Attached files
file | filename |
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EX-31.1 - EX-31.1 - NxStage Medical, Inc. | b86124exv31w1.htm |
EX-32.2 - EX-32.2 - NxStage Medical, Inc. | b86124exv32w2.htm |
EX-32.1 - EX-32.1 - NxStage Medical, Inc. | b86124exv32w1.htm |
EX-31.2 - EX-31.2 - NxStage Medical, Inc. | b86124exv31w2.htm |
EX-10.33 - EX-10.33 - NxStage Medical, Inc. | b86124exv10w33.htm |
EX-10.32 - EX-10.32 - NxStage Medical, Inc. | b86124exv10w32.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 March 31, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 000-51567
NxStage Medical, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 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)
(Former Name, Former Address, and Former Fiscal year, If Changed Since Last Report)
( 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.
(Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
There
were 54,292,032 shares of the registrants common stock outstanding as of the close of
business on May 2, 2011.
NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2011
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2011
TABLE OF CONTENTS
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
(In thousands, except share data) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 99,930 | $ | 104,339 | ||||
Accounts receivable, net |
14,796 | 14,107 | ||||||
Inventory |
36,709 | 34,950 | ||||||
Prepaid expenses and other current assets |
2,355 | 2,084 | ||||||
Total current assets |
153,790 | 155,480 | ||||||
Property and equipment, net |
11,382 | 8,290 | ||||||
Field equipment, net |
13,710 | 13,660 | ||||||
Deferred cost of revenues |
40,339 | 40,081 | ||||||
Intangible assets, net |
24,712 | 25,412 | ||||||
Goodwill |
42,698 | 42,698 | ||||||
Other assets |
564 | 473 | ||||||
Total assets |
$ | 287,195 | $ | 286,094 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 21,037 | $ | 16,811 | ||||
Accrued expenses |
12,902 | 19,537 | ||||||
Current portion of long-term debt |
31 | 43 | ||||||
Total current liabilities |
33,970 | 36,391 | ||||||
Deferred revenues |
55,967 | 55,366 | ||||||
Long-term debt |
41,127 | 40,454 | ||||||
Other long-term liabilities |
4,985 | 1,754 | ||||||
Total liabilities |
136,049 | 133,965 | ||||||
Commitments and contingencies (Note 10) |
||||||||
Stockholders equity: |
||||||||
Undesignated preferred stock: par value
$0.001, 5,000,000 shares authorized; no
shares issued and outstanding as of March
31, 2011 and December 31, 2010 |
| | ||||||
Common stock: par value $0.001,
100,000,000 shares authorized; 54,678,198
and 54,043,317 shares issued as of March
31, 2011 and December 31, 2010,
respectively |
54 | 53 | ||||||
Additional paid-in capital |
473,117 | 465,642 | ||||||
Accumulated deficit |
(314,436 | ) | (308,426 | ) | ||||
Accumulated other comprehensive income |
314 | 85 | ||||||
Treasury stock, at cost: 447,929 and
325,104 shares as of March 31, 2011 and
December 31, 2010, respectively |
(7,903 | ) | (5,225 | ) | ||||
Total stockholders equity |
151,146 | 152,129 | ||||||
Total liabilities and stockholders equity |
$ | 287,195 | $ | 286,094 | ||||
See accompanying notes to these condensed consolidated financial statements.
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Table of Contents
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
(In thousands, except per share data) | ||||||||
Revenues |
$ | 50,564 | $ | 40,408 | ||||
Cost of revenues |
32,531 | 28,595 | ||||||
Gross profit |
18,033 | 11,813 | ||||||
Operating expenses: |
||||||||
Selling and marketing |
9,210 | 8,017 | ||||||
Research and development |
3,717 | 3,035 | ||||||
Distribution |
4,158 | 3,411 | ||||||
General and administrative |
5,582 | 4,938 | ||||||
Total operating expenses |
22,667 | 19,401 | ||||||
Loss from operations |
(4,634 | ) | (7,588 | ) | ||||
Other expense: |
||||||||
Interest expense |
(1,157 | ) | (1,108 | ) | ||||
Other expense, net |
(26 | ) | (117 | ) | ||||
(1,183 | ) | (1,225 | ) | |||||
Net loss before income taxes |
(5,817 | ) | (8,813 | ) | ||||
Provision for income taxes |
193 | 186 | ||||||
Net loss |
$ | (6,010 | ) | $ | (8,999 | ) | ||
Net loss per share, basic and diluted |
$ | (0.11 | ) | $ | (0.19 | ) | ||
Weighted-average shares outstanding, basic and diluted |
53,423 | 46,971 | ||||||
See accompanying notes to these condensed consolidated financial statements.
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NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
(In thousands) | ||||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (6,010 | ) | $ | (8,999 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: |
||||||||
Depreciation and amortization |
5,690 | 5,464 | ||||||
Stock-based compensation |
3,414 | 2,892 | ||||||
Other |
874 | 477 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(667 | ) | (766 | ) | ||||
Inventory |
(6,671 | ) | (6,654 | ) | ||||
Prepaid expenses and other assets |
(324 | ) | (556 | ) | ||||
Accounts payable |
3,985 | 940 | ||||||
Accrued expenses and other liabilities |
(3,887 | ) | 2,521 | |||||
Deferred revenues |
602 | 3,065 | ||||||
Net cash used in operating activities |
(2,994 | ) | (1,616 | ) | ||||
Cash flows from investing activities: |
||||||||
Purchases of property and equipment |
(623 | ) | (225 | ) | ||||
Net cash used in investing activities |
(623 | ) | (225 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from stock option and purchase plans |
1,451 | 883 | ||||||
Purchase of treasury stock |
(2,526 | ) | (1,741 | ) | ||||
Repayments on loans and lines of credit |
(15 | ) | (15 | ) | ||||
Net cash used in financing activities |
(1,090 | ) | (873 | ) | ||||
Foreign exchange effect on cash and cash equivalents |
298 | 80 | ||||||
Decrease in cash and cash equivalents |
(4,409 | ) | (2,634 | ) | ||||
Cash and cash equivalents, beginning of period |
104,339 | 21,720 | ||||||
Cash and cash equivalents, end of period |
$ | 99,930 | $ | 19,086 | ||||
Noncash Investing Activities |
||||||||
Transfers from inventory to field equipment |
$ | 4,595 | $ | 4,178 | ||||
Transfers from field equipment to deferred cost of revenues |
$ | 2,942 | $ | 3,542 | ||||
See accompanying notes to these condensed consolidated financial statements.
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NXSTAGE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Nature of Operations
We are a medical device company that develops, manufactures and markets innovative products
for the treatment of kidney failure, fluid overload and related blood treatments and procedures.
Our primary product, the NxStage System One, or System One, was designed to satisfy an unmet
clinical need for a system that can deliver the therapeutic flexibility and clinical benefits
associated with traditional dialysis machines in a smaller, portable, easy-to-use form that can be
used by healthcare professionals and trained lay users alike in a variety of settings, including
patient homes, as well as more traditional care settings such as hospitals and dialysis clinics.
Given its design, the System One is particularly well-suited for home hemodialysis and a range of
dialysis therapies including more frequent, or daily, dialysis, which clinical literature
suggests provides patients better clinical outcomes and improved quality of life. The System One is
cleared or approved for commercial sale in the United States, Europe, Canada and other select
markets for the treatment of acute and chronic kidney failure and fluid overload. The System One
is cleared specifically by the United States Food and Drug Administration, or FDA, for home
hemodialysis as well as therapeutic plasma exchange, or TPE, in a clinical environment. We also
sell needles and blood tubing sets primarily to dialysis clinics for the treatment of end-stage
renal disease, or ESRD, which we refer to as the in-center market. These products are cleared or
approved for commercial sale in the United States, Europe, Canada and other select markets. We
believe our largest future product market opportunity is for our System One used in the home
hemodialysis market, or home market, for the treatment of ESRD.
Over the past several years we have improved our cash flows from operating activities and
continue to work towards our long-term goal of positive cash flows from operating activities.
However, we expect cash flows from operating activities in the near term to fluctuate between
negative and positive on a quarterly basis, primarily due to changes in working capital. There can
be no assurance that we will be able to continue to improve cash flows from operating activities or
whether we will be able to generate positive cash flows from operating activities in the future.
We believe, based on current projections and the current nature of our business, that we have the
required resources to fund our ongoing operating requirements. Our ability to and the rate at
which we continue to improve cash flows from operating activities will depend on many factors,
including growing revenues, continued improvements in gross margins, leverage of our operating
infrastructure and continued sale versus rental of a significant percentage of our System One
equipment.
Basis of Presentation
The accompanying condensed consolidated financial statements as of March 31, 2011 and for the
three months then ended, and related notes, are unaudited but, in the opinion of our management,
include all adjustments, consisting of normal recurring adjustments that are necessary for fair
statement of the interim periods presented. Our unaudited condensed consolidated financial
statements have been prepared following the requirements of the Securities and Exchange Commission,
or SEC, for interim reporting. As permitted under these rules, we have condensed or omitted certain
footnotes and other financial information that are normally required by U.S. generally accepted
accounting principles, or GAAP. Our accounting policies are described in the notes to the
consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2010 and updated, as necessary, in this Quarterly Report on Form 10-Q. Operating
results for the three months ended March 31, 2011 are not necessarily indicative of results for the
entire fiscal year or future periods. The December 31, 2010 condensed consolidated balance sheet
contained herein was derived from audited financial statements, but does not include all
disclosures required by GAAP. For further information, refer to the consolidated financial
statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2010.
2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of NxStage
Medical, Inc. and our wholly-owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation.
Use of Estimates
The preparation of our condensed consolidated financial statements in conformity with GAAP
requires our management to make estimates and assumptions that affect reported amounts of assets
and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates.
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Revenue Recognition
We recognize revenue from product sales and services when earned. Revenues are recognized
when: (a) there is persuasive evidence of an arrangement, (b) the product has been shipped or
services and supplies have been provided to the customer, (c) the sales price is fixed or
determinable and (d) collection is reasonably assured.
Certain agreements with distributors allow for product returns and credits. For shipment of
product sold to distributors, revenue is recognized at the time of sale if a reasonable estimate of
future returns or credit can be made. If a reasonable estimate of future returns or credit cannot
be made, we recognize revenue using the sell-through method. Under the sell-through method,
revenue and related costs of revenue is deferred until the final resale of such products to end
customers.
In addition to contractually determined volume discounts, in many agreements we offer rebates
based on sales to specific end customers and discounts for early payment. Rebates and discounts are
recorded as a reduction of sales and trade accounts receivable, based on our best estimate of the
amount of probable future rebate or discount on current sales.
We enter into multiple-element arrangements that may include a combination of equipment,
related disposables and services. Effective January 1, 2011, we adopted Accounting Standards
Update, or ASU, No. 2009-13, Multiple Deliverable Revenue Arrangements, as required, using the
prospective method as permitted under the guidance. Accordingly, this guidance is being applied to
all revenue arrangements entered into or materially modified on or after January 1, 2011. The
impact of adopting this amended guidance on our results of operations has been limited to products
sold internationally through distributors in the System One segment, which revenue has not been
significant in the current or historical periods. ASU No. 2009-13 amended the previous guidance
for multiple-element arrangements. Pursuant to the amended guidance in ASU 2009-13 our revenue
arrangements with multiple elements are divided into separate units of accounting if specified
criteria are met, including whether the delivered element has stand-alone value to the customer,
and the consideration received is allocated among the separate units based on their respective
selling price, and the applicable revenue recognition criteria are applied to each of the separate
units.
Under the amended guidance we determine selling price using vendor specific objective evidence
(VSOE), if it exists, otherwise third-party evidence. If neither VSOE nor third-party evidence of
selling price exists for a unit of accounting, we use best estimated selling price (BESP). We
generally expect that we will not be able to establish third-party evidence due to the nature of
our products and the markets in which we compete, and, as such, we typically will determine selling
price using VSOE or BESP.
We determine BESP for an individual element based on consideration of both market and
Company-specific factors, including the selling price and profit margin for similar products, the
cost to produce the deliverable and the anticipated margin on that deliverable and the
characteristics of the varying markets in which the deliverable is sold.
The adoption of the amended guidance did not change the accounting for arrangements entered
into prior to January 1, 2011. Therefore, these arrangements with multiple elements were divided
into separate units of accounting if there was objective and reliable evidence of fair value of the
undelivered items and if other criteria were met, including whether the delivered element had
stand-alone value to the customer. If either criteria were not met, the arrangement was accounted
for as a single unit of accounting and the fees received upon the completion of delivery of
equipment were deferred and are recognized as revenue on a straight-line basis over the expected
term of our remaining obligation and direct costs relating to the delivered equipment are amortized
over the same period as the related revenue, while disposable products revenue is recognized on a
monthly basis upon delivery. The adoption of the amended guidance did
not have a material impact on our revenues for the three months ended March 31, 2011.
System One Segment
We derive revenue in the home market from the sales of hemodialysis therapy to customers in
which the customer either purchases or rents the System One and/or PureFlow SL hardware and
purchases a specified number of disposable products and service.
For customers that purchase the System One and PureFlow SL hardware, in the home U.S. market,
due to the depot service model whereby equipment requiring service is picked up and a replacement
device is shipped to the site of care, we recognize fees received from equipment sale as revenue
on a straight-line basis over the expected term of our remaining service obligation and direct
costs relating to the delivered equipment are deferred and amortized over the same expected period
as the related revenue. Disposable products revenue is recognized on a monthly basis upon
delivery.
Under the rental arrangements revenue is recognized on a monthly basis in accordance with
agreed upon contract terms and pursuant to binding customer purchase orders and fixed payment
terms.
Our sales arrangements with our international distributors are structured as direct product
sales and have no significant post delivery obligations with the exception of standard warranty
obligations. However, under the previous guidance, for
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arrangements entered into prior to January
1, 2011 we determined that we could not account for the sale of equipment as a separate unit of
accounting and, therefore, the fees received upon the completion of delivery of equipment were
deferred and recognized as revenue on a straight-line basis over the expected term of our remaining
service obligation and direct costs relating to the delivered equipment were amortized over the
same expected period as the related revenue. Under the amended guidance, for arrangements entered
into or materially modified on or after January 1, 2011, we will recognize revenues and related
direct costs upon delivery in accordance with contract terms. Disposable product revenue is
recognized on a monthly basis upon delivery under both the previous and amended guidance.
