PART I
ITEM 1. Business
This Annual Report on Form 10-K 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 about Natus Medical Incorporated (“Natus,” “we,” “us,” or “our Company”). These statements include, among other things, statements concerning our expectations, beliefs, plans, intentions, future operations, financial condition and prospects, and business strategies. The words “may,” “will,” “continue,” “estimate,” “project,” “intend,” “believe,” “expect,” “anticipate,” and other similar expressions generally identify forward-looking statements. Forward-looking statements in this Item 1 include, but are not limited to, statements regarding the effectiveness and advantages of our products, factors relating to demand for and economic advantages of our products, our plan to develop and acquire additional technologies, products or businesses, our marketing, technology enhancement, and product development strategies, and our ability to complete all of our backlog orders.
Forward-looking statements are not guarantees of future performance and are subject to substantial risks and uncertainties that could cause our actual results to differ materially from those that we predicted in the forward-looking statements. Investors should carefully review the information contained under the caption “Risk Factors” contained in Item 1A for a description of risks and uncertainties that could cause actual results to differ from those that we predicted. All forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update forward-looking statements, except as required by Federal Securities laws.
“Natus” and other trademarks of ours appearing in this report are our property.
Overview
Natus is a leading provider of newborn care and neurology healthcare products and services used for the screening, diagnosis, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, sleep disorders, neuromuscular diseases and balance and mobility disorders.
Product Families
We are organized into two strategic business units, each with multiple product families:
Neurology
—Includes products and services for diagnostic electroencephalography (“EEG”) and long term monitoring (“LTM”), Intensive Care Unit (“ICU”) monitoring, electromyography (“EMG”), sleep analysis or polysomnography (“PSG”), intra-operative monitoring (“IOM”), and diagnostic and monitoring transcranial doppler (“TCD”) ultrasound technology. Additionally, Global Neuro-Diagnostic Services provides ambulatory EEG services with and without video in the patient's home.
Newborn Care
—Includes products and services for newborn care including hearing screening, brain injury, thermoregulation, jaundice management, and various disposable newborn care supplies, as well as products for diagnostic hearing assessment for children through adult populations, and products to diagnose and assist in treating balance and mobility disorders.
In January 2017, we acquired a third strategic business unit with multiple product families:
Otometrics
—Includes products and services including computer-based audiological, otoneurologic and vestibular instrumentation and sound rooms for hearing and balance care professionals worldwide. Otometrics has a complete product and brand portfolio known for its sophisticated design technology in the hearing and balance assessment markets. Global brands include Aurical®, ICS® and Madsen®.
Neurology
Our neurology business unit represents a comprehensive line of products that are used by healthcare practitioners in the diagnosis and monitoring of neurological disorders of the central and peripheral nervous system, including outpatient private practice facilities and inpatient hospital environments including diagnostic procedures and monitoring of patients during admissions, surgery, while under sedation, in post-operative care, and in intensive care units. Our neurology products and services include:
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Electroencephalography
—Equipment, supplies and services used to monitor and visually display the electrical activity generated by the brain and other key physiological signals for both diagnosis and monitoring of neurological disorders in the hospital, research laboratory, clinician office and patient’s home.
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Electromyography
—Equipment and supplies used to measure electrical activity in nerves, muscles, and critical pathways includes EMG, nerve conduction and evoked potential functionality.
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Polysomnography
—Equipment and supplies used to measure a variety of respiratory and physiologic functions to assist in the diagnosis and monitoring of sleep disorders, such as insomnia and obstructive sleep apnea, a condition that causes a person to stop breathing intermittently during sleep.
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Intraoperative monitoring
—Equipment and supplies used to monitor the functional integrity of certain neural structures (i.e. nerves, spinal cord and parts of the brain) during surgery. The goal of IOM is to provide real time guidance to the surgeon and anesthesiologist which will reduce the risk to the patient during surgery.
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Transcranial Doppler
—Equipment and supplies used to measure blood flow parameters such as velocity in key vascular structures in the brain. This vascular information is helpful in identifying strokes, infarcts and vasospasms.
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Diagnostic EEG and Long-term Monitoring
We design, manufacture, and market a full line of instruments and supplies used to help diagnose the presence of seizure disorders and epilepsy, look for causes of confusion, evaluate head injuries, tumors, infections, degenerative diseases, and metabolic disturbances that affect the brain, and assist in surgical planning. This type of testing is also done to diagnose brain death in comatose patients. These systems and instruments work by detecting, amplifying, and recording the brain’s electrical impulses, as well as other physiological signals needed to support clinical findings. Routine clinical EEG recording is done by placing electrodes on a patient’s scalp over various areas of the brain to record and detect patterns of activity and specific types of electrical events. EEG technologists perform the tests, and neurologists, neurophysiologists and epileptologists review and interpret the results.
Routine outpatient clinical EEG testing is performed in hospital neurology laboratories, private physician offices, and in ambulatory settings such as the patient’s home, providing physicians with a clinical assessment of a patient’s condition. Long-term inpatient monitoring of EEG and behavior (LTM) is used to determine complex treatment plans, and for patients with seizures that do not respond to conventional therapeutic approaches, surgical solutions may be appropriate. Patients suffering from severe head trauma and other acute conditions that may affect the brain are monitored in ICUs. In addition, research facilities use EEG equipment to conduct research on humans and laboratory animals.
Global Neuro-Diagnostic Services (“GND”) which we acquired in early 2015, provides in-home ambulatory EEG monitoring. GND works with physicians and hospitals to provide superior care and testing services to its patients. Upon receiving a physician referral, GND provides program services in the patient's home, professional oversight throughout the study and preliminary report generation for physician review. GND has received accreditation by The Joint Commission as a home EEG testing services company and also has achieved the American Board of Registered Electroencephalographic and Evoked Potential Technologists (ABRET) Laboratory Accreditation in routine EEG services. GND is a leader in EEG testing services because of our focus on meeting the most stringent quality standards and providing the highest quality patient care.
Diagnostic Electroencephalograph Monitoring Product Lines
Our EEG diagnostic monitoring product lines for neurology consist of signal amplifiers, workstations to capture and store synchronize video and EEG data, and proprietary software. These products are typically used in concert, as part of an EEG “system” by the neurology/neurophysiology department of a hospital or clinic to assist in the diagnosis and monitoring of neurological conditions.
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NeuroWorks; Coherence; NicoletOne; Twin.
Our EEG Systems include a broad range of products, from software licenses and ambulatory monitoring systems to advanced laboratory systems with multiple capabilities for EEG, ICU monitoring, long-term monitoring of up to 256 channels, and physician review stations with quantitative EEG analysis capabilities.
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Stellate/Gotman Spike and Seizure; GridView; NicoletOne Trends.
Our proprietary spike and seizure detection algorithm detects, summarizes, and reports EEG events that save health care professionals time by increasing the speed and accuracy of interpretation. GridView is a tool that allows the clinician to correlate EEG patterns with electrode contacts on a 3D view of the patient brain using magnetic resonance (“MR”) or computed tomography (“CT”) images, thus enabling the visualization and annotation of the brain surface and internal structures involved in the diagnosis of epilepsy. NicoletOne Trends provides a comprehensive set of EEG analysis algorithms that are used to generate compressed trends of large amounts of data to assist in the clinical evaluation and data review process.
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Proprietary Signal Amplifiers.
Our proprietary signal amplifiers function as the interface between the patient and the computer. The headbox connects electrodes attached to the patient’s head to our EEG monitoring systems. Our proprietary amplifier products are sold for a wide variety of applications under the following brand names: Xltek, Trex, EEG32U, EMU40EX, Brain Monitor, Quantum, Schwarzer EEG, Nicolet v32 and v44 models, C series and Nicolet Wireless 32- and 64- channel amplifiers.
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Nicolet Cortical Stimulator.
This product is our proprietary device that provides cortical stimulation to the brain during functional brain mapping either before or during surgery to help the surgeon protect the eloquent parts of the brain. The device can be used as a standalone unit or with the fully integrated NicoletOne software that supports control of the device from the software, automated mapping and comprehensive report generation.
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Supplies.
We also manufacture and market a full line of proprietary EEG needles and other supplies used in the electroencephalography field.
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Global Neuro-Diagnostic Services.
GND provides ambulatory EEG services with and without video in the patient’s home. Other services such as Remote Monitoring, ICU monitoring, Virtual EMU monitoring and Detailed Video EEG Technical Descriptions with cloud-based test results are also provided. Our services are specifically designed to partner with hospitals and physicians to improve efficiency, results, and turn-around time, and to reduce costs.
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Electrodiagnostic Monitoring
Our electrodiagnostic systems include EMG, nerve conduction (“NCS”), and often evoked potential (“EP”) functionality. EMG and NCS involve the measurement of electrical activity of muscles and nerves both at rest and during contraction. Measuring the electrical activity in muscles and nerves can help diagnose diseases of the peripheral, central nervous system or musculature system. An electromyogram is done to determine if there is any disease present that effects muscle tissue, nerves, or the junctions between nerve and muscle (neuromuscular junctions). An electromyogram can also be used to diagnose the cause of weakness, paralysis, and muscle twitching, and is also used as a primary diagnosis for carpal tunnel syndrome, which is the most frequently encountered peripheral compressive neuropathy. EMG is also used for clinical applications of botox to relieve muscle spasm and pain. We market both the clinical system and the needles used for these procedures.
In addition to EMG and NCS functionality, many of our Electrodiagnostic systems also include EP. Evoked potentials are elicited in response to a stimulus. These evoked potentials can come from the sensory pathways (such as hearing and visual) or from the motor pathways. An examination tests the integrity of these pathways including the associated area of the brain. Sophisticated amplifiers are required to recognize and average evoked potential EMG and NCS signals.
Electrodiagnostic Product Lines
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Dantec Keypoint.
The Dantec Keypoint EMG and EP family of products features amplifiers, stimulators, and strong signal quality. The Keypoint is used for advanced neurodiagnostic applications such as single fiber EMG, visual and auditory evoked potentials, and in routine nerve conduction studies. The Keypoint system is also available in a portable laptop configuration.
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Dantec Clavis.
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Dantec Clavis device is a hand-held EMG and current stimulation device that provides muscle and nerve localization information to assist with medication and botox injections. In conjunction with the Bo-ject hypodermic needle and electrodes, physicians can better localize the site of the injection.
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Nicolet EDX family.
A hardware platform of amplifiers, base control units, stimulators and hand-held probes that are sold with Nicolet brand proprietary software. These mid to high end systems have full functionality, strong signal quality, and flexibility. They include EMG, NCS, EP’s, IOM and advanced data analysis features.
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Nicolet VikingQuest.
An EMG system for the mid-range market. The device runs on our proprietary software.
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Natus Neurology UltraPro.
This is a low to mid-level product that offers high quality data collection using the Dantec Keypoint amplifiers and the proprietary Natus EMG software.
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Supplies.
We also manufacture and market a full line of proprietary EMG needles and other supplies used in the electrodiagnostic field.
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Diagnostic Polysomnography Monitoring
PSG, which involves the analysis of respiratory patterns, brain electrical activity and other physiological data, has proven critical for the diagnosis and treatment of sleep-related diseases such as apnea, insomnia, and narcolepsy. A full polysomnographic sleep study entails a whole-night recording of brain electrical activity, muscle movement, airflow, respiratory effort, oxygen levels, electrical activity of the heart, and other parameters. In some studies patients are fitted with treatment devices using Positive Airway Pressure technology (“PAP”) during the sleep study and the proper settings for the treatment devices are determined. In many cases, the sleep study is performed in the patient’s home.
Diagnostic PSG Monitoring Product Lines
We market dedicated diagnostic PSG monitoring products that can be used individually or as part of a networked system for overnight sleep studies to assist in the diagnosis of sleep disorders. Additionally we offer products that are specifically designed to be used in the patient’s home. Some of our EEG systems described above can also be configured to perform diagnostic PSG monitoring. These products include software licenses, ambulatory monitoring systems, and laboratory systems that combine multiple capabilities, including EEG monitoring, physician review stations, and quantitative PSG analysis capabilities.
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Embla REMlogic, and Sandman; Xltek SleepWorks; Schwartzer Coherence; and Grass Twin.
Our diagnostic PSG systems capture and store all data digitally. The systems enable users to specify rules and personal preferences to be used during analysis, summarizing the results graphically and incorporating them in detailed reports.
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Proprietary Amplifiers.
Our data acquisition systems incorporate recent developments in superior amplifiers for sleep analysis and are sold under brand names such as Embla and MPR, Xltek Trex and SleepWorks, and Schwarzer. Our amplifiers are used in both hospitals and stand-alone clinics. In addition to exceptional signal quality, headboxes include various tools such as built-in oximeters and controls to allow the user to start and stop a study or perform electrode impedance testing either at the patient’s bedside or from the monitoring room.
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Practice Management Software.
Our Embla Enterprise Practice Management Software provides a solution for institutions as well as private labs and physicians for patient scheduling, inventory control, staff scheduling, data management, business reports and billing interfaces. Enterprise may be used in conjunction with many Natus PSG products.
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PMSD.
PastuerMatic Sterile Dryers are used in hospital and clinic sleep laboratories to provide non-chemical sterilization of products used in sleep therapy. An environmentally friendly approach to disinfection, the PMSD products offer cost effective sterilization for sleep labs of all sizes.
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Supplies.
We also market a broad line of supplies, disposable products and accessories for the PSG laboratory.
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Intraoperative Monitoring
Intraoperative monitoring (“IOM”) is the use of electrophysiological methods such as EEG, EMG, and evoked potentials to monitor the functional integrity of certain neural structures (i.e. nerves, spinal cord and parts of the brain) during surgery. The purpose of IOM is to reduce the risk to the patient’s nervous system, and/or to provide functional guidance to the surgeon and anesthesiologist during surgery.
Diagnostic IOM Product Lines
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Xltek Protektor
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The Protektor system is an IOM system that provides medical professionals with all information necessary to make immediate and critical surgical decisions. The system combines flexibility with multi-modality allowing full coverage of IOM techniques. The Protektor comes in 16 or 32 channel options.
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Nicolet Endeavor.
A dedicated multi-modality IOM system that offers complete flexibility in work flow and test protocols.
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Nicolet EDX.
These combo systems are used in IOM applications where a smaller number of channels is sufficient. This approach is primarily followed in international markets that utilize the integrated system approach that allows for the use of the system in EMG clinical applications as well as in IOM applications.
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Transcranial Doppler
Transcranial Doppler is the use of Doppler ultrasound technology to measure blood flow parameters such as velocity in key vascular structures in the brain. A Doppler probe is held against a specific location on the head and the device displays the information in both visual and auditory formats. This technology is used as preventative screening, diagnosis, and monitoring of various diseases and brain injuries such as stroke, embolism, reduced blood flow during surgery, and vasospasm.
Transcranial Doppler Products
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Sonara and Sonara Tek.
The Sonara is an embedded system that is a self-contained unit that includes CPU, data display screen and speakers. It uses proprietary software with a touch screen menu. Sonara Tek is a small portable device used with a laptop. Both models enable the uploading of images to the hospital information system.
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Newborn Care
Our newborn care business unit represents a line of products and services that are used by healthcare practitioners in the diagnosis and treatment of common medical ailments in newborn care, as well as other products used in newborn through adult populations, including hearing diagnostics and balance & mobility systems. Our products include:
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Newborn Hearing Screening
—Products used to screen hearing in newborns.
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Newborn Brain Injury
—Products used to diagnose the severity of brain injury, monitor the effectiveness of drug therapies, detect seizure activity and monitor general neurological status.
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Thermoregulation
—Products used to control the newborn environment including incubators and warmers.
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Jaundice Management
—Products used to treat jaundice, the single largest cause for hospital readmission of newborns in the U.S.
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Diagnostic Hearing Assessment
—Products used to screen for or diagnose hearing loss, or to identify abnormalities affecting the peripheral and central auditory nervous systems in patients of all ages.
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Balance and Mobility
—Systems to diagnose and assist in treating balance disorders in an evidence-based, multidisciplinary approach.
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Pediatric Ocular Imaging
—Imaging systems and products used in the advanced science and practice of neonatal and pediatric retinal imaging.
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NicView
—Streaming video for families with babies in the neonatal intensive care unit (NICU) that enables family members and approved friends to see the new baby, 24/7, from anywhere in the world - from any device.
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Nursery Essentials
—Products used in the everyday operation of a newborn intensive care unit (“NICU”) and well-baby nursery department within the hospital environment. These products include such items as: Biliband eye protectors, GumDrop pacifiers, MiniMuffs noise attenuators, NeatNick heel lancets, neonatal oxygen hoods, Olympic Circumstraint, Olympic Papoose Boards, Olympic Smart Scales, Olympic Warmettes, OraSwab oral care products, Save the Gonads x-ray protection devices, SugarPlum glucose lancets, SunFish temperature probe covers and TootSweet sucrose solutions.
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Newborn Hearing Screening
Hearing impairment is the most common treatable chronic disorder in newborns, affecting as many as five babies out of every 1,000 newborns. It is estimated that 20,000 hearing-impaired babies are born in the United States (“U.S.”) every year, and as many as 60,000 more in the rest of the developed world. Until the introduction of universal newborn hearing screening programs, screening was generally performed only on those newborns that had identifiable risk factors for hearing impairment. However, screening only those newborns with risk factors for hearing impairment overlooks approximately half of newborns with some level of hearing impairment.
Early identification of hearing impairment and early intervention has been shown to improve language development significantly. Undetected hearing impairment often results in the failure to learn, process spoken language, and speak.
Newborn Hearing Screening Techniques
The two traditional technologies used to screen newborns and infants for hearing impairment are auditory brainstem response and otoacoustic emissions.
Auditory brainstem response (“ABR”).
ABR technology is the most accurate and comprehensive method for screening and diagnosing hearing impairment. ABR technology is based on detecting the brain’s electric impulses resulting from a specific auditory stimulus.
Otoacoustic emission (“OAE”).
OAEs are sounds created by the active biomechanical processes within the sensory cells of the cochlea. They occur both spontaneously and in response to acoustic stimuli. OAE screening uses a probe placed in the ear canal to deliver auditory stimuli and to measure the response of the sensory cells with a sensitive microphone.
Newborn Hearing Screening Product Lines
Our newborn hearing screening product lines consist of the ALGO, ABaer, AuDX, and Echo-Screen newborn hearing screeners. These hearing screening products utilize proprietary signal detection technologies to provide accurate and non-invasive hearing screening for newborns and are designed to detect hearing loss at 30 or 35 dB nHL or higher. Each of these devices is designed to generate a PASS or REFER result.
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ALGO 5 and 3i Newborn Hearing Screeners.
