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| ELGX > SEC Filings for ELGX > Form 10-K on 10-Mar-2009 | All Recent SEC Filings |
10-Mar-2009
Annual Report
Overview
Our Business
We are engaged in the development, manufacturing, marketing and sale of
minimally invasive treatments for aortic disorders. Our primary focus is the
marketing and sale of the Powerlink System, a catheter-based alternative
treatment to surgery for AAA. AAA is a weakening of the wall of the aorta, the
largest artery of the body. Once AAA develops, it continues to enlarge and if
left untreated becomes increasingly susceptible to rupture. The overall patient
mortality rate for ruptured abdominal aortic aneurysms is approximately 75%,
making it a leading cause of death in the United States.
Prior to the acquisition of former Endologix and the restructuring that
occurred during the third and fourth quarters of 2001, we were researching,
developing and marketing a radiation therapy catheter for the treatment of
blockages in arteries after angioplasty, or restenosis.
Between 1999 and 2003, our source of revenues shifted gradually from direct
sales of previous catheter and stent products to royalties from licenses of our
stent delivery technology. In June 1998, we licensed to Guidant rights to
manufacture and distribute products using our Focus technology for the delivery
of stents in exchange for milestone and royalty payments. In April 2006, Abbott
acquired Guidant's vascular business, including all rights and obligations under
the license.
Our license revenue decreased in 2008 from 2007. In 2007, under our licensing
agreement with BioLucent, Inc., we received $504,000 in royalties and fees,
including a one-time payment of $500,000 in exchange for a fully paid-up license
to certain of our patents. License revenue from Abbott remained at the
contractual minimum level of $250,000 for 2007 and the minimum payment
requirement under the agreement expired at December 31, 2007. In 2008, we
received de minimus royalties under this agreement prior to its expiration in
June 2008. Sales of our Powerlink System are now our only material source of
revenue.
For the years ended December 31, 2008 and 2007, we incurred net losses of
$12.0 million and $15.1 million, respectively. As of December 31, 2008, we had
an accumulated deficit of approximately $143.7 million.
We believe that our current cash balance, in combination with cash receipts
generated from sales of the Powerlink System and borrowings available under our
credit facility, will be sufficient to fund ongoing operations through at least
December 31, 2009. If we do not realize expected revenue and gross margin
levels, or if we are unable to manage our operating expenses in line with our
revenues, or if we cannot maintain our days sales outstanding accounts
receivable ratio, we may not be able to fund our operations through December 31,
2009.
In the event that we require additional funding to continue our operations,
we will attempt to raise the required capital through either debt or equity
arrangements. We cannot provide any assurance that the required capital would be
available on acceptable terms, if at all, or that any financing activity would
not be dilutive to our current stockholders. If we are not able to raise
additional funds, we may be required to significantly curtail our operations and
this would have an adverse effect on our financial position, results of
operations and cash flows.
Summary of Accounting Policies and Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. On an on-going
basis, we evaluate our estimates, including those related to collectibility of
customer accounts, whether the cost of inventories can be recovered, the value
assigned to and estimated useful life of intangible assets, the realization of
tax assets and estimates of tax liabilities, contingent liabilities and the
potential outcome of litigation. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities. Actual results may differ from
these estimates under different assumptions or conditions.
The following critical accounting policies and estimates were used in the
preparation of the consolidated financial statements:
Revenue Recognition and Accounts Receivable
We comply with the revenue recognition guidelines in SEC Staff Accounting
Bulletin No. 104, "Revenue Recognition." We recognize revenue when all of the
following criteria are met:
• Persuasive evidence of an arrangement exists;
• The sales price is fixed or determinable;
• Collection of the relevant receivable is probable at the time of sale; and
• Products have been shipped or used and the customer has taken ownership and assumed risk of loss.
In the past, we have earned royalty revenue, which was included in license
revenue in the consolidated statement of operations, as a result of the sale of
product rights and technologies to third parties. Royalties were recognized upon
the sale of products subject to the royalty by the third party.
We do not offer rights of return and we have no post delivery obligations
other than our specified warranty.
We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. These estimates
are based on our review of the aging of customer balances, correspondence with
the customer, and the customer's payment history. If additional information
becomes available to us indicating the financial condition of the customer is
deteriorating, additional allowances may be required.
