthcare payors, including
Medicare. |
If we are unable to convince additional hospitals and healthcare providers of the benefits of our
products for the treatment of acute kidney failure and fluid overload, we will not be successful in
increasing our market share in the critical care market.
We sell the System One in the critical care market for use in the treatment of acute kidney
failure and fluid overload. Physicians currently treat most acute kidney failure patients using
conventional hemodialysis systems or dialysis systems designed specifically for use in the
intensive care unit, or ICU. We will need to convince hospitals and healthcare providers that using
the System One is as effective as using conventional hemodialysis systems or ICU-specific dialysis
systems for treating acute kidney failure and that it provides advantages over conventional systems
or other ICU-specific systems because of its significantly smaller size, ease of operation and
clinical flexibility. In addition, the impact of tightened credit markets on hospitals could impair
the manner in which we sell products in the critical care market. Hospitals facing pressure to
reduce capital spending may choose to delay capital equipment purchases or seek alternative
financing options.
Our business and results of operations may be negatively impacted by general economic and financial
market conditions, including fluctuations in foreign exchange rates, and such conditions may
increase other risks that affect our business.
Global macro economic conditions and the worlds financial markets continue to experience some
degree of turmoil, resulting in reductions in available credit, foreign currency fluctuations and
volatility in the valuations of securities generally. In general, we believe demand for our
products in the home and in-center market will not be substantially affected by the changing market
conditions as regular dialysis is a life-sustaining, non-elective therapy. However, there is no
assurance that future
29
economic changes or global uncertainties would not negatively impact our business, especially
the manner and pace in which we sell equipment in the System One segment or delay equipment
placements. Hospitals or clinics facing pressure to reduce capital spending may choose to rent
equipment rather than purchase it outright, or to enter into other less-capital intensive purchase
structures with us, which may, in turn, have a negative impact on our cash flows. Our ability to
sell products internationally is particularly vulnerable to adverse impacts from global macro
economic conditions. Government funded hospitals in various international markets may seek to
defer capital purchases or tenders. Distributors with reduced access to capital may be less
willing to purchase our equipment outright, impairing our ability to sell our products. Further,
unfavorable changes in foreign exchange rates versus the U.S. dollar would increase our product
costs which would negatively impact our gross profit and gross profit as a percentage of revenues.
The non-cash discounts we have offered to DaVita may lead to reductions in our future net revenues
that will fluctuate because the amount of the discount is based upon the number of warrants earned
and our stock price.
Under our July 22, 2010 agreement with DaVita, we offered DaVita the opportunity to earn
pricing discounts based upon the achievement of System One home patient growth targets at June 30,
2011, 2012 and 2013. In order to preserve cash, the discount takes the form of warrants to purchase
up to 5.5 million shares of our common stock that become exercisable based on the achievement of
certain System One home patient growth targets (reflecting home patients who have remained on
contiguous home hemodialysis therapy for at least three full months with the System One) at June
30, 2011, 2012 and 2013, and which further require DaVita to continue to grow its home patient
census every six months during the term of the agreement. The discount associated with these
warrants will be measured at fair value through the date of vesting using a Black-Scholes option
pricing model, and is being recognized as a reduction of revenues over the same period as the
related product revenues (between seven to ten years) based on the number of warrants expected to
vest. The warrants are non-transferable, must be exercised in cash and have an exercise price of
$14.22 per share, which is equal to the trailing fifteen day volume weighted average price of a
share of NxStage Common Stock on the NASDAQ Global Market as of the close of business on July 21,
2010, the day prior to entering into our agreement.
For the period ended June 30, 2011, DaVita achieved System One home patient growth targets
that entitled DaVita to become vested in warrants to purchase 250,000 shares of our common stock.
The reduction of revenues recorded in connection with these warrants was not significant during the
three or nine months ended September 30, 2011. However, there can be no assurance that the value
of the discount, and, therefore, the amount of reduction of revenues recorded, will not be higher
in the future based upon the level of warrants DaVita actually earns under the agreement, as well
as the price of our stock on the date the warrants vest. Should our stock price increase above its
current price, the amount of the discount would be increased.
Healthcare reform legislation could adversely affect our revenue and financial condition.
In recent years, there have been numerous initiatives on the federal and state levels for
comprehensive reforms affecting the payment for, the availability of and reimbursement for
healthcare services in the United States. These initiatives have ranged from proposals to
fundamentally change federal and state healthcare reimbursement programs, including providing
comprehensive healthcare coverage to the public under governmental funded programs, to minor
modifications to existing programs.
In March 2010, the U.S. Congress adopted and President Obama signed into law comprehensive
health care reform legislation through the passage of the Patient Protection and Affordable Care
Act (Pub. L. No. 111-148) and the Health Care and Education Reconciliation Act of 2010 (Pub. L. No.
111-152). Among other initiatives, these bills impose a 2.3% excise tax on domestic sales of
certain medical devices after December 31, 2012. This legislation also applies a productivity
adjustment to the Medicare payment rates for dialysis facilities that could cause variable annual
decreases in payment rates as of 2012. Outside of the excise tax, which will impact our results of
operations following December 31, 2012, and the productivity adjustments, which may impact our
operations when the amount of the adjustments are announced, we cannot predict the effect such
legislation will have on us. If significant reforms are made to the healthcare system in the United
States, or in other jurisdictions, those reforms may have a material adverse effect on our
financial condition and results of operations.
As our business continues to grow, we may have difficulty managing our growth and expanding our
operations successfully.
As our business continues to grow, we will need to expand our manufacturing, product
distribution, sales and marketing and on-going development capabilities or contract with other
organizations to provide these capabilities for us. As our operations expand, we expect that we
will need to manage additional relationships with various partners, suppliers, manufacturers and
other organizations. Our ability to manage our operations and growth requires us to continue to
improve our information technology infrastructure, operational, financial and management controls,
reporting systems and procedures and management resources. Our rationalization and consolidation
of our manufacturing activities will place additional burdens on the existing infrastructure at our
plants, particularly at our manufacturing facility in Tijuana Mexico. If we are unable to
continue to grow and improve our information technology infrastructure, operational, financial and
management controls, reporting systems and procedures and management resources, our ability to run
our business efficiently and effectively could be
impaired.
30
If we are unable to maintain strong product reliability for our products, our ability to maintain
or grow our business and achieve profitability could be impaired. Transition of supply or
manufacturing locations of products can also lead to product quality and reliability issues which
could impair our ability to maintain or grow our business and achieve profitability.
Product reliability issues associated with any of our product lines could lead to decreases in
customer satisfaction and our ability to grow or maintain our revenues and could negatively impact
our reputation. Further, any unfavorable changes in product reliability would result in increased
service and distribution costs which negatively impacts our gross profit and increases our working
capital requirements. We continue to work to maintain strong product reliability for all products.
If we are unable to maintain strong product reliability for our existing products, our ability to
achieve our growth objectives as well as profitability could be significantly impaired.
