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ELGX > SEC Filings for ELGX > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for ENDOLOGIX INC /DE/

Form 10-Q for ENDOLOGIX INC /DE/


2-May-2014

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Cautionary Note Concerning Forward-Looking Statements

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These forward looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by the use of forward-looking terminology such as "anticipates," "believes," "can," "continue," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "should" or "will" or the negative of these terms or other comparable terminology, or by discussions of strategies, opportunities, plans or intentions. In addition, any statements that refer to projections of our future financial performance, trends in our businesses, or other characterizations of future events or circumstances are forward-looking statements. We have based these forward-looking statements largely on our current expectations based on information currently available to us and projections about future events and trends affecting the financial condition of our business. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward- looking statements. Actual results could differ materially from those projected in forward-looking statements as a result of the following factors, among others:

• continued market acceptance of our products;

• continued growth in the number of patients qualifying for treatment of abdominal aortic aneurysms through our products;

• our ability to effectively compete with the products offered by our competitors; the level and availability of third party payor reimbursement for our products;

• our ability to successfully commercialize products which incorporate the technology obtained in our acquisition of Nellix, Inc. ("Nellix");

• our ability to effectively develop new or complementary technologies; our ability to manufacture our endovascular systems to meet demand; changes to our international operations;

• our ability to effectively manage our business and keep pace with our anticipated growth;

• our ability to develop and retain a direct sales force in the United States and select European and other foreign countries;

• the nature of and any changes to legislative, regulatory and other legal requirements that apply to us, our products, our suppliers and our competitors;

• the timing of and our ability to obtain and maintain any required regulatory clearances and approvals; our ability to protect our intellectual property rights and proprietary technologies;

• our ability to operate our business without infringing the intellectual property rights and proprietary technology of third parties;

• product liability claims and litigation expenses; reputational damage to our products caused by mis-use or off-label use or government or voluntary product recalls; our utilization of a single source supplier for specialized components of our product lines;

• our ability to attract, retain, and motivate qualified personnel; our ability to make future acquisitions and successfully integrate any such future-acquired businesses;

• our ability to maintain adequate liquidity to fund our operational needs and research and developments expenses; and

• general macroeconomic and world-wide business conditions.

Our actual results, performance or achievements may differ materially from any future results, performance or achievements expressed or implied from such forward-looking statements. Important factors that could cause our actual results, performance or achievements to differ materially from our expectations are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 3, 2014, including but not limited to those factors discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Risk Factors," "Consolidated Financial Statements" and "Notes to Consolidated Financial Statements." All subsequent written and oral forward-looking statements attributable to us or by persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. We expressly disclaim any intent or obligation to update information contained in any forward-looking statement after the date thereof to conform such information to actual results or to changes in our opinions or expectations.

Our forward-looking statements speak only as of the date each such statement is made. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations, except as required by applicable law or the rules and regulations of the SEC and The NASDAQ Stock Market, LLC.


Overview
Our Business
Our corporate headquarters and manufacturing facility is located in Irvine, California. We develop, manufacture, market, and sell innovative medical devices for the treatment of aortic disorders. Our principal products are intended for the treatment of abdominal aortic aneurysms ("AAA"). Our AAA products are built on one of two platforms: (1) traditional minimally-invasive endovascular repair ("EVAR") or (2) endovascular sealing ("EVAS"), our innovate solution for sealing the aneurysm sac while maintaining blood flow through two blood flow lumens. We sell our products through (i) our direct U.S. and European sales forces and
(ii) third-party international distributors and agents in other parts of the world.
See Item 1. of our Annual Report on Form 10-K for the year ended December 31, 2013, entitled "Business," for a discussion of:
• Market Overview and Opportunity

• Our Products

• Manufacturing and Supply

• Marketing and Sales

• Competition

• Clinical Trials and Product Developments

Endologixฎ, AFXฎ and Nellixฎ are registered trademarks of Endologix, Inc., and Ventana™ and the respective product logos are trademarks of Endologix, Inc.

Recent Highlights of Our Product Development Initiatives and Regulatory Approvals

Nellix
In February 2013, our EVAS device, the Nellix EVAS System, commenced limited market introduction in Europe and a limited commercial release is currently underway. In December 2013, we received Investigational Device Exemption ("IDE") approval in the United States to begin a clinical trial which commenced in January 2014.

AFX

In February 2014, we launched a new proximal extension in the US, VELA, designed specifically for the treatment of proximal aortic neck anatomies. VELA features a circumferential graft line marker and controlled delivery system that enable predictable deployment and final positional adjustments. The VELA launch is expected in Europe in the second half of 2014.