These AABR devices deliver thousands of soft audible clicks to the newborn’s ears through sound cables and disposable earphones connected to the instrument. Each click elicits an identifiable brain wave, which is detected by disposable electrodes placed on the head of the child and analyzed by the screening device. These devices use our proprietary AABR signal detection algorithm.
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ABaer Newborn Hearing Screener.
The ABaer, which is a PC-based newborn hearing screening device, offers a combination of AABR, OAE, and diagnostic ABR technologies in one system.
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Echo-Screen.
Our hand-held Echo-Screen products provide a choice or combination of proprietary ABR and OAE technologies that can also be used for children through adults. The Echo-Screen III device is a compact, multi-modality handheld hearing screener that is tightly integrated with audible Lite Hearing Screening Data Management.
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AuDX.
Our AuDX product is a hand-held OAE screening device that can be used for newborn hearing screening, as well as patients of all ages, from children through adults. AuDX devices record and analyze OAEs generated by the cochlea through sound cables and disposable ear probes inserted into the patient’s ear canal. OAE technology is unable to detect hearing disorders affecting the neural pathways, such as auditory neuropathy
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Hearing Screening Supply Products
For infection control, accuracy, and ease of use, the supply products used with our newborn hearing screening devices are designed as single-use, disposable products. Each screening supply product is designed for a specific hearing screening technology.
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ABR Screening Supply Kits.
Each ABR screen is carried out with single-use earphones and electrodes, which are alcohol and latex-free. The adhesives used in these supply products are specially formulated for use on the sensitive skin of newborns. To meet the needs of our customers we offer a variety of packaging options. Echo-Screen and ABaer offer the choice of either an earphone or use of ear tips for perform ABR screening.
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OAE Supply Products.
Each OAE screen is carried out with single-use ear tips that are supplied in a variety of sizes and packaging options.
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Peloton Screening Services
Launched in early 2014, Peloton Screening Services is a nationwide service offering that provides hearing screening services to hospital-based customers. The platform of the program meets the objectives of today’s healthcare environment by aligning with family centered care principals and Joint Committee on Infant Hearing (JCIH) recommendations. Peloton provides all aspects of the program: equipment, supplies, professional oversight by nurses or audiologists, screening personnel, case management, quality review & oversight, and state data management reporting.
Newborn Brain Injury
For many years, newborn infants admitted to the NICU of a hospital have been routinely monitored for heart activity, temperature, respiration, oxygen saturation, and blood pressure. Recently it has also been considered important to monitor brain activity. A cerebral function monitor, utilizing amplitude-integrated EEGs (“aEEGs”), is a device for monitoring background neurological activity. Our simplified aEEG devices introduced over ten years ago, allow neonatologists and nurses to set-up and interpret basic neurological traces without neurology oversight.
Newborn Brain Injury Products
Our newborn brain injury products record and display parameters that the neonatologist uses to assess and monitor neurological status in the newborn. These devices continuously monitor and record brain activity, aiding in the detection and treatment of HIE and seizures. The devices also monitor the effects of drugs and other therapies on brain activity and improve the accuracy of newborn neurological assessments. They are used with electrodes attached to the head of the newborn to acquire an EEG signal that is then filtered, compressed, and displayed graphically on the device or as a hardcopy printout. The monitors have touch screens for easy navigation and onscreen keyboards for data entry at the bedside.
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Olympic Brainz Monitor
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The Olympic Brainz Monitor is our latest generation Cerebral Function Monitor. The device can be used in single-channel, two-channel or three-channel modes to continuously monitor and record brain activity.
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Thermoregulation
Incubators offer a controlled, consistent microenvironment for thermoregulation and humidification within a closed system to maintain skin integrity and body temperature.
Thermoregulation products
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Incubators.
Our NatalCare incubators, including those used for transporting infants, provide high thermal performance with a double wall design, easy to use control panels and features such as improved weighing functionality with automatic centering and an electronic tilting mechanism. The easy to clean, smooth design, and choice of options make these customizable incubators appropriate for different use environments.
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Jaundice Management
The American Academy of Pediatrics estimates that each year 60% of the approximately four million newborns in the U.S. become jaundiced. According to the Journal of the American Medical Association, neonatal jaundice is the single largest cause for hospital readmission of newborns in the U.S., and accounts for 50% of readmissions. Because of the serious consequences of hyperbilirubinemia, the American Academy of Pediatrics recommends that all newborns be closely monitored for jaundice and has called for the physician to determine the presence or absence of an abnormal rate of hemolysis to establish the appropriate treatment for the newborn.
In 2004, the American Academy of Pediatrics issued new guidelines for the treatment of jaundice in newborns. The guidelines recommend phototherapy as the standard of care for the treatment of hyperbilirubinemia in infants born at 35 weeks or more of gestation. The guidelines further highlight the need for “intense” phototherapy, and specifically recommend the use of the “blue” light treatment incorporated into our neoBLUE products.
Jaundice Management Products
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neoBLUE Product Family.
This product line consists of our neoBLUE, neoBLUE Mini, neoBLUE Cozy, neoBLUE Compact and neoBLUE blanket devices, which utilize light emitting diodes (“LEDs”) to generate a high-intensity, narrow spectrum of blue light that is clinically proven to be most effective in the treatment of newborn jaundice. Our neoBLUE phototherapy devices emit significantly less ultraviolet light and heat than conventional phototherapy devices, reducing the risk of skin damage and dehydration for infants undergoing treatment. Because of the high intensity of these lights, the treatment time associated with phototherapy is reduced.
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Medix MediLED Product Family.
A full-size, free-standing LED phototherapy system and a MediLED mini light to be used on top of an incubator or attached to the Medix radiant warmer. The MediLED incorporates an array of blue and white LEDs, while the mini system utilizes blue “super LEDs” that provide high intensity phototherapy.
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Diagnostic Hearing Assessment
We design and manufacture a variety of products used to screen for or diagnose hearing loss, or to identify abnormalities affecting the peripheral and central auditory nervous systems in patients of all ages. The technology used in most of these systems is either electrodiagnostic in nature or measures a response from the cochlea known as an OAE.
Diagnostic Hearing Assessment Product Lines
Our diagnostic hearing assessment products consist of the Navigator Pro system, the Scout Sport portable diagnostic device, and the AuDX PRO.
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Navigator PRO.
Our Navigator PRO for hearing assessment consists of a base system that is augmented by discrete software applications that enhance the system. The Navigator Pro System is a PC-based, configurable device that utilizes evoked potentials, which are electrical signals recorded from the central nervous system that appear in response to repetitive stimuli, such as a clicking noise. The evoked potentials are used to record and display human physiological data associated with auditory and hearing-related disorders. The Navigator Pro System can be used for patients of all ages, from children to adults, including infants and geriatric patients. The device can be configured with additional proprietary software programs for various applications. These additional software programs include: MASTER, AEP, ABaer, and Scout.
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Scout SPORT.
The Scout SPORT is a PC-based OAE system. The ultra-portable Scout Sport can be carried from one computer to another to test in different locations. For office-based environments, the Scout Sport can be used with a dedicated notebook computer to create an independent portable system.
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AuDX PRO.
The AuDX PRO is a hand-held OAE screening device with a large color display that can be used for patients of all ages. The AuDX PRO records and analyzes OAEs generated by the cochlea through sound cables and disposable ear probes inserted into the patient’s ear canal.
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Diagnostic Hearing Supply Products
For infection control, accuracy, and ease of use, most supply products used with our diagnostic hearing devices and systems are designed as single-use, disposable products. Each screening supply product is designed for a specific diagnostic hearing technology, and is similar in nature to our previously described OAE supply products for use in newborn hearing screening.
Balance and Mobility
Balance is an ability to maintain the line of gravity of the body within the base of support with minimal postural sway. Maintaining balance requires coordination of input from multiple sensory systems including the vestibular (i.e. inner ear), somatosensory (i.e. touch, temperature, body position), and visual systems. Balance disorders impact a large percentage of the population in all age ranges from children to adults. Common complaints include dizziness, vertigo, or an inability to walk or drive a vehicle, which can all lead to the curtailment of daily life activities. These symptoms are exacerbated in elderly patients and can result in falls, orthopedic injuries, and sometimes death.
Balance and Mobility Products
Our principal balance and mobility products are sold under the Neurocom brand:
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EquiTest.
Proprietary protocols in the EquiTest family of devices objectively quantify and differentiate among sensory, motor, and central adaptive impairments to balance control. This approach is commonly referred to as computerized dynamic posturography (“CDP”). CDP is complementary to clinical tests designed to localize and categorize pathological mechanisms of balance disorders in that it can identify and differentiate the functional impairments associated with the identified disorders.
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Balance Master.
A family of devices providing objective assessment and retraining of the sensory and voluntary motor control of balance.
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VSR and VSR Sport.
The VSR provides objective assessment of sensory and voluntary motor control of balance with visual biofeedback. The VSR Sport is designed specifically for the athletic market as part of a concussion management program. It is portable, easy-to use and offers athletic trainers, sports medicine practitioners, and other sport professionals the data needed to make objective return-to-play decisions without relying on subjective evaluation.
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inVision.
Our inVision device incorporates a set of proprietary diagnostic tests that quantify a patient’s ability to maintain visual acuity and stable gaze while actively moving the head. The objective information enables the clinician to assess the patient’s ability to live and move safely in a dynamic world and to participate in daily-life functions such as driving, walking through a grocery store, or actively engaging in family activities.
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RetCam
Our RetCam devices incorporate a camera combined with proprietary imaging software that are used to diagnose and monitor a range of ophthalmic maladies in premature infants. RetCam is the market leader in NICU ophthalmic imaging used in the detection of retinopathy of prematurity in newborns.
The RetCam system is a mobile, hand-held wide-field ophthalmic digital imaging system for the hospital and clinic that enables the capture of brilliant, full color digital images and videos that can be used for immediate assessment of the pediatric retina and the adult or pediatric anterior chamber. The digital images can also be sent electronically to an ophthalmologist for immediate interpretation. RetCam imaging provides the ophthalmologist with the ability to manage a patient through photographic documentation of the disease, communication with the parents of a child, follow-up using longitudinal comparisons and consultations through second opinions when warranted.
There are three different RetCam systems available; RetCam 3 which has an optional module for fluorescein angiography, RetCam Shuttle which allows the RetCam to be easily transported between hospitals and clinics and the RetCam Portable which allows easy transport from one location to another.
Segment and Geographic Information
We operate in one reportable segment, which we have presented as the aggregation of our neurology and newborn care product families. Within this reportable segment we are organized on the basis of the healthcare products and services we provide which are used for the screening, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, and sleep disorders.
Our end-user customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies. Most of our international sales are to distributors, who in turn resell our products to end users or sub-distributors.
Information regarding our sales and long-lived assets in the U.S. and in countries outside the U.S. is contained in
Note 19—Segment, Customer and Geographic Information
of our Consolidated Financial Statements included in this report and is incorporated in this section by this reference.
Revenue by Product Family and Product Category
For the years ended
December 31, 2016
,
2015
and
2014
, revenue from our product families as a percent of total revenue was approximately as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Neurology
|
62
|
%
|
|
63
|
%
|
|
65
|
%
|
Newborn Care
|
38
|
%
|
|
37
|
%
|
|
35
|
%
|
Total
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
We also look at revenue as either being generated from sales of Devices and Systems, which are generally non-recurring, or related Supplies and Services, which are generally recurring. The products that are attributable to these categories are described above. Revenue from Devices and Systems, Supplies and Services as a percent of total revenue for the years ending
December 31, 2016
,
2015
and
2014
is as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Devices and Systems
|
63
|
%
|
|
64
|
%
|
|
68
|
%
|
Supplies
|
28
|
%
|
|
29
|
%
|
|
30
|
%
|
Services
|
9
|
%
|
|
7
|
%
|
|
2
|
%
|
Total
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
In
2016
,
2015
and
2014
, no single end-user customer comprised more than 10% of our revenue.
Backlog
For the years ended
December 31, 2016
,
2015
and
2014
, backlog was approximately as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Backlog
|
$
|
10,555
|
|
|
$
|
9,359
|
|
|
$
|
12,429
|
|
Marketing and Sales
Marketing
Our marketing strategy differentiates our products by their level of quality, performance, and customer benefit. We educate customers worldwide about our products through:
|
|
•
|
Trade conference exhibits; and
|
|
|
•
|
Direct presentations to healthcare professionals.
|
Domestic Direct and Distributor Sales
We sell our products in North America primarily through a direct sales organization. We believe this direct sales organization allows us to maintain a higher level of customer service and satisfaction than would otherwise be possible by other distribution methods. We also sell certain products under private label and distribution arrangements.
For the years ended
December 31, 2016
,
2015
and
2014
, domestic revenue as a percent of total revenue was approximately as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Domestic revenue
|
65.6
|
%
|
|
64.4
|
%
|
|
60.6
|
%
|
International Direct and Distributor Sales
We sell some of our products outside the U.S. through direct sales channels in Canada, France, Germany, Denmark, and parts of Latin America; we sell other products in those regions and into more than 100 other countries through a distributor sales channel.
For the years ended
December 31, 2016
,
2015
and
2014
, international revenue as a percent of total revenue was approximately as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
International revenue
|
34.4
|
%
|
|
35.6
|
%
|
|
39.4
|
%
|
We sell products to our distributors under substantially the same terms as sales through our direct sales channels. Terms of sales to international distributors are generally EXW, reflecting that goods are shipped “ex works,” in which title and risk of loss are assumed by the distributor at the shipping point. Distributors are generally given exclusive rights in their territories to purchase products from Natus and to resell to end users or sub distributors. Our distributors typically perform marketing, sales, and technical support functions in their respective markets. Each distributor may sell Natus products to their customer directly, via other distributors or resellers, or both. We actively train our distributors in product marketing, selling, and technical service techniques.
Seasonality in Revenue
We experience seasonality in our revenue. Demand for our products is historically higher in the second half of the year compared to the first. Our seasonality results from the purchasing habits of our hospital-based customers, whose purchases are often governed by calendar year budgets.
Group Purchasing Organizations
More than 90% of the hospitals in the U.S. are members of group purchasing organizations (“GPO”s), which negotiate volume purchase agreements for member hospitals, group practices, and other clinics.
For the years ended
December 31, 2016
,
2015
and
2014
, direct purchases by GPO members as a percent of revenue were approximately as follows:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Direct purchases by GPO members
|
12.3
|
%
|
|
9.3
|
%
|
|
9.1
|
%
|
Third-Party Reimbursement
In the U.S., healthcare providers generally rely on third-party payors, including private health insurance plans, federal Medicare, state Medicaid, and managed care organizations, to reimburse all or part of the cost of the procedures they perform. Third-party payors can affect the pricing or the relative attractiveness of our products by regulating the maximum amount of reimbursement these payors provide for services utilizing our products. In addition, our Peloton hearing screening service and GND services are dependent on third-party payors to reimburse us for services provided.
Customer Service and Support
We generally provide a one-year warranty on our medical device products. We also sell extended service agreements on our medical device products. Service, repair, and calibration services for our domestic customers are provided by Company-owned service centers and our field service specialists. Service for international customers is provided by a combination of Company-owned facilities and vendors on a contract basis.
Manufacturing
Other companies manufacture a significant portion of the components used in our products; however, we perform final assembly, testing, and packaging of many of the devices ourselves to control quality and manufacturing efficiency. We also use contract vendors to manufacture some of our disposable supply and medical device products. We perform regular quality assessments of these vendors, which include on-site quality audits.
We purchase materials and components from qualified suppliers that are subject to our quality specifications and inspections. We conduct quality audits of our key suppliers, several of which are experienced in the supply of components to manufacturers of finished medical devices, or supplies for use with medical devices. Most of our purchased components are available from more than one supplier.
Our manufacturing, service, and repair facilities are subject to periodic inspection by local and foreign regulatory authorities. Our quality assurance system is subject to regulation by the U.S. Food and Drug Administration (“FDA”) and other government agencies. We are required to conduct our product design, testing, manufacturing, and control activities in conformance with the FDA’s quality system regulations and to maintain our documentation of these activities in a prescribed manner. In addition, our production facilities have received International Organization for Standardization (“ISO”) 13485 certification. ISO 13485 certification standards for quality operations have been developed to ensure that medical device companies meet the standards of quality on a worldwide basis. We have also received the EC Certificate pursuant to the European Union Medical Device Directive 93/42/EEC, which allows us to place a CE mark on our products.
Research and Development
We are committed to introducing new products and supporting current product offerings in our markets through a combination of internal as well as external efforts that are consistent with our corporate strategy.
Internal product development capabilities.
We believe that product development capabilities are essential to provide our customers with new product offerings. We plan to leverage our core technologies by introducing product line extensions as well as new product offerings.
Partnerships that complement our expertise.
We continue to seek strategic partners in order to develop products that may not otherwise be available to us. By taking advantage of our core competencies, we believe that we can bring products to market in an efficient manner and leverage our distribution channels.
New opportunities through technology acquisition.
We continue to evaluate new, emerging, and complementary technologies in order to identify new product opportunities. With our knowledge of our current markets we believe that we can effectively develop technologies into successful new products.
Our research and development expenses were $33.4 million or 8.8% of total revenue in
2016
, $30.4 million or 8.1% of total revenue in
2015
, and $30.1 million or 8.5% of total revenue in
2014
.
Proprietary Rights
We protect our intellectual property through a combination of patent, copyright, trade secret, and trademark laws. 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, distribution channels, documentation, and other proprietary information. However, we believe that these measures afford only limited protection.
The intellectual rights to some of the original patents for technology incorporated into our products are now in the public domain. However, we do not consider these patents, or any currently viable patent or related group of patents, to be of such importance that their expiration or termination would materially affect our business.
We capitalize the cost of purchased technology and intellectual property, as well as certain costs incurred in obtaining patent rights, and amortize these costs over the estimated economic lives of the related assets.
We have several registered trademarks and service marks. Our marks are pending or registered trademarks in the United States and several foreign countries. We intend to file for additional trademarks to strengthen our trademark rights, but we cannot be certain that our trademark applications will result in registration or that our trademarks will be enforceable.
Competition
We sell our products in competitive and rapidly evolving markets. We face competition from other companies in all of our product lines. Our competitors range from small privately-held companies to multinational corporations and their product offerings vary in scope and breadth. We do not believe that any single competitor is dominant in any of our product lines.
We derive a significant portion of our revenue from the sale of disposable supplies that are used with our medical devices. In the U.S., we sell our supply products in a mature market and we expect that our products could face increasing competition, including competitors offering lower prices, which could have an adverse effect on our revenue and profit margins.