We also need to establish strong product reliability for all new products we offer. With new
products, we are more exposed to risks relating to product quality and reliability until the
manufacturing processes for these new products mature. We also choose from time to time to
transition the manufacturing and supply of products and components to different suppliers or
locations . As we make these changes, we are also more exposed to risks relating to product
quality and reliability until the manufacturing processes mature. In May 2011, we agreed not to
renew our supply and distribution agreement with Kawasumi and we are currently working to
consolidate all of our bloodline supply in our manufacturing facility in Tijuana Mexico in order to
achieve long term margin improvements and other efficiencies. Recently, we also agreed not to
renew our agreements with the Entrada Group, through which we have access to our Fresnillo Mexico
facility. As a result of this decision, we will now be consolidating our equipment manufacturing
and service activities, which have been conducted in Fresnillo, into our manufacturing facility in
Tijuana Mexico. These transitions could expose us to product quality and reliability issues. Like
all transitions of this nature, these transitions will also lead us to incur additional costs in
the short term, which will negatively impact our gross profits in the short term.
We have a significant amount of System One field equipment and our inability to effectively manage
this asset could negatively impact our working capital requirements and future profitability.
Because our home market relies upon an equipment service swap model and, for some of our
customers, an equipment rental model, our ability to manage System One equipment is important to
minimizing our working capital requirements. Both factors require that we maintain a significant
level of field equipment of our System One and PureFlow SL hardware. In addition, our gross profit
as a percentage of revenues may be negatively impacted if we have excess equipment deployed and
unused in the field. If we are unable to successfully track, service and redeploy equipment, we
could (1) incur increased costs, (2) realize increased cash requirements and/or (3) have material
write-offs of equipment. This would negatively impact our working capital requirements and future
profitability.
If kidney transplantation becomes a viable treatment option for more patients with ESRD, or if
medical or other solutions for renal replacement become viable, the market for our products may be
limited.
While kidney transplantation is the treatment of choice for most ESRD patients, it is not
currently a viable treatment for most patients due to the limited number of donor kidneys, the high
incidence of kidney transplant rejection and the higher surgical risk associated with older ESRD
patients. According to USRDS data, in 2008, approximately 17,400 patients received kidney
transplants in the United States. The development of new medications designed to reduce the
incidence of kidney transplant rejection, progress in using kidneys harvested from genetically
engineered animals as a source of transplants or any other advances in kidney transplantation could
limit the market for our products. The development of viable medical or other solutions for renal
replacement or prolonging kidney life may also limit the market for our products.
We could be subject to costly and damaging product and professional liability claims and may not be
able to maintain sufficient liability insurance to cover claims against us.
If any of our employees or products is found to have caused or contributed to injuries or
deaths, we could be held liable for substantial damages. Claims of this nature may also adversely
affect our reputation, which could damage our position in the market. While we maintain insurance,
including professional liability, product and excess liability, claims may be brought against us
that could result in court judgments or settlements in amounts that are in excess of the limits of
our insurance coverage. In addition, due to the recent tightening of global credit and the
disruption in the financial markets, there may be a disruption in our insurance coverage or delay
or disruption in the payment of claims by our insurance providers. Our insurance policies also have
various exclusions and we may be subject to a product or professional liability claim for which we
have no coverage. We will have to pay any amounts awarded by a court or negotiated in a settlement
that exceed our coverage limitations or that are not covered by our insurance.
31
Any product liability or professional liability claim brought against us, with or without
merit, could result in the increase of our product liability or professional liability insurance
rates, respectively, or the inability to secure additional insurance coverage in the future. A
product liability claim, whether meritorious or not, could be time consuming, distracting and
expensive to defend and could result in a diversion of management and financial resources away from
our primary business, in which case our business may suffer.
We maintain insurance at levels deemed adequate by management; however, future claims could exceed
our applicable insurance coverage.
We maintain insurance for property and general liability, directors and officers liability,
product liability, workers compensation and other coverage in amounts and on terms deemed adequate
by management based on our expectations for future claims. Future claims could, however, exceed our
applicable insurance coverage, or our coverage could not cover the applicable claims.
We face risks associated with having international manufacturing operations, and if we are unable
to manage these risks effectively, our business could suffer.
We operate manufacturing facilities in Germany, Italy and Mexico. We also purchase components,
products and supplies from foreign vendors. We are subject to a number of risks and challenges that
specifically relate to these international operations, and we may not be successful if we are
unable to meet and overcome these challenges. Significant among these risks are risks relating to
foreign currency, in particular the Euro, Peso and Thai Baht. We do not currently hedge our foreign
currency transactions. To the extent we fail to control our exchange rate risk, our gross profit as
a percentage of revenues and profitability could suffer and our ability to maintain mutually
beneficial and profitable relationships with foreign vendors could be impaired. In addition to
these risks, through our international operations, we are exposed to costs and challenges
associated with sourcing and shipping goods internationally and importing and exporting goods,
difficulty managing operations in multiple locations, local regulations that may restrict or impair
our ability to conduct our operations, and health issues, such as pandemic disease risk, which
could disrupt our manufacturing and logistical and import activities. In certain locations, such
as Mexico, we are also exposed to risks associated with local instability, including threats of
increased violence, which could lead to disruptions in supply at our manufacturing facilities or
key vendors.
We obtain some of our raw materials, components and finished goods from a single source or a
limited group of suppliers. We also obtain sterilization services from a single supplier. We also
manufacture certain of our products at only one manufacturing facility. The partial or complete
loss of one of these suppliers or facilities could cause significant production delays, an
inability to meet customer demand, and a substantial loss in revenues.
We depend upon a number of single-source suppliers for some of the raw materials and
components we use in our products. We also depend upon one single-source supplier for certain of
our finished goods and a single-vendor for sterilization services. Our most critical single-source
supply relationships are with Membrana and Kawasumi. Membrana is our sole supplier of the fiber
used in our filters for System One products. Kawasumi is our only supplier of needles that we sell
to our customers. Our dependence upon these and other single-source suppliers of raw materials,
components, finished goods and sterilization services, as well as our dependence on our
manufacturing facilities, exposes us to several risks, including disruptions in supply, price
increases, late deliveries, and an inability to meet customer demand. This could lead to customer
dissatisfaction, damage to our reputation, or customers switching to competitive products. Any
interruption in supply could be particularly damaging to our customers using the System One to
treat chronic ESRD and who need access to the System One and related disposables to continue their
therapy.
Finding alternative sources for these raw materials, components, finished goods and
sterilization services would be difficult and in many cases entail a significant amount of time and
disruption. In the case of Membrana, for fiber, we are contractually prevented from obtaining an
alternative source of fiber for our System One products. Our relationship with Asahi could afford
us back-up supply in the event of an inability to supply by Membrana, however, switching to Asahi
fiber at this time would likely entail significant delays and difficulties. We do not have the
regulatory approvals necessary to use Asahi fiber in our System One cartridge in the United States.
