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NXTM > SEC Filings for NXTM > Form 10-Q on 2-May-2013All Recent SEC Filings

Show all filings for NXSTAGE MEDICAL, INC.

Form 10-Q for NXSTAGE MEDICAL, INC.


2-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Forward Looking Statements

The following discussion should be read with our unaudited condensed consolidated financial statements and notes included in Part I, Item 1 of this Quarterly Report, as well as the audited financial statements and notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the year ended December 31, 2012, included in our 2012 Form 10-K.

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 U.S. and internationally; the growth of the home, critical care and in-center dialysis markets in general and the home dialysis market in particular; access to home or more frequent hemodialysis; plans for expanding internationally; the development and commercialization of new products and improvements to existing products; sales to our key customers, including DaVita HealthCare Partners Inc., or DaVita, and Fresenius Medical Care, or Fresenius; the status of our efforts to renew or extend our customer and supplier agreements; the adequacy of our funding; our ability to achieve and sustain positive cash flows; expectations with respect to future demand for our products and revenue growth; the timing and success of our initiatives to improve our gross profit as a percentage of revenues; our manufacturing operations and supply chain; our initiative to establish our centers of excellence; expectations with respect to our operating expenses and working capital; expected reduction in the base payment rate under the ESRD prospective payment system; achieving our business plan; the impact of global economic conditions; expectations with respect to achieving profitable operations; volatility of our stock price; expectations with respect to achieving improvements in product reliability; the impact of our acquisition of Kimal's assets; expectations as to the sufficiency of our inventory of raw materials, components, and finished goods; and expectations with respect to our litigation with Gambro Renal Products, Inc., or Gambro. 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", "will" 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.

Readers should carefully review the "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" set forth in this Quarterly Report, as these sections describe important factors that could cause actual results to differ materially from those indicated by our forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statement.

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 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 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 U.S., Canada and certain other markets for the treatment of acute and chronic kidney failure and fluid overload. The System One is also CE marked in the EU for the treatment of acute and chronic kidney failure and fluid overload. The System One is cleared specifically by the FDA for home hemodialysis as well as TPE in a clinical environment. We also sell needles and blood tubing sets primarily to dialysis clinics for the treatment of ESRD. These products are cleared or approved for commercial sale in the U.S., Canada and certain other markets. These products are also CE marked in the EU. We believe our largest product market opportunity is for our System One used in the home dialysis market for the treatment of ESRD.

We have two reportable business segments: System One and In-Center.

Our System One segment includes 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. 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. The results of our international business are included in the System One segment.

Our In-Center segment includes 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. Nearly all In-Center products are sold through national distributors.

The remainder of our operations and financial information, included within the Other category, relates primarily to (1) the manufacturing of dialyzers for sale to Asahi Kasei Kuraray Medical Co., or Asahi, (2) certain business development activities,


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including our early work on establishing centers of excellence, which are dialysis clinics focused on the provision of home therapies, including home hemodialysis, and (3) research and development and general and administrative expenses that are excluded from the segment operating performance measures.

Segment and Market Highlights

Our customers in the System One segment are highly consolidated. DaVita and Fresenius own and operate the two largest chains of dialysis clinics in the U.S. and collectively provide treatment to approximately two-thirds of U.S. dialysis patients. DaVita and Fresenius are our two largest and most significant customers in the System One segment. Direct sales to DaVita represented 32% and 31% of our System One segment revenues for the three months ended March 31, 2013 and 2012, respectively. Further, DaVita is our largest customer in the home market, with over 40% of our home hemodialysis patients. Direct sales to Fresenius represented 19% and 16% of our System One segment revenues for the three months ended March 31, 2013 and 2012, respectively. 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 could be negatively affected.

Our In-Center segment revenues are highly concentrated in several significant purchasers. Our two largest distributors are Gambro and Henry Schein. Revenues from Gambro represented 45% and 43% of our In-Center segment revenues for the three months ended March 31, 2013 and 2012, respectively. Revenues from Henry Schein represented 30% and 31% of our In-Center segment revenues for the three months ended March 31, 2013 and 2012, respectively.