We believe the principal factors that will draw clinicians and other buyers to our products, include:
|
|
•
|
Level of specificity, sensitivity, and reliability of the product;
|
|
|
•
|
Time required to obtain results with the product, such as to test for or treat a clinical condition;
|
|
|
•
|
Relative ease of use of the product;
|
|
|
•
|
Depth and breadth of the products features;
|
|
|
•
|
Quality of customer support for the product;
|
|
|
•
|
Frequency of product updates;
|
|
|
•
|
Extent of third-party reimbursement of the cost of the product or procedure;
|
|
|
•
|
Extent to which the products conform to standard of care guidelines; and
|
We believe that our primary competitive strength relates to the functionality and reliability of our products. Different competitors may have competitive advantages in one or more of the categories listed above and they may be able to devote greater resources to the development, promotion, and sale of their products.
Government Regulation
FDA’s Premarket Clearance and Approval Requirements
Unless an exemption applies, the medical devices we sell in the United States, with the exception of some disposable products, must first receive one of the following types of FDA premarket review authorizations under the Food, Drug, and Cosmetics Act, as amended:
|
|
•
|
Clearance via Section 510(k); or
|
|
|
•
|
Premarket approval via Section 515 if the FDA has determined that the medical device in question poses a greater risk of injury.
|
The FDA’s 510(k) clearance process usually takes from three to 12 months, but can take longer. The process of obtaining premarket approval via Section 515 is much more costly, lengthy, and uncertain. Premarket approval generally takes from one to three years, but can take longer. We cannot be sure that the FDA will ever grant either 510(k) clearance or premarket approval for any product we propose to market in the United States.
The FDA decides whether a device must undergo either the 510(k) clearance or premarket approval process based upon statutory criteria. These criteria include the level of risk that the FDA perceives to be associated with the device and a determination of whether the product is a type of device that is substantially equivalent to devices that are already legally marketed. The FDA places devices deemed to pose relatively less risk in either Class I or Class II, which requires the manufacturer to submit a premarket notification requesting 510(k) clearance, unless an exemption applies. The premarket notification under Section 510(k) must demonstrate that the proposed device is substantially equivalent in intended use and in safety and effectiveness to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of premarket approval applications.
The FDA places devices deemed to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed to be not substantially equivalent to a predicate device, in its Class III classification. The FDA requires these devices to undergo the premarket approval process via Section 515 in which the manufacturer must prove the safety and effectiveness of the device. A premarket approval application must provide extensive pre-clinical and clinical trial data.
The FDA may require results of clinical trials in support of a 510(k) submission and generally requires clinical trial results for a premarket approval application. In order to conduct a clinical trial on a significant-risk device, the FDA requires manufacturers to apply for and obtain, in advance, an investigational-device exemption. The investigational-device exemption application must be supported by appropriate data, such as animal and laboratory testing results. If the FDA and the Institutional Review Boards at the clinical trial sites approve the investigational-device exemption application for a significant-risk device, the manufacturer may begin the clinical trial. An investigational-device exemption approval provides for a specified clinical protocol, including the number of patients and study sites. If the manufacturer deems the product a non-significant risk device, the product will be eligible for more abbreviated investigational-device exemption requirements. If the Institutional Review Boards at the clinical trial sites concur with the non-significant risk determination, the manufacturer may begin the clinical trial.
Most of our products have been cleared by the FDA as Class II devices. Some of our disposable products and newborn care products, such as our neonatal headshields and oxygen delivery systems, have received FDA clearance as Class I devices.
FDA Regulation
Numerous FDA regulatory requirements apply to our products. These requirements include:
|
|
•
|
FDA quality system regulations which require manufacturers to create, implement, and follow design, testing, control, documentation, and other quality assurance procedures;
|
|
|
•
|
Medical device reporting regulations, which require that manufacturers report to the FDA certain types of adverse and other events involving their products; and
|
|
|
•
|
FDA general prohibitions against promoting products for unapproved uses.
|
Class II and III devices may also be subject to special controls applied to them, such as performance standards, post-market surveillance, patient registries, and FDA guidelines that may not apply to Class I devices. We believe we are in compliance with applicable FDA guidelines, but we could be required to change our compliance activities or be subject to other special controls if the FDA changes existing regulations or adopts new requirements.
We are subject to inspection and market surveillance by the FDA to determine compliance with regulatory requirements. If the FDA finds that we have failed to adequately comply, the FDA can institute a wide variety of enforcement actions, including:
|
|
•
|
Issuance of a Form 483 citation;
|
|
|
•
|
Fines, injunctions, and civil penalties;
|
|
|
•
|
Recall or seizure of our products;
|
|
|
•
|
Issuance of public notices or warnings;
|
|
|
•
|
Imposition of operating restrictions, partial suspension, or total shutdown of production;
|
|
|
•
|
Refusal of our requests for 510(k) clearance or pre-market approval of new products;
|
|
|
•
|
Withdrawal of 510(k) clearance or pre-market approval already granted; or
|
The FDA also has the authority to require us to repair, replace, or refund the cost of any medical device manufactured or distributed by us.
Other Regulations
We also must comply with numerous additional federal, state, and local laws relating to matters such as safe working conditions, manufacturing practices, environmental protection, biohazards, fire hazard control, and hazardous substance disposal. We believe we are currently in compliance with such regulations.
Countries outside of the U.S. regulate medical devices in a manner similar to that of the FDA. Our manufacturing facilities are subject to audit and have been certified to be ISO 13485:2003, Medical Device Directive 93/42/EEC, and CMDCAS compliant, which allows us to sell our products in Canada, Europe, and other territories around the world. Our manufacturing facilities in North America are subject to ISO 13485 inspections by our notified body, British Standards Institution Management Systems, and by other notified bodies outside of North America. We plan to seek approval to sell our products in additional countries, while maintaining our current approvals. The time and cost of obtaining new, and maintaining existing, market authorizations from countries outside of North America, and the requirements for licensing products in these countries may differ significantly from FDA requirements.
Employees
On
December 31, 2016
, we had approximately 1,160 full time employees worldwide. In Argentina, some of our production employees are represented by labor unions and our employees in Germany have established a works council. We have not experienced any work stoppages, and we consider our relations with our employees to be good.
Executive Officers
The following table lists our executive officers and their ages as of
February 24, 2017
:
|
|
|
|
|
|
|
Name
|
|
Age
|
|
Position(s)
|
James B. Hawkins
|
|
61
|
|
|
President and Chief Executive Officer
|
Jonathan Kennedy
|
|
46
|
|
|
Executive Vice President and Chief Financial Officer
|
Austin F. Noll, III
|
|
50
|
|
|
Vice President and General Manager, Neurology SBU
|
Kenneth M. Traverso
|
|
56
|
|
|
Vice President and General Manager, Newborn Care SBU
|
D. Christopher Chung, M.D.
|
|
53
|
|
|
Vice President Medical Affairs, Quality & Regulatory
|
James B. Hawkins
has served as Chief Executive Officer, and as a member of the Board of Directors, since joining Natus in April 2004, and as President from April 2004 through January 2011 and from June 2013 to present. In addition, he currently serves on the Board of Directors for Eldorado Resorts, Inc. and OSI Systems. Prior to joining Natus, Mr. Hawkins was President, Chief Executive Officer and a Director of Invivo Corporation, a developer and manufacturer of multi-parameter vital sign monitoring equipment, and its predecessor, from August 1985 through January 2004. Mr. Hawkins also served as Secretary of Invivo from July 1986 until January 2004. He earned his undergraduate degree in Business Commerce from Santa Clara University and holds a Masters of Business Administration degree from San Francisco State University.
Jonathan A. Kennedy
joined Natus as Senior Vice President and Chief Financial Officer in April 2013. Before joining Natus, Mr. Kennedy was Senior Vice President and Chief Financial Officer of Intersil Corporation, a global semiconductor manufacturer, since 2009. Prior to that, he was Intersil’s Corporate Controller since 2005 and Director of Finance since 2004. Before joining Intersil, Mr. Kennedy held management roles in Finance and Information Technology with Alcon Inc. and Harris Corporation. He holds a Bachelor of Science degree in Business Administration and a Master of Science degree in Accounting from the University of Central Florida. Mr. Kennedy is also a Certified Public Accountant.
Austin F. Noll, III
joined Natus in August 2012 as the Vice President and General Manager, Neurology. Mr. Noll has over 24 years’ experience in the medical device industry. Mr. Noll most recently served as the President and CEO of Simpirica Spine, a California-based start-up company that developed and is commercializing a novel device for spinal stabilization, since 2009. Prior to joining Simpirica Spine, Mr. Noll was the President and CEO of NeoGuide Systems, a medical robotics company acquired by Intuitive Surgical in 2009. Prior to joining NeoGuide Systems, Mr. Noll held numerous positions at Medtronic over a 13-year period, where he served as the Vice President and General Manager of the Powered Surgical Solutions and the Neurosurgery businesses. Before Medtronic, he held sales positions at C.R. Bard and Baxter Healthcare. He received a bachelor’s degree in business administration from Miami University and a master’s of business administration from the University of Michigan.
Kenneth M. Traverso
has served as our Vice President and General Manager, Newborn Care, since October 2012. Previously, he served as Vice President Marketing and Sales from April 2002 to September 2012. From September 2000 to April 2002, he
served as our Vice President Sales. From October 1999 to July 2000, Mr. Traverso served as President of DinnerNow.com Inc., an internet aggregator for the restaurant industry. From January 1998 to September 1999, Mr. Traverso served as Vice President Sales, Western Region of Alere Medical, an outpatient chronic disease management company. From May 1995 to January 1998, Mr. Traverso served as Vice President Marketing and Sales of AbTox, Inc., a low temperature sterilization company. From August 1990 to May 1995, Mr. Traverso served in various capacities at Natus, including Vice President Sales. From September 1984 to July 1990 Mr. Traverso served various positions at Nellcor, a medical device company, including Regional Sales Manager, Western Region. Mr. Traverso holds a Bachelor of Science degree in Administration & Marketing from San Francisco State University.
D. Christopher Chung, M.D.,
has served as our Vice President Medical Affairs, Quality and Regulatory since June 2003, and has served as our Vice President Medical Affairs since February 2003. Dr. Chung also served as our Medical Director from October 2000 to February 2003. From August 2000 to present, Dr. Chung has also served as a Pediatric Hospitalist at the California Pacific Medical Center in San Francisco. From June 1997 to June 2000, Dr. Chung trained as a pediatric resident at Boston Children’s Hospital and Harvard Medical School. From May 1986 to July 1993, Dr. Chung worked as an Engineer at Nellcor, a medical device company. Dr. Chung holds a Bachelor of Arts degree in Computer Mathematics from the University of Pennsylvania and a Doctor of Medicine degree from the Medical College of Pennsylvania-Hahnemann University School of Medicine. He is board certified in Pediatrics and is a Fellow of the American Academy of Pediatrics.
Other Information
Natus was incorporated in California in May 1987 and reincorporated in Delaware in August 2000.
We maintain corporate offices at 6701 Koll Center Parkway Suite 120, Pleasanton, California 94566. Our telephone number is (925) 223-6700. We maintain a corporate website at
www.natus.com
. References to our website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.
We make available, free of charge on our corporate website, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements, and all amendments to these reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the Securities Exchange Act. We also show detail about stock trading by corporate insiders by providing access to SEC Forms 3, 4 and 5. This information may also be obtained from the SEC’s on-line database, which is located at
www.sec.gov
. Our common stock is traded on the Nasdaq Stock Market under the symbol “BABY”.
Item 1A. Risk Factors
We have completed a number of acquisitions and expect to complete additional acquisitions in the future. There are numerous risks associated with acquisitions and we may not achieve the expected benefit of any of our acquisitions
Our acquisitions of products, technology assets, or businesses may have a negative impact on our business if we fail to achieve the anticipated financial, strategic, and other benefits of acquisitions or investments, and our operating results may suffer because of this.
We expect to continue to pursue opportunities to acquire other businesses in the future. The acquisitions that we have completed may not result in improved operating results for us, or in our achieving a financial condition superior to that which we would have achieved had we not completed them. Our results of operations may be adversely impacted by costs associated with our acquisitions, including one-time charges associated with restructurings. Further, our acquisitions could fail to produce the benefits that we anticipate, or could have other adverse effects that we currently do not foresee. In addition, some of the assumptions that we have relied upon, such as achievement of operating synergies, may not be realized. In this event, one or more of the acquisitions could result in reduced earnings as compared to the earnings that would have been achieved by us if the acquisition had not occurred.
Previously we have assumed, and may in the future enter into, contingent obligations associated with earnout provisions in some of our acquisitions. We believe these provisions help us to negotiate mutually agreeable purchase terms between us and the sellers. However, a disagreement between us and a seller about the terms of an earnout provision could result in our paying more for an acquisition than we intended.
If we are required to seek additional external financing to support our need for cash to fund future acquisitions, we may not have access to financing on terms that are acceptable to us, or at all. Alternatively, we may feel compelled to access additional financing on terms that are dilutive to existing holders of our common stock or that include covenants that restrict our business, or both.
In January 2017 we completed the acquisition of GN Otometrics, which is our largest acquisition to date in terms of purchase price and size of business acquired. Accordingly, the risks described above are potentially more material to us than would have
otherwise been the case. Further, Otometrics is headquartered in Denmark and most of its operating facilities are located outside the United States, and the risks we face that are associated with international operations, including those discussed in these risk factors, are enhanced as a result of this transaction.
Adverse economic conditions in markets in which we operate may harm our business
Unfavorable changes in U.S. and international economic environments may adversely affect our business and financial results. During challenging economic times, and in tight credit markets, our customers may delay or reduce capital expenditures. This could result in reductions in sales of our products, longer sales cycles, difficulties in collection of accounts receivable, slower adoption of new technologies, and increased price competition, all of which could impact our results of operations and financial condition. In addition, we expect these factors will cause us to be more cautious in evaluating potential acquisition opportunities, which could hinder our ability to grow through acquisition while these conditions persist. In 2016 voters in the United Kingdom approved "Brexit," calling for the United Kingdom to withdraw from the European Union and there is speculation that this exit could have adverse consequences for the economies of the United Kingdom and other European countries. We have a significant amount of sales in the European Union and this business could be adversely affected by these developments.
In October 2015, we announced a contract between our Argentinian subsidiary, Medix I.C.S.A, and the Ministry of Health of Venezuela under which our subsidiary would deliver products and services, including third party products, over a three year period pursuant to prepayments received from the Venezuelan Ministry of Health. Following the announcement of this contract, there have been elections in both Venezuela and Argentina leading to significant political changes in those countries. Further, Venezuela is experiencing a highly inflationary economy and recessionary economic conditions. These developments may impact the likelihood of the Venezuelan Ministry of Health’s following through with orders under the agreement. While Medix has received the first installment under this contract, the remainder of the contract will not be fulfilled until the outstanding consideration is received. If, for these or any other reasons, the Venezuelan Ministry of Health does not make the additional prepayments required to initiate deliveries under the Medix agreement, we will not receive any additional benefit from it.
Our operating results may suffer because of our exposure to foreign currency exchange rate fluctuations
Substantially all of our sales contracts with our U.S. based customers provide for payment in U.S. dollars. With the exception of our Canadian operations, substantially all of the revenue and expenses of our foreign subsidiaries are denominated in the applicable foreign currency. Our exposure to the currency fluctuations is enhanced as a result of the Otometrics acquisition. To date we have executed only limited foreign currency contracts to hedge these currency risks. Our future revenue and expenses may be subject to volatility due to exchange rate fluctuations that could result in foreign exchange gains and losses associated with foreign currency transactions and the translation of assets and liabilities denominated in foreign currencies.
Substantially all our sales from our U.S. operations to our international distributors provide for payment in U.S. dollars. A strengthening of the U.S. dollar relative to other foreign currencies could increase the effective cost of our products to our international distributors as their functional currency is typically not the U.S. dollar. This could have a potential adverse effect on our ability to increase or maintain average selling prices of our products to our foreign-based customers.
Healthcare reforms, changes in healthcare policies, and changes to third-party reimbursements for our products may affect demand for our products
In March 2010 the U. S. government signed into law the
Patient Protection and Affordable Care Act
and the
Health Care & Education Reconciliation Act
(collectively, the “ACA”). The ACA contains many provisions designed to generate the revenues necessary to fund the coverage expansions and to reduce costs of Medicare and Medicaid, including imposing a 2.3% excise tax on domestic sales of many medical devices by manufacturers and importers. This tax began in 2013, and subsequently was suspended for the calendar years 2016 and 2017. Unless there is further legislative action during that two-year period, the tax will be automatically reinstated for sales of medical devices on or after January 1, 2018. Subsequent to the adoption of the ACA, changes to this statute have been adopted that, among other things, reduced Medicare payments to several providers, including hospitals and imaging centers.
The Trump administration has been critical of the ACA and has spoken of materially revising or even repealing it. Uncertainty surrounding the ACA may adversely impact the spending of our U.S. based customers and revised provisions of the ACA, if any, could adversely impact our business. If we fail to effectively react to the implementation of health care reform, our business may be adversely affected.
We have initiated changes to our information systems that could disrupt our business and our financial results
We plan to continuously improve our information systems to support the form, functionality, and scale of our business. These types of transitions frequently prove disruptive to the underlying business of an enterprise and may cause us to incur higher
costs than we anticipate. Failure to manage a smooth transition to the new systems and the ongoing operations and support of the new systems could materially harm our business operations.
For example, beginning in 2012 we implemented the rollout of a world-wide, single-platform enterprise resource planning (“ERP”) application including customer relationship management, product lifecycle management, demand management, consolidation and financial statement generation, and business intelligence, and in 2015 we completed the final implementation of the ERP. We may fail to gain the efficiencies the implementation is designed to produce within the anticipated timeframe. We will continue to incur additional costs associated with stabilization and ongoing development of the new platform. The ongoing development and stabilization could also be disruptive to our operations, including the ability to timely ship and track product orders to customers, project inventory requirements, manage our supply chain and otherwise adequately service our customers. As we integrate the Otometrics operations and implement the ERP to cover its operations, we will incur costs and face challenges that could disrupt our operations.
Future changes in technology or market conditions could result in adjustments to our recorded asset balance for intangible assets, including goodwill, resulting in additional charges that could significantly impact our operating results
Our balance sheet includes significant intangible assets, including goodwill and other acquired intangible assets. The determination of related estimated useful lives and whether these assets are impaired involves significant judgment. Our ability to accurately predict future cash flows related to these intangible assets might be hindered by events over which we have no control. Due to the highly competitive nature of the medical device industry, new technologies could impair the value of our intangible assets if they create market conditions that adversely affect the competitiveness of our products. Further, declines in our market capitalization may be an indicator that our intangible assets or goodwill carrying values exceed their fair values which could lead to potential impairment charges that could impact our operating results. In the past we have recorded charges for goodwill impairment and impairments of our trade names.
