UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
- --- EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from ______ to _____
Commission file number: 000-33001
____________________
NATUS MEDICAL INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 77-0154833
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
1501 Industrial Road, San Carlos, CA 94070
(Address of Principal Executive Offices) (Zip Code)
(650) 802-0400
Registrant's telephone number, including area code
____________________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for shorter period that the registrant was
required to file such reports); and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
The number of issued and outstanding shares of the Registrant's Common Stock,
$0.001 par value, as of September 30, 2001, was 15,751,453.
NATUS MEDICAL INCORPORATED
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
- -------- ------------------------------------------------------------------------------ --------
Item 1. Condensed Consolidated Financial Statements .................................. 3
Condensed Consolidated Balance Sheets as of September 30, 2001 (unaudited) and
December 31, 2000 ........................................................... 3
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2001 and 2000 (unaudited) ............................... 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2001 and 2000 (unaudited) ..................................... 5
Notes to Condensed Consolidated Financial Statements ......................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations ............................................................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk ................... 29
PART II. OTHER INFORMATION PAGE NO.
- --------- ------------------------------------------------------------------------------ --------
Item 2. Changes in Securities and Use of Proceeds .................................... 31
Item 6. Exhibits and Reports on Form 8-K ............................................. 31
Signatures .............................................................................. 32
-2-
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
NATUS MEDICAL INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
September 30, December 31,
2001 2000(1)
------------- ------------
(unaudited)
ASSETS:
Current assets:
Cash and equivalents.............................................................. $ 55,942 $ 681
Short-term investments ........................................................... -- 302
Accounts receivable, net of allowance for doubtful accounts of $ 214 in 2001
and $203 in 2000 .............................................................. 4,054 4,400
Inventories ...................................................................... 3,054 2,194
Prepaid expenses and other current assets ........................................ 594 263
--------- ---------
Total current assets .......................................................... 63,644 7,840
Property and equipment, net ......................................................... 1,500 1,308
Convertible notes receivable ........................................................ -- 115
Long-term investment ................................................................ 326 321
Deposits and other assets ........................................................... 362 1,134
--------- ---------
Total assets .................................................................. $ 65,832 $ 10,718
========= =========
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Liabilities:
Accounts payable ................................................................. $ 1,218 $ 750
Accrued liabilities .............................................................. 2,544 2,694
Deferred revenues ................................................................ 253 331
--------- ---------
Total liabilities ............................................................. 4,015 3,775
--------- ---------
Commitments and contingencies
Convertible preferred stock:
Series A convertible preferred stock, $0.001 par value; 1,241,842 shares
authorized in 2000; 1,241,841 shares issued and outstanding in 2000;
aggregate liquidation value of $3,803 in 2000 .................................. -- 2,227
Redeemable convertible preferred stock, $0.001 par value; 8,781,412 shares
authorized in 2000; aggregate liquidation value of $25,178 in 2000 and
aggregate redemption value of $22,999 in 2000:
Series B: 3,967,126 shares authorized in 2000; 3,967,120 shares issued and
outstanding in 2000 ...................................................... -- 12,478
Series C: 3,214,286 shares authorized in 2000; 2,490,181 shares issued and
outstanding in 2000 ...................................................... -- 5,864
Series D: 1,600,000 shares authorized in 2000; 1,232,392 shares issued and
outstanding in 2000 ...................................................... -- 4,657
--------- ---------
Total convertible preferred stock ........................................... -- 25,226
--------- ---------
Stockholders' equity (deficit):
Common stock, $0.001 par value, 120,000,000 shares authorized; shares issued
and outstanding: 15,751,453 in 2001 and 868,034 in 2000 ........................ 85,847 2,902
Preferred stock, $0.001 par value, 10,000,000 shares authorized in 2001; no
shares issued and outstanding in 2001 ............................................ -- --
Deferred stock compensation ...................................................... (1,005) (1,532)
Accumulated deficit .............................................................. (23,005) (19,653)
Accumulated other comprehensive loss ............................................. (20) --
--------- ---------
Total stockholders' equity (deficit) ........................................ 61,817 (18,283)
--------- ---------
Total liabilities, convertible preferred stock and stockholders' equity
(deficit) ................................................................ $ 65,832 $ 10,718
========= =========
_____________________
(1) Derived from the consolidated audited financial statements at December 31,
2000.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-3-
NATUS MEDICAL INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Revenues .................................................. $ 6,324 $ 6,653 $ 19,885 $ 17,662
Cost of revenues* ......................................... 2,432 2,391 7,570 6,299
---------- ---------- ---------- ----------
Gross profit ........................................ 3,892 4,262 12,315 11,363
---------- ---------- ---------- ----------
Operating expenses:
Marketing and selling .................................. 3,010 2,208 8,981 6,640
Research and development ............................... 1,184 915 3,213 2,520
General and administrative ............................. 855 789 2,591 1,941
Amortization of deferred stock compensation* ........... 238 188 810 429
---------- ---------- ---------- ----------
Total operating expenses ............................ 5,287 4,100 15,595 11,530
---------- ---------- ---------- ----------
Income (loss) from operations ....................... (1,395) 162 (3,280) (167)
Interest income ........................................... 499 16 521 23
Interest expense .......................................... (14) -- (35) (6)
Other income, net ......................................... 217 -- 206 11
---------- ---------- ---------- ----------
Income (loss) before provision for income taxes ..... (693) 178 (2,588) (139)
Provision for income taxes ................................ -- 23 1 23
---------- ---------- ---------- ----------
Net income (loss) ................................... (693) 155 (2,589) (162)
Accretion of redeemable convertible preferred stock ....... 71 346 763 1,038
---------- ---------- ---------- ----------
Net loss available to common stockholders ........... $ (764) $ (191) $ (3,352) $ (1,200)
========== ========== ========== ==========
Basic and diluted net loss per share ...................... $ (0.06) $ (0.25) $ (0.71) $ (1.77)
========== ========== ========== ==========
Common shares used in computing basic and diluted net loss
per share (Note 3) ..................................... 12,287 766 4,741 678
________________________
* Amortization of deferred stock compensation included in:
Cost of revenues .......................................... $ 34 $ 58 $ 117 $ 135
========== ========== ========== ==========
Operating expenses:
Marketing and selling .................................. $ 121 $ 44 $ 420 $ 99
Research and development ............................... 23 32 83 75
General and administrative ............................. 94 112 307 255
---------- ---------- ---------- ----------
Total ............................................. $ 238 $ 188 $ 810 $ 429
========== ========== ========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-4-
NATUS MEDICAL INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
September 30,
--------------------------
2001 2000
-------- --------
Operating activities:
Net loss .................................................................... $ (2,589) $ (162)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization ............................................. 574 435
Amortization of deferred stock compensation ............................... 927 564
Changes in operating assets and liabilities:
Accounts receivable ..................................................... 276 (302)
Inventories ............................................................. (855) (717)
Prepaid expenses and other current assets ............................... (339) (120)
Accounts payable ........................................................ 468 92
Accrued liabilities and deferred revenues ............................... (284) 1,253
-------- --------
Net cash provided by (used in) operating activities ................... (1,822) 1,043
-------- --------
Investing activities:
Acquisition of property and equipment ....................................... (646) (506)
Purchase of convertible notes receivable .................................... -- (20)
Deposits and other assets ................................................... (103) 17
Purchases of short-term investments ......................................... -- (302)
Sales of short-term investments ............................................. 302 289
Cash paid for acquisition of business ....................................... (9) --
-------- --------
Net cash used in investing activities ................................. (456) (522)
-------- --------
Financing activities:
Issuance of common stock .................................................... 58,928 125
Deferred offering costs ..................................................... (1,383) (725)
Borrowings on bank loans .................................................... 2,000 --
Repayments of borrowings .................................................... (2,000) (112)
-------- --------
Net cash provided by (used in) financing activities ................... 57,545 (712)
-------- --------
Exchange rate effect on cash and equivalents ................................... (6) --
-------- --------
Net increase (decrease) in cash and equivalents ................................ 55,261 (191)
Cash and equivalents, beginning of period ...................................... 681 2,087
-------- --------
Cash and equivalents, end of period ............................................ $ 55,942 $ 1,896
======== ========
Noncash investing and financing activities:
Accretion of redeemable convertible preferred stock ......................... $ 763 $ 1,038
======== ========
Forgiveness of convertible notes receivable and accounts receivable for
acquisition of business ................................................... $ 189 $ --
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest ...................................................... $ 35 $ 8
======== ========
Cash paid for income taxes .................................................. $ 59 $ 18
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-5-
NATUS MEDICAL INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1 -- Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the rules and regulations of the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and notes required by generally accepted accounting principles for
annual financial statements. The financial statements include all adjustments
(consisting only of normal recurring adjustments) that the management of Natus
Medical Incorporated (the "Company") believes necessary for fair presentation of
the Company's financial position, results of operations and cash flows for the
periods presented. These interim financial results are not necessarily
indicative of results to be expected for the full fiscal year. The accompanying
condensed consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries and significant intercompany transactions have
been eliminated. The accompanying financial information should be read in
conjunction with the audited financial statements and notes thereto for the
fiscal year ended December 31, 2000 included in the Company's Registration
Statements on Form S-1, as amended (Registration Nos. 333-44138 and 333-65478).
Use of Estimates
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. Examples include allowances for potentially uncollectable accounts
receivable, warranty costs, and a valuation allowance for deferred tax assets.
Actual results may differ from these estimates.
Recently Issued Accounting Pronouncements
In October 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, or SFAS No. 144. SFAS No. 144 requires that one
accounting model be used for long-lived assets to be disposed of by sale,
whether previously held and used or newly acquired, and broadens the
presentation of discontinued operations to include more disposal transactions.
