e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2008
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 000-51567
NxStage Medical, Inc.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware
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04-3454702 |
(State of Incorporation)
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(I.R.S. Employer Identification No.) |
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439 S. Union St., 5th Floor, Lawrence, MA
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01843 |
(Address of Principal Executive Offices)
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(Zip Code) |
Registrants Telephone Number, Including Area Code:
(978) 687-4700
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
There were 36,794,575 shares of the registrants common stock issued and outstanding as of the
close of business on May 8, 2008.
NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2008
TABLE OF CONTENTS
- 2 -
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(Unaudited)
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March 31, |
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December 31, |
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2008 |
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2007 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
16,181 |
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$ |
33,245 |
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Short-term investments |
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1,100 |
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Accounts receivable, net |
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11,027 |
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7,990 |
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Due from affiliate |
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435 |
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435 |
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Inventory |
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40,160 |
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29,965 |
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Prepaid expenses and other current assets |
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1,606 |
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2,455 |
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Total current assets |
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69,409 |
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75,190 |
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Property and equipment, net |
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12,937 |
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12,146 |
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Field equipment, net |
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31,812 |
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30,885 |
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Deferred cost of revenues |
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18,709 |
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14,850 |
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Intangible assets, net |
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33,102 |
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33,801 |
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Goodwill |
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41,462 |
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41,457 |
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Other assets |
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2,074 |
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2,057 |
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Total assets |
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$ |
209,505 |
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$ |
210,386 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
25,359 |
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$ |
21,887 |
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Accrued expenses |
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10,618 |
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9,820 |
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Due to affiliates |
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774 |
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2,774 |
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Current portion of long-term debt |
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2,131 |
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54 |
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Total current liabilities |
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38,882 |
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34,535 |
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Deferred revenue |
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23,789 |
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19,530 |
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Long-term debt |
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28,099 |
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25,170 |
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Other long-term liabilities |
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1,511 |
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1,434 |
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Total liabilities |
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92,281 |
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80,669 |
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Commitments and contingencies |
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Stockholders equity: |
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Undesignated preferred stock: par value $0.001,
5,000,000 shares authorized; zero shares issued and
outstanding, as of March 31, 2008 and December 31, 2007 |
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Common stock: par value $0.001, 100,000,000 shares authorized;
36,793,409 and 36,771,893 shares issued and outstanding, as of
March 31, 2008 and December 31, 2007, respectively |
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37 |
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37 |
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Additional paid-in capital |
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312,660 |
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311,172 |
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Accumulated deficit |
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(195,980 |
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(182,036 |
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Accumulated other comprehensive income |
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507 |
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544 |
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Total stockholders equity |
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117,224 |
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129,717 |
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Total liabilities and stockholders equity |
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$ |
209,505 |
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$ |
210,386 |
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See accompanying notes to these condensed consolidated financial statements.
- 3 -
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
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Three Months Ended |
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March 31, |
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2008 |
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2007 |
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Revenues |
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$ |
31,005 |
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$ |
8,374 |
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Cost of revenues |
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26,987 |
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9,917 |
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Gross profit (deficit) |
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4,018 |
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(1,543 |
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Operating expenses: |
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Selling and marketing |
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6,835 |
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4,732 |
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Research and development |
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2,126 |
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1,436 |
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Distribution |
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3,395 |
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2,344 |
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General and administrative |
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4,815 |
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2,667 |
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Total operating expenses |
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17,171 |
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11,179 |
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Loss from operations |
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(13,153 |
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(12,722 |
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Other income (expense): |
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Interest income |
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213 |
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904 |
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Interest expense |
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(810 |
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(175 |
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Other income (expense), net |
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(149 |
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(746 |
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729 |
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Net loss before income taxes |
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(13,899 |
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(11,993 |
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Provision for income taxes |
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45 |
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Net loss |
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$ |
(13,944 |
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$ |
(11,993 |
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Net loss per share, basic and diluted |
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$ |
(0.38 |
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$ |
(0.41 |
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Weighted-average shares outstanding, basic and diluted |
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36,774 |
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29,020 |
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See accompanying notes to these condensed consolidated financial statements.
- 4 -
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
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Three Months Ended |
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March 31, |
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2008 |
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2007 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(13,944 |
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$ |
(11,993 |
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Adjustments to reconcile net loss to net
cash used in operating activities: |
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Depreciation and amortization |
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4,210 |
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1,435 |
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Stock-based compensation |
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1,486 |
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760 |
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Other |
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16 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(3,073 |
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(2,772 |
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Inventory |
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(17,425 |
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(9,377 |
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Prepaid expenses and other current assets |
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865 |
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293 |
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Accounts payable |
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2,978 |
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3,063 |
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Accrued expenses |
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(1,493 |
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742 |
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Deferred revenue |
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4,259 |
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7,240 |
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Net cash used in operating activities |
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(22,121 |
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(10,609 |
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Cash flows from investing activities: |
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Purchases of property and equipment |
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(1,187 |
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(401 |
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Maturities of short-term investments |
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1,100 |
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4,254 |
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Purchases of short-term investments |
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(9,893 |
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Increase in other assets |
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(17 |
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(209 |
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Net cash used in investing activities |
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(104 |
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(6,249 |
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Cash flows from financing activities: |
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Net proceeds from private placement sale of common stock |
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19,957 |
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Proceeds from stock option and purchase plans |
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2 |
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942 |
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Proceeds from loans and lines of credit |
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5,000 |
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Net repayments on loans and lines of credit |
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(15 |
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(700 |
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Net cash provided by financing activities |
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4,987 |
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20,199 |
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Foreign exchange effect on cash and cash equivalents |
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174 |
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(110 |
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Decrease in cash and cash equivalents |
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(17,064 |
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3,231 |
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Cash and cash equivalents, beginning of period |
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33,245 |
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49,959 |
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Cash and cash equivalents, end of period |
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$ |
16,181 |
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$ |
53,190 |
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Noncash Investing Activities |
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Transfers from inventory to field equipment and
deferred cost of revenues |
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$ |
7,527 |
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$ |
6,649 |
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See accompanying notes to these condensed consolidated financial statements.
- 5 -
NXSTAGE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Nature of Operations
NxStage Medical, Inc., or the Company is a medical device company that develops, manufactures
and markets innovative products for the treatment of kidney failure, fluid overload and related
blood treatments and procedures. The Companys primary product, the NxStage System One, was designed to satisfy an unmet clinical need for a system that can deliver the therapeutic
flexibility and clinical benefits associated with traditional dialysis machines in a smaller,
portable, easy-to-use form that can be used by healthcare professionals and trained lay users alike
in a variety of settings, including patient homes, as well as more traditional care settings such
as hospitals and dialysis clinics. The System One is cleared by the United States Food and Drug
Administration or the FDA, and sold commercially in the United States for the treatment of acute
and chronic kidney failure and fluid overload. The System One consists of an electromechanical
medical device (cycler), a disposable blood tubing set and a dialyzer (filter) pre-mounted in a
disposable, single-use cartridge, and fluids used in conjunction with therapy. Following the recent
acquisition of Medisystems Corporation and certain affiliated entities, or the MDS Entities, the Company
also sells needles and blood tubing sets primarily to the in-center market for the treatment of
end-stage renal disease, or ESRD.
As of March 31, 2008, the Company had approximately $16.2 million of cash, cash equivalents
and short-term investments. In February 2007, the Company received cash proceeds of $20.0 million
from the sale of 2.0 million shares of its common stock to DaVita Inc. or DaVita. In November
2007, the Company entered into a credit facility with Merrill Lynch Capital a division of Merrill
Lynch Business Services Inc., which was acquired by General Electric Capital or GE, consisting of
a $30.0 million term loan and a $20.0 million revolving credit facility. The Company drew $25.0
million under the term loan at closing, and drew the remaining $5.0 million on March 25, 2008. The
Company has experienced negative operating margins and cash flows from operations and it expects to
continue to incur net losses in the foreseeable future. The Company believes that it has sufficient
cash and cash available through its credit facility to meet its funding requirements through 2008.
The Company expects that its existing resources will be insufficient
to satisfy our liquidity requirements beyond 2008 and the Company
will need to sell additional equity, issue debt securities, obtain
capital through strategic investment, or otherwise obtain additional
capital to fund its capital requirements beyond 2008. Additionally,
beginning in 2009, the Company will need to begin paying down the
principal under its revolving credit facility. Any sale of additional
equity or issuance of debt securities will likely result in dilution
to the Companys stockholders, and the Company cannot be certain
that additional public or private financing or other capital will be
available in amounts or in terms acceptable to the Company, if at
all. The Company expects to raise additional capital in the second or
third quarters of 2008. If the Company is unable to obtain this
additional capital when needed, the Company may be required to delay,
reduce the scope of, or eliminate one or more aspects of the
Companys business development activities, which would likely
harm the Companys business.
Basis of Presentation
The accompanying condensed consolidated financial statements as of March 31, 2008 and for
the three months ended March 31, 2008 and 2007, and related notes, are unaudited but, in
managements opinion, include all adjustments, consisting of normal recurring adjustments that the
Company considers necessary for fair statement of the interim periods presented. The Company has
prepared its unaudited, condensed consolidated financial statements following the requirements of
the Securities and Exchange Commission, or SEC for interim reporting. As permitted under these
rules, the Company has condensed or omitted certain footnotes and other financial information that
are normally required by U.S. generally accepted accounting principles, or GAAP. The Companys
accounting policies are described in the Notes to the Consolidated Financial Statements in the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and updated, as
necessary, in this Form 10-Q. Operating results for the three months ended March 31, 2008 are not
necessarily indicative of results for the entire fiscal year or future periods. The accompanying
condensed consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries at March 31, 2008. The year-end condensed consolidated balance sheet was
derived from audited financial statements, but does not include all disclosures required by GAAP.
Medisystems Acquisition
As more fully described in Note 7, effective October 1, 2007, the Company purchased from David
S. Utterberg, a member of the Companys Board of Directors, the issued and outstanding shares of
Medisystems Corporation and various related entities, collectively the MDS Entities. The Company refers to its acquisition of the MDS Entities as the Medisystems Acquisition. In
consideration for the Medisystems Acquisition, the Company issued Mr. Utterberg 6.5 million shares
of our common stock, which we refer to as the Acquisition Shares. The MDS Entities design, manufacture, and
distribute disposables used in dialysis and related blood treatments and procedures. The assets and
liabilities of the MDS Entities are included in the March 31, 2008 and December 31, 2007 condensed
consolidated balance sheets of the Company and the operating results of the MDS Entities have been
included in the Companys results of operations since October 1, 2007. The purchase consideration
was allocated to the assets and liabilities of the MDS Entities, which included $34.5 million of
definite-lived intangible assets and $41.5 million of goodwill. In addition, the Company wrote up
inventory acquired from manufacturing cost to fair value by $1.6 million and wrote up property,
plant and equipment to fair value by $2.5 million. Adjustments to the purchase price allocation of
$5,000 during the quarter ended March 31, 2008 consisted primarily of changes in estimates related
to certain exit-related costs as described in Note 3.