Characteristics of Our Revenue and Expenses Revenue
Revenue is derived from sales of our EVAR and EVAS products (including extensions and accessories) to hospitals upon completion of AAA repair procedure, or from sales to distributors upon title transfer (which is typically at shipment), provided our other revenue recognition criteria have been met. Cost of Goods Sold
Cost of goods sold includes compensation (including stock-based compensation) and benefits of production personnel and production support personnel. Cost of goods sold also includes depreciation expense for production equipment, production materials and supplies expense, allocated facilities-related expenses, and certain direct costs such as shipping. Research and Development
Research and development expenses consist of compensation (including stock-based compensation) and benefits for research and development personnel, materials and supplies, research and development consultants, outsourced and licensed research and development costs, and allocated facilities-related costs. Our research and development activities primarily relate to the development and testing of new devices and methods to treat aortic disorders.


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Clinical and Regulatory
Clinical and regulatory expenses consist of compensation (including stock-based compensation) and benefits for clinical and regulatory personnel, regulatory and clinical payments related to studies, regulatory costs related to registration and approval activities, and allocated facilities-related costs. Our clinical and regulatory activities primarily relate to gaining regulatory approval for the commercialization of our devices.
Marketing and Sales
Marketing and Sales expenses primarily consist of compensation (including stock-based compensation) and benefits for our sales force, clinical specialist, internal sales support functions, and marketing personnel. It also includes costs attributable to marketing our products to our customers and prospective customers.
General and Administrative
General and administrative expenses primarily include compensation (including stock-based compensation) and benefits for personnel that support our general operations such as information technology, executive management, financial accounting, and human resources. General and administrative expenses also include bad debt expense, patent and legal fees, financial audit fees, insurance, recruiting fees, other professional services, the federal Medical Device Excise Tax, and allocated facilities-related expenses. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. While management believes these estimates are reasonable and consistent, they are by their very nature, estimates of amounts that will depend on future events. Accordingly, actual results could differ from these estimates. Our Audit Committee periodically reviews our significant accounting policies.
For a description of our critical accounting policies and estimates, please refer to the "Critical Accounting Policies and Estimates" section in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", in our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no material changes in any of our critical accounting policies and estimates during the three months ended March 31, 2014.


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Results of Operations
Operations Overview - Three Months Ended March 31, 2014 versus 2013
The following table presents our results of continuing operations and the
related percentage of the period's revenue (in thousands):
                                                  Three Months Ended March 31,
                                                   2014                 2013
Revenue                                     $ 33,264    100.0%   $ 29,784    100.0%
Cost of goods sold                             8,969     27.0%      7,256     24.4%
Gross profit                                  24,295     73.0%     22,528     75.6%
Operating expenses:
Research and development                       4,105     12.4%      3,519     11.8%
Clinical and regulatory affairs                2,200     6.6%       2,364     7.9%
Marketing and sales                           16,143     48.5%     15,249     51.2%
General and administrative                     7,163     21.5%      5,885     19.8%
Total operating expenses                      29,611     89.0%     27,017     90.7%
Loss from operations                          (5,316 )  (16.0)%    (4,489 )  (15.1)%
Total other income (expense)                  10,827     32.5%     (4,506 )  (15.1)%
Net income (loss) before income tax expense    5,511     16.5%     (8,995 )  (30.2)%
Income tax expense                              (216 )  (0.6)%       (339 )  (1.1)%
Net income (loss)                           $  5,295     15.9%   $ (9,334 )  (31.3)%

Comparison of the Three Months Ended March 31, 2014 versus 2013 Revenue
Three Months Ended March 31, 2014 2013 Variance Percent Change

(in thousands)

Revenue $ 33,264 $ 29,784 $ 3,480 11.7%

Our 11.7% revenue increase of $3.5 million over the prior year period primarily resulted from:

(i) a $3.2 million increase in European sales volume due to strong direct sales growth related to both Nellix and AFX;

(ii) an increase in sales volume to Latin America and our Asia Pacific markets; and

(iii) a decrease in U.S. sales procedures due to competitive pressures and a delay with the VELA FDA approval.


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Cost of Goods Sold, Gross Profit, and Gross Margin

                                              Three Months Ended March 31,
                                                                                               Percent
                                                   2014             2013         Variance       Change
                                                     (in thousands)
Cost of goods sold                           $       8,969      $    7,256     $    1,713       23.6 %
Gross profit                                        24,295          22,528          1,767        7.8 %
Gross margin percentage (gross profit as a
percent of revenue)                                   73.0 %          75.6 %

The $1.7 million increase in cost of goods sold was driven by our revenue increase of $3.5 million.

