Attached files
file | filename |
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EX-31.1 - EX-31.1 - NxStage Medical, Inc. | b81599exv31w1.htm |
EX-31.2 - EX-31.2 - NxStage Medical, Inc. | b81599exv31w2.htm |
EX-10.1 - EX-10.1 - NxStage Medical, Inc. | b81599exv10w1.htm |
EX-10.3 - EX-10.3 - NxStage Medical, Inc. | b81599exv10w3.htm |
EX-32.2 - EX-32.2 - NxStage Medical, Inc. | b81599exv32w2.htm |
EX-10.2 - EX-10.2 - NxStage Medical, Inc. | b81599exv10w2.htm |
EX-32.1 - EX-32.1 - NxStage Medical, Inc. | b81599exv32w1.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 000-51567
NxStage Medical, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 04-3454702 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
439 S. Union St., 5th Floor, Lawrence, MA | 01843 | |
(Address of Principal Executive Offices) | (Zip Code) |
(978) 687-4700
(Registrants Telephone Number, Including Area Code)
(Registrants Telephone Number, Including Area Code)
(Former Name, Former Address, and Former Fiscal year, If Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act:
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
There were 48,621,258 shares of the registrants common stock outstanding as of the close of
business on July 30, 2010.
NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2010
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2010
TABLE OF CONTENTS
2
Table of Contents
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Unaudited)
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
(In thousands, except share data) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 20,045 | $ | 21,720 | ||||
Accounts receivable, net |
14,769 | 14,238 | ||||||
Inventory |
30,889 | 28,117 | ||||||
Prepaid expenses and other current assets |
1,888 | 1,227 | ||||||
Total current assets |
67,591 | 65,302 | ||||||
Property and equipment, net |
8,633 | 10,336 | ||||||
Field equipment, net |
17,340 | 21,726 | ||||||
Deferred cost of revenues |
33,760 | 27,799 | ||||||
Intangible assets, net |
26,810 | 28,208 | ||||||
Goodwill |
42,698 | 42,698 | ||||||
Other assets |
550 | 909 | ||||||
Total assets |
$ | 197,382 | $ | 196,978 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 18,868 | $ | 19,827 | ||||
Accrued expenses |
11,695 | 9,377 | ||||||
Current portion of long-term debt |
53 | 61 | ||||||
Total current liabilities |
30,616 | 29,265 | ||||||
Deferred revenues |
47,234 | 38,490 | ||||||
Long-term debt |
39,123 | 37,854 | ||||||
Other long-term liabilities |
1,763 | 1,923 | ||||||
Total liabilities |
118,736 | 107,532 | ||||||
Commitments and contingencies (Note 12) |
||||||||
Stockholders equity: |
||||||||
Undesignated preferred stock: par value $0.001, 5,000,000 shares authorized;
no shares issued and outstanding as of June 30, 2010 and December 31, 2009 |
| | ||||||
Common stock: par value $0.001, 100,000,000 shares authorized; 48,731,290
shares issued as of June 30, 2010 and 46,795,859 shares issued and
outstanding as of December 31, 2009 |
48 | 47 | ||||||
Additional paid-in capital |
374,320 | 365,548 | ||||||
Accumulated deficit |
(293,969 | ) | (276,714 | ) | ||||
Accumulated other comprehensive (loss) income |
(12 | ) | 565 | |||||
Treasury stock, at cost: 174,757 shares as of June 30, 2010 |
(1,741 | ) | | |||||
Total stockholders equity |
78,646 | 89,446 | ||||||
Total liabilities and stockholders equity |
$ | 197,382 | $ | 196,978 | ||||
See accompanying notes to these condensed consolidated financial statements.
3
Table of Contents
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenues |
$ | 44,008 | $ | 36,398 | $ | 84,416 | $ | 70,133 | ||||||||
Cost of revenues |
30,246 | 27,581 | 58,841 | 54,261 | ||||||||||||
Gross profit |
13,762 | 8,817 | 25,575 | 15,872 | ||||||||||||
Operating expenses: |
||||||||||||||||
Selling and marketing |
8,565 | 7,411 | 16,582 | 14,642 | ||||||||||||
Research and development |
3,202 | 2,271 | 6,237 | 4,673 | ||||||||||||
Distribution |
3,632 | 3,525 | 7,043 | 7,209 | ||||||||||||
General and administrative |
5,643 | 4,749 | 10,581 | 9,704 | ||||||||||||
Total operating expenses |
21,042 | 17,956 | 40,443 | 36,228 | ||||||||||||
Loss from operations |
(7,280 | ) | (9,139 | ) | (14,868 | ) | (20,356 | ) | ||||||||
Other expense: |
||||||||||||||||
Interest income |
| 14 | | 25 | ||||||||||||
Interest expense |
(1,148 | ) | (3,337 | ) | (2,256 | ) | (4,372 | ) | ||||||||
Other income (expense), net |
330 | (14 | ) | 213 | 79 | |||||||||||
(818 | ) | (3,337 | ) | (2,043 | ) | (4,268 | ) | |||||||||
Net loss before income taxes |
(8,098 | ) | (12,476 | ) | (16,911 | ) | (24,624 | ) | ||||||||
Provision for income taxes |
158 | 39 | 344 | 119 | ||||||||||||
Net loss |
$ | (8,256 | ) | $ | (12,515 | ) | $ | (17,255 | ) | $ | (24,743 | ) | ||||
Net loss per share, basic and diluted |
$ | (0.17 | ) | $ | (0.27 | ) | $ | (0.37 | ) | $ | (0.53 | ) | ||||
Weighted-average shares outstanding, basic and diluted |
47,492 | 46,575 | 47,228 | 46,565 | ||||||||||||
See accompanying notes to these condensed consolidated financial statements.
4
Table of Contents
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Unaudited)
Six Months Ended | ||||||||
June 30, | ||||||||
2010 | 2009 | |||||||
(In thousands) | ||||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (17,255 | ) | $ | (24,743 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: |
||||||||
Depreciation and amortization |
11,077 | 10,229 | ||||||
Stock-based compensation |
6,875 | 3,877 | ||||||
Other |
1,128 | 1,197 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(527 | ) | 2,494 | |||||
Inventory |
(13,327 | ) | (2,179 | ) | ||||
Prepaid expenses and other assets |
(404 | ) | 700 | |||||
Accounts payable |
(399 | ) | (2,788 | ) | ||||
Accrued expenses and other liabilities |
3,060 | (144 | ) | |||||
Deferred revenues |
8,745 | 672 | ||||||
Net cash used in operating activities |
(1,027 | ) | (10,685 | ) | ||||
Cash flows from investing activities: |
||||||||
Purchases of property and equipment |
(457 | ) | (566 | ) | ||||
Decrease in other assets |
| (582 | ) | |||||
Net cash used in investing activities |
(457 | ) | (1,148 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from stock option and purchase plans |
2,140 | 148 | ||||||
Purchase of treasury stock |
(1,741 | ) | | |||||
Proceeds from loans and lines of credit |
| 39,895 | ||||||
Net repayments on loans and lines of credit |
(28 | ) | (30,506 | ) | ||||
Net cash provided by financing activities |
371 | 9,537 | ||||||
Foreign exchange effect on cash and cash equivalents |
(562 | ) | 109 | |||||
Decrease in cash and cash equivalents |
(1,675 | ) | (2,187 | ) | ||||
Cash and cash equivalents, beginning of period |
21,720 | 26,642 | ||||||
Cash and cash equivalents, end of period |
$ | 20,045 | $ | 24,455 | ||||
Noncash Investing Activities |
||||||||
Transfers from inventory to field equipment and deferred cost of revenues |
$ | 9,625 | $ | 3,225 | ||||
Transfers from field equipment to deferred cost of revenues |
$ | 10,203 | $ | 1,712 | ||||
See accompanying notes to these condensed consolidated financial statements.
5
Table of Contents
1. Nature of Operations
NxStage Medical, Inc., or the Company, is a medical device company that develops, manufactures
and markets innovative products for the treatment of kidney failure, fluid overload and related
blood treatments and procedures. The Companys primary product, the NxStage 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 centers. The System One is cleared or
approved for commercial sale in the United
States, Europe and Canada 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. Dialysate used in
conjunction with this system in the home is most frequently prepared using the Companys PureFlow
SL hardware and premixed concentrate bags. The Company also sells needles and blood tubing to
dialysis centers for the treatment of end-stage renal disease, or ESRD.
The Company has experienced negative operating margins and it expects to continue to incur net
losses in the foreseeable future. Until the second quarter of 2010, the Company had experienced
negative cash flows from operating activities. There can be no assurance that the Company will be able to
continue to generate positive cash flows from operating activities. The Company believes, based on current
projections and the current nature of the Companys business, that it has the required resources to
fund its ongoing operating requirements. Future capital requirements will depend on many factors,
including the rate of revenue growth, continued progress on improving gross margins, the expansion
of selling and marketing and research and development activities, the timing and extent of
expansion into new geographies or territories, the timing of new product introductions and
enhancement to existing products, the continuing market acceptance of products, the availability of
credit, and the potential investments in, or acquisitions of, complementary businesses, services or
technologies.
Basis of Presentation
The accompanying condensed consolidated financial statements as of June 30, 2010 and for the
three and six months ended June 30, 2010, and related notes, are unaudited but, in managements
opinion, include all adjustments, consisting of normal recurring adjustments that the Company
considers necessary for fair statement of the interim periods presented. The Company has prepared
its unaudited, condensed consolidated financial statements following the requirements of the
Securities and Exchange Commission, or SEC, for interim reporting. As permitted under these rules,
the Company has condensed or omitted certain footnotes and other financial information that are
normally required by U.S. generally accepted accounting principles, or GAAP. The Companys
accounting policies are described in the notes to the consolidated financial statements in the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and updated, as
necessary, in this Quarterly Report on Form 10-Q. Operating results for the three and six months
ended June 30, 2010 are not necessarily indicative of results for the entire fiscal year or future
periods. The December 31, 2009 condensed consolidated balance sheet contained herein was derived
from audited financial statements, but does not include all disclosures required by GAAP. For
further information, refer to the consolidated financial statements and footnotes thereto included
in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
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.
Use of Estimates
The preparation of the Companys condensed consolidated financial statements in conformity
with GAAP 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.
Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable is limited to certain
customers to whom the Company makes substantial sales. One customer represented 17% of accounts
receivable at June 30, 2010, and one customer represented 19% of accounts receivable at December
31, 2009.
Warranty Costs
The Company accrues estimated costs that it may incur under its product warranty programs at
the time the product revenue is recognized, based on contractual rights and historical experience.
Warranty expense is included in cost of revenues in the condensed consolidated statements of
operations. Following is a rollforward of the Companys warranty accrual (in thousands):
6
Table of Contents
Balance at December 31, 2009 |
$ | 205 | ||
Provision |
219 | |||
Usage |
(188 | ) | ||
Balance at June 30, 2010 |
$ | 236 |
Recent Accounting Pronouncements
Effective January 1, 2010, the Company adopted an accounting standard update regarding
accounting for transfers of financial assets. As codified under Accounting Standards Codification,
or ASC, 860, this update prescribes the information that a reporting entity must provide in its
financial reports about a transfer of financial assets; the effects of a transfer on its financial
position, financial performance, and cash flows; and a transferors continuing involvement in
transferred financial assets. Specifically, among other aspects, the update amends Statement of
Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, or SFAS 140, by removing the concept of a qualifying
special-purpose entity from SFAS 140 and removes the exception from applying FASB Interpretation
No. 46, Consolidation of Variable Interest Entities (revised), to variable interest entities that
are qualifying special-purpose entities. It also modifies the financial-components approach used in
SFAS 140. Because the update is effective for transfer of financial assets occurring on or after
January 1, 2010 and the Company has not had any such transactions subsequent to January 1, 2010 to
date, the adoption of this update did not have an impact on the Companys condensed consolidated
financial statements.
Effective January 1, 2010, the Company adopted an accounting standard update regarding fair
value measures. As codified under ASC 820, this update requires additional disclosures about fair
value measurements including transfers in and out of Levels 1 and 2 and a higher level of
disaggregation for the different types of financial instruments. For the reconciliation of Level 3
fair value measurements, information about purchases, sales, issuances and settlements should be
presented separately. Because this update addresses disclosure requirements, the adoption of this
update did not impact the Companys financial position, results of operations or cash flows.
3. Significant Revenue Contracts
National Service Provider Agreement and Stock Purchase Agreement with DaVita, Inc., or DaVita
In February 2007, the Company entered into a National Service Provider Agreement, or the
Original Agreement, and a Stock Purchase Agreement with DaVita, a significant customer, which the
Company considered to be a single arrangement.
In connection with the Original Agreement, the Company agreed to sell the System One and
PureFlow SL hardware along with the right to purchase disposable products and service on a monthly
basis. The Original Agreement included other terms such as development efforts, training, market
collaborations and volume discounts. The Original Agreement expired on December 31, 2009, but
sales continued in accordance with the terms specified in the Original Agreement.
In July 2010, the Company entered into a First Amended and Restated National Service Provider
Agreement, the Amended Agreement, with DaVita which supersedes the Original Agreement. Pursuant to
the terms of the Amended Agreement, the Company will continue to sell the System One and PureFlow
SL hardware along with the right to purchase disposable products and service on a monthly basis.
The Amended Agreement includes other terms such as rebates, training and volume discounts.
The sale of equipment and other items included in the Original and Amended Agreements were
considered to be multiple-element sales arrangements pursuant to ASC 605, Revenue Recognition. The
Company has determined that it cannot account for the sale of equipment as a separate unit of
accounting. Therefore, fees received upon the completion of delivery of equipment under the
Original and Amended Agreements are deferred and recognized as revenue on a straight-line basis
over the expected term of the Companys obligation to supply disposables and service, which is
seven years, and direct costs relating to the delivered equipment are deferred and amortized over
the same period as the related revenues.
In connection with the Amended Agreement the Company issued to DaVita a warrant that may vest
and become exercisable to purchase up to 5.5 million shares of the Companys common stock based
upon the achievement of certain DaVita and NxStage System One home patient growth targets achieved
at June 30, 2011, 2012 and 2013. The warrants have an exercise price of $14.22 per share are
non-transferable and must be exercised in cash. The warrants will be recorded at fair value, using
the Black-Scholes options pricing model, and recognized as a reduction of revenues over the same
period as the related product revenues.
4. Inventory
Inventories include material, labor and overhead, and are stated at lower of cost (first-in,
first-out) or market. The components of inventories are as follows (in thousands):
7
Table of Contents
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
Purchased components |
$ | 17,598 | $ | 14,214 | ||||
Work in process |
2,003 | 1,640 | ||||||
Finished goods |
11,288 | 12,263 | ||||||
$ | 30,889 | $ | 28,117 | |||||
5. Property and Equipment and Field Equipment
Accumulated depreciation on property and equipment was $10.0 million and $10.5 million at June
30, 2010 and December 31, 2009, respectively. Accumulated depreciation on field equipment was
$27.1 million and $26.7 million at June 30, 2010 and December 31, 2009, respectively.
6. Intangible Assets
Accumulated amortization on intangible assets was $7.7 million and $6.3 million at June 30,
2010 and December 31, 2009, respectively.
