Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

¨ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 000-33001

 

 

NATUS MEDICAL INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   77-0154833

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1501 Industrial Road, San Carlos, CA 94070

(Address of principal executive offices) (Zip Code)

(650) 802-0400

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of issued and outstanding shares of the registrant’s Common Stock, $0.001 par value, as of October 31, 2013 was 30,963,777.

 

 

 


Table of Contents

NATUS MEDICAL INCORPORATED

TABLE OF CONTENTS

 

         Page No.  
PART I.   FINANCIAL INFORMATION      3   
Item 1.   Financial Statements      3   
 

Condensed Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012 (unaudited)

     3   
 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2013 and 2012 (unaudited)

     4   
 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012 (unaudited)

     5   
  Notes to Condensed Consolidated Financial Statements (unaudited)      6   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      17   
Item 3.   Quantitative and Qualitative Disclosures about Market Risk      25   
Item 4.   Controls and Procedures      26   
PART II.   OTHER INFORMATION      27   
Item 1.   Legal Proceedings      27   
Item 1A.   Risk Factors      27   
Item 6.   Exhibits      28   
Signatures      29   

 

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PART I.    FINANCIAL INFORMATION

Item 1.    Financial Statements

NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share and per share amounts)

 

     September 30,
2013
    December 31,
2012
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 44,192      $ 23,057   

Accounts receivable, net of allowance for doubtful accounts of $3,863 in 2013 and $2,617 in 2012

     84,803        89,960   

Inventories

     39,376        40,756   

Prepaid expenses and other current assets

     5,835        6,379   

Deferred income tax

     8,400        8,719   
  

 

 

   

 

 

 

Total current assets

     182,607        168,871   

Property and equipment, net

     24,425        26,512   

Intangible assets

     102,377        96,594   

Goodwill

     97,323        92,048   

Other assets

     9,037        7,828   
  

 

 

   

 

 

 

Total assets

   $ 415,768      $ 391,853   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 26,497      $ 32,537   

Short-term borrowings

     —          11,300   

Current portion of long-term debt

     10,563        8,526   

Accrued liabilities

     25,922        32,938   

Deferred revenue

     12,449        13,305   
  

 

 

   

 

 

 

Total current liabilities

     75,431        98,606   

Long-term liabilities:

    

Long-term debt, net of current portion

     37,500        13,034   

Other liabilities

     3,759        3,038   

Deferred income tax

     10,366        8,423   
  

 

 

   

 

 

 

Total liabilities

     127,056        123,101   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common Stock, $0.001 par value, 120,000,000 shares authorized; shares issued and outstanding 30,880,758 in 2013 and 30,106,933 in 2012

     284,288        275,395   

Retained earnings

     25,387        11,638   

Accumulated other comprehensive loss

     (20,963     (18,281
  

 

 

   

 

 

 

Total stockholders’ equity

     288,712        268,752   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 415,768      $ 391,853   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(unaudited)

(in thousands, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2013     2012     2013     2012  

Revenue

   $ 85,392      $ 81,019      $ 253,475      $ 201,459   

Cost of revenue

     34,058        36,456        104,518        89,237   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     51,334        44,563        148,957        112,222   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Marketing and selling

     20,337        21,805        64,305        54,693   

Research and development

     7,536        8,513        24,337        21,844   

General and administrative

     14,323        18,811        40,160        39,206   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     42,196        49,129        128,802        115,743   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     9,138        (4,566     20,155        (3,521

Other income (expense), net

     (580     (218     (1,437     259   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for income tax

     8,558        (4,784     18,718        (3,262

Provision for income tax (benefit) expense

     2,271        (3,037     4,969        (2,128
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 6,287      $ (1,747   $ 13,749      $ (1,134
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign currency translation adjustment

     646        147        (2,683     (1,813
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 6,933      $ (1,600   $ 11,066      $ (2,947
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per share:

        

Basic

   $ 0.21      $ (0.06   $ 0.46      $ (0.04
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.20      $ (0.06   $ 0.45      $ (0.04
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares used in the calculation of earnings (loss) per share:

        

Basic

     30,096        29,062        29,825        28,947   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     30,790        29,062        30,576        28,947   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

 

     Nine Months Ended
September 30,
 
     2013     2012  

Operating activities:

    

Net income (loss)

   $ 13,749      $ (1,134

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     9,554        9,356   

Provision for losses on accounts receivable

     446        195   

Warranty reserve

     818        540   

Loss on disposal of property and equipment

     141        80   

Share-based compensation

     4,608        5,007   

Excess tax benefit on the exercise of stock options

     (637     (125

Changes in operating assets and liabilities:

    

Accounts receivable

     7,105        (12,827

Inventories

     (1,428     5,154   

Prepaid expenses and other assets

     (281     (4,219

Accounts payable

     (5,880     9,201   

Deferred income tax

     (1,176     7   

Accrued liabilities and deferred revenue

     (6,365     5,803   

Liabilities acquired in acquisitions

     61        0   
  

 

 

   

 

 

 

Net cash provided by operating activities

     20,715        17,038   
  

 

 

   

 

 

 

Investing activities:

    

Acquisition of businesses, net of cash acquired

     (18,600     (57,632

Purchases of property and equipment

     (597     (3,799

Purchase of intangible assets

     (1,815     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (21,012     (61,431
  

 

 

   

 

 

 

Financing activities:

    

Proceeds from stock option exercises and ESPP purchases

     5,097        970   

Excess tax benefit on the exercise of stock options

     637        125   

Proceeds from short-term borrowings

     —          7,300   

Proceeds from long-term borrowings

     57,383        25,000   

Payments on borrowings

     (42,182     (2,230
  

 

 

   

 

 

 

Net cash provided by financing activities

     20,935        31,165   
  

 

 

   

 

 

 

Exchange rate changes effect on cash and cash equivalents

     497        (88
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     21,135        (13,316

Cash and cash equivalents, beginning of period

     23,057        32,816   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 44,192      $ 19,500   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid for interest

   $ 1,084      $ 215   
  

 

 

   

 

 

 

Cash paid for income taxes

   $ 9,861      $ 5,007   
  

 

 

   

 

 

 

Non-cash investing activities:

    

Property and equipment included in accounts payable

   $ 79      $ 1,919   
  

 

 

   

 

 

 

Inventory transferred to property and equipment

   $ 885      $ 278   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1 - Basis of Presentation

The accompanying interim condensed consolidated financial statements of Natus Medical Incorporated (“Natus,” “we,” “us,” “our,” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Except as noted below, the accounting policies followed in the preparation of the interim condensed consolidated financial statements are consistent in all material respects with those presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Interim financial reports are prepared in accordance with the rules and regulations of the Securities and Exchange Commission; accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. The interim financial information is unaudited, but reflects all normal adjustments that are, in the opinion of management, necessary for the fair presentation of our financial position, results of operations, and cash flows for the interim periods presented. The condensed consolidated balance sheet as of December 31, 2012 was derived from audited financial statements, but does not include all disclosures required by GAAP. The accompanying financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Operating results for the nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Recent Accounting Pronouncements

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income - In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. (“ASU”) 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This topic requires us to provide information about the amounts reclassified out of accumulated other comprehensive income by component and the line items of net income to which significant amounts are reclassified. This topic is for annual and interim periods beginning after December 15, 2012. The update did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

2 - Business Combinations

Grass Technologies

On February 2, 2013, we completed an asset purchase of the Grass Technologies Product Group (“Grass”) from Astro-Med Inc. for a cash consideration of $18.6 million pursuant to purchase agreement. Grass manufactures and sells clinically differentiated neurodiagnostic and monitoring products, including a portfolio of electroencephalography (EEG) and polysomnography (PSG) systems for both clinical and research use and related accessories and proprietary electrodes. The acquisition strengthened the Company’s existing neurology portfolio and provided new product categories. A total of $624,000 of direct costs associated with the acquisition was expensed as incurred and reported as a component of general and administrative expenses.

The Company has accounted for the acquisition as a business combination. Under the acquisition method of accounting, the assets acquired and liabilities assumed from Grass are recorded in the consolidated financial statements at their respective fair values as of the acquisition date. The excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill. Grass’s results of operations are included in our consolidated financial statements since February 2, 2013, the date of the acquisition.

Valuing certain components of the acquisition, primarily accounts receivable required us to make significant estimates that may be adjusted in the future; consequently, the purchase price allocation is considered preliminary. Final determination of these estimates could result in an adjustment to the preliminary purchase price allocation, with an offsetting adjustment to goodwill. As of September 30, 2013, there have been no adjustments to the preliminary purchase price.

 

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Approximately $5.2 million has been allocated to goodwill. Goodwill is calculated as the difference between the acquisition date fair value of the consideration transferred and the provisional values assigned to the assets acquired and liabilities assumed and represent primarily the expected synergies of combining the operations of the Company and the Grass business. None of the goodwill is expected to be deductible for tax purposes. In accordance with ASC 350-20, goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). As of September 30, 2013, we have not yet tested the Grass goodwill for impairment. In the event that management determines that the value of goodwill has become impaired, we will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.

