Item 1B.
Unresolved Staff Comments
None.
Our corporate headquarters are located in Framingham, Massachusetts. We have an operations and manufacturing facility in Miami Lakes, Florida, a small development and operations facility in Sydney, Australia and a small distribution and customer service facility in Hannover, Germany.
Our office in Framingham, Massachusetts consists of approximately 15,000 square feet of office space. The lease expires on December 31, 2014 and we have an option to renew the lease for one additional four-year term. We also have an option to expand with an additional 3,002 square foot space in the building.
Our operations and manufacturing facility in Miami Lakes, Florida consists of approximately 59,000 square feet and includes office space, laboratories, research and development space and three clean rooms which are ISO Class 100,000 compliant. The lease expires on June 30, 2013 and we have an option to renew the lease for two additional, three-year terms.
On December 8, 2010, we entered into a lease for a new facility in Miami Lakes, Florida as part of our planned expansion to support our efforts to prepare for U.S. commercialization. The facility will be used primarily for manufacturing, research and development and administrative functions. Under the lease, we will rent approximately 131,000 square feet for a period ending February 28, 2022, with an option to renew for two five-year terms.
Our facility in Sydney, Australia is approximately 2,600 square feet. The lease commenced on August 31, 2009 with an initial term of two years. We have an option to renew the lease for two additional three-year terms.
Our facility in Hannover, Germany is approximately 3,900 square feet. The lease commenced on October 11, 2010 with an initial term of two years. We have an option to renew the lease for one additional three-year term.
Our manufacturing activities to date consist primarily of process development, component assembly, quality control testing, sustaining engineering and research and development activities. Currently, approximately 80% of our space in Miami Lakes, Florida is being used for these activities.
We believe that the facilities noted above are suitable and adequate for our needs now and for the foreseeable future.
The Company is not a party to any material legal proceedings at the date of filing of this Annual Report on Form 10-K.
Part II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
On February 24, 2009 we listed on the NASDAQ Stock Market with trading commencing on February 25, 2009 under the symbol “HTWR”. Our shares of common stock also trade in the form of CHESS Depositary Interests (“CDIs”), each CDI representing one thirty-fifth of a share of our common stock, on the Australian Securities Exchange (“ASX”) under the symbol “HIN” since November 13, 2008. Prior to that date, our ordinary shares of HeartWare Limited, (since renamed HeartWare Pty. Limited), of which we are the successor issuer, were traded on the ASX under the symbol “HTW”.
The following table sets forth, for the periods indicated, the high and low closing prices for our common stock on the NASDAQ (commencing February 25, 2009) and the high and low closing prices for our CDIs on the ASX (from January 1, 2009 through February 23, 2009). The prices of our CDIs have been adjusted to give effect to the 35 for one exchange ratio and have been converted to U.S. dollars using the spot rate applicable on the relevant date.
As of February 11, 2011 we had 13,891,230 shares of common stock issued and outstanding and there were approximately 20 holders of record of our common stock. In addition, as of that date, there were approximately 760 registered owners of our CDIs.
We have not declared or paid any cash dividends on our shares, and we currently do not anticipate paying any cash dividends in the foreseeable future. Our convertible notes were issued pursuant to the terms of an Indenture dated December 15, 2010. The Indenture does not contain any covenants or restrictions on the payments of dividends. We intend to retain any earnings to finance the development and expansion of our products and business.
As long as CDIs representing our common stock are listed on the ASX, prior to February 1, 2012, we will not issue any shares of our common stock (other than upon conversion of our convertible notes) or any securities convertible into our common stock unless either (1) our stockholders approve such proposed issuance; (2) our stockholders ratify the issuance of the convertible notes and the common stock underlying the convertible notes; or (3) the ASX provides a waiver of the requirement to seek stockholder approval for the issue of shares of our common stock or securities convertible into our common stock, in each case within the meaning of ASX rules and regulations.
Stock Price Performance Graph
The graph below compares the cumulative total stockholder return on an investment in our CDI’s, the NASDAQ Composite Index (U.S. companies only) and the Morningstar Medical Devices Index for the five-year period ended December 31, 2010. The graph assumes the value of an investment in our CDI’s traded on the ASX and each index was $100 on December 31, 2005 and the reinvestment of all dividends, if any.
The graph also presents the cumulative total stockholder return on an investment in our common stock for the period from February 25, 2009 to December 31, 2010. The graph assumes the value of an investment in our common stock was $100 on February 25, 2009, the date our common stock commenced trading on the NASDAQ Stock Market, and the reinvestment of all dividends, if any.
Equity Compensation Plans
The following table sets forth information regarding the Company’s Equity Compensation Plans as of December 31, 2010:
The following selected consolidated statement of operations data for the years ended December 31, 2010, 2009 and 2008 and the selected consolidated balance sheet data as of December 31, 2010 and 2009 have been derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The following selected consolidated statement of operations data for the years ended December 31, 2007 and 2006 and balance sheet data as of December 31, 2008, 2007 and 2006 have been derived from our audited consolidated financial statements which are not included in this Annual Report on Form 10-K. The selected consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below and our audited consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K.
In connection with the 2008 redomiciliation of our corporate parent entity from Australia to the United States, each holder of HeartWare Limited ordinary shares received one share of common stock of HeartWare International, Inc., for every 35 of HeartWare Limited ordinary shares held by such holder. The per share information listed below has been adjusted to give effect to the 2008 redomiciliation transaction, whether such information pertains to a date or period of time subsequent or prior to the redomiciliation transaction.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties, judgment and assumptions. You should review the “Risk Factors” section of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Certain abbreviated key terms have the meanings defined elsewhere in this Annual Report on Form 10-K.
Overview
HeartWare develops and manufactures small implantable heart pumps, or ventricular assist devices, for the treatment of advanced heart failure.
The HeartWare Ventricular Assist System (the “HeartWare System”), which includes a left ventricular assist device (“LVAD”), or blood pump, patient accessories and surgical tools, is designed to provide circulatory support for patients in the advanced stage of heart failure. The core of the HeartWare System is a proprietary continuous flow blood pump, the HVAD Pump, which is a full-output device capable of pumping up to 10 liters of blood per minute. The HeartWare System is designed to be implanted adjacent to the heart, avoiding the abdominal surgery generally required to implant similar devices.
In 2009, we have received CE Marking for the HeartWare System in the European Union allowing for commercial sale and distribution of our device. In the U.S., the device is the subject of clinical trials for two indications: bridge-to-transplant under a CAP and destination therapy. Our device is also available in other countries around the world under special access programs.
Recent key milestones in the development of the HVAS include the following:
•
Completion of enrollment in our ADVANCE trial,
•
FDA approval of a CAP for the ADVANCE trial allowing for the continued enrollment of patients,
•
Submission of PMA application for bridge-to-transplant indication,
•
IDE approval of our ENDURANCE trial for destination therapy indication, and
•
Being named to the REVIVE-IT study, a study to be completed by the Universities of Michigan and Pittsburgh on the benefits of LVAD’s in patients with earlier access to the device.
Beyond the HeartWare System, we are also evaluating our next generation device, the MVAD. The MVAD is based on the same technology platform as the HeartWare System but adopts an axial flow, rather than a centrifugal flow configuration, and is being developed in multiple configurations. The MVAD designs are currently at the preclinical stage and undergoing animal studies focused on minimally invasive implantation techniques. Each of the MVAD configurations is approximately one-third the size of the HVAD Pump. We believe that the MVAD designs will be implantable by surgical techniques that are even less invasive than those required to implant the HVAD Pump.
We began generating revenue from our product sales in August 2008 and have incurred net losses in each year since our inception. We expect our losses to continue as we advance and expand our clinical trial activities in the U.S., continue to develop commercial markets outside of the U.S. and expand our research and development into next generation products including the MVAD.
We have financed our operations primarily through the issuance of convertible notes and the issuance of shares of our common stock. Most recently, on December 15, 2010, the Company issued Convertible Senior Notes with an aggregate principal amount of $143.75 million pursuant to the terms of an Indenture dated as of December 15, 2010. The Convertible Senior Notes are senior unsecured obligations of the Company. The Convertible Senior Notes bear interest at a rate of 3.5% per annum, payable semi-annually in arrears on June 15 and December 15 of each year, beginning on June 15, 2011. The Convertible Senior Notes will mature on December 15, 2017, unless earlier repurchased or converted. In February 2010, we closed a public offering, under a shelf registration on Form S-3 filed with the Securities and Exchange Commission on December 24, 2009, of approximately 1.77 million shares of our common stock at an offering price of $35.50 per share for aggregate gross proceeds of approximately $62.8 million. This amount includes the underwriter’s exercise of their over-allotment option to purchase an additional 230,595 shares of our common stock at the offering price. In August 2009, we sold approximately 2.74 million shares of our common stock through private placements in the United States and Australia, which raised net proceeds of approximately $58.6 million.
We are headquartered in Framingham, Massachusetts. We have an operations and manufacturing facility in Miami Lakes, Florida, a small development and operations facility in Sydney, Australia and a small distribution and customer service facility in Hannover, Germany.
Critical Accounting Policies and Estimates
We prepare our financial statements in accordance with accounting principles generally accepted in the United States. We are required to make estimates and judgments in preparing the financial statements that affect the reported amounts of our assets, liabilities, revenue and expenses. We base our estimates on our historical experience to the extent practicable and on various other assumptions that we believe are reasonable under the circumstances and at the time they are made. If our assumptions prove inaccurate or if our future results are not consistent with our historical experience, we may be required to make adjustments in our policies that affect our reported results. Our most critical accounting policies and estimates include: revenue recognition, inventory capitalization, accounting for share-based compensation, measurement of fair value, income taxes and reserves. We also have other key accounting policies that are less subjective and, therefore, their application would not have a material impact on our reported results of operations. The following is a discussion of our most critical policies, as well as the estimates and judgments involved.
Revenue recognition
We recognize revenue from product sales in accordance with FASB ASC 605 - Revenue Recognition. Pursuant to agreements or orders from customers, we ship product to our customers. Revenue from product sales is only recognized when substantially all the risks and rewards of ownership have transferred to our customers, the selling price is fixed and collection is reasonably assured. A majority of product sales are made on a consignment basis and as such, pursuant to the terms of the consignment arrangements, revenue is recognized on the date the consigned product is implanted or otherwise consumed. Revenue from product sales not sold on a consignment basis is recognized upon customer receipt and acceptance of the product. Revenue recognized to date is from sales of our devices in connection with our U.S. clinical trial and commercial sales in Europe and to a lesser extent under special access in other countries.
Inventory Capitalization
We expense costs relating to the production of inventories as research and development (“R&D”) expense in the period incurred until such time as we believe future commercialization is considered probable and future economic benefit is expected to be recognized, which generally is reliant upon receipt of regulatory approval. We then begin to capitalize subsequent inventory costs relating to that product. We received a full Investigational Device Exemption in September 2008 from the FDA for the HeartWare System and subsequently began selling our product through our U.S. clinical trial. Therefore, effective September 1, 2008, we adopted a policy for capitalizing inventory and recognizing cost of sales related to the HeartWare System.
Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first out (FIFO) method. We utilize a standard costing system, which requires significant management judgment and estimates in determining and applying labor and overhead rates. Labor and overhead rates are estimated based on our best estimate of annual production volumes and labor rates and hours per manufacturing process. These estimates are based on historical experience and budgeted expenses and production volume. Estimates are set at the beginning of the year and updated periodically. While we believe our standard costs are reliable, actual production costs and volume changes may impact inventory, costs of sales and the absorption of production overhead expenses.
We review our inventory for excess or obsolete inventory and write down obsolete or otherwise unmarketable inventory to its estimated net realizable value.
We include in inventory materials and finished goods that are held for sale. Certain materials and finished goods held in inventory may be used in research and development activities and are expensed as part of research and development costs when consumed.
Share-Based Compensation
We recognize share-based compensation expense in connection with our share-based awards, net of an estimated forfeiture rate, and therefore only recognize compensation cost for those awards expected to vest over the service period of the award. We value Restricted Stock Units (“RSU’s”) at their intrinsic value on the date of grant. We use a Black-Scholes option pricing model to estimate the fair value of our stock options. Calculating share-based compensation expense requires the input of highly subjective judgment and assumptions, including estimates of expected life of the award, stock price volatility, forfeiture rates and risk-free interest rates. The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future.
When appropriate, we estimate the expected life of an option by averaging the contractual term of the stock option grants (up to 10 years) with the associated vesting term (typically 4 years).We estimate the volatility of our shares on the date of grant considering several factors, including the historical volatility of our publicly-traded shares. We estimate the forfeiture rate based on our historical experience of forfeitures and our employee retention rate. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be significantly different from what we have recorded in the current period. We estimate the risk-free interest rate based on rates in effect for United States government bonds with terms similar to the expected lives of the awards, at the time of grant.
We have issued share-based awards with performance-based vesting criteria. Achievement of the milestones must be “probable” before we begin recording share-based compensation expense. At each reporting period, we review the likelihood that these awards will vest and if the vesting is deemed probable, we begin to recognize compensation expense at that time. In the period that achievement of the performance based criteria is deemed probable, U.S. GAAP requires the immediate recognition of all previously unrecognized compensation since the original grant date. As a result, compensation expense recorded in the period that achievement is deemed probable could include a substantial amount of previously unrecorded compensation expense related to the prior periods. During 2009 and 2010, we determined that achievement of certain performance-based vesting criteria for awards originally granted in 2007 and 2008 was probable. Therefore, we began recording compensation expense during 2009 and 2010 in connection with certain share-based awards that had been outstanding but for which we had not previously recorded any compensation expense. If ultimately performance goals are not met, for any awards where vesting was previously deemed probable, previously recognized compensation cost will be reversed.
Fair Value Measurements
FASB ASC 820 - Fair Value Measurements and Disclosures defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 requires disclosures about the fair value of all financial instruments, whether or not recognized, for financial statement purposes. Disclosures about the fair value of financial instruments are based on pertinent information available to us as of the respective reporting dates. Accordingly, the estimates presented in our financial statements are not necessarily indicative of the amounts that could be realized on disposition of the financial instruments.
FASB ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).
The three levels of the fair value hierarchy are as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as exchange-traded instruments and listed equities.
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 includes financial instruments that are valued using models or other valuation methodologies. These models consider various assumptions, including volatility factors, current market prices and contractual prices for the underlying financial instruments. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.
Level 3 - Unobservable inputs for the asset or liability. Financial instruments are considered Level 3 when their fair values are determined using pricing models, discounted cash flows or similar techniques and at least one significant model assumption or input is unobservable.
Calculating fair value utilizing Level 2 and Level 3 inputs requires the input of highly subjective judgment and assumptions. The assumptions used in calculating the fair value of financial instruments represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, the use of different estimates or assumptions would result in a higher or lower fair value and different amounts being recorded in our financial statements.
Income Taxes
We account for income taxes in accordance with the liability method presented by FASB ASC 740 - Income Taxes. Under this method, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income, and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required. Valuation allowances are recorded related to deferred tax assets based on the “more likely than not” criteria of FASB ASC 740. Through December 31, 2010, we have historically concluded that a full valuation allowance is required to offset our net deferred tax assets.
FASB ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the “more-likely-than-not” threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.
Reserves
Management must make estimates and judgments to determine the amount of reserves to record in the financial statements. If any of these decisions proves incorrect, our consolidated financial statements could be materially and adversely affected.
We maintain allowances for doubtful accounts for estimated losses that may result from an inability to collect payments owed to us for product sales. We regularly review the allowance by considering factors such as historical experience, the age of the accounts receivable balances and current economic conditions that may affect a customer’s ability to pay.