The following unaudited pro forma financial information presents a summary of the consolidated
results of operations of the Company and the MDS Entities as if the acquisition had occurred on
January 1, 2006. The historical financial information of the Company has been adjusted to give
effect to pro forma events that are (i) directly attributable to the acquisition and (ii) factually
supportable. The pro forma condensed consolidated financial information is presented for
informational purposes only and is not necessarily indicative of what the results of operations
actually would have been had the acquisition been completed on January 1, 2006 (in thousands,
except per share amounts):
- 6 -
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Three Months Ended |
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March 31, |
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2007 |
Proforma net revenue |
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$ |
22,151 |
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Proforma operating loss |
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(11,151 |
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Proforma net loss |
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(10,413 |
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Pro forma net loss per share, basic and diluted |
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$ |
(0.29 |
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2. Summary of Significant Accounting Policies
(a) Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries at March 31, 2008. All material intercompany transactions
and balances have been eliminated in consolidation.
(b) Use of Estimates
The preparation of the Companys condensed consolidated financial statements in conformity
with generally accepted accounting principles in the United States requires management to make
estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could differ from those
estimates.
(c) Revenue Recognition
The Company recognizes revenue from product sales and services when earned in accordance with
Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition , and Emerging Issues Task Force
(EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Revenues are
recognized when: (a) there is persuasive evidence of an arrangement, (b) the product has been
shipped or services and supplies have been provided to the customer, (c) the sales price is fixed
or determinable and (d) collection is reasonably assured.
SystemOne Segment
Prior to 2007, the Company principally derived revenue in the home market from short-term
rental arrangements with its customers. These rental arrangements, which combine the use of the
System One with a specified number of disposable products supplied to customers for a fixed amount
per month, are recognized on a monthly basis in accordance with agreed upon contract terms and
pursuant to a binding customer purchase order and fixed payment terms. In the home market, rental
arrangements continue to represent nearly half of the arrangements the Company has with its
customers.
Beginning in 2007, the Company entered into long-term customer contracts to sell the System
One and PureFlow SL hardware along with the right to purchase disposable products and service on a
monthly basis. Some of these agreements include other terms such as development efforts, training,
market collaborations, limited market exclusivity and volume discounts. The equipment and related
items provided to the Companys customers in these arrangements are considered a multiple-element
sales arrangement pursuant to EITF 00-21. When a sales arrangement involves multiple elements, the
deliverables included in the arrangement are evaluated to determine whether they represent separate
units of accounting. The Company has determined that it cannot account for the sale of equipment
as a separate unit of accounting. Therefore, fees received upon the completion of delivery of
equipment are deferred, and are recognized as revenue on a straight-line basis over the expected
term of the Companys obligation to supply disposables and service, which is five to seven years.
The Company has deferred both the unrecognized revenue and direct costs relating to the delivered
equipment, which costs are being amortized over the same period as the related revenue. As of
March 31, 2008, the Company has deferred approximately $23.8 million of revenue and $18.7 million
of related costs for equipment sales, which principally relate to the home market.
The Company entered into a National Service Provider Agreement and a Stock Purchase Agreement
with DaVita on February 7, 2007. Pursuant to EITF 00-21, the Company considers these agreements a
single arrangement. In connection with the Stock Purchase Agreement, DaVita purchased 2.0 million
shares of the Companys common stock for $10.00 per share, which represented a premium over the
market price on that date of $1.50 per share, or $3.0 million. The Company has recorded the $3.0
million premium as deferred revenue and will recognize this revenue ratably over seven years,
consistent with its equipment service obligation to DaVita. The Company recognized revenue of $0.1
million associated with the $3.0 million premium for each of the three months ended March 31, 2008
and 2007, respectively.
In the critical care market, the Company structures sales of the System One as direct product
sales or as a disposables-based program in which a customer acquires the equipment through the
purchase of a specific quantity of disposables over a specific period of time. The Company
recognizes revenue from direct product sales at the later of the time of shipment or, if
applicable, delivery in accordance with contract terms. Under a disposables-based program, the
customer is granted the right to use the equipment for a period of time, during which the customer
commits to purchase a minimum number of disposable cartridges or fluids at a price that
includes a premium above the otherwise average selling price of the cartridges or fluids to
recover the cost of the equipment and provide for a profit. Upon reaching the contractual minimum
purchases, ownership of the equipment transfers to the customer.
- 7 -
Revenue under these arrangements
is recognized over the term of the arrangement as disposables are delivered. During the reported
periods, the majority of our critical care market revenue is derived from supply contracts and
direct product sales.
The Companys contracts for the System One provide for training, technical support and
warranty services to its customers. The Company recognizes training and technical support revenue
when the related services are performed. In the case of extended warranty, the revenue is
recognized ratably over the warranty period.
In-Center Segment
In the in-center market, sales are structured primarily through supply and distribution
contracts with distributors. The Companys distribution contracts for the in-center market contain
minimum volume commitments with negotiated pricing triggers at different volume tiers. Each
agreement may be cancelled upon a material breach, subject to certain curing rights, and in many
instances minimum volume commitments can be reduced or eliminated upon certain events. In addition
to contractually determined volume discounts, we offer rebates based on sales to specific end
customers and discount incentives for early payment. The Companys revenues are presented net of
these rebates, incentives, discounts and returns. During the reported periods, the majority of our
in-center market revenue is derived from direct product sales.
The Company recognizes rebates to customers in its in-center market in accordance with EITF
01-09, Accounting for Consideration given by a Vendor to a Customer (Including) Reseller of the
Vendors Products. Customer rebates are included as a reduction of sales and trade accounts
receivable and are the Companys best estimate of the amount of probable future rebates on current
sales. For the three month period ended March 31, 2008, the Company recognized $1.5 million as a
reduction of sales in connection with customer rebates. At March 31, 2008, the Company has a $1.4
million reserve against trade accounts receivable for future rebates.
(d) Foreign Currency Translation and Transactions
Assets and liabilities of the Companys foreign operations are translated in accordance with
Statement of Financial Accounting Standards (SFAS) No. 52, Foreign Currency Translation. In
accordance with SFAS No. 52, assets and liabilities of the Companys foreign operations are
translated into U.S. dollars at current exchange rates, and income and expense items are translated
at average rates of exchange prevailing during the year. Gains and losses realized from
transactions denominated in foreign currencies, including intercompany balances not considered
permanent investments, are included in the condensed consolidated statements of operations. The
Companys foreign exchange losses totaled $0.1 million and $46,000 in March 31, 2008 and 2007,
respectively.
(e) Cash, Cash Equivalents, Marketable Securities and Restricted Cash
The Company considers all highly-liquid investments purchased with original maturities of
90 days or less to be cash equivalents. Cash equivalents include amounts invested in federal agency
securities, certificates of deposit, commercial paper and money market funds. Cash equivalents are
stated at cost plus accrued interest, which approximates market value.
At March 31, 2008, the Company had $1.4 million in standby letters of credit to guarantee
annual value added tax (VAT) refunds in Italy. These amounts are restricted and classified as
other assets.
(f) Fair Value of Financial Instruments and Concentration of Credit Risk
Financial instruments consist principally of cash and cash equivalents, accounts receivable,
accounts payable and long-term debt. The estimated fair value of these instruments approximates
carrying value due to the short period of time to maturity. The fair value of the Companys debt is
estimated based on the current rates offered to the Company for debt with the same remaining
maturities. The carrying amount of our long-term debt approximates fair value since the stated rate
of interest approximates a market rate of interest.
The following table summarizes the number of customers who individually comprise greater than
10% of total revenue and accounts receivable:
|
|
|
|
|
|
|
|
|
|
|
Percent of |
|
Percent of |
|
|
Total |
|
Total |
Quarter Ended |
|
Revenue |
|
Accounts Receivable |
March 31, 2008 |
|
|
|
|
|
|
|
|
Customer A |
|
|
15 |
% |
|
|
11 |
% |
Customer B |
|
|
42 |
% |
|
|
21 |
% |
Customer C |
|
|
|
|
|
|
14 |
% |
March 31, 2007 |
|
|
|
|
|
|
|
|
Customer A |
|
|
23 |
% |
|
|
|
|
For the year ended December 31, 2007, no single customer represented greater than 10% of total
accounts receivable.
Sales to Customer A and C are primarily in the SystemOne segment and sales to Customer B were
primarily in the in-center segment.
- 8 -
(g) Inventory
Inventories at March 31, 2008 and December 31, 2007 consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Purchased components |
|
$ |
13,490 |
|
|
$ |
12,211 |
|
Work in process |
|
|
1,425 |
|
|
|
1,718 |
|
Finished units |
|
|
25,245 |
|
|
|
16,036 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
40,160 |
|
|
$ |
29,965 |
|
|
|
|
|
|
|
|
Inventory is shown net of a valuation reserve of approximately $1.1 million and $1.8 million
at March 31, 2008 and December 31, 2007, respectively.
(h) Property and Equipment and Field Equipment
Property and equipment is carried at cost less accumulated depreciation. Depreciation expense
for property and equipment was $0.8 million and $0.2 million for the three months ended March 31,
2008 and 2007, respectively.
Field equipment is carried at cost less accumulated depreciation at March 31 2008 and December
31, 2007 as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Field equipment |
|
$ |
42,421 |
|
|
$ |
39,470 |
|
Less accumulated depreciation and amortization |
|
|
(10,609 |
) |
|
|
(8,585 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Field equipment, net |
|
$ |
31,812 |
|
|
$ |
30,885 |
|
|
|
|
|
|
|
|
Depreciation expense for field equipment was $2.1 million and $1.2 million for the three
months ended March 31, 2008 and 2007, respectively.
(i) Intangibles
Intangible assets are carried at cost less accumulated amortization. For assets with
determinable useful lives, amortization is computed using the straight-line method over the
estimated economic lives of the respective intangible assets, ranging from 8 to 14 years.