Grass’s revenue of $3.8 million and $9.7 million and income from operations of $1.1 and $2.1 million are included in our condensed consolidated statements of operations and comprehensive income (loss) for the period from July 1, 2013 to September 30, 2013 and February 2, 2013 (acquisition date) to September 30, 2013, respectively.

Nicolet

We acquired the Nicolet neurodiagnostic business (“Nicolet”) from CareFusion on July 2, 2012 pursuant to a Share and Acquisition Purchase Agreement. The Nicolet business develops clinically differentiated neurodiagnostic and monitoring products, including a portfolio of electroencephalography (EEG) and electromyography (EMG) systems and related accessories, as well as vascular and obstetric Doppler sensors and connectivity products. The acquisition strengthened the Company’s existing neurology portfolio and provided new product categories. The acquisition also better positions the Company in international markets, as over 50 percent of the Nicolet business is in markets outside of the United States.

We acquired all of the outstanding common shares of CareFusion subsidiaries comprising the Nicolet business in the United States, Ireland, and the United Kingdom, and certain assets and liabilities of Nicolet sales divisions principally in China, Brazil, Germany, Italy, the Netherlands, and Spain for $55.5 million. A total of $3.3 million of direct costs associated with the acquisition were expensed as incurred and reported as a component of general and administrative expenses.

The Nicolet acquisition has been accounted for as a business combination. Under the acquisition method of accounting, the assets acquired and liabilities assumed from Nicolet are recorded in the consolidated financial statements at their respective fair values as of the acquisition date. The excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill. Nicolet’s results of operations are included in the consolidated financial statements since July 2, 2012, the date of the acquisition.

During the nine months ending September 30, 2013, we recorded adjustments to the preliminary purchase price allocation for deferred taxes that resulted in a net increase to goodwill of $256,000.

Pro forma financial information

The following unaudited pro forma information combining results of operations of the Company for the nine months ended September 30, 2013 and 2012 are presented as if the acquisitions of Grass and Nicolet had occurred on January 1, 2012:

Unaudited Pro forma Financial Information

(in thousands)

 

     Nine Months Ended
September 30,
 
     2013      2012  

Revenue

   $ 254,480       $ 264,781   

Income (loss) from operations

   $ 21,603       $ (1,298

 

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The unaudited pro forma financial information is provided for comparative purposes only and is not necessarily indicative of what actual results would have been had the acquisitions occurred on the dates indicated, nor does it give effect to synergies, cost savings, and other changes expected to result from the acquisitions. Accordingly, the pro forma financial results do not purport to be indicative of results of operations as of the date hereof, for any period ended on the date hereof, or for any other future date or period.

For purposes of preparing the unaudited pro forma financial information for the period January 1, 2013 through September 30, 2013, Grass’s statement of operations for the period from January 1, 2013 to February 1, 2013 was combined with our consolidated statement of operations and comprehensive income (loss) for the nine months ended September 30, 2013.

For purposes of preparing the unaudited pro forma financial information for the period January 1, 2012 through June 30, 2012, Grass’s statement of operations and Nicolet’s consolidated statement of revenue and direct expenses for the nine months ended September 30, 2012 were combined with our consolidated statement of operations and comprehensive income (loss) for the nine months ended September 30, 2012.

The unaudited pro forma consolidated results for the nine month period ended September 30, 2013 reflect the historical information of Natus and Grass, adjusted for the following pre-tax amounts:

 

    Additional amortization expense of $59,300 related to the fair value of identifiable intangible assets acquired;

 

    Decrease of depreciation expense of $14,800 related to the fair value adjustment to property and equipment acquired;

 

    Decrease in general and administrative expense of $624,000 related to the direct acquisition costs that were recorded in the unaudited pro forma financial information in the nine months ended September 30, 2012.

The unaudited pro forma consolidated results for the nine month period ended September 30, 2012 reflect the historical information of Natus, Grass and Nicolet, adjusted for the following pre-tax amounts:

 

    Elimination of Nicolet’s historical intangible asset amortization expense of approximately $423,000;

 

    Additional amortization expense related to Grass of $535,000 and Nicolet of $564,636 related to the fair value of identifiable intangible assets acquired;

 

    Decrease of Grass’s depreciation expense of approximately $134,000 and Nicolet’s depreciation expense of approximately $782,000 related to the fair value adjustment to property and equipment acquired;

 

    Increase in general and administrative expense relating to Grass’s direct acquisition costs of approximately $624,000 and Nicolet’s direct acquisition costs of $3.3 million;

 

    Increase in cost of goods sold relating to Nicolet’s fair value inventory adjustments of $571,000.

3 - Basic and Diluted Earnings Per Common Share

Basic earnings per share is based upon the weighted average number of common shares outstanding during the period. Diluted earnings 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 our stock awards plans and are calculated under the treasury stock method. Common equivalent shares from unexercised stock options and unvested restricted stock are excluded from the computation when there is a loss as their effect is anti-dilutive or if the exercise price of such unexercised options is greater than the average market price of the stock for the period.

For the three and nine months ended September 30, 2013, common stock equivalents of 694,582 and 752,544 shares, respectively, were included in the weighted average shares outstanding used to calculate diluted earnings per share, while common stock equivalents of 1,657,210 and 1,660,852 shares, respectively, were excluded from the calculation of diluted earnings per share because the exercise price of the underlying options was greater than the average market price of the stock for the period.

For the three and nine months ended September 30, 2012, no common stock equivalent shares were included in the weighted average shares outstanding used to calculate diluted earnings per share because there was a loss in the periods.

 

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4 - Inventories

Inventories consist of the following (in thousands):

 

     September 30,
2013
    December 31,
2012
 

Raw materials and subassemblies

   $ 21,814      $ 21,373   

Work in process

     3,007        3,085   

Finished goods

     19,409        19,795   
  

 

 

   

 

 

 

Total inventories

     44,230        44,253   
  

 

 

   

 

 

 

Less: Non-current inventories

     (4,854     (3,497
  

 

 

   

 

 

 

Inventories, current

   $ 39,376      $ 40,756   
  

 

 

   

 

 

 

At September 30, 2013 and December 31, 2012, the Company has classified $4.9 million and $3.5 million respectively, of inventories, as non-current. This inventory consists primarily of service components used to repair products pursuant to warranty obligations and extended service contracts, including service components for products we are not currently selling. Management believes that these inventories will be utilized for their intended purpose.

5 - Intangible Assets

The following table summarizes the components of gross and net intangible asset balances (in thousands):

 

    September 30, 2013     December 31, 2012  
    Gross
Carrying
Amount
    Accumulated
Impairment
    Accumulated
Amortization
    Net Book
Value
    Gross
Carrying
Amount
    Accumulated
Impairment
    Accumulated
Amortization
    Net Book
Value
 

Intangible assets with definite lives:

               

Technology

  $ 66,380        —        $ (24,161   $ 42,219      $ 63,880        —        $ (20,901   $ 42,979   

Customer related

    32,148        —          (9,563     22,585        26,948        —          (7,563     19,385   

Internally developed software

    11,068        —          (4,816     6,252        9,790        —          (4,045     5,745   

Patents

    2,812        —          (2,016     796        2,812        —          (1,925     887   

Backlog

    724        —          (724     —          724        —          (724     —     
 

 

 

     

 

 

   

 

 

   

 

 

     

 

 

   

 

 

 

Definite-lived intangible assets

    113,132          (41,280     71,852        104,154          (35,158     68,996   

Intangible assets with indefinite lives:

               

Tradenames

    33,770        (1,560     —          32,210        30,778        (1,560     —          29,218   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Intangibles before translation

    146,902        (1,560     (41,280     104,062        134,932        (1,560     (35,158     98,214   

Translation

    (1,964     —          278        (1,687     (1,864     —          244        (1,620
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total intangibles assets

  $ 144,938      $ (1,560   $ (41,002   $ 102,377      $ 133,068      $ (1,560   $ (34,914   $ 96,594   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Definite-lived intangible assets are amortized over their weighted average lives of 15 years for technology, 12 years for customer related intangibles, 7 years for internally developed software, and 14 years for patents. Intangible assets with indefinite lives are not subject to amortization.

Internally developed software consists of $10.1 million relating to costs incurred for development of internal use computer software and $943,000 for development of software to be sold.