Certain patient accessories sold with the HeartWare System are covered by a limited warranty ranging from one to two years. Estimated contractual warranty obligations are recorded as an expense when the related revenue is recognized and are included in “Cost of revenues” on our consolidated statements of operations. Factors that affect estimated warranty liability include the number of units sold, historical and anticipated rates of warranty claims, cost per claim, and vendor supported warranty programs. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary.
Results of Operations
The following is a description of significant components of our operations, including significant trends and challenges that we believe are important to an understanding of our business and results of operations.
Fiscal Years 2010 and 2009
Revenue, net
For the year ended December 31, 2010, we generated revenue from commercial sales outside of the U.S. and sales in connection with our U.S. clinical trials. The increase in revenue is primarily due to increased market penetration outside of the U.S. and increased activity in our U.S. bridge-to-transplant study including sales after completion of the study through a Continued Access Protocol (“CAP”). Approximately 73% of our product sales in 2010 were derived outside of the U.S. as compared to 59% in the prior year. The increase in the portion of our revenues derived from outside of the United States is due to the continued commercial rollout of the HeartWare System in Europe and other countries with additional implants at existing sites and the addition of new sites.
We expect to continue to generate and grow commercial revenue from product sales as we further expand our sales and marketing efforts outside of the United States, continue implanting under CAP for a bridge-to-transplant indication, and increase the number of implants in our destination therapy clinical trial, ENDURANCE, in the U.S. Notwithstanding our plans to generally expand our U.S. clinical programs, revenues from U.S. sources in connection with our trials may vary from quarter to quarter as the number of implants under CAP is subject to FDA approval for each cohort of patients.
Future product sales are dependent on many factors, including receiving and maintaining the necessary regulatory approvals in the United States and internationally, market acceptance among physicians, patients, health care payers and the medical community as well as our capacity to meet customer demand by manufacturing sufficient quantities of our products.
Cost of Revenues
Cost of revenues totaled approximately $24.4 million for the year ended December 31, 2010 and approximately $13.2 million for the year ended December 31, 2009.
Gross profit and gross margin percentage are as follows:
The increase in gross margin is primarily due to the increase in unit production reducing the overhead and labor costs applied on a per unit basis.
Selling, General and Administrative
Selling, general and administrative expenses include costs associated with selling and marketing our products and the general corporate administration of the Company. These costs are primarily related to salaries and wages and related employee costs, depreciation of fixed assets, travel, external consultants and contractors, legal and accounting fees and general infrastructure costs and include all operating costs not associated with or otherwise classified as research and development costs or cost of revenues.
Selling, general and administrative expenses were as follows:
During 2010, we experienced significant growth as we expanded European sales and distribution capabilities and increased the number of implants in the U.S. under clinical trials. We also experienced growth in administrative costs as we continued to manage dual listings of our securities in the United States and Australia, raised additional capital and expanded our administrative capabilities to support overall corporate growth. As a result, we experienced expansion of our staff, including in senior management, and overall growth in selling and marketing and administrative functions and experienced a related expansion in infrastructure costs.
The increase of $10.2 million in selling, general and administrative costs are primarily a result of an increase in share-based payment expense of $5.6 million, an increase in employee costs, including salaries and wages and related costs, of $3.7 million, and an increase in travel of $1.2 million. In addition, we experienced increases in costs of $508,000 related to accounting and tax matters, consultants and contractors of $469,000, office expenses of $350,000, marketing expenses of $396,000 and bad debt expense related to the establishment of a reserve for doubtful accounts of $600,000. Increases in costs were partially offset by a decrease in legal fees in 2010 as compared to 2009 of approximately $4.4 million associated with a failed merger transaction in 2009. The decrease in sales and marketing expenses as a percentage of operating expenses is due to R&D expenses comprising a higher percentage of overall costs as discussed below.
Research and Development
Research and development expenses are the direct and indirect costs associated with developing our products prior to commercialization and are expensed as incurred. These expenses fluctuate based on project level activity and availability of funding to support new and ongoing projects and consist primarily of salaries and wages and related employee costs of our research and development and clinical and regulatory staff, external research and development costs, materials and expenses associated with clinical trials. Additional costs include travel, facilities and overhead allocations.
Research and development expenses were as follows:
As discussed above, we experienced significant growth in 2010. We achieved significant research and development milestones including enrolling a substantial number of patients in our U.S. clinical trial, developing three design configurations for the MVAD and furthering animal studies for less invasive implantable techniques related to the MVAD. The increase in research and development expenses, in total and as a percentage of total operating expenses, was primarily a result of increased clinical trial activity, continued development of next generation products, and costs associated with preparing the PMA application submission to the FDA.
The increase in research and development expenses of approximately $18.0 million is primarily due to an increase in costs associated with our U.S. clinical trials of $5.5 million, an increase in costs associated with development projects including outside engineering, consultants and contractors of $6.9 million related to MVAD development and preparation for our PMA application for HVAD and an increase in headcount and related employee costs, including salaries and wages and related costs, of approximately $2.8 million.
Even with commercial approval of the HeartWare System in Europe, we expect that research and development expenses will continue to represent a significant portion of our operating expenses for the foreseeable future related to clinical trials in the U.S. and new product development, including costs related to the development of the MVAD.
Foreign Exchange
Foreign exchange losses totaled approximately $502,000 in the year ended December 31, 2010, as compared to a loss of approximately $285,000 for the prior year. In 2010, the majority of our realized and unrealized foreign exchange gains and losses were experienced upon the collection of certain accounts receivable that were denominated in foreign currencies, and the translation to U.S. dollars of customer accounts receivable denominated in foreign currencies at period end, primarily the Euro. We expect this trend to continue for the foreseeable future as the majority of our sales denominated in foreign currencies are settled in Euros. In 2009, the majority of our foreign exchange gains and losses were due to remeasurement of our cash holdings denominated in U.S. dollars held by our Australian subsidiary as a result of movements in the exchange rate between the Australian dollar and the U.S. dollar. During the first half of 2009, we maintained the majority of our cash and cash equivalents in Australia, denominated in both Australian and U.S. dollars. However, beginning in the second half of 2009, the majority of our cash and cash equivalents are in U.S. dollars on deposit with banks located in the United States.
Interest Expense
Interest expense was approximately $431,000 for the year ended December 31, 2010, which consists of accrued interest incurred on the principal amount of the convertible senior notes of approximately $210,000 and non-cash amortization of the related discount and deferred financing costs totaling approximately $221,000. Interest expense was approximately $820,000 for the year ended December 31, 2009, which consists of interest incurred on the principal amount of the convertible loans from Thoratec of approximately $149,000 and non-cash amortization of the deferred financing costs of approximately $671,000.
Interest on the convertible senior notes is payable at a rate of 3.5% per annum. Interest expense also includes amortization of the discount on the convertible senior notes and amortization of the deferred financing costs associated with the convertible senior notes. We expect interest expense to significantly increase in 2011 due to the issuance of these convertible senior notes.
Interest expense in 2009 consists of interest incurred on the principal amount of the convertible loans from Thoratec that were drawn down in August and December 2009 and amortization of deferred (non cash) financing costs related to the Thoratec Loan Agreement. Interest on the convertible loans was payable at a rate of 10% per annum. The deferred financing costs were being amortized over the term of the Thoratec Loan Agreement, which was set to expire no later than November 1, 2011. However, with the repayment of all amounts available to be borrowed under the terms of the agreement, we effectively extinguished all debt under this agreement. There was no such interest expense in 2010 as the convertible loans were repaid and the Loan Agreement terminated in the fourth quarter of 2009.
Interest Income, net
Interest income is primarily derived from investments and cash and short-term deposit accounts held in the U.S. The amortization of premium on our investments is also included in interest income, net. Interest income, net was approximately $564,000 for the year ended December 31, 2010 as compared to approximately $101,000 for the prior year. The increase was primarily due to higher cash balances during the 2010 period resulting from the capital raises completed in the second half of 2009 and in February 2010. However, we experienced lower interest rates in 2010 compared to 2009.
Change in Fair Value of Derivative Instrument
As further discussed in Note 8 to the accompanying financial statements, we recorded the fair value of a derivative instrument on July 31, 2009 related to the Australian dollar denominated conversion feature in the Thoratec Loan Agreement. We were required to initially record this derivative at fair value on July 31, 2009 and re-measure fair value at each reporting period. During the year ended December 31, 2009 we recognized aggregate non-cash expenses of approximately $3.9 million due to the increase in the fair value of this derivative between July 31, 2009 and December 29, 2009, the date the derivative was extinguished. This increase in fair value was primarily due to an increase in the fair value of our common stock and is non-cash in nature.
Gain on Early Extinguishment of Debt
As further discussed in Note 8 to the accompanying financial statements, in 2009, we recorded a net gain (non-cash) on the early extinguishment of debt related to the Thoratec Loan Agreement. Due to the repayment of all amounts borrowed under the Loan Agreement, our inability to re-borrow amounts repaid and Thoratec’s inability to convert any repaid amounts into our common stock, the fair value of the derivative instrument at the repayment dates, aggregating approximately $7.8 million, was recorded as a gain on the extinguishment of debt. Further, the unamortized balance of the deferred financing costs at the repayment dates, aggregating approximately $3.2 million, was recorded as a reduction of the gain on early extinguishment of debt, resulting in a net gain on the early extinguishment of debt of $4.6 million for the year ended December 31, 2009. Since there are no funds held in escrow, there are no amounts remaining for us to borrow and no amounts remaining for Thoratec to convert into shares of HeartWare common stock. Therefore, Thoratec’s conversion rights, and thus the derivative, have been eliminated.
Income Taxes
We are subject to taxation in multiple jurisdictions. We have incurred losses since inception. Changes in share ownership, as well as other factors, may limit our ability to utilize any net operating loss carry-forwards, and as such a 100% valuation allowance has been recorded against our net deferred tax assets.
As of December 31, 2010, we did not have revenues or profit which would be sufficient to allow any portion of our deferred tax assets to be recorded. We intend to monitor closely the question of whether to record a deferred tax asset as we expand the commercialization of our products.
Fiscal Years 2009 and 2008
Revenue, net
For the year ended December 31, 2009, we generated net revenue from product sales of approximately $24.2 million as compared to $332,000 in the year ended December 31, 2008. For the year ended December 31, 2009, we generated revenue from sales in connection with our U.S. clinical trial and commercial sales outside of the U.S. For the year ended, December 31, 2008, revenue consisted of a limited number of unit sales following commencement of our U.S. bridge-to-transplant clinical trial in August 2008 with no revenue being derived during that period from sources outside the U.S. As of December 31, 2009, we had enrolled 114 of the 150 patients we intend to enroll in the U.S. trial. In January 2009, we received CE Marking approval for our HeartWare System and began generating commercial revenue in Europe. Approximately 59% of our product sales in 2009 were derived internationally.
We expect to continue to generate and grow commercial revenue from product sales as we further expand our sales and marketing efforts outside of the United States. Notwithstanding our plans to generally expand our U.S. clinical programs, revenues from U.S. sources in connection with our bridge-to-transplant trial may wane, after the first half of 2010 as we complete enrollment of this trial and we await approvals from the FDA to commence a destination therapy clinical trial and to continue implanting additional bridge-to-transplant patients under a Continued Access Program, or CAP, protocol in any U.S. center that implanted a patient in the bridge-to-transplant trial. Future product sales are dependent on many factors, including receiving and maintaining the necessary regulatory approvals in the United States and internationally, market acceptance among physicians, patients, health care payers and the medical community as well as our capacity to meet customer demand by manufacturing sufficient quantities of our products.
Cost of Revenues
Cost of revenues totaled approximately $13.2 million for the year ended December 31, 2009 and approximately $78,000 for the year ended December 31, 2008.
Gross profit and gross margin percentage are as follows:
We began capitalizing inventory on September 1, 2008. Prior to that time, product costs were expensed as R&D costs (see Critical Accounting Policies and Estimates - Inventories). At September 1, 2008, we had product on hand that was previously expensed as R&D costs but was subsequently utilized in the production and sale of finished goods. From September 2008 through the first half of 2009, the carrying value of our inventories and our cost of revenues were reduced by the value of product on hand that had been previously expensed as R&D. Therefore, cost of revenues for the last four months of 2008 and the first half of 2009 did not include the cost of this existing or pre-launch inventory and this resulted in a higher than expected gross margin until all pre-launch inventory was consumed. In addition, as we have limited manufacturing experience and we use a standard costing method for determining costs of inventory based on limited historical data, our actual results may differ from standards. As a result, gross margins have been and may continue to be inconsistent from quarter to quarter.
Selling, General and Administrative
Selling, general and administrative expenses include costs associated with selling and marketing our products and the general corporate administration of the Company. These costs are primarily related to salaries and wages and related employee costs, depreciation of fixed assets, travel, external consultants and contractors, legal and accounting fees and general infrastructure costs and include all operating costs not associated with or otherwise classified as research and development costs or cost of revenues.
During 2009, we experienced significant growth as we established European sales and distribution capabilities and sold commercially throughout Europe and under special access in other countries. We also experienced growth in the U.S. as we initiated wider enrollment in our first human clinical trial in the United States, continued to manage dual listings of our securities in the United States and Australia, raised additional capital and expanded our research and development and manufacturing activities. As a result, we experienced expansion of our staff, including senior management, and a related expansion in infrastructure costs.
Also, in 2009, we entered into a merger agreement with Thoratec Corporation that ultimately was not consummated due to intervention from the U.S. Government on anti-competitive grounds. This unsuccessful merger did however result in the expenditure of substantial legal and other professional expenses.
In 2009, selling, general and administrative expenses were approximately $16.4 million, or 52%, of operating expenses, as compared to $11.0 million, or 37% of operating expenses in 2008. The increase was primarily a result of $4.7 million of legal and other expenses related to the proposed merger with Thoratec Corporation and increased share-based compensation of approximately $981,000. The increase in share-based compensation was due to the issuance of additional awards and the recognition in 2009 of expense related to awards previously granted in 2007 and 2008 with performance criteria that were not previously deemed probable. Upon being deemed probable in 2009, compensation expense was recognized from the initial grant date through the date the achievement of the performance criteria were deemed probable (see Note 9 of the accompanying financial statements).
Research and Development
Research and development expenses are the direct and indirect costs associated with developing our products prior to commercialization and are expensed as incurred. These expenses consist primarily of salaries and wages and related employee costs of our research and development and clinical and regulatory staff external research and development costs, materials and expenses associated with clinical trials. Additional costs include travel, facilities and overhead allocations.
Even with commercial approval of the HeartWare System in Europe, we expect that research and development expenses will continue to represent a significant portion of our operating expenses for the foreseeable future related to clinical trials in the U.S. and new product development, including costs related to the development of the MVAD.
As discussed above, we experienced significant growth in 2009. We achieved significant research and development milestones including enrolling a substantial number of patients in our U.S. clinical trial, developing three design configurations for the MVAD and furthering animal studies for less invasive implantable techniques related to the MVAD.
In 2009, research and development expenses were $15.1 million, or 48%, of operating expenses as compared to $18.6 million, or 63% of operating expenses, in 2008. The decrease was primarily a result of recognizing the labor, material and overhead costs of manufacturing the HeartWare System as part of inventory, and upon sale, as costs of revenue, in 2009 subsequent to the recognition of revenue and the capitalization of inventory (see Critical Accounting Policies and Estimates - Inventories). The decrease was partially offset by an increase in headcount and related employee costs in our research and development and clinical and regulatory groups as well as increased clinical trial costs, professional fees and other research and development expenses related to existing research projects and on-going clinical trials and regulatory activities.
Foreign Exchange
Foreign exchange losses totaled approximately $285,000 in the year ended December 31, 2009, as compared to a gain of approximately $4.6 million for the prior year. The difference was due to fluctuations in the overall balance, proportion and value of our cash holdings denominated in U.S. dollars held by our Australian subsidiary as a result of movements in the exchange rate between the Australian dollar and the U.S. dollar.