We may not be able to preserve the value of our intellectual property because we may not be able to protect access to it 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 products with features similar to ours, and this could reduce demand for our products. We protect our intellectual property through a combination of patent, copyright, trade secret and trademark laws. 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. 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. Failing to enforce our intellectual property rights could also result in the loss of those rights.
If we are not able to maintain effective internal control over financial reporting in the future, the accuracy and timeliness of our financial reporting may be adversely affected.
The Sarbanes-Oxley Act requires, among other things, that we assess the effectiveness of our internal control over financial reporting annually and disclosure controls and procedures quarterly. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. If we are not able to maintain effective internal control over financial reporting and otherwise comply with the requirements of Section 404 in a timely manner, our reported financial results could be materially misstated or could be restated, we could receive an adverse opinion regarding our controls from our accounting firm and we could be subject to investigations or sanctions by regulatory authorities, which would require additional financial and management resources, and the market price of our stock could decline.
If health care providers are not adequately reimbursed for procedures conducted with our devices or supplies, or if reimbursement policies change adversely, we may not be successful marketing and selling our products or technologies
Clinicians, hospitals, and government agencies are unlikely to purchase our products if they are not adequately reimbursed for the procedures conducted with our devices or supplies. Unless a sufficient amount of conclusive, peer-reviewed clinical data about our products has been published, third-party payors, including insurance companies and government agencies, may refuse to provide reimbursement. Furthermore, even if reimbursement is provided, it may not be adequate to fully compensate the clinicians or hospitals. Some third-party payors may impose restrictions on the procedures for which they will provide reimbursement. If health care providers cannot obtain sufficient reimbursement from third-party payors for our products or the screenings conducted with our products, we may not achieve significant market acceptance of our products. Acceptance of our products in international markets will depend upon the availability of adequate reimbursement or funding within prevailing healthcare payment systems. Reimbursement, funding, and healthcare payment systems vary significantly by country. We may not obtain approvals for reimbursement in a timely manner or at all.
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, particularly those in countries and regions outside the U.S. 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. In a managed care system, the cost of our products may not be incorporated into the overall payment for patient care or there may not be adequate reimbursement for our products separate from reimbursement for other procedures.
Our Peloton hearing screening service and our GND EEG service are dependent on third-party payors to reimburse us for services provided to patients. We have encountered challenges in obtaining reimbursement from third parties and are dedicating resources to the education of third-party payors to the benefits of these services. Our inability to obtain reimbursement for these services, and any adverse changes in reimbursement policies or amounts for either of these services, or other products or services that we provide, could harm our business.
Our business would be harmed if the FDA determines that we have failed to comply with applicable regulations governing the manufacture of our products and/or we do not pass an inspection
We and our suppliers are required to demonstrate and maintain compliance with the FDA’s Quality System Regulation. The Quality System Regulation sets forth the FDA’s requirements for good manufacturing practices of medical devices and includes requirements for, among other things, the design, testing, production processes, controls, quality assurance, labeling, packaging, storage and shipping of such products. In addition, we and our suppliers must engage in extensive recordkeeping and reporting and must make available our manufacturing facility and records for periodic unscheduled inspections by federal, state and foreign agencies, including the FDA. We cannot assure you that we and our suppliers are or will continue to be in full compliance with the Quality System Regulation, and that we will not encounter any manufacturing difficulties.
In 2014 and 2016 we received formal communications from the FDA regarding deficiencies in our manufacturing processes in our Seattle facility. As a result, we imposed ship-holds on certain of our products produced there and are dedicating substantial resources to the resolution of the conditions identified by the FDA. These actions had an adverse effect on our results of operations in 2016.
Our inability to address issues that have been raised by the FDA, or failure of us or our third party suppliers and manufacturers to comply with applicable regulations could result in sanctions being imposed on us, including, among other things, fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of our products, delays, suspension or withdrawal of approvals, seizures or recalls of products and manufacturing restrictions, any of which could harm our business.
If we fail in our efforts to educate clinicians, government agency personnel, and third-party payors about the effectiveness of our products, we may not achieve future sales growth
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 their use. The commercial success of our products depends upon clinician, government agency, and other third-party payer confidence in the economic and clinical benefits of our products as well as their comfort with the efficacy, reliability, sensitivity and specificity of our products. We believe that clinicians will not use our products unless they determine, based on published peer-reviewed journal articles and experience, that our products provide an accurate and cost-effective alternative to other means of testing or treatment. Our customers may choose to use competitive products, which may be less expensive or may provide faster results than our devices. Clinicians are traditionally slow to adopt new products, testing practices and clinical treatments, partly because of perceived liability risks and the uncertainty of third-party reimbursement. If clinicians, government agencies and hospital administrators do not adopt our products, we may not maintain profitability. Factors that may adversely affect the medical community’s acceptance of our products include:
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Publication of clinical study results that demonstrate a lack of efficacy or cost-effectiveness of our products;
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Changing governmental and physician group guidelines;
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Actual or perceived performance, quality, price, and total cost of ownership deficiencies of our products relative to other competitive products;
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Our ability to maintain and enhance our existing relationships and to form new relationships with leading physicians, physician organizations, hospitals, state laboratory personnel, and third-party payers;
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Changes in federal, state and third-party payer reimbursement policies for our products; and
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Repeal of laws requiring universal newborn hearing screening and metabolic screening.
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Sales through group purchasing organizations and sales to high volume purchasers may reduce our average selling prices, which could reduce our operating margins
We have entered, and expect in the future to enter into agreements with customers who purchase a high volume of our products. Our agreements with these customers may contain discounts from our normal selling prices and other special pricing considerations, which could cause our operating margins to decline. In addition, we have entered into agreements to sell our products to members of GPOs, which negotiate volume purchase prices for medical devices and supplies for member hospitals, group practices and other clinics. While we make sales directly to GPO members, the GPO members receive volume discounts from our normal selling price and may receive other special pricing considerations from us. Sales to members of all GPOs accounted for approximately 12.3%, 9.3% and 9.1% of our total revenue during
2016
,
2015
and
2014
, respectively. Certain other existing customers may be members of GPOs with which we do not have agreements. Our sales efforts through GPOs may conflict with our direct sales efforts to our existing customers. If we enter into agreements with new GPOs and some of our existing customers begin purchasing our products through those GPOs, our operating margins could decline.
Consolidation in the healthcare industry could have an adverse effect on our revenues and results of operations
Many healthcare industry companies, include our customers and competitors, are consolidating to create new companies with greater market power. As the healthcare industry consolidates, competition to provide goods and services to our customers could become more intense. Our customers may try to use their market power to negotiate price concessions and our competitors may utilize their size and broad product lines to offer cheaper alternatives to our products. If we are forced to reduce our prices because of consolidation in the healthcare industry, our revenues would decrease and our consolidated earnings, financial condition, or cash flow would suffer.
Demand for some of our products depends on the capital spending policies of our customers, and changes in these policies could harm our business
A majority of customers for our products are hospitals, physician offices, and clinics. Many factors, including public policy spending provisions, available resources, and economic cycles have a significant effect on the capital spending policies of these entities and therefore the amount that they can spend on our equipment products. If budget resources limit the capital spending of our customers, they will be unlikely to either purchase any new equipment from us or upgrade to any of our newer equipment products. Lack of liquidity in credit markets and uncertainty about future economic conditions can have an adverse effect on the spending patterns of our customers. These factors can have a significant adverse effect on the demand for our products.
Our markets are very competitive and in the United States we sell certain of our products in a mature market
We face competition from other companies in all of our product lines. Our competitors range from small privately held companies to multinational corporations and their product offerings vary in scope and breadth. We do not believe that any single competitor is dominant in any of our product lines.
The markets for certain of our products in the U.S., including the newborn hearing screening and EEG monitoring markets, are mature and we are unlikely to see significant growth for such products in the U.S. In the U.S. we derive a significant portion of our revenue from the sale of disposable supplies that are used with our hearing screening devices. Our hearing disposable supply products could face increasing competition, including competitors offering lower prices, which could have an adverse effect on our revenue and margins.
Our competitors may have certain competitive advantages, which include the ability to devote greater resources to the development, promotion, and sale of their products. Consequently, we may need to increase our efforts, and related expenses for research and development, marketing, and selling to maintain or improve our position.
We expect recurring sales to our existing customers to generate a majority of our revenue in the future, and if our existing customers do not continue to purchase products from us, our revenue may decline.
Our operating results may decline if we do not succeed in developing, acquiring, and marketing additional products or improving our existing products
We intend to develop additional products and technologies, including enhancements of existing products, for the screening, detection, treatment, monitoring and tracking of common medical ailments. Developing new products and improving our existing products to meet the needs of current and future customers requires significant investments in research and development. If we fail to successfully sell new products, update our existing products, or timely react to changes in technology, our operating results may decline as our existing products reach the end of their commercial life cycles.
Our growth in recent years has depended substantially on the completion of acquisitions and we may not be able to complete acquisitions of this nature or of a relative size in the future to support a similar level of growth
The acquisitions that we have completed have contributed to our growth in recent years. We expend considerable effort in seeking to identify attractive acquisition candidates and ultimately, to negotiate mutually agreeable acquisition terms. If we are not successful in these efforts in the future, our growth rate will not increase at a rate corresponding to that which we have achieved in recent years. Further, as we grow larger it will be necessary to complete the acquisition of larger companies and product lines
to support a growth similar to that which we have achieved in the past. The market for attractive acquisitions is competitive and others with greater financial resources than we have may be better positioned than we are to acquire desirable targets. Further, we may not be able to negotiate acquisition terms with target companies that will allow us to achieve positive financial returns from the transaction.
Our plan to expand our international operations will result in increased costs and is subject to numerous risks; if our efforts are not successful, this could harm our business
We have expanded our international operations through acquisitions, including the Otometrics acquisition, and plan to expand our international sales and marketing efforts to increase sales of our products in foreign countries. We may not realize corresponding growth in revenue from growth in international unit sales, due to the lower average selling prices we receive on sales outside of the U.S. Even if we are able to successfully expand our international selling efforts, we cannot be certain that we will be able to create or increase demand for our products outside of the U.S. Our international operations are subject to other risks, which include:
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Impact of possible recessions in economies outside the U.S.;
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Political and economic instability, including instability related to war and terrorist attacks;
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Contractual provisions governed by foreign law, such as local law rights to sales commissions by terminated distributors;
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Decreased healthcare spending by foreign governments that would reduce international demand for our products;
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Continued strengthening of the U.S. dollar relative to foreign currencies that could make our products less competitive because approximately half of our international sales are denominated in U.S. dollars;
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Greater difficulty in accounts receivable collection and longer collection periods;
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Difficulties of staffing and managing foreign operations;
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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;
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Difficulty in obtaining and maintaining foreign regulatory approval;
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Attitudes by clinicians, and cost reimbursement policies, towards use of disposable supplies that are potentially unfavorable to our business;
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Complying with U.S. regulations that apply to international operations, including trade laws, the U.S. Foreign Corrupt Practices Act, and anti-boycott laws, as well as international laws such as the U.K. Bribery Act;
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Loss of business through government tenders that are held annually in many cases; and
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Potentially negative consequences from changes in tax laws, including legislative changes concerning taxation of income earned outside of the U.S.
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In particular, our international sales could be adversely affected by a strengthening of the U.S. dollar relative to other foreign currencies, which makes our products more costly to international customers for sales denominated in U.S. dollars.
If guidelines mandating universal newborn hearing screening do not continue to develop in foreign countries and governments do not mandate testing of all newborns as we anticipate, or if those guidelines have a long phase-in period, our sales of newborn hearing screening products may not achieve the revenue growth we have achieved in the past
We estimate that approximately 95% of the children born in the U.S. are currently being tested for hearing impairment prior to discharge from the hospital. To date, there has been only limited adoption of newborn hearing screening prior to hospital discharge by foreign governments, and when newborn hearing screening programs are enacted by foreign governments there can be a phase-in period spanning several years. The widespread adoption of guidelines depends, in part, on our ability to educate foreign government agencies, neonatologists, pediatricians, third-party payors, and hospital administrators about the benefits of universal newborn hearing screening as well as the use of our products to perform the screening and monitoring. Our revenue from our newborn hearing screening product lines may not grow if foreign governments do not require universal newborn hearing screening prior to hospital discharge, if physicians or hospitals are slow to comply with those guidelines, or if governments provide for a lengthy phase-in period for compliance.
Because we rely on distributors or sub-distributors to sell our products in most of our markets outside of the U.S., our revenue could decline if our existing distributors reduce the volume of purchases from us, or if our relationship with any of these distributors is terminated
We currently rely on our distributors or sub-distributors for a majority of our sales outside the U.S. Some distributors also assist us with regulatory approvals and education of clinicians and government agencies. Our contracts with our distributors or
sub-distributors do not assure us significant minimum purchase volume. If a contract with a distributor or sub-distributor is terminated for cause or by us for convenience, the distributor or sub-distributor will have no obligation to purchase products from us. We intend to continue our efforts to increase our sales in Europe, Japan, and other developed countries. If we fail to sell our products through our international distributors, we would experience a decline in revenue 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 to 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 revenue 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.
We may be subject to foreign laws governing our relationships with our international distributors. These laws may require us to make payments to our distributors if we terminate our relationship for any reason, including for cause. Some countries require termination payments under local law or legislation that may supersede our contractual relationship with the distributor. Any required payments would adversely affect our operating results.
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. We have relatively few sources of supply for some of the components used in our products and in some cases we rely entirely on sole-source suppliers. In addition, the lead-time involved in the manufacturing of some of these components can be lengthy and unpredictable. If our suppliers become unwilling or unable to supply us with components meeting 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 revenue 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 may not be able to obtain the necessary regulatory clearance or approval. This could create supply disruptions that would harm our product sales and operating results.
We depend upon key employees in a competitive market for skilled personnel, and, without additional employees, we cannot grow or maintain profitability
Our products and technologies are complex, and we depend substantially on the continued service of our senior management team. The loss of any of our key employees could adversely affect our business and slow our product development process. 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. Demand for these skilled employees in our industry is very competitive due to the limited number of people available with the necessary technical skills and understanding of our product technologies. We may be unable to attract and retain personnel necessary for the development of our business.
Our ability to market and sell products depends upon receipt of domestic and foreign regulatory approval of our products and manufacturing operations. Our failure to obtain or maintain regulatory approvals and compliance could negatively affect our business
Our products and manufacturing operations are subject to extensive regulation in the United States by the FDA and by similar regulatory agencies in other countries. Our products are classified as medical devices. Medical devices are subject to extensive regulation by the FDA pursuant to regulations that are wide ranging and govern, among other things: design and development; manufacturing and testing; labeling; storage and record keeping; advertising, promotion, marketing, sales distribution and export; and surveillance and reporting of deaths or serious injuries.
Unless an exemption applies, each medical device that we propose to market in the U.S. must first receive one of the following types of FDA premarket review authorizations:
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Clearance via Section 510(k) of the Food, Drug, and Cosmetics Act of 1938, as amended; or
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Premarket approval via Section 515 of the Food, Drug, and Cosmetics Act if the FDA has determined that the medical device in question poses a greater risk of injury.
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The FDA will clear marketing of a medical device through the 510(k) process if it is demonstrated that the new product is substantially equivalent to other 510(k)-cleared products. The premarket approval application process is much more costly, lengthy and uncertain than the 510(k) process, and must be supported by extensive data from preclinical studies and human clinical trials. The FDA may not grant either 510(k) clearance or premarket approval for any product we propose to market. Further, any
modification to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design or manufacture, requires a new 510(k) clearance or, possibly, approval of a premarket approval application. The FDA requires every manufacturer to make this determination in the first instance, but the FDA may review any manufacturer’s decision. If the FDA requires us to seek 510(k) clearance or premarket approval for modification of a previously cleared product for which we have concluded that new clearances or approvals are unnecessary, we may be required to cease marketing or to recall the modified product until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties. Further, our products could be subject to recall if the FDA determines, for any reason, that our products are not safe or effective.
Delays in receipt of, or failure to receive, clearances or approvals, the loss of previously received clearances or approvals, or the failure to comply with existing or future regulatory requirements could adversely impact our operating results. If the FDA finds that we have failed to comply with these requirements, the FDA can institute a wide variety of enforcement actions, ranging from a public warning letter to more severe sanctions such as:
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Fines, injunctions and civil penalties;
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Recall or seizure of our products;
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Issuance of public notices or warnings;
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Imposition of operating restrictions, partial suspension, or total shutdown of production;
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Refusal of our requests for Section 510(k) clearance or premarket approval of new products;
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Withdrawal of Section 510(k) clearance or premarket approvals already granted;
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Criminal prosecution; or
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Domestic regulation of our products and manufacturing operations, other than that which is administered by the FDA, includes the Environmental Protection Act, the Occupational Safety and Health Act, and state and local counterparts to these Acts.
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Our Olympic Cool-Cap product is subject to greater products liability exposure and FDA regulation
The FDA classifies medical devices into one of three classes depending on the degree of risk associated with each medical device and the extent of controls that are needed to ensure safety and effectiveness. Devices deemed to pose lower risk are placed in either Class I or Class II. Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life supporting or implantable devices, or a device deemed to not be substantially equivalent to a previously cleared 510(k) device are placed in Class III, and generally require premarket approval from the FDA before they may be marketed.
Our Olympic Cool-Cap is a Class III minimally invasive medical device, and as such we may be subject to an increased product liability risk relative to our other Class I and Class II non-invasive products.
Our business may suffer if we are required to revise our labeling or promotional materials, or if the FDA takes an enforcement action against us for off-label uses
We are prohibited by the FDA from promoting or advertising our medical device products for uses not within the scope of our clearances or approvals, or from making unsupported promotional claims about the benefits of our products. If the FDA 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 FDA, our sales could be delayed, our revenue could decline, and our reputation among clinicians could be harmed. Likewise, if we acquire new products, either through the purchase of products, technology assets, or businesses, that are subsequently deemed to have inadequate supporting data, we may be required to (i) obtain adequate data, which could be costly and impede our ability to market these products, or (ii) modify the labeling on these products, which could impair their marketability, as described above.
If we deliver products with defects, we may incur costs to repair and, possibly, recall that product and market acceptance of our products may decrease.
The manufacturing and marketing of our products involve an inherent risk of our delivering a defective product or products that do not otherwise perform as we expect. We may incur substantial expense to repair any such products and may determine to recall such a product, even if not required to do so under applicable regulations. Any such recall would be time consuming and expensive. Product defects or recalls may adversely affect our customers’ acceptance of the recalled and other of our products.
If we fail to comply with healthcare regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected.
We could be subject to healthcare fraud regulation and enforcement by both the federal government and the states in which we conduct our business. The laws that may affect our ability to operate include: (i) the federal healthcare programs Anti-Kickback
Law, which prohibits, among other things, persons from knowingly and willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under federal healthcare programs such as Medicare or Medicaid, (ii) federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers, and/or (iii) state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers, many of which differ from their federal counterparts in significant ways, thus complicating compliance efforts.