Additionally, the performance of Asahi fiber in our System One has not yet been validated. We
purchase all of our needles, and, until recently, a significant amount of our bloodlines, from
Kawasumi. Kawasumis contractual obligation to manufacture bloodlines expires in February 2012,
and recent flooding at the site of Kawasumis bloodline manufacturing facility in Thailand will
prevent Kawasumi from supplying any further bloodlines to us prior to the expiration of that
agreement. Although we have recently been successfully transitioning bloodline supply from
Kawasumi to our Tijuana Mexico manufacturing facility, and we believe that we can manufacture at
this facility any products ordered from Kawasumi that it is now not able to supply, there is no
guarantee that we will not experience any interruption in our ability to supply Streamline or
ReadySet bloodlines, or that the transition of this supply will not increase our product costs or
impair our product quality or reliability, at least in the near term. Kawasumis contractual
obligation to supply needles to us expires in February 2014, with opportunities to extend the term
beyond that date. Kawasumis contractual obligation to supply needles to us is, at times, less than
our forecasted demand. In the event Kawasumi supplies no more than the amount of their
32
required maximum monthly supply, or in the event of any inability of Kawasumi to supply, we
may not have enough needle supply to meet the demands of our customers. Presently, the flooding
experienced by Kawasumi at its bloodline manufacturing facility in Thailand has not impacted its
needle manufacturing operations. However, there can be no assurance that its operations will not
be impacted by the floods or by any other event which could lead to an interruption in supply. We
maintain a limited extra supply of needles to mitigate against the risk of any intermittent
shortfalls in needle supply, but do not have sufficient quantities to address any significant
interruption in Kawasumis ability to supply our forecasted demand for needles. Any significant
interruption in our key single source suppliers ability to supply products to us would impair our
business, at least in the near term.
We manufacture filters only at our facility in Germany. We manufacture our System One
cartridges and related disposables and Medisystems bloodlines only at our facility in Tijuana
Mexico. With the planned termination of our relationship with Entrada, we will soon only
manufacture and service our equipment at the same Tijuana Mexico facility. We perform most of our
molding activities at our facility in Italy. The loss of any of these facilities due to fire,
flood, natural disaster, war, strike, or other cause beyond our control could cause significant
production delays, an inability to meet customer demand, and a substantial loss in revenues. As we
consolidate bloodline and equipment manufacturing and equipment service to our facility in Tijuana,
Mexico, the risks associated with the loss of that facility for any reason are significantly
increased.
Our In-Center segment relies heavily upon third-party distributors.
We sell the majority of our In-Center segment products through several distributors, which
collectively accounted for substantially all of In-Center revenues during the three and six months
ended September 30, 2011 and 2010, with Henry Schein and Gambro being our most significant
distributors. Our distribution agreement with Henry Schein expires in April 2012. Our distribution
agreement with Gambro expires in June 2014. The loss of Gambro or Henry Schein as our distributors
for any reason could materially adversely affect our business, at least in the near term.
Unless we can demonstrate sufficient product differentiation in our In-Center segment products that
we introduce in the future, we will continue to be susceptible to further pressures to reduce
product pricing and more vulnerable to the loss of our blood tubing set business to competitors in
the dialysis industry.
Our blood tubing set business has historically been a commodities business. Prior to the
Medisystems Acquisition, Medisystems competed favorably and gained share through the development of
a high quality, low-cost, standardized blood tubing set, which could be used on several different
dialysis machines. Our products continue to compete favorably in the dialysis blood tubing set
business, but are increasingly subject to pricing pressures, especially given recent market
consolidation in the United States dialysis services industry, with Fresenius and DaVita
collectively controlling approximately two-thirds of the United States dialysis services business.
Unless we can successfully demonstrate to customers the differentiating features of our current
In-Center segment products or products that we introduce in the future, we may be susceptible to
further pressures to reduce our product pricing and more vulnerable to the loss of our blood tubing
set business to competitors in the dialysis industry.
The activities of our business involve the import of finished goods into the United States from
foreign countries, subject to customs inspections and duties, and the export of components and
certain other products from other countries into Germany, Mexico, Thailand and Italy. To a lesser,
but increasing degree, our business also involves the export of finished goods from the United
States to foreign countries. If we misinterpret or violate these laws, or if laws governing our
exemption from certain duties change, we could be subject to significant fines, liabilities or
other adverse consequences.
We import into the United States disposable medical supplies from Germany, Thailand and
Mexico. We also import into the United States disposable medical components from Germany and Italy
and export components and assemblies into Mexico, Thailand and Italy. We also import into Mexico
components and assemblies from Germany, Italy and Thailand. To a lesser, but increasing degree, our
business also involves the export of finished goods from the United States to foreign countries.
The import and export of these items are subject to extensive laws and regulations with which we
will need to comply. To the extent we fail to comply with these laws or regulations, or fail to
interpret our obligations accurately, we may be subject to significant fines, liabilities and a
disruption to our ability to deliver product, which could cause our combined businesses and
operating results to suffer. To the extent there are modifications to the Generalised System of
Preferences or cancellation of the Nairobi Protocol Classification such that our products would be
subject to duties, our profitability would also be negatively impacted.
The success of our business depends on the services of each of our senior executives as well as
certain key engineering, scientific, manufacturing, clinical and marketing personnel, the loss of
whom could negatively affect the combined businesses.
Our success has always depended upon the skills, experience and efforts of our senior
executives and other key personnel, including our research and development and manufacturing
executives and managers. Much of our expertise is concentrated in relatively few employees, the
loss of whom for any reason could negatively affect our business. Competition for our highly
skilled employees is intense and we cannot prevent the future resignation of any employee. We
maintain key person insurance
for only one of our executives, Jeffrey Burbank, our Chief Executive Officer.
33
Risks Related to the Regulatory Environment
We are subject to significant regulation, primarily by the FDA. We cannot market or commercially
distribute our products without obtaining and maintaining necessary regulatory clearances or
approvals.
Our products are medical devices subject to extensive regulation in the United States and in
foreign markets we may wish to enter. To market medical devices in the United States, approval or
clearance by the FDA is required, either through the pre-market approval process or the 510(k)
clearance process. We have obtained the FDA clearance necessary to sell our current products under
the 510(k) clearance process. Medical devices may only be promoted and sold for the indications for
which they are approved or cleared. In addition, even if the FDA has approved or cleared a product,
it can take action affecting such product approvals or clearances if serious safety or other
problems develop in the marketplace. We may be required to obtain 510(k) clearances or pre-market
approvals for additional products, product modifications, or for new indications of our products.
Regulatory pathways for such clearances may be difficult to define and could change. For example,
we completed an approval IDE study intended to support a home nocturnal indication for the System
One. Enrollment started in the first quarter of 2008 and we submitted the associated 510(k) to the
FDA in 2010. We met our primary safety and efficacy endpoints for the study. Nevertheless, the FDA
notified us that their standards for what will be required for a home nocturnal clearance may have
changed from what was required in our approved IDE. The FDA did not clear our 510(k) application
for home nocturnal use, and we continue to evaluate next steps in determining a pathway to
clearance for our System One for nocturnal use. Although we do not see the delay in timing for our
home nocturnal clearance as material to our opportunities, we cannot be certain when this clearance
will be obtained. We also cannot provide assurance that this or other clearances or approvals might
be obtained. Delays in obtaining clearances or approvals could adversely affect our ability to
introduce new products or modifications to our existing products in a timely manner, which would
delay or prevent commercial sales of our products. Although the 510(k) regulation has not been
formally changed, the FDA has announced that it is intending to implement modifications to the
510(k) process. New draft guidance issued by FDA suggests that modifications to the FDAs process
will soon be made. Any changes in regulatory policies could have an adverse affect on our ability
to gain regulatory clearance, sell, and promote our products and our business as a whole.
Modifications to our marketed devices may require new regulatory clearances or pre-market
approvals, or may require us to cease marketing or recall the modified devices until clearances or
approvals are obtained.