Historically, we maintained the majority of our cash and cash equivalents in Australia, denominated in both Australian and U.S. dollars throughout 2009, and as of December 31, 2009, the majority of our cash and cash equivalents were in U.S. dollars on deposit with banks located in the United States. Therefore, we expect that the amount of foreign exchange gains and losses on cash holdings held by our Australian subsidiary will not be as significant as historical amounts.
Interest Expense
Interest expense in 2009 consists of interest incurred on the principal amount of the convertible loans from Thoratec that were drawn down in August and December 2009 and amortization of deferred (non cash) financing costs related to the Thoratec Loan Agreement. Interest on the convertible loans was payable at a rate of 10% per annum. The deferred financing costs were being amortized over the term of the Thoratec Loan Agreement, which was set to expire no later than November 1, 2011. However, with the repayment of all amounts available to be borrowed under the terms of the agreement, we effectively extinguished all debt under this agreement. We will not incur any further amortization costs related to this agreement.
Interest expense was approximately $820,000 for the year ended December 31, 2009. Interest incurred on the principal amount of the convertible loans was approximately $149,000 and non-cash amortization of the deferred financing costs totaled approximately $671,000.
Interest Income, net
Interest income is primarily derived from cash and short-term deposit accounts, denominated in both Australian and U.S. dollars, held in Australia and the U.S. Interest income was approximately $101,000 for the year ended December 31, 2009 as compared to approximately $1.3 million for the prior year. The decrease was primarily due to lower interest rates earned and lower average daily cash balances during the 2009 period.
Change in Fair Value of Derivative Instrument
As further discussed in Note 8 to the accompanying financial statements, we recorded the fair value of a derivative instrument on July 31, 2009 related to the Australian dollar denominated conversion feature in the Thoratec Loan Agreement. We were required to initially record this derivative at fair value on July 31, 2009 and re-measure fair value at each reporting period. During the year ended December 31, 2009 we recognized aggregate non-cash expenses of approximately $3.9 million due to the increase in the fair value of this derivative between July 31, 2009 and December 29, 2009, the date the derivative was extinguished. This increase in fair value was primarily due to an increase in the fair value of our common stock and is non-cash in nature.
Gain on Early Extinguishment of Debt
As further discussed in Note 8 to the accompanying financial statements, in 2009, we recorded a net gain (non-cash) on the early extinguishment of debt related to the Thoratec Loan Agreement. Due to the repayment of all amounts borrowed under the Loan Agreement, our inability to re-borrow amounts repaid and Thoratec’s inability to convert any repaid amounts into our common stock, the fair value of the derivative instrument at the repayment dates, aggregating approximately $7.8 million, was recorded as a gain on the extinguishment of debt. Further, the unamortized balance of the deferred financing costs at the repayment dates, aggregating approximately $3.2 million, was recorded as a reduction of the gain on early extinguishment of debt, resulting in a net gain on the early extinguishment of debt of $4.6 million for the year ended December 31, 2009. Since there are no funds held in escrow, there are no amounts remaining for us to borrow and no amounts remaining for Thoratec to convert into shares of HeartWare common stock. Therefore, Thoratec’s conversion rights, and thus the derivative, have been eliminated.
Other, net
Other, net consists of gains and losses on the disposal of fixed assets. For the year ended December 31, 2009, we incurred a loss on the disposal of fixed assets of approximately $25,000 primarily in connection with the termination of our lease for administrative offices in Australia. For the year ended December 31, 2008, we incurred a loss on the disposal of fixed assets of approximately $188,000 primarily in connection with the termination of our lease for our prior manufacturing facility in Florida.
Income Taxes
We are subject to taxation in the United States and Australia. We have incurred losses since inception in both jurisdictions. Changes in share ownership, as well as other factors, may limit our ability to utilize any net operating loss carry-forwards, and as such a 100% valuation allowance has been recorded against our net deferred tax assets.
As of December 31, 2009, we did not have revenues or profit which would be sufficient to allow any portion of our deferred tax assets to be recorded. We intend to monitor closely the question of whether to record a deferred tax asset as we expand the commercialization of our products.
Liquidity and Capital Resources
As of December 31, 2010, our cash and cash equivalents were approximately $192.1 million as compared to $50.8 million at December 31, 2009. The increase is primarily a result of the cash proceeds from the issuance of convertible notes in December 2010, the issuance of common stock in February 2010 and the exercise of stock options, partially offset by cash used to support our operating and investing activities.
Following is a summary of our cash flow activities:
Cash Used in Operating Activities
Cash used in operating activities for the year ended December 31, 2010 was approximately $27.6 million as compared to approximately $29.5 million for the same period in the prior year. For 2010, this amount included a net loss of approximately $29.4 million and non-cash adjustments to net loss in a total amount of approximately $13.6 million, which primarily consisted of $10.6 million of share-based compensation, and $1.5 million of depreciation and amortization. Also included in cash used in operating activities in 2010 is approximately $8.2 million related to an increase in accounts receivable and $6.7 million for the purchase and manufacture of inventories offset by cash provided by the increase of accrued expenses and other current liabilities of approximately $3.0 million. We expect increases in accounts receivable and inventory purchases to continue to be a significant use of cash throughout 2011 in support of our U.S. clinical trials and international commercial sales.
Cash used in operating activities for the year ended December 31, 2009 was approximately $29.5 million. For 2009, this amount included a net loss of approximately $20.9 million and non-cash adjustments to net loss in a total amount of approximately $5.1 million, which primarily consisted of approximately $4.6 million for the gain on early extinguishment of debt, $4.1 million of share-based compensation, $3.9 million for the change in fair value of a derivative and $1.6 million of depreciation and amortization. Included in cash used in operating activities in 2009 is approximately $11.1 million related to an increase in accounts receivable and $5.4 million for the purchase and manufacture of inventories offset by cash provided related to an increase in accounts payable of $2.5 million.
Cash Used in Investing Activities
Investing activities used cash of approximately $32.1 million and $1.5 million for the years ended December 31, 2010 and 2009, respectively. In 2010, cash used in investing activities included $25.8 million for the purchase of available-for-sale securities, $5.1 million to acquire property, plant and equipment and capitalized patent costs and $1.25 million of cash paid for a security deposit on a new facility lease. In 2009, cash used in investing activities primarily consisted of the costs to acquire property, plant and equipment and capitalized patent costs.
Cash Provided by Financing Activities
Cash provided by financing activities for the years ended December 31, 2010 and 2009 was approximately $200.9 million and $60.3 million, respectively. During 2010, these amounts were primarily the result of the net cash proceeds from the issuance of convertible senior notes and capital raises through the issuance of common stock.
In December 2010, we issued Convertible Senior Notes with an aggregate principal amount of $143.75 million pursuant to the terms of an Indenture dated as of December 15, 2010, and received net cash proceeds of approximately $139.0 million. The Convertible Senior Notes are senior unsecured obligations of the Company. The Convertible Senior Notes bear interest at a rate of 3.5% per annum, payable semi-annually in arrears on June 15 and December 15 of each year, beginning on June 15, 2011. The Convertible Senior Notes will mature on December 15, 2017, unless earlier repurchased by the Company or converted.
In February 2010, we closed a public offering, under a shelf registration on Form S-3 filed with the Securities and Exchange Commission on December 24, 2009, of approximately 1.77 million shares of our common stock at an offering price of $35.50 per share for aggregate gross proceeds of approximately $62.8 million. This amount includes the underwriter’s exercise of their over-allotment option to purchase an additional 230,595 shares of our common stock at the offering price. In 2010, we also received approximately $3.6 million from the exercise of stock options.
In 2009, we completed a private placement for the sale of approximately 2.74 million shares of our common stock at an issue price of $22.00 per share for aggregate gross proceeds of approximately $60.2 million. Related costs of approximately $1.5 million were paid in 2009. In 2009, we also received approximately $1.5 million from the exercise of stock options. Financing activities in 2009 reflect the borrowing and repayment of an aggregate of $20.0 million under a loan agreement. This loan agreement is discussed in the Note 6 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Operating Capital and Capital Expenditure Requirements
We have incurred operating losses to date and anticipate that we will continue to incur substantial net losses as we expand our sales and marketing capabilities, develop new products and seek regulatory approvals for the HeartWare System in the U.S. In 2011, cash on hand is expected to primarily be used to fund our ongoing operations, including expanding our sales and marketing capabilities on a global basis, continuing implants under a CAP, and enrolling patients in our U.S. destination therapy clinical study, continued product development, regulatory and other compliance functions as well as for general working capital. We expect to experience increased cash requirements for inventory and property related to the expansion of our manufacturing capabilities to support continued growth.
We believe cash on hand and investment balances as of December 31, 2010 is sufficient to support our planned operations throughout 2011 and 2012.
Because of the numerous risks and uncertainties associated with the development of medical devices and the current economic situation, we are unable to estimate the exact amounts of capital outlays and operating expenditures necessary to obtain regulatory approvals in the U.S., fund commercial expansion outside of the U.S. and develop new products. Our future capital requirements will depend on many factors, including but not limited to the following:
•
commercial acceptance of our products,
•
costs to manufacture our products,
•
expenses required to operate multiple clinical trials,
•
further product research and development for next generation products and peripherals and efforts to sustain and maintain incremental improvements to existing products,
•
expanding our sales and marketing capabilities on a global basis, including building a team to support U.S. commercialization should the FDA approve our device for marketing in the U.S.,
•
broadening our infrastructure in order to meet the needs of our growing operations, and
•
complying with the requirements related to being a public company in both the United States and Australia.
Contractual Obligations
At December 31, 2010, our contractual financial obligations and commitments by due dates were as follows:
On January 24, 2011, the University of Michigan Cardiovascular Center and the University of Pittsburgh announced that they have been awarded grants from the National Heart, Lung and Blood Institute and the Company to conduct a study exploring the potential benefits of LVADs in patients who will be given earlier access to these devices. In the study, called REVIVE-IT, researchers will compare whether non-transplant eligible patients with heart failure less advanced than that of current LVAD recipients do better with implanted devices than with current medical therapy. This future financial commitment is not included in the above table. Our financial commitment for the study is up to $9.6 million of actual costs over the five-year trial period. The terms and conditions of the financial commitment are subject to completion of a definitive agreement.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of changes in the value of market risk sensitive instruments caused by fluctuations in interest rates, foreign exchange rates and commodity prices. Changes in these factors could cause fluctuations in our results of operations and cash flows.
Interest Rate Risk
Our exposure to interest rate risk is currently confined to interest earnings on our cash and cash equivalents that are invested in highly liquid money market funds. The primary objective of our investment activities is to preserve our capital to fund operations. We also seek to maximize income from our investments without assuming significant risk. We do not presently use derivative financial instruments in our investment portfolio. Our cash and investments policy emphasizes liquidity and preservation of principal over other portfolio considerations.
Our convertible notes do not bear interest rate risk as the notes were issued with a fixed interest rate of 3.5% per annum.
Foreign Currency Rate Fluctuations
We conduct business in foreign countries. For U.S. reporting purposes, we translate all assets and liabilities of our non-U.S. entities at the period-end exchange rate and revenues and expenses at the average exchange rates in effect during the periods. The net effect of these translation adjustments is shown in the accompanying consolidated financial statements as a component of stockholders’ equity.
We generate a substantial portion of our revenues and collect receivables in foreign currencies. Fluctuations in the exchange rate of the U.S. dollar against the Euro, British Pound and Australian dollar can result in foreign currency exchange gains and losses that may significantly impact our financial results and our overall cash position. These foreign currency transaction gains and losses are presented as a separate line item on our consolidated statements of operations. Continued fluctuation of these exchange rates could result in financial results that are not comparable from quarter to quarter. We do not currently utilize foreign currency contracts to mitigate the gains and losses generated by the remeasurement of non-functional currency assets and liabilities but do hold cash reserves in currencies in which those reserves are anticipated to be expended.
Item 8.
Item 8.
Financial Statements and Supplementary Data
HEARTWARE INTERNATIONAL, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
HeartWare International, Inc.
We have audited the accompanying consolidated balance sheets of HeartWare International, Inc. and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HeartWare International, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), HeartWare International, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 24, 2011 expressed an unqualified opinion.
/s/ Grant Thornton LLP
Fort Lauderdale, Florida
February 24, 2011
HEARTWARE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
HEARTWARE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
HEARTWARE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
The accompanying notes are an integral part of these financial statements.
HEARTWARE INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these financial statements.
HEARTWARE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 1. Description of Business
HeartWare International, Inc., referred to in these notes collectively with its subsidiaries HeartWare Pty. Limited, HeartWare, Inc., HeartWare (UK) Limited and HeartWare GmbH as “we,” “our,” “HeartWare” or the “Company”, is a medical device company that develops and manufactures small implantable heart pumps, or ventricular assist devices, which are used by physicians and hospitals for the treatment of advanced heart failure.
The HeartWare Ventricular Assist System (the “HeartWare System”), which includes a left ventricular assist device (“LVAD”), patient accessories and surgical tools, is designed to provide circulatory support for patients with advanced heart failure. The core of the HeartWare System is a proprietary continuous flow blood pump, the HVAD Pump, which is a full-output device capable of pumping up to 10 liters of blood per minute.
In January 2009, the HeartWare System received Conformite Europenne (“CE”) Marking approval, which allows us to market and sell the device in Europe. Our first commercial sale in Europe occurred in March 2009. The HeartWare System is also sold to customers located in the U.S. through our clinical trials and under special access in other countries.
In April 2008, we received conditional Investigational Device Exemption (“IDE”) approval from the United States Food & Drug Administration (“FDA”) to enroll 150 patients in a bridge-to-transplant clinical study in the United States (called “ADVANCE”). Full IDE approval for the HeartWare System was received from the FDA in September 2008 and, in October 2009 we received FDA approval to expand the number of participating sites from 28 to 40 centers. In February 2010, we completed enrollment in this trial with 140 patients receiving the HeartWare System. The remaining 10 patients were enrolled but did not receive an implant of the HeartWare System because they failed to meet the trial’s inclusion and exclusion criteria after being enrolled.
We continue to enroll patients in our ADVANCE trial under a Continued Access Protocol (“CAP”). The CAP makes the HeartWare System available to patients and clinicians while also providing additional data for the FDA to evaluate prior to determining whether or not to approve the HeartWare System. The CAP patients will be enrolled and followed under a modified protocol of the ADVANCE trial. The FDA grants approval to enroll under CAP for specific patient cohorts, the most recent being a third allotment of 94 patients, approved in January 2011.
In June 2010, we received conditional IDE approval from the FDA to begin enrollment in our destination therapy clinical study for the HeartWare System. Designed to enroll up to 450 patients at 50 U.S. hospitals, the non-inferiority study, which is named “ENDURANCE,” is a randomized, controlled, unblinded, multi-center clinical trial to evaluate the use of the HeartWare System as a destination therapy in advanced heart failure patients. The study population will be selected from patients with end-stage heart failure who have not responded to standard medical management and who are ineligible for cardiac transplantation. Patients in the study will be randomly selected to receive either the HeartWare System or, as part of a control group they will be implanted with any alternative LVAD approved by the FDA for destination therapy, in a 2:1 ratio. Each patient receiving the HeartWare System or control LVAD will be followed to the primary endpoint at two years, with a subsequent follow-up period extending to five years post implant. In August 2010, our first patient was implanted as part of the ENDURANCE trial and we received full IDE approval from the FDA in September 2010.
Beyond the HeartWare System, we are also evaluating our next generation device, the Miniaturized Ventricular Assist Device (“MVAD”). The MVAD is based on the same technology platform as the HeartWare System but adopts an axial flow, rather than a centrifugal flow, configuration and is being developed in multiple configurations. The MVAD designs are currently at the preclinical stage and undergoing animal studies focused on less invasive implantation techniques. Each of the MVAD configurations is approximately one-third the size of the HVAD Pump. We believe that the MVAD designs will be implantable by surgical techniques that are even less invasive than those required to implant the HVAD Pump.