7. Comprehensive Loss
The following table presents the components of comprehensive loss (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net loss |
$ | (8,256 | ) | $ | (12,515 | ) | $ | (17,255 | ) | $ | (24,743 | ) | ||||
Foreign currency translation adjustment |
(569 | ) | 107 | (577 | ) | 47 | ||||||||||
Comprehensive loss |
$ | (8,825 | ) | $ | (12,408 | ) | $ | (17,832 | ) | $ | (24,696 | ) | ||||
8. Net Loss per Share
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 (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Options to purchase common stock |
2,895 | 126 | 2,554 | 69 | ||||||||||||
Restricted stock |
723 | | 697 | | ||||||||||||
Warrants to purchase common stock |
941 | | 827 | | ||||||||||||
Total |
4,559 | 126 | 4,078 | 69 | ||||||||||||
9. Debt
On March 10, 2010, the Company entered into a Loan and Security Agreement, the Credit
Facility, with Silicon Valley Bank, or SVB, with a maturity date of April 1, 2012. The Credit
Facility provides a credit commitment of up to $15.0 million, subject to certain limitations and
calculations of borrowing amount. The Credit Facility is secured by all or substantially all of
the Companys assets. Borrowings under the Credit Facility bear interest at a floating rate per
annum equal to two percentage points (2.00%) above the prime rate (initial prime rate of 4%).
Pursuant to the Credit Facility, the Company has agreed to certain financial covenants relating to
liquidity requirements and adjusted EBITDA, as defined in the Credit Facility. The Credit Facility
contains events of default customary for transactions of this type, including nonpayment,
misrepresentation, breach of covenants, material adverse effect and bankruptcy. At June 30, 2010,
there were no outstanding borrowings and the Company had approximately all of the $15.0 million credit
commitment available for borrowing under the Credit Facility.
In connection with the Credit Facility, the Company amended its term loan and security
agreement with Asahi Kasei Kuraray Medical Co., Ltd., or Asahi, a medical supply company
headquartered in Japan, to provide for certain amendments, including granting to Asahi
junior liens on certain of the Companys assets for so long as the Credit Facility remains
outstanding. Upon termination of all obligations under the Credit Facility, Asahis security will
revert to a security in all assets other than cash, bank accounts, accounts receivable, field
equipment and inventory.
10. Segment Disclosures
After an evaluation of the business activities regularly reviewed by the Companys chief
operating decision-maker for which separate discrete financial information is available, management
determined that the Company has two reporting segments, System One and In-Center.
8
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The accounting policies of the reportable segments are the same as those described in Note 2
to the consolidated financial statements included in the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 2009. The profitability measure employed by the Company and its
chief operating decision maker for making decisions about allocating resources to segments and
assessing segment performance is segment (loss) profit, which consists of sales, less cost of
sales, selling and marketing and distribution expenses.
The Companys management measures are designed to assess performance of these operating
segments excluding certain items. As a result, certain corporate expenses are excluded from the
segment operating performance measures, including research and development expenses and general and
administrative expenses, as they are managed centrally.
Within the System One segment, the Company derives revenue from the sale and rental of the
System One and PureFlow SL equipment and the sale of disposable products in the home and critical
care markets. The home market is devoted to the treatment of ESRD patients in the home, while the
critical care market is devoted to the treatment of hospital-based patients with acute kidney
failure or fluid overload. Within the System One segment, the Company sells a similar technology
platform of the System One with different features to the home and critical care markets. Some of
the Companys largest customers in the home market provide outsourced renal dialysis services to
some of the Companys customers in the critical care market. Sales of product to both markets are
made primarily through dedicated sales forces and distributed directly to the customer, or the
patient, with certain products sold through distributors internationally.
Within the In-Center segment, the Company sells blood tubing sets and needles for hemodialysis
and needles for apheresis primarily for the treatment of ESRD patients at dialysis centers. Nearly
all In-Center products are sold through national distributors.
The Companys reportable segments consist of the following (in thousands):
System One | In-Center | Unallocated | Total | |||||||||||||
Three Months Ended June 30, 2010 |
||||||||||||||||
Revenues from external customers |
$ | 27,467 | $ | 16,541 | $ | | $ | 44,008 | ||||||||
Segment (loss) profit |
(810 | ) | 2,375 | (8,845 | ) | (7,280 | ) | |||||||||
Segment assets |
82,554 | 14,204 | 100,624 | 197,382 | ||||||||||||
Three Months Ended June 30, 2009 |
||||||||||||||||
Revenues from external customers |
$ | 20,446 | $ | 15,952 | $ | | $ | 36,398 | ||||||||
Segment (loss) profit |
(5,000 | ) | 2,881 | (7,020 | ) | (9,139 | ) | |||||||||
Segment assets |
70,775 | 17,397 | 110,793 | 198,965 | ||||||||||||
Six Months Ended June 30, 2010 |
||||||||||||||||
Revenues from external customers |
$ | 52,569 | $ | 31,847 | $ | | $ | 84,416 | ||||||||
Segment (loss) profit |
(2,089 | ) | 4,039 | (16,818 | ) | (14,868 | ) | |||||||||
Segment assets |
82,554 | 14,204 | 100,624 | 197,382 | ||||||||||||
Six Months Ended June 30, 2009 |
||||||||||||||||
Revenues from external customers |
$ | 39,268 | $ | 30,865 | $ | | $ | 70,133 | ||||||||
Segment (loss) profit |
(10,615 | ) | 4,637 | (14,378 | ) | (20,356 | ) | |||||||||
Segment assets |
70,775 | 17,397 | 110,793 | 198,965 |
Substantially all of the Companys revenues are derived from the rental and sale of the System
One and related products, and from the sale of needles and blood tubing sets to customers located
in the United States.
The following table summarizes the customers who individually comprise greater than 10% of
total revenues for the periods shown below:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Customer A |
22 | % | 22 | % | 22 | % | 21 | % | ||||||||
Customer B |
17 | % | 35 | % | 17 | % | 36 | % | ||||||||
Customer C |
13 | % | | 13 | % | |
Sales to Customer A are primarily in the System One segment and sales to Customer B and
Customer C are to significant distributors in the In-Center segment. Almost all of Customer Cs
sales are to Customer A.
The following table presents a reconciliation of the total segment assets to total assets (in
thousands):
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Table of Contents
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
Total segment assets |
$ | 96,758 | $ | 91,880 | ||||
Corporate assets: |
||||||||
Cash and cash equivalents |
20,045 | 21,720 | ||||||
Property and equipment, net |
8,633 | 10,336 | ||||||
Intangible assets, net |
26,810 | 28,208 | ||||||
Goodwill |
42,698 | 42,698 | ||||||
Prepaid expenses and other assets |
2,438 | 2,136 | ||||||
Total assets |
$ | 197,382 | $ | 196,978 | ||||
11. Income Taxes
The Companys provision for income taxes of $158,000 and $39,000 for the three months ended
June 30, 2010 and 2009, respectively, and $344,000 and $119,000 for the six months ended June 30,
2010 and 2009, respectively, relates to the profitable operations of certain foreign entities.
12. Commitments and Contingencies
Significant commitments and contingencies at June 30, 2010 are consistent with those discussed
in Note 12 to the consolidated financial statements in the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 2009.
13. Stock-Based Compensation
The captions in the Companys condensed consolidated statements of operations for the three
and six months ended June 30, 2010 and 2009 include stock-based compensation as follows (in
thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Cost of revenues |
$ | 555 | $ | 370 | $ | 1,015 | $ | 664 | ||||||||
Selling and marketing |
1,470 | 787 | 2,481 | 1,451 | ||||||||||||
Research and development |
630 | 176 | 1,031 | 313 | ||||||||||||
General and administrative |
1,328 | 859 | 2,348 | 1,449 | ||||||||||||
$ | 3,983 | $ | 2,192 | $ | 6,875 | $ | 3,877 | |||||||||
Stock Options
The Company granted options to purchase 204,000 and 129,000 shares of common stock during the
three months ended June 30, 2010 and 2009, respectively, and options to purchase 1,300,300 and
1,657,430 shares of common stock during the six months ended June 30, 2010 and 2009, respectively.
The weighted-average fair value of options granted during the six months ended June 30, 2010 and
2009 was $5.52 and $1.21 per option, respectively.
Restricted Stock Awards
In March 2010, the Companys Compensation Committee of the Board of Directors, or the
Compensation Committee, approved the Companys 2010 Performance Share Plan in which it committed to
grant up to 811,800 shares of restricted stock to certain employees and executive officers based on
the achievement of certain Company financial performance metrics for the year ending December 31,
2010. The restricted stock, if awarded, vests over a requisite service period of three years.
Further, in March 2010, the Compensation Committee approved the Companys 2010 Corporate Bonus
Plan. Payout under the 2010 Corporate Bonus Plan will be based on individual performance and the
achievement of certain Company financial performance metrics for the year ending December 31, 2010
and will be paid in cash, or in shares of the Companys common stock, at the discretion of the
Compensation Committee. The estimated payout under the 2010 Corporate Bonus Plan is being
recognized as compensation expense during 2010 and has been classified as a liability on the
Companys condensed consolidated balance sheet.
14. Stockholders Equity
On March 3, 2010, the Company received 174,757 shares that were surrendered by employees in
payment for the minimum required withholding taxes due on issuance of shares of the Companys
common stock under the Companys 2009 Corporate Bonus Plan and vesting of the first tranche of the
restricted stock awards under the Companys 2009 Performance Share Plan. These shares have been
classified as treasury stock in the condensed consolidated balance sheets. The settlement of the
Companys 2009 Corporate Bonus Plan obligation of $1.6 million during the first quarter of 2010 in
shares of its common stock represents a noncash financing activity.
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15. Fair Value Measurements
At June 30, 2010, the Company had $11.8 million in money market funds, included in cash and
cash equivalents, measured at fair value on a recurring basis utilizing quoted prices (unadjusted)
in active markets of identical assets, also referred to as level 1 inputs.
The carrying amounts reflected in the condensed consolidated balance sheets for cash, accounts
receivable, prepaid expenses and other current and non-current assets, accounts payable and accrued
expenses approximate fair value due to their short-term nature.
The carrying amount of the Companys long-term debt approximates fair value at June 30, 2010.
The fair value of the Companys long-term debt was estimated using inputs derived principally from
market observable data, also referred to as level 2 inputs, including current rates offered to the
Company for debt of the same or similar remaining maturities.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward Looking Statements
The following discussion should be read with our unaudited condensed consolidated financial
statements and notes included in Part I, Item 1 of this Quarterly Report for the three and six
months ended June 30, 2010, as well as the audited financial statements and notes and Managements
Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended
December 31, 2009, included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission, or SEC. This Quarterly Report contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, concerning our business,
operations and financial condition, including statements with respect to the market adoption of our
products in the United States and internationally; the growth of the home, critical care and
in-center dialysis markets in general and the home hemodialysis market in particular; the
development and commercialization of our products; changes in the historical purchasing patterns
and preferences of our major customers, including DaVita, Inc.; the adequacy of our funding, our
need for and our ability to obtain additional funding; whether and when we might achieve
improvements to our gross margins and operating expenses; expectations with respect to our
operating expenses and achieving our business plan; expectations with respect to achieving
profitable operations; expectations with respect to achieving improvements in product reliability;
the timing and success of the submission, acceptance and approval of regulatory filings, the scope
of patent protection with respect to our products, expectations with respect to the clinical
findings of our FREEDOM study, the impact of future changes to reimbursement for chronic dialysis
treatments and the impact of current economic conditions on our business. All statements other than
statements of historical facts included in this report regarding our strategies, prospects,
financial condition, costs, plans and objectives are forward-looking statements. When used in this
report, the words expect, anticipate, intend, plan, believe, seek, estimate,
potential, continue, predict, may, and similar expressions are intended to identify
forward-looking statements, although not all forward-looking statements contain these identifying
words. Because these forward-looking statements involve risks and uncertainties, actual results
could differ materially from those expressed or implied by these forward-looking statements.
Among the important factors that could cause actual results to differ materially from those
indicated by our forward-looking statements are those discussed under the heading Risk Factors in
Item 1A of Part II. We undertake no obligation to revise or update publicly any forward-looking
statement for any reason. Readers should carefully review the factors described under the heading
Risk Factors in Item 1A of Part II of this Quarterly Report and in Managements Discussion and
Analysis of Financial Condition and Results of Operations, as well as in other documents filed by
us with the SEC, as they may be amended from time to time, including our Annual Report on Form 10-K
and Quarterly Reports on Form 10-Q.
Overview
We are a medical device company that develops, manufactures and markets innovative products
for the treatment of kidney failure, fluid overload and related blood treatments and procedures.
Our primary product, the NxStage System One, or System One, was designed to satisfy an unmet
clinical need for a system that can deliver the therapeutic flexibility and clinical benefits
associated with traditional dialysis machines in a smaller, portable, easy-to-use form that can be
used by healthcare professionals and trained lay users alike in a variety of settings, including
patient homes, as well as more traditional care settings such as hospitals and dialysis clinics.
Given its design, the System One is particularly well-suited for home hemodialysis and a range of
dialysis therapies including more frequent, or daily, dialysis, which clinical literature
suggests provides patients better clinical outcomes and improved quality of life. The System One is
cleared or approved for commercial sale in the United States, Europe
and Canada for the treatment of acute and chronic kidney failure and
fluid overload. We also sell needles and blood tubing
sets primarily to dialysis clinics for the treatment of end-stage renal disease, or ESRD, which we
refer to as the in-center market. We believe our largest future product market opportunity is for
our System One used in the home hemodialysis market, or home market, for the treatment of ESRD.
We report the results of our operations in two segments: System One and In-Center. We
distribute our products in three markets: home, critical care and in-center. In the System One
segment we derive our revenues from the sale and rental of equipment and the sale of disposable
products in the home and critical care markets. We define the home 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 similar technology platform of the System One for the home and critical care markets
with different features. In the In-Center segment, we derive our revenues from the sale of needles
and blood tubing sets used predominantly in hemodialysis performed in-center as well as apheresis,
which we refer to as the in-center market. Our blood tubing set products include the ReadySet
High Performance Blood Tubing set and our next generation Streamline Airless Blood Tubing set.
Streamline is designed to provide improved patient outcomes and lower costs to dialysis centers.
Our needle product line includes AV fistula needle sets incorporating safety features including
PointGuard Anti-Stick Needle Protectors and MasterGuard technology and ButtonHole needle sets.
In our System One segment, we market the System One in the home and critical care markets
through a direct sales force in the United States primarily to dialysis centers, for ESRD
hemodialysis patients, and hospitals. In 2009, we began entering into arrangements with
distributors to sell the System One and certain of our other products internationally. However, to
date, substantially all System One segment revenues have been derived from sales within the United
States. In our In-Center segment, we market our blood tubing set and needle products primarily
through distributors, although we also have a small dedicated sales force for that business. Nearly
all In-Center sales are made to customers within the United States, with very limited amounts sold
internationally through distributors.
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The manufacture of our products is accomplished through a complementary combination of
outsourcing and internal production. We have manufacturing facilities in Mexico, Germany and Italy.
We outsource the manufacture of premixed dialysate, needles, some blood tubing sets, and some
components.
We received clearance from the Food and Drug Administration, or 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 for the treatment of patients with ESRD. In June 2005,
the FDA cleared the System One for hemodialysis in the home. We presently have CE marking as well
as Canadian regulatory authority to sell our System One as well as certain other products in Canada
and Europe. We are currently pursuing a nocturnal indication for the System One under an IDE study
started in the first quarter of 2008. We completed the IDE study in February 2010 and are currently
seeking pre-market clearance from the FDA through the 510(k) clearance process.
Our customers, who include dialysis centers and hospitals, receive reimbursement for the
dialysis treatments provided with our products typically from Medicare, and to a lesser degree from
private insurers. Medicare provides comprehensive and well-established reimbursement in the United
States for ESRD. Reimbursement claims for dialysis therapy using the System One or our blood
tubing sets and needles are typically submitted by the dialysis center 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 patients primary diagnosis. Medicare presently limits reimbursement
for chronic hemodialysis to three treatments per week, absent a finding of medical justification.
Because most of our System One home dialysis patients are treated more than three times a week,
expanding Medicare reimbursement over time to more predictably cover more frequent therapy may be
critical to the market penetration of the System One in the home market and to our revenue growth
in the future.