Furthermore, periodically the Company assesses whether long-lived assets, including intangible
assets, should be tested for recoverability whenever events or circumstances indicate that their
carrying value may not be recoverable. The amount of impairment, if any, is measured based on fair
value, which is determined using projected discounted future operating cash flows. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less selling costs. No
such impairments were recorded during the period ended March 31, 2008. The Company recognized $34.5
million of acquired definite-lived intangible assets as a result of acquiring the MDS Entities.
These definite-lived intangible assets are expected to be amortized over periods ranging from 8 to
14 years with an average life of 12.9 years.
The Company recognized $0.7 million of amortization expense for the three months ended March
31, 2008. The Company will record $2.8 million of amortization expense for each of the years ended
December 31, 2008 through 2012 related to the above intangible assets.
(j) Goodwill
The Company accounts for goodwill in accordance with SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 requires that goodwill not be amortized but instead be tested at
least annually for impairment, or more frequently when events or changes in circumstances indicate
that the assets might be impaired. This impairment test is performed annually during the fourth
quarter of the fiscal year at the reporting unit level based on product market. A two-step test is
used to identify the potential impairment and to measure the amount of goodwill impairment, if any.
The first step is to compare the fair value of the reporting unit with its carrying amount,
including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill
is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing
step two. Under step two, the impairment loss is measured by comparing the implied fair value of
the reporting unit goodwill with the carrying amount of goodwill.
(k) Stock-Based Compensation
On January 1, 2006, the Company adopted SFAS No. 123, Share-Based Payment(R) (SFAS 123(R)),
using a combination of the prospective and the modified prospective transition methods. Under the
prospective method, the Company will not recognize the remaining compensation cost for any stock
option awards that had previously been valued using the minimum value method, which
- 9 -
was allowed
until the Companys initial filing with the SEC for the sale of securities (i.e., stock options
granted prior to July 19, 2005). Under the modified prospective method, the Company has (a)
recognized compensation expense for all share-based payments granted after January 1, 2006 and (b)
recognized compensation expense for awards granted to employees between July 19, 2005 and December
31, 2005 that remained unvested at December 31, 2005.
The captions in the Companys condensed consolidated statement of operations for the
three months ended March 31, 2008 and 2007 include share-based compensation as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
Cost of revenues |
|
$ |
255 |
|
|
$ |
41 |
|
Selling and marketing |
|
|
549 |
|
|
|
209 |
|
Research and development |
|
|
124 |
|
|
|
40 |
|
General and administrative |
|
|
558 |
|
|
|
470 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,486 |
|
|
$ |
760 |
|
|
|
|
|
|
|
|
(l) Deferred Cost of Revenues
Costs relating to equipment sold for which deferral of revenue is required are
capitalized and amortized ratably over the same period in which the associated revenue is being
recognized. Deferred costs relating to equipment sold at March 31, 2008 and December 31, 2007
totaled $18.7 million and $14.9 million, respectively, and are separately presented in the
accompanying condensed consolidated balance sheets. Amortization of deferred costs charged to cost
of revenues was $0.6 million for the three months ended March 31, 2008 and $0.1 million for the
three months ended March 31, 2007.
(m) Warranty Costs
For a period of one year following the delivery of products to critical care customers, the
Company provides for product repair or replacement if it is determined there is a defect in
material or manufacture of the product. For sales in the critical care market, the Company accrues
estimated warranty costs at the time of shipment based on contractual rights and historical
experience. Warranty expense is included in cost of revenues in the condensed consolidated
statements of operations. Following is a roll-forward of the Companys warranty accrual (in
thousands):
|
|
|
|
|
Balance at December 31, 2007 |
|
$ |
220 |
|
Provision |
|
|
57 |
|
Usage |
|
|
(89 |
) |
|
|
|
|
|
|
|
|
|
Balance at March 31, 2008 |
|
$ |
188 |
|
|
|
|
|
(n) Distribution Expenses
Distribution expenses consist of the costs incurred in shipping products to customers and are
charged to operations as incurred. Shipping and handling costs billed to customers are included in
revenues and totaled $0.1 million for the three months ended March 31, 2008.
(o) Research and Development Costs
Research and development costs are charged to operations as incurred.
(p) Income Taxes
The Company accounts for federal and state income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. Under the liability method specified by SFAS No. 109, a deferred tax
asset or liability is determined based on the difference between
the financial statement and tax basis of assets and liabilities, as measured by the enacted tax
rates. The Companys provision for income taxes represents the amount of taxes currently payable,
if any, plus the change in the amount of net deferred tax assets or liabilities. A valuation
allowance is provided against net deferred tax assets if recoverability is uncertain on a more
likely than not basis. The Company had no unrecognized tax benefits recorded as of March 31, 2008.
The Company files federal, state and foreign tax returns. The Company has accumulated
significant losses since its inception in 1998. Since the net operating losses may potentially be
utilized in future years to reduce taxable income, all of the Companys tax years remain open to
examination by the major taxing jurisdictions to which the Company is subject.
The Company recognizes interest and penalties for uncertain tax positions in income tax
expense. The Company had no interest or penalty accruals for the three months ended March 31, 2008.
(q) Net Loss per Share
SFAS No. 128, Earnings Per Share, requires two presentations of earnings per share, basic
and diluted. Basic earnings per
- 10 -
share is computed by dividing income available to common
stockholders (the numerator) by the weighted-average number of common shares outstanding (the
denominator) for the period. The computation of diluted earnings per share is similar to basic
earnings per share, except that the denominator is increased to include the number of additional
common shares that would have been outstanding if the potentially dilutive common shares had been
issued.
The following potential common stock equivalents were not included in the computation of
diluted net loss per share as their effect would have been anti-dilutive (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
Options to purchase common stock |
|
|
2,599 |
|
|
|
1,378 |
|
Restricted stock units |
|
|
|
|
|
|
|
|
Warrants to purchase common stock |
|
|
|
|
|
|
19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
2,599 |
|
|
|
1,397 |
|
|
|
|
|
|
|
|
(r) Comprehensive Income (Loss)
SFAS No. 130, Reporting Comprehensive Income, establishes standards for reporting
comprehensive income (loss) and its components in the body of the financial statements.
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss).
Other comprehensive income (loss) includes certain changes in equity, such as foreign currency
translation adjustments, that are excluded from results of operations.
The components of comprehensive income (loss) are presented below for the periods presented in the
condensed consolidated statements of operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
Net loss |
|
$ |
(13,944 |
) |
|
$ |
(11,993 |
) |
Foreign currency translation (loss) gain |
|
|
(37 |
) |
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(13,981 |
) |
|
$ |
(11,988 |
) |
|
|
|
|
|
|
|
(s) Recent Accounting Pronouncements
In December 2007, the FASB issued Statement No. 141(R), Business Combinations (Statement 141
(R)), a replacement of FASB Statement No. 141. Statement 141(R) is effective for fiscal years
beginning on or after December 15, 2008 and applies to all business combinations. Statement 141(R)
provides that, upon initially obtaining control, an acquirer shall recognize 100 percent of the
fair values of acquired assets, including goodwill and assumed liabilities, with only limited
exceptions, even if the acquirer has not acquired 100 percent of its target. As a consequence, the
current step acquisition model will be eliminated. Additionally, Statement 141(R) changes current
practice, in part, as follows: (1) contingent consideration arrangements will be fair valued at
the acquisition date and included on that basis in the purchase price consideration; (2)
transaction costs will be expensed as incurred, rather than capitalized as part of the purchase
price; (3) pre-acquisition contingencies, such as legal issues, will generally have to be accounted
for in purchase accounting at fair value; and (4) in order to accrue for a restructuring plan in
purchase accounting, the requirements in FASB Statement No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, would have to be met at the acquisition date. While there is no
expected impact to our consolidated financial statements on the accounting for acquisitions
completed prior to December 31, 2008, the adoption of Statement 141(R) on January 1, 2009 could
materially change the accounting for business combinations consummated subsequent to that date.
In September 2006, the FASB issued Statement 157, Fair Value Measurement (Statement 157).
Statement 157 defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles and establishes a hierarchy that categorizes and prioritizes the
sources to be used to estimate fair value. Statement 157 also expands financial statement
disclosures about fair value measurements. On February 12, 2008, the FASB issued FASB Staff
Position FSP 157-2 which delays the effective date of Statement 157 for one year for all
non-financial assets and non-financial liabilities, except those that are recognized or disclosed
at fair value in the financial statements on a recurring basis (at least annually). Statement 157
and FSP 157-2 are effective for financial statements issued for fiscal years beginning after
November 15, 2007. The adoption of Statement 157 did not have a material impact on the Company.
- 11 -
In February 2007, the FASB issued Statement 159, The Fair Value Option for Financial Assets
and Financial Liabilities Including an Amendment of SFAS 115 (Statement 159), which allows an
entity the irrevocable option to elect fair value for the initial and subsequent measurement for
certain financial assets and liabilities on a contract-by-contract basis. Unrealized gains and
losses on items for which the fair value option has been elected are reported in earnings. This
statement is effective for financial statements issued for fiscal years beginning after November
15, 2007. The Company has not adopted Statement 159 and therefore has not elected the fair value
option for any of its financial assets and liabilities.
In December 2007, the SEC issued Staff Accounting Bulletin No. 110 (SAB 110). SAB 110 amends
and replaces Question 6 of
Section D.2 of Topic 14, Share-Based Payment. SAB 110 expresses the views of the SEC staff
regarding the use of the simplified method in developing an estimate of expected term of plain
vanilla share options in accordance with SFAS 123(R). The use of the simplified method was
scheduled to expire on December 31, 2007. SAB 110 extended the use of the simplified method for
plain vanilla awards in certain situations. The Company currently uses the simplified method to
estimate the expected term for share option grants as it does not have enough historical experience
to provide a reasonable estimate due to the limited period the Companys equity shares have been
publicly traded. The Company will continue to use the simplified method until it has enough
historical experience to provide a reasonable estimate of expected term in accordance with SAB 110.
SAB 110 is effective for options granted after December 31, 2007.