SFAS No. 144 will be effective for fiscal years beginning after December 15,
2001. The Company intends to adopt the provisions of SFAS No. 144 as of the
effective date and does not expect SFAS No. 144 will have material effect on its
financial position or results of operations.
In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations, or SFAS No. 143. SFAS 143 requires that the liability for an asset
retirement obligation be recognized at its fair market value when the liability
is incurred. SFAS No. 143 will be effective for fiscal years beginning after
June 15, 2002. The Company intends to adopt the provisions of SFAS No. 143 as of
the effective date and does not expect SFAS No. 143 will have a material effect
on its financial position or results of operations.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations, or SFAS No. 141,
and Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, or SFAS No. 142. SFAS No. 141 requires that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method and addresses the initial recognition and measurement of goodwill and
other intangible assets acquired in a business combination. SFAS No. 142
addresses the initial recognition and measurement of intangible assets acquired
outside of a business combination and the accounting for goodwill and other
intangible assets subsequent to their acquisition. SFAS No. 142 provides that
intangible assets with finite useful lives be amortized and that goodwill and
intangible assets with indefinite lives will not be amortized, but will rather
be tested at least annually for impairment. Under the provisions of SFAS No.
142, any impairment loss identified upon adoption of this standard is recognized
as a cumulative effect of a change in accounting principle, which is charged
directly to retained earnings. Any impairment loss incurred subsequent to
initial adoption of SFAS No. 142 is recorded as a change to current period
earnings. The Company will adopt SFAS No. 142 in 2002 and, at that time, will
stop amortizing goodwill that resulted from business combinations completed
prior to June 30, 2001. The Company believes that the adoption of SFAS No. 141
and SFAS No. 142 will not have a material effect on the Company's financial
position and results of operations.
-6-
In December 1999, the staff of the Securities and Exchange Commission (the
"SEC") issued Staff Accounting Bulletin No. 101, Revenue Recognition in
Financial Statements, or SAB No. 101, which summarizes certain of the SEC
staff's views in applying accounting principles generally accepted in the United
States of America to revenue recognition in financial statements. The adoption
of SAB No. 101 had no impact on the Company's financial position or results of
operations.
In June 1998, the Financial Accounting Standard Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
defines derivatives, requires all derivatives to be carried at fair value and
provides for hedge accounting when certain conditions are met. SFAS No. 133 is
effective for the Company in fiscal year 2001. The Company does not utilize
derivative instruments and had no such instruments at January 1, 2001.
Therefore, the adoption of SFAS 133 did not have an impact on the Company's
financial position or results of operations.
Comprehensive Loss
In accordance with SFAS No. 130, Reporting Comprehensive Income, the
Company is required to report, by major components and as a single total, the
change in its assets during the period from non-owner sources. The following are
the components of comprehensive loss (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net loss ..................................... $ (693) $ 155 $ (2,589) $ (162)
Net foreign currency translation loss ........ (28) -- (20) --
---------- ---------- ---------- ----------
Comprehensive loss ........................ $ (721) $ 155 $ (2,609) $ (162)
========== ========== ========== ==========
2 -- Inventories
Inventories consisted of (in thousands):
September 30, 2001 December 31, 2000
------------------ -----------------
Raw materials and subassemblies ........................ $ 1,787 $ 1,017
Finished goods ......................................... 1,267 1,177
----------- -----------
Total inventories ................................... $ 3,054 $ 2,194
=========== ===========
3 -- Basic and Diluted Net Loss Per Common Share
For all periods presented, both basic and diluted net loss per common share
were computed by dividing the net loss available to common stockholders by the
number of weighted average common shares outstanding during the respective
periods. The impact of convertible preferred stock and stock options could
potentially dilute basic earnings per share in the future, but were excluded
from the computation of diluted net loss per common share as their effect is
antidilutive for the periods presented.
4 -- Customer and Geographic Information
The Company operates in one reportable segment and is engaged in the
design, manufacture, and marketing of newborn screening products for the
identification and monitoring of common medical disorders that may occur during
the critical development period of infants. The nature of the Company's products
and production process as well as the type of customers and distribution methods
are consistent among all of the Company's devices.
-7-
The following table summarizes total revenues by geographic region.
Revenues were attributable to countries based on the location of the Company's
customer (in thousands):
Three Months Ended Nine Months Ended
--------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
------------- ------------- ------------- -------------
United States ................ $ 5,563 $ 5,802 $ 16,593 $ 15,313
Japan ........................ 640 661 2,568 1,984
All other .................... 121 190 724 365
---------- ---------- ---------- ----------
Total ...................... $ 6,324 $ 6,653 $ 19,885 $ 17,662
========== ========== ========== ==========
For the nine months ended September 30, 2001 and 2000, revenues from one
customer, a distributor, accounted for approximately 10% and 11% of total
revenues, respectively.
5 - Initial Public Offering
In July 2001, the Company completed an initial public offering of 5,000,000
shares of its common stock at $11.00 per share. Proceeds to the Company from
this offering, net of issuance costs, were approximately $51.2 million after
underwriting discounts and commissions, but before any expenses payable by the
Company in connection with the offering. In August 2001, the underwriters of the
offering exercised their overallotment option to purchase an additional 750,000
shares at $11.00 per share for net proceeds to the Company of approximately $7.7
million after underwriting discounts and commissions, but before any expenses
payable by the Company in connection with the offering. Upon the closing of the
Company's initial public offering, all of the then outstanding shares of the
Company's preferred stock were automatically converted into 8,931,534 shares of
common stock. In connection with its initial public offering, the Company also
filed its Restated Certificate of Incorporation which, among other things,
authorizes the Company to issue 10,000,000 shares of Preferred Stock with such
rights, preferences and privileges as the board of directors of the Company may
determine.
-8-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, as amended. These statement include, among other things,
statements concerning our future operations, financial condition and prospects,
and business strategies. The words "believe," "expect," "anticipate," and other
similar expressions generally identify forward-looking statements. These
forward-looking statements are subject to substantial risks and uncertainties
that could cause our future business, financial condition, or results of
operations to differ materially from our historical results or currently
anticipated results. You should carefully review the information contained under
"Factors Affecting Future Results," beginning on page 15 of this Management's
Discussion and Analysis of Financial Condition and Results of Operation," and
elsewhere in or incorporated by reference into this report.
The following information should be read in conjunction with the condensed
consolidated financial statements and notes thereto set forth in Item 1 of this
quarterly report. We also urge you to review and consider our disclosures
describing various factors that could affect our business, including the
disclosures under Management's Discussion and Analysis of Financial Condition
and Results of Operations and Risk Factors and the audited financial statements
and notes thereto contained in our Registration Statements on Form S-1 (File
Nos. 333-44138 and 333-65478) filed in connection with our initial public
offering.
Overview
We develop, manufacture and market screening products for the detection and
monitoring of common medical disorders in infants. Currently, we sell our ALGO
products for hearing screening and our CO-Stat products for the analysis of
hemolysis and management of jaundice.
Our revenues consist of revenues from sales of equipment and disposable
supplies. We currently derive substantially all of our revenues from sales of a
limited number of products. Nearly all of our revenues were from sales of our
ALGO products in the three and nine months ended September 30, 2001 and 2000.
Although we commercially launched our CO-Stat product in January 2001, we expect
that a substantial majority of our revenues will continue to be generated from
sales of our ALGO products for at least the next two years.
Historically we have sold our products directly through our sales force in
the United States and indirectly through distributors internationally. Domestic
sales were 88% and 87% of our revenues during the three months ended September
30, 2001 and 2000, respectively. Domestic sales were 83% and 87% of our revenues
during the nine months ended September 30, 2001 and 2000, respectively. We plan
to expand our international operations significantly because we believe
international markets represent a significant growth opportunity. We acquired
the distribution operations of our United Kingdom distributor in January 2001
and also began direct distribution operations in Japan in July 2001, when we
acquired the activities of our Japanese distributor. The results of our
operations in the United Kingdom and Japan were immaterial and have been
included in our consolidated results from those dates. We anticipate that
international revenues will increase as a percent of revenues in the future. If
international sales increase, we may not experience corresponding growth in
operating income due to the higher cost of selling outside of the United States.
Historically, our international sales have been through distributors and have
been characterized by lower gross margins due to the discount the distributors
receive from our list prices.
We recognize revenues from product sales, including sales to distributors,
upon shipment when a purchase order has been received, the sales price is fixed
and determinable and collection of the resulting receivable is probable. We
generally do not provide rights of return on our products. We, however, do make
-9-
provision for initial standard warranty obligations of one year and post-sale
training and customer support at the time the related revenues are recognized.
Revenues from extended warranty contracts are recognized ratably over the
warranty period. Advance payments from customers are recorded as deferred
revenues until shipment of the related product. Allowances for estimated
warranty costs are estimated based on our historical results. To date, warranty
and extended warranty costs have been in line with projected amounts. However,
our past product warranty experience may not be indicative of the warranty costs
we may experience in the future. We provide ALGO screening equipment to our
customers on loan without charge while we repair or service their screening
equipment.
In January 2001, we reorganized and expanded our domestic sales force to
commercially launch and focus on our CO-Stat products. We expect to increase
spending on the marketing of our CO-Stat products in 2001 and beyond. Because we
have not previously marketed newborn jaundice management products, we cannot be
certain that our planned resources will be sufficient to support the launch of
our CO-Stat products.
Our net loss available to common stockholders includes accretion charges to
increase the carrying amount of our redeemable convertible preferred stock to
the amount we would have been required to pay if the preferred stock had been
redeemed prior to the date of our initial public offering in July 2001. Our
redeemable convertible preferred stock converted to common stock on a
one-for-one basis upon the closing of our initial public offering in July 2001.