In the critical care market, we structure sales of the System One and disposable products as
direct product sales and have no significant post delivery obligations with the exception of
standard warranty obligations. Revenue from direct product sales is recognized upon delivery in
accordance with contract terms. Certain of these arrangements provide for training, technical
support and extended warranty services to our customers. We recognize training and technical
support revenue when the related services are performed. In the case of extended warranty, the
service revenue is recognized ratably over the warranty period.
In-Center Segment
Our In-Center segment sales are structured as direct product sales primarily through
distributors, and we have no significant post delivery obligations with the exception of standard
warranty obligations. Revenue from direct product sales is recognized upon delivery in accordance
with contract terms. Some of our distribution contracts for the In-Center segment contain minimum
volume commitments with negotiated pricing discounts at different volume tiers. Each agreement may
be canceled upon a material breach, subject to certain curing rights, and in many instances minimum
volume commitments can be reduced or eliminated upon certain events.
Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable is primarily limited to
certain customers to whom we make substantial sales. One customer represented 25% and 23% of
accounts receivable at March 31, 2011 and December 31, 2010 respectively.
Warranty Costs
We accrue estimated costs that we may incur under our product warranty programs at the time
the product revenue is recognized, based on contractual rights and historical experience. Warranty
expense is included in cost of revenues in the consolidated statements of operations. The following
is a rollforward of our warranty accrual (in thousands):
Balance at December 31, 2010 |
$ | 268 | ||
Provision |
148 | |||
Usage |
(129 | ) | ||
Balance at March 31, 2011 |
$ | 287 |
3. Inventory
Inventory includes material, labor and overhead, and is stated at lower of cost (first-in,
first-out) or market. The components of inventory are as follows (in thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Purchased components |
$ | 14,706 | $ | 14,928 | ||||
Work in process |
7,451 | 6,372 | ||||||
Finished goods |
14,552 | 13,650 | ||||||
$ | 36,709 | $ | 34,950 | |||||
4. Property and Equipment, Field Equipment and Deferred Cost of Revenues
Accumulated depreciation on property and equipment was $12.9 million and $11.8 million at
March 31, 2011 and December 31, 2010, respectively. Accumulated depreciation on field equipment
was $30.3 million and $29.1 million at March 31, 2011 and December 31, 2010, respectively.
In the first quarter of 2011, we recorded $3.1 million in fixed assets and other long-term
liabilities related to our construction of a new manufacturing facility in Germany pursuant to the
terms of our Dialyzer Production Agreement entered into in May 2009 with Asahi Kasei Kuraray
Medical, or Asahi. We are overseeing construction of this new facility and will
operate the new facility under a manufacturing agreement upon its completion. Asahi will fund
construction costs up to an original fixed amount; however, we will be responsible for any
additional costs. If the agreement is terminated, due to our
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breach, insolvency or bankruptcy
during the construction period, Asahi has the option to require us to pay for all amounts expended
for construction of the new facility. If such event occurs we would take title to the land and
any construction in process. Subsequent to the completion of construction, if the agreement is
terminated due to our breach, insolvency or bankruptcy or by us pursuant to certain terms of the
agreement, Asahi has the option to require us to purchase the new facility from them by paying one
hundred percent of the then net book value of the new facility, as calculated in accordance with
GAAP. Given these options and our involvement in the construction we are considered the owner of
the new facility, for accounting purposes, and will therefore record its cost as
construction-in-process and a corresponding liability for the construction cost funded by Asahi.
The $3.1 million recorded in the first quarter of 2011 reflects the construction costs incurred to
date in connection with this project.
5. Intangible Assets
Accumulated amortization on intangible assets was $9.8 million and $9.1 million at March 31,
2011 and December 31, 2010.
6. Comprehensive Loss
The following table presents the components of comprehensive loss (in thousands):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Net loss |
$ | (6,010 | ) | $ | (8,999 | ) | ||
Foreign currency translation gain (loss) |
229 | (8 | ) | |||||
Comprehensive loss |
$ | (5,781 | ) | $ | (9,007 | ) | ||
7. Net Loss per Share
Basic net loss per share is computed by dividing loss available to common stockholders (the
numerator) by the weighted-average number of common shares outstanding (the denominator) for the
period. The computation of diluted loss per share is similar to basic loss per share, except that
the denominator is increased to include the number of additional common shares that would have been
outstanding if the potentially dilutive common shares had been issued.
The following potential common stock equivalents, as calculated using the treasury stock
method, were not included in the computation of diluted net loss per share as their effect would
have been anti-dilutive due to the net loss incurred (in thousands):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Options to purchase common stock |
3,624 | 2,108 | ||||||
Restricted stock |
731 | 723 | ||||||
Warrants to purchase common stock |
1,174 | 776 | ||||||
Total |
5,529 | 3,607 | ||||||
8. Segment Disclosures
After an evaluation of the business activities regularly reviewed by our chief operating
decision-maker for which separate discrete financial information is available, we determined that
we have two reporting segments, System One and In-Center. The accounting policies of the
reportable segments are the same as those described in Note 2 to the consolidated financial
statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
The profitability measure employed by us and our chief operating decision maker for making
decisions about allocating resources to segments and assessing segment performance is segment
profit (loss), which consists of sales, less cost of sales, selling and marketing and distribution
expenses.
Our management measures are designed to assess performance of these operating segments
excluding certain items. As a result, certain corporate expenses are excluded from the segment
operating performance measures, including research and development expenses and general and
administrative expenses, as they are managed centrally.
Within the System One segment, we derive revenues from the sale and rental of the System One
and PureFlow SL equipment and the sale of disposable products in the home and critical care
markets. The home market is devoted to the treatment of ESRD patients in the home, while the
critical care market is devoted to the treatment of hospital-based patients with acute kidney
failure or fluid overload. Within the System One segment, we sell a similar technology platform of
the
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System One with different features to the home and critical care markets. Some of our largest
customers in the home market provide outsourced renal dialysis services to some of our customers in
the critical care market. Sales of product to both markets are made primarily through dedicated
sales forces and distributed directly to the customer, or the patient, with certain products sold
through distributors internationally.
Within the In-Center segment, we sell blood tubing sets and needles for hemodialysis and
needles for apheresis primarily for the treatment of ESRD patients at dialysis centers. Nearly all
In-Center products are sold through national distributors.
Our reportable segments consist of the following (in thousands):
System One | In-Center | Unallocated | Total | |||||||||||||
Three Months Ended March 31, 2011 |
||||||||||||||||
Revenues from external customers |
$ | 33,483 | $ | 17,081 | $ | | $ | 50,564 | ||||||||
Segment profit (loss) |
2,513 | 2,152 | (9,299 | ) | (4,634 | ) | ||||||||||
Segment assets |
88,252 | 17,302 | 181,641 | 287,195 | ||||||||||||
Three Months Ended March 31, 2010 |
||||||||||||||||
Revenues from external customers |
$ | 25,102 | $ | 15,306 | $ | | $ | 40,408 | ||||||||
Segment (loss) profit |
(1,279 | ) | 1,664 | (7,973 | ) | (7,588 | ) | |||||||||
Segment assets |
79,461 | 15,552 | 101,447 | 196,460 |
Substantially all of our revenues are derived from the sale of the System One and related
products, which cannot be used with any other dialysis system, and from needles and blood tubing
sets to customers located in the United States.
The following table summarizes the number of customers who individually comprise greater than
10% of total revenues:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Customer A |
21 | % | 23 | % | ||||
Customer B |
13 | % | 17 | % | ||||
Customer C |
13 | % | 14 | % |
Sales to Customer A are primarily in the System One segment and sales to Customer B and
Customer C are to significant distributors in the In-Center segment. A portion of Customer Bs
sales of our products are to Customer A. All of Customer Cs sales of our products are to Customer
A.
The following table presents a reconciliation of the total segment assets to total assets (in
thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Total segment assets |
$ | 105,554 | $ | 102,798 | ||||
Corporate assets: |
||||||||
Cash and cash equivalents |
99,930 | 104,339 | ||||||
Property and equipment, net |
11,382 | 8,290 | ||||||
Intangible assets, net |
24,712 | 25,412 | ||||||
Goodwill |
42,698 | 42,698 | ||||||
Prepaid and other assets |
2,919 | 2,557 | ||||||
Total assets |
$ | 287,195 | $ | 286,094 | ||||
9. Income Taxes
The provision for income taxes of $0.2 million for the three months ended March 31, 2011 and
2010, respectively, relates to the profitable operations of certain foreign entities.
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10. Commitments and Contingencies
Significant commitments and contingencies at March 31, 2011 are consistent with those
discussed in Note 11 to the consolidated financial statements in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2010.
11. Stock-Based Compensation
Stock-based Compensation Expense
The following table presents stock-based compensation expense included in the condensed
consolidated statements of operations (in thousands):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Cost of revenues |
$ | 540 | $ | 460 | ||||
Selling and marketing |
1,330 | 1,011 | ||||||
Research and development |
342 | 401 | ||||||
General and administrative |
1,202 | 1,020 | ||||||
$ | 3,414 | $ | 2,892 | |||||
12. Stockholders Equity
We received 115,418 shares during the quarter ended March 31, 2011 that were surrendered by
employees in payment for the minimum required withholding taxes associated with awards under our
Corporate Bonus and Performance Share Plans and 7,407 shares that were surrendered in payment for
the exercise of stock options. We received 174,757 shares during the quarter ended March 31, 2010
that were surrendered by employees in payment for the minimum required withholding taxes associated
with awards under our Corporate Bonus and Performance Share Plans. The settlement of $2.8 million
and $1.6 million during the first quarter of 2011 and 2010, respectively, of the Bonus Plan
obligation in shares of our common stock represents a noncash financing activity.
13. Fair Value Measurements
At March 31, 2011, we had $84.8 million in money market funds, included in cash and cash
equivalents, measured at fair value on a recurring basis utilizing quoted prices (unadjusted) in
active markets for identical assets, also referred to as level 1 inputs.
The carrying amounts reflected in the condensed consolidated balance sheets for cash, accounts
receivable, prepaids and other current and non-current assets, accounts payable and accrued
expenses approximate fair value due to their short-term nature.
The carrying amount of our long-term debt approximates fair value at March 31, 2011. The fair
value of our long-term debt was estimated using inputs derived principally from market observable
data, including current rates offered to us for debt of the same or similar remaining maturities.
Within the hierarchy of fair value measurements, these are level 2 inputs.
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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 months ended
March 31, 2011, as well as the audited financial statements and notes and Managements Discussion
and Analysis of Financial Condition and Results of Operations for the fiscal year ended December
31, 2010, included in our Annual Report on Form 10-K filed with the Securities and Exchange
Commission, or SEC.
This Quarterly Report contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, concerning our business, operations and financial
condition, including statements with respect to the market adoption of our products in the United
States and internationally; the growth of the home, critical care and in-center dialysis markets in
general and the home hemodialysis market in particular; the development and commercialization of
our products; changes in the historical purchasing patterns and preferences of our key customers,
including DaVita Inc. and Fresenius Medical Care; the adequacy of our funding; our ability to
achieve and sustain positive cash flows; whether and when we might achieve improvements to our
gross 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 and the impact of any changes in
the regulatory environment with respect to our products or business; the scope of patent protection
with respect to our products; expectations with respect to the clinical findings of our FREEDOM
study, and the impact of new and future changes to reimbursement for chronic dialysis treatments.
All statements other than statements of historical facts included in this report regarding our
strategies, prospects, financial condition, costs, plans and objectives are forward-looking
statements. When used in this report, the words expect, anticipate, intend, plan,
believe, seek, estimate, potential, continue, predict, may, and similar expressions
are intended to identify forward-looking statements, although not all forward-looking statements
contain these identifying words. Because these forward-looking statements involve risks and
uncertainties, actual results could differ materially from those expressed or implied by these
forward-looking statements.
Among the important factors that could cause actual results to differ materially from those
indicated by our forward-looking statements are those discussed under the heading Risk Factors in
Item 1A of Part II. We undertake no obligation to revise or update publicly any forward-looking
statement for any reason. Readers should carefully review the factors described under the heading
Risk Factors in Item 1A of Part II of this Quarterly Report and in Managements Discussion and
Analysis of Financial Condition and Results of Operations, as well as in other documents filed by
us with the SEC, as they may be amended from time to time, including our Annual Report on Form 10-K
and Quarterly Reports on Form 10-Q.
Introduction
We are a medical device company that develops, manufactures and markets innovative products
for the treatment of kidney failure, fluid overload and related blood treatments and procedures.
Our primary product, the NxStage System One, or the System One, was designed to satisfy an unmet
clinical need for a system that can deliver the therapeutic flexibility and clinical benefits
associated with traditional dialysis machines in a smaller, portable, easy-to-use form that can be
used by healthcare professionals and trained lay users alike in a variety of settings, including
patient homes, as well as more traditional care settings such as hospitals and dialysis clinics.
Given its design, the System One is particularly well-suited for home hemodialysis and a range of
dialysis therapies including more frequent, or daily, dialysis, which clinical literature
suggests provides patients better clinical outcomes and improved quality of life. The System One is
cleared or approved for commercial sale in the United States, Europe, Canada and other select
markets for the treatment of acute and chronic kidney failure and fluid overload. The System One is
cleared specifically by the United States Food and Drug Administration, or FDA, for home
hemodialysis as well as therapeutic plasma exchange, or TPE, in a clinical environment. We also
sell needles and blood tubing sets primarily to dialysis clinics for the treatment of end-stage
renal disease, or ESRD. We believe our largest future product market opportunity is for our System
One used in the home hemodialysis market for the treatment of ESRD using more frequent, or daily
hemodialysis.
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. 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.