3. Restructuring Activities
As a result of the Companys acquisition of the MDS Entities on October 1, 2007, the Company
established and approved a plan to integrate the acquired operations of the MDS Entities into the
operations of the Company, for which the Company recorded $0.5 million in exit related purchase
accounting adjustments in 2007. These purchase accounting adjustments consist of severance and
relocation benefits for certain employees of the MDS Entities. The Company recorded an additional
$5,000 as an adjustment to goodwill for the three months ended March 31, 2008, which was an
adjustment to the cost of the MDS Entities acquisition. The following table summarizes the
reserves related to exit activities that the Company has established through purchase accounting
and the related activity as of March 31, 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance |
|
|
Relocation |
|
|
Total |
|
Balance at 12/31/07 |
|
$ |
301 |
|
|
$ |
139 |
|
|
$ |
440 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring charge |
|
|
5 |
|
|
|
|
|
|
|
5 |
|
Cash payments |
|
|
(22 |
) |
|
|
(21 |
) |
|
|
(43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at 3/31/2008 |
|
$ |
284 |
|
|
$ |
118 |
|
|
$ |
402 |
|
|
|
|
|
|
|
|
|
|
|
4. Financing Arrangements
Debt
On November 21, 2007, the Company obtained a $50.0 million credit and security agreement from
a group of lenders led by Merrill Lynch Capital, a division of Merrill Lynch Business Services
Inc., which was acquired by GE for a term of 42 months. The credit
facility is secured by nearly all assets of the Company, other than intellectual property, and
consists of a $30.0 million term loan and a $20.0 million revolving credit facility. The Company
borrowed $25.0 million under the term loan in November 2007 and borrowed the remaining $5.0 million
on March 25, 2008. The Company used $4.9 million of the proceeds from the term loan to repay all
amounts owed under a term loan dated May 15, 2006 with Silicon Valley Bank. Borrowings under the GE
term loan bear interest equal to LIBOR plus 6% per annum, fixed on November 21, 2007 for our first
borrowings (at a rate of 10.77% per year) and fixed on March 25, 2008 for our second borrowings (at
a rate of 8.61% per year). Interest on the term loan must be paid on a monthly basis. Beginning on
February 1, 2009, the Company must repay principal under the term loan in 29 equal monthly
installments. The Company will also be required to pay a maturity premium of $0.9 million at the
time of loan payoff. The Company is accruing the maturity premium as additional interest over the
42 month term. The Companys borrowing capacity under the revolving credit facility is subject to
satisfaction of certain conditions and calculations of the borrowing amount. There is no guarantee
that the Company will be able to borrow the full amount, or any funds, under the revolving credit
facility. Any borrowings under the revolving credit facility will bear interest at LIBOR plus
4.25% per annum. There is an unused line fee of 0.75% per annum and descending deferred revolving
credit facility commitment fees, which are charged in the event the revolving credit facility is
terminated prior to May 21, 2011 of 4% in year one, 2% in year two and 1% thereafter.
The credit facility includes covenants that (a) require the Company to achieve certain minimum
net revenue and certain minimum
- 12 -
earnings
before interest, taxes, depreciation and amortization, or EBITDA, targets relating to the acquired MDS Entities, (b) place limitations on the Companys
ability to incur debt, (c) place limitations on the Companys ability to grant or incur liens,
carry out mergers, and make investments and acquisitions, and (d) place limitations on the
Companys ability to pay dividends, make other restricted payments, enter into transactions with
affiliates and amend certain contracts. The credit agreement contains customary events of default,
including nonpayment, misrepresentation, breach of covenants, material adverse effects, and
bankruptcy. In the event the Company fails to satisfy the covenants, or otherwise go into default,
GE has a number of remedies, including sale of the Companys assets, control of cash and cash
equivalents and acceleration of all outstanding indebtedness. Any of these remedies would likely
have a material adverse effect on the Companys business.
In addition to the Companys debt under the GE credit facility, the Company had one loan
outstanding as of March 31, 2008
totaling
145,000 ($230,000) which expires in September 2011 and is included in current and
long-term debt. The interest on outstanding borrowings is equal to EURIBOR for 3 months (plus
1.15%) subject to an interest rate swap agreement at rates greater than 4%. When EURIBOR (three
months) plus 1.15% exceeds 4%, interest is calculated on a blended basis, with 50% of the nominal
value of the loan subject to a fixed rate of 4%, and the remaining 50% subject to the EURIBOR
(three months) plus 1.15%. EURIBOR for three months at March 31, 2008 was 4.727%, according to
published sources. Interest expense reflects the applied blended interest rate calculation. As of
March 31, 2008, the interest rate on this loan was 5.572%.
Annual maturities of principal under the Companys debt obligations outstanding at March 31,
2008 are as follows (in thousands):
|
|
|
|
|
2008 |
|
$ |
46 |
|
2009 |
|
|
11,443 |
|
2010 |
|
|
12,481 |
|
2011 |
|
|
6,260 |
|
|
|
|
|
|
|
$ |
30,230 |
|
|
|
|
|
5. Stockholders Equity
Common and Preferred Stock
On October 1, 2007, the Company issued 6.5 million shares of its common stock at a price of
$12.50 per share in connection with the MDS Entities discussed in Note 3.
On February 7, 2007, the Company issued and sold to DaVita 2.0 million shares of common stock
at a purchase price of $10.00 per share, for an aggregate purchase price of $19.9 million, net of
issuance costs. The price of the Companys common stock on February 7, 2007 was $8.50 per share,
resulting in a $3.0 million premium, which was deferred and is being recognized ratably to revenue
over a term of seven years as discussed in Note 1.
2005 Stock Incentive Plan and 2005 Employee Stock Purchase Plan
The Company grants options and restricted stock to its employees under its 2005 Stock
Incentive Plan. As of March 31, 2008, the Company has reserved 5,276,313 shares of common stock for
issuance upon exercise of stock options and vesting of restricted stock and 35,730 shares for
issuance under the 2005 Employee Stock Purchase Plan.
The Companys 2005 Employee Stock Purchase Plan (the 2005 Purchase Plan) originally
authorized the issuance of up to 50,000 shares of common stock to participating employees through a
series of periodic offerings. An incremental 50,000 shares was approved by the Companys
stockholders on May 30, 2007. Each six-month offering period begins in January or July. The first
offering under the 2005 Purchase Plan began on January 3, 2006 and ended on June 30, 2006. An
employee becomes eligible to participate in the 2005 Purchase Plan once he or she has been employed
for at least three months and is regularly employed for at least 20 hours per week for more than
three months in a calendar year. The price at which employees can purchase common stock in an
offering is 95 percent of the closing price of the common stock on the NASDAQ Global Market on the
day the offering terminates, unless otherwise determined by the Companys Board of Directors or
Compensation Committee.
6. Segment and Enterprise Wide Disclosures
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes
standards for reporting information regarding operating segments in annual financial statements.
On October 1, 2007, the Company completed its acquisition of the MDS Entities. As a result of
the acquisition, during the quarter ended March 31, 2008, the Company began operating in two
segments: System One and In-Center. Prior to January 1, 2008, the Company operated in one segment. The segment information noted below for the period ended March 31, 2007
does not include any in-center amounts since the acquisition of the MDS Entities did not occur
until October 2007. Within the System One segment, the Company sells the System One and related
products in the home and critical care markets. The home market consists of dialysis centers and
hospitals that provide treatment options for patients that have ESRD,
while the critical care market consists of hospitals or facilities that treat patients that have
suddenly, and possibly temporarily, lost kidney function. The Company sells essentially the same
System One cyclers and disposables within each market and some of the Companys largest customers
in the home market provide outsourced renal dialysis services to hospitals in the critical care
market to which the Company sells System One cyclers and disposables. Sales of product to both
markets are made through dedicated sales forces and products are distributed directly to the
customer.
- 13 -
Sales
in the in-center segment primarily consist of blood tubing sets and needles for
hemodialysis and needles for apheresis. in-center products are sold
through national distributors.
The Companys reportable segments consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System One |
|
In-Center |
|
Total |
Three Months Ended March 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers |
|
$ |
14,867 |
|
|
$ |
16,138 |
|
|
$ |
31,005 |
|
Segment (loss) profit |
|
|
(6,365 |
) |
|
|
2,364 |
|
|
|
(4,001 |
) |
Segment assets |
|
|
86,042 |
|
|
|
15,666 |
|
|
|
101,708 |
|
Three Months Ended March 31, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers |
|
|
8,374 |
|
|
|
|
|
|
|
8,374 |
|
Segment loss |
|
|
(7,062 |
) |
|
|
|
|
|
|
(7,062 |
) |
Segment assets |
|
|
46,510 |
|
|
|
|
|
|
|
46,510 |
|
Revenues recognized by each segment were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
System One segment |
|
|
|
|
|
|
|
|
Home |
|
$ |
10,546 |
|
|
$ |
5,435 |
|
Critical Care |
|
|
4,321 |
|
|
|
2,939 |
|
|
|
|
|
|
|
|
Total System One segment |
|
|
14,867 |
|
|
|
8,374 |
|
In-Center segment |
|
|
16,138 |
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
31,005 |
|
|
$ |
8,374 |
|
|
|
|
|
|
|
|
All revenues were generated in the United States.
The following table presents a reconciliation of the total reportable segment loss to consolidated
net loss before income taxes (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2008 |
|
|
2007 |
|
Total segment loss |
|
$ |
(4,001 |
) |
|
$ |
(7,062 |
) |
Unallocated expenses: |
|
|
|
|
|
|
|
|
Manufacturing operations |
|
|
(2,211 |
) |
|
|
(1,557 |
) |
Research and development |
|
|
(2,126 |
) |
|
|
(1,436 |
) |
General and administrative |
|
|
(4,815 |
) |
|
|
(2,667 |
) |
Other income (expense) |
|
|
(746 |
) |
|
|
729 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss before income taxes |
|
$ |
(13,899 |
) |
|
$ |
(11,993 |
) |
|
|
|
|
|
|
|
Segment (loss) profit consists of sales, less cost of sales, direct selling, marketing and
distribution expenses.
