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NXTM > SEC Filings for NXTM > Form 10-K on 29-Feb-2012All Recent SEC Filings

Show all filings for NXSTAGE MEDICAL, INC.

Form 10-K for NXSTAGE MEDICAL, INC.


29-Feb-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation

Overview

We report the results of our operations in two segments: System One and In-Center. We distribute our products in three markets: home, critical care and in-center. In the System One segment we derive our revenues from the sale and rental of the System One and PureFlow SL equipment and the sale of disposable products in the home and critical care markets. The home market is devoted to the treatment of ESRD patients in the home, while the critical care market is devoted to the treatment of hospital-based patients with acute kidney failure or fluid overload. In the In-Center segment, we derive our revenues from the sale of blood tubing sets and needles for hemodialysis primarily for the treatment of ESRD patients at dialysis centers and needles for apheresis, which is referred to as the in-center market.

Financial Performance

During 2011, we grew our revenues by 21% from $179.2 million during 2010 to $217.3 million during 2011, with growth occurring in each market: home, critical care and in-center. In the home market, revenues increased $22.7 million, or 27%, during 2011 compared to 2010, with the significant majority resulting from an increase in the number of patients prescribed to use the System One. We have continued to increase both the average number of patients at existing centers and centers offering the System One, primarily through existing relationships with service providers, including DaVita and Fresenius. Critical care market revenues increased $6.9 million, or 25%, during 2011 compared to 2010, primarily due to increased sales of disposables from our growing installed base of System One equipment and increased sales of the System One resulting from our efforts to increase our market share. In 2012, we expect to see continued growth in our System One revenues, primarily driven by the annuity nature of our business, as well as the life-sustaining, non-elective nature of dialysis therapy. Our two largest customers in the home market, DaVita and Fresenius, will be important to that growth. If the purchasing patterns of either of these customers adversely change, our business will be adversely affected, at least in the near term. In-center revenues increased $8.4 million, or 13%, during 2011 compared to 2010. The increase was driven by increased sales of Streamline, our next generation blood tubing set product, due to increased end user demand and increased inventories at our distributors. We expect future demand 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, particularly as they complete the transition of a majority of their blood tubing set requirements from our ReadySet to our Streamline product.

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 from 25% during 2009 to 32% during 2010 to 36% during 2011. The improvement in gross profit as a percentage of revenues was mainly attributable to lower product and service costs and favorable product mix with higher relative sales of higher margin products, partially offset by costs incurred by our In-Center segment related to the transition of manufacturing of certain blood tubing sets from a contract manufacturer to our own manufacturing facility beginning in the second quarter of 2011. While we expect to continue to improve gross profit as a percentage of revenues as a result of various initiatives including the consolidation of our manufacturing network, these improvements will continue to be offset in the short-term as a result of costs to rationalize and


consolidate our manufacturing operations and will be impacted favorably and unfavorably by foreign exchange rates versus the U.S. dollar.

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, depend 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. Additionally, our profitability may be impacted beginning in 2013 due to the 2.3% medical device excise tax which will be assessed on certain of our products.

Statement of Operations Components

Revenues

In the System One segment we derive our revenues from the sale and rental of equipment and the sale of disposable products in the home and critical care markets. In the home market, customers purchase or rent the System One equipment, including cycler and PureFlow SL, and then purchase the related disposable products based on a specific patient prescription. In the critical care market, we sell or rent the System One and related disposables to hospital customers. In the In-Center segment, we derive our revenues from the sale of needles and blood tubing sets. Nearly all of our sales in the In-Center segment are through supply and distribution contracts with distributors.

In the home market the majority of our revenue is derived from recurring sales of disposable products. For customers that purchase the System One, we recognize revenue from the equipment sale ratably over the expected service obligation period. For customers that rent the System One, we recognize revenue on a monthly basis. We recognize revenues related to the disposable products upon delivery. Over time, as more home patients are treated with the System One and more systems are placed in patient homes, we expect to derive a growing recurring revenue stream from the sale of related disposables.

Our contracts with dialysis centers in the home market for ESRD home dialysis patients generally include terms providing for the sale of disposable products to accommodate up to the number of prescribed treatments per month per patient and the purchase or monthly rental of System One cyclers and, in most instances, our PureFlow SL hardware. These contracts typically have a term of one to seven years, and may be renewed on a month-to-month basis thereafter, subject to a 30-day termination notice. Under these contracts, if home hemodialysis is prescribed, supplies are shipped directly to patient homes and paid for by the treating dialysis center. We also include vacation delivery terms, providing for the shipment of products to a designated vacation destination for a specified number of vacation days. We derive a small amount of revenues from the sale of supplementary products and services such as ancillaries, reserve inventory and special deliveries.