If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.
Our operating results would suffer if we were subject to a protracted infringement claim
The medical technology industry is characterized by a substantial amount of litigation and related administrative proceedings regarding patents and intellectual property rights. We expect that medical screening and diagnostic products may become increasingly subject to third-party infringement claims as the number of competitors in our industry grows and the functionality of products overlap. 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:
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Result in costly litigation and damage awards;
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Divert our management’s attention and resources;
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Cause product shipment delays or suspensions; or
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Require us to seek to enter into royalty or licensing agreements.
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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, or design and build non-infringing products, could prevent us from selling our products and adversely affect our business and financial results.
We may also find it necessary to bring infringement actions against third parties to seek to protect our intellectual property rights. Litigation of this nature, even if successful, is often expensive and disruptive of our management’s attention, and in any event may not lead to a successful result relative to the resources dedicated to any such litigation.
We license intellectual property rights from third parties and would be adversely affected if our licensors do not appropriately defend their proprietary rights or if we breach any of the agreements under which we license commercialization rights to products or technology from others
We license rights from third parties for products and technology that are important to our business. If our licensors are unsuccessful in asserting and defending their proprietary rights, including patent rights and trade secrets, we may lose the competitive advantages we have through selling products that we license from third parties. Additionally, if it is found that our licensors infringe on the proprietary rights of others, we may be prohibited from marketing our existing products that incorporate those proprietary rights. Under our licenses, we are subject to commercialization and development, sublicensing, royalty, insurance and other obligations. If we fail to comply with any of these requirements, or otherwise breach a license agreement, the licensor may have the right to terminate the license in whole or to terminate the exclusive nature of the license.
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 products could lead to the filing of a product liability claim by someone claiming to have been injured using one of our products or claiming that one of our products failed to perform properly. 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 reputation or financial condition. Our product liability insurance may not 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 have experienced seasonality in the sale of our products
We experience seasonality in our revenue. For example, our sales typically decline from the second half of our fiscal year to the first half of the fiscal year, due to patterns in the capital budgeting and purchasing cycles of our customers, many of which are government agencies, and the compensation arrangements of our direct sales employees, as those arrangements are tied to calendar-year sales plans. We anticipate that we will continue to experience seasonal fluctuations, which may lead to fluctuations in our quarterly operating results. We believe that you should not rely on our results of operations for interim periods as an indication of our expected results in any future period.
An interruption in or breach of security of our information or manufacturing systems, including the occurrence of a cyber-incident or a deficiency in our cybersecurity, or disclosure of private patient health information, may result in a loss of business or damage to our reputation.
We rely on communications, information and manufacturing systems to conduct our business. Any failure, interruption or cyber incident of these systems could result in failures or disruptions in our customer relationship management or product manufacturing. A cyber incident is an intentional attack or an unintentional event that can include gaining unauthorized access to information systems to disrupt operations, corrupt data, or steal confidential information. The occurrence of any failures, interruptions or cyber incidents could result in a loss of customer business or reputation and have a material effect on our business, financial condition, results of operations and cash flows.
In the course of performing our business we obtain, from time to time, confidential patient health information. For example, we may learn patient names and be exposed to confidential patient health information when we provide training on our products to our customers’ staff. Complying with federal and state privacy and security requirements imposes compliance related costs, subjects us to potential regulatory audits, and may restrict our business operations. These various laws may be subject to varying interpretations by courts and government agencies creating potentially complex compliance issues for our business. If we were to violate any of our legal obligations to safeguard any confidential patient health information or protected health information against improper use and disclosure, we could lose customers and be exposed to liability, and our reputation and business could be harmed. Concerns or allegations about our practices with regard to the privacy or security of personal health information or other privacy-related matters, even if unfounded, could damage our reputation and harm our business.
We are also subject to laws and regulations in foreign countries covering data privacy and other protection of health and employee information that may be more onerous than corresponding U.S. laws. These regulations may require that we obtain individual consent before we collect or process any personal data, restrict our use or transfer of personal data, impose technical and organizational measures to ensure the security of personal data, and require that we notify regulatory agencies, individuals or the public about any data security breaches. As we expand our international operations, we may be required to expend significant time and resources to put in place additional mechanisms to ensure compliance with multiple data privacy laws. Failure to comply with these laws may result in significant fines and other administrative penalties and harm our business.
Our stock price may be volatile, which may cause the value of our stock to decline or subject us to a securities class action litigation.
The trading price of our common stock price may be volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:
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general economic, industry and market conditions;
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actions by institutional or other large stockholders;
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the depth and liquidity of the market for our common stock;
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volume and timing of orders for our products;
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developments generally affecting medical device companies;
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the announcement of new products or product enhancements by us or our competitors;
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changes in earnings estimates or recommendations by securities analysts;
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investor perceptions of us and our business, including changes in market valuations of medical device companies; and
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our results of operations and financial performance.
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In addition, the stock market in general, and the NASDAQ Stock Market and the market for medical devices in particular, have experienced substantial price and volume volatility that is often seemingly unrelated to the operating performance of particular companies. These broad market fluctuations may cause the trading price of our common stock to decline. In the past, securities class action litigation has often been brought against a company after a period of volatility in the market price of its common stock. We may become involved in this type of litigation in the future. Any securities litigation claims brought against us could result in substantial expense and the diversion of management’s attention from our business.
ITEM 1B. Unresolved Staff Comments.
None.
ITEM 2. Properties
Our corporate headquarters are located in Pleasanton, California, in a facility covering 8,200 square feet pursuant to a lease that expires in October 2019.
We also utilize the following properties:
Company-owned Facilities:
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116,000 square feet in Buenos Aires, Argentina, utilized substantially for manufacturing;
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44,900 square feet in Oakville, Ontario, Canada, utilized substantially for research and development;
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42,600 square feet in Gort, Ireland, utilized substantially for manufacturing;
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26,000 square feet in Mundelein, Illinois, previously utilized substantially for manufacturing. Currently held for sale; and
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6,400 square feet in Old Woking, England, utilized substantially for research and development.
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Leased Facilities:
Following is a listing of our most significant leased properties; we have a number of smaller facilities under lease in various countries where we operate.
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124,000 square feet in Middleton, Wisconsin, pursuant to a lease that expires in April 2024, that is primarily utilized for manufacturing;
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65,000 square feet in Seattle, Washington, pursuant to a lease that expires in December 2017, that is utilized substantially for manufacturing;
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43,000 square feet in Planegg, Germany, pursuant to a lease that expires in December 2021 that is utilized substantially for manufacturing; and
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14,300 square feet in Skovlunde, Denmark, pursuant to a lease that expires with six-month notice that is utilized for research and development.
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ITEM 3. Legal Proceedings
We may from time to time become a party to various legal proceedings or claims that arise in the ordinary course of business. We are not currently involved in any legal or administrative proceedings that we believe are likely to have a material effect on our business, financial condition, or results of operations, although we cannot be assured of the outcome of such matters.
On January 30, 2017, an alleged class action entitled
Badger v. Natus Medical Incorporated, et al.
, No. 3:17-cv-00458-JSW, was filed in the United States District Court for the Northern District of California against the Company and two of our officers. The suit asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 for allegedly misleading statements regarding our business (including a contract entered into by a subsidiary of the Company), guidance and financial results. The suit is purportedly brought on behalf of purchasers of our common stock between October 16, 2015 and April 3, 2016, and seeks compensatory damages, fees and costs. We believe the claims are without merit and intend to defend them vigorously.
ITEM 4. Mine Safety Disclosures
The disclosure required by this item is not applicable.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended
December 31, 2016
,
2015
and
2014
1—ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
Natus Medical Incorporated (“Natus”, the “Company”) was incorporated in California in May 1987 and reincorporated in Delaware in August 2000. Natus is a leading provider of newborn care and neurology healthcare products and services used for the screening, diagnosis, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, sleep disorders, neuromuscular diseases and balance and mobility disorders. Product offerings include computerized neurodiagnostic systems for audiology, neurology, polysomnography, and neonatology, as well as newborn care products such as hearing screening systems, phototherapy devices for the treatment of newborn jaundice, head-cooling products for the treatment of brain injury in newborns, incubators to control the newborn’s environment, and software systems for managing and tracking disorders and diseases for public health laboratories.
Basis of Presentation and Principles of Consolidation
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications to the prior periods have been made to conform to the current period presentation. The consolidated statements of income for 2014 reflect reclassifications from Cost of revenue to Intangibles amortization, from Marketing and selling, Research and development, and General and administrative to Intangible amortization, and from General and administrative to Restructuring.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities in the Consolidated Financial Statements and the reported amount of revenue and expenses during the reporting period. Such estimates include allowances for potentially uncollectible accounts receivable, valuation of inventory, intangible assets, goodwill, share-based compensation, deferred income taxes, reserves for warranty obligations, and the provision for income taxes. Actual results could differ from those estimates.
Revenue recognition
Revenue, net of discounts, is recognized from sales of medical devices and supplies, including sales to distributors, when the following conditions have been met: a purchase order has been received, title has transferred, the selling price is fixed or determinable, and collection of the resulting receivable is reasonably assured. Terms of sale for most domestic sales are FOB origin, reflecting that title and risk of loss are assumed by the purchaser at the shipping point; however, terms of sale for some neurology, sleep-diagnostic, and head cooling systems are FOB destination, reflecting that title and risk of loss are assumed by the purchaser upon delivery. Terms of sales to international distributors are generally EXW, reflecting that goods are shipped “ex works,” in which title and risk of loss are assumed by the distributor at the shipping point. For products shipped under FOB origin or EXW terms, delivery is generally considered to have occurred when the product is shipped. Freight charges billed to customers are included in revenue and freight-related expenses are charged to cost of revenue. The Company generally does not provide rights of return on products.
For products containing embedded software, the Company has determined that the hardware and software components function together to deliver the products’ essential functionality, and therefore, the revenue from the sale of these products does not fall within the scope of the software revenue recognition rules. The Company's revenue recognition policies for sales of these products are substantially the same as for other tangible products.
Revenue from sales of certain products that remain within the scope of the software revenue recognition rules under ASC Subtopic 985-605 is not significant.
Revenue from extended service and maintenance agreements, for both medical devices and data management systems, is recognized ratably over the service period. Revenue from installation or training services is deferred until such time service is provided. Hearing screening and ambulatory EEG monitoring revenue is recorded when the procedure is performed at the estimated net realizable value based on contractual agreements with payers and historical collections.
Certain revenue transactions include multiple element arrangements. The Company allocates revenue in these arrangements to each unit of accounting using the relative selling price method. The selling prices used during the allocation process are based on vendor specific objective evidence (“VSOE”) if available, third party evidence (“TPE”) if VSOE is not available, or estimated selling price (“ESP”) if neither VSOE or TPE is available.
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
Group purchasing organization (“GPOs”) negotiate volume purchase prices for member hospitals, group practices, and other clinics. The Company's agreements with GPOs typically contain preferential terms for the GPO and its members, including provisions for some, if not all, of the following:
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Payment of marketing fees by Natus to the GPO, usually based on purchasing experience of group members; and
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Non-recourse cancellation provisions.
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Natus does not sell products to GPOs. Hospitals, group practices, and other clinics that are members of a GPO purchase products directly from the Company under the terms negotiated by the GPO. Negotiated pricing and discounts are recognized as a reduction of the selling price of products at the time of the sale. Revenue from sales to members of GPOs is otherwise consistent with general revenue recognition policies as previously described.
Inventory
Inventories are carried at the lower of cost or market, with cost being determined using the first-in, first-out method. The carrying value of the Company's inventories is reduced for any difference between cost and estimated market value of inventories that is determined to be obsolete or unmarketable, based upon assumptions about future demand and market conditions. Adjustments to the value of inventory establish a new cost basis and are considered permanent even if circumstances later suggest that increased carrying amounts are recoverable. If demand is higher than expected, Natus may sell inventory that had previously been impaired.
Carrying value of intangible assets and goodwill
The Company amortizes intangible assets with finite lives over the useful lives; any future changes that would limit the useful lives or any determination that these assets are carried at amounts greater than the estimated fair value could result in additional charges.
Goodwill is not amortized but is subject to an annual impairment analysis, which is performed as of October 1st; this assessment is also performed whenever there is a change in circumstances that indicates the carrying value of goodwill may be impaired.
In 2016, 2015 and 2014, the Company performed a qualitative assessment to test goodwill for impairment. Qualitative factors considered in this assessment include industry and market considerations, overall financial performance and other relevant events and factors affecting each reporting unit. Based on the qualitative assessment, the Company determined that the fair value was more likely than not to be greater than its carrying amount, and no further analysis was needed.
If the fair value was less than its carrying amount, the Company would perform a two-step impairment test on goodwill. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit to its carrying value, including goodwill. The Company uses a projected discounted cash flow model to determine the fair value of a reporting unit. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, and the second step of the impairment test is not required. The second step, if required, compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The fair value of a reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. If the carrying amount of the reporting unit’s goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess.
Prior to the assignment of definite lives to trade names in the second quarter of 2015 (See
Note 6 - Intangible Assets
), the Company tested indefinite lived intangibles for impairment by comparing the carrying value of those assets to be fair value as of the assessment date. The Company used the relief from royalty method to determine the fair value of the assets. This analysis is dependent upon a number of quantitative and qualitative factors including estimates of forecasted revenue, royalty rate, and taxes. The discount rate applied also has an impact on the estimates of fair value, as use of a higher rate will result in a lower estimate of fair value. As of the October 1, 2014 testing dates, the Company determined that certain trade names were impaired and the Company recorded impairment charges of
$0.6 million
.
Long lived assets
The Company continually monitors events and changes in circumstances that could indicate that carrying amounts of its long-lived assets, including property and equipment and intangible assets, may not be recoverable. When such events or changes in circumstances occur, the Company assess the recoverability by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, the Company will recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets.
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
Liability for product warranties
The Company provides a warranty for products that is generally one year in length. In some cases, regulations may require the Company to provide repair or remediation beyond the typical warranty period. If any products contain defects, the Company may be required to incur additional repair and remediation costs. Service for domestic customers is provided by Company-owned service centers that perform all service, repair, and calibration services. Service for international customers is provided by a combination of Company-owned facilities and vendors on a contract basis.
A warranty reserve is included in accrued liabilities for the expected future costs of servicing products. Additions to the reserve are based on management’s best estimate of probable liability. The Company considers a combination of factors including material and labor costs, regulatory requirements, and other judgments in determining the amount of the reserve. The reserve is reduced as costs are incurred to honor existing warranty and regulatory obligations.
Share-based compensation
The Company recognizes share-based compensation expense associated with employee stock options under the single-option straight line method over the requisite service period, which is generally a
four
-year vesting period and
ten
-year contractual term pursuant to ASC Topic 718,
Compensation-Stock Compensation
. See Note 14 of the Consolidated Financial Statements.
For employee stock options, the value of each option is estimated on the date of grant using the Black-Scholes option pricing model, which was developed for use in estimating the value of freely traded options. Similar to other option pricing models, the Black-Scholes method requires the input of highly subjective assumptions, including stock price volatility. Changes in the subjective input assumptions can materially affect the estimated fair value of the employee stock options.
The Company recognizes share-based compensation associated with Restricted Stock Awards (“RSA”) and Restricted Stock Units (“RSU”). RSAs and RSUs vest ratably over a
three
-year period for employees. RSAs and RSUs for executives vest over a
four
-year period;
50%
on the second anniversary of the awarded date and
25%
on each of the third and fourth anniversaries. RSAs and RSUs for non employees (Board of Directors) vest over a
one
-year period;
100%
on the first anniversary. The value is estimated based on the market value of Natus common stock on the date of issuance pursuant to ASC Topic 718, Compensation-Stock Compensation.
The Company issues new shares of common stock upon the exercise of stock options and the vesting of RSAs and RSUs.
Forfeitures of employee stock options and awards are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Share-based compensation expense is recorded net of estimated forfeitures, such that expense is recorded only for those share-based awards that are expected to vest.
The Company elected to early adopt ASU 2016-09 in the first quarter of 2016. In 2015 and 2014, the cash flow from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for employee options (excess tax benefits) was classified as a cash inflow from financing activities and a cash outflow from operating activities in the Statement of Cash Flows. The Company treated tax deductions from certain stock option exercises as being realized when the Company reduced taxes payable in accordance with relevant tax law.
Cash Equivalents and Short-term Investments
All highly liquid investments purchased with an original maturity of three months or less are classified as cash equivalents. Investments with maturities greater than one year are classified as current because management considers all investments to be available for current operations. Cash equivalents and investments are stated at amounts that approximate fair value based on quoted market prices.
The Company's investments have been classified and accounted for as available-for-sale. Such investments are recorded at fair value and unrealized holding gains and losses are reported as a separate component of comprehensive income until realized. Realized gains and losses on sales of investments, if any, are determined on the specific identification method and are reclassified from accumulated other comprehensive loss to results of operations as other income (expense).
Allowance for Doubtful Accounts
The Company estimates the allowance for potentially uncollectible accounts receivable based on historical collection experience within the markets in which the Company operates and other customer-specific information, such as bankruptcy filings or customer liquidity problems. When all internal efforts have been exhausted to collect the receivable, it is written off and relieved from the reserve.
Fair Value of Financial Instruments
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
Financial instruments include cash and cash equivalents, investments, accounts receivable, and accounts payable. Cash is reported at its fair value on the balance sheet dates. The recorded carrying amounts of investments, accounts receivable and accounts payable approximate the fair values due to the short-term maturities.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation expense is computed using the straight-line method over estimated useful lives of the respective assets, which are
three
to
ten
years for office furniture and equipment,
three
to
five
years or the length of the license for computer software and hardware,
three
to
five
years for demonstration and loaned equipment, and
30
to
40
years for buildings. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life. Land is not depreciated. Costs associated with acquiring and installing software to be used for internal purposes are capitalized and amortized on a straight-line basis over
three
years.
Research & Development Costs
Costs incurred in research and development are charged to operations as incurred.
Income Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company records net deferred tax assets to the extent it is more likely than not that the assets will be realized. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. To the extent that previously reserved deferred tax assets are estimated to be realizable, the Company adjusts the valuation allowance which reduces the provision for income taxes.
The Company recognizes the tax benefit of uncertain tax positions in the financial statements in accordance with ASC Topic 740, Income Tax. When the tax position is deemed more likely than not of being sustained, the Company recognizes the largest amount of tax benefit that is greater than
50 percent
likely of being ultimately realized upon settlement, in accordance with ASC 740-10-05.