We are headquartered in Framingham, Massachusetts. We have an operations and manufacturing facility in Miami Lakes, Florida, a small development and operations facility in Sydney, Australia and a small distribution and customer service facility in Hannover, Germany.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Basis of Presentation
Effective November 13, 2008, we redomiciled from Australia to the United States. Pursuant to a court approved scheme of arrangement under Australian law, all ordinary shares of HeartWare Limited, a company incorporated in Australia, were transferred by court order to HeartWare International, Inc., a Delaware corporation, in exchange for shares of common stock of HeartWare International, Inc. Holders received common stock in a ratio of 35 HeartWare Limited ordinary shares to 1 share of HeartWare International, Inc. common stock. All outstanding equity awards of HeartWare Limited were assumed by HeartWare International, Inc. at historical cost. All share-based awards were assumed by HeartWare International, Inc. and equitably adjusted to reflect the reincorporation. Throughout these financial statements, all share information, including related per share data, has been adjusted to give retroactive effect to the reincorporation for all periods presented.
HeartWare International, Inc. shares trade on the NASDAQ Stock Market under the symbol of “HTWR”. The Company’s shares also trade on the Australian Securities Exchange (“ASX”) in the form of CHESS Depositary Interests (“CDIs”) under the symbol of “HIN”. Each CDI represents 1/35th of a share of common stock.
Note 2. Liquidity
At December 31, 2010, we had approximately $217.5 million of cash, cash equivalents and investments. The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which contemplate continuation of the Company as a going concern. We have sustained substantial losses from operations since our inception, and such losses have continued through December 31, 2010. At December 31, 2010, we had an accumulated deficit of approximately $127.3 million.
We have financed our operations primarily through the issuance of shares of our common stock and the issuance of convertible notes. Most recently, in December 2010, we consummated the issuance and sale of $143.75 million aggregate principal amount of convertible notes. The convertible notes are the senior unsecured obligations of the Company. The convertible notes bear interest at a rate of 3.5% per annum, payable semi-annually in arrears on June 15 and December 15 of each year, beginning on June 15, 2011. The convertible notes will mature on December 15, 2017, unless earlier repurchased or converted. The convertible notes will be convertible at an initial conversion rate of 10 shares of common stock per $1,000 principal amount of convertible notes, which corresponds to an initial conversion price of $100.00 per share of common stock.
In 2011, our cash, cash equivalents and investments are expected to primarily be used to fund our ongoing operations including expanding our sales and marketing capabilities on a global basis, continuing our ENDURANCE trial for destination therapy, enrolling additional patients in our ADVANCE trial under a CAP, continued product development, regulatory and other compliance functions as well as for general working capital. We believe our cash, cash equivalent and investment balances are sufficient to support our planned operations through 2012.
Note 3. Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of HeartWare International, Inc., and its subsidiaries described in Note 1. All inter-company balances and transactions have been eliminated in consolidation.
Accounting Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Cash and Cash Equivalents
Cash and cash equivalents are recorded in the consolidated balance sheets at cost, which approximates fair value. All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.
Investments
Our investments classified as available-for-sale are stated at fair value with unrealized gains and losses reported in accumulated other comprehensive loss within stockholders’ equity. We classify our available-for-sale investments as short-term if their remaining time to maturity is beyond three months. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. Interest on investments classified as available-for-sale is included in interest income, net. Premiums paid on our short-term investments are amortized over the remaining term of the investment and are included in Interest income, net.
Receivables
Accounts receivable consists of amounts due from the sale of our HeartWare System to our customers, which are primarily hospitals and health research institutions. As of December 31, 2010, one customer had an accounts receivable balance greater than 10% of total accounts receivable representing approximately 13% of our total accounts receivable. As of December 31, 2009, one customer had an accounts receivable balance representing approximately 16% of our total accounts receivable.
We maintain allowances for doubtful accounts for estimated losses that may result from an inability to collect payments owed to us for product sales. We regularly review the allowance by considering factors such as historical experience, the age of the accounts receivable balances and current economic conditions that may affect a customer’s ability to pay. Prior to 2010, we did not maintain an allowance for doubtful accounts and as of December 31, 2010 and 2009 we did not have an allowance for returns.
The following table summarizes the change in our allowance for doubtful accounts for the year ended December 31, 2010:
Inventories, net
Components of Inventories, net are as follows:
Finished goods inventories includes inventory held on consignment at customer sites of $4.7 million and $3.8 million, at December 31, 2010 and 2009, respectively.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Inventories are stated at the lower of cost or market. Cost is determined using a first-in, first-out, or FIFO, method. Work-in-process and finished goods includes direct and indirect labor and manufacturing overhead. Finished goods includes product which is ready-for-use and which is held by us or by our customers on a consignment basis. We review our inventory for excess or obsolete inventory and write-down obsolete or otherwise unmarketable inventory to its estimated net realizable value.
Property, Plant and Equipment
We record property, plant and equipment and leasehold improvements at historical cost. Expenditures for maintenance and repairs are recorded to expense; additions and improvements are capitalized. We generally provide for depreciation using the straight-line method at rates that approximate the estimated useful lives of the assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the useful life of the improvement or the remaining term of the lease.
Property, plant and equipment, net consists of the following at December 31:
Depreciation expense was $1,390,159, $894,928 and $663,894 for the years ended December 31, 2010, 2009 and 2008, respectively.
We enter into agreements with medical centers participating in our U.S. clinical trials under which we loan certain equipment, including patient monitors, to the center to be used throughout the trials. The equipment loaned to the centers is classified as a long-lived asset and included as a component of Property, plant and equipment (machinery and equipment) on our consolidated balance sheets. Depreciation expense on equipment subject to these agreements is classified in cost of revenues and is computed using the straight-line method based on the estimated useful life of three years.
We also enter into short-term cancellable rental agreements with certain commercial customers for components of the HeartWare System, including patient monitors and controllers. Under the terms of such agreements, we provide the equipment to the customers, but we retain title to the equipment. Equipment subject to rental agreements is classified as a long-lived asset and included as a component of property, plant and equipment (machinery and equipment). Depreciation expense on equipment subject to these agreements is classified in cost of revenues and is computed using the straight-line method based on the estimated useful life of one and one half years.
The net carrying value of equipment subject to the agreements discussed above was approximately $520,000 as of December 31, 2010.
Deferred Financing Costs
Costs incurred in connection with the issuance of our convertible senior notes have been allocated between the liability component and the equity component as further discussed in Note 8. The liability component of the issuance costs incurred was capitalized and is included in Deferred financing costs, net on the consolidated balance sheets. These costs are amortized using the effective interest method until December 15, 2017, the maturity date of the notes, and such amortization expense is reflected in Interest expense on our consolidated statements of operations. The amount of amortization for the year ended December 31, 2010 was approximately $11,000.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Other Intangible Assets, net
The gross carrying amount of intangible assets and the related accumulated amortization for intangible assets subject to amortization at December 31 are as follows:
Amortization expense for the years ended December 31, 2010, 2009 and 2008 was $101,500, $75,871 and $41,187, respectively.
Estimated amortization expense for each of the five succeeding fiscal years based upon our intangible asset portfolio at December 31, 2010 is approximately $124,000.
Revenue Recognition
We recognize revenue from product sales in accordance with FASB ASC 605 - Revenue Recognition. Pursuant to agreements or orders from customers, we ship product to our customers. Revenue from product sales is only recognized when substantially all the risks and rewards of ownership have transferred to our customers, the selling price is fixed and collection is reasonably assured. A majority of product sales are made on a consignment basis and as such, pursuant to the terms of the consignment arrangements, revenue is recognized on the date the consigned product is implanted or otherwise consumed. Revenue from product sales not sold on a consignment basis is recognized upon customer receipt and acceptance of the product. Shipping fees billed to customers are included in revenues and the related shipping costs are included in cost of revenues. Value added taxes and other similar types of taxes collected from customers in connection with the sale of our products are recorded on a net basis and are not included in Revenues, net. Revenue recognized to date is from sales of our devices in connection with our U.S. clinical trials, as commercial products to customers in Europe and under special access in countries.
Product Warranty
Certain patient accessories sold with the HeartWare System are covered by a limited warranty ranging from one to two years. Estimated contractual warranty obligations are recorded as an expense when the related revenue is recognized and are included in Cost of revenues on our consolidated statements of operations. Factors that affect estimated warranty liability include the number of units sold, historical and anticipated rates of warranty claims, cost per claim, and vendor supported warranty programs. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary.
The amount of the liability recorded is equal to the estimated costs to repair or otherwise satisfy claims made by customers. Accrued warranty expense is included as a component of Accrued expenses and other current liabilities on the consolidated balance sheets. Prior to 2009, we did not maintain an accrual for product warranty as revenue was minimal.
The costs to repair or replace products associated with product recalls and voluntary service campaigns are recorded when they are determined to be probable and reasonably estimable as a cost of revenues and are not included in product warranty liability.
The following table summarizes the change in our warranty liability for the years ended December 31, 2010 and 2009:
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Share-Based Payments
We recognize share-based compensation expense in connection with our share-based awards, net of an estimated forfeiture rate and therefore only recognize compensation cost for those awards expected to vest over the service period of the award. We value Restricted Stock Units (“RSU’s”) at their intrinsic value on the date of grant. We use a Black-Scholes option pricing model to estimate the fair value of our stock options. Calculating share-based compensation expense requires the input of highly subjective judgment and assumptions, including estimates of expected life of the award, stock price volatility, forfeiture rates and risk-free interest rates. The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future.
When appropriate, we estimate the expected life of an option by averaging the contractual term of the stock option grants (up to 10 years) with the associated vesting term (typically 4 years).We estimate the volatility of our shares on the date of grant considering several factors, including the historical volatility of our publicly-traded shares. We estimate the forfeiture rate based on our historical experience of forfeitures and our employee retention rate. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be significantly different from what we have recorded in the current period. We estimate the risk-free interest rate based on rates in effect for United States government bonds with similar lives, at the time of grant.
We have issued share-based awards with performance-based vesting criteria. Achievement of the milestones must be “probable” before we begin recording share-based compensation expense. At each reporting date, we review the likelihood that these awards will vest and if the vesting is deemed probable, we begin to recognize compensation expense at that time. If ultimately performance goals are not met, for any awards where vesting was previously deemed probable, previously recognized compensation cost will be reversed.
Impairment of Long-Lived Assets
We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable from future undiscounted cash flows. Impairment losses are recorded for the excess, if any, of the carrying value over the fair value of the long-lived assets. As of December 31, 2010, none of our long-lived assets were impaired.
Income Taxes
We account for income taxes in accordance with FASB ASC 740 - Income Taxes. Under this method, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income, and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required. Valuation allowances are recorded related to deferred tax assets based on the “more likely than not” criteria of FASB ASC 740 - Income Taxes.
FASB ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the “more-likely-than-not” threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.
Translation of Foreign Currency
Assets and liabilities of our non-U.S. entities are translated at the period-end exchange rate and revenues and expenses are translated at the average exchange rates in effect during the respective periods. Equity transactions are translated at the spot rates on the dates of the original transactions. The net effect of these translation adjustments is shown in the accompanying consolidated financial statements as a component of stockholders’ equity, titled Accumulated other comprehensive loss. Items in Accumulated other comprehensive loss are not tax affected as we have incurred a net loss in each period since inception.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
While most of the transactions of our domestic and international operations are denominated in the respective local currency, some transactions are denominated in other currencies. Transactions denominated in other currencies are accounted for in the respective local currency at the time of the transaction. Upon settlement of this type of transaction, any foreign currency gains or losses are included in our consolidated statements of operations.
The exchange rate between the U.S. and Australian dollar has fluctuated substantially in the past. This fluctuation resulted in significant changes in the cumulative translation adjustment and foreign exchange gains during the year ended December 31, 2008. During that period of time, our Australian subsidiary, HeartWare Pty. Limited, which operates in a functional currency of Australian dollars, held significant U.S. dollar cash accounts. Exchange rate fluctuations affect the value of these accounts and result in foreign currency gains and losses. Such gains and losses are included in our consolidated statements of operations.
Research and Development
Research and development costs, including new product development programs, regulatory compliance and clinical research, are expensed as incurred.
Marketing and Advertising Costs
Marketing, advertising and promotional costs are expensed when incurred. Advertising expenses were immaterial to our results of operations for the years ended December 31, 2010, 2009 and 2008.
Fair Value Measurements
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses and other current liabilities approximate their fair value based on the short-term maturity of these instruments. Investments are considered available-for-sale as of December 31, 2010 and are carried at fair value. Our convertible senior notes were recorded at fair value on the issuance date. See Note 5, “Fair Value Measurements” and Note 8, “Debt” for more information.
Vendor Concentration
For the years ended December 31, 2010, 2009 and 2008, we purchased approximately 66%, 60% and 58%, respectively, of our inventory components and supplies from three vendors. In addition, one of the three vendors supplies consulting services and material used in research and development activities. As of December 31, 2010 and 2009, the amounts due to these vendors totaled approximately $902,000 and $846,000, respectively.
Concentration of Credit Risk and other Risks and Uncertainties
Financial instruments that potentially expose us to concentrations of credit risk consist primarily of cash and cash equivalents, investments and trade accounts receivable. Cash and cash equivalents are primarily on deposit with financial institutions in the United States and these deposits generally exceed the amount of insurance provided by the Federal Deposit Insurance Corporation. The Company has not experienced any historical losses on its deposits of cash and cash equivalents. Our investments consist of investment grade rated corporate and government agency debt.
Concentration of credit risk with respect to our trade accounts receivable from our customers is primarily limited to hospitals and health research institutions. Credit is extended to our customers, based on an evaluation of a customer’s financial condition and collateral is not required. To date, we have not experienced any credit losses, but have established an allowance for doubtful accounts of $600,000 at December 31, 2010.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
We are subject to certain risks and uncertainties including, but not limited to, our ability to achieve profitability, to generate cash flow sufficient to satisfy our indebtedness, to run clinical trials in order to receive and maintain FDA and foreign regulatory approvals for our products, the ability to achieve widespread acceptance of our product, our ability to manufacture our products in a sufficient volume and at a reasonable cost, the ability to protect our proprietary technologies and develop new products, the risks associated with operating in foreign countries, and general competitive and economic conditions. Changes in any of the preceding areas could have a material adverse effect on our business, results of operations or financial position.
New Accounting Standards
In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (a consensus of the FASB Emerging Issues Task Force). ASU No. 2009-14 amends ASC 985-605, Software: Revenue Recognition, such that tangible products, containing both software and non-software components that function together to deliver the tangible product’s essential functionality, are no longer within the scope of ASC 985-605. It also amends the determination of how arrangement consideration should be allocated to deliverables in a multiple-deliverable revenue arrangement. ASU No. 2009-14 will become effective for us for revenue arrangements entered into or materially modified after our fiscal year ending December 31, 2010. Earlier application is permitted with required transition disclosures based on the period of adoption. Adoption of the provisions of ASU No. 2009-14 is not expected to have a material effect on our consolidated financial position, results of operations or cash flows.
In January 2010, the FASB issued ASU No. 2010-6, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update requires new disclosures for fair value measurements and provides clarification for existing disclosures requirements. The majority of the new disclosure requirements became effective for us on January 1, 2010. Certain of the disclosure requirements will be effective for us on January 1, 2011. As ASU No. 2010-6 only requires enhanced disclosures, the adoption of ASU No. 2010-6 did not have a material effect on our consolidated financial position, results of operations or cash flows and did not materially expand our financial statement footnote disclosures.
In April 2010, the FASB issued ASU No. 2010-13, Compensation-Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. ASU No. 2010-13 clarifies that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The provisions of ASU No. 2010-13 will be effective for us on January 1, 2011. Early adoption is permitted. Adoption of the provisions of ASU No. 2010-13 is not expected to have a material effect on our consolidated financial position, results of operations or cash flows.