Inventories
We write down our inventory for estimated obsolescence or unmarketable
inventory equal to the difference between the cost of inventory and the
estimated realizable value based upon assumptions about future demand, as driven
by economic and market conditions, and the product's shelf life. If actual
demand, or economic or market conditions are less favorable than those projected
by management, additional inventory write-downs may be required.
Goodwill, Intangible Assets and Long-Lived Assets
We record an impairment charge, or expense, for long-lived assets whenever
events or changes in circumstances indicate that the value recorded for the
asset may not be recoverable. Future changes in operations could cause us to
write down the asset value and record an expense to better reflect our current
estimate of its value. Goodwill and indefinite-lived intangible assets are
tested for impairment annually, or more frequently if events or changes in
circumstances indicate that the goodwill or indefinite-lived intangible assets
are impaired. Factors that may impact whether there is potential goodwill
impairment include a significant decrease in our stock price and our evaluation
of a control premium that may be used when estimating our total fair value. Our
stock price may decline, or other factors may arise, which could result in
goodwill impairment in future periods. Factors that may impact whether there is
a potential impairment to our indefinite-lived intangible assets include legal
and regulatory considerations.
Income Taxes
We record the estimated future tax effects of temporary differences between
the tax basis of assets and liabilities and amounts reported in the financial
statements, as well as operating losses and tax credit carry forwards. We have
recorded a full valuation allowance to reduce our deferred tax assets to zero,
because we believe that, based upon a number of factors, it is more likely than
not that the deferred tax assets will not be realized. If we were to determine
that we would be able to realize our deferred tax assets in the future, an
adjustment to the valuation allowance on our deferred tax assets would increase
net income in the period such determination was made.
In July 2006, the Financial Accounting Standards Board issued FIN 48. FIN 48
prescribes a comprehensive model for how companies should recognize, measure,
present, and disclose, in their financial statements, uncertain tax positions
taken or expected to be taken on a tax return. Under FIN 48, tax positions must
initially be recognized in the financial statements when it is more likely than
not the position will be sustained upon examination by the tax authorities. Such
tax positions must initially and subsequently be measured as the largest amount
of tax benefit that is greater than 50% likely of being realized upon ultimate
settlement with the tax authority assuming full knowledge of the position and
relevant facts.
Stock-based compensation
Effective at the beginning of our fiscal year 2006, we adopted Statement of
Financial Accounting Standards, or SFAS No. 123R, "Share-Based Payments," or
SFAS 123R. This statement requires us to recognize the cost of employee and
director services received in exchange for stock options awarded. Under SFAS
123R, we are required to recognize compensation expense over an award's vesting
period based on the award's fair value at the date of grant. We use the
Black-Scholes option pricing model to value stock option grants. The fair value
for awards that are expected to vest is then amortized on a straight-line basis
over the requisite service period of the award, which is generally the option
vesting term. The amount of expense attributed is net of an estimated forfeiture
rate, which is updated as appropriate. This option pricing model requires the
input of highly subjective assumptions, including the expected volatility of our
common stock, pre-vesting forfeiture rate and the option's expected life. The
financial statements include such amounts based on our best estimates and
judgments.
Results of Operations
Comparison of Years Ended December 31, 2008 and 2007
Product Sales. Sales increased 39% to $37.6 million in 2008 from
$27.0 million in 2007 primarily due to the increased productivity of our
domestic field sales personnel, and the introduction of our suprarenal proximal
extensions and Powerlink XL products. Domestic sales increased from
$23.0 million to $31.9 million, and sales to distributors outside the United
States increased from $4.0 million in 2007 to $5.7 million in 2008. This
increase was primarily due to sales to our distributor Cosmotec in Japan, as
well as an increase in sales to distributors in Latin America.
We expect that product sales will increase in 2009 by an estimated 17% to 22%
from 2008 to $44 million to $46 million in 2009. In the U.S. market the increase
is expected due to increased productivity from our sales representatives and the
introduction of two new products in the second and third quarters of 2009, and
the full year effect of two new products launched in the fourth quarter of 2008.
Outside the U.S., we expect growth in each of our major markets of Europe,
Japan, and Latin America.
License Revenue. License revenue decreased 96% to $33,000 in 2008 from
$754,000 in 2007. License revenue from Abbott remained at the contractual
minimum level of $250,000 for 2007, and expectedly declined sharply in 2008 as
the minimum royalty provision of the agreement expired at December 31, 2007. The
license expired and was fully paid up in June 2008. Additionally in 2007, due to
our licensing agreement with BioLucent, we received $504,000 in royalties and
fees, including a one-time payment of $500,000 in exchange for a fully paid up
license to certain of our patents in a certain field of use. Beginning
January 1, 2008, sales of our Powerlink System were our only material source of
revenue.