Foreign Currency
The functional currency of the Company's subsidiaries outside of North America is generally the local currency of the country where the subsidiary is located. Accordingly, foreign currency translation adjustments relating to the translation of foreign subsidiary financial statements are included as a component of accumulated other comprehensive loss. The Company recorded
$5.0 million
,
$8.4 million
, and
$11.2 million
of foreign currency translation losses for the years ended December 31, 2016, 2015 and 2014, respectively.
Gains and losses from transactions denominated in currencies other than the functional currencies are included in other income and expense. In 2016, 2015, and 2014, net foreign currency transaction losses were
$0.4
million,
$1.4
million, and
$0.0
million, respectively. Foreign currency gains and losses result primarily from fluctuations in the exchange rate between the U.S. Dollar, Canadian Dollar, Euro, Argentine Peso, British Pound, and Danish Kroner.
Comprehensive Income
The Company reports by major components and as a single total the change in net assets during the period from non-owner sources in accordance with ASC Topic 220, Comprehensive Income. The consolidated statement of comprehensive income has been included with the consolidated statements of operations. Accumulated other comprehensive income consists of translation gains and losses on foreign subsidiary financial statements as well as unrealized gains and losses on investments.
Basic and Diluted Net Income per Share
Natus computes net income per share in accordance with ASC Topic 260, Earnings per Share. Basic net income per share is based upon the weighted average number of common shares outstanding during the period. Diluted net income per share is based upon the weighted average number of common shares outstanding and dilutive common stock equivalents outstanding during the period. Common stock equivalents are options granted and shares of restricted stock issued under the stock awards plans and are calculated under the treasury stock method. Common equivalent shares from unexercised stock options and restricted stock
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
are excluded from the computation when there is a loss as the effect is anti-dilutive, or if the exercise price of such options is greater than the average market price of the stock for the period.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2041-09”), which supersedes nearly all existing revenue recognition guidance. The standard's core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard creates a five-step model to achieve its core principle: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction's price to the separate performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. In addition, entities must disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative disclosures are required about: (i) the entity's contracts with customers; (ii) the significant judgments, and changes in judgments, made in applying the guidance to those contracts; and (iii) any assets recognized from the costs to obtain or fulfill a contract with a customer. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 616) - Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to interim and annual periods beginning January 1, 2018. The standard allows entities to apply the standard retrospectively to each prior period presented (“full retrospective adoption”) or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application (“modified retrospective adoption”). The Company plans to adopt this guidance on January 1, 2018, and continues to evaluate the impact of adopting under the modified retrospective adoption versus the full retrospective method. The Company is currently in the process of determining the impact of the new revenue recognition guidance on its revenue transactions, including any impacts on associated processes, systems, and internal controls. The Company's preliminary assessment indicates implementation of this standard will not have a material impact on financial results. The Company's evaluation has included determining whether the unit of account (i.e., performance obligations) will change as compared to current GAAP, as well as determining the standalone selling price of each performance obligation. Standalone selling prices under the new guidance may not be substantially different from the Company's current methodologies of establishing fair value on multiple element arrangements. The Company continues to evaluate the impact of this guidance and its subsequent amendments on the consolidated financial position, results of operations, and cash flows, and any preliminary assessments are subject to change.
In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330). This standard requires an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. ASU 2015-11 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company plans to adopt ASU 2015-11 on January 1, 2017.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This standard requires a lessee to recognize the lease assets and lease liabilities arising from operating leases in the statement of financial position. Qualitative along with specific quantitative disclosures are required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 including interim periods within those fiscal years. The Company is currently evaluating the impact that will result from adopting ASU 2016-02.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvement to Employee Share-Based Payment Accounting. The new standard contains several amendments that simplify the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The changes in the new standard eliminate the accounting for excess tax benefits to be recognized in additional paid-in capital and tax deficiencies recognized either in the income tax provision or in additional paid-in capital. The Company elected to early adopt ASU 2016-09 in the first quarter of 2016 which was applied using a modified retrospective approach. For the year ended December 31, 2016, the Company recognized all excess tax benefits and tax deficiencies as income tax expense or benefit as discrete items. An income tax benefit of approximately
$1.6 million
was recognized in the year ended December 31, 2016 as a result of the adoption of ASU 2016-09. There was no cumulative-effect adjustment required to retained earnings under the modified retrospective method as of the beginning of the year because all tax benefits had been previously recognized when the tax deductions related to stock compensation were utilized to reduce taxes payable. The Company is not recording deferred tax assets or tax losses as the result of the adoption of ASU 2016-09. The treatment of forfeitures has not changed as the Company is electing to continue the current process of estimating the number of forfeitures. With the early adoption of 2016-09, the
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
Company has elected to present the cash flow statement on a prospective transition method and no prior periods have been adjusted.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This standard provides guidance for eight cash flow classification issues in current GAAP. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company elected to early adopt ASU 2016-15 in the first quarter of 2016 including Contingent Consideration Payments Made after a Business Combination. For the year ended December 31, 2016, the Company recognized
$1.0 million
as a cash outflow for investing activities on the Statement of Cash Flows. This payment was made soon after the acquisition date of a business combination to settle the contingent consideration from the Monarch acquisition.
2—BUSINESS COMBINATIONS
The assets acquired and liabilities assumed at the date of acquisition are recorded in the Consolidated Financial Statements at the respective fair values as of the acquisition date. The excess of the purchase price over the fair value of the acquired net assets is recorded as goodwill.
The determination of estimated fair value of acquired assets and liabilities requires management to make significant estimates and assumptions. The Company determines the fair value by applying established valuation techniques, based on information that management believes to be relevant to this determination. The Company also utilizes independent third parties to assist in the valuation of goodwill and intangible assets.
The results of operations from acquisitions are included in the Consolidated Financial Statements from the date of the acquisition.
RetCam
On July 6, 2016, the Company acquired the portfolio of RetCam Imaging Systems ("RetCam") from Clarity Medical Systems, Inc. for
$10.6 million
in cash. RetCam is an imaging system used to diagnose and monitor a range of ophthalmic maladies in premature infants. The purchase agreement also included a holdback of
$2.0 million
which is contingent upon completion of certain modifications to RetCam 3 no later than March 31, 2017. Subsequent to the acquisition, an additional
$1.1 million
was paid by the Company to Clarity Medical Systems as a result of a working capital adjustment. Results of operations for RetCam are included in the consolidated financial statements from the date of acquisition. The total purchase price was allocated
$7.2 million
to tangible assets,
$3.3 million
to intangible assets with an assigned weighted average life of
5
years being amortized on the straight line method, and
$3.2 million
to goodwill, offset by
$2.0 million
to net liabilities. Pro forma financial information for the RetCam acquisition is not presented as it is not considered material.
NeuroQuest
On March 2, 2016, the Company acquired NeuroQuest, LLC (“NeuroQuest”) through an asset purchase. NeuroQuest complements the Global Neuro-Diagnostics and Monarch Medical Diagnostics, LLC ("Monarch") acquisitions which offer patients a convenient way to complete routine-electroencephalography and extended video electronencephalography ("VEEG") testing. The cash consideration for NeuroQuest was
$4.6 million
. The purchase agreement included a consideration holdback of
$0.5 million
which will be held until March 2, 2017. The total purchase price was allocated to
$0.5 million
of tangible assets,
$1.3 million
of intangible assets with an assigned weighted average life of
5
years being amortized on the straight line method, and
$3.5 million
of goodwill, offset by
$0.1 million
of net liabilities. Pro forma financial information for the NeuroQuest acquisition is not presented as it is not considered material.
Monarch
The Company acquired Monarch Medical Diagnostics, LLC ("Monarch") through an asset purchase on November 13, 2015. Monarch's service compliments the Global Neuro-Diagnostics acquisition which offers patients a more convenient way to complete routine diagnostic electroencephalography and video electromyography testing which can be performed at the home, hospital or physician's office. The service also provides comprehensive reporting and support to the physician. The cash consideration for Monarch was
$2.7 million
. The purchase agreement also included contingent consideration which was paid on January 11, 2016 of
$1.0 million
. The total purchase price was allocated to
$112,000
of tangible assets,
$1.2 million
of intangible assets with an assigned weighted average life of
5
years being amortized on the straight line method, and
$2.4 million
of goodwill. Pro forma financial information for the Monarch acquisition is not presented as it is not considered material.
Global Neuro-Diagnostics
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
The Company acquired GND through an equity purchase on January 23, 2015. GND's service offers patients a more convenient way to complete routine EEG and EMG testing which can be performed at the home, hospital or physician's office. The service also provides comprehensive reporting and support to the physician. The cash consideration for GND was
$11.4 million
, which consists primarily of
$1.5 million
of tangible assets,
$4.8 million
of intangible assets with an assigned weighted average life of
5
years being amortized on the straight line method, and
$8.9 million
of goodwill, offset by
$0.5 million
of net liabilities. The purchase agreement also included an earn-out condition which was originally estimated to be
$3.2 million
. The earn-out condition was subsequently estimated to be
$0.5 million
in the fourth quarter of 2016. The earn-out is contingent upon GND achieving certain revenue milestones in 2017. Pro forma financial information for the GND acquisition is not presented as it is not considered material.
NicView
On January 2, 2015, the Company purchased the assets of NicView. NicView provides streaming video for families with babies in the neonatal intensive care unit. The cash consideration for NicView was
$1.1 million
, of which
$0.3 million
was allocated to tangible assets and
$2.7 million
to goodwill, offset by
$0.6 million
allocated to net liabilities. The asset purchase agreement included an earn-out condition contingent upon orders received in and installed by February 28, 2016. The Company settled this earnout for
$1.3 million
in March 2016. Pro forma financial information for the NicView acquisition is not presented as it is not considered material.
Hearing Screening as a Service
In the first quarter of 2014, the Company entered into
two
asset purchase agreements for companies in the newborn hearing screening services market for total cash consideration of
$2.6 million
. The purchase agreements also included earn-out conditions contingent upon annual revenue growth through 2016. These earn-outs, originally estimated at
$0.8 million
, were settled during the second quarter of 2015 for
$0.7 million
. Both acquisitions support the entry into this market, which complements the newborn hearing screening device business. This hearing screening services business operates under the name Peloton. Pro forma financial information for these two acquisitions is not presented as it is not considered material.
3—CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS
The Company has invested its excess cash in highly liquid marketable securities such as corporate debt instruments, U.S. government agency securities and asset-backed securities. Investments with maturities greater than one year are classified as current because management considers all investments to be available for current operations.
The Company's investments are designed to provide liquidity, preserve capital and maximize total return on invested assets with a focus on high credit-quality securities.
The Company's investments have been classified and accounted for as available-for-sale. Such investments are recorded at fair value, and unrealized holding gains and losses are reported as a separate component of accumulated other comprehensive income (loss) in the stockholders' equity until realized. Realized gains and losses on sales of investments, if any, are determined on the specific identification method and are reclassified from accumulated other comprehensive income (loss) to results of operations as other income (expense).
The Company, to date, has not determined that any of the unrealized losses on its investments are considered to be other-than-temporary. The Company reviews its investment portfolio to determine if any security is other-than-temporarily impaired, which would require the Company to record an impairment charge in the period any such determination is made. In making this judgment, the Company evaluates, among other things: the duration and extent to which the fair value of a security is less than its cost; the financial condition of the issuer and any changes thereto; and the Company's intent and ability to hold its investment for a period of time sufficient to allow for any anticipated recovery in market value, or whether the Company will more likely than not be required to sell the security before recovery of its aggregated cost basis.
Cash, cash equivalents and short-term investments consisted of the following (in thousands):
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
Cash and cash equivalents:
|
|
|
|
Cash
|
213,551
|
|
|
82,469
|
|
Short-term investments:
|
|
|
|
U.S. investment grade bonds
|
24,477
|
|
|
—
|
|
Developed investment grade bonds
|
9,542
|
|
|
—
|
|
Total short-term investments
|
34,019
|
|
|
—
|
|
Total cash, cash equivalents and short-term investments
|
247,570
|
|
|
82,469
|
|
Short-term investments by investment type are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
Aggregated Cost Basis
|
|
Gross Unrealized Gains
|
|
Gross Unrealized Losses
|
|
Aggregated Fair Value
|
|
Aggregated Cost Basis
|
|
Gross Unrealized Gains
|
|
Gross Unrealized Losses
|
|
Aggregated Fair Value
|
U.S. investment grade bonds
|
24,531
|
|
|
—
|
|
|
(54
|
)
|
|
24,477
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Developed investment grade bonds
|
9,567
|
|
|
—
|
|
|
(25
|
)
|
|
9,542
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total short-term investments
|
$
|
34,098
|
|
|
$
|
—
|
|
|
$
|
(79
|
)
|
|
$
|
34,019
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Short-term investments by contractual maturity are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
Investments
|
|
Investments
|
Due in one year or less
|
$
|
21,655
|
|
|
$
|
—
|
|
Due after one year through five years
|
12,364
|
|
|
—
|
|
Total short-term investment
|
$
|
34,019
|
|
|
$
|
—
|
|
See Note 21 to these Consolidated Financial Statements for additional discussion regarding the fair value of the Company's short-term investments.
4—INVENTORIES
Inventories consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Raw materials and subassemblies
|
$
|
28,245
|
|
|
$
|
19,041
|
|
Work in process
|
1,507
|
|
|
1,343
|
|
Finished goods
|
34,908
|
|
|
36,149
|
|
Total Inventories
|
64,660
|
|
|
56,533
|
|
Less: Non-current Inventories
|
(15,073
|
)
|
|
(7,961
|
)
|
Inventories
|
$
|
49,587
|
|
|
$
|
48,572
|
|
At
December 31, 2016
and
2015
, the Company has classified
$15.1 million
and
$8.0 million
, respectively, of inventories as non-current. This inventory consists of service components used to repair products held by customers pursuant to warranty obligations and extended service contracts, including service components for products that the Company no longer sells, inventory
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
purchased for lifetime buys, and inventory that will be shipped when the ship hold on the NeoBLUE
®
products is released. The Company believes that these inventories will be utilized for the intended purpose.
5—PROPERTY AND EQUIPMENT
Property and equipment consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Land
|
$
|
2,856
|
|
|
$
|
2,918
|
|
Buildings
|
5,219
|
|
|
5,662
|
|
Leasehold improvements
|
2,386
|
|
|
2,345
|
|
Office furniture and equipment
|
18,398
|
|
|
15,602
|
|
Computer software and hardware
|
9,100
|
|
|
8,752
|
|
Demonstration and loaned equipment
|
11,393
|
|
|
11,216
|
|
|
49,352
|
|
|
46,495
|
|
Accumulated depreciation
|
(32,019
|
)
|
|
(29,528
|
)
|
Total
|
$
|
17,333
|
|
|
$
|
16,967
|
|
Depreciation expense of property and equipment was
$3.7 million
,
$4.2 million
, and
$4.3 million
in the years ending
December 31, 2016
,
2015
and
2014
, respectively.
In the third quarter of 2014 the Company's manufacturing facility in Mundelein, Illinois was listed for sale. This asset was measured at fair value less cost to sell as of September 30, 2014 based on market price and Level 2 inputs and resulted in a
$2.2 million
impairment. The Company continues to actively market this facility. The impairment was recorded in restructuring expenses and the asset was reclassified from property and equipment, net to other current assets.
6—INTANGIBLE ASSETS
The following table summarizes the components of gross and net intangible asset balances (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
Gross
Carrying
Amount
|
|
Accumulated
Impairment
|
|
Accumulated
Amortization
|
|
Net Book
Value
|
|
Gross
Carrying
Amount
|
|
Accumulated
Impairment
|
|
Accumulated
Amortization
|
|
Net Book
Value
|
Technology
|
$
|
62,563
|
|
|
—
|
|
|
$
|
(34,683
|
)
|
|
$
|
27,880
|
|
|
$
|
63,668
|
|
|
—
|
|
|
$
|
(31,600
|
)
|
|
$
|
32,068
|
|
Customer related
|
38,087
|
|
|
—
|
|
|
(17,610
|
)
|
|
20,477
|
|
|
35,529
|
|
|
—
|
|
|
(14,352
|
)
|
|
21,177
|
|
Trade names
|
32,106
|
|
|
(3,290
|
)
|
|
(7,135
|
)
|
|
21,681
|
|
|
31,837
|
|
|
(3,340
|
)
|
|
(3,052
|
)
|
|
25,445
|
|
Internally developed software
|
16,978
|
|
|
—
|
|
|
(10,220
|
)
|
|
6,758
|
|
|
15,513
|
|
|
—
|
|
|
(8,155
|
)
|
|
7,358
|
|
Patents
|
2,620
|
|
|
—
|
|
|
(2,251
|
)
|
|
369
|
|
|
2,663
|
|
|
—
|
|
|
(2,175
|
)
|
|
488
|
|
Total Definite-lived intangible assets
|
152,354
|
|
|
(3,290
|
)
|
|
(71,899
|
)
|
|
77,165
|
|
|
149,210
|
|
|
(3,340
|
)
|
|
(59,334
|
)
|
|
86,536
|
|
Finite lived intangible assets are amortized over their weighted average lives, which are
13
years for patents,
17
years for technology,
11
years for customer-related intangibles,
7
years for trade names, and
5
years for internally developed software.
Internally developed software consists of
$14.8 million
relating to costs incurred for development of internal use computer software and
$2.2 million
for development of software to be sold.
During the year ended December 31, 2014 the Company recorded a charge of
$0.6 million
related to the impairment of the Grass trade name. This impairment was the result of deterioration of expected future cash flows. Impairments were determined by performing a discounted cash flow analysis on intangibles assets. This charge was recorded in Intangible amortization.
Amortization expense related to intangible assets with finite lives was as follows (in thousands):
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Technology
|
$
|
3,407
|
|
|
$
|
3,916
|
|
|
$
|
3,993
|
|
Customer related
|
3,452
|
|
|
2,938
|
|
|
1,892
|
|
Trade names
|
4,115
|
|
|
3,159
|
|
|
—
|
|
Internally developed software
|
2,069
|
|
|
1,620
|
|
|
1,434
|
|
Patents
|
112
|
|
|
112
|
|
|
113
|
|
Total amortization
|
$
|
13,155
|
|
|
$
|
11,745
|
|
|
$
|
7,432
|
|
Expected annual amortization expense related to amortizable intangible assets is as follows (in thousands):
|
|
|
|
|
2017
|
$
|
13,130
|
|
2018
|
12,908
|
|
2019
|
11,753
|
|
2020
|
9,558
|
|
2021
|
8,270
|
|
Thereafter
|
21,546
|
|
Total expected amortization expense
|
$
|
77,165
|
|
During the second quarter of 2015 the Company initiated a strategy to increase the brand strength of Natus by replacing acquired product trade names with Natus branded products over time. The implementation of this strategy placed definite expected future lives on the acquired trade names which previously had indefinite lives. The Company assigned these trade names lives of
seven
years based on the timeline of the Company's branding strategy. The Company will continue to assess the lives of these assets based on the timing and execution of this strategy. Amortization expense for trade names is recorded as a component of operating expense.