Note 4. Investments
We have cash investment policies that limit investments to investment grade securities. At December 31, 2010, all of our investments were classified as available-for-sale and carried at fair value. Our short-term investments had maturity dates of less than twenty-four months, while our long-term investments matured beyond twenty-four months, but within thirty months of the date of this report. Such investments consist of corporate debt, a portion of which is guaranteed by foreign governments, and U.S. government agency debt securities. At December 31, 2009, we did not hold any investments.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
The amortized cost and fair value of our investments, with gross unrealized gains and losses, at December 31, 2010 is as follows:
In the year ended December 31, 2010 we did not have any realized gains or losses on our investments.
Note 5. Fair Value Measurements
FASB ASC 820 - Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 requires disclosures about the fair value of all financial instruments, whether or not recognized, for financial statement purposes. Disclosures about the fair value of financial instruments are based on pertinent information available to us as of the reporting dates. Accordingly, the estimates presented in these consolidated financial statements are not necessarily indicative of the amounts that could be realized on disposition of the financial instruments.
FASB ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).
The three levels of the fair value hierarchy are as follows:
Level 1 - Quoted prices for identical instruments in active markets.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 - Instruments with primarily unobservable value drivers.
The following table represents the fair value of our financial assets and financial liabilities measured at fair value on a recurring basis and which level was used in the fair value hierarchy.
(1)
The carrying amount of our convertible senior notes is net of unamortized discount. See Note 8, “Debt” for more information.
The fair value of our investments and convertible senior notes was determined using quoted prices for the instruments in markets that are not active. The fair value of our convertible senior notes is presented for disclosure purposes only.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 6. Other Balance Sheet Information
Accrued expenses and other current liabilities consist of the following at December 31:
Accrued payroll and other employee costs included year-end employee bonuses of approximately $3.1 million and $1.7 million at December 31, 2010 and 2009, respectively.
Note 7. Exchange of Equity Interests Among Entities Under Common Control
On November 13, 2008, the Company completed an Australian court approved redomiciliation transaction whereby HeartWare International, Inc., a Delaware Corporation, replaced HeartWare Limited, an Australian public company as the ultimate parent company of the HeartWare Group. The transaction was accounted for as an exchange of equity interests among entities under common control. All assets and liabilities of HeartWare Limited were assumed by HeartWare International, Inc. and were accounted for at historical cost.
Note 8. Debt
Convertible Senior Notes
On December 15, 2010, we consummated the issuance and sale of $143.75 million aggregate principal amount of 3.5% convertible senior notes due 2017 (the “Convertible Notes”) pursuant to the terms of an Indenture dated December 15, 2010. The Convertible Notes are the senior unsecured obligations of the Company. The Convertible Notes bear interest at a rate of 3.5% per annum, payable semi-annually in arrears on June 15 and December 15 of each year, beginning on June 15, 2011. The Convertible Notes will mature on December 15, 2017, unless earlier repurchased by us or converted.
The Convertible Notes will be convertible at an initial conversion rate of 10 shares of our common stock per $1,000 principal amount of Convertible Notes, which corresponds to an initial conversion price of $100.00 per share of our common stock, representing a conversion premium of approximately 23% based on the closing price of $81.31 per share of our common stock on December 9, 2010. The conversion rate is subject to adjustment from time to time upon the occurrence of certain events.
Prior to June 15, 2017, holders may convert their Convertible Notes at their option only upon satisfaction of one or more conditions relating to the sale price of our common stock, the trading price per $1,000 principal amount of Convertible Notes or specified corporate events. On or after June 15, 2017 until the close of business of the business day immediately preceding the date the Convertible Notes mature, holders may convert their Convertible Notes at any time, regardless of whether any of the foregoing conditions have been met. As of the date of the filing, none of the events that would allow holders to convert their Convertible Notes have occurred. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination thereof, at our election.
We may not redeem the Convertible Notes prior to maturity. Holders of the Convertible Notes may require us to purchase for cash all or a part of their Convertible Notes at a repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest, upon the occurrence of certain fundamental changes (as defined in the Indenture) involving the Company. The Indenture does not contain any financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
The Indenture contains customary terms and nonfinancial covenants and defines events of default. If an event of default (other than certain events of bankruptcy, insolvency or reorganization involving the Company occurs and is continuing, the Trustee (by notice to the Company) or the holders of at least 25% in principal amount of the outstanding Convertible Notes (by notice to the Company and the Trustee) may declare 100% of the principal of and accrued and unpaid interest, if any, on all the Convertible Notes to be due and payable. In case of certain events of bankruptcy, insolvency or reorganization, involving the Company, 100% of the principal of and accrued and unpaid interest on the Convertible Notes will automatically become due and payable. Upon such a declaration of acceleration, such principal and accrued and unpaid interest, if any, will be due and payable immediately. Notwithstanding the foregoing, the Indenture provides that, to the extent we elect, the sole remedy for an event of default relating to certain failures by us to comply with certain reporting covenants in the Indenture consists exclusively of the right to receive additional interest on the Convertible Notes.
In accordance with ASC 470-20, Debt, which applies to certain convertible debt instruments that may be settled in cash or other assets, or partially in cash, upon conversion, we recorded the long-term debt and equity components on our Convertible Notes separately on the issuance date. The amount recorded for long-term debt was determined by measuring the fair value of a similar liability that does not have an associated equity component. The measurement of fair value required the Company to make estimates and assumptions to determine the present value of the cash flows of the Convertible Notes, absent the conversion feature. This treatment increased interest expense associated with our Convertible Notes by adding a non-cash component to amortize a debt discount calculated based on the difference between the 3.5% cash coupon rate and the effective interest rate on debt borrowing of approximately 12.5%. The discount is being amortized to interest expense through the December 15, 2017 maturity date of the Convertible Notes using the effective interest method and is included in interest expense on the consolidated statements of operations. Additionally, we allocated the costs related to issuance of the Convertible Notes on the same percentage as the long-term debt and equity components, such that a portion of the costs is allocated to the long-term debt component and the equity component included in additional paid-in capital. The portion of the costs allocated to the long-term debt component is presented as Deferred financing costs, net on our consolidated balance sheets. These deferred financing costs are also being amortized to interest expense through the December 15, 2017 maturity date of the Convertible Notes using the effective interest method and such amortization is included in interest expense on the consolidated statements of operations
The Convertible Notes and the equity component, which is recorded in additional paid-in-capital, consisted of the following at December 31, 2010:
Based on the initial conversion rate of 10 shares of our common stock per $1,000 principal amount of Convertible Notes, which corresponds to an initial conversion price of $100.00 per share of our common stock, the number of shares issuable upon conversion of the Convertible Notes is 1,437,500. The value of these shares, based on the closing price of our common stock on December 31, 2010 of $87.57, was approximately $125.9 million. The fair value of our Convertible Notes as presented in Note 5 was $160.7 million at December 31, 2010.
Interest expense related to the Convertible Notes consisted of interest due on the principal amount, amortization of the discount and amortization of the portion of the deferred financing costs allocated to the long-term debt component. For the year ended December 31, 2010, interest expense related to the Convertible Notes was as follows:
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Thoratec Loan Agreement
On February 12, 2009, we entered into an Agreement and Plan of Merger (“Merger Agreement”) with Thoratec Corporation (“Thoratec”). Concurrent with the Merger Agreement, and as described in a Current Report on Form 8-K filed with the SEC on February 13, 2009, we entered into a loan agreement (“Loan Agreement”) with Thoratec, pursuant to which Thoratec committed to loan us up to $28.0 million through one or more term loans subject to the terms and conditions set forth in the Loan Agreement. On July 31, 2009, HeartWare and Thoratec agreed to terminate the Merger Agreement pursuant to Section 8.01 (a) of the agreement. The Loan Agreement survived the termination of the Merger Agreement and as of July 31, 2009, the date the Merger Agreement was terminated, we were able to borrow up to $20.0 million under the Loan Agreement.
Any loans to us under the Loan Agreement, at Thoratec’s option, could have been converted in whole or in part into shares of HeartWare common stock prior to the maturity date of the loans The number of shares to be issued was determined by dividing the outstanding principal amount of the loans, including any accrued and unpaid interest, or funds held in escrow by the U.S. dollar equivalent of AU$35.00 at the time of the conversion. The conversion price was subject to customary adjustment provisions as defined in the Loan Agreement.
As of December 31, 2009, the entire $20.0 million commitment under the Loan Agreement had been borrowed and repaid and was no longer available to us. In addition, since there are no funds held in escrow, there are no amounts for Thoratec to convert into shares of HeartWare common stock, thereby eliminating entirely Thoratec’s conversion rights. The amount of interest expense incurred and paid on amounts borrowed under the Loan Agreement during the year ended December 31, 2009 was approximately $149,000.
Beginning July 31, 2009, the date the Merger Agreement was terminated, Thoratec became entitled to convert any escrow funds in whole or in part into shares of HeartWare International common stock at any time prior to termination of the Loan Agreement. The terms and conditions of this conversion provision were evaluated and determined to result in an embedded derivative within the host contract Loan Agreement. We computed the fair value of the embedded derivative to be approximately $3.9 million at July 31, 2009, the initial measurement date. Fair value was determined using a valuation model with observable market inputs to determine relevant assumptions including interest rates and stock and foreign currency volatilities. The initial fair value was capitalized as deferred financing costs and was being amortized over the contractual term of the Loan Agreement. The amount of amortization for the year ended December 31, 2009 was approximately $671,000 and is included in Interest expense on our consolidated statements of operations. Due to the repayment of all amounts borrowed under the Loan Agreement and our inability to re-borrow amounts repaid, the proportionate amount of the unamortized balance of the deferred financing costs at the repayment dates were recorded as an expense. These amounts aggregating approximately $3.2 million are included in the line item Gain on early extinguishment of debt, net on our consolidated statements of operations.
The change in the fair value of the derivative instrument during the period of time it remained outstanding resulted in an expense aggregating approximately $3.9 million. This amount is presented as a separate line item on our consolidated statements of operations. Due to the repayment of all amounts borrowed under the Loan Agreement, our inability to re-borrow amounts repaid and Thoratec’s inability to convert any repaid amounts into our common stock, the proportionate amount of the fair value of the derivative at the repayment dates, aggregating to $7.8 million, as well as the unamortized balance of deferred financing costs of $3.2 million, was recorded as a gain on the extinguishment of debt. The net amount of $4.6 million is shown on the line item Gain on early extinguishment of debt, net on our consolidated statements of operations.
Note 9. Leases
On September 30, 2010, we amended and renewed our lease for our facility in Miami Lakes, Florida. This facility contains our domestic operations and manufacturing. Under the amended lease we will maintain our existing space of approximately 59,000 square feet, extend the lease term by approximately two years to expire on June 30, 2013 and pay a base rent of $9.00 per square foot starting in June 2011, subject to a 3% annual escalation thereafter. Under the amended lease, we have an option to renew for two additional three-year periods.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
On August 16, 2010, we amended and renewed our lease for our headquarters in Framingham, Massachusetts. Under the amended lease we began occupying additional space in the fourth quarter of 2010, increasing our total square footage from 7,040 to approximately 15,000. Base rent obligations will increase to approximately $275,000 per year. The lease term expires on December 31, 2014 and we have an option to renew for an additional four-year period at fair market value, as defined in the lease agreement. We also have an option to expand with an additional 3,002 square foot space in the building.
On December 9, 2010, we signed a lease for a new facility in Miami Lakes, Florida as part of our planned expansion to support our efforts to prepare for U.S. commercialization. The facility will be used primarily for manufacturing, research and development and administrative functions. Under the lease, we will rent approximately 131,000 square feet for a period ending February 28, 2022, with an option to renew for two five-year terms. The landlord will provide up to $1.75 million towards capital improvements. Base rent will be $9.00 per square foot, payable starting March 2012 and subject to a 3% annual escalation thereafter. A security deposit of $1.25 million was provided in the form of an unconditional stand-by letter of credit. The letter of credit is supported by a certificate of deposit for the same amount, which is included in Restricted cash on our consolidated balance sheet as of December 31, 2010.
In addition to the leases discussed above, we have entered into various operating lease agreements for miscellaneous office space and equipment. The duration of these agreements is typically twenty-four to thirty-six months from origination. The aggregate base annual rental payment on these leases is less than $100,000.
We recognize rent expense on a straight-line basis over the term of the lease. Any scheduled rent increases, rent holidays and other related incentives are recognized on a straight-line basis over the term of the lease. Rent expense was approximately $931,000, $879,000 and $967,000 in 2010, 2009 and 2008, respectively. Future minimum rental commitments under non-cancelable operating lease agreements with remaining terms of at least one year as of December 31, 2010 are as follows:
Note 10. Stockholders’ Equity
Preferred Stock
We are authorized to issue up to 5,000,000 shares of preferred stock, $.001 par value per share. Our board of directors is authorized, subject to any limitations prescribed by law, to provide for the issuance of the shares of preferred stock in series, and by filing a certificate pursuant to the applicable law of the state of Delaware, to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences and rights of the shares of each such series and any qualifications, limitations or restrictions thereof. No shares of preferred stock have been issued or are outstanding.
Common Stock
We are authorized to issue up to 25,000,000 shares of common stock, $.001 par value per share. As of December 31, 2010, we had 13,878,686 shares outstanding. Holders are entitled to one vote for each share of common stock (or its equivalent).
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Shares of our common stock reserved at December 31, 2010, for possible future issuance are as follows:
See the Consolidated Statement of Stockholders’ Equity for details related to our equity transactions.
2010 Public Offering
In February 2010, we completed a public offering of approximately 1.77 million shares of our common stock, including the underwriter’s exercise of their overallotment to purchase 230,595 shares, at an offering price of $35.50 per share for aggregate gross proceeds of approximately $62.8 million. The underwriters for the transaction received a fee of 6% of the gross proceeds. After fees and related expenses, net proceeds from the offering were approximately $58.5 million.
The offering was completed pursuant to a prospectus supplement, dated January 27, 2010, to a shelf registration statement on Form S-3 that was previously filed with the SEC and which was declared effective on January 20, 2010. This shelf registration statement allows us to offer and sell from time to time, in one or more series or issuances and on terms that we will determine at the time of the offering, any combination of the securities described in the prospectus, up to an aggregate amount of $100 million.
2009 Private Placement
In August and September 2009, we entered into Purchase Agreements separately with a number of institutional and accredited investors for the private placement of approximately 2.74 million shares of our common stock at an issue price of $22.00 per share for aggregate gross proceeds of approximately $60.2 million. The placement agent for the transaction received a placement fee in aggregate of approximately 2% of the gross proceeds.
The issuance of approximately 1.4 million shares of the total number of shares sold to the investors in the Private Placement was subject to approval by our stockholders in accordance with NASDAQ Stock Market Rules and Australian Securities Exchange Listing Rules and, as a result, approximately $30.7 million of the proceeds from the Private Placement were held in escrow by an independent third party. Such proceeds were released to us and the 1.4 million shares were issued following stockholder approval which was obtained at a special meeting of stockholders held on October 26, 2009.
2008 Private Placement
In July 2008, we completed a private placement of approximately 1.78 million shares of our common stock for gross proceeds of approximately $29.9 million. After fees and expenses, net proceeds were approximately $29.4 million.
The Company’s issuance and sale of its shares of common stock in this private placement were exempt from SEC registration pursuant to Regulation S under the Securities Act of 1933, as amended (the “Act”) with respect to Australian investors, and pursuant to Regulation D under the Act with respect to United States investors.
