e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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| þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2006
OR
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| 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)
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| Delaware
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04-3454702 |
| (State of Incorporation)
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|
(I.R.S. Employer Identification No.) |
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| 439 S. Union Street 5th Floor, Lawrence, MA
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|
01843 |
| (Address of Principal Executive Offices)
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|
(Zip Code) |
Registrant’s Telephone Number, Including Area Code: (978) 687-4700
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 is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act: (Check One):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yes o No þ
There were 27,776,378 shares of the registrant’s common stock issued and outstanding as of the
close of business on October 23, 2006.
NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2006
TABLE OF CONTENTS
2
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
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September 30, |
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December 31, |
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2006 |
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2005 |
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ASSETS |
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|
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Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
46,059,185 |
|
|
$ |
61,223,377 |
|
Short-term investments |
|
|
31,816,195 |
|
|
|
— |
|
Accounts receivable, net |
|
|
3,100,785 |
|
|
|
1,367,860 |
|
Inventory |
|
|
9,885,148 |
|
|
|
5,956,336 |
|
Prepaid expenses and other current assets |
|
|
588,234 |
|
|
|
523,160 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
91,449,547 |
|
|
|
69,070,733 |
|
|
|
|
|
|
|
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|
|
|
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Property and equipment, net |
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2,819,868 |
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|
2,070,387 |
|
Field equipment, net |
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|
15,285,057 |
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|
4,843,398 |
|
Other assets |
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|
406,435 |
|
|
|
446,508 |
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|
|
|
|
|
|
|
Total assets |
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$ |
109,960,907 |
|
|
$ |
76,431,026 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
4,187,254 |
|
|
$ |
3,027,524 |
|
Accrued expenses |
|
|
4,058,656 |
|
|
|
2,204,621 |
|
Deferred rent obligation |
|
|
252,983 |
|
|
|
224,694 |
|
Deferred revenue |
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|
87,917 |
|
|
|
— |
|
Current portion of long-term debt |
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|
2,800,000 |
|
|
|
1,513,480 |
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|
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|
|
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Total current liabilities |
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11,386,810 |
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|
6,970,319 |
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|
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|
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Deferred rent obligation |
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|
410,817 |
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|
473,268 |
|
Long-term debt |
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|
5,316,667 |
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|
1,633,070 |
|
|
|
|
|
|
|
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Total liabilities |
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|
17,114,294 |
|
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|
9,076,657 |
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Commitments and contingencies |
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Stockholders’ equity: |
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Undesignated preferred stock: par value
$0.001, 5,000,000 shares authorized; zero
shares issued and outstanding as of
September 30, 2006 and December 31, 2005 |
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|
— |
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— |
|
Common stock: par value $0.001, 100,000,000
shares authorized; 27,776,378 and 21,176,554
shares issued and outstanding as of
September 30, 2006 and December 31, 2005,
respectively |
|
|
27,776 |
|
|
|
21,177 |
|
Additional paid-in capital |
|
|
205,996,642 |
|
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|
151,675,548 |
|
Deferred compensation |
|
|
— |
|
|
|
(259,910 |
) |
Accumulated deficit |
|
|
(113,229,106 |
) |
|
|
(84,010,669 |
) |
Accumulated other comprehensive income (loss) |
|
|
51,301 |
|
|
|
(71,777 |
) |
|
|
|
|
|
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|
Total stockholders’ equity |
|
|
92,846,613 |
|
|
|
67,354,369 |
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|
|
|
|
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Total liabilities and stockholders’ equity |
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$ |
109,960,907 |
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|
$ |
76,431,026 |
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|
See accompanying notes to these condensed consolidated financial statements.
3
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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|
2006 |
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|
2005 |
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|
2006 |
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|
2005 |
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Revenues |
|
$ |
5,511,774 |
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|
$ |
1,496,785 |
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|
$ |
13,458,769 |
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|
$ |
3,933,960 |
|
Cost of revenues |
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|
6,620,268 |
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|
2,270,865 |
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|
17,481,151 |
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|
6,114,408 |
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|
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|
|
|
|
|
|
|
|
|
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|
Gross profit (deficit) |
|
|
(1,108,494 |
) |
|
|
(774,080 |
) |
|
|
(4,022,382 |
) |
|
|
(2,180,448 |
) |
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Operating expenses: |
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Selling and marketing |
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|
3,662,698 |
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|
2,084,967 |
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|
10,614,218 |
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|
4,986,376 |
|
Research and development |
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|
1,386,150 |
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|
1,648,887 |
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|
4,741,339 |
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|
4,704,659 |
|
Distribution |
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|
2,027,272 |
|
|
|
623,366 |
|
|
|
4,835,556 |
|
|
|
1,409,030 |
|
General and administrative |
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|
2,367,653 |
|
|
|
1,298,249 |
|
|
|
6,491,398 |
|
|
|
3,501,210 |
|
|
|
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|
|
|
|
|
|
|
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|
Total operating expenses |
|
|
9,443,773 |
|
|
|
5,655,469 |
|
|
|
26,682,511 |
|
|
|
14,601,275 |
|
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|
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|
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|
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Loss from operations |
|
|
(10,552,267 |
) |
|
|
(6,429,549 |
) |
|
|
(30,704,893 |
) |
|
|
(16,781,723 |
) |
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Other income (expense): |
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|
|
|
|
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|
|
|
|
|
|
|
|
Interest income |
|
|
1,069,849 |
|
|
|
118,304 |
|
|
|
2,273,177 |
|
|
|
268,090 |
|
Interest expense |
|
|
(93,218 |
) |
|
|
(278,667 |
) |
|
|
(786,721 |
) |
|
|
(592,063 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
976,631 |
|
|
|
(160,363 |
) |
|
|
1,486,456 |
|
|
|
(323,973 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
Net loss |
|
$ |
(9,575,636 |
) |
|
$ |
(6,589,912 |
) |
|
$ |
(29,218,437 |
) |
|
$ |
(17,105,696 |
) |
|
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|
Net loss per share, basic and diluted |
|
$ |
(0.34 |
) |
|
$ |
(2.57 |
) |
|
$ |
(1.23 |
) |
|
$ |
(6.66 |
) |
|
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|
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|
Weighted-average shares outstanding,
basic and diluted |
|
|
27,760,835 |
|
|
|
2,567,618 |
|
|
|
23,818,789 |
|
|
|
2,566,852 |
|
|
|
|
|
|
|
|
|
|
|
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|
See accompanying notes to these condensed consolidated financial statements.
4
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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|
Nine Months Ended |
|
| |
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(29,218,437 |
) |
|
$ |
(17,105,696 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
Loss on disposal of equipment |
|
|
26,959 |
|
|
|
— |
|
Depreciation and amortization |
|
|
2,199,320 |
|
|
|
622,549 |
|
Amortization/write-off of debt discount |
|
|
281,666 |
|
|
|
105,625 |
|
Stock-based compensation |
|
|
2,041,481 |
|
|
|
171,474 |
|
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(1,732,925 |
) |
|
|
(411,530 |
) |
Inventory |
|
|
(16,069,873 |
) |
|
|
(3,927,313 |
) |
Prepaid expenses and other current assets |
|
|
(74,026 |
) |
|
|
(84,411 |
) |
Accounts payable |
|
|
1,139,037 |
|
|
|
1,285,227 |
|
Accrued
expenses and other current liabilities |
|
|
2,496,535 |
|
|
|
1,154,270 |
|
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(38,910,263 |
) |
|
|
(18,189,805 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
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|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Purchases of property and equipment |
|
|
(1,231,618 |
) |
|
|
(845,337 |
) |
Purchases of short-term investments |
|
|
(31,816,195 |
) |
|
|
— |
|
Sale of marketable securities |
|
|
— |
|
|
|
12,495,000 |
|
(Decrease) increase in other assets |
|
|
(622,297 |
) |
|
|
260,766 |
|
|
|
|
|
|
|
|
Net cash (used in) provided by investing activities |
|
|
(33,670,110 |
) |
|
|
11,910,429 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Net proceeds from issuance of redeemable convertible preferred stock |
|
|
— |
|
|
|
15,965,003 |
|
Net proceeds from issuance of common stock |
|
|
51,340,579 |
|
|
|
— |
|
Proceeds from stock option and purchase plans |
|
|
789,520 |
|
|
|
4,749 |
|
Proceeds from exercise of warrants |
|
|
502,901 |
|
|
|
— |
|
Cost of initial public offering |
|
|
— |
|
|
|
(1,642,962 |
) |
Net borrowings (repayments) on loans and lines of credit |
|
|
4,679,560 |
|
|
|
(1,052,316 |
) |
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
57,312,560 |
|
|
|
13,274,474 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange effect on cash and cash equivalents |
|
|
103,621 |
|
|
|
(89,326 |
) |
|
|
|
|
|
|
|
(Decrease) increase in cash and cash equivalents |
|
|
(15,164,192 |
) |
|
|
6,905,772 |
|
Cash and cash equivalents, beginning of period |
|
|
61,223,377 |
|
|
|
5,639,499 |
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
46,059,185 |
|
|
$ |
12,545,271 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Supplemental Disclosure |
|
|
|
|
|
|
|
|
Cash paid for interest |
|
$ |
800,965 |
|
|
$ |
205,478 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncash Investing Activities |
|
|
|
|
|
|
|
|
Transfers from inventory to field equipment |
|
$ |
12,158,528 |
|
|
$ |
2,725,397 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncash Financing Activities |
|
|
|
|
|
|
|
|
Deferred compensation and paid-in capital |
|
$ |
1,948 |
|
|
$ |
79,810 |
|
|
|
|
|
|
|
|
See accompanying notes to these condensed consolidated financial statements.
5
NXSTAGE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Description of Business
Operations
NxStage Medical, Inc. (the “Company”) is a medical device company that develops, manufactures
and markets products for the treatment of kidney failure and fluid overload. The Company’s primary
product, the NxStage System One (the “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. The System
One is cleared by the United States Food and Drug Administration (the “FDA”) and sold commercially
in the United States for the treatment of acute and chronic kidney failure and fluid overload. The
System One consists of an electromechanical medical device (cycler), a disposable blood tubing set
and a dialyzer (filter) pre-mounted in a disposable, single-use cartridge, and fluids used in
conjunction with therapy.
The Company has experienced and continues to experience negative operating margins and cash
flow from operations and it expects to continue to incur net losses in the foreseeable future. The
Company believes that it has sufficient cash and availability under its equipment line of credit to
meet its funding requirements at least through 2007. There can be no assurance as to the
availability of additional financing or the terms upon which additional financing may be available
in the future if, and when, it is needed. If the Company is unable to obtain additional financing
when needed, it may be required to delay, reduce the scope of, or eliminate one or more aspects of
its business development activities, which could harm the growth of its business. As of September
30, 2006, the Company had approximately $77.9 million of cash,
cash equivalents and short-term
investments.
Basis of Presentation
The condensed consolidated financial statements reflect the operations of the Company and its
wholly-owned subsidiaries. The interim financial statements and notes thereto have been prepared
pursuant to the rules of the Securities and Exchange Commission (the “SEC”) for quarterly reports
on Form 10-Q and do not include all of the information and note disclosures required by accounting
principles generally accepted in the United States of America (“GAAP”). In the opinion of
management, the interim financial statements reflect all adjustments consisting of normal,
recurring adjustments necessary for a fair presentation of the results for interim periods.
Operating results for the three and nine months ended September 30, 2006 are not necessarily
indicative of results that may ultimately be achieved for the entire year ending December 31, 2006.
These condensed consolidated financial statements should be read in conjunction with the audited
financial statements and notes included in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2005.
2. Summary of Significant Accounting Policies
(a) Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All material intercompany transactions and balances have
been eliminated in consolidation.
(b) Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires 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
(c) Revenue Recognition
The Company recognizes revenues from product sales and services when earned in accordance with
Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition, and Emerging Issues Task Force
(“EITF”) 00-21, Revenue Arrangements with Multiple Deliverables. 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. In the critical care market, sales are structured as direct
product sales or as a disposables-based program in which a customer acquires the equipment through
the purchase of a specific quantity of disposables over a specific period of time. During the
reported periods, the majority of the Company’s critical care revenues were derived from direct
product sales. In the chronic care market, revenues are realized using short-term rental
arrangements.
In the critical care market, the Company recognizes revenue from direct product sales at the
later of the time of shipment or, if applicable, delivery in accordance with contract terms. For
the chronic care market, the Company recognizes revenue derived from short-term rental arrangements
ratably over the rental period. These rental arrangements combine the use of a system with a
specified number of disposable products supplied to customers for a fixed amount per month. Revenue
is recognized on a monthly basis in accordance with agreed upon contract terms and pursuant to
customer purchase orders with fixed payment terms. Customer contracts are generally cancelable on
30-days notice and there are no purchase requirements from customers under the Company’s chronic
agreements.
Under a disposables-based program, the customer is granted the right to use the equipment for
a period of time, during which the customer commits to purchase a minimum number of disposable
cartridges or fluids at a price that includes a premium above the otherwise average selling price
of the cartridges or fluids to recover the cost of the equipment and provide for a profit. Upon
reaching the contractual minimum purchases, ownership of the equipment transfers to the customer.
Revenues under these arrangements are recognized over the term of the arrangement as disposables
are delivered. The Company records the cost of the equipment in inventory and amortizes the cost of
the equipment through charges to cost of revenues consistent with the customer’s minimum purchase
requirement.
When the Company enters into a multiple-element arrangement, it allocates the total revenue to
all elements of the arrangement based on their respective fair values. Fair value is determined by
the price charged when each element is sold separately. The Company’s most common multiple-element
arrangements are products sold under a disposables-based program in the critical care market as
described above. The Company accounts for the disposables-based program as a single economic
transaction and has determined that it does not have a basis to separate the transaction into
multiple elements to recognize revenue at the time of shipment of each element. Rather, the Company
recognizes revenue related to all elements over the term of the arrangement as the disposables are
delivered.
The Company’s contracts provide for training, technical support and warranty services to its
customers. The Company recognizes training and technical support revenue when the related services
are performed. In the case of extended warranty, the revenue is recognized ratably over the
warranty period.
(d) Foreign Currency Translation and Transactions
Assets and liabilities of the Company’s foreign operations are translated in accordance with
Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation”. In
accordance with SFAS No. 52, assets and liabilities of the Company’s foreign operations are
translated into U.S. dollars at current exchange rates, and income and expense items are translated
at average rates of exchange prevailing during the year. Gains and losses realized from
transactions, including intercompany balances not considered permanent investments, denominated in
foreign currencies are included in the consolidated statements of operations. The Company’s foreign
exchange losses totaled $152,000 and $228,000 for the three and nine months ended September 30,
2006, respectively. A foreign exchange gain of $21,000 was realized for the three months ended
September 30, 2005, while a foreign exchange loss of $7,100 was realized for the nine months ended
September 30, 2005.