In recent years, there have been numerous initiatives on the federal and state levels for
comprehensive reforms affecting the payment for, the availability of and reimbursement for
healthcare services in the United States. One of these initiatives was the Medicare Improvements
for Patients and Providers Act, or MIPPA Act, which was signed into law in 2008. As a result of
this legislation, the Centers for Medicare and Medicaid Services, or CMS, announced that, on
January 1, 2011, it will implement a new bundled payment for dialysis treatment. Final rules
were issued on July, 23, 2010 after publication of proposed rules and a formal comment period. One
of the stated goals of this new prospective payment system is to encourage home hemodialysis and
certain elements (e.g., bundling of certain drugs into the payment, a uniform treatment payment
whether dialysis is administered in the center or at home and a separate payment adjustor for home
dialysis training) are intended to support this objective. However, it is not possible at this
time to determine what impact this new bundled payment will have on the adoption of home and/or
daily hemodialysis or the price for which we can sell our products.
Further, in March 2010, the U.S. Congress adopted and President Obama signed into law
comprehensive health care reform legislation through the passage of the Patient Protection and
Affordable Health Care Act (H.R. 3590) and the Health Care and Education Reconciliation Act (H.R.
4872). Among other initiatives, these bills impose a 2.3% excise tax on domestic sales of medical
devices following December 31, 2012. Outside of the excise tax, which will impact our results of
operations following December 31, 2012, we cannot predict the effect such legislation will have on
us.
Since inception, we have incurred losses every quarter, and at June 30, 2010, we had an
accumulated deficit of approximately $294.0 million. We expect our operating expenses to continue
to increase as we grow our business. While we have achieved positive gross margins for our
products, in aggregate, since the fourth quarter of 2007, and positive cash flows from operating activities,
beginning in the second quarter of 2010, we cannot provide assurance that our cash flows from
operating activities will remain positive, or improve, or that our gross margins will improve or, if they do
improve, the rate at which they will improve. We cannot provide assurance that we will achieve
profitability, when we will become profitable, the sustainability of profitability, should it
occur, or the extent to which we will be profitable. Our ability to become profitable depends
principally upon implementing design and process improvements to lower the costs of manufacturing
our products, obtaining better purchasing terms and prices, growing revenue, increasing reliability
of our products, improving the management of our field equipment assets, achieving efficiencies in
manufacturing and supply chain overhead costs, achieving efficiencies in the distribution of our
products and achieving a sufficient scale of operations.
We have experienced negative operating margins and expect to continue to incur net losses in
the foreseeable future. Until the second quarter of 2010, we had experienced negative cash flows
from operating activities. There can be no assurance that we will be able to continue to generate positive
cash flows from operating activities. We believe, based on current projections and the current nature of our
business, that we have the required resources to fund our ongoing operating requirements. Future
capital requirements will depend on many factors, including the rate of revenue growth, continued
progress on improving gross margins, the expansion of selling and marketing and research and
development activities, the timing and extent of expansion into new geographies or territories, the
timing of new product introductions and enhancement to existing products, the continuing market
acceptance of products, the availability of credit, and the potential investments in, or
acquisitions of, complementary businesses, services or technologies.
Statement of Operations Components
Revenues
In the System One segment we derive our revenues from the sale and rental of equipment and the
sale of disposable products in the home and critical care markets. In the home market, customers
rent or purchase the System One equipment, including the cycler
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and PureFlow SL hardware, and then
purchase the related disposable products based on a specific patient prescription. In the critical
care market, we sell or rent the System One and related disposables to hospital customers. In the
In-Center segment, the majority of revenues are derived from supply and distribution contracts with
distributors.
In the home market, for those customers that rent the System One, we recognize revenues on a
monthly basis in accordance with customer contracts under which we supply the use of hardware and
disposables needed to perform dialysis therapy sessions during a month. For customers that purchase
the System One in the home market, we recognize revenue from the equipment sale ratably over the
expected service obligation period and recognize disposable product revenue upon delivery.
Currently, less than half of our sales to customers in the home market include the rental rather
than the purchase of System One equipment.
Our contracts with dialysis centers in the home market for ESRD home dialysis patients
generally include terms providing for the sale of disposable products to accommodate up to the
number of prescribed treatments per month per patient and the purchase or monthly rental of System
One cyclers and, in some instances, our PureFlow SL hardware. These contracts typically have a
term of one to three years, and may be renewed on a month-to-month basis thereafter, subject to a
30-day termination notice. Under these contracts, if home hemodialysis is prescribed, supplies are
shipped directly to patient homes and paid for by the treating dialysis center. We also include
vacation delivery terms, providing for the shipment of products to a designated vacation
destination for a specified number of vacation days. We derive an insignificant amount of revenues
from the sale of ancillary products, such as extra lengths of tubing. Over time, as more home
patients are treated with the System One and more systems are placed in patient homes, we expect to
derive a growing recurring revenue stream from the sale of related disposables.
In the critical care market we recognize revenue from direct product sales at the later of the
time of shipment or, if applicable, delivery in accordance with contract terms. Our contracts with
hospitals in the critical care market generally include terms providing for the sale of our System
One hardware and disposables, although we also provide a hardware rental option. These contracts
typically have a term of one year. We derive a small amount of revenue from the sale of one and
two year service contracts following the expiration of our standard one-year warranty period for
System One hardware. To further support service in this market, we have a bio-medical training
program, whereby we train bio-medical engineers on how to service and repair certain aspects of the
System One in the critical care setting. Bio-medical training is not offered for the home market
within our System One segment. Bio-medical training is typically provided under a two-year contract
following the expiration of our standard one-year warranty period for System One hardware. Similar
to our home market, as more System One equipment is placed within hospitals, we expect to derive a
growing recurring revenue stream from the sale of disposable cartridges and fluids as well as, to a
much lesser degree, from the sale of service and bio-medical training contracts.
In the In-Center segment, nearly all sales to end users are structured through supply and
distribution contracts with distributors. These contracts contain minimum volume commitments with
negotiated pricing triggers at different volume tiers. Each agreement may be cancelled upon a
material breach, subject to certain cure rights, and in many instances minimum volume commitments
can be reduced or eliminated upon certain events. In addition to contractually determined volume
discounts, we offer rebates based on sales to specific end customers and discount incentives for
early payment. Our revenues are presented net of these rebates, incentives, discounts and returns,
collectively rebates and other discounts. As of June 30, 2010, we had $1.6 million reserved
against trade accounts receivable for future rebates and other discounts. We recorded $1.2 million
and $2.4 million during the three months ended June 30, 2010 and 2009, respectively, and $3.0
million and $4.9 million during the six months ended June 30, 2010 and 2009, respectively, as a
reduction of revenues in connection with rebates and other discounts. Our In-Center segment
revenues are subject to fluctuation as a result of changes in sales volumes and variations in
inventory management policies of our distributors and end users. We regularly monitor the amount
of inventory held by distributors to ensure it is not excessive when compared to end user demand.
Our customers in the System One segment are highly consolidated. Fresenius and DaVita own and
operate the two largest chains of dialysis clinics in the United States and collectively provide
treatment to approximately 60% of United States dialysis patients. DaVita is our most significant
customer for the System One segment. Sales to DaVita represented approximately 35% of our System
One segment revenues for both the three and six months ended June 30, 2010 and approximately 38% of
our System One segment revenues for both the three and six months ended June 30, 2009. Further,
DaVita is our largest customer in the home market, constituting over 40% of our home hemodialysis
patients. A small, but growing, percentage of our sales in the System One segment are to
Fresenius, with nearly all of those sales in the home market.
In July 2010, we entered into a First Amended and Restated National Service Provider
Agreement, or the Amended Agreement, with DaVita expiring on June 30, 2013. The Amended Agreement
supersedes the National Service Provider Agreement dated as of February 7, 2007, as amended, or the
Original Agreement. Pursuant to the terms of the Amended Agreement, we will continue to supply the
System One and PureFlow SL and related supplies for home hemodialysis therapy to DaVita. Under the
Amended Agreement, DaVita commits to continue to purchase, rather than rent, nearly all of its
future System One equipment needs. The term of the Amended Agreement is for approximately three
years through June 30, 2013, but may be automatically extended on a monthly basis unless terminated
by either party pursuant to the Amended Agreement.
The Amended Agreement includes a modest increase to DaVitas pricing from the levels under the
Original Agreement, and continues DaVitas right to receive most favored nations pricing for the
System One and related supplies for home hemodialysis therapy, subject to certain requirements,
including DaVita achieving certain System One home patient growth targets. In addition,
under the Amended Agreement, we issued to DaVita a warrant that may vest and become
exercisable to purchase up to 5.5 million shares of our common stock based upon the achievement of
certain System One home patient growth targets at June 30, 2011, 2012
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and 2013, which require
DaVita to continue to grow its home patient census every six months during the term of the Amended
Agreement. Under this tiered rebate structure, DaVita would be required to grow its net patients
on the NxStage System One at a compounded annual growth rate of approximately 20 percent, from its
current level, to receive the lowest level of warrants during each of the three years. Achieving
the highest level of warrants will require a significant increase above that. The warrant-based
rebate structure preserves NxStages cash, and provides for the issuance of shares upon the
exercise of any warrants earned only if patient access to home hemodialysis with the System One is
materially expanded. The warrants have an exercise price of $14.22 per share and are
non-transferable and must be exercised in cash.
In connection with the issuance of the warrants, we entered into a Registration Rights
Agreement with DaVita pursuant to which we agreed to file, on or prior to April 1, 2011, a
registration statement on Form S-3 with respect to the resale by DaVita of any shares issued to
DaVita under the warrant. We are required to use our best efforts to cause the registration
statement to be declared effective as promptly as possible after the filing but in any event not
later than (i) July 30, 2011 or (ii) the date on which any warrants become exercisable and vested,
whichever is later.
Our In-Center segment revenues are highly concentrated in several significant purchasers.
Revenues from Henry Schein, Inc., or Henry Schein, a significant distributor, represented
approximately 45% of our In-Center segment revenues during both the three and six months ended June
30, 2010 and approximately 80% of our In-Center segment revenues during both the three and six
months ended June 30, 2010. Our second largest distributor is Gambro Renal Products, Inc., or
Gambro. Revenues from Gambro represented approximately 35% of our In-Center segment revenues
during both the three and six months ended June 30, 2010. During the later part of 2009, in
connection with our Gambro agreement, we transitioned our sales of blood tubing sets to DaVita from
Henry Schein to Gambro, significantly reducing our sales to Henry Schein.
Sales of products through distributors to DaVita accounted for nearly half of In-Center
segment revenues for the three and six months ended June 30, 2010. DaVita has contractual purchase
commitments under two agreements: one with us for needles and one with Gambro for blood tubing
sets. DaVitas purchase obligations with respect to needles will expire under an agreement with us
in January 2013. Gambros long term product supply agreement with DaVita entered into in connection
with the sale of Gambros United States dialysis clinic business to DaVita, obligates DaVita to
purchase a significant majority of its blood tubing set requirements from Gambro. However, in June
2009, we entered into a five year distribution agreement in the United States with Gambro, which
contractually obligates Gambro to exclusively supply our blood tubing sets, including our ReadySet
and the Streamline product lines to DaVita.
Our distribution agreement with Henry Schein, a significant distributor for the In-Center
segment, will expire in April 2012. Our agreements with two other distributors for the In-Center
segment are scheduled to expire in July 2011 and February 2012, respectively. Our blood tubing set
distribution agreement with Gambro expires in July 2014.
Cost of Revenues
Cost of revenues consists primarily of direct product costs, material and labor, including
stock based compensation, required to manufacture our products, service of System One equipment
that we rent and sell to customers and production overhead. It also includes the cost of
inspecting, servicing and repairing System One equipment prior to sale or during the warranty
period. The cost of our products depends on several factors, including the efficiency of our
manufacturing operations, the cost at which we can obtain labor and products from third-party
suppliers, product reliability and related servicing costs and the design of our products.
Operating Expenses
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 and their
partners in the operation of our products.
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.
Distribution. Distribution expenses include the freight costs of delivering our products to
our customers or our customers patients, depending on the market and the specific agreements with
our customers, salary, benefits and stock-based compensation for distribution personnel and the
cost of any equipment lost or damaged in the distribution process. We use common carriers and
freight companies to deliver our products and do not operate our own delivery service. Also
included in this category are the expenses of shipping products under warranty from customers back
to our service center for repair and the related expense of shipping a replacement product to our
customers or their patients.
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 of 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.
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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 condensed 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 | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenues |
100 | % | 100 | % | 100 | % | 100 | % | ||||||||
Cost of revenues |
69 | % | 76 | % | 70 | % | 77 | % | ||||||||
Gross profit |
31 | % | 24 | % | 30 | % | 23 | % | ||||||||
Operating expenses: |
||||||||||||||||
Selling and marketing |
20 | % | 20 | % | 20 | % | 21 | % | ||||||||
Research and development |
7 | % | 6 | % | 7 | % | 7 | % | ||||||||
Distribution |
8 | % | 10 | % | 8 | % | 10 | % | ||||||||
General and administrative |
13 | % | 13 | % | 13 | % | 14 | % | ||||||||
Total operating expenses |
48 | % | 49 | % | 48 | % | 52 | % | ||||||||
Loss from operations |
(17 | %) | (25 | %) | (18 | %) | (29 | %) | ||||||||
Other expense: |
||||||||||||||||
Interest income |
| | | | ||||||||||||
Interest expense |
(3 | %) | (9 | %) | (2 | %) | (6 | %) | ||||||||
Other income (expense), net |
1 | % | | | | |||||||||||
(2 | %) | (9 | %) | (2 | %) | (6 | %) | |||||||||
Provision for income taxes |
| | | | ||||||||||||
Net loss |
(19 | %) | (34 | %) | (20 | %) | (35 | %) | ||||||||
Comparison of the Three and Six Months Ended June 30, 2010 and 2009
Revenues
Our revenues for the three and six months ended June 30, 2010 and 2009 were as follows (in
thousands, except percentages):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||||
June 30, | June 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||||||||||||||||||
System One segment |
||||||||||||||||||||||||||||||||
Home |
$ | 20,815 | 47 | % | $ | 15,205 | 42 | % | $ | 39,858 | 47 | % | $ | 29,559 | 42 | % | ||||||||||||||||
Critical Care |
6,652 | 15 | % | 5,241 | 14 | % | 12,711 | 15 | % | 9,709 | 14 | % | ||||||||||||||||||||
Total System One segment |
27,467 | 62 | % | 20,446 | 56 | % | 52,569 | 62 | % | 39,268 | 56 | % | ||||||||||||||||||||
In-Center segment |
16,541 | 38 | % | 15,952 | 44 | % | 31,847 | 38 | % | 30,865 | 44 | % | ||||||||||||||||||||
Total |
$ | 44,008 | 100 | % | $ | 36,398 | 100 | % | $ | 84,416 | 100 | % | $ | 70,133 | 100 | % | ||||||||||||||||
The increase in revenues for both periods was primarily attributable to increased sales and
rentals of the System One and related disposables in both the home and critical care markets,
primarily as a result of the growing number of patients using the System One as we continue to
penetrate the market place.
In the home market, revenues increased $5.6 million, or 37%, and $10.3 million, or 35%, for
the three and six months ended June 30, 2010, respectively, versus the prior year comparable
periods, primarily as a result of an increase in the number of patients prescribed to use and
centers offering the System One. Critical care market revenues increased $1.4 million, or 27%, and
$3.0 million, or 31%, for the three and six months ended June 30, 2010, respectively, versus the
prior year comparable periods, primarily due to increased sales of the System One resulting from
our efforts to continue to penetrate the market and increased sales of disposables from our growing
number of installed units. Future demand for our products in both the home and critical care
markets is
expected to remain strong due to the life-sustaining, non-elective nature of dialysis therapy.