We did not pay accrued dividends on the redeemable convertible preferred stock
when it converted, and accrued but unpaid dividends became additional paid-in
capital.
Results of Operations
The following table sets forth the results of our operations expressed as a
percent of revenues. Our historical operating results are not necessarily
indicative of the results for any future period.
Percent of Total Revenues
-------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Revenues ..................................................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues* ............................................ 38.5 35.9 38.1 35.7
--------- --------- --------- ---------
Gross profit .............................................. 61.5 64.1 61.9 64.3
--------- --------- --------- ---------
Operating expenses:
Marketing and selling ..................................... 47.6 33.2 45.2 37.5
Research and development .................................. 18.7 13.8 16.1 14.3
General and administrative ................................ 13.5 11.9 13.0 11.0
Amortization of deferred stock compensation* .............. 3.8 2.8 4.1 2.4
--------- --------- --------- ---------
Total operating expenses .............................. 83.6 61.7 78.4 65.2
--------- --------- --------- ---------
Income (loss) from operations ............................. (22.1) 2.4 (16.5) (0.9)
Interest income (expense), net ............................... 7.7 0.2 2.4 0.1
Other income, net ............................................ 3.4 -- 1.0 --
--------- --------- --------- ---------
Income (loss) before provision for income taxes ........... (11.0) 2.6 (13.1) (0.8)
Provision for income taxes ................................... -- 0.3 -- 0.1
--------- --------- --------- ---------
Net income (loss) ......................................... (11.0) 2.3 (13.1) (0.9)
Accretion of redeemable convertible preferred stock .......... 1.1 5.2 3.8 5.9
--------- --------- --------- ---------
Net loss available to common stockholders ............. (12.1)% (2.9)% (16.9)% (6.8)%
========= ========= ========= =========
* Amortization of deferred stock compensation included in:
Cost of revenues ............................................. 0.5% 0.9% 0.6% 0.8%
========= ========= ========= =========
Marketing and Selling ..................................... 1.9% 0.6% 2.1% 0.6%
Research and development .................................. 0.4 0.5 0.4 0.4
General and administrative ................................ 1.5 1.7 1.6 1.4
--------- --------- --------- ---------
Operating expenses .................................... 3.8% 2.8% 4.1% 2.4%
========= ========= ========= =========
-10-
Three and Nine Months Ended September 30, 2001 and 2000
Revenues
Our revenues consist almost exclusively of revenues from the sale of ALGO
screening equipment and its related disposable supplies. Our revenues decreased
$329,000, or 5%, to $6.3 million in the three months ended September 30, 2001
from $6.7 million in the three months ended September 30, 2000. This decrease
primarily was attributable to a decrease in revenues from sales of our screening
equipment. Our revenues increased $2.2 million, or 13%, to $19.9 million in the
nine months ended September 30, 2001 from $17.7 million in the nine months ended
September 30, 2000. This increase was primarily due to an increase in the
quantities of disposable supplies sold. No end customer accounted for more than
10% of our revenues in the three months ended September 30, 2001 and 2000. Sales
to our Japanese distributor, Nippon Eurotec, accounted for 10% of our revenues
in the nine months ended September 30, 2001 and 11% of our revenues in the nine
months ended September 30, 2000.
Revenues from screening equipment decreased $712,000, or 30%, to $1.7
million in the three months ended September 30, 2001 from $2.4 million in the
three months ended September 30, 2000. Revenues were adversely impacted by the
terrorist attacks in the United States on September 11, 2001 and by delays in
the implementation of screening programs in Europe, particularly in the United
Kingdom. Revenues from screening equipment remained fairly constant and were
$6.3 million in each of the nine months ended September 30, 2001 and 2000.
Revenues from disposable supplies increased $317,000, or 8%, to $4.4
million in the three months ended September 30, 2001 from $4.1 million in the
three months ended September 30, 2000. Revenues from disposable supplies
increased $2.0 million, or 19%, to $13.0 million in the nine months ended
September 30, 2001 from $10.9 million in the nine months ended September 30,
2000.
Revenues from sales outside the United States decreased by $90,000, or 11%,
to $761,000 in the three months ended September 30, 2001 from $851,000 in the
three months ended September 30, 2000. The decrease primarily was attributable
to lower sales in Europe. Revenues from sales outside the United States
increased $943,000, or 40%, to $3.3 million in the nine months ended September
30, 2001 from $2.3 million in the nine months ended September 30, 2000. These
increases were due primarily to increased screening equipment sales in Japan,
and, to a lesser extent, to revenues from our newly formed subsidiary in the
United Kingdom.
Costs of Revenues and Operating Expenses
Cost of revenues includes material costs, personnel expenses, amortization
of deferred stock compensation, packaging and shipping costs, other
manufacturing costs, warranty expenses and technology license fees. Our cost of
revenues increased $41,000, or 2%, to $2.4 million in the three months ended
September 30, 2001 from $2.4 million in the three months ended September 30,
2000. The increase in cost of revenues in absolute dollars was primarily
attributable to increased manufacturing costs related to early production runs
of our ALGO 3 product, which we released in October 2001. Our cost of revenues
increased $1.3 million, or 20%, to $7.6 million in the nine months ended
September 30, 2001 from $6.3 million in the nine months ended September 30,
2000. The increase in the cost of revenues in absolute dollars was primarily due
to the higher volume of disposable supplies sold relative to sales of screening
equipment as well as increases in manufacturing costs that were primarily
associated with early production runs of our ALGO 3 product. As a percent of
revenues, the cost of revenues increased to 38.5% in the three months ended
September 30, 2001 from 35.9% in the three months ended September 30, 2000 and
to 38.1% in the nine months ended September 30, 2001 from 35.7% in the nine
months ended September 30, 2000. The increase in cost of revenues as a percent
of revenues was attributable to the higher percentage of international sales and
-11-
the lower per unit selling prices associated with those sales, a promotion on
our ALGO Portable product in the United States during the three months ended
March 31, 2001 and September 30, 2001 and the increased manufacturing costs. The
impact of temporary price increases on certain ALGO components earlier in the
year and costs associated with production of our ALGO 3 product later in the
year further increased costs and reduced gross margin percentages during the
nine months ended September 30, 2001.
Marketing and selling expenses consist primarily of salaries, commissions,
travel and promotional and advertising costs. Our marketing and selling expenses
increased $802,000, or 36%, to $3.0 million in the three months ended September
30, 2001 from $2.2 million in the three months ended September 30, 2000. Our
marketing and selling expenses increased $2.3 million, or 35%, to $9.0 million
in the nine months ended September 30, 2001 from $6.6 million in the nine months
ended September 30, 2000. The increase in marketing and selling expenses was
primarily attributable to the hiring of additional marketing and selling
personnel associated with the commercial introduction of our CO-Stat product,
and costs associated with our international expansion.
Research and development expenses consist of engineering costs to develop
new products, enhance existing products and validate the design of our new or
enhanced products. Our research and development expenses increased $269,000, or
29%, to $1.2 million in the three months ended September 30, 2001 from $915,000
in the three months ended September 30, 2000. Our research and development
expenses increased $693,000, or 28%, to $3.2 million in the nine months ended
September 30, 2001 from $2.5 million in the nine months ended September 30,
2000. This increase in research and development expenses was primarily
attributable to the hiring of consultants and additional engineers and staff and
other costs associated with the development of new products.
General and administrative expenses consist of corporate, finance, human
resource, administrative and legal expenses. Our general and administrative
expenses increased $66,000, or 8%, to $855,000 in the three months ended
September 30, 2001 from $789,000 in the three months ended September 30, 2000.
Our general and administrative expenses increased $650,000, or 33%, to $2.6
million in the nine months ended September 30, 2001 from $1.9 million in the
nine months ended September 30, 2000. The increase in general and administrative
expenses was primarily attributable to the hiring of additional personnel, as
well as increased accounting fees and fees for other outside services.
Other income and expense consists of interest income and capital gains and
losses associated with changes in our investment portfolio, interest expense,
currency exchange loss and other miscellaneous income and expenses. Interest
income increased $483,000 to $499,000 in the three months ended September 30,
2001 from $16,000 for the three months ended September 30, 2000. Interest income
increased $498,000 to $521,000 in the nine months ended September 30, 2001 from
$23,000 for the nine months ended September 30, 2000. Due to the investments
made in expanding our operations, we drew down on our bank line early in the
quarter ended September 30, 2001 and incurred interest charges. We repaid our
total borrowing of $2.0 million in July 2001 out of the proceeds of our initial
public offering and invested the net remaining proceeds in short term cash
equivalent investments. During the three months ended September 30, 2001 we also
received a one-time settlement from a component supplier which, net of estimated
product improvement costs, totaled $147,000.
We recorded aggregate amortization of deferred stock compensation of
$272,000 and $246,000 in the three months ended September 30, 2001 and 2000,
respectively, and $927,000 and $564,000 in the nine months ended September 30,
2001 and 2000, respectively.
-12-
Liquidity and Capital Resources
As of September 30, 2001, we had cash and equivalents of $55.9 million, an
accumulated deficit of $23.0 million and working capital of $59.6 million. We
completed an initial public offering of 5,000,000 shares of our common stock at
$11.00 per share in July 2001 and raised $51.2 million after underwriting
discounts and commissions but before expenses payable by us. In August 2001, our
managing underwriters exercised their right to purchase an additional 750,000
shares of our common stock at $11.00 per share for net proceeds of $7.7 million
after underwriting discounts and commissions but before any expenses payable by
us.