7
(e) Cash, Cash Equivalents and Short-Term Investments
The Company considers all highly-liquid investments purchased with original maturities of 90
days or less to be cash equivalents. Cash equivalents include amounts invested in federal agency
securities, certificates of deposit, commercial paper and money market funds. Cash equivalents are
stated at cost plus accrued interest, which approximates market value. Short-term investments
represent federal agency securities, certificates of deposit and commercial paper with an original
maturity date of more than 90 days, but less than 180 days. Short-term investments have been
classified as held-to-maturity and carried at amortized cost because the Company has the intent and
ability to hold the investments to maturity.
(f) Fair Value of Financial Instruments and Concentration of Credit Risk
Financial instruments consist principally of cash and cash equivalents, accounts receivable,
accounts payable and long-term debt. The estimated fair value of these instruments approximates
their carrying value due to the short period of time to their maturities. The fair value of the
Company’s debt is estimated based on the current rates offered to the Company for debt with the
same remaining maturities. The carrying amount of long-term debt approximates fair value.
(g) Inventory
Inventory is stated at the lower of cost (weighted-average) or market (net realizable value).
The Company regularly reviews its inventory quantities on hand and related cost and records a
provision for any excess or obsolete inventory based on its estimated forecast of product demand
and existing product configurations. The Company also reviews its inventory value to determine if
it reflects lower of cost or market, with market determined based on net realizable value.
Appropriate consideration is given to inventory items sold at negative gross margins and other
factors in evaluating net realizable value. The medical device industry is characterized by rapid
development and technological advances that could result in obsolescence of inventory.
Additionally, the Company’s estimates of future product demand may prove to be inaccurate.
Inventories at September 30, 2006 and December 31, 2005 are as follows:
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Purchased components |
|
$ |
2,822,431 |
|
|
$ |
2,026,986 |
|
Finished units |
|
|
7,062,717 |
|
|
|
3,929,350 |
|
|
|
|
|
|
|
|
|
|
$ |
9,885,148 |
|
|
$ |
5,956,336 |
|
|
|
|
|
|
|
|
Inventory is shown net of a valuation reserve of approximately $399,000 and $646,000 at
September 30, 2006 and December 31, 2005, respectively.
(h) Property and Equipment and Field Equipment
Property and equipment is carried at cost less accumulated depreciation. A summary of the
components of property and equipment is as follows:
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Computer and office equipment |
|
$ |
1,101,947 |
|
|
$ |
829,298 |
|
Machinery, equipment and tooling |
|
|
2,380,814 |
|
|
|
1,613,359 |
|
Furniture |
|
|
410,026 |
|
|
|
279,815 |
|
Leasehold improvements |
|
|
1,003,186 |
|
|
|
930,213 |
|
Construction-in-process |
|
|
279,580 |
|
|
|
246,639 |
|
|
|
|
|
|
|
|
|
|
|
5,175,553 |
|
|
|
3,899,324 |
|
Less accumulated depreciation and amortization |
|
|
(2,355,685 |
) |
|
|
(1,828,937 |
) |
|
|
|
|
|
|
|
Property and equipment, net |
|
$ |
2,819,868 |
|
|
$ |
2,070,387 |
|
|
|
|
|
|
|
|
8
Depreciation expense for property and equipment was $176,259 and $99,211 for the three months
ended September 30, 2006 and 2005, respectively, and $492,410 and $291,468 for the nine months
ended September 30, 2006 and 2005, respectively.
Field equipment is carried at cost less accumulated depreciation as follows:
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Field equipment |
|
$ |
17,669,928 |
|
|
$ |
5,521,359 |
|
Less accumulated depreciation and amortization |
|
|
(2,384,871 |
) |
|
|
(677,961 |
) |
|
|
|
|
|
|
|
Field equipment, net |
|
$ |
15,285,057 |
|
|
$ |
4,843,398 |
|
|
|
|
|
|
|
|
Depreciation expense for field equipment was $795,489 and $162,003 for the three months ended
September 30, 2006 and 2005, respectively, and $1,706,910 and $330,070 for the nine months ended
September 30, 2006 and 2005, respectively.
The estimated service lives of property and equipment and field equipment are as follows:
| |
|
|
| |
|
Estimated |
| |
|
Useful Life |
Leasehold improvements
|
|
Lesser of 5 years or lease term |
Computer and office equipment
|
|
3 years |
Machinery, equipment and tooling
|
|
5 years |
Furniture
|
|
7 years |
Field equipment
|
|
5 years |
(i) Share-Based Compensation
Until December 31, 2005, the Company accounted for stock-based employee compensation in
accordance with Accounting Principles Board (“APB”), Opinion No. 25, “Accounting for Stock Issued
to Employees”, and related interpretations. Accordingly, compensation expense was recorded for
stock options awarded to employees and directors to the extent that the option exercise price was
less than the fair market value of the Company’s common stock on the date of grant, where the
number of shares and exercise price were fixed. The difference between the fair value of the
Company’s common stock and the exercise price of the stock option, if any, was recorded as deferred
compensation and was amortized to compensation expense over the vesting period of the underlying
stock option. All stock-based awards to nonemployees were accounted for at their fair value in
accordance with SFAS No. 123, “Accounting for Stock-Based Compensation” and related
interpretations.
On January 1, 2006, the Company adopted SFAS No. 123R “Share-Based Payment”, using a
combination of the prospective and the modified prospective transition methods. Under the
prospective method, the Company will not recognize the remaining compensation cost for any stock
option awards which had previously been valued using the minimum value method, which was allowed
until the Company’s initial filing with the SEC for the sale of securities (i.e., stock options
granted prior to July 19, 2005). Under the modified prospective method, the Company has (a)
recognized compensation expense for all share-based payments granted after January 1, 2006 and (b)
recognized compensation expense for awards granted to employees between July 19, 2005 and December
31, 2005 that remained unvested as of December 31, 2005.
The Company filed a registration statement on Form S-1 for an initial public offering of its
common stock on July 19, 2005 and closed the initial public offering on November 1, 2005. Stock
options granted prior to July 19, 2005 were valued using the minimum value method, while stock
options granted after July 19, 2005 were valued using the Black-Scholes option-pricing model. The
minimum value method excludes the impact of stock volatility, whereas the Black-Scholes
option-pricing model includes a stock volatility assumption in its calculation. The inclusion of a
stock volatility assumption, the principal difference between the two methods, ordinarily yields a
higher fair value.
9
As a result of adopting SFAS 123R on January 1, 2006, the Company’s net loss for the three and
nine months ended September 30, 2006 was $668,668 and $1,810,123 higher, respectively, than if it
had continued to account for share-based compensation under APB No. 25. Basic and diluted loss per
share for the three and nine months ended September 30, 2006 are $0.02 and $0.08 higher,
respectively, than if the Company had continued to account for share-based compensation under APB
No. 25.
The Company recognized the impact of its share-based payment plans in the condensed
consolidated statement of operations for the three and nine month periods ended September 30, 2006
under SFAS 123R. The following table presents the captions in which share-based compensation
expense is included in the Company’s condensed consolidated statement of operations, including
share-based compensation recorded in accordance with APB No. 25:
| |
|
|
|
|
|
|
|
|
| |
|
Three Months |
|
|
Nine Months |
|
| |
|
Ended |
|
|
Ended |
|
| |
|
September 30, 2006 |
|
|
September 30, 2006 |
|
Cost of revenues |
|
$ |
17,472 |
|
|
$ |
44,972 |
|
Selling and marketing |
|
|
140,672 |
|
|
|
388,976 |
|
Research and development |
|
|
28,856 |
|
|
|
85,720 |
|
Distribution |
|
|
2,588 |
|
|
|
7,339 |
|
General and administrative |
|
|
581,627 |
|
|
|
1,514,474 |
|
|
|
|
|
|
|
|
Total |
|
$ |
771,215 |
|
|
$ |
2,041,481 |
|
|
|
|
|
|
|
|
The weighted-average fair value of options granted during the three and nine months ended
September 30, 2006 was $5.96 and $7.86, respectively. The fair value of options at date of grant
was estimated using the Black-Scholes option-pricing model with the following assumptions:
| |
|
|
|
|
|
|
|
|
| |
|
Three Months |
|
Nine Months |
| |
|
Ended |
|
Ended |
| |
|
September 30, 2006 |
|
September 30, 2006 |
Expected life of the options |
|
|
4.75 years (1) |
|
|
|
4.75 years (1) |
|
Risk-free interest rate |
|
|
4.63% – 4.88%(2) |
|
|
|
4.35% – 4.88%(2) |
|
Expected stock price volatility |
|
|
85%(3) |
|
|
|
85%(3) |
|
Expected dividend yield |
|
|
— |
|
|
|
— |
|
|
|
|
| (1) |
|
The expected term was determined using the simplified method for estimating expected option
life of “plain-vanilla” options. |
| |
| (2) |
|
The risk-free interest rate for each grant is equal to the U.S. Treasury rate in effect at
the time of grant for instruments with an expected life similar to the expected option term. |
| |
| (3) |
|
Because the Company has no options that are traded publicly and because of its limited
trading history as a public company, the stock volatility assumption is based on an analysis
of the stock volatility of comparable companies in the medical device and technology
industries. |
The Company has estimated expected forfeitures of stock options with the adoption of SFAS
123R. In developing a forfeiture rate estimate, the Company considered its historical experience,
its growing employee base and the limited liquidity of its common stock.
(j) Warranty Costs
For a period of one year following the delivery of products to its critical care customers,
the Company provides for product repair or replacement if it is determined that there is a defect
in material or manufacture of the product. For sales into the critical care market, the Company
accrues estimated warranty costs at the time of shipment based on contractual rights and historical
experience.
10
(k) Distribution Expenses
Distribution expenses consist of the costs incurred in shipping products to customers and are
charged to operations as incurred. Shipping and handling costs billed to customers are included in
revenues and totaled $4,705 and $12,052 for the three months ended September 30, 2006 and 2005,
respectively, and $25,381 and $31,870 for the nine months ended September 30, 2006 and 2005,
respectively.
(l) Research and Development Costs
Research and development costs are charged to operations as incurred.
(m) Income Taxes
The Company accounts for federal and state income taxes in accordance with SFAS No. 109,
“Accounting for Income Taxes”. Under the liability method specified by SFAS No. 109, a deferred tax
asset or liability is determined based on the difference between the financial statement and tax
basis of assets and liabilities, as measured by the enacted tax rates. The Company’s provision for
income taxes represents the amount of taxes currently payable, if any, plus the change in the
amount of net deferred tax assets or liabilities. A valuation allowance is provided against net
deferred tax assets if recoverability is uncertain on a more likely than not basis.
(n) Net Loss per Share
Until the closing of the Company’s initial public offering on November 1, 2005, the Company
calculated net loss per share in accordance with SFAS No. 128, “Earnings per Share”, and EITF 03-6,
“Participating Securities and the Two Class Method under FASB Statement No. 128, Earnings per
Share”. EITF 03-6 clarifies the use of the “two-class” method of calculating earnings per share as
originally prescribed in SFAS No. 128. Effective for periods beginning after March 31, 2004, EITF
03-6 provides guidance on how to determine whether a security should be considered a “participating
security” for purposes of computing earnings per share and how earnings should be allocated to a
participating security when using the two-class method for computing earnings per share. The
Company had determined that its redeemable preferred stock represented a participating security
because it may have participated in dividends with common stock and, therefore, had calculated net
loss per share consistent with the provisions of EITF 03-6 for all periods in which its redeemable
preferred stock was outstanding. All of the Company’s redeemable preferred stock converted to
common stock on November 1, 2005, the date of the Company’s initial public offering.
Accordingly, subsequent to November 1, 2005, the Company no longer uses the two-class method
and calculates net loss per share based on the weighted average number of shares of common stock
outstanding, excluding unvested shares of restricted common stock. The following potential common
stock equivalents were not included in the computation of diluted net loss per share as their
effect would have been anti-dilutive:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Options to purchase common stock |
|
|
203,037 |
|
|
|
1,579,460 |
|
|
|
595,505 |
|
|
|
805,461 |
|
Warrants to purchase common stock |
|
|
4,633 |
|
|
|
203,625 |
|
|
|
— |
|
|
|
203,625 |
|
Unvested shares of common stock
subject to repurchase |
|
|
— |
|
|
|
23 |
|
|
|
— |
|
|
|
172 |
|
Redeemable convertible preferred
stock |
|
|
— |
|
|
|
12,124,840 |
|
|
|
— |
|
|
|
12,124,840 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
207,670 |
|
|
|
13,907,948 |
|
|
|
595,505 |
|
|
|
13,134,098 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
(o) Comprehensive Income (Loss)
SFAS No. 130, “Reporting Comprehensive Income”, establishes standards for reporting
comprehensive income (loss) and its components in the body of the financial statements.
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss).
Other comprehensive income (loss) includes certain changes in equity, such as foreign currency
translation adjustments, that are excluded from results of operations.
The components of comprehensive income (loss) are presented below for the periods presented in
the condensed consolidated statements of operations:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net loss |
|
$ |
(9,575,636 |
) |
|
$ |
(6,589,912 |
) |
|
$ |
(29,218,437 |
) |
|
$ |
(17,105,696 |
) |
Foreign currency translation gain (loss) |
|
|
65,247 |
|
|
|
(10,318 |
) |
|
|
123,078 |
|
|
|
(134,402 |
) |
Realized gain on marketable securities |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(24,000 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(9,510,389 |
) |
|
$ |
(6,600,230 |
) |
|
$ |
(29,095,359 |
) |
|
$ |
(17,264,098 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(p) Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No.
(“FIN”) 48, “Accounting for Uncertainty in Income Taxes”, which clarifies the accounting for
uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB
Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods, disclosure
and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company
is currently in a loss position and does not pay income taxes; therefore the adoption of FIN 48 is
not expected to have a significant impact on the Company’s 2006 financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which addresses
the measurement of “fair value” where such measure is required for recognition or disclosure
purposes under GAAP. Among other provisions, SFAS No. 157 includes (1) a new definition of fair
value, (2) a fair value hierarchy used to classify the source of information used in fair value
measurements, (3) new disclosure requirements of assets and liabilities measured at fair value
based on their level in the hierarchy, and (4) a modification of the accounting presumption that
the transaction price of an asset or liability equals its initial fair value. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007 (i.e., beginning in 2008 for NxStage).
The Company is currently evaluating whether SFAS No. 157 will have an impact on its consolidated
financial statements.