- 14 -
The following table presents a reconciliation of the total segment assets to total assets (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
March
31, |
|
|
December
31, |
|
|
|
2008 |
|
|
2007 |
|
Total segment assets |
|
$ |
101,708 |
|
|
$ |
83,689 |
|
Corporate assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
|
16,181 |
|
|
|
33,245 |
|
Short-term investments |
|
|
|
|
|
|
1,100 |
|
Property and equipment, net |
|
|
12,937 |
|
|
|
12,146 |
|
Intangible assets, net |
|
|
33,102 |
|
|
|
33,801 |
|
Goodwill |
|
|
41,462 |
|
|
|
41,457 |
|
Prepaid and other assets |
|
|
4,115 |
|
|
|
4,948 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
209,505 |
|
|
$ |
210,386 |
|
|
|
|
|
|
|
|
Long-lived tangible assets consist of property and equipment and field equipment. The
following table presents total long-lived tangible assets by geographic areas (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
United States |
|
$ |
37,726 |
|
|
$ |
36,754 |
|
Europe |
|
|
3,990 |
|
|
|
3,551 |
|
Mexico |
|
|
3,033 |
|
|
|
2,726 |
|
|
|
|
|
|
|
|
Total tangible long-lived assets, net |
|
$ |
44,749 |
|
|
$ |
43,031 |
|
|
|
|
|
|
|
|
7. Related-Party Transactions
On June 4, 2007, the Company entered into a stock purchase agreement with David S. Utterberg
under which the Company agreed to purchase from Mr. Utterberg the issued and outstanding shares of
the MDS Entities. The Company refers to its acquisition of the MDS Entities as the Medisystems
Acquisition. Mr. Utterberg is a director and significant stockholder of NxStage. The Medisystems
Acquisition was completed on October 1, 2007 and, as a result, each of the MDS Entities is a direct
or indirect wholly-owned subsidiary of NxStage. In addition, as a result of completion of the
Medisystems Acquisition, the supply agreement, dated January 2007, with Medisystems, under which
Medisystems agreed to provide cartridges for use with the System One, was terminated with no
resultant gain or loss recognized. In consideration for the Medisystems Acquisition, the Company
issued Mr. Utterberg 6.5 million shares of our common
stock, which we refer to as the Acquisition Shares. As a
result of the Medisystems Acquisition and the issuance of the
Acquisition Shares to Mr. Utterberg,
Mr. Utterbergs aggregate ownership of outstanding common stock increased to approximately 23%. In
addition, the Company may be required to issue additional shares of common stock to Mr. Utterberg
since, pursuant to the terms of the stock purchase agreement, Mr. Utterberg and the Company have
agreed to indemnify each other in the event of certain breaches or failures, and any such
indemnification amounts must be paid in shares of the Companys common stock, valued at the time of
payment. However, the Company will not be required to issue shares for indemnification purposes
that in the aggregate would exceed 20% of the then outstanding shares of the Companys common stock
without first obtaining stockholder approval, and any such shares will not be registered under the
Securities Act of 1933, as amended. An aggregate of 1.0 million
of the Acquisition Shares issued to
Mr. Utterberg were placed into escrow to cover potential indemnification claims the Company may
have against Mr. Utterberg. In connection with the Medisystems Acquisition and as a result of
Medisystems Corporation, one of the MDS Entities, becoming a direct or indirect wholly-owned
subsidiary of the Company, NxStage acquired rights under an existing license agreement between Medisystems
and DSU Medical Corporation, a Nevada corporation, which is wholly-owned by Mr. Utterberg, or DSU.
The Company refers to this agreement as the license agreement. Additionally, as a condition to the
parties obligations to consummate the Medisystems Acquisition, Mr. Utterberg and DSU entered into
a consulting agreement with us dated October 1, 2007, which the Company refers to as the consulting
agreement.
Under the license agreement, Medisystems Corporation received an exclusive, irrevocable,
sublicensable, royalty-free, fully paid license to certain DSU patents, or the licensed patents, in
exchange for a one-time payment of $2.7 million. The licensed patents fall into two categories,
those patents that are used exclusively by the MDS Entities, referred to as the Class A patents,
and those patents
- 15 -
that are used by the MDS Entities and other companies owned by Mr. Utterberg,
referred to as the Class B patents. Pursuant to the terms of the license agreement, Medisystems
Corporation has a license to (a) the Class A patents, to practice in all fields for any purpose and
(b) the Class B patents, solely with respect to certain defined products for use in the treatment
of extracorporeal fluid treatments and/or renal insufficiency treatments. The license agreement
further provides that the rights of Medisystems Corporation under the agreement are qualified by
certain sublicenses previously granted to third parties. The Company has agreed that
Mr. Utterberg retains the right to the royalty income under one of these sublicenses.
Under the consulting agreement, Mr. Utterberg and DSU will provide consulting, advisory and
related services to us for a period of two years following the consummation of the Medisystems
Acquisition. In addition, under the terms of the consulting agreement, Mr. Utterberg and DSU have
agreed during the term of the agreement not to compete with NxStage during the term of the
consulting agreement in the field defined in the consulting agreement and not to encourage or
solicit any of our employees, customers or suppliers to alter their relationship with us. The
consulting agreement further provides that (a) Mr. Utterberg and DSU assign to us certain
inventions and proprietary rights received by him/it during the term of the agreement and (b) the
Company grants Mr. Utterberg and DSU an exclusive, worldwide, perpetual, royalty-free irrevocable,
sublicensable, fully paid license under such assigned inventions and proprietary rights for any
purpose outside the inventing field, as defined in the consulting agreement. Under the terms of the
consulting agreement, Mr. Utterberg and DSU will receive an aggregate of $200,000 per year, plus
expenses, in full consideration for the services and other obligations provided for under the terms
of the consulting agreement. The consulting agreement also requires Mr. Utterberg and NxStage to
indemnify each other in the event of certain breaches and failures under the agreement and requires
that any such indemnification liability be satisfied with shares of our common stock, valued at the
time of payment. However, the Company will not be required to issue shares for indemnification
purposes that in the aggregate would exceed 20% of the then outstanding shares of our common stock
without first obtaining stockholder approval, and any such shares will not be registered under the
Securities Act of 1933, as amended. During the quarter ended March 31, 2008, the Company paid Mr.
Utterberg and DSU $50,000 for consulting fees under this agreement.
The Company assumed a $2.8 million liability owed to DSU as a result of the acquisition of the
MDS Entities. The amount owed represents consideration owed to DSU by the MDS Entities for the
termination of a royalty-bearing sublicense agreement and the establishment of the royalty-free
license agreement. During the quarter ended March 31, 2008, the Company paid Mr. Utterberg $2.0
million of the liability owed.
As of March 31, 2008, the Company has a receivable for reimbursements of costs related to the
acquisition in the amount of $0.4 million from Mr. Utterberg and DSU.
Finally, in connection with the Medisystems Acquisition, the Company agreed that if Mr.
Utterberg is no longer a director of the Company, the Companys Board of Directors will nominate
for election to the Companys Board of Directors any director nominee proposed by Mr. Utterberg,
subject to certain conditions.
8. Commitments and Contingencies
The Company enters into arrangements to purchase inventory requiring minimum purchase
commitments in the ordinary course of business.
On January 6, 2008, the Companys wholly-owned subsidiary, Medisystems Corporation, entered
into a needle purchase agreement, which we refer to as the needle
agreement, with DaVita, pursuant to which DaVita has
agreed to purchase the majority of its safety needle requirements from Medisystems for five years,
subject to certain terms and conditions. The term of the needle agreement expires on January 5,
2013. Either party may terminate the needle agreement upon a substantial breach of the terms thereof that
remains uncured, or upon the insolvency of the other party. DaVita
may also terminate the needle agreement
(a) upon our continued failure to supply safety needles, or (b) if Medisystems delivers defective
safety needles to DaVita for a continued period of time. DaVita has the right to reduce or
eliminate its purchase requirements under the Agreement following the introduction of a materially
improved product (as defined in the Agreement) from a third party. If DaVita exercises this right,
Medisystems may terminate the Agreement. The needle agreement provides for liquidated damages in
the event DaVita fails to satisfy its purchase requirements or Medisystems fails to meet its supply
obligations to DaVita.
As of October 1, 2007, in connection with the Medisystems Acquisition, the Company assumed a
supply and distribution agreement with Kawasumi Laboratories, Inc., a Japanese contract
manufacturer. This agreement covers blood tubing sets and needle sets for the in-center segment,
expiring in May 2009 for blood tubing sets and February 2011 for needle sets. Under the terms of
the agreement, the Company agrees to purchase from this supplier an annual quantity at least equal
to 80% of the goals established by both parties for each 12 month period commencing February 1.
There have been no losses as a result of this commitment historically and the Company does not
expect any losses over the remaining term of this annual agreement.
On
March 1, 2007, the Company entered into a long-term agreement
with the Entrada Group, or Entrada, to establish manufacturing and service operations in Mexico, initially for its cycler
and PureFlow SL disposables and later for its PureFlow SL hardware. The agreement obligates Entrada
to provide the Company with manufacturing space, support services and a labor force through 2012.
Subject to certain exceptions, the Company is obligated for facility fees through the term of the
agreement which approximate $0.2 million annually. The agreement may be terminated upon material
breach, generally following a 30-day cure period, or upon the insolvency of the other party.
In January 2007, the Company entered into a long-term supply agreement with Membrana, pursuant
to which Membrana has agreed to supply, on an exclusive basis, capillary membranes for use in the
filters used with the System One for ten years. In exchange for Membranas agreement to pricing
reductions based on volumes ordered, the Company has agreed to purchase a base amount of membranes
per year. The agreement may be terminated upon a material breach, generally following a 60-day cure
period.
- 16 -
9. Subsequent Events
On May 6, 2008, the Companys wholly-owned subsidiary, Medisystems Corporation entered
into a supply and distribution agreement with Kawasumi Laboratories, Inc.. Pursuant to the terms of
that agreement, Kawasumi has agreed to continue to manufacture and supply blood tubing sets to
Medisystems through January 31, 2010. In exchange for Kawasumis commitment to
supply blood tubing sets, and Kawasumis agreement not to sell blood tubing sets to any other
entity in the United States, Medisystems has agreed to purchase certain minimum quantities of blood
tubing sets, including Streamline blood tubing sets. If Medisystems fails to purchase this amount,
Kawasumi may ship any shortfall to Medisystems and Medisystems must pay for such shortfall
shipment. Either party may terminate the agreement (a) for any material breach of the agreement by
the other party, upon ninety days prior written notice if after such ninety-day period the
material breach remains uncured, or (b) immediately upon the insolvency of the other party. This
agreement amends, but does not replace, the prior supply and distribution agreement entered into
between Medisystems Corporation and Kawasumi as of February 1, 2001, as subsequently amended. The
prior agreement originally covered the supply of needles as well as blood tubing sets. The new
agreement supersedes the prior agreement with respect to the supply of blood tubing sets while the
prior agreement continues to be in effect with respect to needles supplied by Kawasumi.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward Looking Statements
The following discussion should be read with our unaudited condensed consolidated
financial statements and notes included in Part I, Item 1 of this Quarterly Report for the three
months ended March 31, 2008 and 2007, as well as the audited financial statements and notes and
Managements Discussion and Analysis of Financial Condition and Results of Operations for the
fiscal year ended December 31, 2007, included in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission, or SEC. This Quarterly Report contains forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements regarding future events and our future results are
based on current expectations, estimates, forecasts and projections and the beliefs and assumptions
of our management including, without limitation, our expectations regarding our results of
operations, revenues, cost of revenues, distribution expenses, sales and marketing expenses,
general and administrative expenses, research and development expenses, the impact of the
Medisystems Acquisition, our liquidity and capital resources, and the sufficiency of our cash for
future operations. Words such as expect, anticipate, target, project, believe, goals,
estimate, potential, predict, may, will, might, could, intend, variations of these
terms or the negative of those terms and similar expressions are intended to identify these
forward-looking statements, although not all forward-looking statements contain these identifying
words. Readers are cautioned that these forward-looking statements are predictions and are subject
to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results
may differ materially and adversely from those expressed in any forward-looking statements.