Any modifications to a 510(k) cleared device that could significantly affect its safety or
effectiveness, or would constitute a major change in its intended use, requires the submission of
another 510(k) pre-market notification to address the change. Although in the first instance we may
determine that a change does not rise to a level of significance that would require us to make a
pre-market notification submission, the FDA may disagree with us and can require us to submit a
510(k) for a significant change in the labeling, technology, performance specifications or
materials or major change or modification in intended use, despite a documented rationale for not
submitting a pre-market notification. We have modified various aspects of our products and have
filed and received clearance from the FDA with respect to some of the changes in the design of our
products. If the FDA requires us to submit a 510(k) for any modification to a previously cleared
device, or in the future a device that has received 510(k) clearance, we may be required to cease
marketing the device, recall it, and not resume marketing until we obtain clearance from the FDA
for the modified version of the device. Also, we may be subject to regulatory fines, penalties
and/or other sanctions authorized by the Federal Food, Drug, and Cosmetic Act. In the future, we
intend to introduce new products and enhancements and improvements to existing products. We cannot
provide assurance that the FDA will clear any new product or product changes for marketing or what
the timing of such clearances might be. In addition, new products or significantly modified
marketed products could be found to be not substantially equivalent and classified as products
requiring the FDAs approval of a pre-market approval application, or PMA, before commercial
distribution would be permissible. PMAs usually require substantially more data than 510(k)
submissions and their review and approval or denial typically takes significantly longer than a
510(k) decision of substantial equivalence. Also, PMA products require approval supplements for any
change that affects safety and effectiveness before the modified device may be marketed. Delays in
our receipt of regulatory clearance or approval will cause delays in our ability to sell our
products, which will have a negative effect on our revenues growth.
Even if we obtain the necessary clearances or approvals, if we or our suppliers fail to comply with
ongoing regulatory requirements our products could be subject to restrictions or withdrawal from
the market.
We are subject to the Medical Device Reporting, or MDR, regulations that require us to report
to the FDA if our products may have caused or contributed to patient death or serious injury, or if
our device malfunctions and a recurrence of the malfunction would likely result in a death or
serious injury. We must also file reports of device corrections and removals and adhere to the
FDAs rules on labeling and promotion. We face similar requirements outside of the U.S. where our
products are distributed. If we manufacture or supply products with manufacturing errors, design
defects and/or labeling inadequacies, or if
34
we fail to comply with any applicable regulatory requirements, we could be subject to an
enforcement action by the FDA or other regulatory agency, which may include any of the following:
|
|
|
untitled letters, warning letters, fines, injunctions and civil penalties; |
|
|
|
|
administrative detention, which is the detention by the FDA of medical devices
believed to be adulterated or misbranded; |
|
|
|
|
customer notification, or orders for repair, replacement or refund; |
|
|
|
|
voluntary or mandatory recall or seizure of our products; |
|
|
|
|
operating restrictions, partial suspension or total shutdown of production; |
|
|
|
|
refusal to review pre-market notification or pre-market approval submissions; |
|
|
|
|
rescission of a substantial equivalence order or suspension or withdrawal of a pre-market approval; and |
|
|
|
|
criminal prosecution. |
Any of these events could impair our business, at least in the near term, and certain of these
events would materially harm our business.
Our products are subject to market withdrawals or product recalls after receiving FDA clearance or
approval, and market withdrawals and product recalls could cause the price of our stock to decline
and expose us to product liability or other claims or could otherwise harm our reputation and
financial results.
Medical devices can experience performance problems in the field that require review and
possible corrective action by us or the product manufacturer. We cannot provide assurance that
component failures, manufacturing errors, design defects and/or labeling inadequacies, which could
result in an unsafe condition or injury to the operator or the patient will not occur. These could
lead to a government mandated or voluntary recall by us. The FDA has the authority to require the
recall of our products in the event a product presents a reasonable probability that it would cause
serious adverse health consequences or death. Similar regulatory agencies in other countries have
similar authority to recall devices because of material deficiencies or defects in design or
manufacture that could endanger health. We believe that the FDA would request that we initiate a
voluntary recall if a product was defective or presented a risk of injury or gross deception. Any
recall would divert management attention and financial resources, could cause the price of our
stock to decline and expose us to product liability or other claims and harm our reputation with
customers.
If we or our contract manufacturers fail to comply with FDAs Quality System Regulations, our
manufacturing operations could be interrupted, and our product sales and operating results could
suffer.
Our finished goods manufacturing processes, and those of some of our contract manufacturers,
are required to comply with the FDAs Quality System Regulations, or QSRs, which cover the
procedures and documentation of the design, testing, production, control, quality assurance,
labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces its QSRs
through periodic unannounced inspections of manufacturing facilities. We and our contract
manufacturers have been, and anticipate in the future being, subject to such inspections. We were
inspected by the FDA in the second quarter of 2010, and received no inspectional observations.
While all of our previous inspections have resulted in no significant observations, we cannot
provide assurance that we can maintain a comparable level of regulatory compliance in the future at
our facilities, or that future inspections would have the same result.
If one of our manufacturing facilities or those of any of our contract manufacturers fails to
take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take
enforcement action, including issuing a public warning letter, shutting down our manufacturing
operations, embargoing the import of components from outside of the United States, recalling our
products, refusing to approve new marketing applications, instituting legal proceedings to detain
or seize products or imposing civil or criminal penalties or other sanctions, any of which could
cause our business and operating results to suffer.
We may be subject to fines, penalties or injunctions if we are determined to be promoting the use
of our products in a manner not consistent with our products cleared indications for use or with
other state or federal laws governing the promotion of our products.
Our promotional materials and other product labeling must comply with FDA and other applicable
laws and regulations. If the FDA determines that our promotional materials or other product
labeling constitute promotion of an unapproved, or uncleared use, it could request that we modify
our materials or subject us to regulatory or enforcement actions, including the issuance of an
untitled letter, a warning letter, injunction, seizure, civil fine and criminal penalties. Other
regulatory agencies, federal, state and foreign, including the U.S. Federal Trade Commission, have
issued guidelines and regulations that govern how we promote our product, including how we use
endorsements and testimonials. If our promotional materials are inconsistent with these guidelines
or regulations, we could be subject to enforcement actions, which could result in significant
fines, costs and penalties. Our reputation could also be damaged and the adoption of our products
could be impaired.
35
Failure to obtain regulatory approval in foreign jurisdictions would prevent us from marketing our
products outside the United States.
In 2009, we began entering into arrangements with distributors to sell the System One and
certain of our other products outside of the United States. We are currently selling the System One
in Europe, the Middle East and other select markets. We are assessing other international markets
for the System One as well. Our In-Center products are presently sold in the United States as well
as in several other countries, through distributors. We presently have CE marking as well as
Canadian regulatory authority to sell our System One as well as certain other products in Canada,
Europe and selected other geographies. However, in order to market directly our products in other
foreign jurisdictions, we must obtain separate regulatory approvals and comply with numerous and
varying regulatory requirements. The approval procedure varies from country to country and can
involve additional testing. The time required to obtain approval abroad may be longer than the time
required to obtain FDA clearance. The foreign regulatory approval process includes many of the
risks associated with obtaining FDA clearance and we may not obtain foreign regulatory approvals on
a timely basis, if at all. FDA clearance does not ensure approval by regulatory authorities in
other countries, and approval by one foreign regulatory authority does not ensure approval by
regulatory authorities in other foreign countries. We may not be able to file for regulatory
approvals and may not receive necessary approvals to commercialize our products in other markets
outside the United States, which could negatively affect our overall market penetration.