Amortization expense related to intangible assets with definite lives was as follows (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2013      2012      2013      2012  

Technology

   $ 1,095       $ 1,034       $ 3,260       $ 2,575   

Customer Related

     678         595         2,000         1,491   

Internally developed software

     262         68         771         1,269   

Patents

     30         60         91         161   

Backlog

     —           712         —           712   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total amortization

   $ 2,065       $ 2,469       $ 6,122       $ 6,208   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Expected amortization expense related to amortizable intangible assets is as follows (in thousands):

 

Three months ending December 31, 2013

   $ 2,032   

2014

     7,922   

2015

     7,581   

2016

     6,747   

2017

     6,364   

2018

     6,193   

Thereafter

     35,013   
  

 

 

 

Total expected amortization expense

   $ 71,852   
  

 

 

 

6 - Goodwill

The carrying amount of goodwill and the changes in those balances are as follows (in thousands):

 

Gross Balance, December 31, 2012

   $ 112,048   

Accumulated impairment losses

     (20,000
  

 

 

 

Balance net of impairment losses, December 31, 2012

     92,048   

Goodwill as a result of acquisitions

     5,607   

Foreign currency translation

     (332
  

 

 

 

Balance, September 30, 2013

   $ 97,323   
  

 

 

 

7 - Property and Equipment, net

Property and equipment, net consist of the following (in thousands):

 

     September 30,
2013
    December 31,
2012
 

Land

   $ 4,232      $ 4,371   

Buildings

     10,737        11,422   

Leasehold improvements

     3,376        3,450   

Office furniture and equipment

     12,182        11,601   

Computer software and hardware

     10,881        10,114   

Demonstration and loaned equipment

     11,372        11,505   
  

 

 

   

 

 

 
     52,780        52,463   

Accumulated depreciation and amortization

     (28,355     (25,951
  

 

 

   

 

 

 

Total

   $ 24,425      $ 26,512   
  

 

 

   

 

 

 

Depreciation and amortization expense of property and equipment was approximately $1.2 and $3.5 million for the three and nine months ended September 30, 2013, respectively, and was approximately $1.0 and $3.2 million for the three and nine months ended September 30, 2012, respectively.

8 - Reserve for Product Warranties

We provide a warranty on all medical device products that is generally one year in length. We also sell extended service agreements on our medical device products that are generally over one year in length. 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 third-party vendors on a contract basis.

We have accrued a warranty reserve, included in accrued liabilities on the accompanying balance sheets, for the expected future costs of servicing products during the initial warranty period. We base the liability on actual warranty costs incurred to service those products. On new products, additions to the reserve are based on a combination of factors including the percentage of service department labor applied to warranty repairs, as well as actual service department costs, and other judgments, such as the degree to which the product incorporates new technology. The reserve is reduced as costs are incurred to honor existing warranty obligations.

 

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Table of Contents

The details of activity in the warranty reserve are as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2013     2012     2013     2012  

Balance, beginning of period

   $ 2,070      $ 2,225      $ 2,260      $ 2,157   

Acquisition warranty assumed

     —          630        191        630   

Warranty accrued for the period

     47        129        818        540   

Repairs for the period

     (83     (500     (1,235     (843
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 2,034      $ 2,484      $ 2,034      $ 2,484   
  

 

 

   

 

 

   

 

 

   

 

 

 

The estimates we use in projecting future product warranty costs may prove to be incorrect. Any future determination that our product warranty reserves are understated could result in increases to our cost of sales and reductions in our operating profits and results of operations.

9 - Share-Based Compensation

At September 30, 2013, we have two active plans that give rise to share-based compensation, the 2011 Stock Awards Plan and the 2011 Employee Stock Purchase Plan. The terms of awards granted during the nine months ended September 30, 2013 and our methods for determining grant-date fair value of the awards were consistent with those described in the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

Detail of share-based compensation expense is as follows (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2013      2012      2013      2012  

Cost of revenue

   $ 14       $ 49       $ 109       $ 161   

Marketing and sales

     202         400         675         927   

Research and development

     175         167         416         380   

General and administrative

     1,037         1,855         3,408         3,539   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,428       $ 2,471       $ 4,608       $ 5,007   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2013, unrecognized compensation expense related to the unvested portion of our stock options and other stock awards was approximately $14.8 million, which is expected to be recognized over a weighted average period of 2.9 years.

Stock Options

Activity in our stock options during the nine months ended September 30, 2013 is as follows:

 

     Shares     Weighted
Average
Exercise
Price
     Weighted-
average
remaining
contractual life
(years)
     Aggregate
intrinsic
value

($ 000’s)
 

Outstanding, beginning of period

     3,882,239      $ 11.71         

Granted

     626,420      $ 14.08         

Exercised

     (562,688   $ 8.09         

Cancelled

     (642,243   $ 15.52         
  

 

 

         

Outstanding, end of period

     3,303,728      $ 12.03         4.0       $ 10,059   
  

 

 

         

Exercisable, end of period

     2,198,970      $ 11.38         2.2       $ 8,647   
  

 

 

         

Vested and expected to vest, end of period

     3,138,903      $ 11.97         3.8       $ 9,859   
  

 

 

         

 

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Table of Contents

The intrinsic value of options exercised during the nine months ended September 30, 2013 was $3.4 million.

Restricted Stock Awards

Activity in our restricted stock awards (“RSAs”) during the nine months ended September 30, 2013 is as follows:

 

     Shares     Weighted-
average grant
date fair
value
     Remaining cost
expected to be
recognized

($ 000’s)
 

Unvested, beginning of period

     690,890      $ 13.02      

Granted

     311,180      $ 14.06      

Vested

     (226,395   $ 13.92      

Forfeited

     (150,020   $ 12.87      
  

 

 

      

Unvested, end of period

     625,655      $ 13.27       $ 9.2   
  

 

 

      

We award restricted stock awards to U.S. employees of the Company that vest 50% upon the second anniversary of the vesting start date and 25% upon each of the third and fourth anniversaries of the vesting start date. We also award RSA’s to non-employee directors of the Company that vest on the first anniversary of the grant date.

At September 30, 2013 the fair market value of outstanding RSAs was $8.9 million and the weighted average remaining recognition period of unvested RSAs was 2.9 years. At December 31, 2012 the fair market value of outstanding RSAs was $7.7 million and the weighted average remaining recognition period was 2.6 years. The intrinsic value of RSAs equals their fair market value.

Restricted Stock Units

Activity in our restricted stock units (“RSUs”) during the nine months ended September 30, 2013 is as follows:

 

     Shares     Weighted-
average
remaining
contractual
life (years)
     Aggregate
intrinsic value
 

Outstanding, beginning of period

     50,050        

Awarded

     30,890        

Released

     (9,974     

Forfeited

     (15,875     
  

 

 

      

Outstanding, end of period

     55,091        1.8       $ 781,000   
  

 

 

      

We award restricted stock units to non-U.S. employees of the Company that vest 50% upon the second anniversary of the vesting start date and 25% upon each of the third and fourth anniversaries of the vesting start date.

At September 30, 2013 the aggregate intrinsic value of outstanding RSUs was $781,000 and the weighted average remaining recognition period for unvested RSUs was 2.9 years. At December 31, 2012 the aggregate intrinsic value of outstanding RSUs was $559,000 and the weighted average remaining recognition period for unvested RSUs was 2.8 years.

10 - Other income (expense), net

Other income (expense), net consisted of (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2013     2012     2013     2012  

Investment income

   $ 4      $ 11      $ 68      $ 20   

Interest expense

     (138     (215     (1,084     (231

Foreign currency exchange gain (loss)

     (165     136        (215     470   

Other

     (281     (150     (206     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

   $ (580   $ (218   $ (1,437   $ 259   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

12


Table of Contents

11 - Income Taxes

Provision for Income Tax Expense

We recorded provisions for income tax of $2.3 and $5 million for the three and nine months ended September 30, 2013, respectively. Our effective tax rate was 26.5% for both the three and nine month periods ended September 30, 2013, respectively.

We recorded provisions for income tax (benefit) of $(3.0) million and $(2.1) million for the three and nine months ended September 30, 2012, respectively. Our effective tax rate was 63.5% and 65.2% for the three and nine months ended September 30, 2012, respectively.

Our effective tax rate for the nine months ended September 30, 2013 differed from statutory tax rates primarily because of profits taxed in foreign jurisdictions with lower tax rates than the statutory rate and tax benefits related to the 2012 federal research and development tax credit by enactment of the American Taxpayer Relief Act of 2012, in January 2013 domestic manufacturer deduction, and the reduction of the Denmark corporate income tax rate beginning in 2014. The federal research and development credit, domestic manufacturer deduction, and Denmark rate reduction collectively benefited the effective tax rate for the nine month period ended September 30, 2013 by approximately 6%.

Our effective tax rate for the nine months ended September 30, 2012 differed from statutory tax rates primarily due to the settlement of foreign and U.S. state income tax audits and from the expiration of the statute of limitations on uncertain tax positions that were recorded as a component of income tax expense in prior years.

There was an insignificant increase of unrecognized tax benefits for the nine months ended September 30, 2013. Within the next twelve months it is possible our uncertain tax benefit may change within a range of approximately zero to $600,000. This change may impact the future effective tax rate and is a result of a lapse of statute of limitations, provided that no taxing authority conducts an examination.

Our tax returns remain open to examination as follows: U.S. Federal, 2010 through 2012, U.S. States 2008 through 2012 and significant foreign jurisdictions, 2009 through 2012.