Among the important factors that could cause actual results to differ materially from
those indicated by our forward-looking statements are those discussed under the heading Risk
Factors in Item 1A of Part II. We undertake no obligation to revise or update publicly any
forward-looking statement for any reason. Readers should carefully review the factors described
under the heading Risk Factors in Item 1A of Part II of this Quarterly Report and in Managements
Discussion and Analysis of Financial Condition and Results of Operations, as well as in the
documents filed by us with the SEC, as they may be amended from time to time, including our Annual
Report on Form 10-K and Quarterly Reports on Form 10-Q.
Overview
We are a medical device company that develops, manufactures and markets innovative systems for
the treatment of ESRD, acute kidney failure and fluid overload. Our
primary product, the NxStage System One, is a small, portable, easy-to-use hemodialysis system
designed to provide physicians and patients improved flexibility in how hemodialysis therapy is
prescribed and delivered. In addition to the System One, we also sell needles and blood tubing sets
primarily to dialysis clinics for the treatment of ESRD, which we refer to as the in-center market.
These product lines were obtained in connection with our Medisystems Acquisition. Although the
revenues derived from our in-center products are a significant percentage of our current revenues,
we believe our largest future product market opportunity is for our System One used in the home
hemodialysis market, or home market, for the treatment of ESRD, which we previously referred to as
the chronic market.
We distribute our products in two segments: System One, which consists of the home and
critical care markets and in-center. We define the home market as the market devoted to the
treatment of ESRD patients in the home, the in-center market as the market devoted to in-center
hemodialysis, and apheresis, and the critical care market as the market devoted to the treatment of
hospital-based patients with acute kidney failure or fluid overload. Within the System One segment,
we offer a different configuration of the System One for the home and critical care markets. The
FDA has cleared the System One for hemodialysis, hemofiltration and ultrafiltration. We offer
primarily needles and blood tubing sets in the in-center segment. Our products are predominantly
used by our customers to treat patients suffering from ESRD or acute kidney failure and we have
marketing and sales efforts dedicated to each segment, although in the in-center segment nearly all
sales are made through distributors.
We received clearance from the FDA in July 2003 to market the System One for treatment of
renal failure and fluid overload using hemodialysis as well as hemofiltration and ultrafiltration.
In the first quarter of 2003, we initiated sales of the System One in the critical care market to
hospitals and medical centers in the United States. In late 2003, we initiated sales of the System
One for the
- 17 -
treatment of patients with ESRD. At the time of these early marketing efforts, our
System One was cleared by the FDA under a general indication statement, allowing physicians to
prescribe the System One for hemofiltration, hemodialysis and/or ultrafiltration at the location,
time and frequency they considered in the best interests of their patients. Our original indication
did not include a specific home clearance, and we were not able to promote the System One for home
use at that time. The FDA cleared the System One in June 2005
for hemodialysis in the home. We are presently pursuing a nocturnal
indication for the System One under an FDA approved investigational
device exemption, or IDE, study started in the first quarter of 2008.
Our business expanded significantly in late 2007 in connection with our Medisystems
Acquisition. With that acquisition, we acquired our needle and blood tubing set product lines for
use predominantly in in-center hemodialysis as well as apheresis. The in-center segment is
significantly more mature than our System One segment. The MDS Entities have been selling products
to dialysis centers for the treatment of ESRD since 1981, and it has achieved leading positions in
the United States market for both blood tubing sets and needles. Our blood tubing set products
include the ReadySet High Performance Blood Tubing set, and the Streamline. ReadySet has been on
the market since 1993. Streamline is our next generation blood tubing product designed to provide
improved patient outcomes and lower costs to dialysis clinics. This product is early in its market
launch and adoption has been limited to date. Our needle products line includes AV fistula needle
sets incorporating safety features including PointGuard Anti-Stick Needle Protectors, and
MasterGuard technology and ButtonHole needle sets. Our AV Fistula Needle Sets with MasterGuard
Anti-Stick Needle Protector were introduced in 1995 and our ButtonHole needle sets were introduced
in 2002.
Our customers receive reimbursement for the dialysis treatments provided with our products
from Medicare and private insurers. Medicare provides comprehensive and well-established
reimbursement in the United States for ESRD. Reimbursement claims for home and in-center dialysis
therapy using the System One or our blood tubing sets and needles are typically submitted by the
dialysis clinic or hospital to Medicare and other third-party payors using established billing
codes for dialysis treatment or, in the critical care setting, based on the patients primary
diagnosis. Medicare presently limits reimbursement for chronic hemodialysis to three treatments per
week, absent a finding of medical justification, which determination
must be made on a case-by-case basis, based on documentation provided
by our customers. Because most of our System One home dialysis
patients are treated more than three times a week and receive primary coverage from Medicare,
expanding Medicare reimbursement over time to predictably cover more
frequent therapy, with less administrative burden for our customers, may be critical to our
ability to significantly expand the market penetration of the System One in the home market and to
our revenue growth in the future.
The manufacture of our products is accomplished through a complementary combination of
outsourcing and internal production. Specifically, we assemble, package and label our PureFlow SL
disposables within our Fresnillo, Mexico facility. We manufacture components used in our System One
cartridge assembly in Lawrence, Massachusetts, and assemble the System One disposable cartridge and
some blood tubing sets, Medics and transducer protectors in Mexico. We manufacture our dialyzers
internally in Rosdorf, Germany. We outsource the manufacture of premixed dialysate and needles. We
rely on internal manufacturing and outsourcing for manufacture of our System One cycler, PureFlow
SL hardware and blood tubing sets. As of the second quarter of 2008, we expect that we will no
longer be outsourcing the manufacturing of our SystemOne cycler and Pure Flow SL hardware.
In our System One segment, we market the System One in the home and critical care markets
through a direct sales force in the United States primarily to dialysis clinics and hospitals. In
our in-center segment, we market our blood tubing and needle products primarily through
distributors, although we also have a small dedicated sales force for that business. We have
increased the number of sales representatives in our combined sales force from 29 at March 31, 2007
to 32 at March 31, 2008. At present, we believe we have an appropriately sized sales force,
although this may change as market conditions warrant.
At March 31, 2008, 2,481 ESRD patients were prescribed to receive therapy using the System One
at 355 dialysis clinics, compared to 1,295 ESRD patients at 200 dialysis clinics at March 31, 2007,
and compared to 2,223 patients at 334 dialysis clinics at December 31, 2007. In addition, at March
31, 2008, 126 hospitals were using the System One for critical care therapy, compared to 82 and 115
hospitals at March 31, 2007 and December 31, 2007, respectively.
The following table sets forth the amount and percentage of revenues derived from each segment
for the periods indicated (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
SystemOne segment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Home |
|
$ |
10,546 |
|
|
|
34 |
% |
|
$ |
5,435 |
|
|
|
65 |
% |
Critical Care |
|
|
4,321 |
|
|
|
14 |
% |
|
|
2,939 |
|
|
|
35 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total SystemOne segment |
|
|
14,867 |
|
|
|
48 |
% |
|
|
8,374 |
|
|
|
100 |
% |
In-Center
segment |
|
|
16,138 |
|
|
|
52 |
% |
|
|
|
|
|
|
0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
31,005 |
|
|
|
100 |
% |
|
$ |
8,374 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
We derive our in-center segment revenues through the business we acquired in connection with
our Medisystems Acquisition. This acquisition was not completed until October 1, 2007, and
therefore, we realized no in-center segment revenues in the first quarter of 2007.
Since inception, we have incurred losses every quarter, and at March 31, 2008, we had an
accumulated deficit of approximately
- 18 -
$196.0 million. We expect to incur increasing operating
expenses as we continue to grow our business. We only recently achieved positive gross margins for
our products, in aggregate, and we can not provide assurance that our gross margins will improve
or, if they do improve, the rate at which they will improve. We cannot provide assurance that we
will achieve profitability, when we will become profitable, the sustainability of profitability
should it occur or the extent to which we will be profitable. Our ability to become profitable is
dependent principally upon implementing design and process improvements to lower our costs of
manufacturing our
products, accessing lower labor cost markets for the manufacture of our products, increasing our
reliability, improving our field equipment utilization, achieving efficiencies in manufacturing and
supply chain overhead costs, achieving efficient distribution of our products, achieving a
sufficient scale of operations and obtaining better purchasing terms and prices.
We
will need to sell additional equity, issue debt securities, obtain
capital through strategic investment, or otherwise obtain additional
capital, to fund our capital
requirements beyond 2008. Any sale of additional equity or issuance of debt securities will likely
result in dilution to our stockholders, and we cannot be certain that additional public or private
financing or other capital will be available in amounts or on terms
acceptable to us, or at all. We expect to raise additional capital in
the second or third quarters of 2008. If we are unable to
obtain this additional capital when needed, we may be required to delay, reduce the scope of, or
eliminate one or more aspects of our business development activities, which would likely harm our
business. Additionally, beginning in February 2009, we will need to begin repaying the principal
of the debt we borrowed under our GE credit facility. As of March 31, 2008, we had borrowed
$30.0 million under this facility. To the extent we are unable
to obtain additional capital, this
obligation to repay debt will only further increase the need to further delay, reduce the scope of,
or eliminate one or more aspects of our business, which would likely harm our business.
2008 Recent Developments
Needle Purchase Agreement with DaVita Inc.
On January 6, 2008, our wholly-owned subsidiary, Medisystems Corporation, entered into a
needle purchase agreement with DaVita pursuant to which DaVita has agreed to purchase the majority
of its safety needle requirements from Medisystems for five years, subject to certain terms and
conditions. The needle purchase agreement expires on January 5, 2013. DaVita has the right to
reduce or eliminate its purchase requirements under the agreement following the introduction of a
materially improved product (as defined in the agreement) from a third party. If DaVita exercises
this right, Medisystems may terminate the agreement. The needle purchase agreement provides for
liquidated damages in the event DaVita fails to satisfy its purchase requirements or Medisystems
fails to meet its supply obligations to DaVita.