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Segment and Market Highlights
Our customers in the System One segment are highly consolidated. Fresenius Medical Care, or
Fresenius, and DaVita Inc., or DaVita, own and operate the two largest chains of dialysis clinics
in the United States and collectively provide treatment to approximately 60% of United States
dialysis patients. DaVita is our most significant customer for the System One segment. Sales to
DaVita represented approximately 32% and 36% of our System One segment revenues for the three
months ended March 31, 2011 and 2010, respectively. Further, DaVita is our largest customer in the
home market, constituting over 40% of our home hemodialysis patients. A growing percentage of our
sales are to Fresenius, which is our second largest customer in the System One segment, with nearly
all of those sales in the home market. Increased sales to DaVita and Fresenius have driven a large
portion of our historical revenue growth and will be important to future growth. If the purchasing
patterns of either of these customers adversely change, our business will be negatively affected,
at least in the near term.
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 39% and 45% of our In-Center segment revenues during the three months ended March 31,
2011 and 2010, respectively. Our second largest distributor is Gambro Renal Products, Inc., or
Gambro. Revenues from Gambro represented approximately 39% and 36% of our In-Center segment
revenues during the three months ended March 31, 2011 and 2010, respectively.
DaVita is also a significant customer in the in-center market. Sales of our products through
distributors to DaVita accounted for approximately half of In-Center segment revenues for the three
months ended March 31, 2011 and 2010. DaVita has contractual purchase commitments under two
agreements: one with us for needles and one with Gambro for blood tubing sets. DaVitas purchase
obligations with respect to needles will expire under an agreement with us in January 2013.
Gambros long term product supply agreement with DaVita entered into in connection with the sale of
Gambros United States dialysis clinic business to DaVita, obligates DaVita to purchase a
significant majority of its blood tubing set requirements from Gambro. Our distribution agreement
with Gambro, which expires in June 2014, contractually obligates Gambro to exclusively supply our
blood tubing sets, including our ReadySet and the Streamline product lines, to DaVita.
We offer certain customers rebates based on sales to specific end users and discounts for
early payment. Our revenues are presented net of these rebates and discounts. As of March 31, 2011,
we had $1.4 million and $0.5 million reserved against trade accounts receivable for future rebates
and discounts for customers in our In-Center and System One segments, respectively. We recorded
$1.4 million and $1.2 million during the three months ended March 31, 2011 and 2010, respectively,
as a reduction of In-Center segment revenues and $0.3 million and $0.1 million, respectively, as a
reduction of System One segment revenues in connection with rebates and discounts.
As an alternative to a cash-based rebate, we issued to DaVita a warrant that may vest and
become exercisable to purchase up to 5.5 million shares of our common stock based upon the
achievement of certain System One home patient growth targets at June 30, 2011, 2012 and 2013.
This warrant-based rebate structure preserves our cash, and provides for the issuance of shares
upon the exercise of any warrants earned only if patient access to home hemodialysis with the
System One is materially expanded. The warrants have an exercise price of $14.22 per share, expire
during 2013, are non-transferable and must be exercised in cash. The accounting for these warrants
is similar to the accounting for cash-based rebates. Specifically, the warrants are measured at
fair value through their date of vesting and recognized as a reduction of revenues, based on the
number of warrants expected to vest, over the same expected period as the related expected product
revenues which is 7 to 10 years. Estimates of the number of warrants expected to vest and the fair
value of the warrants will be revised each reporting period through the date of vesting. The
reduction of revenues recorded in connection with these warrants was not significant during the
three months ended March 31, 2011.
Financial Performance
During the three months ended March 31, 2011, we grew our revenues by 25% to $50.6 million
from $40.4 million during the prior year comparable period, with growth occurring in each market:
home, critical care and in-center. Home revenues drove the growth increasing $7.0 million, or 37%
for the three months ended March 31, 2011 versus the prior year comparable period, due primarily to
an increase in the number of patients prescribed to use and centers offering the System One. In 2011, we expect to
see continued growth in our revenues, primarily driven by the
System One segment as we further penetrate the markets, expand internationally, and leverage
the annuity nature of our business.
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We continue to see improvements in our financial performance below the revenue line. We have
not yet achieved profitable operating margins, but we continue to improve gross profit as a
percentage of revenues and cash flows from operating activities. Gross profit as a percentage of
revenues increased to 36% for the three months ended March 31, 2011 from 29% for
the prior year comparable period. The improvements in gross profit as a percentage of revenues
were driven in meaningful part by lower product manufacturing and service costs, favorable foreign
exchange rates and increased relative sales of higher margin products. While we expect to continue
to improve gross profit as a percentage of revenues, these improvements may be offset in the
short-term by unfavorable foreign exchange rates versus the U.S. dollar, higher transportation
costs, higher costs for raw materials, higher relative sales of lower margin products and pricing
strategies.
Over the long-term, we expect to see continued improvements to our cash flows from operating
activities, driven in meaningful part through continued improvement in our gross profit. However,
in the near term, we expect cash flows from operating activities on a quarterly basis to fluctuate
between negative and positive, primarily due to changes in working capital.
We are encouraged by the improvements to our operating margins and are continuing to work hard
toward our long-term goal of achieving profitable operating margins. However, there can be no
assurance that we will be able to continue to improve our operating margins or achieve positive
operating margins. Our ability to become profitable and its timing and sustainability, depends
principally upon continued improvements in gross margins, growing revenues, and leverage of our
operating infrastructure including any investment in selling and marketing or research and
development activities.
Comparison of the Three Months Ended March 31, 2011 and 2010
Revenues
Our revenues for the three months ended March 31, 2011 and 2010 were as follows (in thousands,
except percentages):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
System One segment |
||||||||||||||||
Home |
$ | 26,045 | 51 | % | $ | 19,043 | 47 | % | ||||||||
Critical Care |
7,438 | 15 | % | 6,059 | 15 | % | ||||||||||
Total System One segment |
33,483 | 66 | % | 25,102 | 62 | % | ||||||||||
In-Center segment |
17,081 | 34 | % | 15,306 | 38 | % | ||||||||||
Total |
$ | 50,564 | 100 | % | $ | 40,408 | 100 | % | ||||||||
The increase in revenues over the comparable prior year period was mainly attributable to
increased sales and rentals of the System One and related disposables in both the home and critical
care markets, primarily as a result of the growing number of patients using the System One as we
continue to penetrate these markets.
In the home market, revenues increased $7.0 million, or 37%, for the three months ended March
31, 2011, versus the prior year comparable period, primarily due to an increase in the number of
patients prescribed to use and centers offering the System One
and, to a lesser extent, the impact of adopting a new accounting standard which effected revenue recognition for
sales to our international distributors. In the US we have increased both
the average number of patients at existing centers and the number of total centers offering the
System One, through new and existing relationships with service providers, including DaVita and
Fresenius. Critical care market revenues increased $1.4 million, or 23%, for
the three months ended March 31, 2011, versus the prior year comparable period, primarily due to
increased sales of disposables from our growing number of System One equipment placed within
hospitals. Future demand for our products and revenue growth in both the home and critical care
markets is expected to remain strong as we further penetrate these markets, expand internationally
and leverage the annuity nature of our business. Our two largest customers in the home market,
DaVita and Fresenius, will be important to that growth, specifically in the U.S. market. If the
purchasing patterns of either of these customers adversely change, our business could be
negatively affected, at least in the near term.
In-Center segment revenues increased $1.8 million, or 12%, for the three months ended March
31, 2011, versus the prior year comparable period, due to higher sales volumes of our blood tubing
sets, primarily Streamline, due to increased end user demand and changes in distributor inventory
levels. While quarterly revenues continue to be susceptible to fluctuations in inventory levels at
our distributors, end user demand of both our blood tubing sets and our needle products continues
to grow. We expect future revenues will continue to be susceptible to fluctuation as a result of
increased competition and variations in inventory management policies with both our distributors
and end users.
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Gross Profit
Our gross profit and gross profit as a percentage of revenues for the three months ended March
31, 2011 and 2010 were as follows (in thousands, except percentages):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
System One segment |
$ | 13,921 | 42 | % | $ | 8,640 | 34 | % | ||||||||
In-Center segment |
4,112 | 24 | % | 3,173 | 21 | % | ||||||||||
Gross profit |
$ | 18,033 | 36 | % | $ | 11,813 | 29 | % | ||||||||
Gross profit increased $6.2 million, or 53%, for the three months ended March 31, 2011, versus
the prior year comparable period, driven in large part by the System One segment. Gross profit for
the System One segment increased $5.3 million, or 61%, for the three months ended March 31, 2011,
versus the prior year comparable period, due to 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 several factors, including, lower product manufacturing and service costs driven by
continued leveraging of our manufacturing infrastructure, certain costs saving initiatives and
improvements in product design and reliability, favorable impact of changes in foreign currency
exchange rates, increased relative sales of higher margin products, and lower depreciation expense
on our field equipment assets resulting from the change in the useful life of certain of these
assets from five to seven years during the fourth quarter of 2010.
Gross profit for the In-Center segment increased $0.9 million, or 30%, for the three months
ended March 31, 2011, versus the prior year comparable period, due to increased revenues and
improvement in gross profit as a percentage of revenues. The improvement in gross profit as a
percentage of revenues was primarily attributable to the increased relative sales of higher margin
products and favorable impact of changes in foreign currency exchange rates.
We expect gross profit as a percentage of revenues will continue to improve in the long-term
for three general reasons, all of which we expect will reduce costs in the future. First, we expect
to introduce additional process improvements and product design changes that have inherently lower
costs than our current products. Second, we anticipate that increased sales volume, rationalization
of our supply chain 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 unit service costs. However, there is
no certainty that our expectations will be achieved or the timing of achievement with respect to
these cost reduction plans. Further, these improvements in gross profit as a percentage of
revenues may be offset in the short-term for four general reasons, all of which could negatively
impact gross profit. First, we manufacture a large majority of our products internationally and
purchase products from foreign companies in other than U.S. dollars and, therefore, our product
costs are subject to fluctuations due to changes in foreign currency exchange rates. Any
unfavorable fluctuations in foreign exchange rates versus the U.S. dollar would negatively impact
our gross profit as a percentage of revenues. Second, we may incur higher transportation costs
driven in large part by increased prices from carriers and changes in fuel prices. Third, we may
see an increase in the cost of certain raw materials, due to increases in the cost of commodities.
Finally, we expect future demand for our products to continue to grow; however, higher relative
sales of lower margin products and certain pricing strategies would have a negative impact on gross
profit as a percentage of revenues.
Selling and Marketing
Our selling and marketing expenses and selling and marketing as a percent of revenues for the
three months ended March 31, 2011 and 2010 were as follows (in thousands, except percentages):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
System One segment |
$ | 7,896 | 24 | % | $ | 6,909 | 28 | % | ||||||||
In-Center segment |
1,314 | 8 | % | 1,108 | 7 | % | ||||||||||
Total Selling and marketing |
$ | 9,210 | 18 | % | $ | 8,017 | 20 | % | ||||||||
Selling and marketing expenses increased $1.2 million, or 15%, for the three months ended
March 31, 2011, versus the prior year comparable period, primarily due to increased personnel and
personnel-related costs, including non-cash stock-based compensation expenses, and increased
spending due to expanded marketing programs within both segments. Selling and marketing expenses
for the System One segment decreased as a percentage of revenues due to our initiative to continue
to
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leverage our infrastructure. Selling and marketing expenses for the In-Center segment
remained relatively consistent as a percentage of revenues, increasing slightly, as we broaden our
marketing programs. We anticipate that selling and marketing expenses will continue to increase in
absolute dollars but continue to decline as a percentage of revenues as we broaden our marketing
initiatives to increase public awareness of the System One in the home market and to support growth
in international markets.
Research and Development
Our research and development expenses and research and development as a percent of revenues
for the three months ended March 31, 2011 and 2010 were as follows (in thousands, except
percentages):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Research and development |
$ | 3,717 | 7 | % | $ | 3,035 | 8 | % |
Research and development expenses increased $0.7 million, or 22%, for the three months ended
March 31, 2011, versus the prior year comparable period but decreased as a percentage of revenues.
The increase in research and development expenses in absolute dollars was primarily due to
increased personnel and personnel-related costs and increased project related spending. For the
near term, we expect research and development expenses will increase in absolute dollars but remain
relatively constant as a percentage of revenues as we seek to further develop and enhance our
System One and related products.
Distribution
Our distribution expenses and distribution as a percent of revenues for the three months ended
March 31, 2011 and 2010 were as follows (in thousands, except percentages):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
System One segment |
$ | 3,512 | 10 | % | $ | 3,010 | 12 | % | ||||||||
In-Center segment |
646 | 4 | % | 401 | 3 | % | ||||||||||
Total Distribution |
$ | 4,158 | 8 | % | $ | 3,411 | 8 | % | ||||||||
Distribution expenses increased $0.7 million, or 22%, for the three months ended March 31,
2011, versus the prior year comparable period due to increased business volumes. Distribution
expenses for the System One segment decreased as a percentage of revenues, 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 efficiencies in our distribution
network. Distribution expenses for the In-Center segment increased slightly as a percentage of
revenues, due primarily to increased delivery costs for certain products shipped from our
international manufacturing locations to our customers. We expect that distribution expenses in
absolute dollars will increase driven in large part by volume along with increased prices from
carriers and changes in fuel prices but, overall, we expect 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.
General and Administrative
Our general and administrative expenses and general and administrative as a percent of
revenues for the three months ended March 31, 2011 and 2010 were as follows (in thousands, except
percentages):
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
General and administrative |
$ | 5,582 | 11 | % | $ | 4,938 | 12 | % |
General and administrative expenses increased $0.6 million, or 13%, for the three months ended
March 31, 2011, versus the prior year comparable period, but decreased as a percentage of revenues.
The increase in general and administrative expenses in absolute dollars was primarily the result
of increased personnel and personnel-related costs, including non-cash stock-based compensation
expenses and other infrastructure related costs. We expect that general and administrative expenses
will decrease as a percentage of revenues over time as we continue to leverage our existing
infrastructure.
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Other Expense
Interest expense increased 4% for the three months ended March 31, 2011, versus the prior year
comparable period, due primarily to fees and amortization of debt issuance costs associated with
our loan and security agreement with Silicon Valley Bank, or SVB, which was entered into in March
2010. We have no debt outstanding under this facility.
The change in other expense during both periods is derived primarily by foreign currency gains
and losses.