12 - Restructuring Reserves

In each of the first and second quarters of 2011, we adopted reorganization plans to improve efficiencies in our operations and integrate the acquisitions of Medix in 2010 and Embla 2011. These restructuring activities were completed as of March 31, 2013.

In July 2012, we initiated an integration and reorganization plan related to the acquisition of Nicolet to improve efficiencies in our operations resulting in costs incurred associated with employee severance. Substantially all of the staff reductions were completed by March 31, 2013.

In January 2013, we adopted reorganization plans that are designed to continue to improve efficiencies in our operating units in Europe and South America. These plans were further expanded during the third quarter of 2013 to improve our North America operations.

The balance of the restructuring reserve is included in accrued liabilities on the accompanying balance sheets. Employee termination benefits expensed are included as a part of general and administrative expenses.

Activity in the restructuring reserves for these plans for the nine months ended September 30, 2013 is as follows (in thousands):

 

     2011
Plans
    July
2012 Plan
    2013
Plans
    Totals  

Balances at December 31, 2012

   $ 83      $ 2,662      $ —        $ 2,745   

Expense – Severance

     4        211        2,198        2,413   

Expense – Lease Termination

     —          —          571        571   

Cash payments

     (71     (1,350     (1,625     (3,046

Accrual reversal

     (16     (1,334     (18     (1,368
  

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2013

   $ —        $ 189      $ 1,126      $ 1,315   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

13


Table of Contents

13 - Debt and Credit Arrangements

At September 30, 2013 the Company had a $75 million credit facility consisting of a $25 million revolving credit line and a $50 million 5-year term loan with Wells Fargo Bank, National Association (“Wells Fargo”). The credit facility contains covenants, including covenants relating to liquidity and other financial measurements, and provides for events of default, including failure to pay any interest when due, failure to perform or observe covenants, bankruptcy or insolvency events, and the occurrence of a material adverse effect, and restricts our ability to pay dividends. We are in compliance with all covenants as of September 30, 2013. We have granted Wells Fargo a security interest in substantially all of our assets. We have no other significant credit facilities.

During the first quarter 2013 we borrowed $22 million under the credit facility principally to fund the Grass acquisition and to provide for other working capital needs. We had no additional borrowings.

The credit facility was increased to $75 million in June 2013 and the term was extended to five years. As part of the amended credit facility in June 2013, we converted $31.2 million of short-term revolving debt to a term loan, increasing the term loan from $18.8 million as of March 31, 2013 to $50 million as of June 30, 2013.

Long-term debt is comprised of the following (2013 and 2012 columns in thousands):

 

     September 30,
2013
    December 31,
2012
 

Term loan $50 million, interest at LIBOR plus 1.75%, due September 30, 2018 with term loan principle repayable in quarterly installments of $2.5 million

   $ 47,500      $ 20,834   

Term loan $2.9 million Canadian (“CAD”), interest at cost of funds plus 2.5%, due September 15, 2014 with principle repayable in monthly installments of $16,000 until August 15, 2014 and one final payment of $404,000 collateralized by a first lien on company owned land and building

     563        726   
  

 

 

   

 

 

 

Total

     48,063        21,560   

Less: current portion of long-term debt

     (10,563     (8,526
  

 

 

   

 

 

 

Total long-term debt

   $ 37,500      $ 13,034   
  

 

 

   

 

 

 

Maturities of long-term debt as of September 30, 2013 are as follows (in thousands):

 

Three months ended December 31, 2013

   $ 2,547   

2014

     10,516   

2015

     10,000   

2016

     10,000   

2017

     10,000   

2018

     5,000   
  

 

 

 

Total

   $ 48,063   
  

 

 

 

At September 30, 2013 and December 31, 2012, the carrying value of total debt approximates fair market value. The fair value of the Company’s debt is considered a Level 2 measurement.

14 - Segment, Customer and Geographic Information

We operate in one reportable segment in which we provide healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments.

Our end-user customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies. Most of our international sales are to distributors who resell our products to end users or sub-distributors.

Revenue and long-lived asset information is as follows (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2013      2012      2013      2012  

Consolidated Revenue:

           

United States

   $ 51,412       $ 48,003       $ 147,702       $ 112,540   

Foreign countries

     33,980         33,016         105,773         88,919   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 85,392       $ 81,019       $ 253,475       $ 201,459   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

14


Table of Contents
     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2013      2012      2013      2012  

Revenue by End Market:

           

Neurology Products

           

Devices and Systems

   $ 34,729       $ 30,722       $ 100,630       $ 70,409   

Supplies

     15,311         14,922         45,949         29,791   

Services

     5,313         4,867         17,258         8,589   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Neurology Revenue

     55,353         50,511         163,837         108,879   
  

 

 

    

 

 

    

 

 

    

 

 

 

Newborn Care Products

           

Devices and Systems

     18,163         17,342         51,461         55,642   

Supplies

     10,031         11,806         33,032         33,602   

Services

     1,845         1,360         5,145         3,426   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Newborn Care Revenue

     30,039         30,508         89,638         92,670   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenue

   $ 85,392       $ 81,019       $ 253,475       $ 201,459   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     September 30,
2013
     December 31,
2012
 

Long-lived assets, net:

     

United States

   $ 9,829       $ 9,813   

Foreign countries

     14,596         16,699   
  

 

 

    

 

 

 

Totals

   $ 24,425       $ 26,512   
  

 

 

    

 

 

 

Long-lived assets consist principally of property and equipment, net of accumulated depreciation and amortization. During the three and nine months ended September 30, 2013 and 2012, no single customer or foreign country contributed to more than 10% of revenue.

15 - 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 fair value of our assets and liabilities subject to fair value measurements are as follows (in thousands):

 

     Fair Value as
of
     Fair Value Measurements as of
9/30/13 Using Fair Value Hierarchy
 
     9/30/13      Level 1      Level 2      Level 3  

Bank money market investments

   $ 1,149         —         $ 1,149         —     
  

 

 

       

 

 

    

Total

   $ 1,149         —         $ 1,149         —     
  

 

 

       

 

 

    

 

15


Table of Contents
    

Fair Value

as of

     Fair Value Measurements as of
12/31/12 Using Fair Value Hierarchy
 
     12/31/12      Level 1      Level 2      Level 3  

Bank money market investments

   $ 1,148         —         $ 1,148         —     
  

 

 

       

 

 

    

Total

   $ 1,148         —         $ 1,148         —     
  

 

 

       

 

 

    

The carrying amount of the Company’s long term debt approximates fair value based on Level 2 inputs since the debt carries a variable interest rate that is tied to the current LIBOR rate plus a spread.

Non-financial assets such as goodwill, intangible assets, and property, plant, and equipment are evaluated for impairment and adjusted to fair value using Level 3 inputs, only when impairment is recognized. Fair values are considered Level 3 when management makes significant assumptions in developing a discounted cash flow model based upon a number of considerations including projections of revenues, earnings and a discount rate. In addition, in evaluating the fair value of goodwill impairment, further corroboration is obtained using our market capitalization. No impairment was recorded in the first nine months of 2013 and 2012.

16 - Immaterial Corrections to Prior Period Financial Statements

Certain amounts previously reported in the condensed consolidated statements of operations and comprehensive income (loss) and condensed statements of cash flows for the three and nine month periods ended September 30, 2012 have been restated to reflect the correction of immaterial errors as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The errors were related primarily to purchase accounting adjustments. In addition, certain other errors related to the liability associated with product trade-ins, currency loss on translation of foreign debt, amortization of intangible assets, the tax benefit associated with the release of accruals for uncertain tax positions were identified and corrected. The errors are not material individually or in the aggregate.