3. Financing Arrangements
Debt
In December 2004, the Company entered into a debt agreement in the principal amount of $5.0
million, which was payable monthly over a three-year term and was secured by all the assets of the
Company. Interest accrued at a rate of 7.0% annually and monthly principal and interest payments
were made in advance. In addition, a final interest payment of $650,000 was due at maturity in
December 2007, or earlier if the loan was prepaid in advance. This additional interest payment was
accrued on a monthly basis using the interest method over the 36-month life of the loan and was
included in accrued expenses in the accompanying condensed consolidated balance sheets. Concurrent
with entering into a new equipment line of credit in May 2006, the Company repaid all outstanding
principal and accrued interest under the debt agreement in the aggregate amount of approximately
$3.4 million. This extinguishment of debt gave rise to the early recognition of approximately
$434,000 of interest expense for the nine months ended September 30, 2006.
12
On May 15, 2006, the Company entered into an equipment line of credit agreement for the
purpose of financing field equipment purchases and placements. The line of credit agreement
provides for the availability of up to $20.0 million through December 31, 2007, and borrowings bear
interest at the prime rate plus 0.5% (8.75% as of September 30, 2006). Under the line of credit
agreement, $10.0 million is available through December 31, 2006 and a further $10.0 million is
available from January 1, 2007 through December 31, 2007. The availability of the line of credit is
subject to a number of covenants, including maintaining certain levels of liquidity, adding
specified numbers of patients and operating within net loss parameters. The Company is also
required to maintain operating and/or investment accounts with the lender in an amount at least
equal to the outstanding debt obligation. Borrowings are secured by all assets of the Company other
than intellectual property and are payable ratably over a three-year period from the date of each
borrowing. During the three and nine months ended September 30, 2006, the Company borrowed $5.0
million and $8.4 million, respectively, under the equipment line of credit. As of September 30,
2006, the Company has $1.6 million of borrowing availability under the equipment line of credit
through the end of the year.
Annual maturities of principal under the Company’s debt obligations and reconciliation to
amounts included in the condensed consolidated balance sheet as of September 30, 2006 are as
follows:
| |
|
|
|
|
2006 |
|
$ |
700,000 |
|
2007 |
|
|
2,800,000 |
|
2008 |
|
|
2,800,000 |
|
2009 |
|
|
1,816,667 |
|
|
|
|
|
Total future principal payments |
|
|
8,116,667 |
|
Less: current portion of long-term debt |
|
|
(2,800,000 |
) |
|
|
|
|
Long-term debt |
|
$ |
5,316,667 |
|
|
|
|
|
4. Segment and Enterprise Wide Disclosures
SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”,
establishes standards for reporting information regarding operating segments in annual financial
statements. Operating segments are identified as components of an enterprise about which separate
discrete financial information is available for evaluation by the chief operating decision-maker in
making decisions on how to allocate resources and assess performance. The Company views its
operations and manages its business as one operating segment. All revenues were generated in the
United States and substantially all assets are located in the United States.
The Company sells products into two markets, critical care and chronic care. The critical care
market consists of hospitals or facilities that treat patients that have suddenly, and possibly
temporarily, lost kidney function. The chronic care market consists of dialysis centers and
hospitals that provide treatment options for patients that have end-stage renal disease (“ESRD”).
Revenues recognized in these markets were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Critical care market |
|
$ |
1,865,607 |
|
|
$ |
624,938 |
|
|
$ |
5,333,680 |
|
|
$ |
2,095,757 |
|
Chronic care market |
|
|
3,646,167 |
|
|
|
871,847 |
|
|
|
8,125,089 |
|
|
|
1,838,203 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
5,511,774 |
|
|
$ |
1,496,785 |
|
|
$ |
13,458,769 |
|
|
$ |
3,933,960 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three and nine months ended September 30, 2006, the Company had one customer who
individually represented 20% and 18% of revenues, respectively, and 18% of accounts receivable as
of September 30, 2006. For the three and nine months ended September 30, 2005, the Company had two
customers who represented 21% and 23% of revenues, respectively, and two customers who represented
26% of accounts receivable as of September 30, 2005.
13
5. Stockholders’ Equity
Common and Preferred Stock
On June 14, 2006, the Company completed a follow-on public offering of 6,325,000 shares of its
common stock at a price of $8.75 per share and with aggregate net proceeds of approximately $51.3
million. On November 1, 2005, the Company completed its initial public offering of 6,325,000 shares
of its common stock at a price of $10.00 per share and with aggregate net proceeds of approximately
$56.5 million. In connection with the initial public offering, all shares of all series of the
Company’s outstanding preferred stock were automatically converted into an aggregate of 12,124,840
shares of common stock.
On September 15, 2005, the Company’s board of directors (the “Board”) declared a
one-for-1.3676 reverse stock split of the outstanding shares of common stock. All references in the
condensed consolidated financial statements to the number of shares outstanding, per share amounts
and stock option data of the Company’s common stock have been retroactively adjusted to reflect the
effect of the reverse stock split for all periods presented.
On July 8, 2005, the Company amended its certificate of incorporation to (a) increase the
number of authorized shares of preferred stock to 15,759,660 shares and (b) designate 2,197,801
shares of Series F-1 Preferred Stock. On September 19, 2005, the Company amended its certificate of
incorporation to authorize 30,000,000 shares of common stock. On October 14, 2005, the Company
authorized 5,000,000 shares of undesignated preferred stock. In connection with its initial public
offering, the Company amended and restated its certificate of incorporation to authorize
100,000,000 shares of common stock, par value $0.001 per share.
Prior to the initial public offering, the Company had authorized several series of $0.001 par
value preferred stock, of which 1,875,000 shares were designated as Series B, 1,155,169 shares were
designated as Series C, 5,011,173 shares were designated as Series D, 2,690,846 shares were
designated as Series E, 2,829,671 shares were designated as Series F and 2,197,801 shares were
designated as Series F-1.
During 1999, the Company sold 1,875,000 shares of Series B Preferred Stock at $2.67 per share,
resulting in net proceeds of $4,968,250. Upon the closing of the Series B Preferred Stock
financing, all shares of the Company’s Series A Preferred Stock converted into an equal number of
shares of the Company’s common stock. On January 22, 2000, the Company sold 1,151,632 shares of
Series C Preferred Stock at $5.21 per share, resulting in net proceeds of $5,957,891. On May 21,
2001, the Company sold 4,857,622 shares of Series D Preferred Stock at $5.97 per share, resulting
in net proceeds of $24,218,379. On April 15, 2003, the Company sold 2,669,908 shares of Series E
Preferred Stock at $5.97 per share, resulting in net proceeds of $15,892,537. On August 18, 2004,
the Company sold 2,747,253 shares of Series F Preferred Stock at $7.28 per share, resulting in net
proceeds of $19,968,522. On July 8, 2005 and July 15, 2005, the Company sold an aggregate of
2,197,801 shares of Series F-1 Preferred Stock at $7.28 per share, resulting in net proceeds of
approximately $15,965,003.
Warrants
At September 30, 2006, warrants to purchase a total of 73,460 shares of common stock were
outstanding. These warrants have a weighted average exercise price of $8.17 and expire in December
2011. There were no warrant exercises during the three months ended September 30, 2006. During the
nine months ended September 30, 2006, certain warrant holders exercised warrants to purchase 78,522
shares of the Company’s common stock for aggregate proceeds of approximately $503,000.
6. Stock-Based Awards
Stock Options
The Company maintains the 1999 Stock Option and Grant Plan (the “1999 Plan”) under which
4,085,009 shares of common stock were authorized for the granting of incentive stock options
(“ISOs”) and nonqualified stock options to employees, officers, directors, advisors, and
consultants of the Company. ISOs under the 1999 Plan were granted only to employees, while
nonqualified stock options under the 1999 Plan were granted to officers, employees, consultants and
advisors of the Company. The Board determined the option exercise price for incentive
14
and nonqualified stock options and grants, and in no event were the option exercise prices of
an incentive stock option less than 100% of the fair market value of common stock at the time of
grant, or less than 110% of the fair market value of the common stock in the event that the
employee owned 10% or more of the Company’s capital stock. All stock options issued under the 1999
Plan expire 10 years from the date of grant and the majority of these grants were exercisable upon
the date of grant into restricted common stock, which vests over a period of four years. Prior to
the adoption of the 1999 Plan, the Company issued non-qualified options to purchase 55,252 shares
of common stock, of which 45,755 shares remain outstanding at September 30, 2006. Effective upon
the closing of the Company’s initial public offering, no further grants were or will be made under
the 1999 Plan.
In October 2005, the Company adopted the 2005 Stock Incentive Plan (the “2005 Plan”) which
became effective upon the closing of the initial public offering. Concurrently, the Company ceased
granting stock options and other equity incentive awards under the 1999 Plan and 971,495 shares,
which were then still available for grant under the 1999 Plan, were transferred and became
available for grant under the 2005 Plan. The number of shares available for grant under the 2005
Plan will be increased annually beginning in 2007 by the lesser of (a) 600,000 shares, or (b) 3% of
the then outstanding shares of the Company’s common stock, or (c) a number determined by the Board.
Unless otherwise specified by the Board or Compensation Committee, stock options issued to
employees under the 2005 Plan expire seven years from the date of grant and generally vest over a
period of four years. At September 30, 2006, options for the purchase of 513,216 shares of common
stock are available for future grant under the 2005 Plan.
The following table summarizes activity of the Company’s stock plans since December 31, 2005:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted |
| |
|
|
|
|
|
Average |
| |
|
|
|
|
|
Exercise |
| Fixed Options |
|
Shares |
|
Price |
Outstanding at December 31, 2005 |
|
|
2,683,286 |
|
|
$ |
6.22 |
|
Granted |
|
|
198,300 |
|
|
$ |
11.47 |
|
Exercised |
|
|
(172,603 |
) |
|
$ |
4.06 |
|
Forfeited |
|
|
(37,714 |
) |
|
$ |
10.25 |
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2006 |
|
|
2,671,269 |
|
|
$ |
6.79 |
|
|
|
|
|
|
|
|
|
|
Vested at September 30, 2006 |
|
|
1,571,952 |
|
|
$ |
5.60 |
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2006 |
|
|
1,893,198 |
|
|
$ |
5.65 |
|
|
|
|
|
|
|
|
|
|
The weighted-average fair value of options granted during the three and nine months ended
September 30, 2006 was $5.96 and $7.86, respectively. The aggregate intrinsic value at September
30, 2006 was $4.4 million for stock options outstanding, $4.4 million for stock options vested and
$5.3 million for stock options exercisable. The intrinsic value for stock options outstanding,
vested and exercisable is calculated based on the exercise price of the underlying awards and the
market price of our common stock as of September 30, 2006, excluding out-of-the-money awards. The
total intrinsic value of options exercised during the three and nine months ended September 30,
2006 was $56,000 and $813,000, respectively.
The following table summarizes information about stock options outstanding at September 30,
2006:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Options Outstanding |
|
Options Exercisable |
| |
|
|
|
|
|
Weighted |
|
Weighted |
|
|
|
|
|
Weighted |
| |
|
|
|
|
|
Average |
|
Average |
|
|
|
|
|
Average |
| |
|
Number |
|
Remaining |
|
Exercise |
|
Number |
|
Exercise |
| Range of Exercise Prices |
|
Outstanding |
|
Contractual Life |
|
Price |
|
Exercisable |
|
Price |
$0.34 to $0.55 |
|
|
96,551 |
|
|
2.5 years |
|
$ |
0.36 |
|
|
|
96,551 |
|
|
$ |
0.36 |
|
$1.37 |
|
|
2,924 |
|
|
3.7 years |
|
$ |
1.37 |
|
|
|
2,924 |
|
|
$ |
1.37 |
|
$2.74 to $4.10 |
|
|
821,660 |
|
|
5.3 years |
|
$ |
3.88 |
|
|
|
821,660 |
|
|
$ |
3.88 |
|
$5.47 to $6.84 |
|
|
594,771 |
|
|
8.0 years |
|
$ |
6.04 |
|
|
|
590,463 |
|
|
$ |
6.04 |
|
$7.90 to $9.10 |
|
|
751,114 |
|
|
6.9 years |
|
$ |
8.55 |
|
|
|
186,899 |
|
|
$ |
8.54 |
|
$9.63 to $11.19 |
|
|
107,900 |
|
|
5.1 years |
|
$ |
10.69 |
|
|
|
84,000 |
|
|
$ |
10.83 |
|
$12.28 to $13.65 |
|
|
296,349 |
|
|
5.7 years |
|
$ |
12.67 |
|
|
|
110,701 |
|
|
$ |
12.59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.34 to $13.65 |
|
|
2,671,269 |
|
|
6.3 years |
|
$ |
6.79 |
|
|
|
1,893,198 |
|
|
$ |
5.65 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15
The following table summarizes the status of the Company’s nonvested shares since December 31,
2005:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted |
| |
|
|
|
|
|
Average |
| |
|
|
|
|
|
Exercise |
| Fixed Options |
|
Shares |
|
Price |
Nonvested at December 31, 2005 |
|
|
1,434,256 |
|
|
$ |
7.89 |
|
Granted |
|
|
198,300 |
|
|
$ |
11.47 |
|
Vested |
|
|
(495,525 |
) |
|
$ |
7.77 |
|
Forfeited |
|
|
(37,714 |
) |
|
$ |
10.25 |
|
|
|
|
|
|
|
|
|
|
Nonvested at September 30, 2006 |
|
|
1,099,317 |
|
|
$ |
8.51 |
|
|
|
|
|
|
|
|
|
|
Certain outstanding stock option awards are subject to an early exercise provision. Upon
exercise, the award was subject to a repurchase right in favor of the Company. The repurchase right
terminated upon the closing of the Company’s initial public offering.
As of September 30, 2006, approximately $3.7 million of unrecognized stock compensation cost
related to nonvested awards (net of estimated forfeitures) is expected to be recognized over a
weighted-average period of 3.3 years.
Employee Stock Purchase Plan
The Company’s 2005 Employee Stock Purchase Plan (the “2005 Purchase Plan”) authorizes the
issuance of up to 50,000 shares of common stock to participating employees through a series of
periodic offerings. Each six-month offering period begins in January or July. An employee becomes
eligible to participate in the 2005 Purchase Plan once he or she has been employed for at least
three months and is regularly employed for at least 20 hours per week for more than three months in
a calendar year. The price at which employees can purchase common stock in an offering is 95
percent of the closing price of the common stock on the NASDAQ Global Market on the day the
offering terminates, unless otherwise determined by the Board or Compensation Committee.