Additionally, any loss of foreign regulatory approvals, for any reason, could negatively affect our
business.
Failure to meet applicable technical product standards and directives would prevent us from
marketing our products globally.
We must comply with numerous and varying technical standards and directives in order to market
our products globally. Standard setting bodies such as UL, AAMI, and IEC routinely review and
modify their standards. One such technical standard, IEC 60601-1, was recently updated, with
mandatory adoption dates in Europe of June 2012, and the U.S. in July 2013. We continue to have
ongoing and active development programs to ensure that we meet all requisite standards, but failure
to meet the dates required for compliance with the new IEC 60601-1 standards , or any new standards
or directives introduced in the future, could negatively affect our business.
We have obligations under our contracts with dialysis clinics and hospitals to protect the privacy
of patient health information.
In the course of performing our business we obtain, from time to time, confidential patient
health information. For example, we learn patient names and addresses when we ship our System One
supplies to home hemodialysis patients. We may learn patient names and be exposed to confidential
patient health information when we provide training on our products to our customers staff. Our
home hemodialysis patients may also call our customer service representatives directly and, during
the call, disclose confidential patient health information. United States federal and state laws
protect the confidentiality of certain patient health information, in particular individually
identifiable information, and restrict the use and disclosure of that information. At the federal
level, the Department of Health and Human Services promulgated health information and privacy and
security rules under the Health Insurance Portability and Accountability Act of 1996, or HIPAA. At
this time, we are not a HIPAA covered entity. However, we have entered into agreements with covered
entities that contain commitments to protect the privacy and security of patients health
information and, in some instances, require that we indemnify the covered entity for any claim,
liability, damage, cost or expense arising out of or in connection with a breach of the agreement
by us. If we were to violate one of these agreements, we could lose customers and be exposed to
liability and/or our reputation and business could be harmed. In addition, the Health Information
Technology for Economic and Clinical Health Act (HITECH), enacted in February 2009, expands the
HIPAA privacy and security rules, including imposing many of the requirements of those rules
directly on business associates and making business associates directly subject to HIPAA civil and
criminal enforcement provisions and associated penalties. Many of these requirements went into
effect on February 17, 2010. We may be required to make costly system modifications to comply with
the HIPAA privacy and security requirements. Our failure to comply may result in criminal and civil
liability.
Many other federal and state laws apply to the use and disclosure of health information, as
well as certain financial information, which could affect the manner in which we conduct our
business. Such laws are not necessarily preempted by HIPAA, in particular those laws that afford
greater protection to the individual than does HIPAA or cover different subject matter. Such state
laws typically have their own penalty provisions, which could be applied in the event of an
unlawful action affecting health information.
We are subject to federal and state laws prohibiting kickbacks and false and fraudulent claims
which, if violated, could subject us to substantial penalties. Additionally, any challenges to or
investigation into our practices under these laws could cause adverse publicity and be costly to
respond to, and thus could harm our business.
The Medicare/Medicaid anti-kickback laws, and similar state laws, prohibit payments that are
intended to induce health care professionals or others either to refer patients or to acquire or
arrange for or recommend the acquisition of healthcare products or services. A number of states
have enacted laws that require pharmaceutical and medical device companies to
36
monitor and report payments, gifts and other remuneration made to physicians and other health
care professionals and health care organizations. In addition, some state statutes, most notably
laws in Massachusetts, Minnesota, and Vermont, impose outright bans on certain gifts to physicians.
Some of these laws referred to as aggregate spend laws or gift laws, carry substantial fines if
they are violated. Recently, the federal Physician Payments Sunshine Act was enacted by Congress in
2010 as part of the comprehensive health care reform legislation and it will require us to begin
publicly disclosing certain payments and other transfers of value to physicians and teaching
hospitals beginning in 2013. These laws affect our sales, marketing and other promotional
activities by limiting the kinds of financial arrangements, including sales programs, we may have
with hospitals, physicians or other potential purchasers or users of medical devices. They also
impose additional administrative and compliance burdens on us. In particular, these laws influence,
among other things, how we structure our sales and rental offerings, including discount practices,
customer support, education and training programs and physician consulting and other service
arrangements. Although we seek to structure such arrangements in compliance with all applicable
requirements, these laws are broadly written and it is often difficult to determine precisely how
these laws will be applied in specific circumstances. If we were to offer or pay inappropriate
inducements to purchase our products, we could be subject to a claim under the Medicare/Medicaid
anti-kickback laws or similar state laws. If we fail to comply with particular reporting
requirements, we could be subject to penalties under applicable federal or state laws.
Other federal and state laws generally prohibit individuals or entities from knowingly
presenting, or causing to be presented, claims for payments to Medicare, Medicaid or other
third-party payors that are false or fraudulent, or for items or services that were not provided as
claimed. Although we do not submit claims directly to payors, manufacturers can be held liable
under these laws if they are deemed to cause the submission of false or fraudulent claims by
providing inaccurate billing or coding information to customers, by providing improper financial
inducements, or through certain other activities. In providing billing and coding information to
customers, we make every effort to ensure that the billing and coding information furnished is
accurate and that treating physicians understand that they are responsible for all billing and
prescribing decisions, including the decision as to whether to order dialysis services more
frequently than three times per week. Nevertheless, we cannot provide assurance that the government
will regard any billing errors that may be made as inadvertent or that the government will not
examine our role in providing information to our customers concerning the benefits of daily
therapy. Likewise, our financial relationships with customers, physicians, or others in a position
to influence the purchase or use of our products may be subject to government scrutiny or be
alleged or found to violate applicable fraud and abuse laws. False claims laws prescribe civil,
criminal and administrative penalties for noncompliance, which can be substantial. Moreover, an
unsuccessful challenge or investigation into our practices could cause adverse publicity, and be
costly to respond to, and thus could harm our business and results of operations.
Foreign governments tend to impose strict price controls, which may adversely affect our future
profitability.
Historically, our marketing efforts had been confined nearly exclusively to the United States.
In 2009, we began entering into arrangements with distributors to sell the System One and certain
of our other products internationally. In some foreign countries, particularly in the European
Union, the pricing of medical devices is subject to governmental control. In these countries,
pricing negotiations with governmental authorities can take considerable time after the receipt of
marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we
may be required to supply data that compares the cost-effectiveness of our products to other
available therapies. If reimbursement of our products is unavailable or limited in scope or amount,
or if pricing is set at unsatisfactory levels, it may not be profitable to sell our products
outside of the United States, which would negatively affect the long-term growth of our business.
Further, reimbursement provided to our products in other jurisdictions could change, positively or
negatively. In the event reimbursements were to be negatively changed, such as, for example, in the
United Kingdom, our ability to sell our products could be impaired.
Failure to comply with the United States Foreign Corrupt Practices Act or similar laws could
subject us to penalties and other adverse consequences.
