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NXTM > SEC Filings for NXTM > Form 10-Q on 7-Nov-2013All Recent SEC Filings

Show all filings for NXSTAGE MEDICAL, INC.

Form 10-Q for NXSTAGE MEDICAL, INC.


7-Nov-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: our market opportunity and 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; the results and timing of clinical studies and plans for regulatory submissions; sales to our key customers, including DaVita HealthCare Partners Inc., or DaVita, and Fresenius Medical Care, or Fresenius; the adequacy of our funding; expectations with respect to future demand for our products and revenue growth; the timing, scope 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 dialysis centers of excellence; expectations with respect to our operating expenses and working capital requirements; changes with respect to our expenses as a percentage of revenues; proposed 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 positive operating margins, positive cash flows and profitable operations; volatility of our stock price; product cost reduction plans; expectations with respect to achieving improvements in product reliability; the impact of our acquisition of Kimal's System One assets; our ability to withstand supply chain disruptions; anticipated requirements for premixed dialysate; and expectations with respect to our litigation with Gambro Renal Products, Inc. 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. The System One is also CE marked in the EU for nocturnal home hemodialysis. 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 dialysate preparation 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 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.


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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, (2) certain business development activities, including our continuing work on establishing centers of excellence, which are dialysis clinics focused on the provision of home therapy and flexible in-center options, 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 30% of our System One segment revenues for both the three and nine months ended September 30, 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 20% and 17% of our System One segment revenues for both the three and nine months ended September 30, 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, including in response to our initiative to establish dialysis centers of excellence, our business could be negatively affected.

On May 15, 2013, we entered into a Second Amended and Restated National Service Provider Agreement ("HHD Agreement") with DaVita. The HHD Agreement is effective as of March 1, 2013 and covers use of our products for home hemodialysis in the U.S. by DaVita. The HHD Agreement continues, in all material respects, the terms of our First Amended and Restated National Service Provider Agreement with DaVita dated July 22, 2010 with pricing for our products subject to System One home patient growth targets. The term of the HHD Agreement extends through December 31, 2015, and thereafter automatically extends on a monthly basis unless terminated by us or DaVita.

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 41% and 34% of our In-Center segment revenues for the three months ended September 30, 2013 and 2012, respectively, and represented 40% and 38% of our In-Center segment revenues for the nine months ended September 30, 2013 and 2012, respectively. Revenues from Henry Schein represented 27% and 35% of our In-Center segment revenues for the three months ended September 30, 2013 and 2012, respectively, and 31% and 33% of our In-Center segment revenues for the nine months ended September 30, 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 and nine months ended September 30, 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. DaVita's needle purchase agreement with us extends through December 31, 2014. Currently, DaVita's product supply agreement with Gambro requires DaVita to purchase a significant majority of its blood tubing set requirements from Gambro, and our distribution agreement with Gambro requires Gambro to exclusively supply our blood tubing sets to DaVita. In September 2013, Baxter International, Inc., or Baxter, announced the completion of its acquisition of Gambro. Our distribution agreement with Gambro, which expires in June 2014, survives a Gambro change of control.

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 September 30, 2013, we had $1.4 million and $1.8 million reserved against trade accounts receivable for future estimated rebates and discounts for customers in our System One and In-Center segments, respectively. We recorded $1.3 million and $1.1 million during the three months ended September 30, 2013 and 2012, respectively, and $4.5 million and $3.7 million during the nine months ended September 30, 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 $1.4 million and $1.7 million during the three months ended September 30, 2013 and 2012, respectively, and $4.3 million and $4.9 million during the nine months ended September 30, 2013 and 2012, respectively, as a reduction of revenues in connection with rebates and discounts.

Financial Performance

During the three months ended September 30, 2013, we grew our revenues by 9% over the prior year comparable period to $66.9 million and during the nine months ended September 30, 2013 we grew our revenues by 10% over the prior year comparable period to $194.0 million with growth occurring in all markets. We expect to see continued growth in revenues,


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particularly 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.