The weighted-average fair value of stock purchase rights granted as part of the Company’s 2005
Purchase Plan during the three and nine months ended September 30, 2006 was $2.20 and $2.30,
respectively. The fair value of the employees’ stock purchase rights was estimated using the
Black-Scholes option-pricing model with the following assumptions:
| |
|
|
|
|
|
|
|
|
| |
|
Three Months |
|
Nine Months |
| |
|
Ended |
|
Ended |
| |
|
September 30, 2006 |
|
September 30, 2006 |
Expected life of the purchase rights |
|
|
6 months |
|
|
|
6 months |
|
Risk-free interest rate |
|
|
5.11% |
|
|
|
4.42% – 5.11% |
|
Expected stock price volatility |
|
|
67.0% |
|
|
|
50.9%- 67.0% |
|
Expected dividend yield |
|
|
— |
|
|
|
— |
|
The Company recognized share-based compensation expense of $16,000 and $40,000 for the three
and nine months ended September 30, 2006, respectively, relating to the 2005 Purchase Plan.
On June 30, 2006, the Company’s first offering under the 2005 Purchase Plan closed, resulting
in the purchase of 10,748 shares of common stock on behalf of employee participants. As of
September 30, 2006, the maximum number of shares available under the 2005 Purchase Plan is 39,252.
As of September 30, 2006, the Company has reserved 3,184,485 shares of common stock for
issuance upon exercise of stock options, 39,252 shares for issuance under the 2005 Purchase Plan
and 73,460 shares for issuance upon exercise of warrants.
16
7. Related-Party Transactions
The Company purchases completed cartridges, tubing and certain other components used in the
System One disposable cartridge from Medisystems Corporation, an entity owned by a significant
stockholder and member of the Board. The Company purchased approximately $1.5 million and $313,000
during the three months ended September 30, 2006 and 2005, respectively, and approximately $2.6
million and $641,000 during the nine months ended September 30, 2006 and 2005, respectively, of
goods and services from this related party. Amounts owed to Medisystems Corporation totaled
$522,000 and $81,000 at September 30, 2006 and December 31, 2005, respectively, and are included in
accounts payable in the accompanying condensed consolidated balance sheets.
17
Item 2. Management’s 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, 2006 and 2005, as well as the audited financial statements and notes and
Management’s Discussion and Analysis of Financial Condition and Results of Operations for the
fiscal year ended December 31, 2005, 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, Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements regarding future events and our future results are
based on current expectations, estimates, forecasts and projections and the beliefs and assumptions
of our management including, without limitation, our expectations regarding our results of
operations, general and administrative expenses, research and development expenses and the
sufficiency of our cash for future operations. Words such as “we expect,” “anticipate,” “target,”
“project,” “believe,” “goals,” “estimate,” “potential,” “predict,” “may,” “will,” “expect,”
“might,” “could,” “intend,” variations of these terms or the negative of those terms and similar
expressions are intended to identify these forward-looking statements. Readers are cautioned that
these forward-looking statements are predictions and are subject to risks, uncertainties and
assumptions that are difficult to predict. Therefore, actual results may differ materially and
adversely from those expressed in any 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 risk factors described under the
heading “Risk Factors” in Item 1A of Part II of this Quarterly Report, as well as in the 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.
Overview
We are a medical device company that develops, manufactures and markets innovative systems for
the treatment of end-stage renal disease, or ESRD, acute kidney failure and fluid overload. Our
primary product, the NxStage System One, is a small, portable, easy-to-use hemodialysis system
designed to provide physicians and patients improved flexibility in how hemodialysis therapy is
prescribed and delivered. We believe the largest market opportunity for our product is the home
hemodialysis market for the treatment of ESRD.
From our inception in 1998 until 2002, our operations consisted primarily of start-up
activities, including designing and developing the System One, recruiting personnel and raising
capital. Historically, research and development costs have been our single largest operating
expense. However, with the launch of the System One in the home chronic care market, selling and
marketing costs became our largest operating expense in 2005 and continued to be our largest
operating expense during the three and nine months ended September 30, 2006 as we expanded our
United States sales force to increase market share and grow revenues.
Our overall strategy since inception has been to (a) design and develop new products for the
treatment of kidney failure, (b) establish that the products are safe, effective and cleared for
use in the United States, (c) further enhance the product design through field experience from a
limited number of customers, (d) establish reliable manufacturing and sources of supply, (e)
execute a market launch in both the chronic and critical care markets and establish the System One
as a preferred system for the treatment of kidney failure, (f) obtain the capital necessary to
finance our working capital needs and build our business and (g) achieve profitability. The
evolution of NxStage, and the allocation of our resources since we were founded, reflects this
plan. We believe we have largely completed steps (a) through (d), and we plan to continue to pursue
the other strategic objectives described above.
We sell our products in two markets: the chronic care market and the critical care market. We
define the chronic care market as the market devoted to the treatment of patients with ESRD and the
critical care market as the market devoted to the treatment of hospital-based patients with acute
kidney failure or fluid overload. We offer a different configuration of the System One for each
market. The United States Food and Drug Administration, or FDA, has
18
cleared both configurations for hemodialysis, hemofiltration and ultrafiltration. Our products
may be used by our customers to treat patients suffering from ESRD or acute kidney failure,
although the site of care, the method of delivering care and the duration of care are sufficiently
different that we have separate marketing and sales efforts dedicated to each market.
We received clearance from the FDA in July 2003 to market the System One for treatment of
renal failure and fluid overload using hemodialysis as well as hemofiltration and ultrafiltration.
In the first quarter of 2003, we initiated sales of the System One in the critical care market to
hospitals and medical centers in the United States. In late 2003, we initiated sales of the System
One in the chronic care market and commenced full commercial introduction in the chronic care
market in September 2004 in the United States. At the time of these early marketing efforts, the
System One was cleared by the FDA under a general indication statement, allowing physicians to
prescribe the System One for hemofiltration, hemodialysis and/or ultrafiltration at the location,
time and frequency they considered in the best interests of their patients. Our original indication
did not include a specific home clearance, and we were not able to promote the System One for home
use at that time. The FDA cleared the System One in June 2005 for hemodialysis in the home.
In March 2006, we received clearance from the FDA to market our PureFlow SL module as an
alternative to the bagged fluid presently used with our System One in the chronic care market. This
accessory to the System One allows for the automated preparation of high purity dialysate in the
patient’s home using ordinary tap water and dialysate concentrate. The PureFlow SL is designed to
help patients with ESRD more conveniently and effectively manage their home hemodialysis therapy by
eliminating the need for bagged fluids. In July 2006, we released the PureFlow SL for commercial
use and began shipping the PureFlow SL product. We expect that over time our chronic care home
patients will predominantly use our PureFlow SL module at home and will use bagged fluid for travel
and use outside of the home. Bagged fluids will continue to be used in the critical care market.
Medicare provides comprehensive and well-established reimbursement in the United States for
ESRD. Reimbursement claims for the System One therapy are typically submitted by the dialysis
clinic or hospital to Medicare and other third-party payors using established billing codes for
dialysis treatment or, in the critical care setting, based on the patient’s primary diagnosis.
Expanding Medicare reimbursement over time to cover more frequent therapy could accelerate our
market penetration and revenue growth in the future.
Our System One is produced through internal and outsourced manufacturing. We purchase many of
the components and subassemblies included in the System One, as well as the disposable cartridges
used in the System One, from third-party manufacturers, some of which are single source suppliers.
In addition to outsourcing with third-party manufacturers, we assemble, package and label a small
quantity of disposable cartridges in our leased facility in Lawrence, Massachusetts. NxStage GmbH &
Co. KG, our wholly-owned German subsidiary, is the sole manufacturer of the dialyzing filter that
is a component of the disposable cartridge used in the System One.
We market the System One through a direct sales force in the United States primarily to
dialysis clinics and hospitals, and we expect revenues to continue to increase in the near future.
Our revenues were $5.5 million for the three months ended September 30, 2006, a 268% increase from
revenues of $1.5 million in the three months ended September 30, 2005 and a 21% increase from
revenues of $4.5 million in the second quarter of 2006. Our revenues were $13.5 million for the
nine months ended September 30, 2006, a 242% increase from revenues of $3.9 million in the nine
months ended September 30, 2005. We have increased the number of sales representatives in our
combined sales force from 15 at September 30, 2005 to 24 at September 30, 2006. We expect to add
additional sales and marketing personnel as needed in the future. As of September 30, 2006, 900
ESRD patients were using the System One at 157 dialysis clinics, compared to 212 ESRD patients at
53 dialysis clinics as of September 30, 2005, and compared to 292 ESRD patients at 70 dialysis
clinics as of December 31, 2005. In addition, at September 30, 2006, 66 hospitals were using the
System One for critical care therapy, compared to 42 and 50 hospitals as of September 30, 2005 and
December 31, 2005, respectively.
19
The following table sets forth the amount and percentage of revenues derived from each market
for the periods indicated:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
|
|
|
|
2005 |
|
|
|
|
|
|
2006 |
|
|
|
|
|
|
2005 |
|
|
|
|
|
Critical care |
|
$ |
1,865,607 |
|
|
|
33.8 |
% |
|
$ |
624,938 |
|
|
|
41.8 |
% |
|
$ |
5,333,680 |
|
|
|
39.6 |
% |
|
$ |
2,095,757 |
|
|
|
53.3 |
% |
Chronic care |
|
|
3,646,167 |
|
|
|
66.2 |
% |
|
|
871,847 |
|
|
|
58.2 |
% |
|
|
8,125,089 |
|
|
|
60.4 |
% |
|
|
1,838,203 |
|
|
|
46.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,511,774 |
|
|
|
100.0 |
% |
|
$ |
1,496,785 |
|
|
|
100.0 |
% |
|
$ |
13,458,769 |
|
|
|
100.0 |
% |
|
$ |
3,933,960 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We have not been profitable since inception, and we expect to incur net losses for the
foreseeable future as we expand our sales efforts and operations. Our accumulated deficit at
September 30, 2006 was $(113.2) million. Our goal is to increase our sales volume and revenues to
realize operating economies of scale and reduced product costs, which we believe, when combined
with product design improvements, will allow us to reach profitability. We expect our revenues in
the chronic care market to increase faster than those in the critical care market and believe they
will continue to represent the majority of our revenues.
Statement of Operations Components
Revenues
Our products consist of the System One, an electromechanical device used to circulate the
patient’s blood during therapy (the cycler); a single-use, disposable cartridge, which contains a
preattached dialyzer, and dialysate fluid used in our therapy, sold either in premixed bags or
prepared with our PureFlow SL module. We distribute our products in two markets: the chronic care
market and the critical care market. We define the chronic care market as the market devoted to the
treatment of ESRD patients in the home and the critical care market as the market devoted to the
treatment of hospital-based patients with acute kidney failure or fluid overload. We offer a
different configuration of the System One for each market. The FDA has cleared both configurations
for hemodialysis, hemofiltration and ultrafiltration. Our products may be used by our customers to
treat patients suffering from either condition, although the site of care, the method of delivering
care and the duration of care are sufficiently different that we have separate marketing and sales
efforts dedicated to each market.
We derive our revenues from the sale and rental of equipment and the sale of the related
disposable products. In the critical care market, we generally sell the System One and disposables
to hospital customers. In the chronic care market, customers generally rent the machine and then
purchase the related disposable products based on a specific patient prescription. We generally
recognize revenues when a product has been delivered to our customer, or, in the chronic care
market, on a monthly basis in accordance with a contract under which we supply the use of a cycler
and the amount of disposables needed to perform a set number of dialysis therapy sessions during a
month.
Our contracts with dialysis centers for ESRD patients include terms providing for the sale of
disposable products to accommodate up to 26 treatments per month per patient and the monthly rental
of System One cyclers and, in some instances, our PureFlow SL module. These contracts typically
have a term of one year and are cancelable at any time by the dialysis clinic with 30 days’ notice.
Under these contracts, if home hemodialysis is prescribed, supplies are shipped directly to patient
homes and paid for by the treating dialysis clinic. We also include vacation delivery terms,
providing for the free shipment of products to a designated vacation destination. We derive an
insignificant amount of revenues from the sale of ancillary products, such as extra lengths of
tubing, and from service contracts. Over time, as more chronic patients are treated with the System
One and more systems are placed in patient homes under monthly agreements that provide for the
rental of the machine and the purchase of the related disposables, we expect this recurring revenue
stream to continue to grow.
Cost of Revenues
Cost of revenues consists primarily of direct product costs, including material and labor
required to manufacture our products, depreciation and maintenance of System One cyclers that we
rent to customers, production overhead and the cost of purchasing system components from vendors
which we then sell to our customers. It also includes the cost of inspecting, servicing and
repairing equipment prior to sale or during the warranty period and stock-based
20
compensation. The cost of our products depends on several factors, including the efficiency of
our manufacturing operations, the cost at which we can obtain products from third party suppliers
and the design of the products.
We are currently operating at negative gross profit as we continue to build a base of
recurring revenues. We expect the cost of revenues as a percentage of revenues to decline over time
for two general reasons. First, we anticipate that increased sales volume and realization of
economies of scale will lead to better purchasing terms and prices, and efficiencies in indirect
manufacturing overhead costs. For example, during the nine months ended September 30, 2006, we have
transitioned our purchases of dialysate to a new lower cost vendor. Second, we have plans to
introduce several process and product design changes that have inherently lower cost than our
current products. For example, in July 2006 we commercially released our PureFlow SL module, which
is expected to reduce our cost of revenues and distribution costs by reducing the volume of dialysate fluid
which we currently purchase and ship to customers.
Operating Expenses
Research and Development. Research and development expenses consist primarily of salary,
benefits and stock-based compensation for research and development personnel, supplies, materials
and expenses associated with product design and development, clinical studies, regulatory
submissions, reporting and compliance and expenses incurred for outside consultants or firms who
furnish services related to these activities. We expect limited research and development expense
increases in the foreseeable future as we continue to improve and enhance our core products.
Selling and Marketing. Selling and marketing expenses consist primarily of salary, benefits
and stock-based compensation for sales and marketing personnel, travel, promotional and marketing
materials and other expenses associated with providing clinical training to our customers. Included
in selling and marketing are the costs of clinical educators, usually nurses, we employ to teach
our customers about our products and prepare our customers to instruct their patients in the
operation of the System One. We anticipate that selling and marketing expenses will continue to
increase as we broaden our marketing initiatives to increase public awareness of the System One in
the chronic care market and as we add additional sales and marketing personnel.
Distribution. Distribution expenses include salary, benefits and stock-based compensation for
distribution personnel, the freight cost of delivering our products to our customers or our
customers’ patients, depending on the market and the specific agreement with our customers. We use
common carriers and freight companies to deliver our products and we do not operate our own
delivery service. Also included in this category are the expenses of shipping products from
customers back to our service center for repair if the product is under warranty, and the related
expense of shipping a replacement product 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 the expected customer adoption of our PureFlow SL module, which significantly
reduces the weight and quantity of monthly disposable shipments.