We are subject to the United States Foreign Corrupt Practices Act which generally prohibits
United States companies from engaging in bribery or other prohibited payments to foreign officials
for the purpose of obtaining or retaining business and requires companies to maintain accurate
books and records and internal controls, including at foreign controlled subsidiaries. Through our
international activities, we are also subject to the UK Anti Bribery Act and other similar anti
bribery laws. While we have policies and procedures in place designed to prevent noncompliance, we
can make no assurance that our employees or other agents will not engage in prohibited conduct
under these laws for which we might be held responsible. If our employees or other agents are found
to have engaged in such practices, we could suffer severe penalties and other consequences that may
have a material adverse effect on our business, financial condition and results of operations.
Our business activities involve the use of hazardous materials, which require compliance with
environmental and occupational safety laws regulating the use of such materials. If we violate
these laws, we could be subject to significant fines, liabilities or other adverse consequences.
37
Our research and development programs as well as our manufacturing operations involve the
controlled use of hazardous materials. Accordingly, we are subject to federal, state and local laws
governing the use, handling and disposal of these materials. Although we believe that our safety
procedures for handling and disposing of these materials comply in all material respects with the
standards prescribed by state and federal regulations, we cannot completely eliminate the risk of
accidental contamination or injury from these materials. In the event of an accident or failure to
comply with environmental laws, we could be held liable for resulting damages, and any such
liability could exceed our insurance coverage.
Risks Related to Operations
Resin is a key input material to the manufacture of our products and System One cartridge. Oil
prices affect both the pricing and availability of this material. Escalation of oil prices could
affect our ability to obtain sufficient supply of resin at the prices we need to manufacture our
products at current rates of profitability.
We currently source resin from a small number of suppliers. Rising oil prices over the last
several years have resulted in significant price increases for this material. We cannot guarantee
that prices will not continue to increase and that these increases would not impair our gross
profits or long term profitability. Our contracts with customers restrict our ability to
immediately pass on these price increases and we cannot guarantee that future pricing to customers
will be sufficient to accommodate increasing input costs.
Distribution costs represent a significant percentage of our overall costs and these costs are
dependent upon fuel prices. Increases in fuel prices could lead to increases in our distribution
costs, which, in turn, could impair our ability to achieve profitability.
We currently incur significant inbound and outbound distribution costs. Our distribution costs
are dependent upon fuel prices. Increases in fuel prices could lead to increases in our
distribution costs, which could impair our ability to achieve profitability.
We have labor agreements with our production employees in Italy and in Mexico. We cannot guarantee
that we will not in the future face strikes, work stoppages, work slowdowns, grievances,
complaints, claims of unfair labor practices, other collective bargaining disputes or in Italy,
anti-union behavior, that may cause production delays and negatively impact our ability to deliver
our products on a timely basis.
Our wholly-owned subsidiary in Italy has a national labor contract with Contratto collettivo
nazionale di lavoro per gli addetti allindustria della gomma cavi elettrici ed affini e
allindustria delle materie plastiche, and our wholly-owned subsidiary in Mexico has entered into a
collective bargaining agreement with a Union named Mexico Moderno de Trabajadores de la Baja
California C.R.O.C. We have not to date experienced strikes, work stoppages, work slowdowns,
grievances, complaints, claims of unfair labor practices, other collective bargaining disputes, or
in Italy, anti-union behavior, however we cannot guarantee that we will not be subject to such
activity in the future. Any such activities would likely cause production delays, and negatively
affect our ability to deliver our production commitments to customers, which could adversely affect
our reputation and cause our combined businesses and operating results to suffer. Additionally,
some of our key single source suppliers have labor agreements. We cannot guarantee that we will not
have future disruptions, which could adversely affect our reputation and cause our business and
operating results to suffer.
We do not have long-term supply contracts with many of our third-party suppliers.
We purchase raw materials and components from third-party suppliers, including some single
source suppliers, through purchase orders and do not have long-term supply contracts with many of
these third-party suppliers. Many of our third-party suppliers are not obligated to perform
services or supply products for any specific period, in any specific quantity or at any specific
price, except as may be provided in a particular purchase order. We do not maintain large volumes
of inventory from most of our suppliers. If we inaccurately forecast demand for finished goods, our
ability to meet customer demand could be delayed and our competitive position and reputation could
be harmed. In addition, if we fail to effectively manage our relationships with these suppliers, we
may be required to change suppliers, which would be time consuming and disruptive and could lead to
disruptions in product supply, which could permanently impair our customer base and reputation.
Risks Related to Intellectual Property
If we are unable to protect our intellectual property and prevent its use by third parties, we will
lose a significant competitive advantage.
We rely on patent protection, as well as a combination of copyright, trade secret and
trademark laws to protect our proprietary technology and prevent others from duplicating our
products. However, these means may afford only limited protection and may not:
38
|
|
|
prevent our competitors from duplicating our products; |
|
|
|
|
prevent our competitors from gaining access to our proprietary information and technology; or |
|
|
|
|
permit us to gain or maintain a competitive advantage. |
Any of our patents, including those we may license, may be challenged, invalidated,
circumvented or rendered unenforceable. We cannot provide assurance that we will be successful
should one or more of our patents be challenged for any reason. If our patent claims are rendered
invalid or unenforceable, or narrowed in scope, the patent coverage afforded our products could be
impaired, which could make our products less competitive.
We cannot specify which, if any, of our patents individually or as a group will permit us to
gain or maintain a competitive advantage. We cannot provide assurance that any pending or future
patent applications we hold will result in an issued patent or that if patents are issued to us,
that such patents will provide meaningful protection against competitors or against competitive
technologies. The issuance of a patent is not conclusive as to its validity or enforceability. The
United States federal courts or equivalent national courts or patent offices elsewhere may
invalidate our patents or find them unenforceable. Competitors may also be able to design around
our patents. Our patents and patent applications cover particular aspects of our products. Other
parties may develop and obtain patent protection for more effective technologies, designs or
methods for treating kidney failure. If these developments were to occur, it would likely have an
adverse effect on our sales.
The laws of foreign countries may not protect our intellectual property rights effectively or
to the same extent as the laws of the United States. If our intellectual property rights are not
adequately protected, we may not be able to commercialize our technologies, products or services
and our competitors could commercialize similar technologies, which could result in a decrease in
our revenues and market share.
Our products could infringe the intellectual property rights of others, which may lead to
litigation that could itself be costly, could result in the payment of substantial damages or
royalties, and/or prevent us from using technology that is essential to our products.
The medical device industry in general has been characterized by extensive litigation and
administrative proceedings regarding patent infringement and intellectual property rights. Products
to provide kidney replacement therapy have been available in the market for more than 30 years and
our competitors hold a significant number of patents relating to kidney replacement devices,
therapies, products and supplies. Although no third party has threatened or alleged that our
products or methods infringe their patents or other intellectual property rights, we cannot provide
assurance that our products or methods do not infringe the patents or other intellectual property
rights of third parties. If our business is successful, the possibility may increase that others
will assert infringement claims against us.