Revenues in the home and critical care markets are expected to continue to increase as we further
penetrate the market place and as we expand internationally. However, in the critical care market,
we expect, at least in the short-term, to see a continuation of a conservative capital spending
environment.
In-Center segment revenues increased $0.6 million, or 4%, and $1.0 million, or 3%, for the
three and six months ended June 30, 2010, respectively, versus the prior year comparable periods,
due to increased sales of our needle products resulting from strong end
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user demand and changes in
distributor inventory levels. We expect future demand will be susceptible to fluctuation as a
result of increased competition and variations in inventory management policies with both our
distributors and end users.
Gross Profit
Our gross profit and gross profit as a percentage of revenues for the three and six months
ended June 30, 2010 and 2009 were as follows (in thousands, except percentages):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||||
June 30, | % | June 30, | % | June 30, | % | June 30, | % | |||||||||||||||||||||||||
2010 | Revenues | 2009 | Revenues | 2010 | Revenues | 2009 | Revenues | |||||||||||||||||||||||||
System One segment |
$ | 9,756 | 36 | % | $ | 4,654 | 23 | % | $ | 18,395 | 35 | % | $ | 8,710 | 22 | % | ||||||||||||||||
In-Center segment |
4,006 | 24 | % | 4,163 | 26 | % | 7,180 | 23 | % | 7,162 | 23 | % | ||||||||||||||||||||
Gross Profit |
$ | 13,762 | 31 | % | $ | 8,817 | 24 | % | $ | 25,575 | 30 | % | $ | 15,872 | 23 | % | ||||||||||||||||
The increase in gross profit for both periods was a result of increased revenues and
improvement in gross profit as a percentage of revenues. The improvement in gross profit as a
percentage of revenues was attributable to the System One segment, specifically, decreased service
costs resulting from improved equipment reliability and lower overall costs of manufacturing as we
continue to realize the benefits of leveraging our manufacturing infrastructure, certain cost
saving initiatives and improvements in product design.
Gross profit for the In-Center segment remained relatively consistent for the six months ended
June 30, 2010, versus the prior year comparable period. Gross profit for the three months ended
June 30, 2010 decreased slightly in absolute dollars and as a percentage of revenues, versus the
prior year comparable period, due to costs incurred related to manufacturing process improvements.
We expect gross profit as a percentage of revenues will continue to improve over time for
three general reasons, all of which we expect will reduce costs in the future. First, we expect to
introduce additional process improvements and product design changes that have inherently lower
cost than our current products. Second, we anticipate that increased sales volume and realization
of economies of scale will lead to better purchasing terms and prices and efficiencies in
manufacturing and supply chain overhead costs. Finally, we expect to continue to improve product
reliability, which would reduce service costs. However, there is no certainty that our
expectations will be achieved with respect to these cost reduction plans.
Selling and Marketing
Our selling and marketing expenses for the three and six months ended June 30, 2010 and 2009
were as follows (in thousands, except percentages):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | % | June 30, | June 30, | % | |||||||||||||||||||
2010 | 2009 | Change | 2010 | 2009 | Change | |||||||||||||||||||
System One segment |
$ | 7,410 | $ | 6,495 | 14 | % | $ | 14,319 | $ | 12,817 | 12 | % | ||||||||||||
In-Center segment |
1,155 | 916 | 26 | % | 2,263 | 1,825 | 24 | % | ||||||||||||||||
Total Selling and marketing |
$ | 8,565 | $ | 7,411 | 16 | % | $ | 16,582 | $ | 14,642 | 13 | % | ||||||||||||
Selling and marketing increased in absolute dollars for both the three and six months
ended June 30, 2010, versus the prior year period, but decreased as a percentage of revenues from
21% for the six months ended June 30, 2009 to 20% for the six months ended June 30, 2010. The
increase in selling and marketing expense was primarily the result of increased personnel and
personnel-related costs, primarily non-cash stock-based compensation expenses, and increased
spending due to expanded marketing programs. 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 home market and to support growth in international markets.
Research and Development
Our research and development expenses for the three and six months ended June 30, 2010 and
2009 were as follows (in thousands, except percentages):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | % | June 30, | June 30, | % | |||||||||||||||||||
2010 | 2009 | Change | 2010 | 2009 | Change | |||||||||||||||||||
Research and development |
$ | 3,202 | $ | 2,271 | 41 | % | $ | 6,237 | $ | 4,673 | 33 | % | ||||||||||||
Research and development increased in absolute dollars but remained relatively consistent
as a percentage of revenues at 7% for both the three and six months ended June 30, 2010, as
compared to 6% and 7% for the three and six months ended June 30, 2009, respectively. The increase
in research and development expenses was primarily due to increased personnel and personnel-related
costs, including non-cash stock-based compensation expense, due to increased headcount and an
increase in other project related spending. This increase was partially offset by a decrease in
clinical trials expenses primarily related to our nocturnal IDE as we
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completed the IDE study in
February 2010 and are currently seeking pre-market clearance from the FDA through the 510(k)
clearance process. We expect research and development expenses will increase in absolute dollars
but remain relatively constant as a percentage of revenues in the foreseeable future as we seek to
further enhance our System One and related products, and their reliability, and with activity
associated with our FREEDOM study.
Distribution
Our distribution expenses for the three and six months ended June 30, 2010 and 2009 were as
follows (in thousands, except percentages):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | % | June 30, | June 30, | % | |||||||||||||||||||
2010 | 2009 | Change | 2010 | 2009 | Change | |||||||||||||||||||
System One segment |
$ | 3,156 | $ | 3,159 | (0 | %) | $ | 6,165 | $ | 6,508 | (5 | %) | ||||||||||||
In-Center segment |
476 | 366 | 30 | % | 878 | 701 | 25 | % | ||||||||||||||||
Total Distribution |
$ | 3,632 | $ | 3,525 | 3 | % | $ | 7,043 | $ | 7,209 | (2 | %) | ||||||||||||
Distribution expenses decreased as a percentage of revenues to 8% for the three and six
months ended June 30, 2010 versus 10% for the prior year comparable periods. Distribution expenses
for the System One segment decreased as a percentage of revenues to 11% and 12% for the three and
six months ended June 30, 2010, respectively versus 15% and 17% for the prior year comparable
periods, due primarily to efficiencies gained from economies of scale resulting from increased
business volume, improved product reliability of our System One and PureFlow SL hardware and better
pricing obtained from carriers. Distribution expenses as a percentage of revenue for the In-Center
segment increased slightly as a percentage of revenues to 3% for the three and six months ended
June 30, 2010 versus 2% for the prior year comparable periods, due primarily to increased delivery
costs for certain products shipped from our international manufacturing locations to our customers.
We expect that distribution expenses will increase at a lower rate than revenues due to expected
efficiencies gained from increased business volume and improved reliability of System One
equipment. We cannot predict the estimated impact, if any, of fuel costs on future distribution
costs.
General and Administrative
Our general and administrative expenses for the three and six months ended June 30, 2010 and
2009 were as follows (in thousands, except percentages):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | % | June 30, | June 30, | % | |||||||||||||||||||
2010 | 2009 | Change | 2010 | 2009 | Change | |||||||||||||||||||
General and administrative |
$ | 5,643 | $ | 4,749 | 19 | % | $ | 10,581 | $ | 9,704 | 9 | % | ||||||||||||
General and administrative expenses increased in absolute dollars but remained relatively
consistent as a percentage of revenues at 13% for both the three and six months ended June 30, 2010
and 13% and 14% for the three and six months ended June 30, 2009, respectively. The increase in
general and administrative expenses for both periods was primarily related to non-cash stock-based
compensation expenses. These increases were offset by lower spending on corporate support
functions, including consulting and legal expenses, due to our continued initiative to control
costs. We expect that general and administrative expenses will decrease as a percentage of
revenues over time as we continue to leverage our existing infrastructure.
Other Income and Expense
Interest income is derived primarily from investments in money market funds. The decrease in
interest income is due to lower
interest rates on investments.
Interest expense decreased $2.2 million, or 66%, for the three months ended June 30, 2010 and
decreased $2.1 million, or 48%, for the six months ended June 30, 2010, versus the prior year
comparable periods due primarily to prepayment and other transaction fees of $2.0 million incurred
during the three months ended June 30, 2009 to pay off the entire debt obligation owed under our
credit and security agreement with General Electric Capital Corporation, or GE.
The change in other expense during both periods is derived primarily by foreign currency gains
and losses.
Provision for Income Taxes
The provision for income taxes of $158,000 and $344,000 for the three and six months ended
June 30, 2010, respectively, and $39,000 and $119,000 for the three and six months ended June 30,
2009, respectively, relates to the profitable operations of certain of our foreign entities.
Liquidity and Capital Resources
We have operated at a loss since our inception in 1998. As of June 30, 2010, our accumulated
deficit was $294.0 million and we had cash and cash equivalents of $20.0 million and working
capital of $37.0 million.
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Our primary ongoing cash requirements will be to fund operating activities, product
development and debt service. Our primary sources of liquidity are cash on hand and ongoing
revenues. A number of our home market customers, including DaVita, have purchased System One
equipment, with certain customers committed to purchase, rather than rent, the significant majority
of their future System One equipment requirements. The decision by our customers to purchase,
rather than rent, our System One equipment allows us to recover the cost of our products upon
initial sale rather than over an extended period of time which has resulted in a significant
decrease in our cash usage. However, there can be no assurance that we will be able to continue to
expand the percentage of our equipment placements that are purchased rather than rented. A
significant factor affecting the management of our ongoing cash requirements is our ability to
continue to improve the management of our field equipment assets and execute upon cost reduction
initiatives to lower product cost.
We have the flexibility under our term loan with Asahi Kasei Kuraray Medical Co., Ltd., or
Asahi, a medical supply company headquartered in Japan, to seek additional debt at market interest
rates to fund our growth objectives and in March 2010 we chose to do so. On March 10, 2010, we
entered into a Loan and Security Agreement, the Credit Facility, with Silicon Valley Bank, or SVB,
with a maturity date of April 1, 2012. The Credit Facility provides a credit commitment of up to
$15.0 million, subject to certain limitations and calculations of borrowing amount. The Credit
Facility is secured by all or substantially all of our assets. Borrowings under the Credit
Facility bear interest at a floating rate per annum equal to two percentage points (2.00%) above
the prime rate (initial prime rate of 4%). Pursuant to the Credit Facility, we have agreed to
certain financial covenants relating to liquidity requirements and adjusted EBITDA, as defined in
the Credit Facility. The Credit Facility contains events of default customary for transactions of
this type, including nonpayment, misrepresentation, breach of covenants, material adverse effect
and bankruptcy. At June 30, 2010, we were in compliance with the covenants, there were no
outstanding borrowings and we had approximately all of the $15.0 million credit commitment available for
borrowing under the Credit Facility.
In connection with the Credit Facility, we amended our term loan and security agreement with
Asahi to provide for certain amendments, including granting to Asahi junior liens on certain of our
assets for so long as the Credit Facility remains outstanding. Upon termination of all obligations
under the Credit Facility, Asahis security will revert to a security in all assets other than
cash, bank accounts, accounts receivable, field equipment and inventory.
At June 30, 2010, we had $41.8 million in principal and deferred interest outstanding under
our term loan and security agreement with Asahi, or Term Loan. The Term Loan bears interest at a
rate of 8% per annum, with fifty percent of such interest being deferred until the maturity date on
May 31, 2013. Principal is payable in one balloon payment at maturity. The Term Loan is secured by
substantially all of our assets. In the event the Term Loan reaches maturity, Asahi may require
that all of the principal and interest on the Term Loan that is unpaid as of the maturity date be
converted into shares of our common stock, with the number of shares to be determined based upon
the average closing stock price of our common stock during the thirty business days preceding the
maturity date, subject to certain conditions.
The Term Loan includes certain affirmative covenants including timely filings and limitations
on contingent debt obligations and sales of assets. It also contains customary events of default,
including nonpayment, misrepresentation, breach of covenants, material adverse effects, and
bankruptcy. In the event we fail to satisfy our covenants, or otherwise go into default, Asahi has
a number of remedies, including sale of our assets and acceleration of all outstanding
indebtedness. Any of these remedies would likely have a material adverse effect on our business.
We maintain postemployment benefit plans for employees in certain foreign subsidiaries. The
plans provide lump sum benefits, payable based on statutory regulations for voluntary or
involuntary termination. Where required, we obtain an annual actuarial valuation of the benefit
plans. We have recorded a liability of $1.5 million as other long-term liabilities at June 30,
2010 for costs associated with these plans. The expense recorded in connection with these plans
was not significant for the three and six months ended June 30, 2010 or 2009.
The following table sets forth the components of our cash flows for the periods indicated (in
thousands):
Six Months Ended | ||||||||
June 30, | ||||||||
2010 | 2009 | |||||||
Net cash used in operating activities |
$ | (1,027 | ) | $ | (10,685 | ) | ||
Net cash used in investing activities |
(457 | ) | (1,148 | ) | ||||
Net cash provided by financing activities |
371 | 9,537 | ||||||
Effect of exchange rate changes on cash |
(562 | ) | 109 | |||||
Net cash flow |
$ | (1,675 | ) | $ | (2,187 | ) | ||
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. Net cash used in
operating activities decreased by $9.7 million during the six months ended June 30, 2010, versus
the prior year comparable period. The decrease in net cash used in operating activities was
primarily due to a decrease in our net loss after adjustments for non-cash charges as we continue
to reduce product costs and improve the management of our field equipment assets, and increases in
deferred revenues. Deferred revenues increased $8.7 million and $0.7 million during the six months
ended June 30,
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2010 and 2009, respectively. The increase in deferred revenues in both periods was
a result of the increase in the number of customers who chose to purchase, rather than rent, the
System One equipment, offset by the amortization of this equipment totaling $2.7 million and $1.5
million during the three months ended June 30, 2010 and 2009, respectively, and $5.0 million and
$2.8 million during the six months ended June 30, 2010 and 2009, respectively, of deferred revenues
into revenues. Currently, over half of our sales to customers in the home market include the
purchase, rather than the rental, of System One equipment. The decreases in net cash used in
operating activities were partially offset by increases in inventory to support the growing number
of customers using our System One equipment and accounts receivable as we continue to expand our
business. Non-cash transfers from inventory to field equipment and deferred costs of revenues for
the placement of units with our customers increased $6.4 million during the six months ended June
30, 2010, versus the prior year comparable period to support the growing number of patients using
the System One. Non-cash transfers from field equipment to deferred costs of revenues increased
$8.5 million during the six months ended June 30, 2010, versus the prior year comparable period,
primarily due to an increase in the number of customers who have purchased rather than rented our
System One equipment.
Net Cash Used in Investing Activities. For each of the periods above, net cash used in
investing activities reflected purchases of property and equipment, primarily for manufacturing
operations and capital improvements to our facilities, research and development and information
technology.
Net Provided by Financing Activities. Net cash provided by financing activities during the
six months ended June 30, 2010 included $2.1 million of proceeds from stock option and stock
purchase plans offset by cash used to repurchase 174,757 shares of our common stock that were
surrendered by employees in payment for the minimum required withholding taxes due on issuance of
shares of our common stock under our 2009 Bonus Plan and vesting of restricted stock awards under
our 2009 Performance Share Plan. Net cash provided by financing activities during the six months
ended June 30, 2009 included $40.0 million of borrowings under our Asahi Term Loan offset by $0.1
million in fees paid in connection with the Asahi debt issuance, $30.0 million in repayments of
borrowing under our credit and security agreement with GE and $0.5 million amendment fee paid in
connection with the March 16, 2009 amendment to our credit and security agreement with GE.