In the critical care market we recognize revenues from direct product sales at the time of shipment or, if applicable, delivery in accordance with contract terms. Our contracts with hospitals generally include terms providing for the sale of our System One hardware and disposables, although we also provide a hardware rental option. These contracts typically have a term of one year. We derive a small amount of revenues from the sale of one-and two-year service contracts following the expiration of our standard one-year warranty period for System One hardware. To further support service in the critical care market, we have a bio-medical training program, whereby we train bio-medical engineers on how to service and repair certain aspects of the System One in the critical care setting. Bio-medical training is typically provided under a two-year contract following the expiration of our standard one-year warranty period for System One hardware. As more System One equipment is placed within hospitals, we expect to continue to derive a growing recurring revenue stream from the sale of disposable cartridges and fluids as well as, to a much lesser degree, from the sale of service and bio-medical training contracts.

In the In-Center segment nearly all sales to end users are structured through supply and distribution contracts with several significant distributors; however, in many instances we have direct contractual


relationships with our end user customers. These contracts typically contain minimum volume commitments with negotiated pricing triggers at different volume tiers.

In addition to contractually determined volume discounts, 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 December 31, 2011, we had $2.1 million and $0.7 million reserved against trade accounts receivable for future rebates and discounts for customers in our In-Center and System One segments, respectively. We recorded $6.7 million, $5.5 million, and $8.6 million during 2011, 2010 and 2009, respectively, as a reduction of In-Center segment revenues and $3.0 million, $2.3 million and $1.2 million during 2011, 2010 and 2009, respectively, as a reduction of System One segment revenues in connection with rebates and discounts.

Currently nearly all of our revenues have been generated from sales to customers in the U.S. However, in 2009 we began selling our System One and certain of our other products internationally through distributors. For sales to our international distributors that occurred prior to January 1, 2011, we recognize revenues from the equipment sale ratably over the expected term of our remaining service obligation, which is five years. For sales occurring on or after January 1, 2011, we recognize revenues from equipment sales at the time of shipment or, if applicable, delivery in accordance with contract terms. Disposable product revenues has continually been recognized upon delivery.

Cost of Revenues

Cost of revenues consists primarily of direct product costs, material and labor required to manufacture our products, service of System One equipment that we sell or rent to customers and manufacturing overhead. It also includes the cost of inspecting, servicing and repairing System One equipment prior to sale or during the warranty period and stock-based compensation for certain personnel. The cost of our products depends on several factors, including the efficiency of our manufacturing operations, the cost at which we can obtain labor and products from third-party suppliers, product reliability and related servicing costs and the design of our products.

Operating Expenses

Selling and Marketing. Selling and marketing expenses consist primarily of salary, benefits and stock-based compensation for sales and marketing personnel, travel, promotional and marketing materials and other expenses associated with providing clinical training to our customers. Included in selling and marketing are the costs of clinical educators, usually nurses, we employ to teach our customers about our products and prepare our customers to instruct their patients and their partners in the operation of our products and customer service and technical support personnel.

Research and Development. Research and development expenses consist primarily of salary, benefits and stock-based compensation for research and development personnel, supplies, materials and expenses associated with product design and development, clinical studies, regulatory submissions, reporting and compliance and expenses incurred for outside consultants or firms who furnish services related to these activities.

Distribution. Distribution expenses include the freight costs of delivering our products to our customers or our customers' patients, depending on the market and the specific agreements with our customers, salary, benefits and stock-based compensation for distribution personnel and the cost of any equipment lost or damaged in the distribution process. We use common carriers and freight companies to deliver our products and do not operate our own delivery service. Also included in this category are the expenses of shipping products under warranty from customers back to our service center for repair and the related expense of shipping a replacement product to our customers or their patients.

General and Administrative. General and administrative expenses consist primarily of salary, benefits and stock-based compensation for our executive management, legal and finance and accounting staff, fees of outside legal counsel, fees for our annual audit and tax services, and general expenses to operate the business, including insurance and other corporate-related expenses.