GE Credit Facility
On March 25, 2008 we borrowed the remaining $5.0 million of the term loan available to us
under the credit and security agreement we entered into on November 21, 2007 with a group of
lenders led by Merrill Lynch Capital, a division of Merrill Lynch Business Services Inc., which was
acquired by GE. Borrowings under the term loan bear interest equal to
LIBOR plus 6% per annum, fixed on March 25, 2008 for our recent $5.0 million borrowing (at a rate
of 8.61% per year). Beginning in February 2009, we will need to begin repaying the principal of the
debt we borrowed pursuant to the agreement.
Supply and Distribution Agreement with Kawasumi Laboratories, Inc.
On May 6, 2008, our wholly-owned subsidiary, Medisystems Corporation, entered into a supply
and distribution agreement with Kawasumi Laboratories, Inc. Pursuant to the terms of the
agreement, Kawasumi has agreed to continue to manufacture and supply blood tubing sets to
Medisystems through January 31, 2010. All products are required to be manufactured and supplied in
accordance with our specifications. In exchange for Kawasumis commitment to supply blood tubing
sets, and Kawasumis agreement not to sell blood tubing sets to any other entity in the United
States, Medisystems has agreed to purchase certain minimum quantities of blood tubing sets,
including Streamline blood tubing sets. If Medisystems fails to purchase this amount, Kawasumi may
ship any shortfall to Medisystems, and Medisystems must pay for that shortfall shipment. This
agreement amends, but does not replace, the prior supply and distribution agreement entered into
between Medisystems and Kawasumi as of February 1, 2001, as subsequently amended. The prior
agreement with Kawasumi originally covered the supply of needles as well as blood tubing sets. The
new agreement supersedes the prior agreement with respect to the supply of blood tubing sets while
the prior agreement continues to be in effect with respect to needles supplied by Kawasumi.
Statement of Operations Components
Revenues
We derive our revenues from the sale and rental of equipment and the sale of disposable
products. In the critical care market, we generally sell the System One and related disposables to
hospital customers. In the home market, customers generally rent or purchase the System One
equipment, including cycler and PureFlow SL, and then purchase the related disposable products
based on a specific patient prescription. In the in-center market, the majority of revenues are
derived from supply and distribution contracts with distributors. We generally recognize revenues
when a product has been delivered to our customer, or, in the home market, for those customers that
rent the System One, we recognize revenues on a monthly basis in accordance with a contract under
which we supply the use of a cycler and the amount of disposables needed to perform a set number of
dialysis therapy sessions during a month. For customers that purchase the System One in the home
market, we recognize revenue from the equipment sale ratably over the expected service obligation
period, while disposable product revenue is recognized upon delivery.
Our rental contracts with dialysis centers for ESRD home dialysis patients generally include
terms providing for the sale of disposable products to accommodate up to 26 treatments per month
per patient and the purchase or monthly rental of System One cyclers and, in some instances, our
PureFlow SL hardware. These contracts typically have a term of one year, and are automatically
renewed on a month-to-month basis thereafter, subject to a 30 day termination notice. Under these
contracts, if home hemodialysis is
- 19 -
prescribed, supplies are shipped directly to patient homes and
paid for by the treating dialysis clinic. We also include vacation delivery terms, providing for
the free shipment of products to a designated vacation destination. We derive an insignificant
amount of revenues from the sale of ancillary products, such as extra lengths of tubing. Over time,
as more home patients are treated with the System One and more systems are placed in patient homes
that provide for the purchase or rental of the machine and the purchase of the related disposables,
we expect this recurring revenue stream to continue to grow.
In early 2007, we entered into long-term home market contracts for the System One with three
larger dialysis chains, including with DaVita, which was our largest customer in 2007. Each of
these agreements has a term of at least three years, and may be cancelled upon a material breach,
subject to certain curing rights. These contracts provide the option to purchase as well as rent
the System One equipment, and, in the case of the DaVita contract, DaVita has agreed to purchase
rather than rent a significant percentage of its future System One equipment needs. In the first
quarter of 2007, two of these dialysis chain customers elected to purchase, rather than rent, a
significant percentage of their System One equipment currently in use. We expect, at least in the
near term, that the the majority of our customers will continue to rent the System One in the home
market. As of March 31, 2008, we had deferred approximately $23.8 million of revenues related to
the sale of equipment in the home market.
Our in-center revenues are highly concentrated in several significant purchasers. Revenues
from Henry Schein, Inc., or Schein, our primary distributor, represented approximately 81% of our
in-center revenues for the three months ended March 31, 2008. Revenues from our other two primary
distributors over the same period were 15% of our in-center revenues. Sales to DaVita, through
Schein, represent a significant percentage of these revenues. DaVita has contractual purchase
commitments under two agreements with us, one for needles and one for blood tubing sets. DaVitas
purchase obligations with respect to needles expire in January 2013, and its purchase obligations
with respect to blood tubing sets expire in September 2008. We have no assurance that we will be
able to negotiate an extension of these agreements, or that DaVitas purchase obligations under
these contracts will not be reduced, as permitted in certain circumstances under the contracts.
Our distribution contracts for our in-center market contain minimum volume commitments with
negotiated pricing triggers at different volume tiers. Each agreement may be cancelled upon a
material breach, subject to certain curing rights, and in many instances minimum volume commitments
can be reduced or eliminated upon certain events. In addition to contractually determined volume
discounts, we offer rebates based on sales to specific end customers and discount incentives for
early payment. Our sales revenues are presented net of these rebates, incentives, discounts and
returns.
Our agreement with Schein, our primary distributor, will expire in July 2009 and our
agreements with the other primary two distributors are scheduled to expire in October 2008 and July
2009. We have no assurance that we will be able to negotiate an extension of any of these
agreements.
Our critical care revenues are less concentrated. At March 31, 2008, the System One was used
in critical care applications in 126 hospitals, none of which accounted for more than 10% of our
critical care revenues. Our critical care contracts with hospitals generally include terms
providing for the sale of our System One hardware and disposables, although we also provide a
hardware rental option. These contracts typically have a term of one year. As our business
matures, we are starting to derive a small amount of revenue from the sale of one year service
contracts following the expiration of our standard one year warranty period for System One
hardware. Similar to our home business, as more System One equipment is placed within hospitals, we
expect to derive a growing recurring revenue stream from the sale of disposable cartridges for use
with our placed System One equipment as well as, to a much lesser degree, from the sale of service
contracts.
Cost of Revenues
Cost of revenues consists primarily of direct product costs, including material and labor
required to manufacture our products, service of System One equipment that we rent and sell to
customers and production overhead. It also includes the cost of inspecting, servicing and repairing
System One equipment prior to sale or during the warranty period and stock-based compensation. The
cost of our products depends on several factors, including the efficiency of our manufacturing
operations, the cost at which we can obtain labor and products from third party suppliers, product
reliability and related servicing costs, and the design of the products.
We expect the cost of revenues as a percentage of revenues to decline over time for four
general reasons. First, we expect to introduce several process and product design changes that have
inherently lower cost than our current products. Second, we plan to continue to move the
manufacture and servicing of certain of our products, including the System One cycler and PureFlow,
to lower labor cost markets. Third, we expect to continue to improve product reliability, which
would reduce service and distribution costs. Finally, we anticipate that increased sales volume and
realization of economies of scale will lead to better purchasing terms and prices and broader
options, and efficiencies in manufacturing and supply chain overhead costs, achieving efficient
distribution or process. We can not, however, guarantee that our expectations will be achieved with
respect to our cost reduction plans.
Operating Expenses
Selling and Marketing. Selling and marketing expenses consist primarily of salary, benefits
and stock-based compensation for sales and marketing personnel, travel, promotional and marketing
materials and other expenses associated with providing clinical training to our customers. Included
in selling and marketing are the costs of clinical educators, usually nurses, we employ to teach
our customers about our products and prepare our customers to instruct their patients in the
operation of our products. We anticipate that selling and marketing expenses will continue to
increase as we broaden our marketing initiatives to increase public awareness of the System One in
the home market and other products, particularly Streamline in the in-center market, and as we add
additional sales support and marketing personnel.
Research and Development. Research and development expenses consist primarily of salary,
benefits and stock-based
- 20 -
compensation for research and development personnel, supplies, materials and expenses
associated with product design and development, clinical studies, regulatory submissions, reporting
and compliance and expenses incurred for outside consultants or firms who furnish services related
to these activities. We expect research and development expenses will increase in the foreseeable
future as we continue to improve and enhance our core products and expand our clinical activities.
Distribution. Distribution expenses include the freight cost of delivering our products to
our customers or our customers patients, depending on the market and the specific agreement with
our customers, and salary, benefits and stock-based compensation for distribution personnel. We use
common carriers and freight companies to deliver our products and we do not operate our own
delivery service. Also included in this category are the expenses of shipping products from
customers back to our service center for repair if the product is under warranty, and the related
expense of shipping a replacement product to our customers. We expect that distribution expenses
will increase at a lower rate than revenues due to expected efficiencies gained from increased
business volume, better pricing obtained from carriers following recent price negotiations,
customer adoption of our PureFlow SL hardware, which significantly reduces the weight and quantity
of monthly disposable shipments, and improved reliability of System One equipment.
General and Administrative. General and administrative expenses consist primarily of salary,
benefits and stock-based compensation for our executive management, legal and finance and
accounting staff, fees from outside legal counsel, fees for our annual audit and tax services and
general expenses to operate the business, including insurance and other corporate-related expenses.
Rent, utilities and depreciation expense are allocated to operating expenses based on personnel and
square footage usage. We expect that general and administrative expenses will increase in the near
term as we add additional administrative support for our business.