We have experienced negative operating margins and expect to continue to incur net losses in
the foreseeable future. Until the second quarter of 2010, we had experienced negative cash flows
from operating activities. There can be no assurance that we will be able to continue to generate positive
cash flows from operating activities. We believe, based on current projections and the current nature of our
business, that we have the required resources to fund our ongoing operating requirements. Future
capital requirements will depend on many factors, including the rate of revenue growth, continued
progress on improving gross margins, the expansion of selling and marketing and research and
development activities, the timing and extent of expansion into new geographies or territories, the
timing of new product introductions and enhancement to existing products, the continuing market
acceptance of products, the availability of credit, and the potential investments in, or
acquisitions of, complementary businesses, services or technologies.
Significant commitments and contingencies at June 30, 2010 are consistent with those discussed
in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations,
and Note 12 to the consolidated financial statements in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2009.
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 described in Item 7 in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2009. There have been no changes to our
critical accounting policies and estimates since December 31, 2009. This summary should be read in
conjunction with our condensed consolidated financial statements and the related notes included
elsewhere in this Quarterly Report on Form 10-Q.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements is included in Note 2 to the consolidated
financial statements included in our Annual Report on Form 10-K for the fiscal year ended December
31, 2009 and in Note 2 to the condensed consolidated financial statements included in this
quarterly report on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risks in the normal course of our business, including changes in
interest rates and exchange rates. For quantitative and qualitative disclosures about market risk
affecting us, see Item 7A, Quantitative and Qualitative Disclosures About Market Risk, of our
Annual Report on Form 10-K for the fiscal year ended December 31, 2009. There have been no
material changes to the market risks described in our Annual Report on Form 10-K for December 31,
2009.
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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 June 30, 2010.
The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, or the Exchange Act, means controls and other procedures of a
company that are designed to ensure that information required to be disclosed by a company in the
reports that it files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SECs rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to ensure that information
required to be disclosed by a company in the reports that it files or submits under the Exchange
Act is accumulated and communicated to the companys management, including its principal executive
and principal financial officers, as appropriate to allow timely decisions regarding required
disclosure. Our management recognizes that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30,
2010, our chief executive officer and chief financial officer concluded that, as of such date, our
disclosure controls and procedures were effective to achieve their stated purpose.
No change in our internal control over financial reporting (as defined in Rule 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2010 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
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PART II OTHER INFORMATION
Item 1A. Risk Factors
In addition to the factors discussed in Managements Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this report, the following are some of the
important risk factors that could cause our actual results to differ materially from those
projected in any forward-looking statements.
Risks Related to our Business
We expect to derive a significant percentage of our future revenues from the rental or sale of our
System One and a limited number of other products.
Since our inception, we have devoted a substantial amount of our efforts to the development of
the System One and the related products used with the System One. We commenced marketing the System
One and the related disposable products to the critical care market in February 2003. We commenced
marketing the System One for chronic hemodialysis treatment in September 2004. Prior to the
acquisition of the Medisystems Corporation and certain affiliated entities, or the Medisystems
Acquisition, on October 1, 2007, nearly 100% of our revenues were derived from the rental or sale
of our System One and the sale of related disposables. Although the Medisystems Acquisition
broadened our product offerings, we expect that in 2010 and in the foreseeable future, we will
continue to derive a significant percentage of our revenues from the System One, and that we will
derive the remainder of our revenues from the sale of a few key disposable products acquired in the
Medisystems Acquisition, including blood tubing sets and needles. To the extent that any of our
primary products are not commercially successful or are withdrawn from the market for any reason,
our revenues will be adversely impacted, and we do not have other significant products in
development that could readily replace these revenues.
We cannot accurately predict the size of the home hemodialysis market, and it may be smaller, and
may develop more slowly than we expect.
We believe our largest future product market opportunity is the home hemodialysis market.
However this market is presently very small and adoption of the home hemodialysis treatment options
has been limited. The most widely adopted form of dialysis therapy used in a setting other than a
dialysis clinic is peritoneal dialysis. Based on the most recently available data from the United
States Renal Data System, or USRDS, the number of patients receiving peritoneal dialysis was
approximately 26,000 in 2006, 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. 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. In addition, many dialysis clinics do not presently have the infrastructure in
place to support home hemodialysis and most do not have the infrastructure in place to support a
significant home hemodialysis patient population. Our long-term growth will depend on the number of
patients who adopt home-based hemodialysis and how quickly they adopt it, which in turn is driven
by the number of physicians willing to prescribe home hemodialysis and the number of dialysis
clinics able or willing to establish and support home hemodialysis therapies.
Because nearly all our home hemodialysis patients are also receiving more frequent dialysis,
meaning dialysis delivered five or more times a week, the market adoption of our System One for
home hemodialysis is also dependent upon the penetration and market acceptance of more frequent
hemodialysis. Given the increased provider supply costs associated with providing more frequent
dialysis versus conventional three-times per week dialysis, market acceptance will be impacted,
especially for Medicare patients by whether dialysis clinics are able to obtain reimbursement for
additional dialysis treatments provided in excess of three times a week. Presently, we understand
that a number of our customers are unable to obtain such additional reimbursement, and that there
are increased administrative burdens associated with articulating the medical justification for
treatments beyond three times per week. Both of these facts will likely negatively impact the rate
and extent of any further market expansion of our System One for home hemodialysis. Expanding
Medicare reimbursement over time to predictably cover more frequent therapy, with less
administrative burden for our customers, may be critical to our ability to significantly expand the
market penetration of the System One in the home market and to grow our revenue in the future.
New regulations particularly impacting home hemodialysis technologies can also negatively
impact the rate and extent of any further market expansion of our System One for home hemodialysis.
In 2008, CMS released new Conditions for Coverage applicable to our customers. These Conditions for
Coverage impose water testing requirements on our patients using our PureFlow SL product. These
water testing requirements increase the burden of our therapy for our patients and may impair
market adoption, especially for our PureFlow SL product. To the
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extent additional regulations are introduced unique to the home environment, market adoption
could be even further impaired.
We are in a developing market and we will need to continue to devote significant resources to
developing the home market. We cannot be certain that this market will develop, how quickly it will
develop or how large it will be.
Current Medicare reimbursement rates, at three times per week, limit the price at which we can
market our home products, and adverse changes to reimbursement would likely negatively affect the
adoption or continued sale of our home products.
Our ability to attain profitability will be driven in part by our ability to set or maintain
adequate pricing for our products. As a result of legislation passed by the United States Congress
more than 30 years ago, Medicare provides broad and well-established reimbursement in the United
States for ESRD. With approximately 75% of United States ESRD patients covered by Medicare, the
reimbursement rate is an important factor in a potential customers decision to use the System One
or our other products and limits the fee for which we can rent or sell our products. Additionally,
current CMS rules limit the number of hemodialysis treatments paid for by Medicare to three times a
week, unless there is medical justification provided by the patients physician for additional
treatments. Most patients using the System One in the home treat themselves, with the help of a
partner, up to six times per week. To the extent that Medicare contractors elect not to pay for the
additional treatments, adoption of the System One would likely be impaired. The determination of
medical justification must be made at the local Medicare contractor level on a case-by-case basis,
based on documentation provided by our customers. If daily therapy is prescribed, a clinics
decision as to how much it is willing to spend on dialysis equipment and services will be at least
partly dependent on whether Medicare will reimburse more than three treatments per week for the
clinics patients. Medicare is switching from intermediaries to Medicare authorized contractors.
This change in the reviewing entity for Medicare claims could lead to a change in whether a
customer receives Medicare reimbursement for additional treatments. If an adverse change to
historical payment practices occurs, market adoption of our System One in the home market may be
impaired. We understand that some of our customers may not be able to obtain additional
reimbursement for more frequent therapy in all cases, and that there are increased administrative
burdens associated with articulating the medical justification for treatments beyond three times a
week. Both of these factors will likely negatively impact the rate and extent of any further market
expansion of our System One for home hemodialysis. Expanding Medicare reimbursement over time to
more predictably cover more frequent therapy, with less administrative burden for our customers,
may be critical to our ability to significantly expand the market penetration of the System One in
the home market and to our revenue growth in the future. Additionally, any adverse changes in the
rate paid by Medicare for ESRD treatments in general would likely negatively affect demand for our
products in the home market and the prices we charge for them.
CMS issued, on July 23, 2010, the final rule for implementation of a new bundled payment for
dialysis treatment effective January 1, 2011. Under this new ESRD prospective payment system, CMS
will make a single bundled payment to the dialysis facility for each dialysis treatment that will
cover all renal dialysis services and home dialysis, and will include certain drugs (including
ESAs, iron, and Vitamin D). It will replace the current system which pays facilities a composite
rate for a defined set of items and services, while paying separately for drugs, laboratory tests,
or other services that are not included in the composite rate. The new bundled payment systems
still limits the number of hemodialysis treatments paid by Medicare to three times a week, unless
there is medical justification provided by the patients physician for additional treatments.
Although a stated goal of the new bundled payment system is to encourage home dialysis, and the
inclusion of drugs into the bundled rate and the retention of a home patient training payment
adjustment with a modest update from current levels are intended to support this goal, it is not
possible at this time to determine what impact the new bundle or healthcare legislation will have
on the adoption of home and/or daily hemodialysis or the price for which we can sell our products.
We require significant capital to build our business, and financing may not be available to us on
reasonable terms, if at all.
We have experienced negative operating margins and we expect to continue to incur net losses
in the foreseeable future. Until the second quarter of 2010, we had experienced negative cash
flows from operating activities. There can be no assurance that we will be able to continue to generate
positive cash flows from operating activities. In addition, our System One home market relies heavily upon a
rental sales model whereby less than half of our sales to customers in the home market include the
rental rather than the purchase of System One equipment. This sales model requires significant
amounts of working capital to manufacture System One equipment for rental to dialysis clinics. A
number of our home market customers, including DaVita, have purchased System One equipment, with
certain
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customers committed to purchase, rather than rent, the significant majority of their future System
One equipment requirements. There can, however, be no assurance that we will be able to continue
to expand the percentage of our equipment placements that are purchased rather than rented.
We believe, based on current projections and the current nature of our business, that we have
the required resources to fund our ongoing operating requirements. Future capital requirements
will depend on many factors, including the rate of revenue growth, continued progress on improving
gross margins, the expansion of selling and marketing and research and development activities, the
timing and extent of expansion into new geographies or territories, the timing of new product
introductions and enhancement to existing products, the continuing market acceptance of products,
the availability of credit, and the potential investments in, or acquisitions of, complementary
businesses, services or technologies. There is no assurance that additional debt or equity capital
will be available to us on favorable terms, if at all.
If we sell additional equity or issue debt securities to fund future capital requirements, it
will likely 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 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 would
likely harm our business.
We have limited operating experience, a history of net losses and an accumulated deficit of $294.0
million at June 30, 2010. We cannot guarantee if, when and the extent to which we will become
profitable, or that we will be able to maintain profitability if it is achieved.
Since inception, we have incurred losses every quarter, and at June 30, 2010, we had an
accumulated deficit of approximately $294.0 million. We expect our operating expenses to continue
to increase as we grow our business. While we have achieved positive gross margins for our
products, in aggregate, since the fourth quarter of 2007, and positive cash flows from operating activities,
beginning in the second quarter of 2010, we cannot provide assurance that our cash flows from
operating activities will remain positive, or improve, or that our gross margins will improve or, if they do
improve, the rate at which they will improve. We cannot provide assurance that we will achieve
profitability, when we will become profitable, the sustainability of profitability, should it
occur, or the extent to which we will be profitable. Our ability to become profitable depends
principally upon implementing design and process improvements to lower the costs of manufacturing
our products, obtaining better purchasing terms and prices, growing revenue, increasing reliability
of our products, improving the management of our field equipment base, achieving efficiencies in
manufacturing and supply chain overhead costs, achieving efficiencies in the distribution of our
products and achieving a sufficient scale of operations.
Our customers in the System One and In-Center segment are highly consolidated, with concentrated
buying power.
Fresenius and DaVita own and operate the two largest chains of dialysis clinics in the United
States. Collectively, these entities provide treatment to approximately 60% of United States
dialysis patients. Additionally, DaVita has certain dialysis supply purchase obligations to Gambro
under a long-term preferred supplier agreement. 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. DaVita is our most significant customer, and we expect it
to continue to be, at least for the foreseeable future. Our earlier agreement with DaVita
contained certain limited exclusivity rights which restricted our ability to sell the System One in
certain markets, and to Fresenius. These restrictions do not exist under our July 2010 Amended and
Restated National Service Provider Agreement with DaVita, and we have a small, but growing,
percentage of our home market sales to Fresenius. However, we have no assurance that our sales to
DaVita or Fresenius will continue to grow. With less than 40% of United States dialysis patients
cared for by independent dialysis clinics, our market adoption, at least within the United States,
will be more constrained without the presence of one or both of DaVita and Fresenius as customers
for our System One and In-Center products.
DaVita is a key customer for our System One and In-Center product lines. The partial or complete
loss of DaVita as a customer would materially impair our financial results, at least in the near
term.
DaVita is our most significant customer. Sales through distributors to DaVita of products
accounted for nearly half of In-Center segment revenues for the three and six months ended June 30,
2010, and direct sales to DaVita accounted for approximately 35% of our System One segment revenues
for both the three and six months
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ended June 30, 2010. Further, DaVita is our largest customer in the home market, constituting
over 40% of our home hemodialysis patients. Although we expect that DaVita will continue to be a
significant customer in the home market, we cannot be certain that DaVita will continue to purchase
and/or rent the System One or add additional System One patients in the future. Our contract for
needles with DaVita, expiring in December 2013, includes certain minimum order requirements;
however, these can be reduced significantly under certain circumstances. Our contract for blood
tubing sets with DaVita expired in September 2009. However, in June 2009, we entered into a five
year distribution agreement in the United States with Gambro, pursuant to which Gambro will
exclusively supply our blood tubing sets, including our ReadySet and the Streamline product lines
to DaVita. The partial or complete loss of DaVita as a customer for any of these product lines
would adversely affect our business, at least in the near term. Further, given the significance of
DaVita as a customer, any change in DaVitas ordering or clinical practices could have a
significant impact on our revenues, especially in the near term.
We entered into a $40.0 million term loan and security agreement with Asahi in May 2009. We are
obligated to pay 50% of the interest on the first day of November and May, beginning on November 1,
2009, and repay the remaining interest and principal upon maturity in May 2013. If we fail to
comply with all terms under this agreement, we may go into default, which could trigger, among
other things, the acceleration of all of our indebtedness thereunder or the sale of our assets.
In May 2009, we entered into a $40.0 million term loan, with Asahi. The four year term loan
bears interest at 8% annually, payable on the first day of November and May beginning on November
1, 2009, with 50% of the interest deferred to maturity. The term loan is secured by substantially
all of our assets.
The term loan and security agreement includes certain affirmative covenants including timely
filings and limitations on contingent debt obligations and sales of assets. The term loan and
security agreement also contains customary events of default, including nonpayment,
misrepresentation, breach of covenants, material adverse effects, and bankruptcy. In the event we
fail to satisfy our covenants, or otherwise go into default, Asahi has a number of remedies,
including sale of our assets and acceleration of all outstanding indebtedness. Certain of these
remedies would likely have a material adverse effect on our business.
We entered into a two year Loan and Security Agreement, the Agreement, dated as of March 10, 2010,
with Silicon Valley Bank, or SVB. The terms of our Agreement may restrict our current and future
operations, which could affect our ability to respond to changes in our business and to manage our
operations.
On March 10, 2010, we entered into an Agreement with SVB for a $15.0 million revolving line of
credit with a maturity date of April 1, 2012. The Agreement is secured by all or substantially all
of our assets. In connection with this Agreement, we amended our term loan and security agreement
with Asahi to provide for certain amendments, including granting to Asahi junior liens on
certain of our assets for so long as the agreement with SVB remains outstanding.
Upon termination of all obligations under that facility, Asahis security will revert to a security
in all assets other than cash, bank accounts, accounts receivable, field equipment and inventory.
