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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Executive Level Overview
Vascular Solutions, Inc. (we, us or Vascular) is an innovative medical device company focused on bringing clinically advanced solutions to the market for treating coronary and peripheral vascular disease. As a vertically-integrated medical device company, we generate ideas, create new minimally invasive medical devices, and then deliver these products and related services to physicians who treat vascular disease.
During the past several years, the markets for diagnostic and therapeutic interventional cardiology products and procedures have undergone only modest growth. We believe this low growth, in both product sales and procedure volumes, is due to a variety of factors, including the effects of weak economies on overall health care utilization rates, efforts by third-party payers to lower costs associated with medical procedures, an increased reliance on the medical management of heart disease, investigations by government agencies into potential over-utilization of procedures, the implementation by hospitals of policies designed to reduce the incidence of unnecessary procedures in the wake of these outside investigations, and heavy competition among the manufacturers of interventional devices. Although worldwide demographic factors, including the growing incidence of cardiovascular disease, seem to favor long-term growth in the number of interventional procedures, we believe that the structural pressures that have been building within the market during the past decade are likely to result in relatively flat catheterization volumes for the foreseeable future. In the United States, in which Vascular Solutions typically generates approximately 80% of its revenues, according to data from Medtech Insight (“U.S. Markets for Interventional Cardiology Products”, April 2016), in 2015 there were approximately 3.8 million combined diagnostic and therapeutic interventional cardiology procedures – consisting of 2.6 million diagnostic and 1.2 million therapeutic catheterizations. Medtech Insight projects that the number of U.S. diagnostic and therapeutic cardiac catheterization procedures will remain flat through 2020.
Vascular Solutions intends to continue to develop and market a vast array of products that serve the needs of interventional physicians. While the overall interventional markets are mature, it has been our strategy to target the discrete pockets of growth within the catheterization labs. Currently, we have a particular focus in our R&D and business development programs in three areas: complex interventions, radial artery catheterizations, and embolization procedures. We believe these relatively new segments of the vascular interventions market have the greatest need for new specialized products and also represent some of the best opportunities for growth.
One of our highest priority R&D programs is a collaboration with the United States Army to develop freeze-dried plasma for the treatment of battlefield trauma. The product we have developed, RePlas™ freeze-dried plasma, is the result of our long-standing expertise in the lyophilization (freeze-drying) of biologic materials. The U.S. Army has agreed to sponsor, conduct, and fund the clinical development of RePlas, and we will retain the rights to market the product after FDA approval. Subject to the completion of clinical studies, we believe RePlas will have broad applicability in both government and private sector first-responder markets.
Our product portfolio includes a broad spectrum of more than 90 products consisting of over 800 stock keeping units (SKUs) covering a wide array of hemostat devices, extraction catheters, vascular access devices, guide catheters, guidewires, retrieval devices and a reprocessing service for radiofrequency catheters used in the treatment of varicose veins. Our management, including our chief executive officer who is our chief operating decision maker, report and manage our operations based on product sales into our four clinical target markets. We have corporate infrastructure and direct sales capabilities in the United States and have established distribution relationships in most major international markets. In order to drive sales growth, we have invested not only in the expansion of our global distribution system, but also in new product development and efforts to obtain additional regulatory approvals. A significant portion of our net revenue historically has been, and we expect to continue to be, attributable to new and enhanced products and services. We expect to continue to further validate the clinical and competitive benefits of our technology platforms to drive utilization of our current products and the development of new and enhanced products and services.
The interventional medical device industry is characterized by intense competition, rapidly evolving technology and a high degree of government regulation. Looking ahead we expect our business may be impacted by the following trends and opportunities:
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The future regulatory approval of newly-developed products
. Any new product that we develop must be approved by the Food and Drug Administration (FDA) in the United States and by similar regulatory bodies in other countries before it can be sold. The requirements for obtaining product approval have undergone change, and the FDA frequently implements changes to the product approval process. We monitor the changing regulatory landscape and modify our regulatory submissions as necessary to obtain product approvals.