General and Administrative. General and administrative expenses consist primarily of salary,
benefits and stock-based compensation for our executive management, legal and finance and
accounting staff, fees from outside legal counsel, fees for our annual audit and tax services and
general expenses to operate the business, including insurance and other corporate-related expenses.
Rent and utilities are initially included in general and administrative expense and, within the
same reporting period, are allocated to operating expenses based on personnel and square footage
usage. We expect that general and administrative expenses will increase in the near term as we add
additional administrative support for our growing business.
21
Results of Operations
The following table presents, for the periods indicated, information expressed as a percentage
of revenues. This information has been derived from our consolidated statements of operations
included elsewhere in this Quarterly Report on Form 10-Q. You should not draw any conclusions about
our future results from the results of operations for any period.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Revenues |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
Cost of revenues |
|
|
120 |
|
|
|
152 |
|
|
|
130 |
|
|
|
155 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
|
(20 |
) |
|
|
(52 |
) |
|
|
(30 |
) |
|
|
(55 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing |
|
|
66 |
|
|
|
139 |
|
|
|
79 |
|
|
|
127 |
|
Research and development |
|
|
25 |
|
|
|
110 |
|
|
|
35 |
|
|
|
120 |
|
Distribution |
|
|
37 |
|
|
|
42 |
|
|
|
36 |
|
|
|
36 |
|
General and administrative |
|
|
43 |
|
|
|
87 |
|
|
|
48 |
|
|
|
89 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
171 |
|
|
|
378 |
|
|
|
198 |
|
|
|
372 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(191 |
) |
|
|
(430 |
) |
|
|
(228 |
) |
|
|
(427 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
|
19 |
|
|
|
8 |
|
|
|
17 |
|
|
|
7 |
|
Interest expense |
|
|
(2 |
) |
|
|
(18 |
) |
|
|
(6 |
) |
|
|
(15 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17 |
|
|
|
(10 |
) |
|
|
11 |
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(174 |
)% |
|
|
(440 |
)% |
|
|
(217 |
)% |
|
|
(435 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparison of Three and Nine Months Ended September 30, 2006 to Three and Nine Months Ended
September 30, 2005
Revenues
Our revenues for the three and nine months ended September 30, 2006 and 2005 were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Revenues |
|
$ |
5,512 |
|
|
$ |
1,497 |
|
|
$ |
4,015 |
|
|
|
268 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Revenues |
|
$ |
13,459 |
|
|
$ |
3,934 |
|
|
$ |
9,525 |
|
|
|
242 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in revenues for both the three and nine months ended September 30, 2006 as
compared to the same periods in 2005 was attributable to increased sales and rentals of the System
One in both the critical care and chronic care markets, primarily as a result of increased sales
and marketing efforts. Revenues in the chronic care market increased to $3.6 million in the three
months ended September 30, 2006 compared to $0.9 million in the three months ended September 30,
2005, an increase of 318%, while revenues in the critical care market increased 199% to $1.9
million in the three months ended September 30, 2006, compared to $0.6 million in the three months
ended September 30, 2005. Revenues in the chronic care market increased to $8.1 million during the
nine months ended September 30, 2006 compared to $1.8 million during the nine months ended
September 30, 2005, an increase of 342%, while revenues in the critical care market increased 154%
to $5.3 million during the nine months ended September 30, 2006, compared to $2.1 million during
the nine months ended September 30, 2005.
22
Cost of Revenues and Gross Profit (Deficit)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Cost of revenues |
|
$ |
6,620 |
|
|
$ |
2,271 |
|
|
$ |
4,349 |
|
|
|
192 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
$ |
(1,108 |
) |
|
$ |
(774 |
) |
|
$ |
334 |
|
|
|
43 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) percentage |
|
|
(20 |
%) |
|
|
(52 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Cost of revenues |
|
$ |
17,481 |
|
|
$ |
6,114 |
|
|
$ |
11,367 |
|
|
|
186 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
$ |
(4,022 |
) |
|
$ |
(2,180 |
) |
|
$ |
1,842 |
|
|
|
84 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) percentage |
|
|
(30 |
%) |
|
|
(55 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in cost of revenues was attributable primarily to our increased revenues. For the
chronic market, we added 237 net patients during the three months ended September 30, 2006 compared
to 71 during the three months ended September 30, 2005, which contributed to a $3.1 million
increase in cost of revenues. In addition, cost of revenues increased during the three months ended
September 30, 2006 as compared to the three months ended September 30, 2005 because of a larger
employee base to manufacture our products which resulted in additional salaries, health benefits
and payroll taxes of $0.4 million, and increased inbound freight costs of $0.3 million to support
our higher production volume. We added 608 net patients during the nine months ended September 30,
2006 compared to 167 during the nine months ended September 30, 2005, which contributed to a $7.8
million increase in cost of revenues. In addition, cost of revenues increased during the nine
months ended September 30, 2006 as compared to the nine months ended September 30, 2005 because of
the larger employee base which resulted in additional salaries, health benefits and payroll taxes
of $1.1 million, and increased inbound freight costs of $0.8 million to support our higher
production volume. We are currently operating at negative gross profit as we continue to build our
base of recurring revenues. We expect the cost of revenues as a percentage of revenues to decline
over time as increased sales volume and realization of economies of scale should lead to better
purchasing terms and prices, and efficiencies in indirect manufacturing overhead costs, and as we
implement product design changes, such as the new PureFlow SL, which reduce the cost of our product
offerings. Inventory at September 30, 2006 and December 31, 2005 has been appropriately reduced to
net realizable value through charges to cost of revenues.
Selling and Marketing
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Selling and marketing |
|
$ |
3,663 |
|
|
$ |
2,085 |
|
|
$ |
1,578 |
|
|
|
76 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing as a percentage of revenues |
|
|
66 |
% |
|
|
139 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Selling and marketing |
|
$ |
10,614 |
|
|
$ |
4,986 |
|
|
$ |
5,628 |
|
|
|
113 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing as a percentage of revenues |
|
|
79 |
% |
|
|
127 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in selling and marketing expenses was the result of several factors. For the
three months ended September 30, 2006 compared to the same period in 2005, approximately $1.2
million of the increase was due to higher salary and benefits resulting from increased headcount,
$141,000 related to stock-based compensation (no comparable charge in 2005) and $190,000 related to
a higher level of sales and marketing activity in both the
23
chronic and critical care markets. We increased our combined sales force from 15 sales
representatives as of September 30, 2005, to 24 sales representatives as of September 30, 2006. For
the nine months ended September 30, 2006 compared to the same period in 2005, approximately $3.7
million of the increase was due to higher salary and benefits resulting from increased headcount,
$389,000 related to stock-based compensation (no comparable charge in 2005) and $930,000 related to
a higher level of sales and marketing activity in both the chronic and critical care markets. We
anticipate that selling and marketing expenses will continue to increase in absolute dollars as we
broaden our marketing initiatives to increase public awareness of the System One in the chronic
care market and as we add additional sales and marketing personnel.
Research and Development
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Decrease |
|
|
Decrease |
|
| |
|
(In thousands, except percentages) |
|
Research and development |
|
$ |
1,386 |
|
|
$ |
1,649 |
|
|
$ |
(263 |
) |
|
|
(16 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development as a percentage of revenues |
|
|
25 |
% |
|
|
110 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Research and development |
|
$ |
4,741 |
|
|
$ |
4,705 |
|
|
$ |
36 |
|
|
|
— |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development as a percentage of revenues |
|
|
35 |
% |
|
|
120 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in research and development expenses during the three months ended September 30,
2006 compared to the same period in 2005 was attributable to $292,000 in consulting costs relating
to the development of the Pure Flow SL module which we incurred in 2005 that did not recur in 2006,
offset by increased salary, benefits and payroll taxes of $63,000 as a result of increased
headcount and approximately $29,000 of stock-based compensation (no comparable charge in 2005). The
increase in research and development expenses during the nine months ended September 30, 2006
compared to the same period in 2005 was attributable to increased salary, benefits and payroll
taxes of $356,000 as a result of increased headcount, approximately $86,000 of stock-based
compensation (no comparable charge in 2005), offset by a decrease of $344,000 of development costs
associated with our PureFlow SL module which we incurred in 2005 that did not recur in 2006. We
expect limited research and development expense increases in the foreseeable future as a
substantial portion of the development effort on the System One and PureFlow SL has been completed
and future expenditures will be limited to enhancements. We expect research and development
expenses to continue to decline as a percentage of revenues.
Distribution
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Distribution |
|
$ |
2,027 |
|
|
$ |
623 |
|
|
$ |
1,404 |
|
|
|
225 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution as a percentage of revenues |
|
|
37 |
% |
|
|
42 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
Distribution |
|
$ |
4,836 |
|
|
$ |
1,409 |
|
|
$ |
3,427 |
|
|
|
243 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution as a percentage of revenues |
|
|
36 |
% |
|
|
36 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in distribution expenses for the three and nine month periods ended September 30,
2006 compared to the same period in 2005 was due to increased volume of shipments of disposable
products to a growing number of patients in the chronic care market. We expect that distribution
expenses will increase at a lower rate than revenues during the remainder of 2006 due to expected
shipping efficiencies gained from increased business volume and density of customers, the reduction
of higher cost deliveries associated with bagged fluid due to the commercial
24
launch of our PureFlow SL module which began in July 2006 and the recent contracting of an
outsourced logistics provider located in the central part of the continental United States.
General and Administrative
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
General and administrative |
|
$ |
2,368 |
|
|
$ |
1,298 |
|
|
$ |
1,070 |
|
|
|
82 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative as a percentage of revenues |
|
|
43 |
% |
|
|
87 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
September 30, |
|
|
|
|
|
|
Percentage |
|
| |
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
| |
|
(In thousands, except percentages) |
|
General and administrative |
|
$ |
6,491 |
|
|
$ |
3,501 |
|
|
$ |
2,990 |
|
|
|
85 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative as a percentage of revenues |
|
|
48 |
% |
|
|
89 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in general and administrative expenses during the three months ended September
30, 2006 compared to the same period in 2005 was primarily due to approximately $582,000 of
stock-based compensation recorded in the three months ended September 30, 2006 (no comparable
charge in 2005), and approximately $501,000 of legal and administrative expenses incurred as a
result of operating as a public company. The increase in general and administrative expenses during
the nine months ended September 30, 2006 compared to the same period in 2005 was primarily due to
approximately $1.5 million of stock-based compensation recorded in the nine months ended September
30, 2006 (no comparable charge in 2005), and approximately $1.2 million of legal and administrative
expenses incurred as a result of operating as a public company. We expect that general and
administrative expenses will continue to increase in the near term as we add support structure for
our growing business and as a result of costs related to operating a public company.
Interest Income and Interest Expense
Interest income is derived primarily from U.S. government securities, certificates of deposit,
commercial paper and money market accounts. For the three and nine months ended September 30, 2006,
interest income increased by $1.0 million and $2.0 million, respectively, due to increased cash and
investment balances resulting from our initial public offering and follow-on public offering and
higher interest rates.
Interest expense decreased during the three months ended September 30, 2006 compared to the
same period in 2005 because of comparatively less debt outstanding during this period due to the
early payoff of a debt arrangement that we made in the second quarter of 2006. Interest expense
increased during the nine months ended September 30, 2006 compared to the same period in 2005 due
to the early payoff of a debt agreement, which resulted in the early recognition of approximately
$434,000 of interest expense during the three months ended June 30, 2006. We expect interest
expense will continue to increase in the future as a result of $8.4 million of gross borrowings
from our equipment line of credit.
Liquidity and Capital Resources
We have operated at a loss since our inception in 1998. As of September 30, 2006, our
accumulated deficit was $(113.2) million and we had cash, cash equivalents and short-term
investments of approximately $77.9 million. On June 14, 2006, we closed a follow-on public offering
in which we received net proceeds, after deducting underwriting discounts, commissions and
expenses, of approximately $51.3 million from the sale and issuance of 6,325,000 shares of common
stock. On November 1, 2005, we closed our initial public offering in which we received net
proceeds, after deducting underwriting discounts, commissions and expenses, of approximately $56.5
million from the sale and issuance of 6,325,000 shares of common stock. Prior to the initial public
offering, we had financed our operations primarily through private sales of redeemable convertible
preferred stock resulting in aggregate net proceeds of approximately $91.9 million as of December
31, 2005.
25
On May 15, 2006, we entered into an equipment line of credit agreement for the purpose of
financing field equipment purchases and placements. The line of credit agreement provides for the
availability of up to $20.0 million through December 31, 2007, and borrowings bear interest at the
prime rate plus 0.5% (8.75% as of September 30, 2006). Under the line of credit agreement, $10.0
million is available through December 31, 2006 and a further $10.0 million is available from
January 1, 2007 through December 31, 2007. The availability of the line of credit is subject to a
number of covenants, including maintaining certain levels of liquidity, adding specified numbers of
patients and operating within net loss parameters. We are also required to maintain operating
and/or investment accounts with the lender in an amount at least equal to the outstanding debt
obligation. Borrowings are secured by all of our assets other than intellectual property and are
payable ratably over a three-year period from the date of each borrowing. As of September 30, 2006,
we had outstanding borrowings of $8.4 million under the equipment line of credit. As of September
30, 2006, we had $1.6 million of borrowing availability under the equipment line of credit.
The following table sets forth the components of our cash flows for the periods indicated (in
thousands):
| |
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
| |
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
Net cash used in operating activities |
|
$ |
(38,910 |
) |
|
$ |
(18,190 |
) |
Net cash used in investing activities |
|
|
(1,854 |
) |
|
|
(584 |
) |
Net cash provided by financing activities |
|
|
57,313 |
|
|
|
13,274 |
|
Effect of exchange rate changes on cash |
|
|
104 |
|
|
|
(89 |
) |
|
|
|
|
|
|
|
Net cash flow |
|
$ |
16,653 |
|
|
$ |
(5,589 |
) |
|
|
|
|
|
|
|
Net Cash Used in Operating Activities. For each of the periods above, net cash used in
operating activities was attributable primarily to net losses after adjustment for non-cash
charges, such as depreciation, amortization and stock-based compensation expense. Significant uses
of cash from operations include increases in accounts receivable and increased inventory
requirements for production and placements of the System One, offset by increases in accounts
payable and accrued expenses. Non-cash transfers from inventory to field equipment for the
placement of rental units with our customers represented $12.2 million and $2.7 million,
respectively, during the nine months ended September 30, 2006 and 2005.