Borrowings under the Agreement bear interest at a floating rate per annum equal to two percentage
points (2.00%) above the prime rate (initial prime rate of 4%). Pursuant to the Agreement, we have
agreed to certain financial covenants relating to liquidity requirements and adjusted EBITDA, as
defined in our agreement with SVB. The Agreement contains events of default customary for
transactions of this type, including nonpayment, misrepresentation, breach of covenants, material
adverse effect and bankruptcy.
As of the date hereof, we do not have an outstanding balance on the Agreement. However, were
we to draw on the Agreement, in the event we fail to satisfy our covenants, or otherwise go into
default, SVB has a number of remedies, including sale of our assets and acceleration of all
outstanding indebtedness. Certain of these remedies would likely have a material adverse effect on
our business.
We compete against other dialysis equipment manufacturers with much greater financial resources and
established products and customer relationships, which may make it difficult for us to penetrate
the market and achieve significant sales of our products. Our competitors may also introduce new
products or features that could impair the competitiveness of our own product portfolio.
Our System One in the critical care market competes against Gambro AB, Fresenius Medical Care
AG, Baxter Healthcare, B. Braun and others. Our System One in the home market is currently the
only system specifically indicated for use in the home market in the United States. Our product
lines in the in-center market compete directly against products produced by Fresenius Medical Care
AG, Gambro AB, Nipro, B. Braun, Baxter Healthcare, JMS and others. Our competitors each market one
or more FDA-cleared medical devices for the treatment of acute or
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chronic kidney failure. Each of these competitors offers products that have been in use for a
longer time than our System One, and in some instances many of our Medisystems 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,
Fresenius owns and operates a chain of dialysis clinics. The product lines of most of these
companies are broader than ours, enabling them to offer a broader bundle of products and have
established sales forces and distribution channels that may afford them a significant competitive
advantage.
The market for our products is competitive, subject to change and affected by new product
introductions and other market activities of industry participants, including increased
consolidation of ownership of clinics by large dialysis chains. If we are successful, our
competitors are likely to develop products that offer features and functionality similar to our
products, including our System One. Improvements in existing competitive products or the
introduction of new competitive products may make it more difficult for us to compete for sales,
particularly if those competitive products demonstrate better reliability, convenience or
effectiveness or are offered at lower prices. Baxter has announced a research and development
collaboration with DEKA Research and Development Corporation and HHD, LLC, or DEKA, and has
recently indicated that it hopes to commence clinical studies of DEKAs new home hemodialysis
system in 2010 and launch in international markets in 2011. We are unable to predict when, if ever,
this product, or products from other companies, may attain regulatory clearance and appear in the
market, or how successful they may be should they be introduced, but if additional viable products
are introduced to the market, it would likely adversely affect our sales and growth. Our ability to
successfully market our products could also be adversely affected by pharmacological and
technological advances in preventing the progression of ESRD and/or in the treatment of acute
kidney failure or fluid overload. If we are unable to compete effectively against existing and
future competitors and existing and future alternative treatments and pharmacological and
technological advances, it will be difficult for us to penetrate the market and achieve significant
sales of our products.
Our continued growth is dependent on our development and successful commercialization of new and
improved products.
Our future success will depend in part on our timely development and introduction of new and
improved products that address changing market requirements. To the extent that we fail to
introduce new and innovative products or incremental product improvements, we may lose revenues or
market share to our competitors, which may be difficult to regain. Our inability, for technological
or other reasons, to successfully develop and introduce new or improved products could reduce our
growth rate or otherwise damage our business. We cannot assure you that our developments will keep
pace with the marketplace or that our new or improved products will adequately meet the
requirements of the marketplace.
The success and growth of our business will depend upon our ability to achieve expanded market
acceptance of our System One.
In the home market, we have to convince four distinct constituencies involved in the choice of
dialysis therapy, namely operators of dialysis clinics, nephrologists, dialysis nurses and
patients, that the System One provides an effective alternative to other existing dialysis
equipment. In the in-center market, we have to convince all of these constituencies, but to a
lesser degree, patients, that our blood tubing sets and needles provide an effective alternative to
other dialysis disposables. In the critical care market, we have to convince hospital purchasing
groups, hospitals, nephrologists, dialysis nurses and critical care nurses that our system provides
an effective alternative to other existing dialysis equipment. Each of these constituencies 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 any of our products, including the System One, for a number of
reasons including:
| the failure by us to demonstrate to operators of dialysis clinics, hospitals, nephrologists, dialysis nurses, patients and others that our products are equivalent or superior to existing therapy options; | ||
| competition from products sold by companies with longer operating histories and greater financial resources, more recognizable brand names and better established distribution networks and relationships with hospitals or dialysis clinics; | ||
| the failure by us to continue to improve product reliability and the ease of use of our products; |
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| limitations on the existing infrastructure in place to support home hemodialysis, including without limitation, home hemodialysis training nurses, and the willingness, cost associated with, and ability of dialysis clinics to build that infrastructure; | ||
| the ownership and operation of some dialysis providers by companies that also manufacture and sell competitive dialysis products; | ||
| the introduction of competing products or treatments that may be more effective, easier to use or less expensive than ours; | ||
| regulations that impose additional burden on patients and their caregivers, such as the recently adopted Medicare conditions for coverage which impose additional water testing requirements in connection with the use of our PureFlow SL; | ||
| the number of patients willing and able to perform therapy independently, outside of a traditional dialysis clinic, may be smaller than we estimate; and | ||
| the availability of satisfactory reimbursement from healthcare payors, including Medicare. |
If we are unable to convince additional hospitals and healthcare providers of the benefits of our
products for the treatment of acute kidney failure and fluid overload, we will not be successful in
increasing our market share in the critical care market.
We sell the System One in the critical care market for use in the treatment of acute kidney
failure and fluid overload. Physicians currently treat most acute kidney failure patients using
conventional hemodialysis systems or dialysis systems designed specifically for use in the
intensive care unit, or ICU. We will need to convince hospitals and healthcare providers that using
the System One is as effective as using conventional hemodialysis systems or ICU-specific dialysis
systems for treating acute kidney failure and that it provides advantages over conventional systems
or other ICU-specific systems because of its significantly smaller size, ease of operation and
clinical flexibility. In addition, the impact of tightened credit markets on hospitals could impair
the manner in which we sell products in the critical care market. Hospitals facing pressure to
reduce capital spending may choose to delay capital equipment purchases or seek alternative
financing options.
Our business and results of operations may be negatively impacted by general economic and financial
market conditions and such conditions may increase other risks that affect our business.
The worlds financial markets continue to experience significant turmoil, resulting in
reductions in available credit, increased costs of credit, increased volatility in security prices,
rating downgrades of investments and reduced valuations of securities generally. These events have
materially and adversely impacted the availability of financing to a wide variety of businesses and
the resulting uncertainty has led to reductions in capital investments, overall spending levels and
future product plans and sales projections. In general, we believe demand for our products in the
home and in-center market will not be substantially affected by the current market conditions as
regular dialysis is a life-sustaining, non-elective therapy. However, revenues in the in-center
market could be impacted by changes in sales volumes and inventory management policies of our
distributors and end customers. Finally, the impact of tightened credit markets on hospitals could
impair the manner and pace in which we sell equipment in the critical care market or delay
equipment placements. Hospitals facing pressure to reduce capital spending may choose to rent
equipment rather than purchase it outright, or to enter into other less-capital intensive purchase
structures with us, which may, in turn, have a negative impact on our cash flows.
Healthcare reform legislation could adversely affect our revenue and financial condition.
In recent years, there have been numerous initiatives on the federal and state levels for
comprehensive reforms affecting the payment for, the availability of and reimbursement for
healthcare services in the United States. These initiatives have ranged from proposals to
fundamentally change federal and state healthcare reimbursement programs, including providing
comprehensive healthcare coverage to the public under governmental funded programs, to minor
modifications to existing programs.
In March 2010, the U.S. Congress adopted and President Obama signed into law comprehensive
health care reform legislation through the passage of the Patient Protection and Affordable Health
Care Act (H.R. 3590) and the Health Care and Education Reconciliation Act (H.R. 4872). Among other
initiatives, these bills impose a 2.3% excise tax on domestic sales of medical devices following
December 31, 2012. Outside of the excise tax, which will impact our results of operations following
December 31, 2012, we cannot predict the effect such legislation will
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have on us. If significant reforms are made to the healthcare system in the United States, or
in other jurisdictions, those reforms may have a material adverse effect on our financial condition
and results of operations.
As our business continues to grow, we may have difficulty managing our growth and expanding our
operations successfully.
As our business continues to grow, we will need to expand our manufacturing, sales and
marketing and on-going development capabilities or contract with other organizations to provide
these capabilities for us. As our operations expand, we expect that we will need to manage
additional relationships with various partners, suppliers, manufacturers and other organizations.
Our ability to manage our operations and growth requires us to continue to improve our information
technology infrastructure, operational, financial and management controls 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.
If we are unable to improve or maintain strong product reliability for our products, our ability to
maintain or grow our business and achieve profitability could be impaired.
We have not yet achieved our long term reliability objectives for certain of our products, and
as a result we continue to incur increased service and distribution costs. This, in turn,
negatively impacts our gross margins and increases our working capital requirements. Additionally,
product reliability issues associated with any of our product lines could lead to decreases in
customer satisfaction and our ability to grow or maintain our revenues and could negatively impact
our reputation. We continue to work to improve product reliability for all products, and have
achieved some improvements to date. If we are unable to continue to improve product reliability,
our ability to achieve our growth objectives as well as profitability could be significantly
impaired.
We have a significant amount of System One field equipment, and our inability to effectively manage
this asset could negatively impact our working capital requirements and future profitability.
Because our home market relies upon an equipment service swap model and, for a significant
number of our customers, an equipment rental model, our ability to manage System One equipment is,
therefore important to minimizing our working capital requirements. Both factors require that we
maintain a significant level of field equipment of our System One and PureFlow SL hardware. In
addition, our gross margins may be negatively impacted if we have excess equipment deployed, and
unused, in the field. If we are unable to successfully track, service and redeploy equipment, we
could (1) incur increased costs, (2) realize increased cash requirements and/or (3) have material
write-offs of equipment. This would negatively impact our working capital requirements and future
profitability.
If kidney transplantation becomes a viable treatment option for more patients with ESRD, or if
medical or other solutions for renal replacement become viable, the market for our products may be
limited.
While kidney transplantation is the treatment of choice for most ESRD patients, it is not
currently a viable treatment for most- patients due to the limited number of donor kidneys, the
high incidence of kidney transplant rejection and the higher surgical risk associated with older
ESRD patients. According to USRDS data, in 2007, approximately 17,500 patients received kidney
transplants in the United States. The development of new medications designed to reduce the
incidence of kidney transplant rejection, progress in using kidneys harvested from genetically
engineered animals as a source of transplants or any other advances in kidney transplantation could
limit the market for our products. The development of viable medical or other solutions for renal
replacement may also limit the market for our products.
We could be subject to costly and damaging product and professional liability claims and may not be
able to maintain sufficient liability insurance to cover claims against us.
If any of our employees or products is found to have caused or contributed to injuries or
deaths, we could be held liable for substantial damages. Claims of this nature may also adversely
affect our reputation, which could damage our position in the market. While we maintain insurance,
including professional liability, product and excess liability claims may be brought against us
that could result in court judgments or settlements in amounts that are in excess of the limits of
our insurance coverage. In addition, due to the recent tightening of global credit and the
disruption in the financial markets, there may be a disruption in our insurance coverage or delay
or disruption in the payment of claims by our insurance providers. Our insurance policies also have
various exclusions, and we may be subject to a product or professional liability claim for which we
have no coverage. We will have to pay any amounts awarded by
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a court or negotiated in a settlement that exceed our coverage limitations or that are not covered
by our insurance.
Any product liability or professional liability claim brought against us, with or without
merit, could result in the increase of our product liability or professional liability insurance
rates, respectively, or the inability to secure additional insurance coverage in the future. A
product liability claim, whether meritorious or not, could be time consuming, distracting and
expensive to defend and could result in a diversion of management and financial resources away from
our primary business, in which case our business may suffer.
We maintain insurance at levels deemed adequate by management; however, future claims could exceed
our applicable insurance coverage.
We maintain insurance for property and general liability, directors and officers liability,
product liability, workers compensation, and other coverage in amounts and on terms deemed adequate
by management based on our expectations for future claims. Future claims could, however, exceed our
applicable insurance coverage, or our coverage could not cover the applicable claims.
We face risks associated with having international manufacturing operations, and if we are unable
to manage these risks effectively, our business could suffer.
We operate manufacturing facilities in Germany, Italy and Mexico. We also purchase components
and supplies from foreign vendors. We are subject to a number of risks and challenges that
specifically relate to these international operations, and we may not be successful if we are
unable to meet and overcome these challenges. Significant among these risks are risks relating to
foreign currency, in particular the Euro, Peso and Thai Baht. To the extent we fail to control our
exchange rate risk, our profitability could suffer and our ability to maintain mutually beneficial
and profitable relationships with foreign vendors could be impaired. In addition to these risks,
through our international operations, we are exposed to costs associated with sourcing and shipping
goods internationally, difficulty managing operations in multiple locations, local regulations that
may restrict or impair our ability to conduct our operations, and health issues, such as pandemic
disease risk, which could disrupt our manufacturing and logistical and import activities.
We currently rely upon Kawasumi, a third-party manufacturer, to manufacture a significant
percentage of our blood tubing set products using our supplied components and all of our needles.
Historically, we have relied upon a third-party manufacturer, Kawasumi, to manufacture a
significant percentage of our blood tubing set products using our supplied components. Kawasumi
has a strong history of manufacturing high-quality product for us. Kawasumis contractual
obligation to manufacture blood tubing sets expires in January 2011, with opportunities to extend
the term beyond that date. We cannot be certain that after the expiration of this agreement we
would be able to manufacture independently the volume of products currently manufactured by
Kawasumi, and therefore, whether we would have sufficient capacity to meet all of our customer
demand, that we would be able to manufacture products at the same cost at which we currently
purchase products from Kawasumi or that we could find a third party to supply blood tubing sets on
favorable terms, if at all, the failure of any of which could impair our business. We also depend
solely on Kawasumi for all of our finished goods needles. Kawasumis obligation to supply needles
to us expires in February 2011, with opportunities to extend the term beyond that date. In the
event this agreement is not renewed or extended on favorable terms, if at all, and we are unable to
manufacture comparable needles for ourselves prior to the contract expiration, or if we are unable
to obtain comparable needles from another third party on favorable terms, if at all, the revenues
and profitability of our business will be impaired.
Our In-Center segment relies heavily upon third-party distributors.
We sell the majority of our In-Center products through several distributors, which
collectively accounted for substantially all of In-Center revenues for the three and six months
ended June 30, 2010, with Henry Schein and Gambro being our most significant distributors. Our
distribution agreement with Henry Schein expires in April 2012. Our distribution agreement with
Gambro expires in June 2014. The loss of Gambro or Henry Schein as our distributors for any reason
could materially adversely affect our business, at least in the near term.
Unless we can demonstrate sufficient product differentiation in our blood tubing set business
through Streamline or products that we introduce in the future, we will continue to be susceptible
to further pressures to reduce product pricing and more vulnerable to the loss of our blood tubing
set business to competitors in the dialysis industry.
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Our blood tubing set business has historically been a commodities business. Prior to the
Medisystems Acquisition, Medisystems competed favorably and gained share through the development of
a high quality, low-cost, standardized blood tubing set, which could be used on several different
dialysis machines. Our products continue to compete favorably in the dialysis blood tubing set
business, but are increasingly subject to pricing pressures, especially given recent market
consolidation in the United States dialysis services industry, with Fresenius and DaVita
collectively controlling approximately 60% of the United States dialysis services business. Unless
we can successfully demonstrate to customers the differentiating features of the Streamline product
or products that we introduce in the future, we may be susceptible to further pressures to reduce
our product pricing and more vulnerable to the loss of our blood tubing set business to competitors
in the dialysis industry.