7—GOODWILL
The carrying amount of goodwill and the changes in those balances are as follows (in thousands):
|
|
|
|
|
As of December 31, 2014
|
$
|
96,316
|
|
Acquisitions/Purchase Accounting Adjustments
|
13,547
|
|
Foreign currency translation
|
(2,397
|
)
|
As of December 31, 2015
|
$
|
107,466
|
|
Acquisitions/Purchase Accounting Adjustments
|
6,705
|
|
Foreign currency translation
|
(1,059
|
)
|
As of December 31, 2016
|
$
|
113,112
|
|
8—ACCRUED LIABILITIES
Accrued liabilities consist of (in thousands):
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Compensation and related benefits
|
$
|
16,064
|
|
|
$
|
16,752
|
|
Accrued federal, state, and local taxes
|
4,160
|
|
|
4,707
|
|
Warranty reserve
|
10,670
|
|
|
10,386
|
|
Accrued professional fees
|
1,191
|
|
|
520
|
|
Contingent consideration
|
3,043
|
|
|
6,209
|
|
Other
|
2,767
|
|
|
3,563
|
|
Total
|
$
|
37,895
|
|
|
$
|
42,137
|
|
9—LONG-TERM OTHER LIABILITIES
Long-term other liabilities consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Contingent tax obligations
|
$
|
6,125
|
|
|
$
|
6,376
|
|
Non-current deferred revenue
|
1,885
|
|
|
1,401
|
|
Other
|
3
|
|
|
4
|
|
Total
|
$
|
8,013
|
|
|
$
|
7,781
|
|
10—DEBT AND CREDIT ARRANGEMENTS
The Company has a Credit Agreement with JP Morgan Chase Bank ("JP Morgan") and Citibank, NA (“Citibank”). The Credit Agreement provides for an aggregate
$150 million
of secured revolving credit facility. The Credit Agreement contains covenants, including covenants which the Company is in compliance with, relating to maintenance of books and records, financial reporting and notification, compliance with laws, maintenance of properties and insurance, and limitations on guaranties, investments, issuance of debt, lease obligations and capital expenditures, and is secured by virtually all of the Company's assets. The Credit Agreement provides for events of default, including failure to pay any principal or interest when due, failure to perform or observe covenants, bankruptcy or insolvency events and the occurrence of a material adverse effect. The Company has no other significant credit facilities. As of
December 31, 2016
, the Company had
$140 million
outstanding under the Credit Agreement. The Company financed a portion of Otometrics acquisition, which closed in January 2017, with borrowing under the revolving credit facility, as well as existing cash. Refer to Note 22 - Subsequent Events for further discussion of the Otometrics acquisition.
Pursuant to the terms of the Credit Agreement, the outstanding principal balance will bear interest at either (a) a fluctuating rate per annum equal to the Applicable Rate, as defined in the Credit Agreement, depending on the leverage ratio plus the higher of (i) the federal funds rate plus one-half of one percent per annum; (ii) the prime rate in effect on such a day; and (iii) the LIBOR rate plus one percent, or (b) a fluctuating rate per annum of LIBOR Rate plus the Applicable Rate. The Credit Agreement matures on September 23, 2021, at which time all principal amounts outstanding under the Credit Agreement will be due and payable.
Due to the execution of the Credit Agreement mentioned above, the Company terminated a previously existing credit agreement between the Company and Citibank. Under this agreement, the Company borrowed and repaid a total of
$16.0 million
during the year ended
December 31, 2016
.
Long-term debt consists of (in thousands):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Revolving credit facility of $140 million, interest at LIBOR plus 1.75%
|
$
|
140,000
|
|
|
$
|
—
|
|
Less: current portion of long-term debt
|
—
|
|
|
—
|
|
Total long-term debt
|
$
|
140,000
|
|
|
$
|
—
|
|
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
Maturities of long-term debt as of
December 31, 2016
are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
2017
|
$
|
—
|
|
|
$
|
—
|
|
2018
|
—
|
|
|
—
|
|
2019
|
—
|
|
|
$
|
—
|
|
Thereafter
|
140,000
|
|
|
—
|
|
Total
|
$
|
140,000
|
|
|
$
|
—
|
|
As of
December 31, 2016
, the carrying value of total debt approximated fair market value. The fair value of the Company's debt is considered a Level 2 measurement. Refer to Note 21 - Fair Value Measurement for further discussion
11—RESERVE FOR PRODUCT WARRANTIES
The Company provides a warranty for products that is generally
one
year in length and in some cases, regulations may require them to provide repair or remediation beyond the typical warranty period. If any of the products contain defects, the Company may be required to incur additional repair and remediation costs. Service for domestic customers is provided by Company-owned service centers that perform all service, repair and calibration services. Service for international customers is provided by a combination of Company-owned facilities and vendors on a contract basis.
A warranty reserve is included in accrued liabilities for the expected future costs of servicing products. Additions to the reserve are based on management's best estimate of probable liability. The Company considers a combination of factors including material and labor costs, regulatory requirements, and other judgments in determining the amount of reserve. The reserve is reduced as costs are incurred to honor existing warranty and regulatory obligations.
As of December 31, 2016 the Company has accrued
$6.6 million
to bring certain NeoBLUE
®
phototherapy products into U.S. regulatory compliance. The Company's estimate of the costs associated with bringing the NeoBLUE
®
phototherapy products into compliance is primarily based upon the number of units outstanding that may require the repair, costs associated with shipping and repairing the product, and the assumption that the FDA will approve the Company's plan for compliance. The Company expects that costs associated with bringing the products back into compliance will not be incurred until the second quarter of 2017.
The details of activity in the warranty reserve are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
Beginning
of Period
|
|
Assumed
Through
Acquisitions
|
|
Additions
Charged to
Expense
|
|
Reductions
|
|
Balance
at End
of Period
|
December 31, 2016
|
$
|
10,386
|
|
|
$
|
222
|
|
|
$
|
2,711
|
|
|
$
|
(2,649
|
)
|
|
$
|
10,670
|
|
December 31, 2015
|
$
|
2,753
|
|
|
$
|
—
|
|
|
$
|
10,729
|
|
|
$
|
(3,096
|
)
|
|
$
|
10,386
|
|
December 31, 2014
|
$
|
3,143
|
|
|
$
|
—
|
|
|
$
|
2,306
|
|
|
$
|
(2,696
|
)
|
|
$
|
2,753
|
|
The estimates the Company uses in projecting future product warranty costs may prove to be incorrect. Any future determination that product warranty reserves are understated could result in increases to cost of sales and reductions in operating profits and results of operations.
12—STOCKHOLDERS’ EQUITY
Common Stock
—The Company has
120,000,000
shares of common stock authorized at a par value or
$0.001
per share.
Preferred Stock
—The Company has
10,000,000
shares of preferred stock authorized at a par value of
$0.001
per share. In accordance with the terms of the amended and restated certificate of incorporation, the Board of Directors is authorized to provide for the issuance of one or more series of preferred stock, including increases or decreases to the series. The Board of Directors has the authority to set the rights, preferences, and terms of such shares. As of
December 31, 2016
, no shares of preferred stock were issued and outstanding.
13—EARNINGS PER SHARE
The components of basic and diluted EPS are as follows (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
|
2014
|
Net income
|
$
|
42,594
|
|
|
$
|
37,924
|
|
|
$
|
32,478
|
|
Weighted average common shares
|
32,460
|
|
|
32,348
|
|
|
31,499
|
|
Dilutive effect of stock based awards
|
596
|
|
|
893
|
|
|
1,069
|
|
Diluted Shares
|
33,056
|
|
|
33,241
|
|
|
32,568
|
|
Basic earnings per share
|
$
|
1.31
|
|
|
$
|
1.17
|
|
|
$
|
1.03
|
|
Diluted earnings per share
|
$
|
1.29
|
|
|
$
|
1.14
|
|
|
$
|
1.00
|
|
Shares excluded from calculation of diluted EPS
|
2
|
|
|
—
|
|
|
239
|
|
14—SHARE-BASED COMPENSATION
Share-Based Compensation Expense
—The Company accounts for share-based compensation in accordance with ASC Topic 718,
Compensation—Stock Compensation
. Share-based compensation was recognized as follows in the consolidated statement of income (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
|
2014
|
Cost of revenue
|
$
|
219
|
|
|
$
|
156
|
|
|
$
|
143
|
|
Marketing and selling
|
821
|
|
|
808
|
|
|
977
|
|
Research and development
|
1,515
|
|
|
1,264
|
|
|
664
|
|
General and administrative
|
6,453
|
|
|
4,725
|
|
|
4,278
|
|
Total expense
|
9,008
|
|
|
6,953
|
|
|
6,062
|
|
Stock Awards Plans
—Natus' 2011 Stock Awards Plan (the “Plan”) provides for the granting of the following:
|
|
•
|
Incentive stock options to employees;
|
|
|
•
|
Non-statutory stock options to employees, directors and consultants;
|
|
|
•
|
Restricted stock awards and restricted stock units;
|
|
|
•
|
Stock appreciation rights.
|
As of
December 31, 2016
, there were
1,098,514
shares available for future awards under the plan.
Under the Plan, stock options may be issued at not less than the fair market value of the common stock on the date of grant, as determined by the Board of Directors. Options issued under the Plan become exercisable as determined by the Board of Directors and expire no more than
six
years after the date of grant. Most options vest ratably over
four
years.
Stock Option Activity
—Stock option activity under the stock awards plans for the year ended
December 31, 2016
is summarized as follows:
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
Weighted
Average
Exercise Price
|
Outstanding, December 31, 2015 (737,032 shares exercisable at a weighted average exercise price of $14.40 per share)
|
1,105,182
|
|
|
$
|
15.07
|
|
Granted
|
—
|
|
|
$
|
—
|
|
Exercised
|
(151,142
|
)
|
|
$
|
15.01
|
|
Forfeited
|
(18,600
|
)
|
|
$
|
17.62
|
|
Expired
|
(2,500
|
)
|
|
$
|
16.78
|
|
Outstanding, December 31, 2016 (816,691 shares exercisable at a weighted average exercise price of $14.54 per share)
|
932,940
|
|
|
$
|
15.02
|
|
As of
December 31, 2016
, unrecognized compensation related to the unvested portion of stock options was approximately
$0.6 million
, which is expected to be recognized over a weighted average period of
0.8
years. The intrinsic value of options exercised, representing the difference between the closing stock price of common stock on the date of the exercise and the exercise price, in the years ended
December 31, 2016
,
2015
and
2014
was
$3.4 million
,
$17.7 million
, and
$20.6 million
, respectively.
As of
December 31, 2016
, there were: (i)
930,544
options vested and expected to vest with a weighted average exercise price of
$15.01
, an intrinsic value of
$18.4 million
, and a weighted average remaining contractual term of
2.1
years; and (ii)
816,691
options exercisable with a weighted average exercise price of
$14.54
, an intrinsic value of
$16.5 million
, and a weighted average remaining contractual term of
2.0
years.
The expected life of options is based primarily on historical share option exercise experience of the employees for options granted by the Company. All options are treated as a single group in the determination of expected life, as the Company does not currently expect substantially different exercise or post-vesting termination behavior among the employee population. The risk-free interest rate is based on the U.S. Treasury yield for a term consistent with the expected life of the awards in effect at the time of grant. Expected volatility is based primarily on historical volatility data of the Company's common stock. The Company has no history or expectation of paying dividends on common stock.
Share-based compensation expense associated with options is based on awards ultimately expected to vest. At the time of an option grant, the Company estimates the expected future rate of forfeitures based on historical experience. These estimates are revised, if necessary, in subsequent periods if actual forfeiture rates differ from those estimates. If the actual forfeiture rate is lower than estimated the Company will record additional expense and if the actual forfeiture is higher than estimated the Company will record a recovery of prior expense.
Restricted Stock Awards Activity
—The following table summarizes the activity for restricted stock awards during the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
|
Shares
|
|
Weighted
Average
Grant
Date Fair
Value
|
Unvested at December 31, 2015
|
535,208
|
|
|
$
|
24.87
|
|
Granted
|
205,234
|
|
|
$
|
44.22
|
|
Vested
|
(212,811
|
)
|
|
$
|
19.75
|
|
Forfeited
|
(21,242
|
)
|
|
$
|
26.69
|
|
Unvested at December 31, 2016
|
506,389
|
|
|
$
|
34.82
|
|
As of
December 31, 2016
, unrecognized compensation related to the unvested portion of stock awards was
$9.2 million
, which is expected to be recognized over a weighted average period of
2.2
years. The fair market value of outstanding restricted stock awards at
December 31, 2016
was
$17.6 million
. For the restricted stock awards units that vested during the years ended
December 31, 2016
,
2015
, and
2014
, the total intrinsic value was
$9.0 million
,
$10.3 million
, and
$6.0 million
, respectively.
Restricted Stock Units Activity
—The following table summarizes restricted stock units activity for the year ended
December 31, 2016
:
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
|
|
|
|
|
|
|
|
|
Shares
|
|
Weighted
Average
Grant
Date Fair
Value
|
Outstanding at December 31, 2015
|
45,483
|
|
|
$
|
24.57
|
|
Awarded
|
11,860
|
|
|
$
|
45.23
|
|
Released
|
(24,687
|
)
|
|
$
|
21.52
|
|
Forfeited
|
(2,753
|
)
|
|
$
|
26.42
|
|
Outstanding at December 31, 2016
|
29,903
|
|
|
$
|
34.39
|
|
As of
December 31, 2016
, unrecognized compensation related to the unvested portion of stock units was
$0.5 million
, which is expected to be recognized over a weighted average period of
1.6
years. The aggregate intrinsic value of outstanding restricted stock units at
December 31, 2016
was
$1.0 million
. For the restricted stock units that vested during the years ended
December 31, 2016
,
2015
, and
2014
, the total intrinsic value was
$0.9 million
,
$0.9 million
, and
$0.4 million
, respectively.
Employee Stock Purchase Plan
—Under Natus' 2011 Employee Stock Purchase Plan (the “ESPP”), U.S. employees can elect to have salary withholdings of up to
15%
of eligible compensation to a maximum of
$10,625
per offering period, to purchase shares of common stock on April 30 and October 31 of each year. The purchase price for shares acquired under the ESPP is
85%
of the fair market value on the last day of the offering period. As of
December 31, 2016
, there were
165,740
shares reserved for future issuance under the ESPP.
Because the ESPP does not have a “look back” feature, the compensation expense associated with the Plan is not measured by the use of the Black-Scholes pricing model, but rather by measuring the difference between the fair market value of common stock on the last day of the offering period and the purchase price for the offering period, which is
85%
of the fair market value. Compensation expense associated with the ESPP for the years ended
December 31, 2016
,
2015
and
2014
, respectively, was
$0.2 million
,
$0.2 million
, and
$0.2 million
.
15—RESTRUCTURING RESERVE
The Company has historically incurred an ongoing level of restructuring-type activities to maintain a competitive cost structure, including manufacturing and workforce optimization resulting from acquisitions.
The balance of the restructuring reserve is included in accrued liabilities on the accompanying consolidated balance sheets. Employee termination benefits are included as a part of restructuring expenses.
Activity in the restructuring reserves for these plans for the years ended
December 31, 2016
,
2015
and
2014
is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Personnel
Related
|
|
Facility
Related
|
|
Total
|
Balance as of December 31, 2013
|
$
|
335
|
|
|
—
|
|
|
$
|
335
|
|
Additions
|
1,209
|
|
|
680
|
|
|
1,889
|
|
Reversals
|
(52
|
)
|
|
—
|
|
|
(52
|
)
|
Payments
|
(1,124
|
)
|
|
(680
|
)
|
|
(1,804
|
)
|
Balance as of December 31, 2014
|
368
|
|
|
—
|
|
|
368
|
|
Additions
|
1,905
|
|
|
156
|
|
|
2,061
|
|
Reversals
|
(124
|
)
|
|
—
|
|
|
(124
|
)
|
Payments
|
(473
|
)
|
|
(156
|
)
|
|
(629
|
)
|
Balance as of December 31, 2015
|
1,676
|
|
|
—
|
|
|
1,676
|
|
Additions
|
1,093
|
|
|
725
|
|
|
1,818
|
|
Reversals
|
(436
|
)
|
|
—
|
|
|
(436
|
)
|
Payments
|
(1,990
|
)
|
|
(573
|
)
|
|
(2,563
|
)
|
Balance as of December 31, 2016
|
$
|
343
|
|
|
152
|
|
|
$
|
495
|
|
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
16—OTHER INCOME (EXPENSE), NET
Other income (expense), net consists of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Interest income
|
$
|
315
|
|
|
$
|
27
|
|
|
$
|
119
|
|
Interest expense
|
(430
|
)
|
|
(352
|
)
|
|
(438
|
)
|
Foreign currency loss
|
(359
|
)
|
|
(1,415
|
)
|
|
(37
|
)
|
Other
|
117
|
|
|
676
|
|
|
514
|
|
Total other income (expense), net
|
$
|
(357
|
)
|
|
$
|
(1,064
|
)
|
|
$
|
158
|
|
17—INCOME TAXES
Income before provision for income tax is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
U.S.
|
$
|
68
|
|
|
$
|
20,507
|
|
|
$
|
16,621
|
|
Foreign
|
54,835
|
|
|
31,902
|
|
|
29,388
|
|
Income before provision for income tax
|
$
|
54,903
|
|
|
$
|
52,409
|
|
|
$
|
46,009
|
|
The components of income tax expense for the years ended
December 31, 2016
,
2015
and
2014
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Current
|
|
|
|
|
|
U.S. Federal
|
$
|
(1,388
|
)
|
|
$
|
13,497
|
|
|
$
|
6,514
|
|
U.S. State and local
|
692
|
|
|
1,984
|
|
|
1,082
|
|
Non-U.S.
|
15,069
|
|
|
2,239
|
|
|
6,874
|
|
Total current tax expense
|
14,373
|
|
|
17,720
|
|
|
14,470
|
|
Deferred
|
|
|
|
|
|
U.S. Federal
|
(1,534
|
)
|
|
(3,410
|
)
|
|
(728
|
)
|
U.S. State and local
|
(378
|
)
|
|
(385
|
)
|
|
(37
|
)
|
Non-U.S.
