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NXTM > SEC Filings for NXTM > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for NXSTAGE MEDICAL, INC.

Form 10-K for NXSTAGE MEDICAL, INC.


3-Mar-2014

Annual Report


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

Overview

The results of our operations are included in two separately reportable segments, System One and In-Center. Other business activities relate primarily to the manufacturing of dialyzers for sale to Asahi, NxStage Kidney Care, and research and development and general and administrative expenses that are excluded from the segment operating performance measures. In the System One segment we derive our 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 a home-like setting, 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.

Financial Performance

For several years, we have focused on operating and financial improvements. During 2013, these efforts resulted in annual revenues increasing by 9% to $263.4 million, with our home, critical care and in-center markets each experiencing growth, and gross profit as a percentage of revenues improving from 38% to 39%. While driving continued improvements will remain an area of focus in 2014 and beyond within our System One and In-Center segments, at the same time, we expect to make significant investments in NxStage Kidney Care. We expect that these investments will have a negative impact on our total operating performance in the near term and likely outweigh performance improvements we expect in our System One and In-Center segments.

Statement of Comprehensive Loss 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 sell 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 equipment. 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 equipment maintenance and service fees, ancillaries, reserve inventory and special deliveries.


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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 equipment and disposables, although we also provide an equipment 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 equipment. 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 equipment. 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 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, 2013, we had $1.7 million and $2.4 million reserved against trade accounts receivable for future rebates and discounts for customers in our System One and In-Center segments, respectively. We recorded $7.1 million, $6.4 million, and $6.7 million during 2013, 2012 and 2011, respectively, as a reduction of In-Center segment revenues and $6.8 million, $5.5 million and $3.0 million during 2013, 2012 and 2011, respectively, as a reduction of System One segment revenues in connection with rebates and discounts.

The majority of our revenues have been generated from sales to customers in the U.S. We sell our System One and certain of our other products internationally through direct sales in the UK and Canada and through distributors in other countries. We recognize revenues from equipment sales to our international distributors at the time of shipment or, if applicable, delivery in accordance with contract terms. Disposable product revenues are recognized upon delivery. We also manufacture and sell dialyzers to Asahi and recognize revenues at time of shipment in accordance with contract terms.

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, marketing, and business development 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, customer service and technical support personnel.


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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. Also included in general and administrative expenses beginning in 2013 were tax expenses incurred related to the medical device excise tax.

Comparison of Years Ended December 31, 2013 and 2012

Revenues

Our revenues for 2013 and 2012 were as follows (in thousands, except
percentages):



                                                Years Ended December 31,
                                             2013                     2012
           System One segment
           Home                       $ 132,944        50 %    $ 123,589        51 %
           Critical Care                 43,812        17 %       39,540        16 %

           Total System One segment     176,756        67 %      163,129        67 %
           In-Center segment             81,852        31 %       76,927        32 %
           Other                          4,821         2 %        2,076         1 %

           Total                      $ 263,429       100 %    $ 242,132       100 %

In the home market, revenues increased $9.4 million, or 8%, during 2013 compared to 2012, 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 direct to patient marketing efforts. Critical care market revenues increased $4.3 million, or 11%, during 2013 compared to 2012, 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, the rate of revenue growth, compared to prior periods, will be impacted 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


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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 NxStage Kidney Care dialysis centers, our business would be negatively affected, at least in the near term. Additionally, as our international business with our distributors grows, our System One revenue will continue to be susceptible to fluctuations in equipment sales and changes in inventory levels at our distributors.

In-Center segment revenues increased $4.9 million, or 6%, during 2013 compared to 2012, driven by increased end user demand and contractual price improvements. Future revenues may continue to fluctuate as a result of increased competition and changes in inventory levels at both our distributors and end users.

Other revenues for 2013 and 2012 relate primarily to dialyzers sold to Asahi.

Gross Profit (Loss)

Our gross profit (loss) and gross profit (loss) as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

                                            Years Ended December 31,
                                          2013                     2012
             System One segment   $  80,585         46 %    $ 74,402         46 %
             In-Center segment       24,088         29 %      19,153         25 %

             Subtotal               104,673         40 %      93,555         39 %
             Other                   (2,170 )      n/a          (747 )      n/a

             Gross Profit         $ 102,503         39 %    $ 92,808         38 %

Gross profit increased $9.7 million, or 10%, and increased as an overall percentage of revenue during 2013 compared to 2012.

Gross profit in the System One segment increased $6.2 million or 8% versus 2012 as a result of increased revenue. Gross profit as a percentage of revenue 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 $4.9 million, or 26%. In addition to the impact of increased revenues, the improvement of gross profits and gross profit as a percentage of revenues in the In-Center segment was attributable to contractual price improvements and lower manufacturing costs, including the non-recurrence 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 NxStage Kidney Care dialysis centers.

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 may lead to


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lower costs and better purchasing terms and prices. Finally, we expect to continue to improve product reliability, which would reduce unit service costs. Additionally, contractual pricing policies may allow us to at least partially offset inflationary cost increases.

Our cost reduction plans and potential improvements in 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 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 may continue to incur higher transportation costs driven 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 and capacity expansions 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.

We expect total gross profit as a percentage of revenues to decline in the near term as our investments in NxStage Kidney Care outweigh improvements in our System One and In-Center segments and improvements related to dialyzer sales to Asahi.