Note 11. Share-Based Compensation
We recognize share-based compensation expense for the portion of awards that are ultimately expected to vest using an accelerated accrual method over the vesting period from the date of grant. We estimate forfeitures at the time of grant. We have applied a forfeiture rate of approximately 12.5% to all unvested share-based awards as of December 31, 2010, which represents the portion that we expect will be forfeited over the vesting period. We reevaluate this analysis periodically and adjust the forfeiture rate as necessary. Vesting of share-based awards issued with performance-based vesting criteria must be “probable” before we begin recording share-based compensation expense. At each reporting period, we review the likelihood that these awards will vest and if vesting is deemed probable, we begin to recognize compensation expense at that time. If ultimately performance goals are not met, for any awards where vesting was previously deemed probable, previously recognized compensation cost will be reversed.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
We allocate share-based compensation expense to cost of revenues, selling, general and administrative expense and research and development expense based on the award holders’ employment function. For the years ended December 31, 2010, 2009 and 2008, we recorded share-based compensation expenses as follows:
For the years ended December 31, 2010 and 2009, we experienced a significant increase in share-based compensation expense due primarily to an annual grant of equity awards to a large group of our employees in September 2009. A portion of this grant was subject to stockholder approval. Upon receipt of stockholder approval at our annual meeting of stockholders in the second quarter of 2010, we recorded a true-up of share-based compensation expense to coincide with the award’s vesting period of approximately $1.2 million.
No deferred tax benefits were attributed to our share-based compensation expense recorded in the accompanying consolidated financial statements because we are in a net operating loss position and a full valuation allowance is maintained for all net deferred tax assets. We receive a tax deduction for certain stock option exercises during the period the options are exercised, and for the vesting of restricted stock units during the period the restricted stock units vest. For stock options, the amount of the tax deduction is generally for the excess of the fair market value of our shares of common stock over the exercise price of the stock options at the date of exercise. For restricted stock units, the amount of the tax deduction is generally for the fair market value of our shares of common stock at the vesting date. Excess tax benefits are not included in the accompanying consolidated financial statements because we are in a net operating loss position and a full valuation allowance is maintained for all net deferred tax assets.
Equity Plans
We have issued share-based awards to employees, non-executive directors and outside consultants through various approved plans and outside of any formal plan. New shares are issued upon the exercise of share-based awards.
On August 5, 2008, we adopted the HeartWare International, Inc. 2008 Stock Incentive Plan (“2008 SIP”). The 2008 SIP allows for the issuance of share-based awards to employees, directors and consultants. We have issued options and restricted stock units (“RSU’s”) to employees and directors under the 2008 SIP. The plan allows for the issuance of share-based awards representing up to 13% of the prior fiscal year’s weighted average shares outstanding, less share-based awards outstanding under our other equity plans. At December 31, 2010, there were no shares available for future awards under the 2008 SIP. Under the terms of the 2008 SIP, the shares available for future issuance are adjusted on January 1st of each year based on the prior year’s weighted average shares outstanding. As of January 1, 2011, the shares available for future issuance were approximately 671,000. Future share-based awards will only be made from the 2008 SIP.
Stock Options
Each option allows the holder to subscribe for and be issued one share of our common stock at a specified price, which is generally the fair market value of our common stock on the date the option is issued. Options generally vest on a pro-rata basis on each anniversary of the issuance date within four years of the date the option is issued. Options may be exercised after they have vested and prior to the specified expiry date provided applicable exercise conditions are met, if any. The expiry date can be for periods of up to ten years from the date the option is issued.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
In 2007 and 2008, we granted options with performance-based vesting criteria. These performance-based options vest in four equal tranches contingent upon the achievement of pre-determined corporate milestones related primarily to the development of our products and the achievement of certain prescribed clinical and regulatory objectives. Any performance-based options that have not vested after five years from the date of grant automatically expire.
The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model using the assumptions established at that time. The following table includes the weighted average assumptions used for the periods noted.
Information related to options granted under all of our plans at December 31, 2010 and activity during the year then ended is as follows (certain amounts in U.S.$ were converted from AU$ at the then period-end spot rate):
The aggregate intrinsic values at December 31, 2010 noted in the table above represent the closing price of our common stock traded on NASDAQ, less the weighted average exercise price at period end multiplied by the number of options outstanding and exercisable.
At December 31, 2010, 34,283 of the 148,248 options outstanding that are not yet exercisable are subject to performance-based vesting criteria as described above.
The weighted average grant date fair value per share of options granted during the years ended December 31, 2010, 2009 and 2008 was $28.62, $16.50 and $9.37, respectively.
The total intrinsic value of options exercised during the years ended December 31, 2010 and 2009 was approximately $4.0 million and $2.9 million, respectively. There were no options exercised during the year ended December 31, 2008. Cash received from option exercises for the year ended December 31, 2010 was approximately $3.6 million.
At December 31, 2010, there was approximately $1.3 million of unrecognized compensation cost related to non-vested option awards, including performance-based options not yet deemed probable of vesting. The expense is expected to be recognized over a weighted average period of 1.5 years.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Restricted Stock Units
RSU’s issued under the plans vest on a pro-rata basis on each anniversary of the issuance date over three or four years or vest in accordance with performance-based criteria. The RSU’s with performance-based vesting criteria vest in tranches contingent upon the achievement of pre-determined corporate milestones. RSU’s with performance-based vesting criteria not vested after five years from the date of grant automatically expire. There is no consideration payable on the vesting or exercise of RSU’s issued under the plans. Upon vesting, the RSU’s are exercised automatically and settled in one share of our common stock.
Information related to RSU’s at December 31, 2010 and activity during the year then ended is as follows:
The aggregate intrinsic value at December 31, 2010 noted in the table above represents the closing price of our common stock traded on NASDAQ, multiplied by the number of RSU’s outstanding.
At December 31, 2010, 58,580 of the 544,865 RSU’s outstanding that are not yet exercisable are subject to performance-based vesting criteria as described above.
The total intrinsic value of RSU’s vested during the years ended December 31, 2010 and 2009 was approximately $11.6 million and $512,000, respectively. No RSU’s vested during the year ended December 31, 2008.
The fair value of each RSU award equals the closing price of our common stock on the date of grant. The weighted average grant date fair value per share of RSU’s granted during the years ended December 31, 2010, 2009 and 2008 was $73.87, $27.21 and $14.40, respectively.
At December 31, 2010, we had approximately $15.7 million of unrecognized compensation cost related to non-vested RSU awards, including awards not yet deemed probable of vesting. The expense is expected to be recognized over a weighted average period of 1.6 years.
Note 12. Income Taxes
At December 31, 2010 and 2009, we had gross deferred tax assets in excess of deferred tax liabilities of $24.7 million and $32.8 million, respectively. We determined that it is not “more likely than not” that such assets will be realized, and as such have applied a valuation allowance of $24.7 million and $32.8 million as of December 31, 2010 and 2009, respectively. We evaluate our ability to realize our deferred tax assets each period and adjust the amount of our valuation allowance, if necessary. If there is an ownership change, as defined under Internal Revenue Code Section 382, the use of operating loss and credit carry-forwards may be subject to limitation on use. We operate within multiple taxing jurisdictions and are subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve.
FASB ASC 740 - Income Taxes requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including our current and past performance, the market environment in which we operate, the utilization of past tax credits and length of carry-back and carry-forward periods. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative objective evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. We have applied a 100% valuation allowance against our net deferred tax assets as of December 31, 2010 and 2009.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
The United States and foreign components of loss before income taxes were as follows:
The effective tax rate of 0% differs from the statutory United States federal income tax rate of 35% for all periods presented due primarily to the valuation allowance. The valuation allowance decreased by approximately $8.1 million for the year ended December 31, 2010 and increased by approximately $6.4 million and $8.8 million for the years ended December 31, 2009 and 2008, respectively.
The primary components of net deferred tax assets are as follows:
At December 31, 2010, we had net operating loss carryforwards of approximately $116.2 million for U.S. federal income tax purposes and $9.7 million for non-U.S. (primarily Australia) income tax purposes. Non-U.S. losses have an unlimited carry forward period and the U.S. operating losses expire as follows:
Uncertain tax positions
The amount of unrecognized tax benefits as of December 31, 2010 and December 31, 2009 was $0. There have been no material changes in unrecognized tax benefits through December 31, 2010. The fiscal years 2005 through 2010 are considered open tax years in U.S. federal and state and Australian tax jurisdictions. In addition, 2010 is considered an open tax year for German and United Kingdom jurisdictions. We currently do not have any audit investigations in any jurisdiction.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Note 13. Net Loss Per Common Share
Basic loss per common share is computed by dividing net loss for the period by the weighted-average number of common shares outstanding during the period. Diluted loss per common share adjusts basic loss per share for the dilutive effects of convertible securities, options and other potentially dilutive instruments only in the periods in which such effect is dilutive. Due to our net loss for all periods presented, all potentially dilutive instruments were excluded because their inclusion would have been anti-dilutive. The following instruments have been excluded from the calculation of diluted loss per share, as their effect would be anti-dilutive.
Note 14. Business Segment, Geographic Areas and Major Customers
For financial reporting purposes, we have one reportable segment which designs, manufactures and markets medical devices for the treatment of advanced heart failure. Products are sold to customers located in the United States through our clinical trials, as commercial products to customers in Europe and under special access in other countries. Product sales attributed to a country or region are based on the location of the customer to whom the products are sold. Long-lived assets are primarily held in the United States.
Product sales by geographic location are as follows:
For the year ended December 31, 2010, one customer exceeded 10% of product sales individually and accounted for approximately 16% of product sales in the aggregate. For the year ended December 31, 2009, two customers exceeded 10% of product sales individually and accounted for approximately 22% of product sales in the aggregate. As the majority of our revenue is generated outside of the U.S., we are dependent on favorable economic and regulatory environments for our products in Europe and other countries outside of the U.S.
The percentage of our revenue generated in the U.S. was lower in 2010 compared to 2009 due to the acceleration of our commercial efforts in Europe and the completion of enrollment in our ADVANCE trial in the U.S. in February 2010. While the FDA approved an Investigational Device Exemption Supplement that allowed us to enroll additional patients in our ADVANCE trial under a Continued Access Protocol, we experienced periods of inactivity while we awaited approval. In August 2010, we commenced enrollment in our ENDURANCE destination therapy clinical trial in the U.S. However, the revenue impact in the year ended December 31, 2010 was not significant as it can take several months to reach a level of enrollment that will have a significant impact on domestic and total revenue.
Note 15. Commitments and Contingencies
The following contingent liabilities resulting from the 2003 acquisition by HeartWare, Inc. of a business that previously held our technology existed as of December 31, 2010:
•
a milestone payment of $1.25 million due within 6 months of the date when the first circulatory assist device is approved for sale in the United States, provided that we have at least $25 million in cash on hand and, if we do not have $25 million at that time, then the payment is deferred until such time that we have $25 million in cash on hand; and
•
a special payment of up to $500,000 upon a sale of our HeartWare, Inc. subsidiary if such sale generates proceeds in excess of the aggregate liquidation preferences of all of HeartWare, Inc.’s then outstanding preferred stock.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
We will record the effect of these payment obligations when and if these events occur or are deemed probable of occurring.
During 2009, we paid $750,000 as a result of our receipt of approval to sell our first circulatory assist device in Europe. This represented the first milestone payment resulting from the acquisition noted above and is included in research and development expense.
At December 31, 2010, we had purchase order commitments of approximately $11.9 million related to product costs and property, plant and equipment purchases. Many of our materials and supplies require long lead times and as such purchase order commitments reflect materials that may be received up to one year from the date of order.
In addition to the above, we have entered into employment agreements with all of our executive officers, including our Chief Executive Officer and our Chief Financial Officer who is also our Chief Operating Officer. These contracts do not have a fixed term and are constructed on an “at will” basis. Some of these contracts provide executives with the right to receive certain additional payments and benefits if their employment is terminated after a change of control, as defined in such agreements.
The taxation and customs requirements, together with other applicable laws and regulations of certain foreign jurisdictions, can be inherently complex and subject to differing interpretation by local authorities. We are subject to the risk that either we have misinterpreted applicable laws and regulations, or that foreign authorities may take inconsistent, unclear or changing positions on local law, customs practices or rules. In the event that we have misinterpreted any of the above, or that foreign authorities take positions contrary to ours, we may incur liabilities that may differ materially from the amounts accrued in the accompanying consolidated financial statements.
From time to time we may be involved in litigation arising out of claims in the ordinary course of business. Except as set forth below, and based on the information presently available, management believes that there are no claims or actions pending or threatened against us, the ultimate resolution of which will have a material adverse effect on our financial position, liquidity or results of operations, although the results of litigation are inherently uncertain and adverse outcomes are possible.
We received a letter from Abiomed, Inc. in September 2009 in which Abiomed suggested that we “may be interested in licensing Abiomed’s technology” as it relates to an Abiomed patent concerning bearingless blood pumps. Further, in a subsequent letter received in February 2010, it was stated that Abiomed was “concerned that HeartWare’s left ventricular assist rotary blood pump infringes one or more claims” of an Abiomed patent. We have had communications with Abiomed, Inc. since receipt of the initial letter. The patent referenced by these letters relates to technology that is potentially material to our business and any litigation in this regard, irrespective of the outcome, may have a material adverse effect on our financial position, liquidity or results of operations. We believe the HeartWare System does not infringe this patent.
On February 24, 2010 we received a letter from two holders of Series A Preferred Stock in HeartWare, Inc., an indirect subsidiary of HeartWare International, Inc., requesting various financial and other information regarding HeartWare, Inc. for the purposes of determining the Company’s compliance with their rights as holders of Series A Preferred Stock, including whether a liquidation event has occurred since inception in 2003. HeartWare, Inc. issued Series A-1 and Series A-2 Preferred Stock to certain creditors of Kriton Medical, Inc. when HeartWare, Inc. purchased substantially all of the assets of Kriton in July 2003. The Series A-1 and Series A-2 Preferred Stock do not have voting or dividend rights but entitle the holders thereof to receive, upon certain liquidation events of HeartWare, Inc. (but not the liquidation of or change of control of HeartWare International, Inc.), an amount equal to $10 per share of Series A-1 and an amount equal to $21 per share of Series A-2, which currently represent an aggregate liquidation preference of approximately $15 million. We do not believe we have abrogated the rights, or in any way failed to satisfy obligations owed to any of our stockholders, including holders of Series A Preferred Stock in HeartWare, Inc. There have been no further communications.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
There can be no certainty that litigation will not arise in relation to the above matters or, if it does arise, whether or not it will be determined in a manner which is favorable to us. As at the date of this report, we are not able to determine the amount, if any, of costs or damages that could be associated with either of the above matters.
Note 16. Guarantees
On December 16, 2008, we entered into a Deed of Cross Guarantee (the “Deed”) by and among the Group’s entities; HeartWare International, Inc., HeartWare Pty. Limited (formerly HeartWare Limited) and HeartWare Inc., whereby the companies have agreed to cross-guarantee each other’s liabilities. The Deed was established as a condition to obtaining financial reporting relief under ASIC Class Order 98/1418 which provides relief for us from the requirement to prepare and lodge audited accounts for HeartWare Pty. Limited in Australia. HeartWare International, Inc. is the holding entity, HeartWare, Inc. is the alternative Trustee and HeartWare Pty. Limited is a member of the Closed Group for purposes of the Class Order.
Note 17. Retirement Savings Plan
We have established a 401(k) plan in which substantially all of our employees are eligible to participate. Contributions made by employees are limited to the maximum allowable for U.S. federal income tax purposes. Beginning in April 2010, we commenced a matching program whereby we match employee contributions at a rate of 100% of applicable contributions up to 3% of included compensation plus 50% of applicable contributions up to the next 2% of included compensation. Our contributions to the 401(k) plan were approximately $276,000 for 2010. We did not make any contributions to the plan in 2009 and 2008.