Cost of Product Revenue. The cost of product revenue, which includes labor,
overhead, materials and parts, rent, depreciation, small tools and supplies,
samples for destructive testing, and utilities, among other items, decreased 2%
to $10.4 million from $10.5 million in 2007. This decrease is directly
attributable to the substitution of lower-cost in-house produced graft material
in a majority of the products sold in 2008.
Gross Profit. Gross profit increased 58% to $27.3 million in 2008 from
$17.2 million in 2007. The increase in gross profit resulted from higher product
sales in 2008 as compared to 2007 and a reduction in the per unit cost of
product due to substitution of lower-cost in-house produced graft material in a
majority of the products sold in 2008. Gross profit as a percentage of revenue
increased to 72% in 2008 from 62% in 2007 for these reasons.
We believe that gross profit dollars will increase marginally in 2009 due to
higher commercial sales of the Powerlink System both in and outside of the
United States. We also expect that gross profit as a percentage of product
revenues will increase due to efficiencies from higher manufacturing volumes
required to support sales growth.
Research, Development and Clinical. Research, development and clinical
expenses decreased by 5% to $6.1 million from $6.4 million in 2007. The decrease
primarily resulted from lower costs associated with clinical trials in the 2008
period. We recorded $236,000 in 2008 and $417,000 in 2007, of stock compensation
expense.
Research, development, and clinical expense has decreased in two consecutive
years for the reasons noted in this discussion. We expect that these expenses
will now increase in 2009 and future years as we pursue opportunities to develop
additional new products for the treatment of aortic disorders.
Marketing and Sales. Marketing and sales expenses increased by 18% to
$23.8 million from $20.1 million in 2007. This increase was due to higher sales
commission payouts on the 39% growth in domestic sales revenue, severance
payments, and the implementation of an in-depth sales training program. We
recorded $1.0 million in 2008 and $878,000 in 2007, respectively, of stock
compensation expense.
We expect that marketing and sales expense will increase in 2009 for three
reasons:
• the marketing related costs to launch two significant new products in 2009 -
the IntuiTrak delivery system for Powerlink in the second quarter and the
IntuiTrak Express delivery system for Powerlink XL in the third quarter;
• expenses related to more intensive training of sales representatives; and
• higher commission expense on the expected increase in sales.
General and Administrative. General and administrative expenses increased by
49% to $9.5 million from $6.4 million in 2007. The increase was due primarily to
increases in patent and legal fees, settlement of the legal dispute with Cook
Medical Products, Inc., our chief executive officer succession process, and our
analysis and response to the unsolicited acquisition proposal from Elliott
Associates. In addition, stock based compensation expense totaled $1.4 million
in 2008 as compared to $894,000 in 2007. We expect general and administrative
expense to decline by approximately $1.0 million in 2009 relative to 2008.
Termination of Supply Agreement. Termination of supply agreement expense was
$550,000 in 2007. The expense was due to the third amendment to our supply
agreement for ePTFE graft material with Bard Peripheral, dated September 21,
2007, which reduced the minimum purchase requirement for the 2007 year from
$2.9 million to $2.2 million, and wherein both parties agreed to terminate the
agreement on December 31, 2007. In consideration for the reduction in the
minimum purchase requirement for the 2007 year, we paid $550,000 to Bard
Peripheral.
Other Income. Other income decreased 95% to $55,000 from $1.1 million in
2007. The decrease in other income was primarily the result of a realized gain
of $412,000 on our investment in BioLucent in 2007, lower interest income, and
higher interest expense in 2008 due to drawing down on the term loan and
revolving line of credit with Silicon Valley Bank in September 2008.