DaVita is also a significant customer in the In-Center segment. Sales of our products through distributors to DaVita accounted for approximately half of In-Center segment revenues for both the three months ended March 31, 2013 and 2012. DaVita has had purchase commitments for our products pursuant to two agreements: one with us for needles and one with Gambro for blood tubing sets. Gambro's long term product supply agreement with DaVita entered into in connection with the sale of Gambro's U.S. dialysis clinic business to DaVita, obligates DaVita to purchase a significant majority of its blood tubing set requirements from Gambro. In December 2012, Baxter International, Inc., or Baxter, announced that it had entered into a definitive agreement to acquire Gambro in the first half of 2013. Our distribution agreement with Gambro, which expires in June 2014 and survives a Gambro change of control, contractually obligates Gambro to exclusively supply our blood tubing sets to DaVita.

The initial term of our agreement with DaVita for the sale and rental of our System One products expires on June 30, 2013 but may be automatically extended on a monthly basis unless terminated by either party. DaVita's purchase obligations with respect to needles expired under an agreement with us at the end of April 2013; however, the agreement contemplates ongoing sales of products after expiration. We continue to work with DaVita to enter into a new agreement with respect to needles and extend the term of our agreement with respect to System One products. We expect that DaVita will continue to be a significant customer, however, there can be no assurance that we will enter into a new agreements or extend our existing agreements with DaVita on similar terms if at all.

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, 2013, we had $1.9 million and $1.7 million reserved against trade accounts receivable for future rebates and discounts for customers in our System One and In-Center segments, respectively. We recorded $1.9 million and $1.3 million during the three months ended March 31, 2013 and 2012, respectively, as a reduction of System One segment revenues in connection with rebates and discounts. For the In-Center segment, we recorded $1.1 million and $1.3 million during the three months ended March 31, 2013 and 2012, respectively, as a reduction of revenues in connection with rebates and discounts.

Financial Performance

During the three months ended March 31, 2013, we grew our revenues by 8% over the prior year comparable period to $61.6 million. Home revenues drove this growth, increasing $1.9 million, or 6%, over the prior year comparable period, driven by the increase in the number of patients prescribed to use and centers offering the System One. We expect to see continued growth in our System One segment revenues as we expand the number of patients prescribed to use and centers offering the System One through existing relationships with service providers, including DaVita and Fresenius, coupled with the annuity nature of our business, as well as the life-sustaining, non-elective nature of dialysis therapy.

We continue to see improvements in our financial performance below the revenue line. We have not yet achieved profitable operating margins, but we continued to improve gross profit as a percentage of revenues to 39% during the three months ended March 31, 2013 compared to 37% during the prior year comparable period. The improvement in gross profit as a percentage of revenues was mainly attributable to lower product costs, including costs incurred during 2012 associated with the transition of certain blood tubing sets from a contract manufacturer to our own manufacturing plant which we completed in mid 2012, favorable changes in foreign exchange rates versus the U.S. Dollar, favorable product mix with higher relative sales of higher margin products partially offset by start up costs incurred during 2013 related to the new dialyzer manufacturing plant in Germany which began operations in the fourth quarter of 2012. While we expect to continue to improve gross profit as a percentage of revenues as a result of various initiatives, including the expansion and rationalization of our manufacturing network, these improvements will continue to be offset in the short-term by associated costs and will be impacted by fluctuations in foreign exchange rates.


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We are encouraged by the improvements to our operating margins and are continuing to work 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. Improvements to our operating margins will require continued improvements in gross margins, revenue growth, and the leverage of our operating infrastructure, and will be adversely impacted by our investments in selling and marketing and research and development activities, and investment in new business development, including with respect to our initiative to establish centers of excellence. Additionally, our operating margins have been negatively impacted by the medical device excise tax on nearly all of our products sold in the U.S. as of the beginning of 2013.