The activities of our business involve the import of finished goods into the United States from
foreign countries, subject to customs inspections and duties, and the export of components and
certain other products from other countries into Germany, Mexico and Thailand. To a lesser, but
increasing degree, our business also involves the export of finished goods from the United States
to foreign countries. If we misinterpret or violate these laws, or if laws governing our exemption
from certain duties change, we could be subject to significant fines, liabilities or other adverse
consequences.
We import into the United States disposable medical supplies from Germany, Thailand and
Mexico. We also import into the United States disposable medical components from Germany and Italy
and export components and assemblies into Mexico, Thailand and Italy. To a lesser, but increasing
degree, our business also involves the export of finished goods from the United States to foreign
countries. The import and export of these items are subject to extensive laws and regulations with
which we will need to comply. To the extent we fail to comply with these laws or regulations, or
fail to interpret our obligations accurately, we may be subject to significant fines, liabilities
and a disruption to our ability to deliver product, which could cause our combined businesses and
operating results to suffer. To the extent there are modifications to the Generalised System of
Preferences or cancellation of the Nairobi Protocol Classification such that our products would be
subject to duties, our profitability would also be negatively impacted.
The success of our business depends on the services of each of our senior executives as well as
certain key engineering, scientific, manufacturing, clinical and marketing personnel, the loss of
whom could negatively affect the combined businesses.
Our success has always depended upon the skills, experience and efforts of our senior
executives and other key personnel, including our research and development and manufacturing
executives and managers. Much of our expertise is concentrated in relatively few employees, the
loss of whom for any reason could negatively affect our business. Competition for our highly
skilled employees is intense and we cannot prevent the future resignation of any employee. We
maintain key person insurance for only one of our executives, Jeffrey Burbank, our President and
Chief Executive Officer.
Risks Related to the Regulatory Environment
We are subject to significant regulation, primarily by the FDA. We cannot market or commercially
distribute our products without obtaining and maintaining necessary regulatory clearances or
approvals.
Our products are medical devices subject to extensive regulation in the United States, and in
foreign markets we may wish to enter. To market 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 our products.
Presently, we are pursuing a nocturnal indication for the System One under an IDE study started in
the first quarter of 2008. We recently completed the IDE study and have submitted the associated
510(k). We cannot provide assurance that this or other clearances or approvals will 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. Although the 510k regulation has not changed,
it is under review and based on comments made by FDA in public forums, changes are likely.
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Modifications to our marketed devices may require new regulatory clearances or pre-market
approvals, or may require us to cease marketing or recall the modified devices until clearances or
approvals are obtained.
Any modifications to a 510(k) cleared device that could significantly affect its safety or
effectiveness, or would constitute a major change in its intended use, requires the submission of
another 510(k) pre-market notification to address the change. Although in the first instance we may
determine that a change does not rise to a level of significance that would require us to make a
pre-market notification submission, the FDA may disagree with us and can require us to submit a
510(k) for a significant change in the labeling, technology, performance specifications or
materials or major change or modification in intended use, despite a documented rationale for not
submitting a pre-market notification. We have modified various aspects of our products and have
filed and received clearance from the FDA with respect to some of the changes in the design of our
products. If the FDA requires us to submit a 510(k) for any modification to a previously cleared
device, or in the future a device that has received 510(k) clearance, we may be required to cease
marketing the device, recall it, and not resume marketing until we obtain clearance from the FDA
for the modified version of the device. Also, we may be subject to regulatory fines, penalties
and/or other sanctions authorized by the Federal Food, Drug, and Cosmetic Act. In the future, we
intend to introduce new products and enhancements and improvements to existing products. We cannot
provide assurance that the FDA will clear any new product or product changes for marketing or what
the timing of such clearances might be. In addition, new products or significantly modified
marketed products could be found to be not substantially equivalent and classified as products
requiring the FDAs approval of a pre-market approval application, or PMA, before commercial
distribution would be permissible. PMAs usually require substantially more data than 510(k)
submissions and their review and approval or denial typically takes significantly longer than a
510(k) decision of substantial equivalence. Also, PMA products require approval supplements for any
change that affects safety and effectiveness before the modified device may be marketed. Delays in
our receipt of regulatory clearance or approval will cause delays in our ability to sell our
products, which will have a negative effect on our revenues growth.
Even if we obtain the necessary 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
FDAs 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:
| untitled letters, warning letters, fines, injunctions and civil penalties; | ||
| administrative detention, which is the detention by the FDA of medical devices believed to be adulterated or misbranded; | ||
| customer notification, or orders for repair, replacement or refund; | ||
| voluntary or mandatory recall or seizure of our products; | ||
| operating restrictions, partial suspension or total shutdown of production; | ||
| refusal to review pre-market notification or pre-market approval submissions; | ||
| rescission of a substantial equivalence order or suspension or withdrawal of a pre-market approval; and | ||
| criminal prosecution. |
Our products are subject to market withdrawals or product recalls after receiving FDA clearance or
approval, and market withdrawals and product recalls could cause the price of our stock to decline
and expose us to product liability or other claims or could otherwise harm our reputation and
financial results.
Medical devices can experience performance problems in the field that require review and
possible corrective action by us or the product manufacturer. We cannot provide assurance that
component failures, manufacturing errors, design defects and/or labeling inadequacies, which could
result in an unsafe condition or injury to the operator or the patient will not occur. These could
lead to a government mandated or voluntary recall by us. The FDA has the authority to require the
recall of our products in the event a product presents a reasonable probability that it would cause
serious adverse health consequences or death. Similar regulatory agencies in other countries have
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similar authority to recall devices because of material deficiencies or defects in design or
manufacture that could endanger health. We believe that the FDA would request that we initiate a
voluntary recall if a product was defective or presented a risk of injury or gross deception. Any
recall would divert management attention and financial resources, could cause the price of our
stock to decline and expose us to product liability or other claims and harm our reputation with
customers.
If we or our contract manufacturers fail to comply with FDAs Quality System Regulations, our
manufacturing operations could be interrupted, and our product sales and operating results could
suffer.
Our finished goods manufacturing processes, and those of some of our contract manufacturers,
are required to comply with the FDAs Quality System Regulations, or QSRs, which cover the
procedures and documentation of the design, testing, production, control, quality assurance,
labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces its QSRs
through periodic unannounced inspections of manufacturing facilities. We and our contract
manufacturers have been, and anticipate in the future being, subject to such inspections. We were
inspected by the FDA in the second quarter of 2010, and received no observations. While all of our
previous inspections have resulted in no significant observations, we cannot provide assurance that
we can maintain a comparable level of regulatory compliance in the future at our facilities, or
that future inspections would have the same result.
If one of our manufacturing facilities or those of any of our contract manufacturers fails to
take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take
enforcement action, including issuing a public warning letter, shutting down our manufacturing
operations, embargoing the import of components from outside of the United States, recalling our
products, refusing to approve new marketing applications, instituting legal proceedings to detain
or seize products or imposing civil or criminal penalties or other sanctions, any of which could
cause our business and operating results to suffer.
Failure to obtain regulatory approval in foreign jurisdictions would prevent us from marketing our
products outside the United States.
Historically, we have not sold or marketed the System One outside the United States and
Canada. In 2009, we began entering into arrangements with distributors to sell the System One and
certain of our other products outside of the United States. We are currently selling the System
One in Europe and the Middle East, and are assessing other international markets for the System One
as well. Our In-Center products are presently sold in the United States as well as in several
other countries, through distributors. We presently have CE marking as well as Canadian regulatory
authority to sell our System One as well as certain other products in Canada and Europe. However,
in order to market directly our products in other foreign jurisdictions, we must obtain separate
regulatory approvals and comply with numerous and varying regulatory requirements. The approval
procedure varies from country to country and can involve additional testing. The time required to
obtain approval abroad may be longer than the time required to obtain FDA clearance. The foreign
regulatory approval process includes many of the risks associated with obtaining FDA clearance and
we may not obtain foreign regulatory approvals on a timely basis, if at all. FDA clearance does not
ensure approval by regulatory authorities in other countries, and approval by one foreign
regulatory authority does not ensure approval by regulatory authorities in other foreign countries.
We may not be able to file for regulatory approvals and may not receive necessary approvals to
commercialize our products in any market outside the United States, which could negatively affect
our overall market penetration. Additionally, any loss of foreign regulatory approvals, for any
reason, could negatively affect our business.
We have obligations under our contracts with dialysis clinics and hospitals to protect the privacy
of patient health information.
In the course of performing our business we obtain, from time to time, confidential
patient health information. For example, we learn patient names and addresses when we ship our
System One supplies to home hemodialysis patients. We may learn patient names and be exposed to
confidential patient health information when we provide training on our products to our customers
staff. Our home hemodialysis patients may also call our customer service representatives directly
and, during the call, disclose confidential patient health information. United States federal and
state laws protect the confidentiality of certain patient health information, in particular
individually identifiable information, and restrict the use and disclosure of that information. At
the federal level, the Department of Health and Human Services promulgated health information and
privacy and security rules under the Health Insurance Portability and Accountability Act of 1996,
or HIPAA. At this time, we are not a HIPAA covered entity. However, we have entered into business
associate agreements with covered entities that contain commitments to protect the
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privacy and security of patients health information and, in some instances, require that we
indemnify the covered entity for any claim, liability, damage, cost or expense arising out of or in
connection with a breach of the agreement by us. If we were to violate one of these agreements, we
could lose customers and be exposed to liability and/or our reputation and business could be
harmed. In addition, the Health Information Technology for Economic and Clinical Health Act
(HITECH), enacted in February 2009, expands the HIPAA privacy and security rules, including
imposing many of the requirements of those rules directly on business associates and making
business associates directly subject to HIPAA civil and criminal enforcement provisions and
associated penalties. Many of these requirements went into effect on February 17, 2010. We may be
required to make costly system modifications to comply with the HIPAA privacy and security
requirements. Our failure to comply may result in criminal and civil liability.
Many other federal and state laws apply to the use and disclosure of health information,
as well as certain financial information, which could affect the manner in which we conduct our
business. Such laws are not necessarily preempted by HIPAA, in particular those laws that afford
greater protection to the individual than does HIPAA or cover different subject matter. Such state
laws typically have their own penalty provisions, which could be applied in the event of an
unlawful action affecting health information.
We are subject to federal and state laws prohibiting kickbacks and false and fraudulent claims
which, if violated, could subject us to substantial penalties. Additionally, any challenges to or
investigation into our practices under these laws could cause adverse publicity and be costly to
respond to, and thus could harm our business.
The Medicare/Medicaid anti-kickback laws, and 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. A number of states have
enacted laws that require pharmaceutical and medical device companies to monitor and report
payments, gifts and other remuneration made to physicians and other health care professionals and
health care organizations. Some state statutes, such as the one in Massachusetts, impose an
outright ban on gifts to physicians. These laws are often referred to as gift ban or aggregate
spend laws and carry substantial fines if they are violated. Similar legislation, known as the
Physician Payments Sunshine Act, has been introduced in Congress each year for the past several
years but has not yet been enacted. These laws affect our sales, marketing and other promotional
activities by limiting the kinds of financial arrangements, including sales programs; we may have
with hospitals, physicians or other potential purchasers or users of medical devices. They also
impose additional administrative and compliance burdens on us. In particular, these laws
influence, among other things, how we structure our sales and rental offerings, including discount
practices, customer support, education and training programs and physician consulting and other
service arrangements. Although we seek to structure such arrangements in compliance with 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 products to a customer, we could be subject to a
claim under the Medicare/Medicaid anti-kickback laws or similar state laws. If we fail to comply
with particular reporting requirements, we could be subject to penalties under applicable
Medicare/Medicaid anti-kickback laws or similar state 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.
Foreign governments tend to impose strict price controls, which may adversely affect our future
profitability.
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Presently, our marketing efforts have been confined nearly exclusively to the United States.
We have had limited activities in Canada with our System One, and in certain other jurisdictions
with our In-Center products sold through distributors. In 2009, we began entering into
arrangements with distributors to sell the System One and certain of our other products in Europe
and the Middle East. We may, in the future, seek 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 our products to other available therapies. If reimbursement of
our products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory
levels, it may not be profitable to sell our products outside of the United States, which would
negatively affect the long-term growth of our business. Further, reimbursement provided to our
products in other jurisdictions could change, positively or negatively. In the event
reimbursements were to be negatively changed, such as, for example, in the United Kingdom, our
ability to sell our products could be impaired.
Failure to comply with the United States Foreign Corrupt Practices Act could subject us to
penalties and other adverse consequences.
We are subject to the United States Foreign Corrupt Practices Act which generally prohibits
United States companies from engaging in bribery or other prohibited payments to foreign officials
for the purpose of obtaining or retaining business and requires companies to maintain accurate
books and records and internal controls, including at foreign controlled subsidiaries. While we
have policies and procedures in place designed to prevent noncompliance, we can make no assurance
that our employees or other agents will not engage in prohibited conduct under the Foreign Corrupt
Practices Act for which we might be held responsible. If our employees or other agents are found to
have engaged in such practices, we could suffer severe penalties and other consequences that may
have a material adverse effect on our business, financial condition and results of operations.
Our business activities involve the use of hazardous materials, which require compliance with
environmental and occupational safety laws regulating the use of such materials. If we violate
these laws, we could be subject to significant fines, liabilities or other adverse consequences.
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 obtain some of our raw materials or components from a single source or a limited group of
suppliers. We also obtain sterilization services from a single supplier. The partial or complete
loss of one of these suppliers could cause significant production delays, an inability to meet
customer demand and a substantial loss in revenues.
We depend on a number of single-source suppliers for some of the raw materials and components
we use in our products. We also obtain sterilization services from a single supplier. Membrana GmbH
is our sole supplier of the fiber used in our filters for System One products. Kawasumi is our only
supplier of needles. We also obtain certain other products and components from other single source
suppliers or a limited group of suppliers. Our dependence on single source suppliers of components,
subassemblies and finished goods exposes us to several risks, including disruptions in supply,
price increases, late deliveries, and an inability to meet customer demand. This could lead to
customer dissatisfaction, damage to our reputation, or customers switching to competitive products.
Any interruption in supply could be particularly damaging to our customers using the System One to
treat chronic ESRD and who need access to the System One and related disposables.
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 the case of Membrana, for
fiber, we are contractually prevented from obtaining an alternative source of supply for our System
One products. In the case of other suppliers, 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 or other products and, potentially, further FDA clearance or approval of
any modification, thereby causing further costs and delays.
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Resin is a key input material to the manufacture of our products and System One cartridge. Oil
prices affect both the pricing and availability of this material. Escalation of oil prices could
affect our ability to obtain sufficient supply of resin at the prices we need to manufacture our
products at current rates of profitability.
We currently source resin from a small number of suppliers. Rising oil prices over the last
several years have resulted in significant price increases for this material. We cannot guarantee
that prices will not continue to increase. Our contracts with customers restrict our ability to
immediately pass on these price increases, and we cannot guarantee that future pricing to customers
will be sufficient to accommodate increasing input costs.
Distribution costs represent a significant percentage of our overall costs, and these costs are
dependent upon fuel prices. Increases in fuel prices could lead to increases in our distribution
costs, which, in turn, could impair our ability to achieve profitability.
We currently incur significant inbound and outbound distribution costs. Our distribution costs
are dependent upon fuel prices. Increases in fuel prices could lead to increases in our
distribution costs, which could impair our ability to achieve profitability.
We have labor agreements with our production employees in Italy and in Mexico. We cannot guarantee
that we will not in the future face strikes, work stoppages, work slowdowns, grievances,
complaints, claims of unfair labor practices, other collective bargaining disputes or in Italy,
anti-union behavior, that may cause production delays and negatively impact our ability to deliver
our products on a timely basis.