A summary of the effects of the correction of these errors on our condensed consolidated financial statements for the three and nine month periods ended September 30, 2012 are presented in the table below (in thousands):

 

     Three Months Ended
September 30, 2012
    Nine Months Ended
September 30, 2012
 
     As
Previously
Reported
    As
Corrected
    As
Previously
Reported
    As
Corrected
 

Condensed Consolidated Statements of Operations and Comprehensive Income

        

Revenue

   $ 80,724      $ 81,019      $ 201,247      $ 201,459   

Cost of revenue

     36,453        36,456        89,266        89,237   

Gross profit

     44,271        44,563        111,981        112,222   

Income (loss) from operations

     (4,851     (4,566     (3,885     (3,521

Income (loss) before provision for income tax

     (5,079     (4,784     (3,659     (3,262

Net income (loss)

     (1,949     (1,747     (1,146     (1,134

Condensed Consolidated Statements of Cash Flows

        

Net income (loss)

       $ (1,146   $ (1,134

Depreciation and amortization

         9,532        9,356   

Change in operating assets and liabilities

        

Inventories

         5,131        5,154   

Deferred income tax

         (648     7   

Accrued liabilities and deferred revenue

         6,261        5,803   

Net cash provided by operating activities

         16,982        17,038   

Exchange rate changes effect on cash and cash equivalents

         (32     (88

 

16


Table of Contents
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Registered Trademarks and Tradenames

Natus®, AABR®, ABaer®, ALGO®, AOAE®, AuDX® Aura®, Balance Manager®, Balance Master®, Balance Shape®, Biliband®, Bio-logic®, Bo-JECT®, Brain Atlas®, Ceegraph®, CHAMP®, Clarity System®, Cochlea Scan®, Cool Cap®, CoolCare®, Comet®, Dantec®, Ear Couplers®, Ear Muffin®, EC2®, Echo Screen®, Embla US®, Embletta®, Enterprise®, EquiTest®, Fass®, Fischer-Zoth®, Flexicoupler®,Grass®,Grass Technologies®, Gumdrop®, Halo Ear Muffin®, Hawaii Medical®, Keypoint®, Keypoint AU®, Keypoint EU®, Keypoint JP®, MASTER®, Medelec®, Medix®, MedixI.C.S.A®, Navigator®, Neatnick®, neoBLUE®, Neurocom®, Neuromax®,Neurotrac®, NeuroWorks®, Nicolet®, NicoletElite®, Oxydome®, Panorama®, Pocket®, Polyview®, REMbrandt®, REMlogic®, Sandm an®, Scout®, Sleeprite®, Sleepscan®, Sleeptrek®, Smart Scale®, Sonamed®, Sonara®, Sonara TEK®, Stellate Notta®, STETHODOP®, SZAC®, TECA®, Tootsweet®, Traveler®, Treetip®,Twin®, VAC PAC®, VERSALAB®, Warmette®, Xact Trace®, Xltek® are registered trademarks of Natus Medical Incorporated and its subsidiaries. Accuscreen™, Bili Lite Pad™, Bili-Lite™, Biomark™, Circumstraint™, Coherence™, Deltamed™, inVision™, Medix MediLED™, MiniMuffs™, NatalCare™, Neometrics™ and Smartpack™ are non-registered trademarks of Natus and its subsidiaries. Solutions for Newborn CareSM is a non-registered service mark of Natus.

Overview

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) supplements the MD&A in the Annual Report on Form 10-K for the year ended December 31, 2012 of Natus Medical Incorporated. Management’s discussion and analysis should be read in conjunction with our condensed consolidated financial statements and accompanying footnotes, the discussion of certain risks and uncertainties contained in Part II, Item 1A of this report, our Annual Report filed on Form 10-K for the year ended December 31, 2012 and the cautionary information regarding forward-looking statements at the end of this section. MD&A includes the following sections:

 

    Our Business. A general description of our business;

 

    2013 Third Quarter Overview. A summary of key information concerning the financial results for the three months ended September 30, 2013;

 

    Application of Critical Accounting Policies. A discussion of the accounting policies that are most important to the portrayal of our financial condition and results of operations and that require significant estimates, assumptions, and judgments;

 

    Results of Operations. An analysis of our results of operations for the periods presented in the financial statements;

 

    Liquidity and Capital Resources. An analysis of capital resources, sources and uses of cash, investing and financing activities, off-balance sheet arrangements, contractual obligations and interest rate hedging;

 

    Recent Accounting Pronouncements. See Note 1 to our Condensed Consolidated Financial Statements for a discussion of new accounting pronouncements that affect us; and

 

    Cautionary Information Regarding Forward-Looking Statements. Cautionary information about forward-looking statements.

Our Business

Natus is a leading provider of healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, sleep disorders, and balance and mobility disorders.

End Markets

Our products address two primary end markets:

 

    Neurology – Includes products for diagnostic electroencephalography (EEG), electromyography (EMG), intra-operative monitoring (IOM), diagnostic sleep analysis, or polysomnography (PSG), newborn brain monitoring, and assessment of balance and mobility disorders.

 

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    Newborn Care – Includes thermoregulation devices and products for the treatment of brain injury and jaundice in newborns and products for newborn hearing screening and diagnostic hearing assessment.

Segment and Geographic Information

We operate in one reportable segment in which we provide healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments.

Our end-user customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies. Most of our international sales are to distributors who 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 14 – Segment, Customer and Geographic Information of our condensed consolidated financial statements included in this report.

Revenue by Product Category

We generate our revenue either from sales of Devices and Systems, which are generally non-recurring, and from related Supplies and Services, which are generally recurring. The products that are attributable to these categories are described in our Annual Report on Form 10-K for the year ended December 31, 2012. Revenue from Devices and Systems, Supplies and Services, as a percent of total revenue for the three and nine months ended September 30, 2013 and 2012 is as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2013     2012     2013     2012  

Devices and Systems

     62     59     60     63

Supplies

     30     33     31     31

Services

     8     8     9     6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100

During the three and nine months ended September 30, 2013 and 2012, no single customer or foreign country contributed to more than 10% of revenue.

2013 Third Quarter Overview

Our business and operating results are driven in part by worldwide economic conditions. Our sales are significantly dependent on both capital spending by hospitals in the United States and healthcare spending by ministries of health within the European Union.

Our consolidated revenue increased $4.4 million in the third quarter ended September 30, 2013 to $85.4 million compared to $81.0 million in the third quarter of the previous year. Grass Technologies Product Group (“Grass”) contributed $3.8 million of revenue in the third quarter of 2013. Excluding revenues from Grass we experienced revenue increases across business units in Canada and Denmark, and declines across other business units in Europe, South America and the United States.

Net income was $6.3 million or $0.20 per diluted share in the three months ended September 30, 2013, compared with a net loss of $1.7 million or $0.06 per share in the same period in 2012. An increase from 55 % to 60% in gross profit percentage for the third quarter of 2013 compared to same period in 2012 resulted primarily from improved margins associated with more favorable product mix.

Application of Critical Accounting Policies

We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In so doing, we must often make estimates and use assumptions that can be subjective, and, consequently, our actual results could differ from those estimates. For any given individual estimate or assumption we make, there may also be other estimates or assumptions that are reasonable.

 

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We believe that the following critical accounting policies require the use of significant estimates, assumptions, and judgments. The use of different estimates, assumptions, or judgments could have a material effect on the reported amounts of assets, liabilities, revenue, expenses, and related disclosures as of the date of the financial statements and during the reporting period:

 

    Revenue recognition

 

    Inventory carried at the lower of cost or market value

 

    Carrying value of intangible assets and goodwill

 

    Liability for product warranties

 

    Share-based compensation

These critical accounting policies are described in more detail in our Annual Report on Form 10-K for the year ended December 31, 2012, under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. There have been no changes to these policies during the nine months ended September 30, 2013.

Results of Operations

The following table sets forth, for the periods indicated selected consolidated statements of operations data as a percentage of total revenue. Our historical operating results are not necessarily indicative of the results for any future period.

 

     Three Months
Ended

September 30,
    Nine Months
Ended

September 30,
 
     2013     2012     2013     2012  

Revenue

     100     100     100     100

Cost of revenue

     39.9        45.0        41.2        44.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     60.1        55.0        58.8        55.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Marketing and selling

     23.8        26.9        25.4        27.1   

Research and development

     8.8        10.5        9.6        10.8   

General and administrative

     16.8        23.2        15.8        19.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     49.4        60.6        50.8        57.4   

Income (loss) from operations

     10.7        (5.6     8.0        (1.7

Other income (expense), net

     (0.7     (0.3     (0.6     0.1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for income tax (benefit)

     10.0        (5.9     7.4        (1.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Provision for income tax (benefit) expense

     2.6        (3.7     2.0        (1.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     7.4     (2.2 )%      5.4     (0.6 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

As the operations of Grass and Nicolet neurodiagnostic business (“Nicolet”) have been reflected in our consolidated results since their acquisition dates of February 2013 and July 2012, where significant, we have noted the impact of these acquisitions on our results of operations for the three and nine months ended September 30, 2013, as compared to the same periods in 2012.

The following discussion reflects the effects of the corrections disclosed in Note 16 to the condensed consolidated financial statements.

Three Months Ended September 30, 2013 and 2012

Revenues

Our consolidated revenue increased by $4.4 million or 5.4% to $85.4 million for the three months ended September 30, 2013, compared to $81.0 million in the comparable 2012 period. Grass contributed $3.8 million of revenue in the third quarter of 2013. Revenue from our products other than Grass increased by $0.6 million in 2013, compared to 2012.

 

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Revenue from our neurology products increased $4.9 million or 9.6% to $55.4 million in the third quarter of 2013, compared to $50.5 million in the same period in 2012. Revenue from our neurology products, other than Grass increased by $1.1 million for the three months ended September 30, 2013 compared to 2012. This increase was attributable to higher demand for neurodiagnostic products. Revenue from our newborn care products decreased by $0.5 million, or 1.5% to $30.0 million in the third quarter of 2013 compared to $30.5 million in the same period in 2012. This decrease was primarily attributed to a decrease in newborn care supplies offset by an increase in newborn care devices and systems.