Infringement and other intellectual property claims and proceedings brought against us,
whether successful or not, could result in substantial costs and harm to our reputation. Such
claims and proceedings can also distract and divert management and key personnel from other tasks
important to the success of the business. In addition, intellectual property litigation or claims
could force us to do one or more of the following:
|
|
|
cease selling or using any of our products that incorporate the asserted
intellectual property, which would adversely affect our revenues; |
|
|
|
pay substantial damages for past use of the asserted intellectual property; |
|
|
|
obtain a license from the holder of the asserted intellectual property, which
license may not be available on reasonable terms, if at all and which could reduce
profitability; and |
|
|
|
redesign or rename, in the case of trademark claims, our products to avoid
infringing the intellectual property rights of third parties, which may not be possible
and could be costly and time-consuming if it is possible to do so. |
Confidentiality agreements with employees and others may not adequately prevent disclosure of trade
secrets and other proprietary information.
In order to protect our proprietary technology and processes, we also rely in part on
confidentiality agreements with our corporate partners, employees, consultants, outside scientific
collaborators and sponsored researchers, advisors and others. These agreements may not effectively
prevent disclosure of confidential information and trade secrets and may not provide an adequate
remedy in the event of unauthorized disclosure of confidential information. In addition, others may
independently discover or reverse engineer trade secrets and proprietary information, and in such
cases we could not assert any trade secret rights against such party. Costly and time consuming
litigation could be necessary to enforce and determine the scope of our proprietary rights, and
failure to obtain or maintain trade secret protection could adversely affect our competitive
position.
39
We may be subject to damages resulting from claims that our employees or we have wrongfully used or
disclosed alleged trade secrets of other companies.
Many of our employees were previously employed at other medical device companies focused on
the development of dialysis products, including our competitors. Although no claims against us are
currently pending, we may be subject to claims that these employees or we have inadvertently or
otherwise used or disclosed trade secrets or other proprietary information of their former
employers. Litigation may be necessary to defend against these claims. If we fail in defending such
claims, in addition to paying monetary damages, we may lose valuable intellectual property rights.
Even if we are successful in defending against these claims, litigation could result in substantial
costs, damage to our reputation and be a distraction to management.
Risks Related to our Common Stock
Our stock price is likely to be volatile, and the market price of our common stock may drop.
The market price of our common stock could be subject to significant fluctuations. As a result
of this volatility, you may not be able to sell your common stock at or above the price you paid
for the stock. Some of the factors that may cause the market price of our common stock to fluctuate
include:
|
|
|
timing of market launch and/or market acceptance of our products; |
|
|
|
|
timing of achieving profitability from operations; |
|
|
|
changes in estimates of our financial results or recommendations by securities
analysts or the failure to meet or exceed securities analysts expectations; |
|
|
|
actual or anticipated variations in our quarterly operating results; |
|
|
|
|
future debt or equity financings; |
|
|
|
developments or disputes with key vendors or customers, or adverse changes to the
purchasing patterns of key customers; |
|
|
|
disruptions in product supply for any reason, including product recalls, our
failure to appropriately forecast supply or demand, difficulties in moving products
across the border, or the failure of third party suppliers to produce needed products or
components; |
|
|
|
reports by officials or health or medical authorities, the general media or the
FDA regarding the potential benefits of the System One or of similar dialysis products
distributed by other companies or of daily or home dialysis; |
|
|
|
announcements by the FDA of non-clearance or non-approval of our products, or
delays in the FDA or other foreign regulatory agency review process; |
|
|
|
|
product recalls; |
|
|
|
|
defaults under our material contracts, including without limitation our credit agreement; |
|
|
|
|
regulatory developments in the United States and foreign countries; |
|
|
|
changes in third-party healthcare reimbursements, particularly a decline in the
level of Medicare reimbursement for dialysis treatments, or the willingness of Medicare
contractors to pay for more than three treatments a week where medically justified; |
|
|
|
|
litigation involving our company or our general industry or both; |
|
|
|
|
announcements of technical innovations or new products by us or our competitors; |
|
|
|
|
developments or disputes concerning our patents or other proprietary rights; |
|
|
|
|
our ability to manufacture and supply our products to commercial standards; |
|
|
|
|
significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors; |
|
|
|
|
departures of key personnel; and |
|
|
|
|
investors general perception of our company, our products, the economy and general market conditions. |
The stock markets in general have experienced substantial volatility that has often been
unrelated to the operating performance of individual companies. These broad market fluctuations may
adversely affect the trading price of our common
40
stock. In the past, following periods of
volatility in the market price of a companys securities, stockholders have often instituted class
action securities litigation against those companies. Such litigation, if instituted, could result
in substantial costs and diversion of management attention and resources, which could significantly
harm our profitability and reputation.
Anti-takeover provisions in our restated certificate of incorporation and amended and restated
bylaws and under Delaware law could make an acquisition of us more difficult and may prevent
attempts by our stockholders to replace or remove our current management.
Provisions in our restated certificate of incorporation and our amended and restated bylaws
may delay or prevent an acquisition of us. In addition, these provisions may frustrate or prevent
attempts by our stockholders to replace or remove members of our board of directors. Because our
board of directors is responsible for appointing the members of our management team, these
provisions could in turn affect any attempt by our stockholders to replace current members of our
management team. These provisions include:
|
|
|
a prohibition on actions by our stockholders by written consent; |
|
|
|
the ability of our board of directors to issue preferred stock without
stockholder approval, which could be used to institute a poison pill that would work
to dilute the stock ownership of a potential hostile acquirer, effectively preventing
acquisitions that have not been approved by our board of directors; |
|
|
|
|
advance notice requirements for nominations of directors or stockholder proposals; and |
|
|
|
|
the requirement that board vacancies be filled by a majority of our directors then in office. |
In addition, because we are incorporated in Delaware, we are governed by the provisions of
Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of
15% of our outstanding voting stock from merging or combining with us for a period of three years
after the date of the transaction in which the person acquired in excess of 15% of our outstanding
voting stock, unless the merger or combination is approved in a prescribed manner. These provisions
would apply even if the offer may be considered beneficial by some stockholders.
If there are substantial sales of our common stock in the market by our large existing
stockholders, our stock price could decline.
If our existing stockholders sell a large number of shares of our common stock or the public
market perceives that existing stockholders might sell a large number of shares of common stock,
the market price of our common stock could decline significantly. We have 55,136,629 shares of
common stock outstanding as of September 30, 2011. Except where sales are made pursuant to an
effective registration statement, shares held by our affiliates may only be sold in compliance with
the volume limitations of Rule 144. These volume limitations restrict the number of shares that may
be sold by an affiliate in any three-month period to the greater of 1% of the number of shares then
outstanding, which approximates 551,366 shares, or the average weekly trading volume of our common
stock during the four calendar weeks preceding the filing of a notice on Form 144 with respect to
the sale. With the higher trading volumes we have recently observed in our stock, the number of
shares that can be sold by our affiliates pursuant to Rule 144 is significantly above the 1% of
shares outstanding limitation of Rule 144 as of the time of the filing of this report.
At September 30, 2011, subject to certain conditions, holders of an aggregate of approximately
9 million shares of our common stock have rights with respect to the registration of these shares
of common stock with the Securities and Exchange Commission, or SEC. If we register their shares of
common stock, they can more easily sell those shares in the public market.
As of September 30, 2011, 10,248,937 shares of common stock are authorized for issuance under
our stock incentive plan, employee stock purchase plan, outstanding stock options and unvested
restricted stock units. As of September 30, 2011, 1,209,587 shares were subject to unvested
restricted stock units and 5,550,615 shares were subject to outstanding options, of which 3,839,531
shares were exercisable and can be freely sold in the public market upon issuance, subject to the
restrictions imposed on our affiliates under Rule 144.