Net cash used in operating activities was $1.8 million for the nine months
ended September 30, 2001, compared to net cash provided by operating activities
of $1.0 million for the nine months ended September 30, 2000. Cash used in
operating activities for the nine months ended September 30, 2001 resulted
primarily from the net loss during the period reduced by non-cash items such as
deferred stock compensation and depreciation and amortization and reduced by an
increase in inventories and a decrease in accrued liabilities. Increases in
inventories primarily are associated with the increased working capital needs of
our wholly owned, foreign operations in the United Kingdom and Japan. Net cash
provided by operating activities for the nine months ended September 30, 2000
resulted primarily from non-cash items such as deferred stock compensation and
depreciation and amortization, plus an increase in accrued liabilities, reduced
by an increase in accounts receivable and inventories.
Net cash used in investing activities was $456,000 for the nine months
ended September 30, 2001 and $522,000 for the nine months ended September 30,
2000. Net cash used in investing activities during these periods was primarily
for the purchase of new computers, equipment and furniture as we expanded
operations. We had no material capital expenditure commitments as of September
30, 2001.
Net cash provided by financing activities was $57.5 million for the nine
months ended September 30, 2001 and net cash used by financing activities was
$712,000 for the nine months ended September 30, 2000. The net cash provided by
financing activities for the nine months ended September 30, 2001 resulted
primarily from the proceeds of our initial public offering. The net cash used in
financing activities for the nine months ended September 30, 2000 resulted
primarily from deferred offering costs and repayment of borrowings.
We have a $3.0 million revolving line of credit that expires in June 2002.
In July 2001, we repaid the $2.0 million borrowed under the line of credit using
a portion of the proceeds from our initial public offering. As of September 30,
2001, we had no outstanding borrowings under this line of credit. Borrowings
under the line of credit are limited to our eligible accounts receivable and are
collateralized by substantially all of our assets and bear interest at the
bank's prime rate plus 2.25%. We are also obligated to reimburse the bank for
certain costs the bank incurs to administer our loan. We are required to meet
certain financial ratios, including minimum tangible net worth, a minimum quick
ratio and total debt to tangible net worth. We must also meet an operating
profitability requirement. We believe that we were in compliance with these
covenants as of September 30, 2001.
Our future liquidity and capital requirements will depend on numerous
factors, including:
. the amount and timing of revenues;
. the extent to which our existing and new products gain market acceptance;
. the extent to which we make acquisitions;
-13-
. the cost and timing of expansion of product development efforts and the
success of these development efforts;
. the cost and timing of expansion of marketing and selling activities; and
. available borrowings under line of credit arrangements and the
availability of other means of financing.
We believe that our current cash and equivalent balances and any cash
generated from operations and from current or future debt financing, will be
sufficient to meet our operating and capital requirements for at least the next
18 months. However, it is possible that we may require additional financing
within this period. We intend to continue to invest heavily in the development
of new products and enhancements to our existing products. The factors described
above will affect our future capital requirements and the adequacy of our
available funds. In addition, even if we raise sufficient funds to meet our
anticipated cash needs during the next 18 months, we may need to raise
additional funds beyond this time. We may be required to raise those funds
through public or private financings, strategic relationships or other
arrangements. Any additional equity financing may be dilutive to stockholders,
and debt financing, if available, may involve restrictive covenants.
Recent Accounting Pronouncements
In October 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, or SFAS No. 144. SFAS No. 144 requires that one
accounting model be used for long-lived assets to be disposed of by sale,
whether previously held and used or newly acquired, and broadens the
presentation of discontinued operations to include more disposal transactions.
SFAS No. 144 will be effective for fiscal years beginning after December 15,
2001. We intend to adopt the provisions of SFAS No. 144 as of the effective
date, and do not expect SFAS No. 144 will have a material effect on our
financial position or results of operations.
In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations, or SFAS No. 143. SFAS 143 requires that the liability for an asset
retirement obligation be recognized at its fair market value when the liability
is incurred. SFAS No. 143 will be effective for fiscal years beginning after
June 15, 2002. We intend to adopt the provisions of SFAS No. 143 as of the
effective date and do not expect SFAS No. 143 will have a material effect on our
financial position or results of operations.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations, or SFAS No. 141,
and Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, or SFAS No. 142. SFAS No. 141 requires that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method and addresses the initial recognition and measurement of goodwill and
other intangible assets acquired in a business combination. SFAS No. 142
addresses the initial recognition and measurement of intangible assets acquired
outside of a business combination and the accounting for goodwill and other
intangible assets subsequent to their acquisition. SFAS No. 142 provides that
intangible assets with finite useful lives be amortized and that goodwill and
intangible assets with indefinite lives will not be amortized, but will rather
be tested at least annually for impairment. Under the provisions of SFAS No.
142, any impairment loss identified upon adoption of this standard is recognized
as a cumulative effect of a change in accounting principle, which is charged
directly to retained earnings. Any impairment loss incurred subsequent to
initial adoption of SFAS No. 142 is recorded as a change to current period
earnings. We will adopt SFAS No. 142 in 2002 and, at that time, will stop
amortizing goodwill that resulted from business combinations completed prior
to June 30, 2001. The Company believes that the adoption of SFAS No. 141 and
SFAS No. 142 will not have a material effect on the Company's financial position
and results of operations.
In December 1999, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements, or SAB No. 101, which summarizes certain of the SEC staff's views in
applying accounting principles generally accepted in the United States of
America to revenue recognition in financial statements. The adoption of SAB No.
101 had no impact on our financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities, or SFAS No. 133. SFAS No. 133 defines derivatives,
requires all derivatives to be carried at fair value and provides for hedge
accounting when certain conditions are met. SFAS No. 133 is effective for our
company in fiscal year 2001. We generally do not utilize derivative instruments
and had no such instruments at January 1, 2001. Therefore, the adoption of SFAS
133 did not have an impact on our financial position or results of operations.
-14-
Factors Affecting Future Results
We have a history of losses and may experience losses in the future, which may
result in the market price of our common stock declining
Since our inception, we have incurred significant net losses, including net
losses available to common stockholders of $1.4 million in 1999, $1.1 million in
2000 and $3.4 million in the nine months ended September 30, 2001. In addition,
we had an accumulated deficit of $23.0 million as of September 30, 2001. We
expect to incur net losses for the 2001 fiscal year.
We anticipate that our expenses will increase substantially in the
foreseeable future as we:
. continue to invest in research and development to enhance our ALGO and
CO-Stat products and develop new technologies;
. develop additional applications for our current technology, such as the
use of our CO-Stat breath analyzer for the detection of pregnancy induced
hypertension;
. increase our marketing and selling activities, particularly outside the
United States;
. continue to increase the size and number of locations of our customer
support organization; and
. develop additional infrastructure and hire additional management and
other employees to keep pace with our growth.
As a result of these increased expenses, we will need to generate
significantly higher revenues to achieve profitability. We cannot be certain
that we will achieve profitability in the future or, if we achieve
profitability, sustain it. If we do not achieve and maintain profitability, the
market price of our common stock is likely to decline, perhaps substantially.
We have relied, and expect to continue to rely, on sales of our ALGO product
family for substantially all of our revenues, and a decline in sales of these
products could cause our revenues to fall
Historically, we have derived substantially all of our revenues from sales
of our ALGO products. Revenues from our ALGO products accounted for
approximately 98% of our revenues in 2000 and approximately 97% of our revenues
in the nine months ended September 30, 2001. We expect that the revenues from
our ALGO product family will continue to account for a substantial majority of
our revenues for at least the next two years. To date, our MiniMuff product,
which is a disposable ear cover for newborns, has accounted for only a small
percentage of our revenues. We have not derived any significant revenues from
sales of our CO-Stat products. Any factors adversely affecting the pricing of
our ALGO screening equipment and related disposables or demand for our ALGO
products, including physician acceptance or the selection of competing products,
could cause our revenues to decline and our business to suffer.
If more physicians do not adopt our ALGO and CO-Stat products, we will not
achieve future sales growth
We acquired the ALGO product family in 1987, and we introduced our CO-Stat
product in January 2001. More neonatologists and pediatricians must adopt our
products for us to increase our sales. We believe that physicians will not
continue to use our products unless they determine, based on published
peer-reviewed journal articles, long-term clinical data and experience, that the
products provide an accurate and cost-
-15-
effective alternative to other means of testing for hearing impairment or
jaundice management. There are currently alternative hearing screening and
jaundice management products, which may be less expensive and may be quicker on
a per test basis. Physicians are traditionally slow to adopt new products and
testing practices, partly because of perceived liability risks and the
uncertainty of third party reimbursement. If more neonatologists and
pediatricians do not adopt our products, we may never have significant revenues
or achieve and maintain profitability. Factors that may affect the medical
community's acceptance of our products, some of which are beyond our control,
include:
. the changing governmental and physician group guidelines for screening of
newborns, particularly with respect to full term babies;
. the performance, quality, price and total cost of ownership of our
screening products relative to other screening products for newborns;
. our ability to maintain and enhance our existing relationships and to
form new relationships with leading physician organizations, hospitals
and third party payors;
. changes in state and third party payor reimbursement policies for newborn
screening equipment; and
. the adoption of state and foreign laws requiring universal newborn
screening.
A general economic downturn in the United States or abroad may reduce our
revenue and harm our business
The primary customers for our products are neonatologists, physicians,
audiologists, hospitals and government agencies. Any significant downturn in
domestic or global economic conditions which results in the reduction of the
capital spending budgets of our customers or a delay in capital equipment
purchases would likely result in a decline in demand for our products and could
harm our business. Economic growth in the United States and other countries has
slowed significantly and many commentators believe that the United States
economy is experiencing a recession. Overall, customer spending is getting
tighter and spending decisions are being more closely scrutinized. These
conditions have negatively impacted our business and may continue to do so if
they persist. Like other companies, we currently have very limited visibility
with respect to our near term quarters and are having difficulty predicting our
revenues and operating results during these periods.