Revenue from neurology devices and systems was $34.7 million for the three months ended September 30, 2013, representing an increase of 13.1% or $4.0 million, from $30.7 million reported in the third quarter of 2012. Grass contributed to $2.2 million of the increase in neurology devices and systems while revenue from our neurology products other than Grass increased by $1.8 million in the third quarter of 2013 compared to the third quarter of 2012, primarily attributable to an increase in EEG revenue. Revenue from newborn care and other devices and systems was $18.1 million for the three months ended September 30, 2013, representing an increase of 4.5% or $0.8 million, from $17.3 million reported in the third quarter of 2012. This increase in newborn care devices and systems revenue was due to higher sales of hearing products.

Revenue from devices and systems was 62% of consolidated revenue in the third quarter of 2013 compared to 59% of consolidated revenue in the third quarter of 2012.

Revenue from neurology supplies was $15.3 million for the three months ended September 30, 2013 representing an increase of 2.6% or $0.4 million, from $14.9 million reported in the third quarter of 2012. Grass contributed to $1.5 million of neurology supplies revenue. Neurology supplies revenue other than Grass decreased $1.1 million in the third quarter of 2013 compared to the third quarter of 2012. This decrease was primarily attributable to a decrease in both domestic and European sleep supplies. Revenue from newborn care supplies was $10.0 million for the three months ended September 30, 2013, representing a decrease of 15.3% or $1.8 million from $11.8 million reported in the third quarter of 2012. This decline is primarily due to a decrease in ALGO hearing supplies.

Revenue from supplies was 30% of consolidated revenue in the third quarter of 2013 compared to 33% in the same period in 2012.

Revenue from neurology services was $5.3 million for the three months ended September 30, 2013 representing an increase of 9.2% or $0.4 million, from $4.9 million reported in the third quarter of 2012. Grass contributed to $0.2 million of the increase in neurology services. Neurology services revenue other than Grass increased by $0.2 million in the third quarter of 2013 compared to the third quarter of 2012. Revenue from newborn care services was $1.9 million for the three months ended September 30, 2013, representing an increase of 35.7% or $0.5 from $1.4 million reported in the third quarter of 2012. This increase was comprised primarily of newborn care hearing screening data management services.

Revenue from services was 8% of consolidated revenue in the third quarter of 2013 and 2012.

No single customer accounted for more than 10% of our revenue in the third quarter of either 2013 or 2012. Revenue from domestic sales increased 7.1% to $51.4 million for the three months ended September 30, 2013 from $48 million in the third quarter of 2012. Revenue from international sales increased 2.9% to $34 million for the three months ended September 30, 2013 compared to $33 million in the third quarter of 2012. Revenue from domestic sales was 60.2% of total revenue for the three months ended September 30, 2013 and 59.2% for the three months ended September 30, 2012. Revenue from international sales was 39.8% of total revenue in the third quarter of 2013 and 40.8% of revenue in the third quarter of 2012.

Cost of Revenue and Gross Profit

Our cost of revenue decreased $2.4 million or 6.6% to $34.1 million for the three months ended September 30, 2013 from $36.5 million in the third quarter of 2012. Grass contributed $2.1 million to our cost of revenue, which was coupled with cost of revenue declines across North America driven by Neurology material cost reduction initiatives. We plan to maintain this level of cost of revenue as a percentage of revenue. Gross profit increased $6.7 million, or 15.2%, to $51.3 million in the third quarter of 2013 from $44.6 million in the third quarter of 2012. Gross profit as a percentage of revenue was 60.1% for the three months ended September 30, 2013 and 55% for the three months ended September 30, 2012. The increase in gross profit as a percentage of revenue was the result of improved margins associated with product mix and material cost reduction initiatives in Neurology.

 

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Operating Costs

Total operating costs decreased $6.9 million or 14.1% to $42.2 million for the three months ended September 30, 2013, from $49.1 million in the third quarter of 2012. The operating costs of Grass contributed to $0.6 million in operating costs.

Our marketing and selling expenses decreased $1.5 million or 6.7% to $20.3 million in the third quarter of 2013, from $21.8 million in the third quarter of 2012. Marketing and selling expenses as a percent of total revenue was 23.8% for the three months ended September 30, 2013 and 26.9% for the same period in 2012. The decrease in marketing and selling expenses is due to cost cutting initiatives.

Our research and development expenses decreased $1.0 million or 11.5% to $7.5 million for the three months ended September 30, 2013 from $8.5 million for the three months ended September 30, 2012. Research and development expenses as a percent of total revenue decreased to 8.8% in the third quarter of 2013 from 10.5% in the third quarter of 2012. The decrease in research and development expenses is due to lower employee compensation costs resulting from restructuring activities initiated in 2012.

Our general and administrative expenses decreased $4.5 million or 23.9% to $14.3 million for the three months ended September 30, 2013 from $18.8 million for the three months ended September 30, 2012. General and administrative expenses as a percent of revenue decreased to 16.8% in the third quarter of 2013 from 23.2% in the third quarter of 2012. The newly enacted medical device tax in 2013 accounted for $0.9 million of general and administrative expenses for the three months ended September 30, 2013. The overall decrease in general and administrative expenses for the period is primarily attributable to a decrease in severance costs of $5.7 million partially offset by the medical device tax noted above.

Other Income (Expense), net

Other income (expense), net consists of investment income, interest expense, net currency exchange gains and losses, and other miscellaneous income and expense. We reported other expense of $580,000 for the three months ended September 30, 2013, compared to $218,000 for the three months ended September 30, 2012. We reported $165,000 of foreign currency exchange losses in the third quarter of 2013 versus $136,000 of foreign exchange gains in the third quarter of 2012. Interest expense was $138,000 for the three months ended September 30, 2013 compared to $215,000 for the three months ended September 30, 2012 due primarily to favorable interest rate fluctuation.

Provision for Income Tax

We recorded a provision (benefit) for income tax of $2.3 million and $(3.0) million for the three months ended September 30, 2013 and 2012, respectively. The increase in tax expense for the three months ended September 30, 2013 compared to the same period of 2012 is primarily attributable to the increase in income before provision for income tax. Our effective tax rate was 26.5% and 63.5% for the three months ended September 30, 2013 and 2012, respectively. For the three months ended September 30, 2013, our effective tax rate differed from statutory tax rates primarily because of profits taxed in foreign jurisdictions with lower tax rates. For the three months ended September 30, 2012, our effective tax rate differed from statutory tax rates primarily due to the settlement of foreign and U.S. state income tax audits and from the expiration of the statute of limitations on uncertain tax positions that were recorded as a component of income tax expense in prior years.

Nine Months Ended September 30, 2013 and 2012

Revenues

Our consolidated revenue increased by $52.0 million or 25.8% to $253.5 million for the nine months ended September 30, 2013, compared to $201.5 million in the comparable 2012 period. The increase was attributable to our recent acquisitions. Grass, acquired in February 2013 contributed $9.7 million of revenue in the nine month period of 2013. Nicolet, acquired in July 2012 contributed $44.8 million of incremental revenue in the nine month period of 2013 as compared to 2012. Revenue from our products other than Grass and Nicolet, decreased by $2.5 million in 2013 compared to 2012. This decrease was attributable to weak economic conditions in Europe partially offset by stronger domestic demand on our neurodiognostic products.

Revenue from our neurology products increased $54.9 million or 50.5% to $163.8 million in the nine month period of 2013, compared to $108.9 million in the same period in 2012. Revenue from our neurology products, other than Grass and Nicolet products, increased by $0.4 million for the nine months ended September 30, 2013 compared to 2012. This increase was attributable to higher demand on neurodiognostic products. Revenue from our newborn care products decreased by $3.1 million, or 3.3% to $89.6 million in the nine month period of 2013 compared to $92.7 million in the same period in 2012. This decline was primarily attributed to weak economic conditions in Europe.

 

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Revenue from neurology devices and systems was $100.6 million for the nine months ended September 30, 2013, representing an increase of 42.9% or $30.2 million, from $70.4 million reported in the nine month period of 2012. Grass and Nicolet contributed incremental revenue of $30.5 million to the increase in neurology devices and systems while revenue from our neurology products other than Grass and Nicolet decreased by $0.3 million in the nine month period of 2013 compared to the nine month period of 2012, primarily attributable to weak economic conditions in Europe partially offset by strong domestic demand on neurodiognostic products. Revenue from newborn care and other devices and systems was $51.5 million for the nine months ended September 30, 2013, representing a decrease of 7.5% or $4.1 million, from $55.6 million reported in the nine month period of 2012. This decline in newborn care devices and systems revenue was due to lower sales of newborn incubators, CFM and diagnostic hearing revenue.

Revenue from devices and systems was 60% of consolidated revenue in the nine month period of 2013 compared to 63% of consolidated revenue in the nine month period of 2012.