Gross profit as a percentage of revenues remained relatively consistent at 38.5% during the nine months ended September 30, 2013 compared to 38.1% during the prior year comparable period. Lower product costs, including the nonrecurrence of costs incurred during 2012 related to the transition of certain blood tubing sets from a contract manufacturer to our own manufacturing plant were partially offset by increased start-up costs related to the new dialyzer plant in Germany which we began to operate in the fourth quarter of 2012. While we expect to improve gross profit as a percentage of revenues for our System One and In-Center segments as a result of various initiatives, including the expansion and rationalization of our manufacturing network, these improvements will continue to be offset in the near-term by associated start-up costs and will be impacted by fluctuations in foreign exchange rates.

We remain focused on growing the business and improving our operating performance. In addition to the revenue growth initiatives described above, we continue to work to reduce our manufacturing costs, leverage our operating structure and invest in our marketing and business development initiatives, including our initiative establishing centers of excellence.


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Comparison of the Three and Nine Months Ended September 30, 2013 and 2012

Revenues

Our revenues for the three and nine months ended September 30, 2013 and 2012
were as follows (in thousands, except percentages):



                                          Three Months Ended September 30,                   Nine Months Ended September 30,
                                            2013                      2012                    2013                     2012
System One segment
Home                                $   33,666         50 %    $ 31,925        52 %    $  97,796        50 %    $  92,171        52 %
Critical Care                           10,671         16 %       9,099        15 %       32,207        17 %       28,257        16 %

Total System One segment                44,337         66 %      41,024        67 %      130,003        67 %      120,428        68 %
In-Center segment                       21,269         32 %      19,637        32 %       61,207        32 %       55,477        31 %
Other                                    1,267          2 %         491         1 %        2,769         1 %        1,207         1 %

Total                               $   66,873        100 %    $ 61,152       100 %    $ 193,979       100 %    $ 177,112       100 %

In the home market, revenues increased $1.7 million, or 5%, and $5.6 million, or 6%, for the three and nine months ended September 30, 2013, respectively, versus the prior year comparable periods, 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 related revenue amortization period. These results also reflect a one-time reduction in revenue due to the transition of our UK business to a direct sales model from a distributor relationship in the first quarter of 2013. 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, and through our marketing efforts. Critical care market revenues increased 17% during the three months ended September 30, 2013 and 14% during the nine months ended September 30, 2012 versus the prior year comparable periods driven by higher sales of System One disposables and equipment. Sales of our System One equipment in the critical care market may fluctuate 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, both in the U.S. and 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 related 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, including in response to our initiative to establish dialysis centers of excellence, 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 equipment sales and changes in inventory levels at our distributors.

In-Center segment revenues increased $1.6 million, or 8%, and $5.7 million, or 10%, for the three and nine months ended September 30, 2013, respectively, versus the prior year comparable periods. The increase in revenues was driven by 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.

Other revenues for the three and nine months ended September 30, 2013 and 2012 relates to dialyzers sold to Asahi.


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Gross Profit (Loss)

Our gross profit (loss) (in thousands, except as percentages of revenues) for
the three and nine months ended September 30, 2013 and 2012 were as follows:



                                          Three Months Ended September 30,                   Nine Months Ended September 30,
                                            2013                     2012                     2013                     2012
System One segment                  $  19,998         45 %    $ 18,810         46 %    $ 58,708         45 %    $ 54,772         45 %
In-Center segment                       6,123         29 %       4,978         25 %      17,695         29 %      12,739         23 %

Subtotal                               26,121         40 %      23,788         39 %      76,403         40 %      67,511         38 %
Other                                    (593 )      n/a           (40 )      n/a        (1,788 )      n/a           (62 )      n/a

Gross profit                        $  25,528         38 %    $ 23,748         39 %    $ 74,615         38 %    $ 67,449         38 %

Gross profit increased $1.8 million, or 7%, and $7.2 million, or 11%, for the three and nine months ended September 30, 2013, respectively, versus the prior year comparable periods.