Our wholly-owned subsidiary in Italy has a national labor contract with Contratto collettivo
nazionale di lavoro per gli addetti allindustria della gomma cavi elettrici ed affini e
allindustria delle materie plastiche, and our wholly-owned subsidiary in Mexico has entered into a
collective bargaining agreement with a Union named Mexico Moderno de Trabajadores de la Baja
California C.R.O.C. We have not to date experienced strikes, work stoppages, work slowdowns,
grievances, complaints, claims of unfair labor practices, other collective bargaining disputes, or
in Italy, anti-union behavior, however we cannot guarantee that we will not be subject to such
activity in the future. Any such activity would likely cause production delays, and negatively
affect our ability to deliver our production commitments to customers, which could adversely affect
our reputation and cause our combined businesses and operating results to suffer. Additionally,
some of our key single source suppliers have labor agreements. We cannot guarantee that we will not
have future disruptions, which could adversely affect our reputation and cause our business and
operating results to suffer.
We do not have long-term supply contracts with many of our third-party suppliers.
We purchase raw materials and components from third-party suppliers, including some single
source suppliers, through purchase orders and do not have long-term supply contracts with many of
these third-party suppliers. Many of our third-party suppliers are not obligated to perform
services or supply products for any specific period, in any specific quantity or at any specific
price, except as may be provided in a particular purchase order. We do not maintain large volumes
of inventory from most of our suppliers. If we inaccurately forecast demand for finished goods, our
ability to meet customer demand could be delayed and our competitive position and reputation could
be harmed. In addition, if we fail to effectively manage our relationships with these suppliers, we
may be required to change suppliers, which would be time consuming and disruptive and could lead to
disruptions in product supply, which could permanently impair our customer base and reputation.
Certain of our products are recently developed and we have recently transitioned the manufacturing
of certain of these products to new locations. We, and certain of our third-party manufacturers,
have limited manufacturing experience with these products.
We continue to develop new products and make improvements to existing products. As such, we
and certain of our third-party manufacturers, have limited manufacturing experience with certain of
our products. We are more exposed to risks relating to product quality and reliability until the
manufacturing processes for these new products mature.
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
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limited protection and may not:
| prevent our competitors from duplicating our products; | ||
| prevent our competitors from gaining access to our proprietary information and technology; or | ||
| permit us to gain or maintain a competitive advantage. |
Any of our patents, including those we license, may be challenged, invalidated, circumvented
or rendered unenforceable. We cannot provide assurance that we will be successful should one or
more of our patents be challenged for any reason. If our patent claims are rendered invalid or
unenforceable, or narrowed in scope, the patent coverage afforded our products could be impaired,
which could make our products less competitive.
We hold multiple U.S. and foreign patents and license multiple patients under our license
agreement with DSU Medical Corporation. 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 equivalent national courts or patent offices
elsewhere may invalidate our patents or find them unenforceable. Competitors may also be able to
design around our patents. Our patents and patent applications cover particular aspects of our
products. Other parties may develop and obtain patent protection for more effective technologies,
designs or methods for treating kidney failure. If these developments were to occur, it would
likely have an adverse effect on our sales.
The laws of foreign countries may not protect our intellectual property rights effectively or
to the same extent as the laws of the United States. If our intellectual property rights are not
adequately protected, we may not be able to commercialize our technologies, products or services
and our competitors could commercialize similar technologies, which could result in a decrease in
our revenues and market share.
Our products could infringe the intellectual property rights of others, which may lead to
litigation that could itself be costly, could result in the payment of substantial damages or
royalties, and/or prevent us from using technology that is essential to our products.
The medical device industry in general has been characterized by extensive litigation and
administrative proceedings regarding patent infringement and intellectual property rights. Products
to provide kidney replacement therapy have been available in the market for more than 30 years and
our competitors hold a significant number of patents relating to kidney replacement devices,
therapies, products and supplies. Although no third party has threatened or alleged that our
products or methods infringe their patents or other intellectual property rights, we cannot provide
assurance that our products or methods do not infringe the patents or other intellectual property
rights of third parties. If our business is successful, the possibility may increase that others
will assert infringement claims against us.
Infringement and other intellectual property claims and proceedings brought against us,
whether successful or not, could result in substantial costs and harm to our reputation. Such
claims and proceedings can also distract and divert management and key personnel from other tasks
important to the success of the business. In addition, intellectual property litigation or claims
could force us to do one or more of the following:
| cease selling or using any of our products that incorporate the asserted intellectual property, which would adversely affect our revenues; | ||
| pay substantial damages for past use of the asserted intellectual property; | ||
| obtain a license from the holder of the asserted intellectual property, which license may not be available on reasonable terms, if at all and which could reduce profitability; and | ||
| redesign or rename, in the case of trademark claims, our products to avoid infringing the intellectual property rights of third parties, which may not be possible and could be costly and time-consuming if it is possible to do so. |
Confidentiality agreements with employees and others may not adequately prevent disclosure of trade
secrets and other proprietary information.
In order to protect our proprietary technology and processes, we also rely in part on
confidentiality agreements
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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 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:
| timing of market launch and/or market acceptance of our products; | ||
| timing of achieving profitability from operations; | ||
| changes in estimates of our financial results or recommendations by securities analysts or the failure to meet or exceed securities analysts expectations; | ||
| actual or anticipated variations in our quarterly operating results; | ||
| future debt or equity financings; | ||
| developments or disputes with key vendors or customers; | ||
| disruptions in product supply for any reason, including product recalls, our failure to appropriately forecast supply or demand, difficulties in moving products across the border, or the failure of third party suppliers to produce needed products or components; | ||
| reports by officials or health or medical authorities, the general media or the FDA regarding the potential benefits of the System One or of similar dialysis products distributed by other companies or of daily or home dialysis; | ||
| announcements by the FDA of non-clearance or non-approval of our products, or delays in the FDA or other foreign regulatory agency review process; | ||
| product recalls; | ||
| defaults under our material contracts, including without limitation our credit agreement; | ||
| regulatory developments in the United States and foreign countries; | ||
| changes in third-party healthcare reimbursements, particularly a decline in the level of Medicare reimbursement for dialysis treatments; | ||
| litigation involving our company or our general industry or both; | ||
| announcements of technical innovations or new products by us or our competitors; | ||
| developments or disputes concerning our patents or other proprietary rights; |
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| our ability to manufacture and supply our products to commercial standards; | ||
| significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors; | ||
| departures of key personnel; and | ||
| investors general perception of our company, our products, the economy and general market conditions. |
The stock markets in general have experienced substantial volatility that has often been
unrelated to the operating performance of individual companies. These broad market fluctuations may
adversely affect the trading price of our common stock. In the past, following periods of
volatility in the market price of a companys securities, stockholders have often instituted class
action securities litigation against those companies. Such litigation, if instituted, could result
in substantial costs and diversion of management attention and resources, which could significantly
harm our profitability and reputation.
Anti-takeover provisions in our restated certificate of incorporation and amended and restated
bylaws and under Delaware law could make an acquisition of us more difficult and may prevent
attempts by our stockholders to replace or remove our current management.
Provisions in our restated certificate of incorporation and our amended and restated bylaws
may delay or prevent an acquisition of us. In addition, these provisions may frustrate or prevent
attempts by our stockholders to replace or remove members of our board of directors. Because our
board of directors is responsible for appointing the members of our management team, these
provisions could in turn affect any attempt by our stockholders to replace current members of our
management team. These provisions include:
| a prohibition on actions by our stockholders by written consent; | ||
| the ability of our board of directors to issue preferred stock without stockholder approval, which could be used to institute a poison pill that would work to dilute the stock ownership of a potential hostile acquirer, effectively preventing acquisitions that have not been approved by our board of directors; | ||
| advance notice requirements for nominations of directors or stockholder proposals; and | ||
| the requirement that board vacancies be filled by a majority of our directors then in office. |
In addition, because we are incorporated in Delaware, we are governed by the provisions of
Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of
15% of our outstanding voting stock from merging or combining with us for a period of three years
after the date of the transaction in which the person acquired in excess of 15% of our outstanding
voting stock, unless the merger or combination is approved in a prescribed manner. These provisions
would apply even if the offer may be considered beneficial by some stockholders.
If there are substantial sales of our common stock in the market by our large existing
stockholders, our stock price could decline.
If our existing stockholders sell a large number of shares of our common stock or the public
market perceives that existing stockholders might sell shares of common stock, the market price of
our common stock could decline significantly. We have 48,556,553 shares of common stock outstanding
as of June 30, 2010. Except where sales are made pursuant to an effective registration statement,
shares held by our affiliates may only be sold in compliance with the volume limitations of Rule
144. These volume limitations restrict the number of shares that may be sold by an affiliate in any
three-month period to the greater of 1% of the number of shares then outstanding, which
approximates 485,566 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.
At June 30, 2010, subject to certain conditions, holders of an aggregate of approximately
24,280,888 shares of our common stock have rights with respect to the registration of these shares
of common stock with the Securities and Exchange Commission, or SEC. If we register their shares of
common stock following the expiration of the lock-up agreements, they can more easily sell those
shares in the public market.
As of June 30, 2010, 10,270,704 shares of common stock are authorized for issuance under our
stock incentive plan, employee stock purchase plan and outstanding stock options. As of June 30,
2010, 8,490,150 shares were subject to outstanding options, of which 4,451,068 were exercisable and
can be freely sold in the public market upon
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issuance, subject to the restrictions imposed on our affiliates under Rule 144.
We have filed resale registration statement covering shares of our common stock that we sold in a
private placement and are obligated to file a resale registration statement with respect to the
resale by DaVita of any shares issued under its warrant. If the holders of these shares or shares
issued pursuant to the terms of the warrant are unable to sell these shares under the respective
registration statements, we may be obligated to pay them damages, which could harm our financial
condition. Further, these resale registration statements could result in downward pressure on the
price of our common stock and may affect the ability of our stockholders to realize the current
trading price of our common stock.
In 2008, we sold an aggregate of 9,555,556 shares of our common stock and warrants to purchase
an additional 1,911,111 shares of our common stock in a private placement. We were required to
register the common stock and the common stock issuable upon exercise of the warrants with the
Securities and Exchange Commission, which we did on August 8, 2008. If the holders of the shares or
the accompanying warrant shares are unable to sell such shares or warrant shares under the
registration statement for more than 30 days in any 365 day period after the effectiveness of the
registration statement, we may be obligated to pay damages equal to up to 1% of the share purchase
price per month that the registration statement is not effective and the investors are unable to
sell their shares.
On July 22, 2010, we issued to DaVita a warrant which, subject to the achievement of certain
System One growth targets, may be exercisable for up to a cumulative total of 5,500,000 shares of
our common stock. In connection with issuance of this warrant we entered into a registration
rights agreement with DaVita, pursuant to which (subject to certain conditions) we have agreed to
file, on or prior to April 1, 2011, a registration statement on Form S-3 with respect to the resale
by DaVita of any shares of our common stock issued to DaVita under the warrant. We are required to
use our best efforts to cause the registration statement to be declared effective as promptly as
possible after the filing but in any event not later than (i) July 30, 2011 or (ii) the date on
which any shares become exercisable and vested under the warrant, whichever is later.
Investors should be aware that the current or future market price of their shares of our
common stock could be negatively impacted by the sale or perceived sale of all or a significant
number of these shares that are available for sale pursuant to these registration statements or
that will be available for sale in the future.
Our outstanding warrants, and the provisions of our Term Loan with Asahi, may result in substantial
dilution to our stockholders.
Warrants held by DaVita and certain investors in our 2008 private placement could result in
the issuance of up to 7,133,329 additional shares of common stock. In addition, in the event our
Term Loan with Asahi reaches maturity, Asahi may require that all of the principal and interest on
the Term Loan that is unpaid as of the maturity date be converted into shares of our common stock,
with the number of shares to be determined based upon the average closing stock price of our common
stock during the thirty business days preceding the maturity date. The issuance and sale of any of
these shares could result in substantial dilution to our stockholders in the form of immediate and
substantial dilution in net tangible book value per share.
Our executive officers, 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 hold, in the
aggregate, approximately 57% of our outstanding common stock. David S. Utterberg, one of our
directors, holds approximately 16% of our outstanding common stock. As a result, these
stockholders, if acting together, may have the ability to determine the outcome of matters
submitted to our stockholders for approval, including the election and removal of directors and any
merger, consolidation or sale of all or substantially all of our assets and other extraordinary
transactions. The interests of this group of stockholders may not always coincide with our
corporate interests or the interests of other stockholders, and they may act in a manner with which
you may not agree or that may not be in the best interests of other stockholders. This
concentration of ownership may have the effect of:
| delaying, deferring or preventing a change in control of our company; | ||
| entrenching our management and/or Board; |
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| impeding a merger, consolidation, takeover or other business combination involving our company; or | ||
| discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company. |
We may grow through additional acquisitions, which could dilute our existing shareholders and could
involve substantial integration risks.
As part of our business strategy, we may acquire other businesses and/or technologies in the
future. We may issue equity securities as consideration for future acquisitions that would dilute
our existing stockholders, perhaps significantly depending on the terms of the acquisition. We may
also incur additional debt in connection with future acquisitions, which, if available at all, may
place additional restrictions on our ability to operate our business. Acquisitions may involve a
number of risks, including:
| difficulty in transitioning and integrating the operations and personnel of the acquired businesses, including different and complex accounting and financial reporting systems; | ||
| potential disruption of our ongoing business and distraction of management; | ||
| potential difficulty in successfully implementing, upgrading and deploying in a timely and effective manner new operational information systems and upgrades of our finance, accounting and product distribution systems; | ||
| difficulty in incorporating acquired technology and rights into our products and technology; | ||
| unanticipated expenses and delays in completing acquired development projects and technology integration; | ||
| management of geographically remote units both in the United States and internationally; | ||
| impairment of relationships with partners and customers; | ||
| customers delaying purchases of our products pending resolution of product integration between our existing and our newly acquired products; | ||
| entering markets or types of businesses in which we have limited experience; | ||
| potential loss of key employees of the acquired company; and | ||
| inaccurate assumptions of the acquired companys product quality and/or product reliability. |
As a result of these and other risks, we may not realize anticipated benefits from our
acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired
businesses and technologies could seriously harm our business.
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Item 6.
Exhibits*
Exhibit | ||
Number | ||
10.1 | First
Amended and Restated National Service Provider Agreement dated as of
July 22, 2010 between the Registrant and DaVita Inc.
|
|
10.2 | Warrant
to Purchase Shares of Common Stock dated July 22, 2010 issued to
DaVita Inc.
|
|
10.3 | Registration
Rights Agreement dated as of July 22, 2010 between the Registrant and
DaVita Inc.
|
|
31.1 | Certification of Chief Executive Officer pursuant to Exchange
Act Rules 13a-14(a) or 15d-14(a), as adopted pursuant to
Section 302 of Sarbanes-Oxley Act of 2002. |
|
31.2 | Certification of Chief Financial Officer pursuant to Exchange
Act Rules 13a-14(a) or 15d-14(a), as adopted pursuant to
Section 302 of Sarbanes-Oxley Act of 2002. |
|
32.1 | Certification of Chief Executive Officer pursuant to Exchange
Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of Sarbanes-Oxley Act of
2002. |
|
32.2 | Certification of Chief Financial Officer pursuant to Exchange
Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of Sarbanes-Oxley Act of
2002. |
* | Filed herewith. | |
| Confidential treatment requested as to certain portions, which portions are omitted and filed separately with the Securities and Exchange Commission. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NXSTAGE MEDICAL, INC. |
||||
By: | /s/ Robert S. Brown | |||
Robert S. Brown | ||||
Chief Financial Officer (Duly authorized officer and principal financial and accounting officer) |
||||
August 6, 2010
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