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Successfully integrating acquired and distributed products and services into our existing operations
. The acquisition of products, product distribution rights, and services complementary to our existing product portfolio and customer call points provides an additional business opportunity, but is dependent on the successful integration of the acquired or distributed products into our existing business structure. Since 2010, we have acquired or licensed more than 10 products and services.
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·
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Managing intellectual property
. The interventional medical device industry is characterized by numerous patent filings and litigation claims made to protect new and evolving product ideas. To maximize the profitability of new product ideas, we seek patent protection for those product design and method concepts which we believe have the potential to provide substantial product revenue. Managing intellectual property assets and claims is a significant challenge for our business.
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Managing greater government regulation and scrutiny.
Our products and business activities are subject to rigorous regulation, including by the U.S. FDA, Department of Justice, and numerous other federal, state, and foreign governmental authorities. These authorities have been increasing scrutiny of our industry and enforcement actions related to companies in it. Managing compliance with existing and future regulation of our industry and fulfilling regulatory disclosure requirements is a significant challenge for our business.
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Results of Operations
The following table sets forth, for the periods indicated, certain items from our statements of earnings expressed as a percentage of net revenue:
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Three Months Ended
June 30,
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Six Months Ended
June 30,
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2016
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|
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2015
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2016
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2015
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Net revenue:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Product revenue
|
|
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100
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%
|
|
|
100
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%
|
|
|
100
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%
|
|
|
100
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%
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License, royalty and collaboration revenue
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
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Total revenue
|
|
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100
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%
|
|
|
100
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%
|
|
|
100
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%
|
|
|
100
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%
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|
|
|
|
|
|
|
|
|
|
|
|
|
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Product costs and operating expenses:
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|
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Cost of goods sold
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35
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%
|
|
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34
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%
|
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35
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%
|
|
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33
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%
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Collaboration expenses
|
|
|
-
|
|
|
|
-
|
|
|
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-
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|
|
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-
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Research and development
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12
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%
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11
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%
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|
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13
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%
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12
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%
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Clinical and regulatory
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5
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%
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4
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%
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5
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%
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|
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4
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%
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Sales and marketing
|
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23
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%
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|
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23
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%
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|
|
24
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%
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|
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24
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%
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General and administrative
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|
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7
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%
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11
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%
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15
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%
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12
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%
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Medical device excise taxes
|
|
|
-
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1
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%
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|
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-
|
|
|
|
1
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%
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Amortization of purchased technology and intangibles
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1
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%
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|
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1
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%
|
|
|
1
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%
|
|
|
1
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%
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Total product costs and operating expenses
|
|
|
83
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%
|
|
|
85
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%
|
|
|
93
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%
|
|
|
87
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%
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Operating earnings
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17
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%
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|
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15
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%
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|
|
7
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%
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|
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13
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%
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Other earnings
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|
|
-
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|
|
|
-
|
|
|
|
-
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|
|
|
-
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Earnings before income taxes .
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17
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%
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15
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%
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7
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%
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13
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%
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Income tax expense
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|
|
(4
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%)
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(5
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%)
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(1
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%)
|
|
|
(5
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%)
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Net earnings
|
|
|
13
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%
|
|
|
10
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%
|
|
|
6
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%
|
|
|
8
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%
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Three and six months ended June 30, 2016, compared to three and six months ended June 30, 2015
Net revenue increased 10% to $41,187,000 for the quarter ended June 30, 2016 from $37,550,000 for the quarter ended June 30, 2015. The increase in revenue is comprised of the following components:
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% Change
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Volume of existing products and services sold (including sales of new versions of existing products and services)
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6
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%
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Pricing of existing products and services sold
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1
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%
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Revenue from new products or services, defined as products and services that had no revenue in the second quarter of 2015
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3
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%
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10
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%
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Approximately 81% and 76% of our net revenue was earned in the United States and 19% and 24% of our net revenue was earned in international markets for the three months ended June 30, 2016 and June 30, 2015, respectively.