|
(152
|
)
|
|
560
|
|
|
(174
|
)
|
Total deferred tax benefit
|
(2,064
|
)
|
|
(3,235
|
)
|
|
(939
|
)
|
Total income tax expense
|
$
|
12,309
|
|
|
$
|
14,485
|
|
|
$
|
13,531
|
|
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets and liabilities as of
December 31, 2016
and
2015
are as follows (in thousands):
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Deferred tax assets:
|
|
|
|
Net operating loss carryforwards
|
$
|
6,557
|
|
|
$
|
5,174
|
|
Credit carryforwards
|
2,512
|
|
|
2,078
|
|
Accruals deductible in different periods
|
16,157
|
|
|
18,721
|
|
Employee benefits
|
2,389
|
|
|
2,081
|
|
Total deferred tax assets
|
27,615
|
|
|
28,054
|
|
Valuation allowance
|
(3,706
|
)
|
|
(3,972
|
)
|
Total net deferred tax assets
|
$
|
23,909
|
|
|
$
|
24,082
|
|
Deferred tax liabilities:
|
|
Basis difference in fixed and intangible assets
|
(12,678
|
)
|
|
(15,197
|
)
|
Total deferred tax liabilities
|
(12,678
|
)
|
|
(15,197
|
)
|
Total net deferred tax assets
|
$
|
11,231
|
|
|
$
|
8,885
|
|
The income tax expense in the accompanying statements of income differs from the provision calculated by applying the U.S. federal statutory income tax rate of
35%
in
2016
,
2015
, and
2014
to income before taxes due to the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Federal statutory tax expense
|
$
|
19,216
|
|
|
$
|
18,343
|
|
|
$
|
16,103
|
|
State tax expense
|
188
|
|
|
1,249
|
|
|
892
|
|
Foreign taxes at rates less than U.S. rates
|
(6,838
|
)
|
|
(1,760
|
)
|
|
(3,097
|
)
|
Deferred charges on sales of U.S. intellectual property
|
980
|
|
|
(5,878
|
)
|
|
—
|
|
Equity compensation
|
(530
|
)
|
|
204
|
|
|
93
|
|
Tax credits
|
(911
|
)
|
|
(935
|
)
|
|
(862
|
)
|
Uncertain tax position
|
485
|
|
|
3,897
|
|
|
1,163
|
|
Lapse of statute
|
(495
|
)
|
|
(784
|
)
|
|
(652
|
)
|
Change of valuation allowance on foreign tax credit
|
—
|
|
|
—
|
|
|
(491
|
)
|
Earnout adjustment
|
(1,184
|
)
|
|
—
|
|
|
—
|
|
Tax audits
|
543
|
|
|
—
|
|
|
—
|
|
Other
|
855
|
|
|
149
|
|
|
382
|
|
Total expense
|
$
|
12,309
|
|
|
$
|
14,485
|
|
|
$
|
13,531
|
|
At
December 31, 2016
, the Company had U.S. federal and state net operating loss carryforwards of
$7.7 million
and
$7.9 million
, respectively. These net operating loss carryforwards will begin to expire in
2036
and
2017
, respectively. As
December 31, 2016
, the Company had U.S. federal and state R&D credit carryforwards of
$0.5 million
and
$0.2 million
, respectively. These R&D credit carryforwards will begin to expire in 2036 and 2021, respectively. At
December 31, 2016
, the Company had
$1.7 million
of U.S. foreign tax credit carryforwards that can be used to offset future U.S. tax liabilities related to foreign source taxable income. The foreign tax credits will start to expire in 2022.
At
December 31, 2016
, certain foreign subsidiaries had deferred tax assets attributable to net operating loss carryforwards as follows:
$1.9 million
in France,
$0.7 million
in Canada, and
$0.5 million
in United Kingdom. These foreign net operating loss carryforwards, if not utilized to offset taxable income in future periods, will expire in various amounts beginning in 2028.
A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Accordingly, valuation allowances of
$3.7 million
and
$4.0 million
were recorded at
December 31, 2016
and
2015
, respectively. The decrease of
$0.3 million
of valuation allowance was primarily due to a partial release of valuation allowance against the Company's net operating loss carryforward in the United Kingdom.
The realizability of the deferred tax assets is primarily dependent on the Company's ability to generate sufficient taxable income in future periods. The Company's management weighed the aggregate effect of all positive evidence and negative evidence in determining the likelihood of realization of the deferred tax assets. The factors used by management to collect evidence included historical earnings of the applicable taxing jurisdiction, the cash refund opportunity to utilize the tax losses, and the future forecast
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
of profitability in the jurisdiction. Weighing all the positive and negative evidence, the Company has recorded a valuation allowance related primarily to net operating losses in certain foreign jurisdictions and U.S. foreign tax credits where it is more likely than not that the tax benefit of the net operating losses and tax credits will not be realized.
The Company elected to early adopt ASU 2016-09 in the first quarter of 2016 which was applied using a modified retrospective approach. For the year ended
December 31, 2016
, the Company recorded all excess tax benefits and tax deficiencies as income tax expense or benefit. The Company receives tax deductions from the gains recognized by employees on the exercise of certain non-qualified stock options, vesting activities related to restricted shares and certain non-qualified disposition of shares acquired from employee stock purchase plan program. During the year to
December 31, 2016
, the Company recorded a tax benefit resulting from the tax deduction of
$1.9 million
and
$0.3 million
tax expense from shortfall transactions in writing off certain deferred tax assets.
The Company has not provided for U.S. federal income and foreign withholding taxes on the majority of undistributed earnings from non-U.S. operations because such earnings are intended to be reinvested indefinitely outside of the U.S. As of
December 31, 2016
, the amount of undistributed earnings for which no taxes were provided was
$147.0 million
. The Company intends to reinvest these earnings in foreign subsidiaries in these regions for foreign acquisitions. If these earnings were distributed to the U.S. in the form of dividends or otherwise, the Company would be subject to additional U.S. income taxes and foreign withholding taxes. As of
December 31, 2016
, the tax impact of undistributed earnings from non-U.S. operations has not been estimated as the determination is not practicable. The Company's foreign subsidiaries held
$155.8 million
of cash and short term investments out of the Company's total cash and short term investments of
$248.0 million
. If the foreign earnings were repatriated, the cash and short term investments available for other foreign financing activities will be reduced by the foreign withholding taxes paid on the repatriation of earnings in these regions.
Uncertain Tax Positions
A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding interest and penalties) is as follows (in thousands):
|
|
|
|
|
Balance at January 1, 2014
|
$
|
3,387
|
|
Increases for tax positions related to prior years
|
493
|
|
Increases for tax positions related to the current year
|
73
|
|
Lapse of statutes of limitations
|
(558
|
)
|
Balance at January 1, 2015
|
$
|
3,395
|
|
Increases for tax positions related to prior years
|
281
|
|
Increases for tax positions related to the current year
|
3,302
|
|
Lapse of statutes of limitations
|
(664
|
)
|
Balance at January 1, 2016
|
$
|
6,314
|
|
Increases for tax positions related to prior years
|
174
|
|
Increases for tax positions related to the current year
|
70
|
|
Lapse of statutes of limitations
|
(475
|
)
|
Foreign exchange difference
|
(185
|
)
|
Balance at December 31, 2016
|
$
|
5,898
|
|
For the year ended
December 31, 2016
, unrecognized tax benefits decreased by
$0.4 million
and
$0.2 million
of tax benefits in the income tax provision were recorded. The decrease was primarily attributable to the lapse of applicable statute of limitations in certain jurisdictions.
The unrecognized tax benefits for the tax years ended
December 31, 2016
,
2015
and
2014
were
$5.9 million
,
$6.3 million
and
$3.4 million
, respectively which include
$2.5 million
,
$2.4 million
and
$2.0 million
, respectively that would impact the effective tax rate if recognized.
The Company expects a range from
zero
to
$1.5 million
of unrecognized tax benefit that will impact the effective tax rate in the next
12 months
due to the lapse of statute of limitations provided that no taxing authority conducts a new examination.
At
December 31, 2016
,
2015
and
2014
, the Company had cumulatively accrued
$0.6 million
,
$0.4 million
, and
$0.3 million
for estimated interest and penalties related to uncertain tax positions. The Company records interest and penalties related to
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
unrecognized tax positions as a component of income tax expense (benefit), which totaled
$0.2 million
,
$0.1 million
, and
$0.0 million
for the years ended
December 31, 2016
,
2015
, and
2014
, respectively.
The Company is currently unaware of any uncertain tax positions that could result in significant additional payments, accruals, or other material deviation in this estimate over the next
12 months
.
The Company's tax returns remain open to examination as follows: U.S. federal,
2013
through
2016
; U.S. states, generally
2012
through
2016
; and significant foreign jurisdictions, generally
2012
through
2016
.
18—EMPLOYEE BENEFIT PLAN
The Company offers pre-tax and after-tax 401(k) savings plan options under which eligible U.S. employees may elect to have a portion of their salary deferred and contributed to the plan. Employer matching contributions are determined by management and are discretionary. Employer matching contributions were
$1.5 million
,
$1.3 million
, and
$1.2 million
respectively, in the years ended
December 31, 2016
,
2015
, and
2014
. For new hires, employer contributions vest ratably over the first two years of employment.
19—SEGMENT, CUSTOMER, AND GEOGRAPHIC INFORMATION
The Company operates in one reportable segment, which is presented as the aggregation of the Neurology and Newborn Care operating segments. Through the
one
reportable segment the Company is organized on the basis of the healthcare products and services provided which are used for the screening, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, and sleep disorders.
End-users customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies. Most of the Company's international sales are to distributors who resell products to end users or sub-distributors. The Company's foreign countries’ revenue is determined based on the customer’s billing address.
Revenue and long-lived asset information by geographic region is as follows (in thousands):
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Revenue:
|
|
United States
|
$
|
250,694
|
|
|
$
|
242,050
|
|
|
$
|
215,543
|
|
Foreign countries
|
131,198
|
|
|
133,815
|
|
|
140,291
|
|
|
$
|
381,892
|
|
|
$
|
375,865
|
|
|
$
|
355,834
|
|
Revenue by Operating Segment:
|
|
Neurology
|
|
Devices and Systems
|
$
|
168,200
|
|
|
$
|
168,776
|
|
|
$
|
173,006
|
|
Supplies
|
58,681
|
|
|
60,205
|
|
|
59,666
|
|
Services
|
11,641
|
|
|
8,320
|
|
|
—
|
|
Total Neurology Revenue
|
$
|
238,522
|
|
|
$
|
237,301
|
|
|
$
|
232,672
|
|
Newborn Care
|
|
Devices and Systems
|
$
|
72,562
|
|
|
$
|
72,669
|
|
|
$
|
67,354
|
|
Supplies
|
47,674
|
|
|
49,982
|
|
|
48,697
|
|
Services
|
23,134
|
|
|
15,913
|
|
|
7,111
|
|
Total Newborn Care Revenue
|
$
|
143,370
|
|
|
$
|
138,564
|
|
|
$
|
123,162
|
|
Total Revenue
|
$
|
381,892
|
|
|
$
|
375,865
|
|
|
$
|
355,834
|
|
Property and equipment, net:
|
|
United States
|
$
|
7,024
|
|
|
$
|
6,664
|
|
|
|
|
Canada
|
4,941
|
|
|
5,165
|
|
|
|
|
Ireland
|
2,530
|
|
|
1,651
|
|
|
|
|
Argentina
|
2,121
|
|
|
2,361
|
|
|
|
|
Other foreign countries
|
717
|
|
|
1,126
|
|
|
|
|
|
$
|
17,333
|
|
|
$
|
16,967
|
|
|
|
During the years ended
December 31, 2016
,
2015
and
2014
, no single customer or foreign country contributed to more than
10%
of revenue.
20—COMMITMENTS AND CONTINGENCIES
Leases
—The Company has entered into noncancelable operating leases for some of the facilities including related office equipment located in the U.S. and Europe through 2024. Minimum lease payments under noncancelable operating leases as of December 31, 2016 are as follows (in thousands):
|
|
|
|
|
|
Operating
Leases
|
Year Ending December 31,
|
|
2017
|
$
|
3,985
|
|
2018
|
3,186
|
|
2019
|
2,996
|
|
2020
|
2,590
|
|
2021
|
2,250
|
|
Thereafter
|
2,838
|
|
Total minimum lease payments
|
$
|
17,845
|
|
Rent expense, which is recorded on the straight-line method from commencement over the period of the lease, totaled
$5.3 million
,
$4.4 million
and
$4.3 million
in
2016
,
2015
, and
2014
, respectively.
Purchase commitments
—The Company has various purchase obligations for goods or services totaling
$48.8 million
at
December 31, 2016
, which are expected to be paid within the next year.
Indemnifications
—Under the bylaws, the Company has agreed to indemnify the officers and directors for certain events or occurrences arising as a result of the officer or director serving in such capacity. The Company has a director and officer liability insurance policy that limits the exposure under these indemnifications and enables them to recover a portion of any future loss arising out of them. In addition, the Company entered into indemnification agreements with other parties in the ordinary course of business. The Company has determined that these agreements fall within the scope of ASC 460,
Guarantees
. In some cases liability insurance is obtained to provide coverage that limits its exposure for these other indemnified matters. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. The Company believes the estimated fair value of these indemnification agreements is minimal and have not recorded a liability for these agreements as of
December 31, 2016
.
Legal matters
—The Company may from time to time become a party to various legal proceedings or claims that arise in the ordinary course of business. The Company does not believe that any current legal or administrative proceedings are likely to have a material effect on business, financial condition, or results of operations.
On January 30, 2017, an alleged class action entitled
Badger v. Natus Medical Incorporated, et al.
, No. 3:17-cv-00458-JSW, was filed in the United States District Court for the Northern District of California against the Company and two of our officers. The suit asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 for allegedly misleading statements regarding our business (including a contract entered into by a subsidiary of the Company), guidance and financial results. The suit is purportedly brought on behalf of purchasers of our common stock between October 16, 2015 and April 3, 2016, and seeks compensatory damages, fees and costs. The Company believes the claims are without merit and intend to defend them vigorously. Due to the inherent uncertainties of litigation, the Company cannot accurately predict the ultimate outcome of this manner. The Company is unable at this time to determine whether the outcome of the litigation would have a material impact on results of operations, financial condition or cash flow.
21—FAIR VALUE MEASUREMENTS
ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined under ASC 820 as the exit price associated with the sale of an asset or transfer of a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes the following three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value:
Level 1
—Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
Level 2—
Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
—Unobservable inputs that are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
The Company does not have any financial assets or liabilities measured at fair value on a recurring basis.
The following financial instruments are not measured at fair value on the consolidated balance sheet as of
December 31, 2016
and
2015
, but require disclosure of fair values: cash and cash equivalents, accounts receivable, and accounts payable. The carrying value of these financial instruments approximates fair values because of the relatively short maturity.
During the third quarter of 2014, the Company listed the facility in Mundelein, Illinois for sale. This asset was measured at fair value less cost to sell as of September 30, 2014 based on market price and Level 2 inputs. The book value of this asset on June 30, 2014 was
$3.6 million
. The Company expensed
$2.2 million
during the third quarter of 2014 for this impairment. As of December 31, 2016 the Company is carrying the asset as held for sale its fair value of
$1.4 million
.
For the year ended December 31, 2014 the Company recorded a charge of
$0.6 million
, related to impairment of trademarks and trade names. The Company measures these non-financial assets at fair value on a nonrecurring basis subsequent to the initial recognition. The fair value of these non-financial assets was measured using Level 3 inputs. See Note 6—
Intangible Assets
.
The Company also has contingent consideration associated with earnouts from acquisitions. Contingent consideration liabilities are classified as Level 3 liabilities, as the Company use unobservable inputs to value them, which is a probability-based income approach. Contingent considerations are classified as accrued liabilities on the consolidated balance sheets.
NATUS MEDICAL INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Years Ended December 31, 2016, 2015 and 2014
Subsequent changes in the fair value of contingent consideration liabilities are recorded within the income statement as an operating expense.
Contingent consideration associated with earnouts from acquisitions is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Additions
|
|
Payments
|
|
Adjustments
|
|
December 31, 2016
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
$
|
6,209
|
|
|
$
|
2,500
|
|
|
$
|
(2,284
|
)
|
|
$
|
(3,382
|
)
|
|
$
|
3,043
|
|
Total
|
$
|
6,209
|
|
|
$
|
2,500
|
|
|
$
|
(2,284
|
)
|
|
$
|
(3,382
|
)
|
|
$
|
3,043
|
|
The significant unobservable inputs used in the fair value measurement of contingent consideration related to the acquisitions are annualized revenue forecasts developed by the Company considering the probability of achievement of those revenue forecasts. Significant increases (decreases) in these unobservable inputs in isolation would result in a significantly lower (higher) fair value measurement.
The Company's Level 2 securities are valued using third-party pricing sources. The pricing services utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities, issuer credit spread, benchmark securities, prepayment/default projections based on historical data and other observable inputs. The Company validates the prices provided by its third-party pricing services by understanding the models used, obtaining market values from other pricing sources, analyzing pricing data in certain instances and confirming those securities traded in active markets. See Note 4 to these Consolidated Financial Statements for further information regarding the Company's financial instruments.
Short term investments are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Level I
|
|
Level II
|
|
Level III
|
|
Total
|
Short term investments
|
|
|
|
|
|
|
|
U.S. Treasury Bills
|
—
|
|
|
7,688
|
|
|
—
|
|
|
7,688
|
|
U.S. investment grade bonds
|
—
|
|
|
16,789
|
|
|
—
|
|
|
16,789
|
|
Developed investment grade bonds
|
—
|
|
|
9,542
|
|
|
—
|
|
|
9,542
|
|
Total short term investments
|
—
|
|
|
34,019
|
|
|
—
|
|
|
34,019
|
|
22—SUBSEQUENT EVENTS
Pursuant to a Purchase Agreement that was entered into on September 26, 2016, the Company completed the acquisition of the Otometrics business from GN Store Nord A/S on January 3, 2017 for a cash purchase price of
$149.2 million
, including
$4.2 million
of net working capital adjustment. Otometrics is a manufacturer of hearing diagnostics and balance assessment equipment, disposables & software. Otometrics provides computer-based audiological, otoneurologic and vestibular instrumentation and sound rooms to hearing and balance care professionals worldwide. Otometrics has a complete product and brand portfolio known for its sophisticated design technology in the hearing and balance assessment markets.
The Company will account for the acquisition under the acquisition method of accounting for business combinations. The results of Otometrics will be included in the Company’s results of operations beginning on January 3, 2017. Upon receipt of the Otometrics opening balance sheet as of January 3, 2017, the Company, with assistance from independent valuation specialists, will allocate the purchase price to acquired tangible assets and assumed liabilities, and identified intangible assets based on their respective fair values. Approximately
$1.5 million
of direct costs associated with the Otometrics acquisition were charged to general and administrative expense during the year ended December 31, 2016. Purchase price allocation is currently being determined at this time.
The Company funded the Otometrics acquisition with a combination of existing cash and borrowings under the revolving credit facility.
ITEM 16. Form 10-K Summary
Not Applicable.