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 research and
development, information technology, manufacturing operations and capital improvements to our
facilities. Excluded from these figures is the purchase of $31.8 million of short-term investments
during the nine months ended September 30, 2006 and the sale of marketable securities in the amount
of $12.5 million during the nine months ended September 30, 2005.
Net Cash Provided By Financing Activities. Net cash provided by financing activities during
the nine months ended September 30, 2006 included $51.3 million of net proceeds received from the
follow-on public offering that closed in June 2006, $1.3 million of proceeds from the exercise of
stock options and warrants and net borrowings of $4.7 million. Net cash provided by financing
activities during the nine months ended September 30, 2005 included $16.0 million of net proceeds
received from the issuance of redeemable convertible preferred stock, offset by net debt repayments
of $1.1 million and $1.6 million for the cost of our initial public offering, which was completed
on November 1, 2005.
We expect to continue to incur net losses for the foreseeable future. We believe we have
sufficient cash and availability under our equipment line of credit to meet our funding
requirements at least through 2007. We expect to be able to extend the availability of our cash
resources through the sale rather than rental of our System One cyclers to chronic customers in the
future. If our existing resources are insufficient to satisfy our liquidity requirements, we may
need to sell additional equity or issue debt securities. Any sale of additional equity or issuance
of debt securities may result in dilution to our stockholders, and we cannot be certain that
additional public or private financing will be available in amounts or on terms acceptable to us,
or at all. If we are unable to obtain this additional financing when needed, we may be required to
delay, reduce the scope of, or eliminate one or more aspects of our business development
activities, which could harm the growth of our business.
26
The following table summarizes our contractual commitments as of September 30, 2006
(unaudited) and the effect those commitments are expected to have on liquidity and cash flow in
future periods:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Payments Due by Period |
|
|
|
|
| |
|
|
|
|
|
Less Than |
|
|
|
|
|
|
|
|
|
|
More Than |
|
| |
|
Total |
|
|
One Year |
|
|
1-3 Years |
|
|
3-5 Years |
|
|
5 Years |
|
| |
|
(In thousands) |
|
|
|
|
|
Equipment line of credit |
|
$ |
8,117 |
|
|
$ |
2,800 |
|
|
$ |
5,317 |
|
|
$ |
— |
|
|
$ |
— |
|
Operating leases |
|
|
3,145 |
|
|
|
496 |
|
|
|
1,068 |
|
|
|
1,109 |
|
|
|
472 |
|
Purchase obligations(1) |
|
|
33,164 |
|
|
|
28,620 |
|
|
|
2,200 |
|
|
|
2,344 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
44,426 |
|
|
$ |
31,916 |
|
|
$ |
8,585 |
|
|
$ |
3,453 |
|
|
$ |
472 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Purchase obligations include purchase commitments for System One components, primarily for
equipment and fluids pursuant to contractual agreements with several of our suppliers. Certain
of these commitments may be extended and/or canceled at the Company’s 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.
A summary of those accounting policies and estimates that we believe are most critical to
fully understanding and evaluating our financial results is set forth below. This summary should be
read in conjunction with our consolidated financial statements and the related notes included in
our 2005 Annual Report on Form 10-K.
Revenue Recognition
We recognize revenues from product sales and services when earned in accordance with Staff
Accounting Bulletin, or SAB, No. 104, Revenue Recognition, and Emerging Issues Task Force, or EITF,
00-21, Revenue Arrangements with Multiple Deliverables. 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. In the critical care market, sales are structured as direct product sales or
as a disposables-based program in which a customer acquires the equipment through the purchase of a
specific quantity of disposables over a specific period of time. During the reported periods, the
majority of our critical care revenues were derived from direct product sales. In the chronic care
market, revenues are realized using short-term rental arrangements.
In the critical care market, we recognize revenues from direct product sales at the later of
the time of shipment or, if applicable, delivery in accordance with contract terms. For the chronic
care market we recognize revenues derived from short-term rental arrangements on a straight-line
basis. These rental arrangements, which combine the use of a system with a specified number of
disposable products supplied to customers for a fixed amount per month, are recognized on a monthly
basis in accordance with agreed upon contract terms and pursuant to a binding customer purchase
order and fixed payment terms.
Under a disposables-based program, the customer is granted the right to use the equipment for
a period of time, during which the customer commits to purchase a minimum number of disposable
cartridges or fluids at a price that includes a premium above the otherwise average selling price
of the cartridges or fluids to recover the cost of the equipment and provide for a profit. Upon
reaching the contractual minimum purchases, ownership of the equipment transfers to the customer.
Revenues under these arrangements are recognized over the term of the arrangement as disposables
are delivered.
27
When we enter into a multiple-element arrangement, we allocate the total revenue to all
elements of the arrangement based on their respective fair values. Fair value is determined by the
price charged when each element is sold separately. Our most common multiple-element arrangements
are products sold under a disposables-based program in the critical care market as described above.
We account for the disposables-based program as a single economic transaction and have determined
that we do not have a basis to separate the transaction into multiple elements to recognize revenue
at the time of shipment of each element. Rather, we recognize revenue related to all elements over
the term of the arrangement as the disposables are delivered.
Our contracts provide for training, technical support and 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 revenue is recognized ratably over the warranty period.
Inventory Valuation
Inventories are valued at the lower of cost (weighted-average) or estimated market. We
regularly review our inventory quantities on hand and related cost and record a provision for
excess or obsolete inventory primarily based on an estimated forecast of product demand for each of
our existing product configurations. We also review our inventory value to determine if it reflects
lower of cost or market, with market determined based on net realizable value. Appropriate
consideration is given to inventory items sold at negative gross margins and other factors in
evaluating net realizable value. The medical device industry is characterized by rapid development
and technological advances that could result in obsolescence of inventory.
Field Equipment
We amortize field equipment using the straight-line method over an estimated useful life of
five years. We review the estimated useful life of five years periodically for reasonableness.
Factors considered in determining the reasonableness of the useful life include industry practice
and the typical amortization periods used for like equipment, the frequency and scope of service
returns, actual equipment disposal rates, and the impact of planned design improvements. We believe
the five-year useful life is appropriate as of September 30, 2006.
Accounting for Stock-Based Awards
Until December 31, 2005, we accounted for stock-based employee compensation in accordance with
Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees”,
and related interpretations. Accordingly, compensation expense was recorded for stock options
awarded to employees and directors to the extent that the option exercise price was less than the
fair market value of our common stock on the date of grant, where the number of shares and exercise
price were fixed. The difference between the fair value of our common stock and the exercise price
of the stock option, if any, was recorded as deferred compensation and was amortized to
compensation expense over the vesting period of the underlying stock option. Prior to becoming a
public company on October 27, 2005, there had been no public market for our common stock. Absent an
objective measure of the fair value of our common stock, the determination of fair value required
judgment. Our board of directors (the “Board”) periodically estimated the fair value of our common
stock in connection with any issuance of stock options. The fair value of our common stock was
estimated based on factors such as independent valuations, sales of preferred stock, the
liquidation preference, dividends, voting rights of the various classes of stock, our financial and
operating performance, progress on development goals, the issuance of patents, the value of other
companies involved in dialysis, general economic and market conditions and other factors that we
believed would reasonably have a significant bearing on the value of our common stock.
Prior to January 1, 2006, we followed the disclosure requirements of Statement of Financial
Accounting Standard, or SFAS No. 123, “Accounting for Stock-Based Compensation” for stock-based
awards to employees. All stock-based awards to non-employees were accounted for at their fair value
in accordance with SFAS No. 123 and related interpretations. For purposes of the pro forma
disclosures required by SFAS No. 123, stock options granted subsequent to July 19, 2005, the date
of filing our initial registration statement with the SEC, were valued using the Black-Scholes
option-pricing model. Prior to July 19, 2005, we used the minimum value method permitted under SFAS
No. 123.
28
We adopted SFAS No. 123R, “Share-Based Payment”, on January 1, 2006. SFAS 123R requires all
share-based payments to employees, including grants of employee stock options, to be recognized in
the statement of operations based on their fair values. In addition, SFAS 123R requires the use of
the prospective method for any outstanding stock options that were previously valued using the
minimum value method. Accordingly, with the adoption of SFAS 123R, we did not recognize the
remaining compensation cost for any stock option awards which had previously been valued using the
minimum value method. In addition, SFAS 123R prohibits the use of pro forma disclosures for stock
option awards valued under the minimum value method (i.e., our pre-July 19, 2005 stock option
awards). Stock option awards granted prior to July 19, 2005, the date on which we filed our
preliminary prospectus with the SEC, that are subsequently modified, repurchased or cancelled after
January 1, 2006 shall be subject to the provisions of SFAS 123R.
We use the modified prospective method under SFAS 123R for any stock options granted after
July 19, 2005. The aggregate value of the unvested portion of stock options issued between July 19,
2005 and December 31, 2005 totaled $4.4 million as of December 31, 2005, net of estimated
forfeitures. Beginning in 2006, this aggregate value will be recognized as compensation expense in
our consolidated statement of operations ratably over the remaining vesting period.
As a result of adopting SFAS 123R on January 1, 2006, our net loss for the three and nine
months ended September 30, 2006 was $668,668 and $1,810,123 higher, respectively, than if we had
continued to account for the share-based compensation under APB No. 25. Basic and diluted loss per
share for the three and nine months ended September 30, 2006 was $0.02 and $0.08 higher,
respectively, than if we had continued to account for share-based compensation under APB No. 25.
Management continues to evaluate the use of stock-based equity awards and may consider other forms
of equity-based compensation arrangements (such as restricted stock units), or reduce the volume of
stock option award grants in the future.
Prospectively, we use the Black-Scholes option-pricing model to estimate the fair value of
equity-based compensation awards on the dates of grant. In accordance with SAB 107, based upon our
stage of development and the short period of time that our common stock has been publicly traded on
the NASDAQ Global Market, we have used the following assumptions in the Black-Scholes
option-pricing model to estimate the fair value of equity-based compensation awards:
Expected Term – the expected term has been determined using the simplified method for estimating
expected option life of “plain-vanilla” options. Unless otherwise determined by the Board or the
Compensation Committee, stock options granted under the 2005 Stock Incentive Plan have a
contractual term of seven years, resulting in an expected term of 4.75 years calculated under
the simplified method.
Risk-Free Interest Rate – the risk-free interest rate for each grant is equal to the U.S.
Treasury rate in effect at the time of grant for instruments with an expected life similar to
the expected option term.
Volatility – the objective in estimating expected volatility is to ascertain the assumption
about expected volatility that marketplace participants would likely use in determining an
exchange price for an option. Because we have no options that are traded publicly and because of
our limited trading history as a public company, our volatility assumption has been based upon
an analysis of the trading of similar companies in the medical device and technology industries,
consistent with the methodology used in 2005. We may change our volatility assumption in the
future once we have a sufficient amount of historical information regarding the volatility of
our share price. For the three and nine months ended September 30, 2006, we have used a
volatility rate assumption of 85% for stock option grants. We expect to use a volatility rate
assumption of 85% for stock options granted during the remainder of 2006.
We have also estimated expected forfeitures of stock options upon adoption of SFAS 123R. In
developing a forfeiture rate estimate, we have considered our historical experience, our growing
employee base and the limited liquidity of our common stock. Actual forfeiture activity may differ
from our estimated forfeiture rate.
29
Accounting for Income Taxes
We account for federal and state income taxes in accordance with SFAS No. 109, “Accounting for
Income Taxes.” Under the liability method specified by SFAS No. 109, a deferred tax asset or
liability is determined based on the difference between the financial statement and tax basis of
assets and liabilities, as measured by the enacted tax rates. Due to uncertainty surrounding the
realization of deferred tax assets through future taxable income, we have provided a full valuation
allowance and no benefit has been recognized for the net operating loss and other deferred tax
assets. Accordingly, a valuation allowance for the full amount of the deferred tax asset has been
established as of September 30, 2006 and December 31, 2005 to reflect these uncertainties.
Related-Party Transactions
Medisystems Corporation is our primary supplier of completed cartridges, tubing and certain
other components used in the System One disposable cartridge. The chief executive officer and
significant stockholder of Medisystems is a member of our board of directors and owns approximately
7.2% of our outstanding common stock as of September 30, 2006. We purchased approximately $1.5
million and $313,000 of products from Medisystems during the three months ended September 30, 2006 and
2005, respectively, and approximately $2.6 million and $641,000 during the nine months ended
September 30, 2006 and 2005, respectively. As of September 30, 2006, we have commitments to
purchase approximately $1.6 million of products from Medisystems. We do not have a long-term supply
agreement with Medisystems, and we purchase products from Medisystems through purchase orders. We
are currently negotiating a long-term supply agreement with Medisystems covering components,
subassemblies and completed cartridges, although we cannot be certain that we will enter into an
agreement with Medisystems. We believe that our purchases from Medisystems have been on terms no
less favorable to us than could be obtained from unaffiliated third parties or through internal
operations.
Off-Balance Sheet Arrangements
Since inception we have not engaged in any off-balance sheet financing activities except for
leases which are properly classified as operating leases and disclosed in the “Liquidity and
Capital Resources” section above.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No.
(“FIN”) 48, “Accounting for Uncertainty in Income Taxes”, which clarifies the accounting for
uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB
Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods, disclosure
and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are
currently in a loss position and do not pay income taxes; therefore the adoption of FIN 48 is not
expected to have a significant impact on our 2006 financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which addresses
the measurement of “fair value” where such measure is required for recognition or disclosure
purposes under GAAP. Among other provisions, SFAS No. 157 includes (1) a new definition of fair
value, (2) a fair value hierarchy used to classify the source of information used in fair value
measurements, (3) new disclosure requirements of assets and liabilities measured at fair value
based on their level in the hierarchy, and (4) a modification of the accounting presumption that
the transaction price of an asset or liability equals its initial fair value. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007 (i.e., beginning in 2008 for NxStage).
We are currently evaluating whether SFAS No. 157 will have an impact on our consolidated financial
statements.
30
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the three and nine months ended September 30, 2006, there were no material changes in
our market risk exposure. For quantitative and qualitative disclosures about market risk affecting
NxStage, 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, 2005. As of the date of this report,
there have been no material changes to the market risks described in our Annual Report on Form 10-K
for December 31, 2005.
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,
2006. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e)
under 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 SEC’s 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 company’s 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, 2006, our chief
executive officer and chief financial officer concluded that, as of such date, our disclosure
controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rule 13a-15(f) and
15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended September 30,
2006 that has materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
The
Company is required as of December 31, 2006 to be in compliance with Section 404 of the
Sarbanes-Oxley Act with respect to the design and operational effectiveness of its internal
accounting controls. The Company is in the process of documenting, testing and evaluating its
system of internal controls subject to Section 404. Although there can be no assurance that the
Company will be in compliance therewith, the Company has no reason to believe that it will not be
in compliance.