Net revenue increased 12% to $80,565,000 for the six months ended June 30, 2016 from $72,161,000 for the six months ended June 30, 2015. The increase in revenue is comprised of the following components:
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% Change
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|
Volume of existing products and services sold (including sales of new versions of existing products and services)
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|
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10
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%
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Pricing of existing products and services sold
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|
|
-
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%
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Revenue from new products or services, defined as products and services that had no revenue in the first six months of 2015
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2
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%
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|
|
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12
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%
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Approximately 80% and 77% of our net revenue was earned in the United States and 20% and 23% of our net revenue was earned in international markets for the six months ended June 30, 2016 and June 30, 2015, respectively.
We recognized $124,000 and $152,000 of license, royalty and collaboration revenue during the three month periods ended June 30, 2016 and 2015, respectively, and $260,000 and $322,000 of license, royalty and collaboration revenue during the six month periods ended June 30, 2016 and 2015, respectively, due to our license and device supply agreements and our royalty agreement with a third party. Collaboration expense of $13,000 and $46,000 was recognized during the three months ended June 30, 2016 and 2015, respectively, and $40,000 and $100,000 during the six months ended June 30, 2016 and 2015, respectively, as a result of an agreement we entered into in April 2013 to develop a new hemostatic device for a third party. License, royalty and collaboration revenue is expected to be approximately $500,000 to $550,000 for the full year 2016.
Gross margin decreased to 65.3% for the quarter ended June 30, 2016, compared to 66.3% for the quarter ended June 30, 2015. Gross margin decreased to 65.4% for the six month period ended June 30, 2016, compared to 66.8% for the six month period ended June 30, 2015. The decrease in gross margin was primarily due to the write-off of $413,000 of raw material as a result of product discontinuations in our international markets. We expect gross margin to be between 65.5% and 66.5% for the full year 2016 as we continue to improve manufacturing efficiencies of recently launched products, subject to variations in our selling mix between United States and international markets and between our lower margin products and our higher margin products such as the D-Stat Dry and GuideLiner products.
Research and development expense for the second quarter of 2016 totaled $5,031,000, or 12% of revenue, compared to $4,202,000, or 11% of revenue, for the second quarter of 2015. Research and development expense for the six month period ended June 30, 2016 totaled $10,058,000 or 13% of revenue, compared to $8,270,000 or 12% of revenue, for the six month period ended June 30, 2015. Research and development expenses have increased on both a percentage and dollar basis compared to the three and six months ended June 30, 2015, due to headcount additions as well as additional testing required to meet increasing regulatory requirements for new products. We expect research and development expenses to be approximately 11.5% to 12.5% of revenue for the full year 2016.
Clinical and regulatory expense for the second quarter of 2016 totaled $2,153,000, or 5% of revenue, compared to $1,605,000, or 4% of revenue, for the second quarter of 2015. Clinical and regulatory expense for the six month period ended June 30, 2016 totaled $4,150,000 or 5% of revenue, compared to $3,086,000 or 4% of revenue, for the six month period ended June 30, 2015. Clinical and regulatory expenses have increased on both a percentage and dollar basis compared to the three and six months ended June 30, 2015, due to headcount additions in the second half of 2015 as a result of the increasing regulatory requirements. We expect clinical and regulatory expenses to be approximately 5.0% for the full year 2016.
Sales and marketing expense for the second quarter of 2016 totaled $9,596,000, or 23% of revenue, compared to $8,461,000, or 23% of revenue, for the second quarter of 2015. Sales and marketing expense for the six month period ended June 30, 2016 totaled $19,240,000 or 24% of revenue, compared to $17,193,000 or 24% of revenue, for the six month period ended June 30, 2015. The increase in sales and marketing expense on a dollar basis for the three and six months ended June 30, 2016, was due to commissions paid on increasing sales in the U.S., combined with a minor increase in the size of our U.S. field sales organization. We expect our sales and marketing expenses as a percentage of revenue to be approximately 22.0% to 23.0% of revenue for the full year 2016.