Revenue from neurology supplies was $45.9 million for the nine months ended September 30, 2013 representing an increase of 54.2% or $16.1 million, from $29.8 million reported in the nine month period of 2012. Grass and Nicolet contributed incremental revenue of $17.9 million to neurology supplies revenue. Neurology supplies revenue other than Grass and Nicolet, decreased by $1.7 million in the nine month period of 2013 compared to the nine month period of 2012. This decline was primarily attributable to a decrease in sleep supplies. Revenue from newborn care supplies was $33.0 million for the nine months ended September 30, 2013, representing a decrease of 1.7% or $0.6 million from $33.6 million reported in the nine month period of 2012. This decrease was comprised primarily of newborn care hearing supplies.

Revenue from supplies was 31% of consolidated revenue in both the nine month period of 2013 and the nine month period of 2012.

Revenue from neurology services was $17.3 million for the nine months ended September 30, 2013 representing an increase of 101% or $8.7 million, from $8.6 million reported in the nine month period of 2012. Incremental revenue from Grass and Nicolet contributed to $6.1 million of the increase in neurology services. Neurology services revenue other than Grass and Nicolet, increased by $2.6 million in the nine month period of 2013 compared to the nine month period of 2012. This increase was primarily attributable to an increase in demand for neurodiagnostic and sleep services. Revenue from newborn care services was $5.1 million for the nine months ended September 30, 2013, representing an increase of 50.2% or $1.7 million from $3.4 million reported in the nine month period of 2012. This increase was primarily attributable to hearing screening data management service revenue.

Revenue from services was 9% of consolidated revenue in the nine month period compared to 6% of consolidated revenue in the nine month period of 2012.

No single customer accounted for more than 10% of our revenue in the nine month period of either 2013 or 2012. Revenue from domestic sales increased 31.3% to $147.7 million for the nine months ended September 30, 2013 from $112.5 million in the nine month period of 2012. Revenue from international sales increased 19% to $105.8 million for the nine months ended September 30, 2013 compared to $88.9 million in the nine month period of 2012. Revenue from domestic sales was 58.3% of total revenue for the nine months ended September 30, 2013 compared to 55.9% of consolidated revenue in the nine month period of 2012, and revenue from international sales was 41.7% of total revenue in the nine month period of 2013 compared to 44.1% of consolidated revenue in the nine month period of 2012.

Cost of Revenue and Gross Profit

Our cost of revenue increased $15.3 million or 17.1% to $104.5 million for the nine months ended September 30, 2013 from $89.2 million in the nine month period of 2012. Grass and Nicolet contributed incremental cost of revenue of $20.2 million partially offset by declines in cost of revenue declines across North America. Gross profit increased $36.8 million, or 32.7%, to $149.0 million in the nine month period of 2013 from $112.2 million in the nine month period of 2012 as a result of our increased sales. Gross profit as a percentage of revenue was 58.8% for the nine months ended September 30, 2013 and 55.7% for the nine months ending September 30, 2012 as a result of product mix, primarily as a result of a higher percentage of sales of neurology products which generally carry higher margins than our other products.

Operating Costs

Total operating costs increased $13.1 million or 11.3% to $128.8 million for the nine months ended September 30, 2013, from $115.7 million in the nine month period of 2012.The incremental operating expense of Grass and Nicolet contributed to $16.7 million in operating costs. The newly enacted medical device tax in 2013 accounted for $3.4 million of the increase in operating costs offset by lower severance and acquisition related direct costs.

 

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Our marketing and selling expenses increased $9.6 million or 17.6% to $64.3 million in the nine month period of 2013, from $54.7 million in the nine month period of 2012. Marketing and selling expenses as a percent of total revenue decreased to 25.4% in the first nine months of 2013 from 27.1% in the first nine months of 2012. The incremental marketing and selling expenses of Grass and Nicolet was $9.8 million.

Our research and development expenses increased $2.5 million or 11.4% to $24.3 million for the nine months ended September 30, 2013 from $21.8 million for the nine months ended September 30, 2012. Research and development expenses as a percent of total revenue decreased to 9.6% in the nine month period of 2013 from 10.8% in the in the nine month period of 2012. The incremental research and development expenses of Grass and Nicolet were $4.2 million for the nine months ended September 30, 2013, partially offset by lower employee compensation costs resulting from cost cutting activities initiated in 2012 in our other operations.

Our general and administrative expenses increased $1.0 million or 2.4% to $40.2 million for the nine months ended September 30, 2013 from $39.2 million for the nine months ended September 30, 2012. General and administrative expenses as a percent of revenue decreased to 15.8% in the nine month period of 2013 from 19.5% in the nine month period of 2012. The incremental general and administrative expense of Grass and Nicolet was $2.7 million. The newly enacted medical device tax in 2013 accounted for $3.4 million of the increase in general and administrative expenses. These increases were offset by a decrease in severance costs of $5.7 million.

Other Income (Expense), net

Other income (expense), consists of investment income, interest expense, net currency exchange gains and losses, and other miscellaneous income and expense. We reported other income (expense), net of $(1.4) million for the nine months ended September 30, 2013, compared to $259,000 for the nine months ended September 30, 2012. We reported $215,000 of foreign currency exchange losses in the nine month period of 2013 versus $470,000 of foreign exchange gains in the nine month period of 2012. Interest expense was $1.1 million for the nine months ended September 30, 2013 compared to $231,000 for the nine months ended September 30, 2012 due primarily to additional borrowings in the second quarter of 2013 to fund the Nicolet and Grass acquisitions.

Provision for Income Tax

We recorded a provision (benefit) for income tax of $5.0 million and $(2.1) million for the nine months ended September 30, 2013 and 2012, respectively. The increase in tax expense for the nine months ended September 30, 2013 compared to the same period of 2012 is primarily attributable to the increase in income before provision for income taxes. Our effective tax rate was 26.5% and 65.2% for the nine months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013, our effective tax rate differed from statutory tax rates primarily because of profits taxed in foreign jurisdictions with lower tax rates than the statutory rate and tax benefits derived from the recognition of the 2012 federal research and development tax credit by enactment of the American Taxpayer Relief Act of 2012 in January 2013, domestic manufacturer deduction, and the reduction of the Denmark corporate income tax rate beginning in 2014. For the nine months ended September 30, 2012, our effective tax rate differed from statutory tax rates primarily due to the settlement of foreign and U.S. state income tax audits and from the expiration of the statute of limitations on uncertain tax positions that were recorded as a component of income tax expense in prior years.

Liquidity and Capital Resources

As of September 30, 2013, we had cash and cash equivalents of $44.2 million and working capital of $107.2 million, compared with cash and cash equivalents of $23.0 million and working capital of $70.3 million as of December 31, 2012. The $36.9 million increase in working capital from December 31, 2012 to September 30, 2013 resulted primarily from refinancing $11.3 million of short-term borrowings to long-term debt, a $12.3 million reduction in accounts payable and accrued expenses, and a $7.1 million reduction in accounts receivable.

As of September 30, 2013, we had cash and cash equivalents outside the U.S. in certain of our foreign operations of approximately $20.6 million. We currently intend to permanently reinvest the cash held by our foreign subsidiaries. If, however, a portion of these funds were needed for and distributed to our operations in the United States, we would be subject to additional U.S. income taxes and foreign withholding taxes. The amount of taxes due would depend on the amount and manner of repatriation, as well as the location from where the funds are repatriated.

At September 30, 2013 we had a $75 million credit facility consisting of a $25 million revolving credit line and a $50 million 5-year term loan with Wells Fargo Bank, National Association (“Wells Fargo”). The credit facility contains covenants, including covenants relating to liquidity and other financial measurements, and provides for events of default, including failure to pay any interest when due, failure to perform or observe covenants, bankruptcy or insolvency events, and the occurrence of a material adverse effect, and restricts our ability to pay dividends. We have granted Wells Fargo a security interest in substantially all of our assets. We have no other significant credit facilities.

 

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In February 2013, we acquired through an asset purchase for a cash price of $18.6 million the Grass Technology Product Group from Astro-Med Inc. We funded this acquisition with a combination of cash-on-hand and an $18 million borrowing under the credit facility.

We believe that our current cash and cash equivalents and any cash generated from operations will be sufficient to meet our ongoing operating requirements for the foreseeable future.

Cash provided by operations increased by $3.7 million to $20.7 million for the nine months ended September 30, 2013 compared to $17.0 million for the same period in 2012. The sum of our net income and certain non-cash expense items, such as reserves, depreciation and amortization, and share based compensation was approximately $28.7 million for the nine months ended September 30, 3013, compared to $13.9 million in the 2012 period. The overall impact of changes in certain operating assets and liabilities on total operating cash flows resulted in a cash outflow of $8 million in the nine months ended September 30, 2013 compared with a cash inflow of $3.1 million in the 2012 period. In particular, our cash flow from operations in the nine months of 2013 was negatively impacted by a $6.3 million decrease in accrued expenses and deferred revenue, a $5.9 million decrease in accounts payable partially offset by a $7.1 million decrease in accounts receivable and $14.9 million higher net income.