Comparison of Years Ended December 31, 2011 and 2010

Revenues

Our revenues for 2011 and 2010 were as follows (in thousands, except
percentages):



                                                Years Ended December 31,
                                             2011                     2010
           System One segment
           Home                       $ 108,489        50 %    $  85,762        48 %
           Critical Care                 34,991        16 %       28,093        16 %

           Total System One segment     143,480        66 %      113,855        64 %
           In-Center segment             73,776        34 %       65,363        36 %

           Total                      $ 217,256       100 %    $ 179,218       100 %

In the home market, revenues increased $22.7 million, or 27%, during 2011 compared to 2010, with the significant majority resulting from an increase in the number of patients prescribed to use the System One. During 2011, we increased both the average number of patients at existing centers and centers offering the System One, primarily through our existing relationships with service providers, including DaVita and Fresenius. Home market revenues also increased due to increased sales to our international distributors. Critical care market revenues increased $6.9 million, or 25%, during 2011 compared to 2010, primarily due to increased sales of disposables from our growing number of System One equipment placed within hospitals and increased sales of the System One resulting from our efforts to further penetrate the market. Future demand for our products and revenue growth in both the home and critical care markets is expected to be strong as we further penetrate these markets, expand internationally, and leverage the annuity nature of our business. As our international business grows our System One revenue may be susceptible to fluctuations in international equipment sales and changes in inventory levels at our international distributors. Our two largest customers in the home market, DaVita and Fresenius, will be important to that growth, specifically in the U.S. market. If the purchasing patterns of either of these customers adversely change, our business could be negatively affected.

In-Center segment revenues increased $8.4 million, or 13%, during 2011 compared to 2010. The increase in revenues was driven by higher sales of our Streamline blood tubing sets due to increased end user demand and increased inventory levels at our distributors largely driven by the transition of the majority of their blood tubing set requirements from our ReadySet to our Streamline product. While revenues continue to be susceptible to fluctuations in inventory levels at our distributors, end user demand of both our blood tubing sets and our needle products continues to grow. We expect future revenues will continue to be susceptible to fluctuation, especially in the near term, due to the transition of our major distributors and customers to our next generation Streamline blood tubing set and, longer-term, as a result of increased competition and variations in inventory management policies with both our distributors and end users.

Gross Profit

Our gross profit and gross profit as a percentage of revenues for 2011 and 2010
were as follows (in thousands, except percentages):



                                             Years Ended December 31,
                                           2011                   2010
                System One segment   $ 60,847       42 %    $ 42,620       37 %
                In-Center segment      16,761       23 %      15,507       24 %

                Gross Profit         $ 77,608       36 %    $ 58,127       32 %


Gross profit increased $19.5 million, or 34%, and increased as an overall percentage of revenue during 2011 compared to 2010 driven in large part by the System One Segment. Gross profit for the System One Segment increased $18.2 million, or 43%, during 2011 compared to 2010, 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 cost saving initiatives and improvements in product design and reliability, and lower depreciation expense on our field equipment assets resulting from the change in the useful life of certain of these assets from five to seven years.

Gross profit for the In-Center segment increased in absolute dollars but decreased slightly as a percentage of revenues during 2011 compared to 2010. The change in gross profit was driven by increased revenues offset by costs incurred relating to the transition of certain blood tubing sets from a contract manufacturer to our own manufacturing facility, increased freight costs and increased resin costs as a result of higher oil prices.

We expect gross profit as a percentage of revenues will continue to improve in the long-term for three general reasons, all of which we expect will reduce costs in the future. First, we expect to introduce additional process improvements and product design changes that have inherently lower costs than the costs associated with our current products. Second, we anticipate that increased sales volume, rationalization and consolidation of our manufacturing operations, rationalization of our supply chain, and realization of economies of scale will lead to lower costs and better purchasing terms and prices. Finally, we expect to continue to improve product reliability, which would reduce unit service costs. However, there is no certainty that our expectations or the projected timing associated with our expectations will be achieved with respect to these cost reduction plans. Further, these improvements in gross profit as a percentage of revenues may be offset in the short-term for five general reasons, all of which could negatively impact gross profit. First, we manufacture a large majority of our products internationally and purchase products from foreign companies in other than U.S. dollars and, therefore, our product costs are subject to fluctuations due to changes in foreign currency exchange rates. Any unfavorable fluctuations in foreign exchange rates versus the U.S. dollar would negatively impact our gross profit as a percentage of revenues. Second, we expect that we will continue to incur higher transportation costs driven in large part by increased prices from carriers and changes in fuel prices. Third, we may see an increase in the cost of certain raw materials, due to increases in the cost of commodities, particularly resin. Fourth, we expect future demand for our products to continue to grow; however, higher relative sales of lower margin products and certain pricing strategies would have a negative impact on gross profit as a percentage of revenues. Finally, rationalization and consolidation of our manufacturing operations, in an effort to drive long-term gross margin improvement, will require us to incur additional costs in the short-term.