General and administrative expense for the second quarter of 2016 totaled $2,839,000, or 7% of revenue, compared to $4,129,000, or 11% of revenue, for the second quarter of 2015. General and administrative expense for the six month period ended June 30, 2016 totaled $12,438,000 or 15% of revenue, compared to $8,907,000 or 12% of revenue, for the six month period ended June 30, 2015. General and administrative expense decreased on both a dollar and percentage basis for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 as a result of reduced litigation expense due to the not guilty jury verdict on February 26, 2016 following our criminal trial in the United States District Court for the Western District of Texas regarding our Vari-Lase Short Kit. General and administrative expense increased on both a dollar and percentage basis for the six months ended June 30, 2016 compared to the six months ended June 30, 2015 as a result of a $2,700,000 increase in legal expenses related to the defense of the Short Kit litigation. Total legal expenses related to the Short Kit litigation were $7,400,000 for the six months ended June 30, 2016. As a result of the resolution of this matter, we expect general and administrative expense to return to a more normalized level and be approximately 5.5% to 6.5% of revenue in each quarter for the remainder of 2016.
Medical device excise taxes for the second quarter of 2016 totaled $0, compared to $395,000, or 1.1% of revenue, for the second quarter of 2015. Medical device excise taxes for the six month period ended June 30, 2016 totaled $0, compared to $770,000, or 1.1% of revenue, for the six month period ended June 30, 2015. In December 2015, the medical device excise tax was suspended for fiscal years 2016 and 2017.
Amortization of purchased technology and other intangibles was $404,000 for both three months ended June 30, 2016 and 2015. Amortization of purchased technology and other intangibles was $808,000 for both six months ended June 30, 2016 and 2015. The amortization resulted from our product and license acquisitions. As part of these asset purchases and licensing agreements, we allocated an aggregate of $16,000,000 to purchased technology and other intangibles that are being amortized over a period of 9 to 11 years. We expect amortization expense to be approximately $400,000 in each quarter for the remainder of 2016.
Income tax expense was $1,482,000 and $863,000 for the three and six months ended June 30, 2016, respectively, on earnings before tax of $6,885,000 and $6,010,000, respectively, resulting in an effective income tax rate of 22% and 14%, respectively. The effective tax rates of 22% and 14% for the three and six month periods ended June 30, 2016, is lower than our expected effective tax rate of 33.5% due to the adoption in the first quarter of 2016 of Accounting Standards Update (ASU) No. 2016-09,
Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
. Upon adoption, we recognized first and second quarter excess tax benefits in our earnings. Excess tax benefits totaled $801,000 in the second quarter and $1,127,000 for the six months ended June 30, 2016. We expect our effective income tax rate to be approximately 33.5% to 34.5% of revenue in each quarter for the remainder of 2016, subject to variations if any, as a result of excess tax benefits recognized related to equity compensation.
Liquidity and Capital Resources
Our cash and cash equivalents totaled $35,008,000 at June 30, 2016 compared to $41,491,000 at December 31, 2015, a decrease of $6,483,000. A small portion of our cash is maintained in operating accounts, with the majority invested in a highly liquid money market type Eurodollar account, which are bank deposited funds denominated in U.S. Dollars and held outside the United States. The Eurodollar account is a direct obligation of a large bank in the U.S. and carries the same credit rating as all other deposits of the bank.
Cash used in operations.
We generated $2,899,000 of cash in operations during the six months ended June 30, 2016. The primary sources and uses of cash from operations were:
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$9,330,000 was generated primarily as a result of our net income of $5,147,000, increased by depreciation and amortization expense of $3,281,000 and stock-based compensation expense of $2,638,000; and reduced by non-cash tax uses of $1,736,000.
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·
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$6,416,000 was used as a result of the net change in operating assets and liabilities primarily due to: an increase of $2,678,000 in accounts receivable; a decrease of $2,179,000 in accounts payable and accruals as a result of our payments of legal expense accruals relating to the Short Kit litigation; an increase of $1,981,000 in overall inventory; and a decrease of $422,000 in prepaid expenses, primarily due to the decrease in taxes receivable.
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The table below presents the change in receivables and inventory in relative terms, through the presentation of financial ratios. Days sales outstanding are calculated by dividing the ending accounts receivable balance, net of reserves for sales returns and doubtful accounts, by the average daily sales for the quarter. The increase in days sales outstanding for the six months ended June 30, 2016 was primarily due to an increase in our receivables from slower-paying international distributors. Days inventory on hand is calculated by dividing 365 by the annualized cost of sales for the quarter divided by inventory. The decrease in days inventory on hand for the six months ended June 30, 2016 was due to sales demand increasing slightly more than our inventory balance and was relatively consistent with the December 31, 2015 days inventory on hand.