Provision for Income Taxes
The provision for income taxes of $0.2 million for the three months ended March 31, 2011 and
2010, 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 March 31, 2011, our accumulated
deficit was $314.4 million and we had cash and cash equivalents of $99.9 million and working
capital of $119.8 million.
Our primary ongoing cash requirements will be to fund operating activities, product
development and debt service. Our primary sources of liquidity are cash on hand and ongoing
revenues.
Over the past several years we have improved our cash flows from operating activities and
continue to work towards our long-term goal of positive cash flows from operating activities.
However, we expect cash flows from operating activities in the near term to fluctuate between
negative and positive on a quarterly basis, primarily due to changes in working capital. There can
be no assurance that we will be able to continue to improve cash flows from operating activities or
whether we will be able to generate positive cash flows from operating activities in the future.
We believe, based on current projections and the current nature of our business, that we have the
required resources to fund our ongoing operating requirements. Our ability to and the rate at
which we continue to improve cash flows from operating activities will depend on many factors,
including growing revenues, continued improvements in gross margins, leverage of our operating
infrastructure and continued sale versus rental of a significant percentage of our System One
equipment.
Historically, our business was fairly capital intensive due to the manner in which we placed
our System One equipment in the home market. However, over the past several years there has been
an increase in the number of customers who choose to purchase rather than rent their System One
equipment which has been important to our historical cash flow improvements. Shifting our
customers to an equipment purchase versus rental model allows us to recover the cost of our
products upon initial sale rather than over an extended period of time, thereby reducing our
working capital requirements. A number of our home market customers, including DaVita, have
committed to purchase, rather than rent, the significant majority of their future System One
equipment requirements. While currently approximately 70% of patients use purchased rather than
rented System One equipment, there can be no assurance that we will be able to continue to expand
or sustain the percentage of our equipment placements that are purchased rather than rented.
Another important factor that has affected our historical improvements in our cash flows is
our effective management of our field equipment assets, including those rented by customers and our
service pool equipment which is equipment owned and maintained by us that is swapped for
equipment that needs repair or maintenance while being owned or rented by our customers. Any
excess equipment, unused equipment or material defects or write-offs of equipment would negatively
impact our working capital requirements.
We have two material debt instruments: the term loan and security agreement with Asahi and the
loan and security agreement with SVB.
In May 2009, we entered into a term loan and security agreement with Asahi. The $40.0 million
term loan bears interest at a rate of 8% per annum, with fifty percent of such interest being
deferred until the maturity date on May 31, 2013. Principal is payable in one balloon payment at
maturity. The term loan is secured by substantially all of our assets. In the event the term loan
reaches maturity, Asahi may require that all of the principal and interest on the term loan that is
unpaid as of the maturity date be converted into shares of our common stock, with the number of
shares to be determined based upon the average closing stock price of our common stock during the
thirty business days preceding the maturity date, subject to certain conditions.
The term loan and security agreement with Asahi includes certain affirmative covenants
including timely filings and limitations on contingent debt obligations and sales of assets. At
March 31, 2011, we were in compliance with these covenants. The term loan and security agreement
also contains customary events of default, including nonpayment, misrepresentation, breach of
covenants, material adverse effects, and bankruptcy. In the event we fail to satisfy our covenants,
or otherwise go into default, Asahi has a number of remedies, including sale of our assets and
acceleration of all outstanding indebtedness, subject to the rights of SVBs senior security
interest. Any of these remedies would likely have a material adverse effect on our business.
We have the flexibility under our term loan with Asahi to seek up to $40.0 million in
additional debt at market interest rates. In March 2010, we entered into a loan and security
agreement with SVB for a $15.0 million revolving line of credit with a
maturity date of April 1, 2012. The agreement was amended in March 2011 to reduce the interest
rate on borrowings, fees on
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unused revolving line and monthly reporting requirements. The
agreement is secured by all or substantially all of our assets. In connection with the agreement,
we amended our term loan and security agreement with Asahi to provide for certain amendments,
including granting to Asahi junior liens on certain of our assets for so long as the agreement with
SVB remains outstanding. Upon termination of all obligations under that facility, Asahis security
will revert to a security in all assets other than cash, bank accounts, accounts receivable, field
equipment and inventory. Borrowings under the agreement, as amended, bear interest at a floating
rate per annum equal to 0.5% percentage points above the prime rate (initial prime rate of 4.00%).
Pursuant to the agreement, we have agreed to certain financial covenants relating to liquidity
requirements and adjusted EBITDA, as defined in the agreement with SVB. The agreement contains
events of default customary for transactions of this type, including nonpayment, misrepresentation,
breach of covenants, material adverse effect and bankruptcy. At March 31, 2011, we were in
compliance with the covenants, there were no outstanding borrowings and we had nearly all of the
$15.0 million credit commitment available for borrowing.
We have begun construction of a new manufacturing facility in Germany pursuant to the terms of
our Dialyzer Production Agreement entered into in May 2009 with Asahi. We are overseeing
construction of this new facility and will operate the new facility under a manufacturing agreement
upon its completion. Asahi will fund construction costs up to an original fixed amount; however,
we will be responsible for any additional costs. If the agreement is terminated, due to our
breach, insolvency or bankruptcy during the construction period, Asahi has the option to require us
to pay for all amounts expended for construction of the new facility. If such event occurs we
would take title to the land and any construction in process. Subsequent to the completion of
construction, if the agreement is terminated due to our breach, insolvency or bankruptcy or by us
pursuant to certain terms of the agreement, Asahi has the option to require us to purchase the new
facility from them by paying one hundred percent of the then net book value of the new facility, as
calculated in accordance with GAAP. Given these options and our involvement in the construction we
are considered the owner of the new facility, for accounting purposes, and will therefore record
its cost as construction-in-process and a corresponding liability for the construction cost funded
by Asahi. The $3.1 million recorded in fixed assets and other long-term liabilities in the first
quarter of 2011 reflects the construction costs incurred to date in connection with this project.
We maintain postemployment benefit plans for employees in certain foreign subsidiaries. The
plans provide lump sum benefits, payable based on statutory regulations for voluntary or
involuntary termination. Where required, we obtain an annual actuarial valuation of the benefit
plans. We have recorded a liability of $1.7 million as other long-term liabilities at March 31,
2011 for costs associated with these plans. The expense recorded in connection with these plans was
not significant during 2011 or 2010.
The following table sets forth the components of our cash flows for the periods indicated (in
thousands):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Net cash used in operating activities |
$ | (2,994 | ) | $ | (1,616 | ) | ||
Net cash used in investing activities |
(623 | ) | (225 | ) | ||||
Net cash used in financing activities |
(1,090 | ) | (873 | ) | ||||
Effect of exchange rate changes on cash |
298 | 80 | ||||||
Net cash flow |
$ | (4,409 | ) | $ | (2,634 | ) | ||
Net Cash Used in Operating Activities. Net cash used in operating activities increased by
$1.4 million during the three months ended March 31, 2011, versus the prior year comparable period.
Net loss after adjustments for non-cash charges, such as depreciation, amortization and
stock-based compensation expense was a positive $4.0 million during the three months ended March
31, 2011 versus a negative $0.2 million for the prior year comparable period. This improvement in
cash flows was offset by an increase in working capital requirements partially driven by a $4.3
million one-time customer prepayment on first quarter 2011 orders received by us during the fourth
quarter of 2010. We expect working capital to fluctuate from quarter to quarter due to various
factors including inventory requirements and timing of payments from our customers and to our
vendors. Deferred revenues decreased $2.5 million to $0.6 million during the three months ended
March 31, 2011 versus $3.1 million for the prior year comparable period, due to lower sales of
previously rented equipment, the change in accounting for equipment sales to our international
distributors and an increase in amortization of deferred revenues into revenues. During the three
months ended March 31, 2011 and 2010, we recognized $3.7 million and $2.3 million, respectively, of
deferred revenues into revenues.
Non-cash transfers from inventory to field equipment for the placement of units with our
customers increased $0.4 million during the three months ended March 31, 2011 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 decreased $0.6 million
during the three months ended March 31, 2011 versus the prior year comparable period. This
activity represents the cost of purchased System One equipment versus rented equipment and is
subject to fluctuation based on the purchasing patterns of our customers.
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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 Cash Used in Financing Activities. During the three months ended March 31, 2011 and 2010
we received $1.5 million and $0.9 million, respectively, of proceeds from stock option and stock
purchase plans due to an increase in the number of stock options exercised. This cash inflow was
offset by $2.5 million and $1.7 million during the three months ended March 31, 2011 and 2010,
respectively, of cash used to repurchase shares of our common stock that were surrendered by
employees in payment for the minimum required withholding taxes associated with awards under our
annual Bonus and Performance Share Plans.
Significant commitments and contingencies at March 31, 2011 are consistent with those
discussed in Item 7, Managements Discussion and Analysis of Financial Condition and Results of
Operations, and Note 11 to the consolidated financial statements in our Annual Report on Form 10-K
for the fiscal year ended December 31, 2010.
Summary of Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States, GAAP. The preparation of these consolidated
financial statements requires us to make significant estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. These items are regularly monitored
and analyzed by management for changes in facts and circumstances, and material changes in these
estimates could occur in the future. Changes in estimates are recorded in the period in which they
become known. We base our estimates on historical experience and various other assumptions that we
believe to be reasonable under the circumstances. Actual results may differ substantially from our
estimates.
The accounting policies and estimates that we believe are most critical to fully understanding
and evaluating our financial results are described in Item 7 in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2010. There were no new accounting pronouncements adopted
during the three months ended March 31, 2011 that had a material impact on our financial
statements.
Revenue Recognition
We recognize revenue from product sales and services when earned. Revenues are recognized
when: (a) there is persuasive evidence of an arrangement, (b) the product has been shipped or
services and supplies have been provided to the customer, (c) the sales price is fixed or
determinable and (d) collection is reasonably assured.
Certain agreements with distributors allow for product returns and credits. For shipment of
product sold to distributors, revenue is recognized at the time of sale if a reasonable estimate of
future returns or credit can be made. If a reasonable estimate of future returns or credit cannot
be made, we recognize revenue using the sell-through method. Under the sell-through method,
revenue and related costs of revenue is deferred until the final resale of such products to end
customers.
In addition to contractually determined volume discounts, in many agreements we offer rebates
based on sales to specific end customers and discounts for early payment. Rebates and discounts are
recorded as a reduction of sales and trade accounts receivable, based on our best estimate of the
amount of probable future rebate or discount on current sales.
We enter into multiple-element arrangements that may include a combination of equipment,
related disposables and services. Effective January 1, 2011, we adopted Accounting Standards
Update, or ASU, No. 2009-13, Multiple Deliverable Revenue Arrangements, as required, using the
prospective method as permitted under the guidance. Accordingly, this guidance is being applied to
all revenue arrangements entered into or materially modified on or after January 1, 2011. The
impact of adopting this amended guidance on our results of operations has been limited to products
sold internationally through distributors in the System One segment, which revenue has not been
significant in the current or historical periods. ASU No. 2009-13 amended the previous guidance
for multiple-element arrangements. Pursuant to the amended guidance in ASU 2009-13 our revenue
arrangements with multiple elements are divided into separate units of accounting if specified
criteria are met, including whether the delivered element has stand-alone value to the customer,
and the consideration received is allocated among the separate units based on their respective
selling price, and the applicable revenue recognition criteria are applied to each of the separate
units.
Under the amended guidance we determine selling price using vendor specific objective evidence
(VSOE), if it exists, otherwise third-party evidence. If neither VSOE nor third-party evidence of
selling price exists for a unit of accounting, we use best estimated selling price (BESP). We
generally expect that we will not be able to establish third-party evidence due to the
nature of our products and the markets in which we compete, and, as such, we typically will
determine selling price using VSOE or BESP.
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We determine BESP for an individual element based on consideration of both market and
Company-specific factors, including the selling price and profit margin for similar products, the
cost to produce the deliverable and the anticipated margin on that deliverable and the
characteristics of the varying markets in which the deliverable is sold.
The adoption of the amended guidance did not change the accounting for arrangements entered
into prior to January 1, 2011. Therefore, these arrangements with multiple elements were divided
into separate units of accounting if there was objective and reliable evidence of fair value of the
undelivered items and if other criteria were met, including whether the delivered element had
stand-alone value to the customer. If either criteria were not met, the arrangement was accounted
for as a single unit of accounting and the fees received upon the completion of delivery of
equipment were deferred and are recognized as revenue on a straight-line basis over the expected
term of our remaining obligation and direct costs relating to the delivered equipment are amortized
over the same period as the related revenue, while disposable products revenue is recognized on a
monthly basis upon delivery.
System One Segment
We derive revenue in the home market from the sales of hemodialysis therapy to customers in
which the customer either purchases or rents the System One and/or PureFlow SL hardware and
purchases a specified number of disposable products and service.
For customers that purchase the System One and PureFlow SL hardware, in the home U.S. market,
due to the depot service model whereby equipment requiring service is picked up and a replacement
device is shipped to the site of care, we recognize fees received from equipment sale as revenue
on a straight-line basis over the expected term of our remaining service obligation and direct
costs relating to the delivered equipment are deferred and amortized over the same expected period
as the related revenue. Disposable products revenue is recognized on a monthly basis upon
delivery.
Under the rental arrangements revenue is recognized on a monthly basis in accordance with
agreed upon contract terms and pursuant to binding customer purchase orders and fixed payment
terms.
Our sales arrangements with our international distributors are structured as direct product
sales and have no significant post delivery obligations with the exception of standard warranty
obligations. However, under the previous guidance, for arrangements entered into prior to January
1, 2011 we determined that we could not account for the sale of equipment as a separate unit of
accounting and, therefore, the fees received upon the completion of delivery of equipment were
deferred and recognized as revenue on a straight-line basis over the expected term of our remaining
service obligation and direct costs relating to the delivered equipment were amortized over the
same expected period as the related revenue. Under the amended guidance, for arrangements entered
into or materially modified on or after January 1, 2011, we will recognize revenues and related
direct costs upon delivery in accordance with contract terms. Disposable product revenue is
recognized on a monthly basis upon delivery under both the previous and amended guidance.