A sluggish economy and recent terrorist attacks in New York and Washington D.C.
could have an adverse effect on our business
The September 11, 2001 terrorist attacks in New York and Washington D.C.
could further contribute to the slowdown in the United States economy and the
economies of other countries. At the time of the attacks, capital investment by
businesses, particularly capital investment in technology, had been experiencing
substantial weakness. Economic and political uncertainties, both domestically
and abroad, resulting from these attacks or otherwise could result in declines
in new technology investments by our customers, including investment in our
products. In addition, at least during the short term, some hospitals may focus
their resources on community preparedness and issues related to readiness for
disasters rather than on compliance with newborn hearing screening mandates to
take effect. For example, we did not receive product orders that we anticipated
in the weeks after the terrorist attacks, which resulted in a decline in
revenues in the quarter ended September 30, 2001. New rules and regulations that
went into effect in New York in October 2001 require inpatient hearing screening
for newborns under certain circumstances. We did not receive the orders we
anticipated that we would receive late in the quarter ended September 30, 2001
from the adoption of these rules and regulations. We do not know what further
effect the terrorist attacks, or resulting military actions by the United
States, could have on our business, revenues or results of operations. If our
customers or potential
-16-
customers defer or cancel purchases of our products, our revenues will be
adversely affected, which would harm our results of operations and financial
condition.
Our quarterly operating results may fluctuate, which could cause our
stock price to decline
Our revenues and operating results have varied significantly from quarter
to quarter in the past and may continue to fluctuate in the future. The
following are among the factors that could cause our revenues, operating results
and margins to fluctuate significantly from quarter to quarter:
. the budgeting cycle of our customers;
. the size and timing of specific sales, such as large purchases of
screening equipment or disposables by government agencies or hospital
systems;
. product and price competition;
. trade-in allowances or other concessions in connection with the
introduction of new products or improvements to existing products;
. the timing and market acceptance of new product introductions and product
enhancements by us and our competitors, such as the expected reduction in
demand for and potential inventory obsolescence relating to our existing
ALGO screener prior to or after the announced launch date of our next
generation ALGO screener;
. the length of our sales cycle;
. the loss of key sales personnel or international distributors; and
. changes caused by the rapidly evolving market for newborn screening
products.
In addition, if a majority of our customers were to implement
enterprise-wide evaluation programs or purchase products for the entire
organization at once, our sales cycle could lengthen and our revenues could be
erratic from quarter to quarter. This could make our business difficult to
manage. For example, in the fourth quarter of 1997, a local government agency in
Belgium made a one time purchase of equipment for each of the hospitals in its
jurisdiction and approximately one year's supply of disposables. This purchase
resulted in an abnormally high level of sales during that period and the
following quarter.
We have limited historical experience selling our CO-Stat products and
cannot determine how the sales cycle for the CO-Stat products will affect our
revenues. The sales cycle, however, could be protracted and could result in
further unpredictability in our revenues from quarter to quarter.
Many of these factors are beyond our control, and we believe that you
should not rely on our results of operations for interim periods as any
indication of our expected results in any future period. If our revenues vary
significantly from quarter to quarter, our business could be difficult to manage
and our quarterly results could be below expectations of investors and stock
market analysts, which could cause our stock price to decline.
Our operating results have been and may continue to be subject to seasonal
fluctuations during the first fiscal quarter of each year
We experience seasonality in the sale of our screening equipment. For
example, our sales typically decline from our fourth fiscal quarter to our first
fiscal quarter. We anticipate that we will continue to experience relatively
lower sales in our first fiscal quarter due to patterns in the capital budgeting
and purchasing cycles of our current and prospective customers, many of which
are government agencies. We may also experience declining sales in the third
fiscal quarter due to summer holiday and vacation schedules. These seasonal
factors may lead to fluctuations in our quarterly operating results. It is
difficult for us to evaluate the degree to which the summer slow down and
capital budgeting and customer purchasing cycle variations may make our revenues
unpredictable in the future.
-17-
Our operating results may decline if we do not succeed in developing and
marketing additional newborn testing products or improving our existing products
We intend to develop additional testing products for the diagnosis and
monitoring of common medical conditions in infants and pregnant women.
Developing new products and improving our existing products to meet the needs of
neonatologists and pediatricians requires significant investments in research
and development. If we fail to successfully develop and market new products and
update our existing products, our operating results may decline as our existing
products reach the end of their commercial life cycles.
Our future growth and profitability will depend on our ability to begin
commercial, volume sales of our CO-Stat products
We introduced our CO-Stat product family for clinical research uses in July
1999 and began commercially marketing it in January 2001. To date, CO-Stat
products have accounted for only a limited portion of our revenues. We have
limited experience marketing our CO-Stat product for commercial use. However,
our future growth and profitability will depend on our ability to commercially
sell our CO-Stat products and to sell our CO-Stat products in volume. We cannot
be certain that our entry into the hemolysis monitoring segment of the newborn
testing market with our CO-Stat products will be successful, that the hemolysis
monitoring market will develop at all or that physicians, governments or other
third party payors will accept and adopt these products.
Physicians may not adopt our CO-Stat products if we cannot show that these
products are cost-effective or if long-term clinical data does not support our
early results, which would harm our operating results
While one clinical study has concluded that our CO-Stat product is more
cost-effective than another test used for jaundice monitoring, we cannot be
certain that additional clinical studies of the cost-effectiveness of our
CO-Stat product compared to other tests used for jaundice monitoring will
produce results that are favorable to our products. The commercial acceptance of
our CO-Stat products depends in part upon favorable results from these studies
if they are conducted. If our CO-Stat products are not shown to be
cost-effective, we may not be able to persuade clinicians to adopt our products
and our results of operations may suffer.
If clinical studies do not continue to produce satisfactory clinical data
supported by the independent efforts of clinicians, our new products may not be
accepted by physicians or government agencies as meeting
-18-
the standards of care for universal newborn screening. Our safety,
effectiveness, reliability, sensitivity and specificity data for the CO-Stat
product is based in part on a study of over 1,300 children conducted in 1998. We
may find that data from longer-term follow-up studies or studies involving a
larger number of children is inconsistent with our relatively short-term data.
If longer-term studies or clinical experience indicate that the CO-Stat product
does not provide sensitive, specific and reliable results, our products may not
gain commercial acceptance and our revenues could decline. In addition, we could
be subject to significant liability for screening that failed to detect
hemolysis leading to jaundice or costs and emotional distress incurred by
families whose children received results indicating elevated hemolysis when none
existed. We could have similar problems with any other products we offer in the
future.
If the guidelines for recommended universal newborn screening do not continue to
develop in the United States and foreign countries, and governments do not
require testing of all newborns as we anticipate, our revenues may not grow
because our products will not be needed for universal newborn screening
The demand for our screening products depends, in part, upon state and
foreign governments' adoption of universal screening requirements for the
disorders for which our products screen. The guidelines for universal newborn
screening for hearing impairment and jaundice monitoring have been adopted by
some physician groups and governments only recently. We cannot predict the
outcome or the impact that statutes and government regulations requiring
universal newborn screening will have on our sales. The widespread adoption of
these guidelines will depend on our ability to educate government agencies,
neonatologists, pediatricians, third party payors and hospital administrators
about the benefits of universal newborn hearing testing and the benefits of
universal newborn hemolysis monitoring, as well as the use of our products to
perform the screening and monitoring.
Our revenues may not grow if densely populated states and foreign countries do
not adopt guidelines requiring universal newborn hearing screening or jaundice
monitoring or if those guidelines have a long phase-in period
If the governments in the most densely populated states and foreign
countries do not require universal screening for the disorders for which our
products test, our business would be harmed and our sales may not grow. As of
September 30, 2001, 35 states had mandated universal newborn hearing screening,
but the phase-in of these guidelines varies widely from six months to four
years. To date, there has been only limited adoption of newborn hearing
screening prior to hospital discharge by foreign governments. Our revenues may
not grow if hospitals are slow to comply with these guidelines or the applicable
government provides for a lengthy phase-in period for compliance.
Our revenues may not grow if state and foreign governments do not mandate
hemolysis monitoring as the standard of care for newborn jaundice screening
To date, physician groups and federal, state and local governments have not
mandated the screening methodology to be used for newborn jaundice management or
established monitoring of hemolysis as the best practice. If these mandates or
practice recommendations are not issued, a market may not develop for our
CO-Stat products.
Any failure in our efforts to educate clinician, government and other third
party payors could significantly reduce our product sales
It is critical to the success of our sales efforts that we educate a
sufficient number of clinicians, hospital administrators and government agencies
about our products and the costs and benefits of universal newborn hearing
testing and universal newborn jaundice management using hemolysis monitoring. We
rely
-19-
on physician, government agency and other third party payor confidence in the
benefits of testing with our products as well as their comfort with the
reliability, sensitivity and specificity of our products. The impact of our
products will not be demonstrable unless highly sensitive and specific
evaluations are performed on a substantial number of newborns, including those
who do not have risk factors for hearing impairment or who do not display signs
of jaundice. If we fail to demonstrate the effectiveness of our products and the
potential long-term benefits to patients and third party payors of universal
newborn screening, our products will not be adopted.
If health care providers are not adequately reimbursed for the screening
procedures or for screening equipment itself, we may never achieve significant
revenues
Physicians, hospitals and state agencies are unlikely to purchase our
products if clinicians are not adequately reimbursed for the screening
procedures conducted with our equipment or the disposable products needed to
conduct the screenings. Unless a sufficient amount of positive, peer-reviewed
clinical data about our products has been published, third party payors,
including insurance companies and government agencies, may refuse to provide
reimbursement for the cost of newborn hearing screening and hemolysis monitoring
with our products. Furthermore, even if reimbursement is provided, it may not be
adequate to fully compensate the clinicians or hospitals. Some third party
payors may refuse adequate reimbursement for screening unless the infant has
demonstrable risk factors. If health care providers cannot obtain sufficient
reimbursement from third party payors for our products or the screenings
conducted with our products, it is unlikely that our products will ever achieve
significant market acceptance.