Comparison of Years Ended December 31, 2007 and 2006
Product Sales. Sales increased 87% to $27.0 million in 2007 from
$14.4 million in 2006 primarily due to the expansion and increased productivity
of our domestic field sales personnel, and increased market acceptance of the
Powerlink System. Domestic sales increased from $12.4 million to $23.0 million,
and sales to distributors outside the United States doubled from $2.0 million in
2006 to $4.0 million in 2007. Our distribution agreement with Edwards
Lifesciences AG, or Edwards Lifesciences, was not renewed beyond the original
expiration of December 31, 2006. Sales to Edwards Lifesciences in 2006 were
$1.2 million. We replaced the Edwards Lifesciences distribution agreement with a
three-year distribution agreement with LeMaitre Vascular. This agreement named
LeMaitre Vascular as the exclusive distributor of the Powerlink System in ten
European countries, including Austria, Belgium, the Czech Republic, France,
Germany, Luxembourg, the Netherlands, Sweden, Switzerland, and the United
Kingdom. Sales to LeMaitre in 2007 were $2.1 million.
License Revenue. License revenue increased 202% to $754,000 in 2007 from
$250,000 in 2006, due to our licensing agreement with BioLucent. Under that
agreement, we received $504,000 in royalties and fees, including a one-time
payment of $500,000 in exchange for a fully paid up license to certain of our
patents in a certain field of use. License revenue from Abbott and Guidant
remained at the contractual minimum level of $250,000 for 2007, equal to 2006.
Cost of Product Revenue. The cost of product revenue increased 66% to
$10.5 million from $6.3 million in 2006. This increase is directly attributable
to the higher unit volume of product sales in 2007 compared to 2006.
Gross Profit. Gross profit increased 107% to $17.2 million in 2007 from
$8.3 million in 2006. The increase in gross profit resulted from higher product
sales in 2007 as compared to 2006, license revenue from BioLucent, and a
reduction in the per unit cost of product due to substitution of lower-cost
in-house produced graft material in a portion of the products sold in 2007.
Gross profit as a percentage of revenue increased to 62% in 2007 from 57% in
2006 for these reasons. Also, the percentage in 2006 was impacted by a second
quarter charge of $326,000, related to the final phase of an earlier limited,
voluntary product recall.
Research, Development and Clinical. Research, development and clinical
expenses decreased by 6% to $6.4 million from $6.8 million in 2006. The decrease
primarily resulted from lower costs associated with clinical trials in the 2007
period. We incurred a charge of $417,000 in 2007 and $347,000 in 2006, for stock
compensation expense pursuant to the adoption of SFAS 123R at January 1, 2006.
Marketing and Sales. Marketing and sales expenses increased by 38% to
$20.1 million from $14.6 million in 2006. This increase was due to staffing
increases in sales and marketing functions in support of the commercial sales of
the infrarenal Powerlink System in the United States market. We incurred a
charge of $878,000 in 2007 and $448,000 in 2006, respectively, for stock
compensation expense pursuant to the adoption of SFAS 123R at January 1, 2006.
General and Administrative. General and administrative expenses increased by
14% to $6.4 million from $5.6 million in 2006. The increase was due primarily to
increases in patent and legal fees and insurance expenses. In addition, stock
based compensation expense totaling $894,000 in 2007 as compared to $767,000 in
2006, pursuant to the adoption of SFAS 123R at January 1, 2006.
Termination of Supply Agreement. Termination of supply agreement expense was
$550,000 in 2007. The expense was due to the third amendment to our supply
agreement for ePTFE graft material with Bard Peripheral, dated September 21,
2007, which reduced the minimum purchase requirement for the 2007 year from
$2.9 million to $2.2 million, and wherein both parties agreed to terminate the
agreement on December 31, 2007. In consideration for the reduction in the
minimum purchase requirement for the 2007 year, we paid $550,000 to Bard
Peripheral.
Other Income. Other income increased 9% to $1.1 million from $1.0 million in
2006. The increase in other income was a result of a realized gain of $412,000
on our investment in BioLucent, offset by less interest income due to a lower
invested cash balance. In 2006, we had a higher cash balance due to a registered
direct public offering of our common stock that resulted in net proceeds of
$18.8 million in June 2006.
Liquidity and Capital Resources
For the years ended December 31, 2008 and 2007, we incurred net losses of
$12.0 million and $15.1 million, respectively. As of December 31, 2008, we had
an accumulated deficit of approximately $143.7 million. Historically, we have
relied on the sale and issuance of equity securities to provide a significant
portion of funding for our operations. In April 2006, we filed a shelf
registration statement with the SEC that would permit us to sell from time to
time, up to a total of $50.0 million of common stock. In June 2006, we completed
an offering of our common stock, which resulted in net proceeds of
$18.8 million, leaving $30.2 million available under the shelf registration.