In the critical care market, we structure sales of the System One and disposable products as
direct product sales and have no significant post delivery obligations with the exception of
standard warranty obligations. Revenue from direct product sales is recognized upon delivery in
accordance with contract terms. Certain of these arrangements provide for training, technical
support and extended warranty services to our customers. We recognize training and technical
support revenue when the related services are performed. In the case of extended warranty, the
service revenue is recognized ratably over the warranty period.
In-Center Segment
Our In-Center segment sales are structured as direct product sales primarily through
distributors, and we have no significant post delivery obligations with the exception of standard
warranty obligations. Revenue from direct product sales is recognized upon delivery in accordance
with contract terms. Some of our distribution contracts for the In-Center segment contain minimum
volume commitments with negotiated pricing discounts at different volume tiers. Each agreement may
be canceled upon a material breach, subject to certain curing rights, and in many instances minimum
volume commitments can be reduced or eliminated upon certain events.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements is included in Note 2 to the consolidated
financial statements included in our Annual Report on Form 10-K for the fiscal year ended December
31, 2010 and 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, 2010. There have been no material changes to the market risks described in our Annual
Report on Form 10-K for December 31, 2010.
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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 March 31,
2011. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, or the Exchange Act, means controls and other procedures
of a company that are designed to ensure that information required to be disclosed by a company in
the reports that it files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SECs rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to ensure that information
required to be disclosed by a company in the reports that it files or submits under the Exchange
Act is accumulated and communicated to the companys management, including its principal executive
and principal financial officers, as appropriate to allow timely decisions regarding required
disclosure. Our management recognizes that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31,
2011, our chief executive officer and chief financial officer concluded that, as of such date, our
disclosure controls and procedures were effective to achieve their stated purpose.
No change in our internal control over financial reporting (as defined in Rule 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended March 31, 2011 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 the related products used with the System One and a limited number of other
products.
Since our inception, we have devoted a substantial amount of our efforts to the development of
the System One and the related products used with the System One. We commenced marketing the System
One and the related disposable products to the critical care market in February 2003. We commenced
marketing the System One for chronic hemodialysis treatment in September 2004. Prior to the
acquisition of the Medisystems Corporation and certain affiliated entities, or the Medisystems
Acquisition, on October 1, 2007, nearly 100% of our revenues were derived from the rental or sale
of our System One and the sale of related disposables. Although the Medisystems Acquisition
broadened our product offerings, we expect that in 2011 and in the foreseeable future, we will
continue to derive a significant percentage of our revenues from the System One, and that we will
derive the remainder of our revenues from the sale of a few key disposable products acquired in the
Medisystems Acquisition, including blood tubing sets and needles. To the extent that any of our
primary products are not commercially successful or are withdrawn from the market for any reason,
our revenues will be adversely impacted, and we do not have other significant products in
development that could readily replace these revenues.
We cannot accurately predict the size of the home hemodialysis market, and it may be smaller, and
may develop more slowly than we expect.
We believe our largest future product market opportunity is the home hemodialysis market.
However this market is presently very small and adoption of the home hemodialysis treatment options
has been limited. The most widely adopted form of dialysis therapy used in a setting other than a
dialysis clinic is peritoneal dialysis. Based on the most recently available data from the United
States Renal Data System, or USRDS, less than 10% of all United States patients receiving dialysis
treatment for ESRD receive either peritoneal dialysis or home hemodialysis. Because the adoption of
home hemodialysis has been limited to date, the number of patients and their partners who desire
to, and are capable of, administering hemodialysis treatment with a system such as the System One
is unknown and there is limited data upon which to make estimates. In addition, many dialysis
clinics do not presently have the infrastructure in place to support home hemodialysis and most do
not have the infrastructure in place to support a significant home hemodialysis patient population.
Our long-term growth will depend on the number of patients who adopt home-based hemodialysis and
how quickly they adopt it, which in turn is driven by the number of physicians willing to prescribe
home hemodialysis and the number of dialysis clinics able or willing to establish and support home
hemodialysis therapies.
Because nearly all our home hemodialysis patients are also receiving more frequent dialysis,
meaning dialysis delivered five or more times a week, the market adoption of our System One for
home hemodialysis is also dependent upon the penetration and market acceptance of more frequent
hemodialysis. Given the increased provider supply costs associated with providing more frequent
dialysis versus conventional three-times per week dialysis, market acceptance will be impacted,
especially for 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 some of our customers are unable to obtain such additional reimbursement in all cases, and
that there are increased administrative burdens associated with articulating the medical
justification for treatments beyond three times per 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 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, the Centers for Medicare and Medicaid Services, or CMS released new Conditions for
Coverage applicable to our customers. These Conditions for Coverage impose water testing
requirements on our patients using our PureFlow SL product. These water testing requirements
increase the burden of our therapy for our patients and may impair market adoption, especially for
our PureFlow SL product. To the extent additional regulations are introduced unique to the home
environment, market adoption could be even further impaired.
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.
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Current Medicare reimbursement rates, at three times per week, limit the price at which we can
market our home products, and adverse changes to reimbursement would likely negatively affect the
adoption or continued sale of our home products.
Our ability to attain profitability will be driven in part by our ability to set or maintain
adequate pricing for our products. As a result of legislation passed by the United States Congress
more than 30 years ago, Medicare provides broad and well-established reimbursement in the United
States for ESRD. With approximately 75% of United States ESRD patients covered by Medicare, the
reimbursement rate is an important factor in a potential customers decision to use the System One
or our other products and limits the fee for which we can sell or rent our products. Additionally,
current CMS rules limit the number of hemodialysis treatments paid for by Medicare to three times a
week, unless there is medical justification provided by the dialysis facility based on information
from the patients physician for additional treatments. Most patients using the System One in the
home treat themselves, with the help of a partner, up to six times per week. To the extent that
Medicare contractors elect not to pay for the additional treatments, adoption of the System One
would likely be impaired. The determination of medical justification must be made at the local
Medicare contractor level on a case-by-case basis, based on documentation provided by our
customers. If daily therapy is prescribed, a clinics decision as to how much it is willing to
spend on dialysis equipment and services will be at least partly dependent on whether Medicare will
reimburse more than three treatments per week for the clinics patients. Medicare is switching from
intermediaries to Medicare administrative contractors. This change in the reviewing entity for
Medicare claims could lead to a change in whether a customer receives Medicare reimbursement for
additional treatments. If an adverse change to historical payment practices occurs, market adoption
of our System One in the home market may be impaired. 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. 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 published, on August 12, 2010, the final rule for implementation of the new prospective
payment system for dialysis treatment effective January 1, 2011. Under this new ESRD prospective
payment system, CMS makes a single bundled payment to the dialysis facility for each dialysis
treatment that covers all renal dialysis services and home dialysis, and includes certain drugs
(including erythropoiesis stimulating agents, or ESAs, iron, and Vitamin D). It has replaced the
former system which payed facilities a composite rate for a defined set of items and services,
while paying separately for drugs, laboratory tests, or other services that were not included in
the composite rate. The prospective payment system still limits the number of hemodialysis
treatments paid by Medicare to three times a week, unless there is medical justification provided
by the patients physician for additional treatments. Although a stated goal of the prospective
payment system is to encourage home dialysis, and the inclusion of drugs into the prospective rate
and the retention of a home patient training payment adjustment with a modest update from current
levels are intended to support this goal, it is not possible at this time to determine what impact
the new payment system or healthcare legislation will have on the adoption of home and/or daily
hemodialysis or the price for which we can sell our products.
We have limited operating experience, a history of net losses and an accumulated deficit of $314.4
million at March 31, 2011. We cannot guarantee if, when and the extent to which we will become
profitable, or that we will be able to maintain profitability if it is achieved.
Since inception, we have incurred negative operating margins and losses every quarter. At
March 31, 2011, we had an accumulated deficit of approximately $314.4 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, we cannot provide
assurance 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 customers in the System One and In-Center segments are highly consolidated, with concentrated
buying power.
Fresenius and DaVita own and operate the two largest chains of dialysis clinics in the United
States. Collectively, these entities provide treatment to approximately 60% of United States
dialysis patients; and this percentage may continue to grow with further market consolidation.
DaVita, for example, recently announced its plans to acquire DSI Renal, Inc. With less than 40% of
United States dialysis patients cared for by independent dialysis clinics, our market adoption, at
least within the United States, would be more constrained without the presence of both DaVita and
Fresenius as customers for our System One and In-Center products.
Additionally, Fresenius is not only a dialysis service provider, it is also the leading
manufacturer of dialysis equipment worldwide. On February 18, 2011 we learned that Fresenius
obtained clearance for its 2008K At Home hemodialysis system for
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use in home chronic therapy in February 2011. DaVita does not manufacture dialysis equipment,
but has certain dialysis supply purchase obligations to Gambro, a dialysis equipment manufacturer,
under a long-term preferred supplier agreement. Fresenius may choose to offer its dialysis patients
only the dialysis equipment Fresenius manufactures, including its recently cleared home
hemodialysis system. DaVita may choose to offer their dialysis patients the equipment it
contractually agreed to offer in its agreement with Gambro. Fresenius and DaVita may also choose to
otherwise limit access to the equipment manufactured by competitors. DaVita is our most significant
customer, and we expect it to continue to be, at least for the foreseeable future. Our earlier
agreement with DaVita contained certain limited exclusivity rights which restricted our ability to
sell the System One in certain markets, and to Fresenius. These restrictions do not exist under our
July 2010 Amended and Restated National Service Provider Agreement with DaVita, and we have a
growing percentage of our home market sales to Fresenius, which is our second largest customer in
the System One segment. However, we have no assurance that our sales to DaVita or Fresenius will
continue to grow, and we cannot predict what impact Fresenius recently cleared home hemodialysis
system will have on our sales to Fresenius in the home market, or our overall performance in the
home market going forward. Given the significance of DaVita and Fresenius as customers in the home
market, any adverse change in eithers ordering or clinical practices, as might be the case in
periodic contract negotiations, would have a significant adverse impact on our home market
revenues, especially in the near term.
DaVita is a key customer for our System One and In-Center product lines. The partial or complete
loss of DaVita as a customer would materially impair our financial results, at least in the near
term.
DaVita is our most significant customer. Sales through distributors to DaVita of products
accounted for approximately half of In-Center segment revenues for the three months ended March 31,
2011, and direct sales to DaVita accounted for approximately 32% of our System One segment revenues
during the same period. Further, DaVita is our largest customer in the home market, constituting
over 40% of our home hemodialysis patients. Although we expect that DaVita will continue to be a
significant customer in the home market, we cannot be certain that DaVita will continue to purchase
and/or rent the System One or add additional System One patients in the future. Our contract for
needles with DaVita, expiring in December 2013, includes certain minimum order requirements;
however, these can be reduced significantly under certain circumstances. Our contract for blood
tubing sets with DaVita expired in September 2009. However, in June 2009, we entered into a five
year distribution agreement in the United States with Gambro, pursuant to which Gambro will
exclusively supply our blood tubing sets, including our ReadySet and the Streamline product lines
to DaVita. The partial or complete loss of DaVita as a customer for any of these product lines
would adversely affect our business, at least in the near term.
We entered into a $40.0 million term loan and security agreement with Asahi in May 2009. We are
obligated to pay 50% of the interest on the first day of November and May, beginning on November 1,
2009, and repay the remaining interest and principal upon maturity in May 2013. If we fail to
comply with all terms under this agreement, we may go into default, which could trigger, among
other things, the acceleration of all of our indebtedness there under or the sale of our assets.
In May 2009, we entered into a $40.0 million term loan, with Asahi. The four year term loan,
maturing in May 2013, bears interest at 8% annually, payable on the first day of November and May
beginning on November 1, 2009, with 50% of the interest deferred to maturity. The term loan is
secured by substantially all of our assets.
The term loan and security agreement includes certain affirmative covenants including timely
filings and limitations on contingent debt obligations and sales of assets. The term loan and
security agreement also contains customary events of default, including nonpayment,
misrepresentation, breach of covenants, material adverse effects, and bankruptcy. In the event we
fail to satisfy our covenants, or otherwise go into default, Asahi has a number of remedies,
including sale of our assets and acceleration of all outstanding indebtedness, subject to the
rights of holders of senior security interests. Certain of these remedies would likely have a
material adverse effect on our business.
We entered into a two year Loan and Security Agreement, dated as of March 10, 2010, with Silicon
Valley Bank, or SVB. The terms of this agreement may restrict our current and future operations,
which could affect our ability to respond to changes in our business and to manage our operations.
On March 10, 2010, we entered into an agreement with SVB for a $15.0 million revolving line of
credit with a maturity date of April 1, 2012. The agreement is secured by all or substantially all
of our assets. In connection with this agreement, we amended our term loan and security agreement
with Asahi to provide for certain amendments, including granting to Asahi junior liens on certain
of our assets for so long as the agreement with SVB remains outstanding. Upon termination of all
obligations under that facility, Asahis security will revert to a security in all assets other
than cash, bank accounts, accounts receivable, field equipment and inventory. Borrowings under the
agreement, as amended, bear interest at a floating rate per annum equal 0.5% percentage points
above the prime rate (initial prime rate of 4.00%). Pursuant to the agreement, we have agreed to
certain financial covenants relating to liquidity requirements and adjusted EBITDA, as defined in
our agreement with SVB. The agreement contains events of default customary for transactions of this
type, including nonpayment, misrepresentation, breach of covenants, material adverse effect and
bankruptcy.
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As of the date hereof, we do not have an outstanding balance under the revolving line of
credit. However, were we to draw on the line of credit, in the event we fail to satisfy our
covenants, or otherwise go into default, SVB has a number of remedies, including sale of our assets
and acceleration of all outstanding indebtedness. Certain of these remedies would likely have a
material adverse effect on our business.
We compete against other dialysis equipment manufacturers with much greater financial resources and
established products and customer relationships, which may make it difficult for us to penetrate
the market and achieve significant sales of our products. Our competitors may also introduce new
products or features that could impair the competitiveness of our own product portfolio.