Selling and Marketing

Our selling and marketing expenses and selling and marketing expenses as a
percentage of revenues for 2013 and 2012 were as follows (in thousands, except
percentages):



                                                 Years Ended December 31,
                                               2013                    2012
          System One segment            $ 37,691        21 %    $ 33,728        21 %
          In-Center segment                5,253         6 %       5,539         7 %
          Other                            4,898       n/a         1,218       n/a

          Total Selling and marketing   $ 47,842        18 %    $ 40,485        17 %

Selling and marketing expenses increased $7.4 million, or 18%, during 2013 compared to 2012.

Selling and marketing expenses for the System One and In-Center segments increased due to increased personnel and personnel-related costs and increased spending due to expanded marketing programs but remained relatively consistent as a percentage of revenues during 2013 compared to 2012 as we continued to leverage our infrastructure. Selling and marketing expenses for our Other category relates primarily to personnel and personnel-related costs related to market development activities to establish NxStage Kidney Care dialysis centers. We anticipate that selling and marketing expenses will continue to increase as we increase public awareness of the System One in the home market, increase our marketing initiatives, support growth in international markets and continue to invest in NxStage Kidney Care.

Research and Development

Our research and development expenses and research and development expenses as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

Years Ended December 31, 2013 2012 Research and development $ 18,887 7 % $ 17,111 7 %


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Research and development expenses increased $1.8 million, or 10%, during 2013 compared to 2012 but remained consistent as a percentage of revenues. 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.

On June 3, 2013 we entered into a research and development program sponsored by the Defense Advanced Research Projects Agency (DARPA) to develop an innovative new device to treat sepsis. The research and development costs of the project will be offset by the funds received under the contract.

Distribution

Our distribution expenses and distribution expenses as a percentage of revenues
for 2013 and 2012 were as follows (in thousands, except percentages):



                                             Years Ended December 31,
                                           2013                   2012
                System One segment   $ 18,858       11 %    $ 16,325       10 %
                In-Center segment       2,388        3 %       2,563        3 %

                Total Distribution   $ 21,246        8 %    $ 18,888        8 %

Distribution expenses increased $2.4 million, or 13%, during 2013 compared to 2012 due to increased business volumes 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 and general and administrative expenses as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

Years Ended December 31, 2013 2012 General and administrative $ 32,326 12 % $ 27,530 11 %

General and administrative expenses increased $4.8 million, or 17%, during 2013 compared to 2012. 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 and increased professional service fees 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

Interest expense decreased $2.2 million during 2013 compared to 2012. In May 2012, we repaid our term loan with Asahi through the issuance of shares of our common stock.

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


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Provision for Income Taxes

We recognized a benefit from taxes of $(0.2) million in 2013 compared to a provision for income taxes of $1.0 million in 2012. We recorded income tax expense during both 2013 and 2012 for certain profitable foreign subsidiaries. The net benefit from income taxes recorded during 2013 includes the favorable conclusion of a foreign income tax audit during the second quarter, offset in part by additional reserves recorded for other uncertain tax positions. Refer to Note 11, Income Taxes, to our consolidated financial statements included in this Annual Report for further discussion of our tax positions.

Comparison of Years Ended December 31, 2012 and 2011

Revenues

Our revenues for 2012 and 2011 were as follows (in thousands, except
percentages):



                                                Years Ended December 31,
                                             2012                     2011
           System One segment
           Home                       $ 123,589        51 %    $ 108,489        50 %
           Critical Care                 39,540        16 %       34,991        16 %

           Total System One segment     163,129        67 %      143,480        66 %
           In-Center segment             76,927        32 %       73,776        34 %
           Other                          2,076         1 %            -        -  %

           Total                      $ 242,132       100 %    $ 217,256       100 %

In the home market, revenues increased $15.1 million, or 14%, during 2012 compared to 2011, driven by the increase in the number of patients prescribed to use and centers offering the System One. During 2012, we 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 $4.5 million, or 13%, during 2012 compared to 2011, primarily due to increased sales of disposables from our growing number of System One equipment placed within hospitals partially offset by lower sales of our System One equipment. 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.

In-Center segment revenues increased $3.2 million, or 4%, during 2012 compared to 2011. The increase in revenues was driven by higher sales of needles due to increased end user demand. 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.

Other revenues relate to dialyzers sold to Asahi pursuant to our Dialyzer Production Agreement.

Gross Profit

Our gross profit and gross profit as a percentage of revenues for 2012 and 2011
were as follows (in thousands, except percentages):



                                            Years Ended December 31,
                                          2012                     2011
              System One segment   $ 74,402         46 %    $ 60,847        42 %
              In-Center segment      19,153         25 %      16,761        23 %

              Subtotal             $ 93,555         39 %    $ 77,608        36 %
              Other                    (747 )      n/a             -       n/a

              Gross Profit         $ 92,808         38 %    $ 77,608        36 %


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Gross profit increased $15.2 million, or 20%, and increased as an overall percentage of revenue during 2012 compared to 2011 driven in large part by the System One segment. Gross profit for the System One segment increased $13.6 million, or 22%, during 2012 compared to 2011. In addition to the impact of increased revenues, the improvement in gross profit and gross profit as a . . .

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