We have filed a resale registration statement covering both shares of our common stock that we sold
in a May 2008 private placement and shares of our common stock issuable upon the exercise of a
warrant held by DaVita. If the holders of these shares or shares issued pursuant to the terms of
the warrant are unable to sell these shares under the respective registration statements, we may be
obligated to pay them damages, which could harm our financial condition. Further, these resale
registration statements could result in downward pressure on the price of our common stock and may
affect the ability of our stockholders to realize the current trading price of our common stock.
In 2008, we sold an aggregate of 9,555,556 shares of our common stock and warrants to purchase
an additional 1,911,111 shares of our common stock in a private placement. We were required to
register the common stock and the common stock issuable upon exercise of the warrants with the
Securities and Exchange Commission, which we did on August 8, 2008. If
41
the holders of the shares or
the accompanying warrant shares are unable to sell such shares or warrant shares under the
registration statement for more than 30 days in any 365 day period after the effectiveness of the
registration statement, we may be obligated to pay damages equal to up to 1% of the share purchase
price per month that the registration statement is not effective and the investors are unable to
sell their shares.
On July 22, 2010, we issued to DaVita a warrant which, subject to the achievement of certain
System One growth targets, may be exercisable for up to a cumulative total of 5,500,000 shares of
our common stock. In connection with issuance of this warrant we entered into a registration rights
agreement with DaVita, pursuant to which (subject to certain conditions) we have agreed to file, on
or prior to April 1, 2011, a registration statement on Form S-3 with respect to the resale by
DaVita of any shares of our common stock issued to DaVita under the warrant. We registered the
shares of common stock issuable upon the exercise of the warrant on February 16, 2011 on our
automatic shelf registration statement on Form S-3 (No. 333-170654) filed on November 17, 2010.
Investors should be aware that the current or future market price of their shares of our
common stock could be negatively impacted by the sale or perceived sale of all or a significant
number of these shares that are available for sale pursuant to these registration statements or
that will be available for sale in the future.
Our outstanding warrants, and the provisions of our Term Loan with Asahi, may result in substantial
dilution to our stockholders.
Warrants held by DaVita and certain investors in our 2008 private placement could result in
the issuance of up to 6.9 million additional shares of common stock. In addition, in the event our
Term Loan with Asahi reaches maturity, Asahi may require that all of the principal and interest on
the Term Loan that is unpaid as of the maturity date be converted into shares of our common stock,
with the number of shares to be determined based upon the average closing stock price of our common
stock during the thirty business days preceding the maturity date. The issuance and sale of any of
these shares could result in substantial dilution to our stockholders in the form of immediate and
substantial dilution in net tangible book value per share.
Our executive officers and directors own a large percentage of
our voting common stock and could limit new stockholders influence on corporate decisions or could
delay or prevent a change in corporate control.
Our directors and executive officers, together with their affiliates and related persons, beneficially hold, in the
aggregate, approximately 18% of our outstanding common stock. David S. Utterberg holds
approximately 9% of our outstanding
common stock. Although these numbers are lower than they have been historically, due to certain
recent selling by larger affiliated stockholders, these stockholders, if acting together, may
nevertheless still have the ability to determine the outcome of matters submitted to our
stockholders for approval, including the election and removal of directors and any merger,
consolidation or sale of all or substantially all of our assets and other extraordinary
transactions. The interests of this group of stockholders may not always coincide with our
corporate interests or the interests of other stockholders, and they may act in a manner with which
you may not agree or that may not be in the best interests of other stockholders. This
concentration of ownership may have the effect of:
|
|
|
delaying, deferring or preventing a change in control of our company; |
|
|
|
|
entrenching our management and/or Board; |
|
|
|
|
impeding a merger, consolidation, takeover or other business combination involving our company; or |
|
|
|
|
discouraging a potential acquirer from making a tender offer or otherwise
attempting to obtain control of our company. |
We may grow through additional acquisitions, which could dilute our existing shareholders and could
involve substantial integration risks.
As part of our business strategy, we may acquire other businesses and/or technologies in the
future. We may issue equity securities as consideration for future acquisitions that would dilute
our existing stockholders, perhaps significantly depending on the terms of the acquisition. We may
also incur additional debt in connection with future acquisitions, which, if available at all, may
place additional restrictions on our ability to operate our business. Acquisitions may involve a
number of risks, including:
|
|
|
difficulty in transitioning and integrating the operations and personnel of the
acquired businesses, including different and complex accounting and financial reporting
systems; |
|
|
|
|
potential disruption of our ongoing business and distraction of management; |
|
|
|
potential difficulty in successfully implementing, upgrading and deploying in a
timely and effective manner new operational information systems and upgrades of our
finance, accounting and product distribution systems;
|
42
|
|
|
difficulty in incorporating acquired technology and rights into our products and technology; |
|
|
|
|
unanticipated expenses and delays in completing acquired development projects and technology integration; |
|
|
|
|
management of geographically remote units both in the United States and internationally; |
|
|
|
|
impairment of relationships with partners and customers; |
|
|
|
|
customers delaying purchases of our products pending resolution of product
integration between our existing and our newly acquired products; |
|
|
|
|
entering markets or types of businesses in which we have limited experience; |
|
|
|
|
potential loss of key employees of the acquired company; and |
|
|
|
|
inaccurate assumptions of the acquired companys product quality and/or product reliability. |
As a result of these and other risks, we may not realize anticipated benefits from our
acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired
businesses and technologies could seriously harm our business.
43
|
|
|
Exhibit |
|
|
Number |
|
|
|
|
|
*31.1
|
|
Certification of Chief Executive Officer pursuant to Exchange
Act Rules 13a-14(a) or 15d-14(a), as adopted pursuant to
Section 302 of Sarbanes-Oxley Act of 2002. |
|
|
|
*31.2
|
|
Certification of Chief Financial Officer pursuant to Exchange
Act Rules 13a-14(a) or 15d-14(a), as adopted pursuant to
Section 302 of Sarbanes-Oxley Act of 2002. |
|
|
|
*32.1
|
|
Certification of Chief Executive Officer pursuant to Exchange
Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of Sarbanes-Oxley Act of
2002. |
|
|
|
*32.2
|
|
Certification of Chief Financial Officer pursuant to Exchange
Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of Sarbanes-Oxley Act of
2002. |
|
|
|
*101.INS
|
|
XBRL Instance Document |
|
|
|
*101.SCH
|
|
XBRL Taxonomy Extension Schema |
|
|
|
*101.CAL
|
|
XBRL Taxonomy Extension Calculation Linkbase |
|
|
|
*101.LAB
|
|
XBRL Taxonomy Extension Label Linkbase |
|
|
|
101.PRE
|
|
XBRL Taxonomy Extension Presentation Linkbase |
44
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
|
|
|
|
|
NXSTAGE MEDICAL, INC.
|
|
|
By: |
/s/ Robert S. Brown
|
|
|
|
Robert S. Brown |
|
|
|
Chief Financial Officer
(Duly authorized officer and principal financial and
accounting officer) |
|
|
November 3, 2011
45