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June 30,
2016
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December 31,
2015
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Days Sales Outstanding
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48
|
|
|
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46
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Days Inventory on Hand
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154
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|
|
|
157
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Cash used in investing activities.
We used $7,562,000 of cash in investing activities for the six months ended June 30, 2016, consisting of $7,062,000 of capital expenditures related to building renovations, and computer and research and development equipment. The cash used in investing activities for building improvements is primarily due to ongoing renovation and expansion of our manufacturing facilities. In addition, in the second quarter we acquired the licensing rights relating to a future product for $500,000.
Cash used in financing activities.
We used $1,642,000 of cash in financing activities for the six months ended June 30, 2016. The cash usage consisted of: $1,809,000 of cash used to repurchase 64,199 shares of our common stock as part of our share purchase program; and $1,718,000 of cash used to repurchase 62,050 shares of our common stock to satisfy income tax withholding obligations on restricted stock awards vesting and a stock options exercise, partially offset by the receipt of $1,885,000 upon the exercise of outstanding stock options and the sale of common stock pursuant to our Employee Stock Purchase Plan.
We currently anticipate that we will experience positive cash flow from our normal operating activities for the foreseeable future. We believe that our working capital of $70.3 million at June 30, 2016 will be sufficient to meet all of our operating and capital requirements for the foreseeable future.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of June 30, 2016.
Contractual Obligations
The following table summarizes our contractual cash commitments as of June 30, 2016:
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Payments Due by Period
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Contractual Obligations
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Total
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Less than
1 year
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|
1 - 3 years
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3 - 5 years
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More than
5 years
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(dollars in thousands)
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Facility operating leases
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$
|
1,069
|
|
|
$
|
350
|
|
|
$
|
436
|
|
|
$
|
283
|
|
|
$
|
-
|
|
Product license rights
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|
|
500
|
|
|
|
100
|
|
|
|
400
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
1,569
|
|
|
$
|
450
|
|
|
$
|
836
|
|
|
$
|
283
|
|
|
$
|
-
|
|
We do not have any other significant cash commitments related to supply agreements, nor do we have any other significant commitments for capital expenditures.
Critical Accounting Policies
Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. The preparation of our financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate these estimates and judgments. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The material accounting policies that we believe are most critical to an investor’s understanding of our financial results and condition and which require complex management judgment are discussed in our Annual Report on Form 10-K for the year ended December 31, 2015 under the caption “Critical Accounting Policies.”
Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995
The Private Securities Litigation Reform Act of 1995 (the Act) provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their business, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement. We desire to take advantage of the safe harbor provisions with respect to any forward-looking statements we may make in this filing, other filings with the Securities and Exchange Commission and any public oral statements or written releases. The words or phrases “will likely,” “is expected,” “will continue,” “is anticipated,” “believe,” “estimate,” “projected,” “forecast,” or similar expressions are intended to identify forward-looking statements within the meaning of the Act. Forward-looking statements such as these are based on management’s current expectations as of the date of this report but involve risks, uncertainties and other factors which may cause actual results to differ materially from those contemplated by such forward-looking statements. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. In accordance with the Act, we identify the following important general factors which, if altered from the current status, could cause our actual results to differ from those described in any forward-looking statements: risks associated with adoption of our new products, exposure to governmental enforcement actions, exposure to potential patent infringement lawsuits, significant variability in quarterly results, exposure to possible product liability claims, the development of new products by others, dependence on third party distributors in international markets, doing business in international markets, the availability of third party reimbursement, actions by the FDA related to our products, the loss of key vendors, information technology risks and those factors set forth under the heading “Risk Factors” in Item 1A of Part II of this Quarterly Annual Report on Form 10-Q. This list is not exhaustive, and we may supplement this list in any future filing with the Securities and Exchange Commission or in connection with the making of any specific forward-looking statement. We undertake no obligation to, and do not intend to, revise or update publicly any forward-looking statement for any reason.