Gross margin for the three months ended March 31, 2014 decreased to 73.0% from 75.6% for the three months ended March 31, 2013. The increase in cost of goods sold, and corresponding decrease to gross margin is due to geography and product mix with a greater proportion of sales from international markets, which have lower average selling prices and a higher cost to produce Nellix compared to AFX.

Operating Expenses
                                          Three Months Ended March 31,
                                                                                          Percent
                                              2014               2013         Variance     Change
                                                 (in thousands)
Research and development               $          4,105     $      3,519     $    586      16.7%
Clinical and regulatory affairs                   2,200            2,364         (164 )    (6.9)%
Marketing and sales                              16,143           15,249          894       5.9%
General and administrative                        7,163            5,885        1,278      21.7%

Research and Development. The $0.6 million increase in research and development expenses was primarily attributable to continued product development investments related to Nellix and AFX.
Clinical and Regulatory Affairs. The $0.2 million decrease in clinical expenses is due to variable stock-based compensation expense, due to the stock price decrease in the first quarter of 2014.
Marketing and Sales. The $0.9 million increase in marketing and sales expenses for the three months ended March 31, 2014, as compared to the prior year period, was primarily related to increased investments in our European sales force and marketing activities.
General and Administrative. The $1.3 million increase in general and administrative expenses is primarily attributable to professional and audit fees and expense to support the continued growth in Europe.

Other income (expense), net
                                        Three Months Ended March 31,
                                            2014              2013         Variance     Percent Change
                                               (in thousands)
Other income (expense), net           $        10,827     $    (4,506 )      15,333         >100%

Other Income (Expense), Net. Other Income for the three months ended March 31, 2014 includes a non-cash benefit of $(11.8) million, which reflects a decrease in the fair value of the Nellix contingent consideration, which was almost entirely related to the decrease in Endologix's stock price during the quarter (see Note 9). Partially offsetting this fair value adjustment is interest expense associated with our convertible notes.


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Provision for Income Taxes
Three Months Ended March 31, 2014 2013 Variance Percent Change

(in thousands)

Income tax expense $ (216 ) $ (339 ) $ 123 (36.3 )%

Our income tax expense was $0.2 million and our effective tax rate was 3.9% for the three months ended March 31, 2014. During the three months ended March 31, 2014 and 2013, we had operating legal entities in the U.S., Italy, New Zealand, Switzerland and the Netherlands (including registered sales branches in certain countries in Europe). We have certain minimum tax liabilities attributable to our operations in these countries and in the U.S (see Note 10).

Liquidity and Capital Resources
The chart provided below summarizes selected liquidity data and metrics as of
March 31, 2014, December 31, 2013, and March 31, 2013:
                                          March 31, 2014       December 31, 2013      March 31, 2013
                                                 (in thousands, except financial metrics data)
Cash and cash equivalents                $        42,179     $            95,152     $        42,029
Marketable securities                             77,418                  31,313                   -
Accounts receivable, net                          25,448                  24,972              25,661
Total current assets                             172,308                 173,633              88,180
Total current liabilities                         60,059                  67,335              18,780
Working capital surplus (a)                      112,249                 106,298              69,400
Current ratio (b)                               2.9                   2.6                   4.7
Days sales outstanding ("DSO") (c)              69                    65                    78
Inventory turnover (d)                          1.6                   1.7                   1.6

(a) total current assets minus total current liabilities as of the corresponding balance sheet date.
(b) total current assets divided by total current liabilities as of the corresponding balance sheet date.
(c) net accounts receivable at period end divided by revenue for the current period multiplied by the number of days in the period.
(d) cost of goods sold divided by the average inventory balance for the corresponding period. Operating Activities
Cash used in operating activities was $3.0 million for the three months ended March 31, 2014 as compared to cash used in operating activities of $3.4 million in the prior year period. The cash used in operating activities primarily consisted of (i) a change in the fair value of the Nellix contingent consideration of $11.8 million; (ii) inventory purchases of $4.4 million; offset by a decrease in accounts payable of $4.0 million.
During the three months ended March 31, 2014, and 2013 our cash collections from customers totaled $33.2 million and $27.4 million, respectively, representing 100% and 92.0% of reported revenue for the same periods. Investing Activities
Cash used in investing activities for the three months ended March 31, 2014 was $49.6 million, as compared to cash used in investing activities of $1.1 million in the prior year period. The cash used in investing activities primarily consisted of $3.5 million used for machinery and equipment purchases and $53.0 million used to purchase marketable debt securities; offset by $6.9 million in maturities of marketable securities.
Financing Activities
Cash used in financing activities was $0.4 million for the three months ended March 31, 2014, as compared to cash provided by financing activities of $1.0 million in the prior year period. Cash used in financing activities consisted of $0.6 million used in minimum tax withholding paid on behalf of employees for restricted stock units; offset by proceeds of $0.2 million from the exercise of stock options.