Note 18. Quarterly Financial Information (Unaudited)
The following table presents selected quarterly financial information for the periods indicated. This information has been derived from our unaudited quarterly consolidated financial statements, which in the opinion of management include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such information. The quarterly per share data presented below was calculated separately and may not sum to the annual figures presented in the consolidated financial statements. These operating results are also not necessarily indicative of results for any future period.
(1)
Net loss per common share for each quarter is computed using the weighted-average number of shares outstanding during that quarter while net loss per common share for the full year is computed using the weighted-average number of shares outstanding during the year. Thus, the sum of the four quarters’ net loss per common share may not equal the full-year earnings per share.
HEARTWARE INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
Significant amounts in per quarter information listed above include:
•
Net loss for the quarter ended June 30, 2009 includes $1.1 million of foreign currency exchange losses arising from the depreciation in value of our cash holdings, which were denominated in foreign currencies, namely Australian dollars.
•
Net loss for the quarter ended December 31, 2009 includes $4.6 million related to the net gain on the early extinguishment of debt related to the borrowing and repayment of all amounts under the Thoratec Loan Agreement.
Note 19. Subsequent Events
We have evaluated events and transactions that occurred subsequent to December 31, 2010 through the date the financial statements were issued, for potential recognition or disclosure in the accompanying consolidated financial statements.
On January 24, 2011, the University of Michigan Cardiovascular Center and the University of Pittsburgh announced that they have been awarded grants from the National Heart, Lung and Blood Institute and the Company to conduct a study exploring the potential benefits of LVADs in patients who will be given earlier access to these devices. In the study, called REVIVE-IT, researchers will compare whether non-transplant eligible patients with heart failure less advanced than that of current LVAD recipients do better with implanted devices than with current medical therapy. Our financial commitment for the study is up to $9.6 million of actual costs over the five-year trial period. The terms and conditions of the financial commitment are subject to completion of a definitive agreement.
Except as disclosed above, we did not identify any events or transactions that should be recognized or disclosed in the accompanying consolidated financial statements.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, carried out an evaluation required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, as of December 31, 2010. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2010, our disclosure controls and procedures were effective to provide reasonable assurance 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 SEC’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements.
Under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2010 based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and in accordance with the interpretive guidance issued by the SEC in Release No. 34-55929. Based on that evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2010.
Our independent registered public accounting firm, Grant Thornton LLP, has issued a report on our internal control over financial reporting, which is presented below.
Attestation Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
HeartWare International, Inc.
We have audited HeartWare International, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2010 and our report dated February 24, 2011 expressed an unqualified opinion.
/s/ Grant Thornton LLP
Fort Lauderdale, Florida
February 24, 2011
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Controls and Procedures
Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Thus, misstatements due to error or fraud may occur and not be detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of controls.
None.
Part III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Our executive officers and their respective ages are as follows:
(1)
The term “Managing Director” with respect to Mr. Godshall is a job title given to him by the Company.
Biographical Summaries
Douglas Godshall. Mr. Godshall has been President and Chief Executive Officer since September 2006 and became a director in October 2006. Prior to joining HeartWare, Mr. Godshall served in various executive and managerial positions at Boston Scientific Corporation, where he had been employed since 1990, including as a member of Boston Scientific’s Operating Committee and since January 2005, as President, Vascular Surgery. Prior thereto, Mr. Godshall spent 5 years as Vice President, Business Development, at Boston Scientific, where he was focused on acquisition strategies for the cardiology, electrophysiology, neuroradiology and vascular surgery divisions. Mr. Godshall has a Bachelor of Arts in Business from Lafayette College and Masters of Business Administration from Northeastern University in Boston, Massachusetts.
David McIntyre. Mr. McIntyre has been our Chief Financial Officer and Company Secretary since February 2005. In addition, in 2008, Mr. McIntyre assumed the role of Chief Operating Officer. From November 2003 to February 2005, Mr. McIntyre was Chief Financial Officer and General Counsel with Unilife Medical Solutions Limited. Mr. McIntyre was also a senior attorney in private practice specializing in corporate, mergers and acquisitions and capital markets with Baker & McKenzie and KPMG Legal. Mr. McIntyre has also held senior financial reporting roles in multinational companies, among them Coal & Allied Limited, an ASX-listed subsidiary of the Rio Tinto group of companies. Mr. McIntyre holds a Bachelor of Economics (in Accounting) from the University of Sydney (in Australia) as well as a Bachelor of Law from the University of Technology, Sydney (in Australia). He is a Certified Practising Accountant (CPA), is admitted as a Legal Practitioner of the Supreme Court of New South Wales (in Australia) and is a member of the Law Society of New South Wales.
Jeffrey LaRose. Mr. LaRose is our Chief Scientific Officer and has been with the Company since its inception. Prior to joining HeartWare, since April 1999, he was involved in the development of HeartWare’s technology through his employment with Kriton Medical, which the Company acquired in 2003. He is responsible for all aspects of the design and physiological controls for HeartWare’s left ventricular assist device, the HeartWare LVAD System. Mr. LaRose also leads the development of our miniaturization technology and has twenty years of experience in hydraulic technology development including roles with AEA Technology Engineering Software and Babcock and Wilcox. He holds a Master of Science in Mechanical Engineering from the University of Akron, Ohio.
Dr. David Hathaway. Dr. Hathaway joined HeartWare in June 2008 as our Chief Medical Officer responsible for all medical and clinical affairs, including the design and execution of HeartWare’s clinical trial program. Prior to joining HeartWare, Dr. Hathaway served as a private consultant in the biotechnology and medical device industry from October 2006 to June 2008. From June 2003 to September 2006, Dr. Hathaway was the Chief Medical Officer of Arginox Pharmaceuticals. Prior to joining Arginox, Dr. Hathaway was Vice President, Clinical Development at Restoragen from May 2001 to February 2003. Dr. Hathaway was previously Vice President of Medical Affairs with Knoll Pharmaceutical Company until it was acquired by Abbott Laboratories. He oversaw the Medical Affairs Department and was responsible for clinical research, regulatory affairs, medical information and drug advocacy. Prior to joining Knoll, Dr. Hathaway was Vice President, Cardiovascular Drug Discovery at Bristol-Myers Squibb, where he managed a team of 90 scientists. Before transitioning to a corporate career, he was Division Chief and Director of the Krannert Institute of Cardiology at the Indiana University School of Medicine, where he practiced for more than 14 years. He also served as a Clinical Associate and Cardiology Fellow at the National Institutes of Health in Bethesda, Md. Dr. Hathaway has been section editor (Cardiovascular Diseases) of Kelley’s Textbook of Medicine and a member of the editorial boards of the Journal of Clinical Investigation, the Journal of the American College of Cardiology and Circulation. He has authored over 80 scientific and medical publications and is an inventor on 13 U.S. patents and 8 pending U.S. patent applications. He is a member of the Association of American Physicians, the American College of Physicians and the American Society for Clinical Investigation and is a fellow in the American College of Cardiology. He earned his medical degree from the Indiana University School of Medicine.
Lauren Farrell. Ms. Farrell joined HeartWare in November 2006 as Group Director, Finance and was promoted to Vice President, Finance in August 2008. Reporting to the Chief Financial Officer, Ms. Farrell has overall responsibility for the Company’s accounting and finance activities. Ms. Farrell has over 20 years accounting and finance experience including roles in public accounting, financial management and reporting with private and public companies. Prior to joining HeartWare, Ms. Farrell was Chief Financial Officer of Ambient Corporation from March 2005 to January 2006. From January 2001 to July 2004, Ms. Farrell served as Vice President at Bingham Strategic Advisors, a strategic consulting firm. Ms. Farrell is a Certified Public Accountant and holds a Bachelors of Science in Accounting and a Masters of Business Administration from Bentley College.
Jeffrey Held. Mr. Held has been our Vice President, General Counsel since July 2010 and Secretary since September 2010. Mr. Held directs our legal function. Prior to joining HeartWare, Mr. Held was at 3Com Corporation (sold to Hewlett-Packard Company) from February 2006 to May 2010, where he served in increasingly senior legal positions including, most recently, as Vice President, Deputy General Counsel and Assistant Secretary. At 3Com, Mr. Held was responsible for a wide range of legal functions, including securities, mergers and acquisitions, finance, corporate governance and strategic transactions, as well as Board support duties. Prior to 3Com, Mr. Held practiced at several leading law firms in Boston and New York where he counseled growth companies in the life sciences and high technology sectors. Mr. Held has a B.A. from Tufts University and earned his law degree from Fordham University School of Law.
Ramon Paz. Mr. Paz joined HeartWare as Director of Quality Assurance in October 2004 and was promoted to Vice President, Quality Assurance in July 2007. He has primary responsibility for establishing and managing the company’s Quality Management System. Mr. Paz has over 23 years of multifunctional experience in the medical device industry across Quality, Manufacturing, Engineering, Regulatory and Clinical organizations. He began his career with Cordis Corporation, where he spent 15 years in a range of progressively more senior positions across the Quality, Manufacturing and Product Development groups. In 1998, Mr. Paz joined World Medical, a start-up company which was later acquired by MedtronicAVE, where he was Head of Quality, with expanded responsibility for managing the regulatory and clinical groups responsible for the clinical study of the TALENT stent graft.
James Schuermann. Mr. Schuermann joined HeartWare in September 2007. He has overall responsibility for HeartWare’s sales and marketing activities across all markets. Mr. Schuermann has over 15 years sales and marketing experience in the medical device arena. Prior to joining HeartWare, he spent nine years in sales and marketing at Boston Scientific Corporation. Over this time he progressed from sales through product management until being appointed Director of Marketing in 2005. Before joining Boston Scientific, he spent 5 years in medical sales and sales management at Sherwood Davis & Geck. Mr. Schuermann received his undergraduate degree in marketing from Kelley School of Business, Indiana University, Bloomington, and his MBA from Ageno School of Business, Golden Gate University, San Francisco.
Other Information
We have a code of business conduct and ethics that applies to each director, officer and employee of the Company, including the executive, financial and accounting officers. Our code of conduct is available on our website at www.heartware.com.
The other information required by this Item 10 is incorporated herein by reference to the applicable information in our definitive proxy statement for our 2011 annual meeting of stockholders to be filed with the Securities and Exchange Commission or is to be included in Item 10 of an amendment to this Annual Report on Form 10-K to be filed with the Securities and Exchange Commission.
The information required by this Item 11
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item 12 is incorporated herein by reference to the applicable information in our definitive proxy statement for our 2011 annual meeting of stockholders to be filed with the Securities and Exchange Commission, including the information set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” or is to be included in Item 12 of an amendment to this Annual Report on Form 10-K to be filed with the Securities and Exchange Commission.
The information required by this Item 12 is included in our 2011 Proxy Statement and is incorporated herein by reference.
Australian Disclosure Requirements
In addition to our primary listing on NASDAQ, we are also listed for quotation in the form of CHESS Depositary Interests (“CDIs”) on the Australian Securities Exchange (“ASX”) and trade under the symbol “HIN”. As part of our ASX listing, we are required to comply with various disclosure requirements as set out in the ASX Listing Rules. The following information is intended to comply with the ASX Listing Rules and is not intended to fulfill information required by Part III of this Annual Report on Form 10-K.
Substantial Shareholders
The number of CDIs held by our substantial shareholders (being shareholders who, together with their associates, have a relevant interest in at least 5% of our voting shares) should their stockholdings be converted from common stock into CDIs as at 31 December 2010 are set out below:
The above amounts are based solely upon information furnished to us or contained in reports filed with the Securities and Exchange Commission.
Distribution of equity security holders as at 31 January 2011
As of 31 January 2011, there were 13,891,230 shares of our common stock outstanding, a portion of which were held as CDI’s. The table below presents the number of shares of common stock and the number of CDI’s held.
Unmarketable parcels
As at 31 January 2011, the number of shareholders holding less than a marketable parcel (for the purposes of the ASX Listing Rules) was 19.
Top 20 Stockholders
Two individuals, Todd Frazier and Stephen Boyce, own 100% of the Company’s options issued outside employee incentive plans, with each owning options for 2,285 and 2,857 shares, respectively.
Voting Rights
HeartWare International’s by-laws provide that each stockholder has one vote for every share of common stock entitled to vote held of record by such stockholder and a proportionate vote for each fractional share of stock entitled to vote so held, unless otherwise provided by Delaware General Corporation Law or in the certificate of incorporation.
Holders of CDIs have one vote for every 35 CDIs held of record by such stockholder.
If holders of CDIs wish to attend HeartWare International general meetings, they will be able to do so. Under the ASX Listing Rules, HeartWare International, as an issuer of CDIs, must allow CDI holders to attend any meeting of the holders of the underlying securities unless relevant U.S. law at the time of the meeting prevents CDI holders from attending those meetings.
In order to vote at such meetings, CDI holders have the following options:
(a)
instructing CDN, as the legal owner, to vote the HeartWare International shares of common stock underlying their CDIs in a particular manner. The instruction form must be completed and returned to HeartWare International’s share registry prior to the meeting;
(b)
informing HeartWare International that they wish to nominate themselves or another person to be appointed as CDN’s proxy for the purposes of attending and voting at the general meeting;
(c)
converting their CDIs into a holding of HeartWare International shares of common stock and voting these at the meeting (however, if thereafter the former CDI holder wishes to sell their investment on ASX, it would be necessary to convert HeartWare International shares of common stock back to CDIs). This must be done prior to the record date for the meeting. See section 7 below for further information regarding the conversion process.
As holders of CDIs will not appear on HeartWare International’s share register as the legal holders of HeartWare International shares of common stock, they will not be entitled to vote at HeartWare International shareholder meetings unless one of the above steps is undertaken.
Proxy forms and details of these alternatives will be included in each notice of meeting sent to CDI holders by HeartWare International.
Holders of options and restricted stock units are not entitled to vote.
Required Statements
The Company makes the following disclosures:
(a)
There is no current on-market buy-back of the Company’s securities.
(b)
HeartWare International, Inc. was incorporated in the state of Delaware in the United States of America.
(d)
Under the Delaware General Corporation Law, shares are generally freely transferable subject to restrictions imposed by U.S. federal or state securities laws, by the certificate of incorporation or by-laws of the Company or by an agreement signed with the holders of the shares at issue. The Company’s certificate of incorporation and by-laws do not impose any specific restrictions on transfer.
General Information
The name of the Company Secretary is Mr. Jeffrey Held.
The address of the principal registered office in Australia is Unit 2, 3 Marshall Road, Kirrawee, NSW 2232 (02) 8078 6164.
Registers of securities are held at Computershare Investor Services Pty. Limited, Level 3, 60 Carrington Street, SYDNEY NSW 2000, Investor Enquiries: 1300 855 080.
Quotation has been granted for the Company’s CDIs on ASX Limited. In addition, the Company’s common stock became listed for quotation on NASDAQ on 24 February 2009.
Australian Corporate Governance Statement
The Board of Directors and employees of HeartWare International, Inc. (“HeartWare” or “the Company”) are committed to developing, promoting and maintaining a strong culture of good corporate governance and ethical conduct.
The Board of Directors is pleased to confirm that the Company’s corporate governance framework is generally consistent with the Australian Securities Exchange’s (“ASX”) Corporate Governance Council’s “Corporate Governance Principles and Recommendations with 2010 amendments (2nd Edition)” (“ASX Governance Recommendations”), other than as set out below. To this end, the Company provides below a review of its corporate governance framework using the same numbering as adopted for the Principles as set out in the ASX Governance Recommendations.
Copies of the Company’s codes and policies may be downloaded from the corporate governance section of the HeartWare website (www.heartware.com).
It should be noted that the Company redomiciled to the United States in November 2008 and listed on NASDAQ in late February 2009. As a result and to meet NASDAQ listing requirements, the policies and practices adopted by the Company have been adopted to be consistent with U.S. listing standards.