Cash used by investing activities was $21 million for the nine months ended September 30, 2013, compared to cash used by investing activities of $61.4 million for the same period in 2012. We used $18.6 million to acquire Grass during the nine months ended September 30, 2013 and we used $57.6 million to acquire Nicolet during the nine months ended September 30, 2012. We used $0.6 and $3.8 million of cash to acquire property and equipment during the nine months ended September 30, 2013 and 2012, respectively.

Cash provided by financing activities was $20.9 million in the nine months ended September 30, 2013, compared to $31.2 million in the nine months ended September 30, 2012. In February 2013 we borrowed $18 million of cash on our credit facility to partially fund the acquisition of Grass and had additional short-term borrowings of $4 million which we refinanced together with the $5 million of short-term borrowings associated with the Nicolet acquisition in 2012 as long-term borrowings as of September 30, 2013. In September 2012 we borrowed $31 million of cash on our credit facility to partially fund the acquisition of Nicolet for which $2.5 million has been repaid. We received cash from sales of our stock pursuant to exercise of stock options and contributions to our employee stock purchase plan in the amount of $5.1 million and $970,000 in the nine months ended September 30, 2013 and 2012, respectively.

Our future liquidity and capital requirements will depend on numerous factors, including the:

 

    Extent to which we make acquisitions;

 

    Amount and timing of revenue;

 

    Extent to which our existing and new products gain market acceptance;

 

    Cost and timing of product development efforts and the success of these development efforts;

 

    Cost and timing of marketing and selling activities; and

 

    Availability of borrowings under line of credit arrangements and the availability of other means of financing.

Commitments and Contingencies

In the normal course of business, we enter into obligations and commitments that require future contractual payments. The commitments result primarily from firm, noncancellable purchase orders placed with contract vendors that manufacture some of the components used in our medical devices and related disposable supply products, as well as commitments for leased office, manufacturing, and warehouse facilities. The only material change to the table of contractual obligations presented in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2012 has been the result of $22 million of debt incurred from borrowings against the credit facility as of September 30, 2013.

Under our bylaws, we have agreed to indemnify our officers and directors for certain events or occurrences arising as a result of the officer or director’s serving in such capacity. We have a directors and officers’ liability insurance policy that limits our exposure and enables us to recover a portion of any future amounts paid resulting from the

 

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indemnification of our officers and directors. In addition, we enter into indemnification agreements with other parties in the ordinary course of business. In some cases we have obtained liability insurance providing coverage that limits our exposure for these other indemnified matters. We have not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. We believe the estimated fair value of these indemnification agreements is minimal and have not recorded a liability for these agreements

Recent Accounting Pronouncements

See Note 1 to our Condensed Consolidated Financial Statements for a discussion of new accounting pronouncements that affect us.

Cautionary Information Regarding Forward Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 about Natus Medical Incorporated. 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 2 include, but are not limited to, statements regarding the following: our belief that the recovery from the worldwide economic downturn has continued, our expectation regarding expansion of our international operations, our expectations regarding our new products, the sufficiency of our current cash, cash equivalents, and short-term investment balances, and any cash generated from operations to meet our ongoing operating and capital requirements for the foreseeable future, the use of debt to fund acquisitions, our expectations of earnout arrangements related to acquisitions, and our intent to acquire additional technologies, products, or businesses.

Forward-looking statements are not guarantees of future performance and are subject to substantial risks and uncertainties that could cause the actual results predicted in the forward-looking statements as well as our future financial condition and results of operations to differ materially from our historical results or currently anticipated results. Investors should carefully review the information contained under the caption “Risk Factors” contained in Part II, Item 1A of this report for a description of risks and uncertainties. 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.

 

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

We develop products in the U.S., Canada, Argentina, and Europe and sell those products into more than 100 countries throughout the world. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Most of our sales in Europe and Asia are denominated in U.S. Dollars and Euros and with the acquisitions of Xltek in 2007, Medix in 2010 and Nicolet in 2012, a small portion of our sales are now denominated in Canadian dollars, Argentine pesos and British pounds. As our sales in currencies other than the U.S. Dollar increase, our exposure to foreign currency fluctuations may increase.

In addition, changes in exchange rates also may affect the end-user prices of our products compared to those of our foreign competitors, who may be selling their products based on local currency pricing. These factors may make our products less competitive in some countries.

If the U.S. Dollar uniformly increased or decreased in strength by 10% relative to the currencies in which our sales were denominated, our net income would have correspondingly increased or decreased by an immaterial amount for the nine months ended September 30, 2013. Our interest income is sensitive to changes in the general level of interest rates in the U.S. However, because current market conditions have resulted in historically low rates of return on our investments, a hypothetical decrease of 10% in market interest rates would not result in a material decrease in interest income earned on our investments held as of September 30, 2013.

When feasible, we invest excess cash in bank money-market funds or discrete short-term investments. The fair value of short-term investments and cash equivalents (“investments”) is sensitive to changes in the general level of interest rates in the U.S., and the fair value of these investments will fall if market interest rates increase. However, since we generally have the ability to hold the investments to maturity, these declines in fair value may never be realized. If market interest rates were to increase by 10% from levels at September 30, 2013, the fair value of our investments would decline by an immaterial amount.

All of the potential changes noted above are based on sensitivity analyses performed on our financial position as of September 30, 2013. Actual results may differ as our analysis of the effects of changes in interest rates does not account for, among other things, sales of securities prior to maturity and repurchase of replacement securities, the change in mix or quality of the investments in the portfolio, and changes in the relationship between short-term and long-term interest rates.

 

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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, under the supervision of our Chief Executive Officer and Chief Financial Officer and with the participation of our disclosure committee, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2013. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2013 at the reasonable assurance level due to a material weakness that we identified as of December 31, 2012 that has not been remediated. The material weakness relates to our controls over the implementation of a single-platform enterprise resource planning (“ERP”) application for our operations in North America exclusive of Nicolet. In particular, we did not perform adequate user acceptance testing prior to implementing this application to identify processes that were later discovered to not operate as designed. This resulted in an inadequate segregation of duties and inadequate controls over approval of certain journal entries based on the roles assigned to users of the ERP. In addition, given the system implementation issues, we were not able to timely prepare account analyses and reconciliations.

These factors prevented us from completing our financial close and preparation of financial statements on a timely basis, which, in turn, made us unable to file our financial statements by the due date required by the applicable rules and regulations established by the Securities and Exchange Commission.

Management’s Remediation Activities

To remediate the material weakness in our internal control over financial reporting described above, we are developing and implementing new control procedures regarding our ongoing implementation of the ERP application, including the following: (i) devoting additional resources to fixing processes associated with the financial close that were not operating as designed, (ii) revising user roles to provide adequate separation of duties, appropriate approval levels, and review of manual transaction details, and (iii) developing detailed reports to facilitate accurate account analyses and timely reconciliation of accounts. However, the material weakness will not be considered remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that the controls are operating effectively.

Changes in Internal Control over Financial Reporting

Other than the actions taken as described above under “Management’s Remediation Activities,” there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, even if determined effective and no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives to prevent or detect misstatements. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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PART II.    OTHER INFORMATION

 

ITEM 1. 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. Our management reviews these matters if and when they arise and believes that the resolution of any such matters currently known will not have a material effect on our results of operations or financial position.

 

ITEM 1A. Risk Factors

A description of the risks associated with our business, financial condition and results of operations is set forth in Part 1, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. There have been no material changes in our risks from such description.

 

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ITEM 6. Exhibits

 

  (a) Exhibits

 

          Incorporated By Reference

Exhibit

No.

  

Exhibit

   Filing    Exhibit
No.
   File No.    File Date
  31.1    Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  31.2    Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  32.1    Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002            
101.INS    XBRL Instance Document            
101.SCH    XBRL Taxonomy Extension Schema Document            
101.CAL    XBRL Taxonomy Extension Label Calculation Linkbase Document            
101.DEF    XBRL Taxonomy Extension Definition Document            
101.LAB    XBRL Taxonomy Extension Label Linkbase Document            
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document            

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    NATUS MEDICAL INCORPORATED
Dated: November 7, 2013     By:  

/s/ James B. Hawkins

     

James B. Hawkins

Chief Executive Officer

(Principal Executive Officer)

Dated: November 7, 2013     By:  

/s/ Jonathan A. Kennedy

     

Jonathan A. Kennedy

Senior Vice President Finance and

Chief Financial Officer

(Principal Financial and

Accounting Officer)

 

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NATUS MEDICAL INCORPORATED

INDEX TO EXHIBITS

 

          Incorporated By Reference

Exhibit

No.

  

Exhibit

   Filing    Exhibit
No.
   File No.    File Date
  31.1    Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  31.2    Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  32.1    Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002            
101.INS    XBRL Instance Document            
101.SCH    XBRL Taxonomy Extension Schema Document            
101.CAL    XBRL Taxonomy Extension Label Calculation Linkbase Document            
101.DEF    XBRL Taxonomy Extension Definition Document            
101.LAB    XBRL Taxonomy Extension Label Linkbase Document            
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document            

 

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