31
PART II – OTHER INFORMATION
Item 1A. Risk Factors
In addition to the factors discussed in “Management’s 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 substantially all of our future revenues from the rental or sale of our System
One and the sale of our related disposable products used with the System One.
Since our inception, we have devoted substantially all 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. We expect that the
rental or sale of the System One and the sale of related products will account for substantially
all of our revenues for the foreseeable future. Most of our related products cannot be used with
any other dialysis systems and, therefore, we will derive little or no revenues from related
products unless we sell or otherwise place the System One. To the extent that the System One is not
a successful product or is withdrawn from the market for any reason, we do not have other products
in development that could replace revenues from the System One.
We cannot accurately predict the size of the home hemodialysis market, and it may be smaller or
slower to develop than we expect.
Although home hemodialysis treatment options are available, adoption 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, the number of patients receiving peritoneal dialysis was approximately 26,000 in
2003, representing approximately 8% of all patients receiving dialysis treatment for ESRD in the
United States. Very few ESRD patients receive hemodialysis treatment outside of the clinic setting;
USRDS data indicates approximately 1,300 patients were receiving home-based hemodialysis in 2003.
Because the adoption of home hemodialysis has been limited to date, the number of patients who
desire to, and are capable of, administering their own hemodialysis treatment with a system such as
the System One is unknown and there is limited data upon which to make estimates. Our long-term
growth will depend on the number of patients who adopt home-based hemodialysis and how quickly they
adopt it, and we do not know whether the number of home-based dialysis patients will be greater or
fewer than the number of patients performing peritoneal dialysis. We received our home use
clearance for the System One from the FDA in June 2005 and we will need to devote significant
resources to developing the market. We cannot be certain that this market will develop, how quickly
it will develop or how large it will be.
We will require significant capital to build our business, and financing may not be available to us
on reasonable terms, if at all.
We believe that the chronic care market is the largest market opportunity for our System One
hemodialysis system. We typically bill the dialysis clinic for the rental of the equipment and the
sale of the related disposable cartridges and treatment fluids. As a result, we expect that we will
generate revenues and cash flow from the use of the System One over time rather than upfront from
the sale of the System One equipment, and we will need significant amounts of working capital to
manufacture System One equipment for rental to dialysis clinics.
We only recently began marketing our System One to dialysis clinics for the treatment of ESRD,
and we have not achieved widespread market acceptance of our product. We may not be able to
generate sufficient cash flow to meet our capital needs. If our existing resources are insufficient
to satisfy our liquidity requirements, we may need to sell additional equity or issue debt
securities. Any sale of additional equity or issuance of debt securities may result in dilution to
our stockholders, and we cannot be certain that additional public or private financing will be
32
available in amounts or on terms acceptable to us, or at all. If we are unable to obtain this
additional financing when needed, we may be required to delay, reduce the scope of, or eliminate
one or more aspects of our business development activities, which could harm the growth of our
business.
We have limited operating experience, a history of net losses and an accumulated deficit of
($113.2) million at September 30, 2006. We cannot guarantee if, when and the extent that we will
become profitable, or that we will be able to maintain profitability once it is achieved.
Since inception, we have incurred losses every quarter and at September 30, 2006, we had an
accumulated deficit of approximately $(113.2) million. We expect to incur increasing operating
expenses as we continue to grow our business. Additionally, in the chronic care market, the cost of
manufacturing the System One and related disposables currently exceeds the market price. We cannot
provide assurance that we will be able to lower the cost of manufacturing the System One and
related disposables below the current chronic care market price, 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 ability to become profitable is dependent in part
upon achieving a sufficient scale of operations, obtaining better purchasing terms and prices,
achieving efficiencies in manufacturing overhead costs, implementing design and process
improvements to lower our costs of manufacturing our products and achieving efficient distribution
of our products.
In March 2006 we received clearance from the FDA to market our PureFlow SL module as an
alternative to the bagged fluid presently used with our System One in the chronic care market. This
accessory to the System One allows for the automated preparation of high purity dialysate in the
patient’s home using ordinary tap water and dialysate concentrate. The PureFlow SL is designed to
help patients with ESRD more conveniently and effectively manage their home hemodialysis therapy by
eliminating the need for bagged fluids. In July 2006, we released the PureFlow SL for commercial
use and began shipping the PureFlow SL product. We have implemented a controlled release of the
product in the chronic market and have made several improvements to the product based upon early
customer feedback. Any delay in the launch of the PureFlow SL module, or any failure to gain rapid
market acceptance of the PureFlow SL module, including converting our installed base of patients
currently using bagged fluid, could adversely affect our ability to achieve profitability.
We compete against other dialysis equipment manufacturers with much greater financial resources and
better established products and customer relationships, which may make it difficult for us to
penetrate the market and achieve significant sales of our products.
Our System One competes directly against equipment produced by Fresenius Medical Care AG,
Baxter Healthcare, Gambro AB, B. Braun and others, each of which markets one or more FDA-cleared
medical devices for the treatment of acute or chronic kidney failure.
To date, only one other company has a hemodialysis product specifically cleared for home use,
Aksys, Ltd. Products sold by the other competitors have also been used in the home, in particular
Fresenius Systems. Each of these competitors offers products that have been in use for a longer
time than our products 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, in the case of Fresenius, own and operate a chain of dialysis clinics. Gambro has a
long term supply agreement with DaVita for a significant majority of DaVita’s dialysis product
supply needs. Most of these companies manufacture additional complementary products enabling them
to offer a bundle of products and have established sales forces and distribution channels that may
afford them a significant competitive advantage. Finally, one of our competitors, Gambro AB, is
subject to an import hold imposed by the FDA. It is not clear what the market impact will be when
the import hold is lifted.
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
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
33
products demonstrate better safety, convenience or effectiveness or are offered at lower
prices than our System One. 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 success will depend on our ability to achieve market acceptance of our System One.
Our products have limited product and brand recognition and have only been used at a limited
number of dialysis clinics and hospitals. In the chronic care market, we will have to convince four
distinct constituencies involved in the choice of dialysis therapy, namely operators of dialysis
clinics, nephrologists, dialysis nurses and patients, that our system provides an effective
alternative to other existing dialysis equipment. Each of these constituencies will use 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 the System One for a number of reasons including:
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the failure by us to demonstrate to patients, operators of dialysis clinics,
nephrologists, dialysis nurses and others that our product is equivalent or superior to
existing therapy options or, that the cost or risk associated with use of our product is
not greater than available alternatives; |
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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 dialysis clinics; |
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the ownership and operation of some dialysis providers by companies that also
manufacture and sell competitive dialysis products; |
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the introduction of competing products or treatments that may be more effective,
safer, easier to use or less expensive than ours; |
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the number of patients willing and able to perform therapy independently, outside
of a traditional dialysis clinic, may be smaller than we estimate; and |
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the continued availability of satisfactory reimbursement from healthcare payors,
including Medicare. |
Current Medicare reimbursement rates limit the price at which we can market the System One, and
adverse changes to reimbursement could affect the adoption of the System One.
Our ability to attain profitability will be driven in part by our ability to set or maintain
adequate pricing for our System One. As a result of legislation passed by the U.S. Congress more
than 30 years ago, Medicare provides comprehensive and well-established reimbursement in the United
States for ESRD. With over 80% of U.S. ESRD patients covered by Medicare, the reimbursement rate is
an important factor in a potential customer’s decision to use the System One and limits the fee for
which we can rent the System One and sell the related disposable cartridges and treatment fluids.
Current CMS rules limit the number of hemodialysis treatments paid for by Medicare to three times a
week, unless there is medical justification 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 may be slowed. Changes in Medicare reimbursement rates could negatively affect
demand for our products and the prices we charge for them.
As we continue to commercialize the System One and related products, we may have difficulty
managing our growth and expanding our operations successfully.
As the commercial launch of the System One continues, we will need to expand our regulatory,
manufacturing, 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
34
requires us to continue to improve our operational, financial and management controls and
reporting systems and procedures. Such growth could place a strain on our administrative and
operational infrastructure. We may not be able to make improvements to our management information
and control systems in an efficient or timely manner and may discover deficiencies in existing
systems and controls.
The two largest dialysis clinic chains in the United States are affiliated with, or have
contractual arrangements with, other dialysis equipment manufacturers, which may present a barrier
to adoption of the System One at these chains.
Fresenius and DaVita own and operate the two largest chains of dialysis clinics in the United
States. Fresenius controls approximately 33% of the U.S. dialysis clinics and is the largest
worldwide manufacturer of dialysis systems. DaVita controls approximately 27% of the U.S. dialysis
clinics, and has entered into a preferred supplier agreement with Gambro pursuant to which Gambro
will provide a significant majority of DaVita’s dialysis equipment and supplies for a period of at
least 10 years. Each of Fresenius and DaVita may choose to offer their dialysis patients only the
dialysis equipment manufactured by them or their affiliates, to offer the equipment they
contractually agreed to offer or to otherwise limit access to the equipment manufactured by
competitors. We are presently renting the System One to several DaVita dialysis clinics under a
two-year contract with DaVita that expires on March 16, 2007. We cannot provide assurance that
DaVita will elect to extend this contract or that we will be able to reach mutually agreeable terms
on any contract extension. Revenues from DaVita clinics represented 20% and 18% of our revenues
during the three and nine months ended September 30, 2006, respectively. We cannot be sure that
DaVita will continue to rent the System One from us or that any future decision by DaVita to stop
or limit the use of the System One would not adversely affect our business.
If kidney transplantation becomes a viable treatment option for more patients with ESRD, the market
for our System One 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 the most recent USRDS data, in 2003 approximately 16,000 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 System One.
If we are unable to convince hospitals and healthcare providers of the benefits of our products for
the treatment of acute kidney failure and fluid overload, we may not be successful in penetrating
the critical care market.
We sell the System One 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 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 and ease of operation.
We are subject to the risk of costly and damaging product liability claims and may not be able to
maintain sufficient product liability insurance to cover claims against us.
If our System One 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. As is the case with a number of other
medical device companies, it is likely that product liability claims will be brought against us.
Since their introduction into the market, our products have been subject to two voluntary recalls
and one voluntary product withdrawal. Our first voluntary recall occurred in February 2001 in
Canada and related to a software glitch that we detected in our predecessor system, which could
have increased the likelihood of a clotted filter during treatment. There were no patient injuries
associated with this recall, and the
35
software glitch was remedied with a subsequent software release. The second voluntary recall
occurred in April 2004 in the United States relating to pinhole-sized dialysate leaks in our
cartridge. The leaks were readily observable and required a cartridge replacement to continue
treatment. There were no patient injuries associated with this recall; we subsequently switched
suppliers and instituted additional testing requirements to minimize the chance for pinhole-sized
leaks in our cartridges. The voluntary market withdrawal occurred in the United States in May 2002
when we suspended sales of our predecessor system while we addressed issues involving limited
instances of contaminated hemofiltration fluids compounded by a pharmacy and supplied by a
third-party. Six patients exposed to contaminated fluids reported fevers and/or chills, with no
lasting clinical effect. We subsequently modified our cartridge to allow for an additional filter
to remove contaminants from fluids used with our product. Our products may be subject to further
recalls or withdrawals, which could increase the likelihood of product liability claims. We have
also received several reports of operator error from both patients in the home hemodialysis setting
and nurses in the critical care setting. We have sought to address many potential sources of
operator error with product design changes to simplify the operator process. In addition, we have
made improvements in our training materials and product labeling. However, instances of operator
error cannot be eliminated and could also increase the likelihood of product liability claims.
Although we maintain insurance, including product liability insurance, we cannot provide
assurance that any claim that may be brought against us will not result in court judgments or
settlements in amounts that are in excess of the limits of our insurance coverage. Our insurance
policies also have various exclusions, and we may be subject to a product 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.
Any product liability claim brought against us, with or without merit, could result in the
increase of our product liability insurance rates 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 have had limited sales, marketing, customer service and distribution experience. We need to
expand our sales and marketing, customer service and distribution infrastructures to be successful
in penetrating the dialysis market.
We currently market and sell the System One through our own sales force, and we have had
limited experience in sales, marketing and distribution of dialysis products. As of September 30,
2006, we had 79 employees in our sales, marketing and distribution organization, including 24
direct sales representatives. We plan to expand our sales, marketing, customer service and
distribution infrastructures as we continue to grow. We cannot provide assurance that we will be
able to retain or attract experienced personnel and build an adequate sales and marketing, customer
service and distribution staff or that the cost will not be prohibitive.
We face risks associated with having international manufacturing operations, and if we are unable
to manage these risks effectively, our business could suffer.
In addition to our operations in Lawrence, Massachusetts, we operate a filter manufacturing
facility in Rosdorf, Germany and we purchase components 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.
These risks include fluctuations in foreign currency exchange rates that may increase the U.S.
dollar cost of the disposables we purchase from foreign third-party suppliers, costs associated
with sourcing and shipping goods internationally, difficulty managing operations in multiple
locations and local regulations that may restrict or impair our ability to conduct our operations.
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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 System One and related products, including the disposables required for its use, are all
medical devices subject to extensive regulation in the United States, and in foreign markets we may
wish to enter. To market a medical device 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 clearances 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 for the System One. We cannot
provide assurance that such clearances or approvals would be forthcoming, or, if forthcoming, what
the timing and expense of obtaining such clearances or approvals might be. 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.
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 the System One 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 FDA’s 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
501(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 FDA 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
FDA’s rules on labeling and promotion. Our failure to comply with these or other applicable
regulatory requirements could result in enforcement action by the FDA, which may include any of the
following:
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untitled letters, warning letters, fines, injunctions and civil penalties; |
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administrative detention, which is the detention by the FDA of medical devices
believed to be adulterated or misbranded; |
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customer notification, or orders for repair, replacement or refund;
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voluntary or mandatory recall or seizure
of our products; |
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operating restrictions, partial suspension or total shutdown of production; |
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refusal to review pre-market notification or pre-market approval submissions; |
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rescission of a substantial equivalence order or suspension or withdrawal of a
pre-market approval; and |
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criminal prosecution. |
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.
Complex medical devices, such as the System One, 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. A recall involving the System One could be
particularly harmful to our business and financial results, because the System One is our only
product.
If we or our contract manufacturers fail to comply with FDA’s 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 FDA’s 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. Our U.S.
manufacturing facility has previously had three FDA QSR inspections. The first resulted in one
observation, which was rectified during the inspection and required no further response from us.
Our last two inspections, including our most recent inspection in March 2006, resulted in no
observations. We cannot provide assurance that any 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, 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.
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Changes in reimbursement for treatment for ESRD could affect the adoption of our System One and the
level of our future product revenues.