Acceptance of our products in international markets will be dependent
upon the availability of adequate reimbursement or funding, as the case may be,
within prevailing health care payment systems. Reimbursement, funding and health
care payment systems vary significantly by country and include both
government-sponsored health care and private insurance. Although we intend to
seek international reimbursement or funding approvals, we may not obtain these
approvals in a timely manner or at all.
Even if third party payors provide adequate reimbursement for some newborn
hearing screening or hemolysis monitoring for jaundice management, adverse
changes in reimbursement policies in general could harm our business
We are unable to predict changes in the reimbursement methods used by
third party health care payors. For example, some payors are moving toward a
managed care system in which providers contract to provide comprehensive health
care for a fixed cost per person. We cannot assure you that in a managed care
system the cost of our products will be incorporated into the overall payment
for childbirth and newborn care or that there will be adequate reimbursement for
our screening equipment and disposable products separate from reimbursement for
the procedure. Unless the cost of screening is reimbursed as a standard
component of the newborn's care, universal screening is unlikely to occur and
the number of infants likely to be screened with our products will be
substantially reduced.
We have very limited experience selling and marketing products other than our
ALGO products, and our failure to build and manage our sales force or to market
and distribute our CO-Stat products or other products effectively will hurt our
revenues and quarterly results
Since we only recently began to market our CO-Stat products, our sales
force has little experience selling these products, and we cannot predict how
successful they will be in selling them. In order to successfully introduce and
build market share for our CO-Stat products, we must sell our products to
hospital administrators accustomed to the use of laboratory bench equipment
rather than portable point of care screening devices for jaundice management.
-20-
We market almost all of our newborn hearing screening products in the
United States through a small direct sales force of 18 persons as of September
30, 2001. During the first quarter of 2001, we expanded our sales force by four
persons in order to market our CO-Stat products along with our other products.
There are significant risks involved in building and managing our sales force
and marketing our products. We may be unable to hire a sufficient number of
qualified sales people with the skills and training to sell our newborn hearing
screening and jaundice management products effectively. Furthermore, we do not
have any agreements with distributors for sales of our CO-Stat products.
We may not be successful in generating revenues from our CO-Stat products
because we may encounter difficulties in manufacturing our CO-Stat products in
commercial quantities
We do not have experience manufacturing our CO-Stat products in
commercial quantities, and we may encounter difficulties in the manufacturing of
these products. We must also increase our manufacturing personnel or increase
the volume of products we purchase from contract manufacturers that produce the
CO-Stat products for us. If we encounter any of these difficulties, we may not
be successful in marketing our CO-Stat products, and our revenues and financial
condition may be harmed.
If we lose our relationship with any supplier of key product components or our
relationship with a supplier deteriorates or key components are not available in
sufficient quantities, our manufacturing could be delayed and our business could
suffer
We contract with third parties for the supply of some of the components
used in our products and the production of our disposable products. Some of our
suppliers are not obligated to continue to supply us. For certain of these
materials and components, relatively few alternative sources of supply exist. In
addition, the lead time involved in the manufacturing of some of these
components can be lengthy. If these suppliers become unwilling or unable to
supply us with our requirements, it might be difficult to establish additional
or replacement suppliers in a timely manner or at all. This would cause our
product sales to be disrupted and our revenues and operating results to suffer.
Replacement or alternative sources might not be readily obtainable due
to regulatory requirements and other factors applicable to our manufacturing
operations. Incorporation of components from a new supplier into our products
may require a new or supplemental filing with applicable regulatory authorities
and clearance or approval of the filing before we could resume product sales.
This process may take a substantial period of time, and we cannot assure you
that we would be able to obtain the necessary regulatory clearance or approval.
This could create supply disruptions that would harm our product sales and
operating results.
There is only one Natus approved supplier that provides hydrogel, the
adhesive used in our disposable products. In addition, we have relied on a
single supplier for the electrochemical sensors used in our CO-Stat analyzer and
we have not qualified another vendor for this component. A disruption in the
supply of the adhesive or electrochemical sensors could negatively affect our
revenues. If we or our contract manufacturers were unable to locate another
supplier, it could significantly impair our ability to sell our products. In
addition, we may be required to make new or supplemental filings with applicable
regulatory authorities prior to our marketing a product containing new materials
or produced in a new facility. If we fail to obtain regulatory approval to use a
new material, we may not be able to continue to sell the affected products and
revenues and operating results could suffer.
We rely on a continuous power supply to conduct our operations and California's
current energy crisis could disrupt our operations and increase our expenses
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall
-21-
below one and one-half percent, the State of California has on some occasions
implemented, and may in the future continue to implement, rolling blackouts
throughout the state. We currently do not have backup generators or alternate
sources of power in the event of a blackout, and our current insurance does not
provide coverage for any damages we or our customers may suffer as a result of
any interruption in our power supply. If blackouts interrupt our ability to
continue operations at our facilities, our reputation could be damaged, our
ability to retain existing customers could be harmed and we could fail to obtain
new customers. These interruptions could also result in lost revenue, any of
which could substantially harm our business and results of operations.
Furthermore, the deregulation of the energy industry instituted in 1996
by the California state government has caused power prices to increase. Under
deregulation, utilities were encouraged to sell their plants, which
traditionally had produced most of California's power, to independent energy
companies that were expected to compete aggressively on price. Instead, due in
part to a shortage of supply, wholesale prices have skyrocketed over the past
year. If wholesale prices continue to increase, our operating expenses will
likely increase, as our primary North American facilities are located in
California.
Some of our component suppliers are also located in California. While
our orders from our suppliers have not been affected by power failure to date,
the continuance of blackouts may affect our suppliers' ability to manufacture
our products and meet scheduled delivery needs.
Our sales efforts through group purchasing organizations or sales to high
volume purchasers may reduce our average selling prices, which would reduce our
revenues and gross profits from these sales
We have entered, and may in the future enter, into agreements with
customers who purchase high volumes of our products. Our agreements with these
customers may contain discounts off of our normal selling prices and other
special pricing considerations, which could cause our revenues and profit
margins to decline. In addition, we have entered into agreements to sell our
products to members of group purchasing organizations, which negotiate volume
purchase prices for medical devices and supplies for member hospitals, group
practices and other clinics. For instance, in the quarter ended September 30,
2001 we entered into agreements relating to our hearing screening products with
Joint Purchasing Corporation and Healthtrust Purchasing Group, two group
purchasing organizations. While we still make sales directly to group purchasing
organization members, the members of these group purchasing organizations now
receive volume discounts off our normal selling price and may receive other
special pricing considerations from us. Sales to members of one group purchasing
organization, Novation, LLC, accounted for approximately 22% of our total
revenues in 2000 and 28% and 25% of our revenues in the three and nine month
periods ended September 30, 2001, respectively. Approximately 79% of the
customers who bought from us under the Novation agreement in 2000 were also our
customers prior to the time we entered into the Novation agreement. Other of our
existing customers may be members of group purchasing organizations with which
we do not have agreements. Our sales efforts through group purchasing
organizations may conflict with our direct sales efforts to our existing
customers. If we enter into agreements with group purchasing organizations and
our existing customers begin purchasing our products through those group
purchasing organizations, our revenues and profit margins could decline.
We rely on sales to existing customers for a majority of our revenues, and if
our existing customers do not continue to purchase products from us, our
revenues may decline
We rely on sales of additional screening products to our existing
customers for a majority of our revenues. Of our customers that purchased
products from us in 1999, 90% also purchased products from us in 2000. If we
fail to sell additional screening products to our existing customers directly or
indirectly, we would experience a material decline in revenues.
-22-
Because we rely on distributors to sell our products in some markets outside of
the United States, our revenues could decline if our existing distributors do
not continue to purchase products from us or if our relationship with any of
these distributors is terminated
We rely on our distributors for a majority of our sales outside the United
States. These distributors also assist us with regulatory approvals and
education of physicians and government agencies. Our revenues from sales through
international distributors outside the United States represented approximately
10% of our revenues in 1999, approximately 14% of our revenues in 2000 and
approximately 10% of our revenues in the nine months ended September 30, 2001.
We intend to continue our efforts to increase our sales in Europe, Japan and
other countries with a relatively high level of health care spending on infants.
If we fail to sell our products through our international distributors, we would
experience a decline in revenues unless we begin to sell our products directly
in those markets. We cannot be certain that we will be able to attract new
international distributors that market our products effectively or provide
timely and cost-effective customer support and service. Even if we are
successful in selling our products through new distributors, the rate of growth
of our revenues could be harmed if our existing distributors do not continue to
sell a large dollar volume of our products. None of our existing distributors
are obligated to continue selling our products.
In the past, we have terminated our relationships with distributors for
poor performance. We are also subject to foreign laws governing our
relationships with our distributors. These laws may require us to make payments
to our distributors even if we terminate our relationship for cause. Some
countries require termination payments under common law or legislation that may
supercede our contractual relationship with the distributor. These payments
could be equal to a year or more of gross margin on sales of our products that
the distributor would have earned. Any required payments would adversely affect
our operating results.
Our plan to expand in international markets will result in increased costs and
may not be successful, which could harm our business
We must expand the number of distributors who sell our products or increase
our direct international sales presence to significantly penetrate international
markets. We have only recently begun to develop a direct sales force outside the
United States. For example, we acquired our United Kingdom distributor in
January 2001. Effective in July 2001, we assumed our Japanese distributor's
sales and support activities, allowing us direct access to redistributors of our
products in Japan. As we continue to increase our direct international sales
presence, we will incur higher personnel costs that may not result in additional
revenues. A higher percentage of our sales to international distributors could
also impair our revenues due to discounts available to these distributors. We
may not realize corresponding growth in operating results from growth in
international sales, due to the higher costs of sales outside of the United
States. Even if we are able to successfully expand our direct and indirect
international selling efforts, we cannot be certain that we will be able to
create or increase demand for our products outside of the United States.