Our System One in the critical care market competes against Gambro AB, Fresenius Medical Care
AG, Baxter Healthcare, B. Braun and others. Our System One in the home market is currently the only
portable system specifically indicated for use in the home market in the United States. However, on
February 18, 2011 we learned that Fresenius, our second largest customer in the System One segment,
with nearly all of those sales in the home market, obtained clearance for its 2008K At Home
hemodialysis system for use in home chronic therapy in February 2011. Our product lines in the
in-center market compete directly against products produced by Fresenius Medical Care AG, Gambro
AB, Nipro, B. Braun, Baxter Healthcare, JMS CO., LTD and others. Our competitors each market one or
more FDA-cleared medical devices for the treatment of acute or chronic kidney failure. Each of
these competitors offers products that have been in use for a longer time than our System One and
are more widely recognized by physicians, patients and providers. These competitors have
significantly more financial and human resources, more established sales, service and customer
support infrastructures and spend more on product development and marketing than we do. Many of our
competitors also have established relationships with the providers of dialysis therapy and,
Fresenius owns and operates a chain of dialysis clinics. The product lines of most of these
companies are broader than ours, enabling them to offer a broader bundle of products and have
established sales forces and distribution channels that may afford them a significant competitive
advantage.
The market for our products is competitive, subject to change and affected by new product
introductions and other market activities of industry participants, including increased
consolidation of ownership of clinics by large dialysis chains. If we are successful, our
competitors are likely to develop products that offer features and functionality similar to our
products, including our System One. Improvements in existing competitive products or the
introduction of new competitive products may make it more difficult for us to compete for sales,
particularly if those competitive products demonstrate better reliability, convenience or
effectiveness or are offered at lower prices. In addition to the recent clearance of the Fresenius
2008K At Home for use in home chronic therapy, Baxter has a research and development collaboration
with DEKA Research and Development Corporation and HHD, LLC, or DEKA, and has recently indicated
that it received IDE approval from the FDA and hopes to commence U.S. and Canadian clinical studies
of DEKAs new home hemodialysis system in 2011 and launch in international markets as early as 2011
and obtain regulatory approval for Europe in 2012. Other small companies are also working to
develop products for this market. We are unable to predict when, if ever, any of these products may
attain regulatory clearance and appear in the market, or how successful they may be should they be
introduced, but if additional viable products are introduced to the market, it could adversely
affect our sales and growth. We also are unable to predict what impact the recent clearance of a
Fresenius home hemodialysis systems will have on our sales to Fresenius or our overall home market
performance. Our ability to successfully market our products could also be adversely affected by
pharmacological and technological advances in preventing the progression of ESRD and/or in the
treatment of acute kidney failure or fluid overload. If we are unable to compete effectively
against existing and future competitors and existing and future alternative treatments and
pharmacological and technological advances, it will be difficult for us to penetrate the market and
achieve significant sales of our products.
Our continued growth is dependent on our development and successful commercialization of new and
improved products.
Our future success will depend in part on our timely development and introduction of new and
improved products that address changing market requirements. To the extent that we fail to
introduce new and innovative products or incremental product improvements, we may lose revenues or
market share to our competitors, which may be difficult to regain. Our inability, for
technological, regulatory or other reasons, to successfully develop and introduce new or improved
products could reduce our growth rate or otherwise damage our business. We cannot assure you that
our developments will keep pace with the marketplace or that our new or improved products will
adequately meet the requirements of the marketplace.
The success and growth of our business will depend upon our ability to achieve expanded market
acceptance of our System One.
In the home market, we have to convince four distinct constituencies involved in the choice of
dialysis therapy, namely operators of dialysis clinics, nephrologists, dialysis nurses and
patients, that the System One provides an effective alternative to other existing dialysis
equipment. In the in-center market, we have to convince all of these constituencies, but to a
lesser degree, patients, that our blood tubing sets and needles provide an effective alternative to
other dialysis disposables. In the critical care market, we have to convince hospital purchasing
groups, hospitals, nephrologists, dialysis nurses and critical care nurses that our system provides
an effective alternative to other existing dialysis equipment. Each of these constituencies uses
different
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considerations in reaching their decision. Lack of acceptance by any of these constituencies
will make it difficult for us to grow our business. We may have difficulty gaining widespread or
rapid acceptance of any of our products, including the System One, for a number of reasons
including:
| the failure by us to demonstrate to operators of dialysis clinics, hospitals, nephrologists, dialysis nurses, patients and others that our products are equivalent or superior to existing therapy options; | ||
| competition from products sold by companies with longer operating histories and greater financial resources, more recognizable brand names and better established distribution networks and relationships with hospitals or dialysis clinics; | ||
| the failure by us to continue to improve product reliability and the ease of use of our products; | ||
| limitations on the existing infrastructure in place to support home hemodialysis, including without limitation, home hemodialysis training nurses, and the willingness, cost associated with, and ability of dialysis clinics to build that infrastructure; | ||
| the ownership and operation of some dialysis providers by companies that also manufacture and sell competitive dialysis products; | ||
| the introduction of competing products or treatments that may be more effective, easier to use or less expensive than ours; | ||
| regulations that impose additional burden on patients and their caregivers, such as the recently adopted Medicare conditions for coverage which impose additional water testing requirements in connection with the use of our PureFlow SL; | ||
| the number of patients willing and able to perform therapy independently, outside of a traditional dialysis clinic, may be smaller than we estimate; and | ||
| the availability of satisfactory reimbursement from healthcare payors, including Medicare. |
If we are unable to convince additional hospitals and healthcare providers of the benefits of our
products for the treatment of acute kidney failure and fluid overload, we will not be successful in
increasing our market share in the critical care market.
We sell the System One in the critical care market for use in the treatment of acute kidney
failure and fluid overload. Physicians currently treat most acute kidney failure patients using
conventional hemodialysis systems or dialysis systems designed specifically for use in the
intensive care unit, or ICU. We will need to convince hospitals and healthcare providers that using
the System One is as effective as using conventional hemodialysis systems or ICU-specific dialysis
systems for treating acute kidney failure and that it provides advantages over conventional systems
or other ICU-specific systems because of its significantly smaller size, ease of operation and
clinical flexibility. In addition, the impact of tightened credit markets on hospitals could impair
the manner in which we sell products in the critical care market. Hospitals facing pressure to
reduce capital spending may choose to delay capital equipment purchases or seek alternative
financing options.
Our business and results of operations may be negatively impacted by general economic and financial
market conditions, including fluctuations in foreign exchange rates, and such conditions may
increase other risks that affect our business.
Global macro economic conditions and the worlds financial markets continue to experience some
degree of turmoil, resulting in reductions in available credit, foreign currency fluctuations and
volatility in the valuations of securities generally. In general, we believe demand for our
products in the home and in-center market will not be substantially affected by the changing market
conditions as regular dialysis is a life-sustaining, non-elective therapy. However, there is no
assurance that future economic changes or global uncertainties would not negatively impact our
business, especially the manner and pace in which we sell equipment in the System One segment or
delay equipment placements. Hospitals or clinics facing pressure to reduce capital spending may
choose to rent equipment rather than purchase it outright, or to enter into other less-capital
intensive purchase structures with us, which may, in turn, have a negative impact on our cash
flows. Further, unfavorable changes in foreign exchange rates versus the U.S. dollar would increase
our product costs which would negatively impact our gross profit and gross profit as a percentage
of revenues.
The non-cash discounts we have offered to DaVita may lead to reductions in our future net revenues
that will fluctuate because the amount of the discount is based upon the number of warrants earned
and our stock price.
Under our July 22, 2010 agreement with DaVita, we offered DaVita the opportunity to earn
pricing discounts based upon the achievement of System One home patient growth targets at June 30,
2011, 2012 and 2013. In order to preserve cash, the
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discount takes the form of warrants to purchase up to 5.5 million shares of our common stock
that become exercisable based on the achievement of certain System One home patient growth targets
(reflecting home patients who have remained on contiguous home hemodialysis therapy for at least
three full months with the System One) at June 30, 2011, 2012 and 2013, and which further require
DaVita to continue to grow its home patient census every six months during the term of the
agreement. The discount associated with these warrants will be measured at fair value through the
date of vesting using a Black-Scholes option pricing model, and is being recognized as a reduction
of revenues over the same period as the related product revenues (between seven to ten years) based
on the number of warrants expected to vest. The warrants are non-transferable, must be exercised in
cash and have an exercise price of $14.22 per share, which is equal to the trailing fifteen day
volume weighted average price of a share of NxStage Common Stock on the NASDAQ Global Market as of
the close of business on July 21, 2010, the day prior to entering into our agreement.
The reduction of revenues recorded in connection with these warrants was not significant
during the three months ended March 31, 2011, based on our assumptions regarding what tiered level
of warrant discounts DaVita is expected to earn. However, there can be no assurance that the value
of the discount, and, therefore, the amount of reduction of revenues recorded, will not be higher
in the future based upon the level of warrants DaVita actually earns under the agreement, as well
as the price of our stock on the date the warrants vest. Should our stock price increase above its
current price, the amount of the discount would be increased.
Healthcare reform legislation could adversely affect our revenue and financial condition.
In recent years, there have been numerous initiatives on the federal and state levels for
comprehensive reforms affecting the payment for, the availability of and reimbursement for
healthcare services in the United States. These initiatives have ranged from proposals to
fundamentally change federal and state healthcare reimbursement programs, including providing
comprehensive healthcare coverage to the public under governmental funded programs, to minor
modifications to existing programs.
In March 2010, the U.S. Congress adopted and President Obama signed into law comprehensive
health care reform legislation through the passage of the Patient Protection and Affordable Care
Act (Pub. L. No. 111-148) and the Health Care and Education Reconciliation Act of 2010 (Pub. L. No.
111-152). Among other initiatives, these bills impose a 2.3% excise tax on domestic sales of
certain medical devices after December 31, 2012. This legislation also applies a productivity
adjustment to the Medicare payment rates for dialysis facilities that could cause variable annual
decreases in payment rates as of 2012. Outside of the excise tax, which will impact our results of
operations following December 31, 2012, and the productivity adjustments, which may impact our
operations when the amount of the adjustments are announced, we cannot predict the effect such
legislation will have on us. If significant reforms are made to the healthcare system in the United
States, or in other jurisdictions, those reforms may have a material adverse effect on our
financial condition and results of operations.
As our business continues to grow, we may have difficulty managing our growth and expanding our
operations successfully.
As our business continues to grow, we will need to expand our manufacturing, 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 maintain strong product reliability for our products, our ability to maintain
or grow our business and achieve profitability could be impaired. Transition of supply or
manufacturing locations of products can also lead to product quality and reliability issues which
could impair our ability to maintain or grow our business and achieve profitability.
Product reliability issues associated with any of our product lines could lead to decreases in
customer satisfaction and our ability to grow or maintain our revenues and could negatively impact
our reputation. Further, any unfavorable changes in product reliability would result in increased
service and distribution costs which negatively impacts our gross profit and increases our working
capital requirements. We continue to work to maintain strong product reliability for all products.
If we are unable to maintain strong product reliability for our existing products, our ability to
achieve our growth objectives as well as profitability could be significantly impaired.
We also need to establish strong product reliability for all new products we offer. With new
products, we are more exposed to risks relating to product quality and reliability until the
manufacturing processes for these new products mature. We also choose from time to time to
transition the manufacturing and supply of products and components to different suppliers or
locations. As we make these changes, we are also more exposed to risks relating to product quality
and reliability until the
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manufacturing processes mature. We are currently working to transition more of our bloodline
supply from Kawasumi to our manufacturing facility in Mexico. This transition could expose us to
product quality and reliability issues. Like all transitions of this nature, it could also lead us
to incur additional costs in the short term, which would negatively impact our gross profits in the
short term.
We have a significant amount of System One field equipment and our inability to effectively manage
this asset could negatively impact our working capital requirements and future profitability.
Because our home market relies upon an equipment service swap model and, for some of our
customers, an equipment rental model, our ability to manage System One equipment is important to
minimizing our working capital requirements. Both factors require that we maintain a significant
level of field equipment of our System One and PureFlow SL hardware. In addition, our gross 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 2008, approximately 17,400 patients received kidney
transplants in the United States. The development of new medications designed to reduce the
incidence of kidney transplant rejection, progress in using kidneys harvested from genetically
engineered animals as a source of transplants or any other advances in kidney transplantation could
limit the market for our products. The development of viable medical or other solutions for renal
replacement may also limit the market for our products.
We could be subject to costly and damaging product and professional liability claims and may not be
able to maintain sufficient liability insurance to cover claims against us.
If any of our employees or products is found to have caused or contributed to injuries or
deaths, we could be held liable for substantial damages. Claims of this nature may also adversely
affect our reputation, which could damage our position in the market. While we maintain insurance,
including professional liability, product and excess liability, claims may be brought against us
that could result in court judgments or settlements in amounts that are in excess of the limits of
our insurance coverage. In addition, due to the recent tightening of global credit and the
disruption in the financial markets, there may be a disruption in our insurance coverage or delay
or disruption in the payment of claims by our insurance providers. Our insurance policies also have
various exclusions, and we may be subject to a product or professional liability claim for which we
have no coverage. We will have to pay any amounts awarded by a court or negotiated in a settlement
that exceed our coverage limitations or that are not covered by our insurance.
Any product liability or professional liability claim brought against us, with or without
merit, could result in the increase of our product liability or professional liability insurance
rates, respectively, or the inability to secure additional insurance coverage in the future. A
product liability claim, whether meritorious or not, could be time consuming, distracting and
expensive to defend and could result in a diversion of management and financial resources away from
our primary business, in which case our business may suffer.
We maintain insurance at levels deemed adequate by management; however, future claims could exceed
our applicable insurance coverage.
We maintain insurance for property and general liability, directors and officers liability,
product liability, workers compensation, and other coverage in amounts and on terms deemed adequate
by management based on our expectations for future claims. Future claims could, however, exceed our
applicable insurance coverage, or our coverage could not cover the applicable claims.
We face risks associated with having international manufacturing operations, and if we are unable
to manage these risks effectively, our business could suffer.
We operate manufacturing facilities in Germany, Italy and Mexico. We also purchase components,
products and supplies from foreign vendors. We are subject to a number of risks and challenges that
specifically relate to these international operations, and we may not be successful if we are
unable to meet and overcome these challenges. Significant among these risks are risks relating to
foreign currency, in particular the Euro, Peso and Thai Baht. We do not currently hedge our foreign
currency transactions. To the extent we fail to control our exchange rate risk, our gross margins
and profitability could suffer and our ability to maintain mutually beneficial and profitable
relationships with foreign vendors could be impaired. In addition to these risks, through our
international operations, we are exposed to costs and challenges associated with sourcing and
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shipping goods internationally and importing and exporting goods, difficulty managing
operations in multiple locations, local regulations that may restrict or impair our ability to
conduct our operations, and health issues, such as pandemic disease risk, which could disrupt our
manufacturing and logistical and import activities.