Gross profit for the System One segment increased $1.2 million, or 6%, and $3.9 million, or 7%, for the three and nine months ended September 30, 2013, respectively, versus the prior year comparable periods, due to increased revenues. Gross profit for the System One segment for both the three and nine months ended September 30, 2013 was negatively impacted by costs associated with the start-up of the new dialyzer plant in Germany.

Gross profit for the In-Center segment increased $1.1 million, or 23%, and $5.0 million, or 39%, and increased as an overall percentage of revenues for the three and nine months ended September 30, 2013, respectively, versus the prior year comparable periods, due to contractual price improvements and lower product manufacturing costs, including the nonrecurrence of costs incurred during 2012 associated with the transition of certain blood tubing sets from a contract manufacturer to our own manufacturing plant.

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, as well as costs associated with establishing our dialysis centers of excellence.

We expect gross profit as a percentage of revenues for our System One and In-Center segments will improve in the long-term as we work to lower costs in three general areas. 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. Our cost reduction plans and potential improvements in our gross profit as a percentage of revenues may be offset in the near-term due to five general factors. 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, particularly resin. Fourth, higher relative sales of lower margin products and certain pricing strategies could 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.

Selling and Marketing

Our selling and marketing expenses (in thousands, except as percentages of
revenues) for the three and nine months ended September 30, 2013 and 2012 were
as follows:



                                          Three Months Ended September 30,                   Nine Months Ended September 30,
                                            2013                      2012                     2013                     2012
System One segment                  $    9,731         22 %    $  8,414        21 %    $   27,601        21 %    $ 25,039        21 %
In-Center segment                        1,332          6 %       1,408         7 %         3,937         6 %       4,063         7 %
Other                                    1,311        n/a           346       n/a           3,248       n/a           904       n/a

Total Selling and marketing         $   12,374         19 %    $ 10,168        17 %    $   34,786        18 %    $ 30,006        17 %

Selling and marketing expenses increased $2.2 million, or 22%, and $4.8 million, or 16%, for the three and nine months ended September 30, 2013, respectively, versus the prior year comparable periods. Selling and marketing expenses for the System One segment increased due to increased personnel and personnel-related costs and increased marketing costs. Selling and marketing expenses for our Other category relates to personnel and other costs related to business development activities for our initiative establishing 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.


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Research and Development

Our research and development expenses (in thousands, except as percentages of revenues) for the three and nine months ended September 30, 2013 and 2012 were as follows:

Three Months Ended September 30, Nine Months Ended September 30, 2013 2012 2013 2012 Research and development $ 4,450 7 % $ 4,274 7 % $ 13,924 7 % $ 12,421 7 %

Research and development expenses increased $0.2 million, or 4%, and $1.5 million, or 12%, for the three and nine months ended September 30, 2013, respectively, versus the prior year comparable periods. The increase was primarily due to increased personnel and personnel-related costs and increased project related spending partially offset by the recognition of $0.7 million during 2013 of a tax incentive received from the Massachusetts Life Sciences Center. 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 expenses (in thousands, except as percentages of revenues) for
the three and nine months ended September 30, 2013 and 2012 were as follows:



                                              Three Months Ended September 30,                   Nine Months Ended September 30,
                                                 2013                      2012                    2013                     2012
System One segment                      $    4,749           11 %    $ 4,066       10 %    $   13,463         10 %    $ 12,017       10 %
In-Center segment                              577            3 %        665        3 %         1,808          3 %       1,828        3 %

Total Distribution                      $    5,326            8 %    $ 4,731        8 %    $   15,271          8 %    $ 13,845        8 %

Distribution expenses increased $0.6 million, or 13%, for the three months ended September 30, 2013 and $1.4 million, or 10%, for the nine months ended September 30, 2013 versus the prior year comparable periods, but remained relatively 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.

General and Administrative

Our general and administrative expenses (in thousands, except as percentages of revenues) for the three and nine months ended September 30, 2013 and 2012 were as follows:

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