Our operating results may suffer because of foreign currency exchange rate
fluctuations or strengthening of the U.S. dollar relative to local currencies
Although historically substantially all of our sales contracts provide for
payment in United States dollars, we expect that we will incur expenses related
to international sales denominated in the respective local currency. We
established a Japanese subsidiary in July 2000 and a United Kingdom subsidiary
in December 2000. These operations will incur expenses in the applicable local
currency. We also expect to begin selling our products in local currencies as we
expand our direct international sales. To date, we have not undertaken any
foreign currency hedging transactions, and as a result, our future revenues and
expense levels from international operations may be unpredictable due to
exchange rate fluctuations. Furthermore, a strengthening of the dollar could
make our products less competitive in foreign markets.
-23-
We face other risks from foreign operations, which could reduce our operating
results and harm our financial condition
Our international operations are subject to other risks, which include:
. the impact of possible recessions in economies outside the United
States;
. political and economic instability, including instability related to
terrorist attacks in the United States and abroad;
. contractual provisions governed by foreign law, such as common law
rights to sales commissions by terminated distributors;
. the dependence of demand for our products on health care spending by
local governments;
. greater difficulty in accounts receivable collection and longer
collection periods;
. difficulties of staffing and managing foreign operations;
. reduced protection for intellectual property rights in some countries
and potentially conflicting intellectual property rights of third
parties under the laws of various foreign jurisdictions; and
. difficulty in obtaining foreign regulatory approvals.
Our failure to obtain necessary U.S. Food and Drug Administration clearances or
approvals or to comply with Food and Drug Administration regulations could hurt
our ability to commercially distribute and market our products in the United
States, and this would harm our business and financial condition
Unless an exemption applies, each medical device that we wish to market in
the United States must first receive one of the following types of Food and Drug
Administration premarket review authorizations:
. 510(k) clearance via Section 510(k) of the federal Food, Drug, and
Cosmetics Act of 1938, as amended; or
. premarket approval via Section 515 of the Food, Drug, and Cosmetics Act
if the Food and Drug Administration has determined that the medical
device in question poses a greater risk of injury.
The Food and Drug Administration's 510(k) clearance process usually takes
from four to 12 months, but can take longer. The process of obtaining premarket
approval is much more costly, lengthy and uncertain. Premarket approval
generally takes from one to three years, but can take even longer. We cannot
assure you that the Food and Drug Administration will ever grant either 510(k)
clearance or premarket approval for any product we propose to market.
Furthermore, if the Food and Drug Administration concludes that these future
products using our technology do not meet the requirements to obtain 510(k)
clearance, we would have to seek premarket approval. We cannot assure you that
the Food and Drug Administration will not impose the more burdensome premarket
approval requirement on modifications to our existing products or future
products, which in either case could be costly and cause us to divert our
attention and resources from the development of new products or the enhancement
of existing products.
Our business may suffer if we are required to revise our labeling or promotional
materials or the Food and Drug Administration takes an enforcement action
against us for off-label uses
We may not promote or advertise the ALGO, MiniMuff or CO-Stat products, or
any future cleared or approved devices, for uses not within the scope of our
clearances or approvals or make unsupported
-24-
promotional claims about the benefits of our products. If the Food and Drug
Administration determines that our claims are outside the scope of our
clearances or are unsupported it could require us to revise our promotional
claims or take enforcement action against us. If we were subject to such an
action by the Food and Drug Administration, our sales could be delayed, our
revenues could decline and our reputation among clinicians could be harmed.
Our business would be harmed if the Food and Drug Administration determines that
we have failed to comply with applicable regulations or we do not pass an
inspection
We are subject to inspection and market surveillance by the Food and Drug
Administration concerning compliance with pertinent regulatory requirements. If
the Food and Drug Administration finds that we have failed to comply with these
requirements, the agency can institute a wide variety of enforcement actions,
ranging from a public warning letter to more severe sanctions such as:
. fines, injunctions and civil penalties;
. the recall or seizure of our products;
. the issuance of public notices or warnings;
. the imposition of operating restrictions, partial suspension or total
shutdown of production;
. the refusal of our requests for 510(k) clearance or premarket approval
of new products;
. the withdrawal of 510(k) clearance or premarket approvals already
granted; and
. criminal prosecution.
If we fail to obtain necessary foreign regulatory approvals in order to market
and sell our products outside of the United States, we may not be able to sell
our products in other countries
Our products are regulated outside the United States as medical devices by
foreign governmental agencies similar to the Food and Drug Administration and
are subject to regulatory requirements similar to the Food and Drug
Administration's regulatory requirements in foreign countries. The time and cost
required to obtain market authorization from other countries and the
requirements for licensing a product in another country may differ significantly
from the Food and Drug Administration requirements. We may not be able to obtain
these approvals without incurring significant expenses or at all.
If we or our suppliers fail to comply with applicable regulations, sales of our
products could be delayed and our revenues could be harmed
Every manufacturer of a finished medical device, including us and some of
our contract manufacturers and suppliers, is required to demonstrate and
maintain compliance with the Food and Drug Administration's quality system
regulation and comparable regulations of states and other countries. The Food
and Drug Administration enforces the quality system regulation through periodic
inspections. Although we have passed inspections in the past, we cannot assure
you that we or our contract manufacturers will pass any future quality system
regulation inspections. If we or our contract manufacturers fail one of these
inspections in the future, our operations could be disrupted and our
manufacturing and sales delayed significantly until we can demonstrate adequate
compliance. If we or our contract manufacturers fail to take adequate corrective
action in a timely fashion in response to a quality system regulations
inspection, the Food and Drug Administration could shut down our or our contract
manufacturers' manufacturing operations and require us, among other things, to
recall our products, either of which would harm our business.
-25-
We may experience intense competition from other medical device companies, and
this competition could adversely affect our revenues and our business
Our most significant current and potential competitors for the ALGO
products include companies that market hearing screening equipment. For the
CO-Stat products, we anticipate that our competitors will be large medical
device companies that market laboratory bench equipment used for blood-based
antibody and bilirubin tests and companies that sell devices that analyze the
amount of yellow in the skin to estimate the level of bilirubin.
We believe that Bio-logic Systems Corp., Intelligent Hearing Systems and
Sonamed Corp., each of which is also currently marketing enhanced auditory
brainstem response and otoacoustic hearing screening equipment products, could
introduce new, lower priced hearing screening equipment that may not require an
audiologist or physician to interpret its results or review its recommendations,
similar to our products. For example, Bio-logic recently announced that it
received FDA approval to sell its disposable products for use with our ALGO
hearing screeners. We do not know the impact this FDA approval or sales efforts
by Bio-logic will have on our revenues from sales of our disposable products. We
believe that Chromatics Color Sciences International, Inc., Minolta Co., Ltd.
and SpectRx, Inc., each of which is currently marketing skin color analysis
products for bilirubin monitoring, or Johnson & Johnson and F. Hoffman-La Roche
Ltd., each of which is currently marketing equipment for blood-based bilirubin
or antibody tests, could also introduce new, lower-priced options for the
management of newborn jaundice. Some of our competitors may have greater
financial resources and name recognition or larger, more established
distribution channels than we do.
We believe our future success depends on our ability to enhance existing
products, develop and introduce new products, satisfy customer requirements and
achieve market acceptance. We cannot be certain that we will successfully
identify new product opportunities. We may not be able to develop and bring new
products to market before our competitors or in a more cost-effective manner.
Increased competition may negatively affect our business and future operating
results by leading to price reductions, higher selling expenses or a reduction
in our market share.
Our business could be harmed if our competitors establish cooperative
relationships with large medical testing equipment vendors or rapidly acquire
market share through industry consolidation or by bundling other products with
their hearing screening or jaundice monitoring products
Large medical testing equipment vendors, such as Johnson & Johnson or F.
Hoffman-La Roche Ltd., may acquire or establish cooperative relationships with
our current competitors. We expect that the medical testing equipment industry
will continue to consolidate. New competitors or alliances among competitors may
emerge and rapidly acquire significant market share, which would harm our
business and financial prospects.
Other medical device companies may decide to bundle their products with
other newborn hearing screening or hemolysis monitoring products and sell the
bundle at lower prices. If this happens, our business and future operating
results could suffer if we were no longer able to offer commercially viable or
competitive products.
We may not be able to preserve the value of our products' intellectual property
because we may not be able to protect access to our intellectual property or we
may lose our intellectual property rights due to expiration of our licenses or
patents
If we fail to protect our intellectual property rights or if our
intellectual property rights do not adequately cover the technology we employ,
other medical device companies could sell hearing screening or hemolysis
monitoring products with features similar to ours, and this could reduce demand
for our products.
-26-
We protect our intellectual property through a combination of patent, copyright,
trade secret and trademark laws. We have eight issued United States patents,
seven patent applications pending before the United States Patent and Trademark
Office and seven patent applications pending before foreign governmental bodies
of which one European Patent Office application has been allowed and will be
registered in nine European countries. We have one patent granted in Japan, six
patent applications pending in Japan and one patent application pending in Hong
Kong. We attempt to protect our intellectual property rights by filing patent
applications for new features and products we develop. We enter into
confidentiality or license agreements with our employees, consultants and
corporate partners and seek to control access to our intellectual property and
the distribution of our hearing screening or hemolysis monitoring products,
documentation and other proprietary information. However, we believe that these
measures afford only limited protection. Others may develop technologies that
are similar or superior to our technology or design around the patents,
copyrights and trade secrets we own. The original patent for an algorithm for
analyzing auditory brainstem responses, which we licensed on a nonexclusive
basis from a third party and upon which we developed our automated auditory
brainstem response technology, expired in late 1999, and that subject matter is
in the public domain. In addition, we cannot assure you that the patent
applications we have filed to protect the features of our products that we have
subsequently developed will be allowed, or will deter others from using the
auditory brainstem response technology.