We obtain some of our raw materials, components and finished goods from a single source or a
limited group of suppliers. We also obtain sterilization services from a single supplier. 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 upon a number of single-source suppliers for some of the raw materials and
components we use in our products. We also depend upon one single-source supplier for certain of
our finished goods and a single-vendor for sterilization services. Our most critical single-source
supply relationships are with Membrana and Kawasumi. Membrana is our sole supplier of the fiber
used in our filters for System One products. Kawasumi is our only supplier of needles and certain
blood tubing sets that we sell to our customers. Our dependence upon these and other single-source
suppliers of raw materials, components, finished goods and sterilization services exposes us to
several risks, including disruptions in supply, price increases, late deliveries, and an inability
to meet customer demand. This could lead to customer dissatisfaction, damage to our reputation, or
customers switching to competitive products. Any interruption in supply could be particularly
damaging to our customers using the System One to treat chronic ESRD and who need access to the
System One and related disposables to continue their therapy.
Finding alternative sources for these raw materials, components, finished goods and
sterilization services would be difficult and in many cases entail a significant amount of time and
disruption. In the case of Membrana, for fiber, we are contractually prevented from obtaining an
alternative source of fiber for our System One products. Our relationship with Asahi could afford
us back-up supply in the event of an inability to supply by Membrana, however, switching to Asahi
fiber at this time would likely entail significant delays and difficulties. We do not have the
regulatory approvals necessary to use Asahi fiber in our System One cartridge in the United States.
Additionally, the performance of Asahi fiber in our System One has not yet been validated. We
purchase the majority of our finished goods of ReadySet blood tubing sets and all of our needles
from Kawasumi. Kawasumis contractual obligation to manufacture blood tubing sets expires in
January 2012, with opportunities to extend the term beyond that date. Kawasumis contractual
obligation to supply needles to us expires in February 2014, with opportunities to extend the term
beyond that date. Kawasumis contractual obligation to supply needles and blood tubing sets to us
is, at times, less than our forecasted demand. In the event Kawasumi supplies no more than the
amount of their required maximum monthly supply, we may not have enough needle or blood tubing set
supply to meet the demands of our customers. We maintain a limited extra supply of needles to
mitigate against the risk of any intermittent shortfalls in needle supply, and we have the ability
to manufacture additional blood tubing sets at our manufacturing facility in Tijuana, Mexico. We
are presently working to transition the manufacture of more blood tubing sets to our Tijuana
facility, however, there is no assurance that this transition will be completed quickly and without
creating any short term product quality or reliability issues. At least in the near term, there
can be no assurance that we will not experience any interruption in needle or blood tubing set
supply or that such an interruption would not impair our business.
Our In-Center segment relies heavily upon third-party distributors.
We sell the majority of our In-Center segment products through several distributors, which
collectively accounted for substantially all of In-Center revenues during the three months ended
March 31, 2011 and 2010, with Henry Schein and Gambro being our most significant distributors. Our
distribution agreement with Henry Schein expires in April 2012. Our distribution agreement with
Gambro expires in June 2014. The loss of Gambro or Henry Schein as our distributors for any reason
could materially adversely affect our business, at least in the near term.
Unless we can demonstrate sufficient product differentiation in our In-Center segment products that
we introduce in the future, we will continue to be susceptible to further pressures to reduce
product pricing and more vulnerable to the loss of our blood tubing set business to competitors in
the dialysis industry.
Our blood tubing set business has historically been a commodities business. Prior to the
Medisystems Acquisition, Medisystems competed favorably and gained share through the development of
a high quality, low-cost, standardized blood tubing set, which could be used on several different
dialysis machines. Our products continue to compete favorably in the dialysis blood tubing set
business, but are increasingly subject to pricing pressures, especially given recent market
consolidation in the United States dialysis services industry, with Fresenius and DaVita
collectively controlling approximately 60% of the United States dialysis services business. Unless
we can successfully demonstrate to customers the differentiating features of our current In-Center
segment products or products that we introduce in the future, we may be susceptible to further
pressures to reduce our product pricing and more vulnerable to the loss of our blood tubing set
business to competitors in the dialysis industry.
The activities of our business involve the import of finished goods into the United States from
foreign countries, subject to customs inspections and duties, and the export of components and
certain other products from other countries into Germany, Mexico, Thailand and Italy. To a lesser,
but increasing degree, our business also involves the export of finished
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goods from the United States to foreign countries. If we misinterpret or violate these laws, or if
laws governing our exemption from certain duties change, we could be subject to significant fines,
liabilities or other adverse consequences.
We import into the United States disposable medical supplies from Germany, Thailand and
Mexico. We also import into the United States disposable medical components from Germany and Italy
and export components and assemblies into Mexico, Thailand and Italy. We also import into Mexico
components and assemblies from Germany, Italy and Thailand. To a lesser, but increasing degree, our
business also involves the export of finished goods from the United States to foreign countries.
The import and export of these items are subject to extensive laws and regulations with which we
will need to comply. To the extent we fail to comply with these laws or regulations, or fail to
interpret our obligations accurately, we may be subject to significant fines, liabilities and a
disruption to our ability to deliver product, which could cause our combined businesses and
operating results to suffer. To the extent there are modifications to the Generalised System of
Preferences or cancellation of the Nairobi Protocol Classification such that our products would be
subject to duties, our profitability would also be negatively impacted.
The success of our business depends on the services of each of our senior executives as well as
certain key engineering, scientific, manufacturing, clinical and marketing personnel, the loss of
whom could negatively affect the combined businesses.
Our success has always depended upon the skills, experience and efforts of our senior
executives and other key personnel, including our research and development and manufacturing
executives and managers. Much of our expertise is concentrated in relatively few employees, the
loss of whom for any reason could negatively affect our business. Competition for our highly
skilled employees is intense and we cannot prevent the future resignation of any employee. We
maintain key person insurance for only one of our executives, Jeffrey Burbank, our Chief Executive
Officer.
Risks Related to the Regulatory Environment
We are subject to significant regulation, primarily by the FDA. We cannot market or commercially
distribute our products without obtaining and maintaining necessary regulatory clearances or
approvals.
Our products are medical devices subject to extensive regulation in the United States, and in
foreign markets we may wish to enter. To market medical devices in the United States, approval or
clearance by the FDA is required, either through the pre-market approval process or the 510(k)
clearance process. We have obtained the FDA clearance necessary to sell our current products under
the 510(k) clearance process. Medical devices may only be promoted and sold for the indications for
which they are approved or cleared. In addition, even if the FDA has approved or cleared a product,
it can take action affecting such product approvals or clearances if serious safety or other
problems develop in the marketplace. We may be required to obtain 510(k) clearances or pre-market
approvals for additional products, product modifications, or for new indications of our products.
Regulatory pathways for such clearances may be difficult to define and could change. For example,
we recently completed an approval IDE study intended to support a home nocturnal indication for the
System One. Enrollment started in the first quarter of 2008 and we submitted the associated 510(k)
to the FDA in 2010. We met our primary safety and efficacy endpoints for the study. Nevertheless,
the FDA notified us that their standards for what will be required for a home nocturnal clearance
may change from what was required in our approval IDE. We continue to discuss with the FDA what the
pathway to clearance for our product should be, and are evaluating our next steps. Although we do
not see the delay in timing for our home nocturnal clearance as material to our opportunities, we
cannot be certain when this clearance will be obtained. We also cannot provide assurance that this
or other clearances or approvals might be obtained. Delays in obtaining clearances or approvals
could adversely affect our ability to introduce new products or modifications to our existing
products in a timely manner, which would delay or prevent commercial sales of our products.
Although the 510(k) regulation has not been formally changed, the FDA has announced that it is
intending to implement modifications to the 510(k) process. Any changes in regulatory policies
could have an adverse affect on our ability to sell and promote our products and our business as a
whole.
Modifications to our marketed devices may require new regulatory clearances or pre-market
approvals, or may require us to cease marketing or recall the modified devices until clearances or
approvals are obtained.
Any modifications to a 510(k) cleared device that could significantly affect its safety or
effectiveness, or would constitute a major change in its intended use, requires the submission of
another 510(k) pre-market notification to address the change. Although in the first instance we may
determine that a change does not rise to a level of significance that would require us to make a
pre-market notification submission, the FDA may disagree with us and can require us to submit a
510(k) for a significant change in the labeling, technology, performance specifications or
materials or major change or modification in intended use, despite a documented rationale for not
submitting a pre-market notification. We have modified various aspects of our products and have
filed and received clearance from the FDA with respect to some of the changes in the design of our
products. If the FDA requires us to submit a 510(k) for any modification to a previously cleared
device, or in the future a device that has received 510(k) clearance, we may be required to cease
marketing the device, recall it, and not resume marketing until we obtain clearance from the FDA
for the modified version of the device. Also, we may be subject to regulatory fines, penalties
and/or other sanctions authorized by the Federal Food, Drug, and Cosmetic Act. In the future, we
intend to introduce new products and enhancements and improvements to existing products. We cannot
provide assurance that the FDA will clear any
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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
similar authority to recall devices because of material deficiencies or defects in design or
manufacture that could endanger health. We believe that the FDA would request that we initiate a
voluntary recall if a product was defective or presented a risk of injury or gross deception. Any
recall would divert management attention and financial resources, could cause the price of our
stock to decline and expose us to product liability or other claims and harm our reputation with
customers.
If we or our contract manufacturers fail to comply with FDAs Quality System Regulations, our
manufacturing operations could be interrupted, and our product sales and operating results could
suffer.
Our finished goods manufacturing processes, and those of some of our contract manufacturers,
are required to comply with the FDAs Quality System Regulations, or QSRs, which cover the
procedures and documentation of the design, testing, production, control, quality assurance,
labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces its QSRs
through periodic unannounced inspections of manufacturing facilities. We and our contract
manufacturers have been, and anticipate in the future being, subject to such inspections. We were
inspected by the FDA in the second quarter of 2010, and received no inspectional observations.
While all of our previous inspections have resulted in no significant observations, we cannot
provide assurance that we can maintain a comparable level of regulatory compliance in the future at
our facilities, or that future inspections would have the same result.
If one of our manufacturing facilities or those of any of our contract manufacturers fails to
take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take
enforcement action, including issuing a public warning
letter, shutting down our manufacturing operations, embargoing the import of components from
outside of the United States,
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recalling our products, refusing to approve new marketing
applications, instituting legal proceedings to detain or seize products or imposing civil or
criminal penalties or other sanctions, any of which could cause our business and operating results
to suffer.
We may be subject to fines, penalties or injunctions if we are determined to be promoting the use
of our products in a manner not consistent with our products cleared indications for use or with
other state or federal laws governing the promotion of our products.
Our promotional materials and other product labeling must comply with FDA and other applicable
laws and regulations. If the FDA determines that our promotional materials or other product
labeling constitute promotion of an unapproved, or uncleared use, it could request that we modify
our materials or subject us to regulatory or enforcement actions, including the issuance of an
untitled letter, a warning letter, injunction, seizure, civil fine and criminal penalties. Other
regulatory agencies, federal, state and foreign, including the U.S. Federal Trade Commission, have
issued guidelines and regulations that govern how we promote our product, including how we use
endorsements and testimonials. If our promotional materials are inconsistent with these guidelines
or regulations, we could be subject to enforcement actions, which could result in significant
fines, costs and penalties. Our reputation could also be damaged and the adoption of our products
could be impaired.
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 expect commercial sales in Australia and New Zealand in the
near term. We are assessing other international markets for the System One as well. Our In-Center
products are presently sold in the United States as well as in several other countries, through
distributors. We presently have CE marking as well as Canadian regulatory authority to sell our
System One as well as certain other products in Canada, Europe and selected other geographies .
However, in order to market directly our products in other foreign jurisdictions, we must obtain
separate regulatory approvals and comply with numerous and varying regulatory requirements. The
approval procedure varies from country to country and can involve additional testing. The time
required to obtain approval abroad may be longer than the time required to obtain FDA clearance.
The foreign regulatory approval process includes many of the risks associated with obtaining FDA
clearance and we may not obtain foreign regulatory approvals on a timely basis, if at all. FDA
clearance does not ensure approval by regulatory authorities in other countries, and approval by
one foreign regulatory authority does not ensure approval by regulatory authorities in other
foreign countries. We may not be able to file for regulatory approvals and may not receive
necessary approvals to commercialize our products in other markets outside the United States, which
could negatively affect our overall market penetration. Additionally, any loss of foreign
regulatory approvals, for any reason, could negatively affect our business.
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 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
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matter. Such state laws typically have their own penalty provisions, which could be applied in
the event of an unlawful action affecting health information.
We are subject to federal and state laws prohibiting kickbacks and false and fraudulent claims
which, if violated, could subject us to substantial penalties. Additionally, any challenges to or
investigation into our practices under these laws could cause adverse publicity and be costly to
respond to, and thus could harm our business.
The Medicare/Medicaid anti-kickback laws, and similar state laws, prohibit payments that are
intended to induce health care professionals or others either to refer patients or to acquire or
arrange for or recommend the acquisition of healthcare products or services. A number of states
have enacted laws that require pharmaceutical and medical device companies to monitor and report
payments, gifts and other remuneration made to physicians and other health care professionals and
health care organizations. In addition, some state statutes, most notably laws in Massachusetts,
Minnesota, and Vermont, impose outright bans on certain gifts to physicians. Some of these laws
referred to as aggregate spend laws or gift laws, carry substantial fines if they are violated.
Recently, the federal Physician Payments Sunshine Act was enacted by Congress in 2010 as part of
the comprehensive health care reform legislation, and it will require us to begin publicly
disclosing certain payments and other transfers of value to physicians and teaching hospitals
beginning in 2013. These laws affect our sales, marketing and other promotional activities by
limiting the kinds of financial arrangements, including sales programs, we may have with hospitals,
physicians or other potential purchasers or users of medical devices. They also impose additional
administrative and compliance burdens on us. In particular, these laws influence, among other
things, how we structure our sales and rental offerings, including discount practices, customer
support, education and training programs and physician consulting and other service arrangements.