Comparison of the Three Months Ended March 31, 2013 and 2012

Revenues

Our revenues for the three months ended March 31, 2013 and 2012 were as follows
(in thousands, except percentages):



                                              Three Months Ended March 31,
                                              2013                    2012
            System One segment
            Home                       $ 31,459        51 %    $ 29,553        52 %
            Critical Care                10,710        17 %       9,787        17 %

            Total System One segment     42,169        68 %      39,340        69 %
            In-Center segment            18,700        30 %      17,611        31 %
            Other                           775         2 %          -         -  %

            Total                      $ 61,644       100 %    $ 56,951       100 %

In the home market, revenues increased $1.9 million, or 6%, for the three months ended March 31, 2013 versus the prior year comparable period, driven by the increase in the number of patients prescribed to use and centers offering the System One, partially offset by lower deferred revenue recognized on previously sold System One equipment in the U.S. home market as a result of equipment reaching the end of its relative revenue amortization period in the first quarter of 2013 and lower international revenues in the first quarter of 2013 as a result of a one time impact from the transition of our UK business to a direct sales model from a distributor relationship. We have increased both the number of patients at existing centers and centers offering the System One, primarily through our existing relationships with service providers, including DaVita and Fresenius. Critical care market revenues increased 9% during the three months ended March 31, 2013 versus the prior year comparable period driven by higher sales of System One equipment and disposables. Sales of our System One equipment in the critical care market are subject to fluctuation due to timing of sales and the overall capital spending environment. We expect future demand for our products and revenue growth in both the home and critical care markets to be strong as we further penetrate these markets, expand internationally, and leverage the annuity nature of our business. However, this revenue growth will be slightly offset on an ongoing basis by lower deferred revenue recognized on previously sold System One equipment in the U.S. home market as a result of equipment reaching the end of its relative revenue amortization period. Furthermore, the U.S. dialysis market is highly consolidated with DaVita and Fresenius providing treatment to approximately two-thirds of U.S. dialysis patients. Our customers in the U.S. home market have a range of treatment options available, including traditional in-center dialysis and peritoneal dialysis. Convincing our customers, in particular DaVita and Fresenius, to make investments in their training infrastructure to expand their offering of home hemodialysis using our System One will be important to continuing our revenue growth in the future. If the purchasing patterns of DaVita or Fresenius adversely change, our business would be negatively affected, at least in the near term. Additionally, as our international business grows, our System One revenue will be susceptible to fluctuations in international equipment sales and changes in inventory levels at our international distributors.

In-Center segment revenues increased $1.1 million, or 6%, for the three months ended March 31, 2013 versus the prior year comparable period. The increase in revenues was driven by higher sales of needles due to increased end user demand and fluctuations in inventory levels at our distributors. 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. Future revenues may continue to fluctuate as a result of increased competition and variations in inventory management policies with both our distributors and end users. In-Center revenues will also be negatively impacted, at least in the near-term, if we are unable to negotiate an extension of our needle purchase agreement with DaVita, which expired at the end of April 2013.

Other revenues for the three months ended March 31, 2013 relates to dialyzers sold to Asahi.


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Gross Profit (Loss)

Our gross profit (loss) and gross profit (loss) as a percentage of revenues for
the three months ended March 31, 2013 and 2012 were as follows (in thousands,
except percentages):



                                           Three Months Ended March 31,
                                          2013                      2012
              System One segment   $ 19,343         46 %     $ 17,609        45 %
              In-Center segment       5,328         28 %        3,703        21 %

              Subtotal               24,671         41 %       21,312        37 %
              Other                    (671 )      (87 )%          -        n/a

              Gross profit         $ 24,000         39 %     $ 21,312        37 %

Gross profit increased $2.7 million, or 13%, and increased as an overall percentage of revenue for the three months ended March 31, 2013 versus the prior year comparable period driven by both the System One and In Center segments. Gross profit for the System One segment increased $1.7 million, or 10%, for the three months ended March 31, 2013 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 for the three months ended March 31, 2013 was attributable to several factors, including lower costs driven by improvement in product design and reliability and continued leveraging of our manufacturing infrastructure coupled with the favorable impact of foreign exchange rate fluctuations versus the U.S. dollar.