Despite our efforts to protect our proprietary rights, others may attempt
to copy or otherwise improperly obtain and use our products or technology.
Policing unauthorized use of our technology is difficult and expensive, and we
cannot be certain that the steps we have taken will prevent misappropriation,
particularly in foreign countries where the laws may not protect our proprietary
rights as fully. Our means of protecting our proprietary rights may be
inadequate. Enforcing our intellectual property rights could be costly and time
consuming and may divert our management's attention and resources. Enforcing our
intellectual property rights could also result in the loss of our intellectual
property rights.
Our operating results would suffer if we were subject to a protracted
infringement claim or a significant damage award
Substantial intellectual property litigation and threats of litigation
exist in our industry. We expect that medical screening equipment may become
increasingly subject to third party infringement claims as the number of
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps. Third parties such as individuals,
educational institutions or other medical device companies may claim that we
infringe their intellectual property rights. Any claims, with or without merit,
could have any of the following negative consequences:
. result in costly litigation and damage awards;
. divert our management's attention and resources;
. cause product shipment delays or suspensions; or
. require us to seek to enter into royalty or licensing agreements, which
may not be available on terms acceptable to us, if at all.
A successful claim of infringement against us could result in a substantial
damage award and materially harm our financial condition. Our failure or
inability to license the infringed or similar technology could prevent us from
selling our products and adversely affect our business and financial results.
-27-
Product liability suits against us could result in expensive and time consuming
litigation, payment of substantial damages and an increase in our insurance
rates
The sale and use of our medical testing products could lead to the filing
of a product liability claim if someone were to be injured using one of our
devices or if one of our devices fails to detect a disorder for which it was
being used to screen. A product liability claim could result in substantial
damages and be costly and time consuming to defend, either of which could
materially harm our business or financial condition. We cannot assure you that
our product liability insurance would protect our assets from the financial
impact of defending a product liability claim. Any product liability claim
brought against us, with or without merit, could increase our product liability
insurance rates or prevent us from securing any coverage in the future.
We may incur significant costs related to a class action lawsuit due to the
likely volatility of the public market price of our stock
Our stock price may fluctuate for a number of reasons including:
. quarterly fluctuations in our results of operations;
. our ability to successfully commercialize our products;
. announcements of technological or competitive developments by us or our
competitors;
. announcements regarding patent litigation or the issuance of patents to
us or our competitors;
. announcements regarding state screening mandates or third party payor
reimbursement policies;
. regulatory developments regarding us or our competitors;
. acquisitions or strategic alliances by us or our competitors;
. changes in estimates of our financial performance or changes in
recommendations by securities analysts; and
. general market conditions, particularly for companies with a relatively
small number of shares available for sale in the public market.
Securities class action litigation is often brought against a company after
a period of volatility of the market price of its stock. If our future quarterly
operating results are below the expectations of securities analysts or
investors, the price of our common stock would likely decline. In September 2001
our stock price fell by more than 45%. Stock price fluctuations may be
exaggerated if the trading volume of our common stock is low. Any securities
litigation claims brought against us could result in substantial expense and
damage awards and divert our management's attention from running our business.
We depend upon key employees in a competitive market for skilled personnel, and,
without additional employees, we cannot grow or achieve and maintain
profitability
Our products and technologies are complex, and we depend substantially on
the continued service of our senior management team including Tim C. Johnson,
our chief executive officer, and William New, Jr., M.D., Ph.D., our chief
technology officer, chairman and a founder. The loss of any of our key employees
could adversely affect our business and slow our product development process.
Although we maintain key person life insurance on Dr. New, we do not maintain
key person life insurance on any of our other employees, and the amount of the
policy on Dr. New may be inadequate to compensate us for his loss.
-28-
Our future success also will depend in part on the continued service of our
key management personnel, software engineers and other research and development
employees and our ability to identify, hire, and retain additional personnel,
including customer service, marketing and sales staff. Hiring sales, marketing
and customer service personnel in our industry is very competitive due to the
limited number of people available with the necessary technical skills and
understanding of pediatric audiology and neonatal jaundice management. We may be
unable to attract and retain personnel necessary for the development of our
business.
We could lose the ability to use net operating losses, which may adversely
affect our financial results
As of December 31, 2000, we had total net operating loss carryforwards of
approximately $6.7 million for income tax purposes. These net operating loss
carryforwards, if not utilized to offset taxable income in future periods, will
expire in various amounts beginning in 2007 through 2019. If we continue to have
net losses, we may not be able to utilize some or all of our net operating loss
carryforwards before they expire.
In addition, applicable United States income tax law imposes limitations on
the ability of corporations to use net operating loss carryforwards if the
corporation experiences a more than 50% change in ownership during any
three-year period. We cannot assure you that we will not take actions, such as
the issuance of additional stock, that would cause an ownership change to occur.
Accordingly, we may be limited to the amount we can use in any given year, so
even if we have substantial net income, we may not be able to use our net
operating loss carryforwards before they expire. In addition, the net operating
loss carryforwards are subject to examination by the Internal Revenue Service,
or IRS, and are thus subject to adjustment or disallowance resulting from any
such IRS examination.
If we are unable to use our net operating loss carryforwards to offset our
taxable income, our future tax payments will be higher and our financial results
may suffer.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We develop products in the United States and sell those products primarily
in the United States, Japan and Europe. Our revenues for sales outside the
United States were approximately 10% of our revenues in 1999, approximately 14%
of our revenues in 2000 and approximately 17% of our revenues in the nine months
ended September 30, 2001. As a result, our financial results could be affected
by factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. Historically, our sales have been generally
denominated in United States dollars; however, with the formation of our
Japanese subsidiary and the acquisition of our United Kingdom distributor, we
expect that a portion of our operating expenses and revenues in international
locations will be denominated in local currencies in the future. Historically,
our exposure to foreign exchange fluctuations has been minimal. As our
international sales and operations expand, however, we anticipate that our
exposure to foreign currency fluctuations will increase. As all of our sales are
currently made in United States dollars, a strengthening of the dollar could
make our products less competitive in foreign markets.
Our interest income is sensitive to changes in the general level of
interest rates in the United States. However, due to the nature of our
short-term investments, we believe that we do not have material market
risk exposure.
-29-
Our investment policy permits us to invest funds in excess of current
operating requirements in:
. corporate securities including commercial paper, rated A1, P1 or
better, and corporate debt instruments, including medium term notes
and floating rate notes issued by foreign and domestic corporations,
that pay in United States dollars and carry a rating of A or better;
. bank certificates of deposit and banker's acceptances that are rated
at least A1 or P1;
. United States treasury bills, notes and bonds and United States
AAA-rated agency securities that carry the direct or implied guarantee
of the United States government, including notes, discount notes,
medium term notes and floating rate notes;
. asset-backed securities rated A or better;
. repurchase agreements with major banks and dealers that are recognized
as primary dealers by the Federal Reserve Bank of New York;
. money market mutual funds that offer daily purchase and redemption;
and
. tax exempt/tax advantage investments in money market funds, variable
rate demand notes, municipal notes or bonds and auction preferred
municipal and corporate securities.
In July and August 2001, we received $58.8 million in aggregate net
proceeds in connection with our initial public offering after deducting
underwriting discounts and commissions, but before deducting offering expenses
payable by us. We are currently investing net offering proceeds from the
offering pursuant to our investment policy.
-30-
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
Between June 30, 2001 and September 30, 2001, we issued 33,633 shares of
unregistered common stock upon the exercise of outstanding options to nine
persons and entities at an average exercise price of $0.74 per share. The sale
of the above securities was deemed to be exempt from registration under the
Securities Act of 1933, as amended (the "Securities Act"), in reliance on Rule
701 promulgated under Section 3(b) of the Securities Act, as transactions not
involving a public offering or transactions pursuant to compensatory benefit
plans and contracts relating to compensation as provided under Rule 701. Each
recipient had adequate access to information about us through his or her
relationship with us.
We have used approximately $2.0 million of the proceeds from our initial
public offering to repay the outstanding amounts on our revolving bank line of
credit. The offering expenses incurred by us was approximately $2.4 million.
There were no direct or indirect payments to any of our directors or officers or
any other person or entity. None of the offering proceeds have been used for the
construction of plant, building or facilities or the purchase or installation of
machinery or equipment or for purchases of real estate or the acquisition of
other businesses. We are currently investing the net offering proceeds for
further use as additional working capital. The net proceeds have been invested
pursuant to our investment policy. A portion of the net proceeds may be used for
the acquisition of technologies, businesses or products that are complementary
to ours. Other than these amounts and future estimated capital expenditures in
the amount of approximately $1.0 million in the next 12 months, we have no
specific plan for the proceeds from our initial public offering.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.18 Leasing Agreement dated June 11, 2001 between Natus Japan and
Sanwa Radiator, Co. Ltd.
(Japanese to English translation)
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the three
months ended September 30, 2001.
-31-
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATUS MEDICAL INCORPORATED
Dated: November 9, 2001 By: /s/Tim C. Johnson
______________________________________
Tim C. Johnson
Chief Executive Officer, President
Chief Operating Officer, Secretary
and Director
(Principal Executive Officer)
Dated: November 9, 2001 By: /s/William H. Lawrenson
______________________________________
William H. Lawrenson
Vice President, Finance
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
-32-