In the United States, all patients who suffer from ESRD, regardless of age, are eligible for
coverage under Medicare, after a requisite coordination period if other insurance is available. As
a result, more than 80% of patients with ESRD are covered by Medicare. Although we rent and sell
our products to hospitals, dialysis centers and other healthcare providers and not directly to
patients, the reimbursement rate for ESRD treatments is an important factor in a potential
customer’s decision to purchase the System One. The dialysis centers that purchase our product rely
on adequate third-party payor coverage and reimbursement to maintain their ESRD facilities. There
is some regional variation in the composite rate for dialysis services, but the national average
rate is currently approximately $149 per treatment for independent clinics and $154 per treatment
for hospital-based dialysis facilities, which is intended to cover most items and services related
to the treatment of ESRD, but does not include payment for physician services or separately
billable laboratory services or drugs. Changes in Medicare reimbursement rates could negatively
affect demand for our products and the prices we charge for them.
Most ESRD patients who use our product for dialysis therapy in the home treat themselves six
times per week. CMS rules, however, limit the number of hemodialysis treatments paid for by
Medicare to three a week, unless there is medical justification for the additional treatments. The
determination of medical justification must be made at the local Medicare contractor level on a
case-by-case basis. If daily therapy is prescribed, a clinic’s 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 clinic’s patients.
Unlike Medicare reimbursement for ESRD, Medicare only reimburses healthcare providers for
acute kidney failure and fluid overload treatment if the patient is otherwise eligible for
Medicare, based on age or disability. Medicare and many other third party payors and private
insurers reimburse these treatments provided to hospital inpatients under a traditional diagnosis
related group, or DRG, system. Under this system, reimbursement is determined based on a patient’s
primary diagnosis and is intended to cover all costs of treating the patient. The presence of acute
kidney failure or fluid overload increases the severity of the primary diagnosis and, accordingly,
may increase the amount reimbursed. For care of these patients to be cost-effective, hospitals must
manage the longer hospitalization stays and significantly more nursing time typically necessary for
patients with acute kidney failure and fluid overload. If we are unable to convince hospitals that
our System One provides a cost-effective treatment alternative under this diagnosis related group
reimbursement system, they may not purchase our product.
Legislative or regulatory reform of the healthcare system may affect our ability to sell our
products profitably.
In both the United States and foreign countries, there have been legislative and regulatory
proposals to change the healthcare system in ways that could affect our ability to sell our
products profitably. The federal government and some states have enacted healthcare reform
legislation, and further federal and state proposals are likely. We cannot predict the exact form
this legislation may take, the probability of passage, or the ultimate effect on us. Our business
could be adversely affected by future healthcare reforms or changes in Medicare.
Failure to obtain regulatory approval in foreign jurisdictions would prevent us from marketing our
products outside the United States.
Although we have not initiated any marketing efforts in jurisdictions outside of the United
States and Canada, we intend in the future to market our products in other markets. In order to
market our products in the European Union or 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 any market outside the United States, which could negatively effect
our overall market penetration.
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We currently 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 System One operations to our customer’s
staff. Our home hemodialysis patients may also call our customer service representatives directly
and, during the call, disclose confidential patient health information. U.S. 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 and consequently are not directly subject to HIPAA.
However, we have entered into several business associate 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, conduct by a person that is not a covered
entity could potentially be prosecuted under aiding and abetting or conspiracy laws if there is an
improper disclosure or misuse of patient information.
Many state laws apply to the use and disclosure of health 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. 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 several similar state laws, prohibit payments
that are intended to induce physicians or others either to refer patients or to acquire or arrange
for or recommend the acquisition of healthcare products or services. 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. 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 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 one of our sales representatives were to offer an inappropriate
inducement to purchase our System One to a customer, we could be subject to a claim under the
Medicare/ Medicaid anti-kickback laws.
Other federal and state laws generally prohibit individuals or entities from knowingly
presenting, or causing to be presented, claims for payments from 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, 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. Anti-kickback and 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.
40
Foreign governments tend to impose strict price controls, which may adversely affect our future
profitability.
Although we have not initiated any marketing efforts in jurisdictions outside of the United
States and Canada, we intend in the future to market our products in other markets. 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 the System One 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.
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.
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
We depend on the services of our senior executives and certain key engineering, scientific,
clinical and marketing personnel, the loss of whom could negatively affect our business.
Our success depends upon the skills, experience and efforts of our senior executives and other
key personnel, including our chief executive officer, certain members of our engineering staff, our
marketing executives and managers and our clinical educators. Much of our corporate expertise is
concentrated in relatively few employees, the loss of which for any reason could negatively affect
our business. Competition for our highly skilled employees is intense and we cannot prevent the
resignation of any employee. On May 16, 2006, we announced that David N. Gill, our Chief Financial
Officer, planned to resign as an officer and employee of NxStage and we are currently recruiting
his replacement. On July 25, 2006, Mr. Gill agreed to continue to serve as Chief Financial Officer
on a part-time basis until a replacement is found. We have agreements with all of our executive
officers which impose obligations that may prevent a former employee of ours from working for a
competitor for a period of time; however, these clauses may not be enforceable, or enforceable only
in part, or the company may choose not to seek enforcement. We do not maintain “key man” life
insurance on any of our senior executives, other than our chief executive officer.
We obtain some of the components, subassemblies and completed products included in the System One
from a single source or a limited group of manufacturers or suppliers, and the partial or complete
loss of one of these manufacturers or suppliers could cause significant production delays, an
inability to meet customer demand and a substantial loss in revenues.
We depend on single source suppliers for some of the components and subassemblies we use in
the System One. KMC Systems, Inc. is our only contract manufacturer of the System One cycler,
although we are considering a plan to develop alternative manufacturing capabilities for this
product; B. Braun Medizintechnologie GmbH is our only supplier of bicarbonate-based dialysate used
with the System One; Membrana GmbH is our only supplier of the fiber used in our filters; PISA is a
primary supplier of lactate-based dialysate and Medisystems Corporation is our primary supplier of
our disposable cartridge and several cartridge components. We also obtain certain other components
included in the System One from other single source suppliers or a limited group of suppliers.
Medisystems is a related party to NxStage. David Utterberg, the chief executive officer and
significant stockholder of Medisystems, is a member of our board of directors and as of September
30, 2006, held approximately 7.2% of our common stock. Our dependence on single source suppliers of
components, subassemblies and finished goods
41
exposes us to several risks, including disruptions in supply, price increases, late
deliveries, or an inability to meet customer demand. This could lead to customer dissatisfaction,
damage to our reputation, or cause customers to switch 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 weekly access to the System One and related disposables.
Finding alternative sources for these components and subassemblies would be difficult in many
cases and may entail a significant amount of time and disruption. In some cases, we would need to
change the components or subassemblies if we sourced them from an alternative supplier. This, in
turn, could require a redesign of our System One and, potentially, further FDA clearance or
approval of any modification, thereby causing further costs and delays.
We do not have long-term supply contracts with many of our third-party suppliers.
We purchase components and subassemblies from third-party suppliers, including some of our
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, therefore, are not
obligated to perform services or supply products to us for any specific period, in any specific
quantity or at any specific price, except as may be provided in a particular purchase order.
Although most of our significant single-source suppliers have long-term supply agreements, we do
not have a long-term supply agreement with Medisystems, a related party and the supplier of the
disposable cartridges used with the System One, as well as other componentry. We are working to
negotiate a long-term supply agreement with Medisystems. If we are unable to agree upon terms
satisfactory to us, or if Medisystems fails to continue the supply of cartridges to us, this could
have a material adverse effect on our business.
We do not maintain large volumes of inventory from most of our suppliers. If we inaccurately
forecast demand for components or subassemblies, our ability to manufacture and commercialize the
System One 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:
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prevent our competitors from duplicating our products; |
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• |
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prevent our competitors from gaining access to our proprietary information and technology; or |
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• |
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permit us to gain or maintain a competitive advantage. |
Any of our patents 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.
As of September 30, 2006,
we had 52 pending patent applications, including foreign,
international and U.S. applications, and 24 U.S. and international issued patents. We cannot
specify which of these 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
42
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:
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• |
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cease selling or using any of our products that incorporate the asserted
intellectual property, which would adversely affect our revenues; |
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• |
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pay substantial damages for past use of the asserted intellectual property; |
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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 |
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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.
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
43
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. Market
prices for securities of early stage companies have historically been particularly volatile. 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:
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timing of market acceptance of our products; |
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timing of achieving profitability and positive cash flow from operations, and related financing plans; |
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changes in estimates of our financial results or recommendations by securities
analysts or the failure to meet or exceed securities analysts’ expectations; |
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actual or anticipated variations in our quarterly operating results; |
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• |
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disruptions in product supply for any reason, including product recalls or the
failure of third party suppliers to deliver needed products or components; |
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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; |
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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; |
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product recalls; |
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regulatory developments in the United States and foreign countries; |
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changes in third-party healthcare reimbursements, particularly a decline in the
level of Medicare reimbursement for dialysis treatments; |
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litigation involving our company or our general industry or both; |
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announcements of technical innovations or new products by us or our competitors; |
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developments or disputes concerning our patents or other proprietary rights; |
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our ability to manufacture and supply our products to commercial standards; |
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significant acquisitions, strategic partnerships, joint ventures or capital
commitments by us or our competitors; |
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departures of key personnel; and |
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investors’ general perception of our company, our products, the economy and
general market conditions. |
44
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 stock.
In the past, following periods of volatility in the market price of a company’s 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:
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a prohibition on actions by our stockholders by written consent; |
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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; |
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advance notice requirements for nominations of directors or stockholder proposals; and |
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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 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 shares of common stock, the market price of
our common stock could decline significantly. We have 27,776,378 shares of common stock outstanding
as of September 30, 2006. 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 277,764 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.
Subject to certain conditions, holders of an aggregate of approximately 13,511,174 shares of
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
sell those shares in the public market without being subject to the volume limitations described
above.
As of September 30, 2006, 3,223,737 shares of common stock are authorized for issuance under
our stock incentive plan, employee stock purchase plan and outstanding stock options. As of
September 30, 2006, 2,671,269
45
shares were subject to outstanding options, of which 1,893,198 were exercisable and which can
be freely sold in the public market upon issuance, subject to the restrictions imposed on our
affiliates under Rule 144.
Our costs have increased significantly as a result of operating as a public company, and our
management is required to devote substantial time to comply with public company regulations
As a public company, we incur significant legal, accounting and other expenses that we did not
incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act,
as well as new rules subsequently implemented by the SEC and the NASDAQ Global Market, have imposed
various new requirements on public companies, including changes in corporate governance practices.
Our management and other personnel now need to devote a substantial amount of time to these new
requirements. Moreover, these rules and regulations increase our legal and financial compliance
costs and make some activities more time-consuming and costly.
In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain effective
internal controls for financial reporting and disclosure controls and procedures. In particular,
commencing in fiscal 2006, we must perform system and process evaluation and testing of our
internal controls over financial reporting to allow management and our independent registered
public accounting firm to report on the effectiveness of our internal controls over financial
reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our compliance with Section 404
will require that we incur substantial accounting expense and expend significant management
efforts. If we are not able to comply with the requirements of Section 404 in a timely manner, or
if we or our independent registered public accounting firm identify deficiencies in our internal
controls over financial reporting that are deemed to be material weaknesses, the market price of
our stock could decline and we could be subject to sanctions or investigations by the NASDAQ Global
Market, SEC or other regulatory authorities.
We do not anticipate paying cash dividends, and accordingly stockholders must rely on stock
appreciation for any return on their investment in us.
We anticipate that we will retain our earnings for future growth and therefore do not
anticipate paying cash dividends in the future. As a result, only appreciation of the price of our
common stock will provide a return to investors. Investors seeking cash dividends should not invest
in our common stock.
Our executive officers, directors and current and principal stockholders 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, executive officers and current holders of more than 5% of our outstanding
common stock, together with their affiliates and related persons, beneficially own, in the
aggregate, approximately 46% of our outstanding common stock. As a result, these stockholders, if
acting together, will have the ability to determine the outcome of all 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:
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delaying, deferring or preventing a change in control of our company; |
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entrenching our management and/or Board; |
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impeding a merger, consolidation, takeover or other business combination involving our company; or |
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discouraging a potential acquirer from making a tender offer or otherwise
attempting to obtain control of our company. |
46
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We registered shares of our common stock in connection with our initial public offering under
the Securities Act of 1933, as amended. The Registration Statement on Form S-1 (File No.
333-126711) filed in connection with our initial public offering was declared effective by the SEC
on October 27, 2005. The offering commenced on October 27, 2005 and did not terminate before any
securities were sold. We sold 5,500,000 shares of our registered common stock in the initial public
offering and an additional 825,000 shares of our registered common stock in connection with the
underwriters’ exercise of their over-allotment option. The underwriters of the offering were
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Thomas Weisel Partners LLC, William Blair &
Company and JMP Securities LLC.
All 6,325,000 shares of our common stock registered in the offering were sold at the initial
public offering price of $10 per share. The aggregate purchase price of the offering was
$63,250,000. The net offering proceeds received by us, after deducting expenses incurred in
connection with the offering, were approximately $56.5 million. These expenses consisted of direct
payments of:
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(a) $4.4 million in underwriters discounts, fees and commissions, |
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(b) $1.6 million in legal, accounting and printing fees, and |
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(c) $0.7 million in miscellaneous expenses. |
No payments for such expenses were directly or indirectly to (i) any of our directors,
officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity
securities or (iii) any of our affiliates.
We closed our initial public offering on November 1, 2005, and we have invested the aggregate
net proceeds in short-term investment-grade securities and money market accounts.
From the effective date of our Registration Statement on Form S-1, October 27, 2005, through
September 30, 2006, we have used approximately $38.4 million of the net proceeds of our initial
public offering to finance working capital needs. The net unused offering proceeds have been
invested into short-term investment grade securities and money market accounts.
47
Item 6. Exhibits
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| Exhibit |
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| Number |
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31.1
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Certification of Chief Executive Officer pursuant to
Exchange Act Rules 13a-14 or 15d-14, as adopted pursuant to
Section 302 of Sarbanes-Oxley Act of 2002. |
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31.2
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Certification of Chief Financial Officer pursuant to
Exchange Act Rules 13a-14 or 15d-14, as adopted pursuant to
Section 302 of Sarbanes-Oxley Act of 2002. |
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32.1
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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. |
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32.2
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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. |
48
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.
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NXSTAGE MEDICAL, INC.
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By: |
/s/ David N. Gill
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David N. Gill |
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Chief Financial Officer and Senior Vice
President (Duly authorized officer and principal
financial officer) |
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November 1, 2006 |
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49