Principle 1 - Lay solid foundations for management and oversight
Recommendation 1.1 - Establish the functions reserved to the Board of Directors and those delegated to senior executives and disclose those functions
The primary responsibility of:
(a)
the Board of Directors is to provide effective governance over the business and affairs of HeartWare and its controlled entities (“the HeartWare Group”) so that the interests of all stakeholders are protected; and
(b)
the Chief Executive Officer is to oversee the day-to-day performance of the HeartWare Group (pursuant to Board delegated powers).
The Board’s responsibilities are recognized and documented on an aggregated basis via the Charter of the Board of Directors and via Letters of Appointment for each individual director. A copy of the Charter of the Board of Directors is available on the corporate governance section of the Company’s website.
While day-to-day management has been delegated to the Chief Executive Officer, it is noted that the following matters are specifically reserved for the attention of the Board:
(a)
decisions about corporate strategy and policies as well as commitments over prescribed limits;
(b)
setting major capital expenditure, acquisitions, divestments and funding arrangements;
(c)
setting the various internal controls and reporting framework for the management of the risks inherent in the operations of the HeartWare Group;
(d)
setting of discretionary financial and related operating limits for management; and
(e)
establishing and determining the powers and functions of the committees of the Board.
Recommendation 1.2 - Disclose the process for evaluating the performance of senior executives
The Company’s 2010 definitive proxy statement filed with the Securities and Exchange Commission included extensive discussions in relation to the mechanics concerning the evaluation of performance of the Company’s senior executives, including relevant benchmarking activities. Information regarding executive compensation for the year ended 31 December 2010, as required by Item 11, is incorporated by reference to the applicable information in our definitive proxy statement for our 2011 annual meeting of stockholders to be filed with the Securities and Exchange Commission, including the information set forth under the captions “Executive Compensation,” “Compensation of Directors” and “Compensation Committee Interlocks and Insider Participation,” or is to be included in Item 11 of an amendment to this Annual Report on Form 10-K to be filed with the Securities and Exchange Commission.
Recommendation 1.3 - Disclosure of information indicated in the guide to reporting on Principle 1of the ASX Governance Recommendations
Reporting Requirement
The Company fully complied with Recommendation 1.1 to 1.3 during the year ended 31 December 2010.
Principle 2 - Structure the Board to add value
Recommendation 2.1 - A majority of the Board of Directors should be independent
Recommendation 2.2 - The Chair should be an independent director
Recommendation 2.3 - The roles of Chairman and Chief Executive Officer should not be exercised by the same individual
The Board of Directors presently comprises eight (8) directors. The eight (8) directors encompass six (6) independent non-executive directors (including the Chairman of the Board), one (1) executive director (being the Chief Executive Officer) and one (1) non-independent, non-executive director (being the Deputy Chairman).
The current composition of the Board and length of tenure of each member of the Board is as follows:
Independent advice
At the Company’s expense, the Board collectively or directors (acting as individuals) are entitled to seek advice from independent external advisers in relation to any matter which is considered necessary to fulfill their relevant duties and responsibilities.
Individual directors seeking such advice must obtain the approval of the Chairman (which may not be unreasonably withheld). Any advice so obtained will be made available to all Board members.
Recommendation 2.4 - The Board should establish a Nomination Committee
The members of the Nominating and Governance Committee are Mr. Barberich, Mr. Larkin (Chair) and Mr. Thomas. A copy of the Nominating and Governance Committee Charter is available on the corporate governance section of the Company’s website. The Nominating and Governance Committee met once during 2010 with each of Mr. Barberich, Mr. Larkin and Mr. Thomas attending.
Reporting Requirement
The Company fully complied with Recommendation 2.1 to 2.4 during the year ended 31 December 2010.
Recommendation 2.5 - Disclose the process for evaluating the performance of the Board, its committees and individual directors
Reporting Requirement
The Company has not undertaken a formal review of the performance of the Board, its committees and individual directors. The Company has not therefore complied with Recommendation 2.5 during the year ended 31 December 2010.
Recommendation 2.6 - Disclosure of information indicated in the guide to reporting on Principle 2 of the ASX Governance Recommendations
Reporting Requirement
Information regarding Directors, including biographical information, key attributes, experience and skills as required by Item 12, is incorporated herein by reference to the applicable information in our definitive proxy statement for our 2011 annual meeting of stockholders to be filed with the Securities and Exchange Commission, including the information set forth under the caption “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” or is to be included in Item 12 of an amendment to this Annual Report on Form 10-K to be filed with the Securities and Exchange Commission.
The Company has fully complied with Recommendation 2.6 during the year ended 31 December 2010.
Principle 3 - Promote ethical and responsible decision-making
Recommendation 3.1 - Establish a Code of Conduct and disclose it
The Company has adopted a Code of Business Conduct and Ethics, a copy of which is available on the corporate governance section of the Company’s website.
The Company fully complied with Recommendation 3.1 during the year ended 31 December 2010.
Principle 4 - Safeguard integrity in financial reporting
Recommendation 4.1 - The Board should establish an Audit Committee
Recommendation 4.2 - The Audit Committee should: (a) consist of non-executive directors only; (b) consist of a majority of independent directors; (c) be chaired by an independent chair who is not chair of the Board; and (d) have at least three members
Recommendation 4.3 - The Audit Committee should have a formal charter
The members of the Audit Committee are Dr. Bennett, Mr. Stockman (Chair), Mr. Thomas and Dr. Wade all of whom are independent non-executive directors. The Audit Committee met five times during 2010 with each of Dr. Bennett, Mr. Thomas and Dr. Wade attending on all occasions. Mr. Stockman (Chair) attended on four occasions.
A copy of the Audit Committee Charter is available on the corporate governance section of the Company’s website.
Reporting Requirement
The Company fully complied with Recommendation 4.1 to 4.3 during the year ended 31 December 2010.
Recommendation 4.4 - Disclosure of information indicated in the guide to reporting on Principle 4 of the ASX Governance Recommendations
Reporting Requirement
Information regarding the skills, experience and expertise of directors, including audit committee members, in accordance with U.S. disclosure requirements is included by reference to the applicable information in our definitive proxy statement for our 2011 annual meeting of stockholders to be filed with the Securities and Exchange Commission. To the extent these disclosures are not specifically restated within in this Corporate Governance Statement then the Company has not complied with the requirement to include this information within the Corporate Governance Statement.
In Item 9A of this Annual Report on Form 10-K, we have disclosed information regarding the Company’s Controls and Procedures, including management’s evaluation of the effectiveness of our disclosure controls and procedures and management’s evaluation of the effectiveness of our internal control over financial reporting. To the extent these disclosures are not specifically restated within in this Corporate Governance Statement then the Company has not complied with the requirement to include this information within the Corporate Governance Statement.
Our independent registered public accounting firm, Grant Thornton LLP, has issued a report on our internal control over financial reporting, which is included in Item 9A of this Annual Report on Form 10-K.
The Company has not disclosed its policy for selection and appointment of the Company’s external auditor or for the rotation of external audit engagement partners.
In all other respects, the Company fully complied with Recommendation 4.4 during the year ended 31 December 2010.
Principle 5 - Make timely and balanced disclosure
Recommendation 5.1 - Establish written policies designed to ensure compliance with ASX Listing Rule disclosure requirements and to ensure accountability at a senior executive level for that compliance and disclose those policies
Recommendation 5.2 - Disclosure of information indicated in the guide to reporting on Principle 5 of the ASX Governance Recommendations
HeartWare is committed to providing timely and balanced disclosure to the market and, in consequence, to meeting its continuous disclosure requirements. In accordance with its commitment to fully comply with its continuous disclosure requirements, the Company has adopted a Continuous Disclosure Policy, together with other internal mechanisms and reporting requirements.
A copy of the Continuous Disclosure Policy is available on the corporate governance section of the Company’s website. In addition, a copy of all of the Company’s ASX announcements, financial reports and related public information are also available on the Company’s website.
Reporting Requirement
The Company fully complied with Recommendation 5.1 and 5.2 during the year ended 31 December 2010.
Principle 6 - Respect the rights of shareholders
Recommendation 6.1 - Design a communications policy for promoting effective communication with shareholders and encourage their participation at general meetings and disclose those policies
Recommendation 6.2 - Disclosure of information indicated in the guide to reporting on Principle 6 of the ASX Governance Recommendations
The Company has implemented a number of measures so as to facilitate what it believes to be the effective and efficient exercise of the rights of shareholders. The Company communicates information to shareholders through a range of media including annual reports, public (ASX) announcements and via the Company’s website including advance notification of investor presentations and results announcements. Key financial information and stock performance are also available on the Company’s website. Shareholders can raise questions with the Company by contacting the Company via telephone, facsimile, post or email, with relevant contact details being available on the Company’s website.
All shareholders are invited to attend the Company’s Annual General Meeting, either in person or by proxy. The Board regards the Annual General Meeting as an excellent forum in which to discuss issues relevant to the Company and thereby encourages full participation by shareholders. Shareholders have an opportunity to submit questions to the Board and the Company’s auditors. The meeting is also webcast to provide access to those shareholders who are unable to attend the Annual General Meeting.
Reporting requirement
The Company fully complied with Recommendation 6.1 and 6.2 for the year ended 31 December 2010.
Principle 7 - Recognise and manage risk
Recommendation 7.1 - Establish policies for the oversight and management of material business risks and disclose it
The risks that the Company faces are continually changing in line with the development of the Company. The primary risks faced by the Company during 2010 included liquidity or funding risk, operational risks associated with the manufacture of an implantable medical device, ongoing risks of the Company’s human clinical trials and achieving relevant regulatory hurdles which will unlock key markets for the Company’s products together with growing revenue and inventory management.
The above is set in an environment where the Company must actively manage fundamental risks such as the integrity of the Company’s intellectual property portfolio, disaster management, exchange rate risk and the risk of losing key management personnel.
In simple terms, risk is inherent in all activities undertaken by HeartWare. Unfortunately, many of these risks are beyond the control of the Company and, as such, it is important that risk be mitigated on a continuous basis, particularly if the Company is to preserve shareholder value.
The Board of Directors has approved a Risk Management Policy, a copy of which is available on the corporate governance page of the Company’s website. In summary, the Risk Management Policy is designed to ensure that risks including, amongst others, technology risks, economic risks, financial risks and other operational risks are identified, evaluated and mitigated to enable the achievement of the Company’s goals.
It would be remiss of the Board not to acknowledge that no risk management system can provide total assurance that HeartWare’s risks will be fully mitigated. This is particularly the case in organizations such as HeartWare where its pre-revenue status means that limited resources can be applied to the risk management process. HeartWare’s approach is therefore not to eliminate risk, rather to utilize available resources as effectively as possible in order to manage the risks inevitably involved in many corporate activities.
Reporting requirement
The Company fully complied with Recommendation 7.1 for the year ended 31 December 2010.
Recommendation 7.2 - Require management to design and implement the risk management and internal control system to manage the Company’s material business risks and report to it whether those risks are being managed effectively (and makes disclosures therein); Disclose that management has reported to the Board as to the effectiveness of the Company’s management of its material business risks
Management provides the Board with frequent (i.e. generally monthly) updates on the state of the Company’s business, including the risks that the Company faces from time-to-time. This update includes up-to-date financial information, operational activity, clinical status and competitor updates. These updates are founded on internal communications that are fostered internally through weekly management meetings and other internal communications. These processes operate in addition to the Company’s system of internal controls over financial reporting, its Quality System, complaint handling processes, employee policies and standard operating procedures.
In addition, the Board of Directors holds regular meetings at the Company’s facility in Miami Lakes for the purposes of discussing and reviewing operational developments.
The Company fully complied with Recommendation 7.2 for the year ended 31 December 2010.
Recommendation 7.3 - Disclose whether the Board has received assurance from the Chief Executive Officer and the Chief Financial Officer that the declaration under Section 295A of the Corporations Act is founded on a sound system of risk management and internal control and is operating effectively in all material respects in relation to financial reporting risks
Reporting requirement
As the Company prepares and files its financial statements under U.S. accounting practices and laws, management is required to provide representations to the Board on a wide range of issues, including in relation to the effectiveness of the Company’s disclosure controls and procedures as well as the design or operation of internal control over financial reporting.
Notwithstanding the above and in consequence of its dual listed status and various waivers granted by the ASX and the Australian Securities and Investments Commission, no declaration is required under Section 295A of the Corporations Act. To this end, shareholders’ attention is drawn to Item 9A of this Annual Report on Form 10-K and the certifications provided by the Chief Executive Officer and the Chief Financial Officer at the end of the Form 10-K. As stated above, Item 9A of this Annual Report on Form 10-K discloses information regarding the Company’s controls and procedures, including management’s evaluation of the effectiveness of our disclosure controls and procedures and management’s evaluation of the effectiveness of our internal control over financial reporting.
For the reasons stated above, the Company has not complied with Recommendation 7.3 for the year ended 31 December 2010.
Recommendation 7.4 - Disclosure of information indicated in the guide to reporting on Principle 7of the ASX Governance Recommendations
Reporting requirement
Except as disclosed above, the Company believes that the aforementioned reporting meets, or otherwise exceeds, the requirements of Recommendation 7.2 to 7.4 for the year ended 31 December 2010.
Principle 8 - Remunerate fairly and responsibly
Recommendation 8.1 - Establish a Remuneration Committee
Recommendation 8.2 - The Remuneration Committee should be structured so that it: (a) consist of a majority of independent directors; (b) is chaired by an independent chair; and (c) has at least three members The members of the Compensation Committee are Mr. Barberich (Chair), Mr. Thomas, Dr. Bennett and Dr. Wade all of whom are independent non-executive directors. A copy of the Compensation Committee Charter is available on the corporate governance section of the Company’s website. The Compensation Committee met four times during 2010 with each of Mr. Barberich, Mr. Thomas, Dr. Bennett and Dr. Wade attending on all occasions.
Recommendation 8.3 - Clearly distinguish the structure of non-executive directors’ remuneration from that of executive directors and senior executives
As noted above in the discussion regarding Recommendation 1.2, the definitive proxy statement for the Company’s 2011 annual meeting of stockholders includes extensive discussions in relation to the mechanics concerning the evaluation of performance of the Company’s senior executives. Information is also included in relation to the Company’s remuneration practices and policies, including its annual performance review process, its external benchmarking review and its meritorious approach to employee performance.
Reporting requirement
As previously disclosed no review or other form of assessment has been undertaken in relation to the non-executive directors.
Recommendation 8.4 - Disclosure of information indicated in the guide to reporting on Principle 8 of the ASX Governance Recommendations
Reporting requirement
With the exception noted above, the Company complied with Recommendation 8.1 to 8.3 during the year ended 31 December 2010.
This report is made in accordance with a resolution of the Board of Directors.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by this Item 13 is incorporated herein by reference to the applicable information in our definitive proxy statement for our 2011 annual meeting of stockholders to be filed with the Securities and Exchange Commission, including the information set forth under the captions “Certain Relationships and Related Transactions, and Director Independence”, “Policies and Procedures for Review and Approval of Related Party Transactions”, “Corporate Governance” and “Compensation Committee Interlocks and Insider Participation,” or is to be included in Item 13 of an amendment to this Annual Report on Form 10-K to be filed with the Securities and Exchange Commission.
Item 14.
Item 14.
Principal Accounting Fees and Services
The information required by this Item 14 is incorporated herein by reference to the applicable information in our definitive proxy statement for our 2011 annual meeting of stockholders to be filed with the Securities and Exchange Commission, including the information set forth under the captions “Principal Accounting Fees and Services” and “Audit Committee’s Pre-Approval Policy,” or is to be included in Item 14 of an amendment to this Annual Report on Form 10-K to be filed with the Securities and Exchange Commission.
Part IV.
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
The following documents are filed as part of this Annual Report on Form 10-K:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Exhibit Index