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Credit Arrangements
See Note 6 of the Notes to the Condensed Consolidated Financial Statements. We were in compliance with all debt covenants as of March 31, 2014.

Credit Risk
The majority of our accounts receivable arise from product sales in the U.S. However, we also have significant
receivable balances from customers within the European Union, Japan, Brazil, Argentina, and Mexico. Our accounts
receivable in the U.S. are primarily due from public and private hospitals. Our accounts receivable outside of the U.S. are primarily due from public and private hospitals and independent distributors. Our historical write-offs of accounts receivable have not been significant.

We monitor the financial performance and credit worthiness of our customers so that we can properly assess
and respond to changes in their credit profile. Since our customers operate in certain countries such as Greece and Italy, where adverse economic conditions persist, it increases the risk of our inability to collect amounts due to us from them. To determine our allowance for doubtful accounts we consider these factors and other relevant considerations. Our allowance for doubtful accounts of $0.2 million as of March 31, 2014, represents our best estimate of the amount of probable credit losses in our existing accounts receivable. Future Capital Requirements
We believe that the future growth of our business will depend upon our ability to successfully develop new technologies for the treatment of aortic disorders and successfully bring these technologies to market. We expect to incur significant expenditures in completing product development and clinical trials for Ventana and the Nellix System.
The timing and amount of our future capital requirements will depend on many factors, including:

• the need for working capital to support our sales growth;

• the need for additional capital to fund future development programs;

• the need for additional capital to fund our sales force expansion;

• the need for additional capital to fund strategic acquisitions;

• our requirements for additional facility space or manufacturing capacity;

• our requirements for additional information technology infrastructure and systems; and

• adverse outcomes from potential litigation and the cost to defend such litigation.

We believe that our world-wide cash resources are adequate to operate our business. We presently have several operating subsidiaries and branches outside of the U.S. As of March 31, 2014, these subsidiaries and branches hold an aggregate $7.0 million in foreign bank accounts to fund their local operations. A portion of these balances related to undistributed earnings, and are deemed by management to be permanently reinvested in the corresponding country in which our subsidiary operates. Management has no present or planned intention to repatriate foreign earnings into the U.S. However, in the event that we required additional funds in the U.S. and had to repatriate any foreign earnings to meet those needs, we would then need to accrue, and ultimately pay, incremental income tax expenses on such "deemed dividend," unless we then had sufficient net operating losses to offset this potential tax liability.

In the event we require additional financing in the future, it may not be available on commercially reasonable terms, if at all. Even if we are able to obtain financing, it may cause substantial dilution (in the case of an equity financing), or may contain burdensome restrictions on the operation of our business (in the case of debt financing). If we are not able to obtain required financing, we may need to curtail our operations and/or our planned product development.


Table of Contents

Contractual Obligations
Contractual obligation payments by year with initial terms in excess of one year
were as follows as of March 31, 2014 (in thousands):
                                       Payments due by period
     Contractual                   Remainder of                                                        2020 and
     Obligations         Total         2014        2015      2016      2017       2018      2019      thereafter
Long-term debt
obligations           $  86,250   $          -   $     -   $     -   $     -   $ 86,250   $     -   $           -
Interest on debt
obligations               9,732          1,968     1,941     1,941     1,941      1,941         -               -
Operating lease
obligations              36,277            847     2,026     2,067     2,123      2,186     2,251          24,777
Total                 $ 132,259   $      2,815   $ 3,967   $ 4,008   $ 4,064   $ 90,377   $ 2,251   $      24,777

Refer to Note 6 of the Notes to the Condensed Consolidated Financial Statements for a discussion of long-term debt obligations and Note 8 of the Notes to the Condensed Consolidated Financial Statements for a discussion of operating lease obligations.
Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements (except for operating leases) that provide financing, liquidity, market or credit risk support, or involve derivatives. In addition, we have no arrangements that may expose us to liability that are not expressly reflected in the accompanying Consolidated Financial Statements.

As of March 31, 2014, we did not have any relationships with unconsolidated entities or financial partnerships, often referred to as "structured finance" or "special purpose entities," established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not subject to any material financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

. . .

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