Selling and Marketing

Our selling and marketing expenses and selling and marketing expenses as a
percentage of revenues for 2011 and 2010 were as follows (in thousands, except
percentages):



                                                 Years Ended December 31,
                                               2011                   2010
           System One segment            $ 32,335       23 %    $ 29,377       26 %
           In-Center segment                5,215        7 %       4,789        7 %

           Total Selling and marketing   $ 37,550       17 %    $ 34,166       19 %

Selling and marketing expenses increased $3.4 million or 10% during 2011 compared to 2010. The increase in selling and marketing expense was primarily the result of increased personnel and personnel-related costs and increased spending due to expanded marketing programs within both segments.

Selling and marketing expenses for the System One segment decreased as a percentage of revenues during 2011 compared to 2010 due to our initiative to continue to leverage our infrastructure. Selling and marketing


expenses for the In-Center segment remained consistent as a percentage of revenues during 2011 compared to 2010 due to our efforts to continue to broaden our marketing programs while still leveraging our existing infrastructure. We anticipate that selling and marketing expenses will continue to increase as we broaden our marketing initiatives, increase public awareness of the System One in the home market, and support growth in international markets.

Research and Development

Our research and development expenses and research and development expenses as a percentage of revenues for 2011 and 2010 were as follows (in thousands, except percentages):

Years Ended December 31, 2011 2010 Research and development $ 14,437 7 % $ 12,900 7 %

Research and development expenses increased $1.5 million, or 12%, during 2011 compared to 2010 but remained consistent as a percentage of revenues. The increase was primarily due to increased project related spending. For the near term, we expect research and development expenses will increase as we seek to further develop and enhance our System One and related products.

Distribution

Our distribution expenses and distribution expenses as a percentage of revenues
for 2011 and 2010 were as follows (in thousands, except percentages):



                                             Years Ended December 31,
                                           2011                   2010
                System One segment   $ 14,892       10 %    $ 12,960       11 %
                In-Center segment       3,024        4 %       1,791        3 %

                Total Distribution   $ 17,916        8 %    $ 14,751        8 %

Distribution expenses increased $3.2 million, or 21%, during 2011 compared to 2010 due to increased business volumes but remained consistent as a percentage of revenues. 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 as a percentage of revenues for the In-Center segment increased due primarily to increased costs associated with shipping certain of our products shipped from our international manufacturing locations to our customers and overall increased fuel prices. We expect that distribution expenses will increase at a lower rate than revenues due to expected efficiencies gained from increased business volume and improved reliability of System One equipment. However, these favorable impacts may be offset by overall increases in fuel costs.

General and Administrative

Our general and administrative expenses and general and administrative expenses as a percentage of revenues for 2011 and 2010 were as follows (in thousands, except percentages):

Years Ended December 31, 2011 2010 General and administrative $ 23,206 11 % $ 22,774 13 %


General and administrative expenses increased $0.4 million, or 2%, during 2011 compared to 2010 but decreased as a percentage of revenues. The increase in general and administrative expenses was primarily the result of increased professional services and other infrastructure related costs. We expect that general and administrative expenses will decrease as a percentage of revenues over time as we continue to leverage our existing infrastructure.

Other Income and Expense

Interest income is derived primarily from investments in money market funds.

Interest expense increased $0.1 million during 2011 compared to 2010, due primarily to compounding interest on the interest amounts deferred until maturity with our term loan and security agreement from Asahi.

The change in other (expense) income, net during both periods is derived primarily by foreign currency gains and losses.

Provision for Foreign Income Taxes

The provision for income taxes of $0.9 million in 2011 and $0.8 million in 2010 relates primarily to the profitable operations of certain of our foreign entities.

Comparison of Years Ended December 31, 2010 and 2009

Revenues

Our revenues for 2010 and 2009 were as follows (in thousands, except
percentages):



                                                Years Ended December 31,
                                             2010                     2009
           System One segment
           Home                       $  85,762        48 %    $  63,461        43 %
           Critical Care                 28,093        16 %       22,340        15 %

           Total System One segment     113,855        64 %       85,801        58 %
           In-Center segment             65,363        36 %       62,875        42 %

           Total                      $ 179,218       100 %    $ 148,676       100 %

The increase in revenues 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 $22.3 million, or 35%, during 2010 compared to 2009, with the significant majority resulting from an increase in the number of patients prescribed to use and centers offering the System One. During 2010, we 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 $5.8 million, or 26%, during 2010 compared to 2009, primarily due to increased sales of the System One resulting from our efforts to further penetrate the market and increased sales of disposables from our growing number of System One equipment placed within hospitals. Growth in the critical care market in 2010 also benefitted from slightly improved economic conditions compared to 2009.

In-Center segment revenues increased $2.5 million, or 4%, during 2010 compared to 2009. The increase in revenues was due to increased sales of our needles.


Gross Profit

Our gross profit and gross profit as a percentage of revenues for 2010 and 2009
were as follows (in thousands, except percentages):


. . .
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