Gross profit for the In-Center segment increased $1.6 million, or 44%, and as a percentage of revenues for the three months ended March 31, 2013 versus the prior year comparable period, due to lower product manufacturing costs, including costs incurred during 2012 associated with the transition of certain blood tubing sets from a contract manufacturer to our own manufacturing plant which we completed in mid 2012 coupled with the favorable impact of foreign exchange rate fluctuations versus the U.S. dollar.

The Other category relates to the manufacturing of dialyzers for sale to Asahi, which should provide us with long term cost efficiencies through increased dialyzer production volumes.

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 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 fluctuate 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, including the sale of dialyzers to Asahi, and certain pricing strategies would have a negative impact on gross profit as a percentage of revenues. Finally, changes in our manufacturing operations, in an effort to drive long-term gross margin improvement, will require us to incur additional costs in the short-term.


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Selling and Marketing

Our selling and marketing and selling and marketing expenses as a percent of
revenues for the three months ended March 31, 2013 and 2012 were as follows (in
thousands, except percentages):



                                               Three Months Ended March 31,
                                                2013                   2012
           System One segment            $  8,502        20 %    $ 8,353        21 %
           In-Center segment                1,310         7 %      1,363         8 %
           Other                              884       n/a          204       n/a

           Total Selling and marketing   $ 10,696        17 %    $ 9,920        17 %

Selling and marketing expenses increased $0.8 million, or 8%, for the three months ended March 31, 2013 versus the prior year comparable period. Selling and marketing expenses for the System One segments increased in absolute dollars due to increased personnel and personnel-related costs and increased marketing costs but decreased as a percentage of revenues due to our initiative to continue to leverage our infrastructure. Selling and marketing expenses for our Other category relates primarily to personnel and personnel related costs related to business development activities, including our initiative to establish dialysis centers of excellence. We anticipate that selling and marketing expenses will continue to increase as we broaden our marketing and business development initiatives, including with respect to our centers of excellence initiative, increase public awareness of the System One in the home market and support growth in international markets.

Research and Development

Our research and development and research and development expenses as percent of revenues for the three months ended March 31, 2013 and 2012 were as follows (in thousands, except percentages):

Three Months Ended March 31, 2013 2012 Research and development $ 5,108 8 % $ 3,897 7 %

Research and development expenses increased $1.2 million, or 31%, for the three months ended March 31, 2013 versus the prior year comparable period and increased as a percentage of revenues. The increase 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 as we seek to further develop and enhance our System One, invest in our peritoneal dialysis product development program and expand our product portfolio.

Distribution

Our distribution and distribution expenses as a percent of revenues for the
three months ended March 31, 2013 and 2012 were as follows (in thousands, except
percentages):



                                          Three Months Ended March 31,
                                           2013                    2012
               System One segment   $   4,328        10 %    $ 4,002       10 %
               In-Center segment          580         3 %        530        3 %

               Total Distribution   $   4,908         8 %    $ 4,532        8 %

Distribution expenses increased $0.4 million, or 8%, for the three months ended March 31, 2013 versus the prior year comparable period, but remained consistent as a percentage of revenues. Distribution expenses for both the System One and In-Center segments increased in absolute dollars but remained consistent as a percentage of revenues. Increased costs due to higher volumes and expanded delivery services in the System One segment were offset by distribution network efficiencies. We expect that distribution expenses will increase at a rate consistent with revenues due to expanded delivery services partially offset by expected efficiencies and improved reliability of System One equipment. However, these favorable impacts may be offset by overall increases in fuel costs and carrier pricing.


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General and Administrative

Our general and administrative and general and administrative expenses as a percent of revenues for the three months ended March 31, 2013 and 2012 were as follows (in thousands, except percentages):

Three Months Ended March 31, 2013 2012 General and administrative $ 7,824 13 % $ 6,622 12 %

General and administrative expenses increased $1.2 million, or 18%, for the three months ended March 31, 2013 versus the prior year comparable period. The increase in general and administrative expenses was primarily the result of the medical device excise tax assessed on nearly all of our products sold in the U.S, beginning in 2013, increased personnel and personnel-related costs and other related infrastructure costs. Over time we expect general and administrative expenses will decrease as a percentage of revenues as we continue to leverage our existing infrastructure.

Other Expense

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