Although we seek to structure such arrangements in compliance with all applicable requirements,
these laws are broadly written, and it is often difficult to determine precisely how these laws
will be applied in specific circumstances. If we were to offer or pay inappropriate inducements to
purchase our products, we could be subject to a claim under the Medicare/Medicaid anti-kickback
laws or similar state laws. If we fail to comply with particular reporting requirements, we could
be subject to penalties under applicable federal or state laws.
Other federal and state laws generally prohibit individuals or entities from knowingly
presenting, or causing to be presented, claims for payments to Medicare, Medicaid or other
third-party payors that are false or fraudulent, or for items or services that were not provided as
claimed. Although we do not submit claims directly to payors, manufacturers can be held liable
under these laws if they are deemed to cause the submission of false or fraudulent claims by
providing inaccurate billing or coding information to customers, by providing improper financial
inducements, or through certain other activities. In providing billing and coding information to
customers, we make every effort to ensure that the billing and coding information furnished is
accurate and that treating physicians understand that they are responsible for all billing and
prescribing decisions, including the decision as to whether to order dialysis services more
frequently than three times per week. Nevertheless, we cannot provide assurance that the government
will regard any billing errors that may be made as inadvertent or that the government will not
examine our role in providing information to our customers concerning the benefits of daily
therapy. Likewise, our financial relationships with customers, physicians, or others in a position
to influence the purchase or use of our products may be subject to government scrutiny or be
alleged or found to violate applicable fraud and abuse laws. False claims laws prescribe civil,
criminal and administrative penalties for noncompliance, which can be substantial. Moreover, an
unsuccessful challenge or investigation into our practices could cause adverse publicity, and be
costly to respond to, and thus could harm our business and results of operations.
Foreign governments tend to impose strict price controls, which may adversely affect our future
profitability.
Presently, our marketing efforts have been confined nearly exclusively to the United States.
We have had limited activities in Canada and other select geographies with our System One and 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 internationally. In some
foreign countries, particularly in the European Union, the pricing of medical devices is subject to
governmental control. In these countries, pricing negotiations with governmental authorities can
take considerable time after the receipt of marketing approval for a product. To obtain
reimbursement or pricing approval in some countries, we may be required to supply data that
compares the cost-effectiveness of our products to other available therapies. If reimbursement of
our products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory
levels, it may not be profitable to sell our products outside of the United States, which would
negatively affect the long-term growth of our business. Further, reimbursement provided to our
products in other jurisdictions could change, positively or negatively. In the event reimbursements
were to be negatively changed, such as, for example, in the United Kingdom, our ability to sell our
products could be impaired.
Failure to comply with the United States Foreign Corrupt Practices Act 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.
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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
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 activities would likely cause production delays, and negatively
affect our ability to deliver our production commitments to customers, which could adversely affect
our reputation and cause our combined businesses and operating results to suffer. Additionally,
some of our key single source suppliers have labor agreements. We cannot guarantee that we will not
have future disruptions, which could adversely affect our reputation and cause our business and
operating results to suffer.
We do not have long-term supply contracts with many of our third-party suppliers.
We purchase raw materials and components from third-party suppliers, including some single
source suppliers, through purchase orders and do not have long-term supply contracts with many of
these third-party suppliers. Many of our third-party suppliers are not obligated to perform
services or supply products for any specific period, in any specific quantity or at any specific
price, except as may be provided in a particular purchase order. We do not maintain large volumes
of inventory from most of our suppliers. If we inaccurately forecast demand for finished goods, our
ability to meet customer demand could be delayed and our competitive position and reputation could
be harmed. In addition, if we fail to effectively manage our relationships with these suppliers, we
may be required to change suppliers, which would be time consuming and disruptive and could lead to
disruptions in product supply, which could permanently impair our customer base and reputation.
Risks Related to Intellectual Property
If we are unable to protect our intellectual property and prevent its use by third parties, we will
lose a significant competitive advantage.
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We rely on patent protection, as well as a combination of copyright, trade secret and
trademark laws to protect our proprietary technology and prevent others from duplicating our
products. However, these means may afford only limited protection and may not:
| prevent our competitors from duplicating our products; | ||
| prevent our competitors from gaining access to our proprietary information and technology; or | ||
| permit us to gain or maintain a competitive advantage. |
Any of our patents, including those we may license, may be challenged, invalidated,
circumvented or rendered unenforceable. We cannot provide assurance that we will be successful
should one or more of our patents be challenged for any reason. If our patent claims are rendered
invalid or unenforceable, or narrowed in scope, the patent coverage afforded our products could be
impaired, which could make our products less competitive.
We cannot specify which, if any, of our patents individually or as a group will permit us to
gain or maintain a competitive advantage. We cannot provide assurance that any pending or future
patent applications we hold will result in an issued patent or that if patents are issued to us,
that such patents will provide meaningful protection against competitors or against competitive
technologies. The issuance of a patent is not conclusive as to its validity or enforceability. The
United States federal courts or equivalent national courts or patent offices elsewhere may
invalidate our patents or find them unenforceable. Competitors may also be able to design around
our patents. Our patents and patent applications cover particular aspects of our products. Other
parties may develop and obtain patent protection for more effective technologies, designs or
methods for treating kidney failure. If these developments were to occur, it would likely have an
adverse effect on our sales.
The laws of foreign countries may not protect our intellectual property rights effectively or
to the same extent as the laws of the United States. If our intellectual property rights are not
adequately protected, we may not be able to commercialize our technologies, products or services
and our competitors could commercialize similar technologies, which could result in a decrease in
our revenues and market share.
Our products could infringe the intellectual property rights of others, which may lead to
litigation that could itself be costly, could result in the payment of substantial damages or
royalties, and/or prevent us from using technology that is essential to our products.
The medical device industry in general has been characterized by extensive litigation and
administrative proceedings regarding patent infringement and intellectual property rights. Products
to provide kidney replacement therapy have been available in the market for more than 30 years and
our competitors hold a significant number of patents relating to kidney replacement devices,
therapies, products and supplies. Although no third party has threatened or alleged that our
products or methods infringe their patents or other intellectual property rights, we cannot provide
assurance that our products or methods do not infringe the patents or other intellectual property
rights of third parties. If our business is successful, the possibility may increase that others
will assert infringement claims against us.
Infringement and other intellectual property claims and proceedings brought against us,
whether successful or not, could result in substantial costs and harm to our reputation. Such
claims and proceedings can also distract and divert management and key personnel from other tasks
important to the success of the business. In addition, intellectual property litigation or claims
could force us to do one or more of the following:
| cease selling or using any of our products that incorporate the asserted intellectual property, which would adversely affect our revenues; | ||
| pay substantial damages for past use of the asserted intellectual property; | ||
| obtain a license from the holder of the asserted intellectual property, which license may not be available on reasonable terms, if at all and which could reduce profitability; and | ||
| redesign or rename, in the case of trademark claims, our products to avoid infringing the intellectual property rights of third parties, which may not be possible and could be costly and time-consuming if it is possible to do so. |
Confidentiality agreements with employees and others may not adequately prevent disclosure of trade
secrets and other proprietary information.
In order to protect our proprietary technology and processes, we also rely in part on
confidentiality agreements with our corporate partners, employees, consultants, outside scientific
collaborators and sponsored researchers, advisors and others. These agreements may not effectively
prevent disclosure of confidential information and trade secrets and may not provide an
adequate remedy in the event of unauthorized disclosure of confidential information. In
addition, others may independently
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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. As a result
of this volatility, you may not be able to sell your common stock at or above the price you paid
for the stock. Some of the factors that may cause the market price of our common stock to fluctuate
include:
| timing of market launch and/or market acceptance of our products; | ||
| timing of achieving profitability from operations; | ||
| changes in estimates of our financial results or recommendations by securities analysts or the failure to meet or exceed securities analysts expectations; | ||
| actual or anticipated variations in our quarterly operating results; | ||
| future debt or equity financings; | ||
| developments or disputes with key vendors or customers, or adverse changes to the purchasing patterns of key customers; | ||
| disruptions in product supply for any reason, including product recalls, our failure to appropriately forecast supply or demand, difficulties in moving products across the border, or the failure of third party suppliers to produce needed products or components; | ||
| reports by officials or health or medical authorities, the general media or the FDA regarding the potential benefits of the System One or of similar dialysis products distributed by other companies or of daily or home dialysis; | ||
| announcements by the FDA of non-clearance or non-approval of our products, or delays in the FDA or other foreign regulatory agency review process; | ||
| product recalls; | ||
| defaults under our material contracts, including without limitation our credit agreement; | ||
| regulatory developments in the United States and foreign countries; | ||
| changes in third-party healthcare reimbursements, particularly a decline in the level of Medicare reimbursement for dialysis treatments, or the willingness of Medicare contractors to pay for more than three treatments a week where medically justified; | ||
| litigation involving our company or our general industry or both; | ||
| announcements of technical innovations or new products by us or our competitors; | ||
| developments or disputes concerning our patents or other proprietary rights; | ||
| our ability to manufacture and supply our products to commercial standards; | ||
| significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors; | ||
| departures of key personnel; and | ||
| investors general perception of our company, our products, the economy and general market conditions. |
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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 a large number of shares of common stock,
the market price of our common stock could decline significantly. We have 54,230,269 shares of
common stock outstanding as of March 31, 2011. Except where sales are made pursuant to an effective
registration statement, shares held by our affiliates may only be sold in compliance with the
volume limitations of Rule 144. These volume limitations restrict the number of shares that may be
sold by an affiliate in any three-month period to the greater of 1% of the number of shares then
outstanding, which approximates 542,303 shares, or the average weekly trading volume of our common
stock during the four calendar weeks preceding the filing of a notice on Form 144 with respect to
the sale. With the higher trading volumes we have recently observed in our stock, the number of
shares that can be sold by our affiliates pursuant to Rule 144 is significantly above the 1% of
shares outstanding limitation of Rule 144 as of the time of the filing of this report.
At March 31, 2011, subject to certain conditions, holders of an aggregate of approximately 9
million shares of our common stock have rights with respect to the registration of these shares of
common stock with the Securities and Exchange Commission, or SEC. If we register their shares of
common stock, they can more easily sell those shares in the public market.
As of March 31, 2011, 6,400,478 shares of common stock are authorized for issuance under our
stock incentive plan, employee stock purchase plan and outstanding stock options. As of March 31,
2011, 5,991,199 shares were subject to outstanding options, of which 3,843,378 were exercisable and
can be freely sold in the public market upon issuance, subject to the restrictions imposed on our
affiliates under Rule 144.
We have filed a resale registration statement covering both shares of our common stock that we sold
in a May 2008 private placement and shares of our common stock issuable upon the exercise of a
warrant held by DaVita. If the holders of these shares or shares issued pursuant to the terms of
the warrant are unable to sell these shares under the respective registration statements, we may be
obligated to pay them damages, which could harm our financial condition. Further, these resale
registration statements could result in downward pressure on the price of our common stock and may
affect the ability of our stockholders to realize the current trading price of our common stock.
In 2008, we sold an aggregate of 9,555,556 shares of our common stock and warrants to purchase
an additional 1,911,111 shares of our common stock in a private placement. We were required to
register the common
stock and the common
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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 registered the
shares of common stock issuable upon the exercise of the warrant on February 16, 2011 on our
automatic shelf registration statement on Form S-3 (No. 333-170654) filed on November 17, 2010.
Investors should be aware that the current or future market price of their shares of our
common stock could be negatively impacted by the sale or perceived sale of all or a significant
number of these shares that are available for sale pursuant to these registration statements or
that will be available for sale in the future.
Our outstanding warrants, and the provisions of our Term Loan with Asahi, may result in substantial
dilution to our stockholders.
Warrants held by DaVita and certain investors in our 2008 private placement could result in
the issuance of up to 7,052,155 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 35% of our outstanding common stock. David S. Utterberg holds
approximately 10% and Gilder, Gagnon, Howe and Co. LLC holds approximately 8% of our outstanding
common stock. Although these numbers are lower than they have been historically, due to certain
recent selling by larger affiliated stockholders, these stockholders, if acting together, may
nevertheless still have the ability to determine the outcome of matters submitted to our
stockholders for approval, including the election and removal of directors and any merger,
consolidation or sale of all or substantially all of our assets and other extraordinary
transactions. The interests of this group of stockholders may not always coincide with our
corporate interests or the interests of other stockholders, and they may act in a manner with which
you may not agree or that may not be in the best interests of other stockholders. This
concentration of ownership may have the effect of:
| delaying, deferring or preventing a change in control of our company; | ||
| entrenching our management and/or Board; | ||
| impeding a merger, consolidation, takeover or other business combination involving our company; or | ||
| discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company. |
We may grow through additional acquisitions, which could dilute our existing shareholders and could
involve substantial integration risks.
As part of our business strategy, we may acquire other businesses and/or technologies in the
future. We may issue equity securities as consideration for future acquisitions that would dilute
our existing stockholders, perhaps significantly depending on the terms of the acquisition. We may
also incur additional debt in connection with future acquisitions, which, if available at all, may
place additional restrictions on our ability to operate our business. Acquisitions may involve a
number of risks, including:
| difficulty in transitioning and integrating the operations and personnel of the acquired businesses, including different and complex accounting and financial reporting systems; | ||
| potential disruption of our ongoing business and distraction of management; |
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| 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 | ||
*10.32
|
Employment Agreement dated April 25, 2011 between Registrant and Michael Miller, Jr. | |
*10.33
|
Amendment, dated as of March 29, 2011, to the Loan and Security Agreement, dated March 10, 2010, by and among Silicon Valley Bank, as the Lender, and the Registrant, EIR Medical, Inc., Medisystems Corporation and Medisystems Services Corporation, as Borrowers. | |
*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 herewidth. |
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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. |
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By: | /s/ Robert S. Brown | |||
Robert S. Brown | ||||
Chief Financial Officer (Duly authorized officer and principal financial and accounting officer) |
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May 4, 2011
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