In February 2007, we entered into a revolving credit facility with Silicon
Valley Bank, under which we may borrow up to $5 million. All outstanding amounts
under the credit facility bear interest at a variable rate equal to the lender's
prime rate plus 0.5%, which is payable on a monthly basis. The unused portion is
subject to an unused
revolving line facility fee, payable quarterly, in arrears, on a calendar year
basis, in an amount equal to one quarter of one percent per annum of the average
unused portion of the revolving line, as determined by the bank. The credit
facility also contains customary covenants regarding operations of our business
and financial covenants relating to ratios of current assets to current
liabilities and tangible net worth during any calendar quarter and is
collateralized by all of our assets with the exception of our intellectual
property. All amounts owing under the credit facility were to become due and
payable on February 21, 2009. In September 2008, we drew down $2.0 million. As
of December 31, 2008, we had $2.0 million in outstanding borrowings under this
credit facility and were in compliance with all of our covenants under the
credit facility.
In July 2008, we entered into an amendment to the credit facility which added
a term loan whereby we may borrow up to $3.0 million and which extended the
repayment date for borrowings under the revolving line of credit to July, 2010.
In September 2008, we drew down the $3.0 million term loan, all of which was
outstanding at December 31, 2008. The term loan requires interest only payments
at a variable rate equal to the lender's prime rate plus 1.0%, which is payable
on a monthly basis through March 31, 2009. The term loan principal is due in
36 monthly installments beginning in April 2009.
Our existing credit facilities with Silicon Valley Bank contain negative
covenants on the operation of our business and financial covenants, including
requiring us to maintain a tangible net worth of $13.0 million. As of
December 31, 2008, our tangible net worth was $13.7 million. If we are not able
to maintain compliance with our financial covenants, certain terms of our credit
facility and term loan will change including an increase in the interest rate
and a limitation on the amounts available for borrowing under the credit
facility based on eligible accounts receivable. Further, if we do not maintain a
tangible net worth of at least $12.0 million through June 29, 2009 and
$12.5 million thereafter, we will be in default under the credit facility which
could allow the lender to accelerate the repayment of the indebtedness under the
credit facility.
At December 31, 2008, we had cash and cash equivalents of $7.6 million. We
expect that our continued growth, strong gross margins and expense controls will
enable us to achieve positive cash flow from operations in the second quarter of
2009, consequently, we believe that our current cash balance, in combination
with cash receipts generated from sales of the Powerlink System and borrowings
available under our credit facility, will be sufficient to meet anticipated cash
needs for operating and capital expenditures through at least December 31, 2009.
If we do not realize expected revenue and gross profit margin levels, or if we
are unable to manage our operating expenses in line with our revenues, or if we
cannot maintain our days sales outstanding accounts receivable ratio, we may not
achieve positive cash flow from operations in the second quarter of 2009, nor be
able to fund our operations through December 31, 2009.
We believe that the future growth of our business will depend upon our
ability to successfully develop new technologies and bring these technologies to
market, as well as increased market acceptance of the Powerlink System. If we
pursue additional research and development opportunities or fail to increase our
penetration of the AAA market, or if we fail to reduce certain discretionary
expenditures, as necessary, we may need to seek additional sources of financing.
In the event that we require additional funding to continue our operations, we
will attempt to raise the required capital through either debt or equity
arrangements.
The timing and amount of our future capital expenditure requirements will
depend on many factors, including:
• the rate of market acceptance of the Powerlink System;
• our requirements for additional manufacturing capacity;
• our requirements for additional IT infrastructure and systems;
• our requirements for additional facility space; and
• the need for additional capital to fund future development programs.
Accounts Receivable. Trade accounts receivable, net, increased 41% to $6.4 million at December 31, 2008 from $4.5 million at December 31, 2007. The increase was due to the 39% increase in product sales in 2008.
Inventories. Inventories decreased 12% to $7.1 million at December 31, 2008
from $8.1 million at December 31, 2007. The decrease was primarily the result of
a lower cost basis of the ePTFE graft material.
Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses
increased 27% to $5.4 million at December 31, 2008 from $4.3 million at
December 31, 2007. The increase is primarily attributable to legal fees and
litigation matters as well as a change in the commission plan for our sales
force.
Cash Used in Operations. Cash used in operations decreased 49% to
$6.0 million for the year ended December 31, 2008 from $11.7 million for the
year ended December 31, 2007. The change was primarily attributed to the
improved gross margin, increased production efficiencies, and higher sales
volume.
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