Results of Operations
The following table presents, for the periods indicated, information expressed as a percentage
of revenues. This information has been derived from our condensed consolidated statements of
operations included elsewhere in this Quarterly Report on Form 10-Q. You should not draw any
conclusions about our future results from the results of operations for any period.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
2008 |
|
2007 |
Revenues |
|
|
100 |
% |
|
|
100 |
% |
Cost of revenues |
|
|
87 |
% |
|
|
118 |
% |
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
|
13 |
% |
|
|
(18 |
%) |
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
Selling and marketing |
|
|
22 |
% |
|
|
57 |
% |
Research and development |
|
|
7 |
% |
|
|
17 |
% |
Distribution |
|
|
11 |
% |
|
|
28 |
% |
General and administrative |
|
|
16 |
% |
|
|
32 |
% |
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
56 |
% |
|
|
134 |
% |
|
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(43 |
%) |
|
|
(152 |
%) |
|
|
|
|
|
|
|
|
|
Other income (expense): |
|
|
|
|
|
|
|
|
Other income |
|
|
1 |
% |
|
|
11 |
% |
Other expense |
|
|
(3 |
%) |
|
|
(2 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
(2 |
%) |
|
|
9 |
% |
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(45 |
%) |
|
|
(143 |
%) |
|
|
|
|
|
|
|
|
|
Comparison of the Three Months Ended March 31, 2008 and 2007 (in thousands, except percentages)
Revenues
Our revenues for the three months ended March 31, 2008 and 2007 were as follows (in thousands,
except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2008 |
|
|
2007 |
|
|
Increase |
|
|
Increase |
|
Revenues |
|
$ |
31,005 |
|
|
$ |
8,374 |
|
|
$ |
22,631 |
|
|
|
270 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in revenues was attributable to in-center sales reported for the first quarter
2008 of $16.1 million and increased sales and rentals of the System One and related disposables of
$6.5 million in both the critical care and home markets, primarily as a result
- 21 -
of increased sales
and marketing efforts as we continue to commercialize the System One. The number of home patients
prescribed to
receive therapy with the System One was 2,481 at March 31, 2008 compared to 1,295 at March 31, 2007, an increase
of 92%. As of March 31, 2008, an additional 155 dialysis clinics were offering the System One as
compared to March 31, 2007. Revenues in the home market increased to $10.5 million for the three
months ended March 31, 2008 compared to $5.4 million in the same period 2007, an increase of 94%,
while revenues in the critical care market increased 48% to $4.3 million for the three months ended
March 31, 2008 compared to $2.9 million for the same period in 2007. Revenues in the in-center
market represented $16.1 million for the three months ended March 31, 2008. We completed the
Medisystems Acquisition on October 1, 2007 and do not have comparable results for the in-center
market for the three months ended March 31, 2007.
Cost of Revenues and Gross Profit (Deficit)
Our cost of revenues and gross profit (deficit) for the three months ended March 31, 2008 and
2007 were as follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2008 |
|
|
2007 |
|
|
Increase |
|
|
Increase |
|
Cost of revenues |
|
$ |
26,987 |
|
|
$ |
9,917 |
|
|
$ |
17,070 |
|
|
|
172 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
$ |
4,018 |
|
|
$ |
(1,543 |
) |
|
$ |
5,561 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin (deficit) |
|
|
13 |
% |
|
|
(18 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in cost of revenues was attributable primarily to our increased revenues from the
home, critical care and in-center markets. In addition, cost of revenues increased during the three
months ended March 31, 2008 as compared to the same period in 2007 due to a larger employee base
that resulted in additional salaries, benefits, payroll taxes of $0.6 million and increased inbound
freight costs of $0.2 million to support our higher production volume and increased service costs.
For the quarter ended March 31, 2008, cost of revenues for our System One segment were $12.1
million or 82% of System One revenues compared to $8.4 million or 100% of revenues for the quarter
ended March 31, 2007. For the quarter ended March 31, 2008,
cost of revenues for the in-center
segment were $12.7 million or 78% of in-center revenues. The improvement in gross margin percentage
for the quarter ended March 31, 2008 as compared to the same period in 2007, is a result of the
Medisystems Acquisition included in the first quarter of 2008, manufacturing cost improvements to
the System One equipment and disposables and the leveraging of our manufacturing overhead.
Selling and Marketing
Our selling and marketing expenses for the three months ended March 31, 2008 and 2007 were as
follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2008 |
|
|
2007 |
|
|
Increase |
|
|
Increase |
|
Selling and marketing |
|
$ |
6,835 |
|
|
$ |
4,732 |
|
|
$ |
2,103 |
|
|
|
44 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing as a percentage of revenues |
|
|
22 |
% |
|
|
57 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The primary increase in selling and marketing expense was the result of an increase in
headcount and related salary, benefits, payroll taxes and stock-based compensation for selling and
marketing personnel from 2007 to 2008. Total headcount for sales and marketing and support
personnel increased by 51 employees from March 31, 2007 to March 31, 2008, and represented an
increase of $1.7 million in expenses. In addition, travel, field expenses, and supplies increased
by $0.3 million, and professional service fees for our scientific advisory board, process
improvements, and reimbursement efforts increased by $0.1 million. For the quarter ended March 31,
2008, selling and marketing expenses for our System One segment were $6.0 million or 40% of
revenues compared to $4.7 million or 57% of revenues for the quarter ended March 31, 2007. For the
quarter ended March 31, 2008, selling and marketing expenses for
the in-center segment were $0.9
million, or 5% of revenues. We anticipate that selling and marketing expenses will continue to
increase in absolute dollars in both segments as we broaden our marketing initiatives to increase
public awareness of the System One in the home market, and to a lesser degree in the critical care
market, and our other products, particularly Streamline, in the in-center market, and as we add
additional sales support personnel.
Research and Development
Our research and development expenses for the three months ended March 31, 2008 and 2007 were
as follows (in thousands, except percentages):
- 22 -
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2008 |
|
|
2007 |
|
|
Increase |
|
|
Increase |
|
Research and development |
|
$ |
2,126 |
|
|
$ |
1,436 |
|
|
$ |
690 |
|
|
|
48 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development as a percentage of revenues |
|
|
7 |
% |
|
|
17 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in research and development expenses for the period ended March 31, 2008 compared
to the same period in 2007 was attributable to an increase in headcount and related salary,
benefits, payroll taxes and stock-based compensation of $0.6 million. We expect research and
development expenses will increase in the foreseeable future as we seek to further enhance our
System One and related products, and their reliability, and with the increased activity associated
with our IDE nocturnal trial and Freedom study.
Distribution
Our distribution expenses for the three months ended March 31, 2008 and 2007 were as follows
(in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2008 |
|
|
2007 |
|
|
Increase |
|
|
Increase |
|
Distribution |
|
$ |
3,395 |
|
|
$ |
2,344 |
|
|
$ |
1,051 |
|
|
|
45 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution as a percentage of revenues |
|
|
11 |
% |
|
|
28 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in distribution expenses for the three months ended March 31, 2008 compared to
the same period in 2007 was due to the addition of the in-center business associated with the
Medisystems Acquisition and an increased volume of shipments of disposable products to a growing
number of patients in the home market. The decreased cost of distribution as a percentage of
revenue is attributable to the lower cost of distribution for the in-center market as compared to
the home and critical care markets as well as improved shipping rates, better product reliability
resulting in fewer expedited shipments, reduction in the cost of shipping bagged fluids as we
convert more patients to our Pureflow SL products, and improved reliability of the System One. For
the quarter ended March 31, 2008, distribution expenses for our System One segment were $3.2
million or 21% of revenues compared to $2.3 million or 28% of revenues for the quarter ended March
31, 2007. For the quarter ended March 31, 2008, distribution
expenses for the in-center segment
were $0.2 million or 1% of revenues. We expect that distribution expenses as a percentage of sales
will continue to decrease due to further distribution efficiencies.
General and Administrative
Our general and administrative expenses for the three months ended March 31, 2008 and 2007 were as
follows (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2008 |
|
|
2007 |
|
|
Increase |
|
|
Increase |
|
General and administrative |
|
$ |
4,815 |
|
|
$ |
2,667 |
|
|
$ |
2,148 |
|
|
|
81 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and
administrative as a
percentage of revenues |
|
|
16 |
% |
|
|
32 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in general and administrative expenses during the three months ended March 31,
2008 compared to the same period in 2007 was due to $0.7 million for the amortization of intangible
assets acquired in the Medisystems Acquisition, $0.5 million of headcount and associated
infrastructure costs, $0.2 million for professional services including tax and audit fees, $0.3
million relating to the acquired MDS Entities and $0.4 million of other corporate expenses.
Other Income and Expense
Interest income of $0.2 million is derived primarily from U.S. government securities,
certificates of deposit, commercial paper and
- 23 -
money market accounts. For the three months ended
March 31, 2008, interest income decreased by $0.7 million due to decreased cash and investments
over the comparable period ending March 31, 2007.
Interest expense of $0.8 million is derived primarily from borrowings under our credit
facility with GE that we entered into in
November 2007. For the three months ended March 31, 2008, interest expense increased by $0.6
million over the comparable period ending March 31, 2007 due to the increase in debt.
Other
expense of $0.1 million is derived primarily by foreign currency losses due to the
unfavorable change of the US Dollar to the Euro.
Provision for Income Taxes
The provision for income taxes of $45,000 relates to operations of our foreign entities.
Liquidity and Capital Resources
We have operated at a loss since our inception in 1998. As of March 31, 2008, our accumulated
deficit was $196.0 million and we had cash and cash equivalents of approximately $16.2 million. On
November 21, 2007, we obtained a $50.0 million credit and security agreement from a group of
lenders led by Merrill Lynch Capital, a division of Merrill Lynch Business Services Inc., which was
acquired by GE, for a term of 42 months. The credit facility is
secured by nearly all our assets, other than intellectual property, and consists of a $30.0 million
term loan and a $20.0 million revolving credit facility. We borrowed $25.0 million under the term
loan in November 2007, and borrowed the remaining $5.0 million in March 2008. We used $4.9 million
of the proceeds from the term loan to repay all amounts owed under a term loan dated May 15, 2006
with Silicon Valley Bank. Borrowings under the term loan bear interest equal to LIBOR plus 6% per
annum, fixed on November 21,2007 for our first borrowings (at a rate of 10.77% per year) and fixed
on March 25, 2008 (at a rate of 8.61%) date of borrowing for our second borrowing. Interest on the
term loan must be paid on a monthly basis. Beginning on February 1, 2009, we must repay principal
under the term loan in 29 equal monthly installments. We will also be required to pay a maturity
premium of $0.9 million at the time of loan payoff. We are accruing the maturity premium as
additional interest over the 42 month term. Our borrowing capacity under the revolving credit
facility is subject to satisfaction of certain conditions and calculations of the borrowing amount.
There is no guarantee that we will be able to borrow the full amount, or any funds, under the
revolving credit facility. Borrowings under the revolving credit facility bear interest at LIBOR
plus 4.25% per annum. There is an unused line fee of 0.75% per annum and descending deferred
revolving credit facility commitment fees, which are charged in the event the revolving credit
facility is terminated prior to May 21, 2011 of 4% in year one, 2% in year two, and 1% thereafter.
As of March 31, 2008, we have borrowed $30.0 million under this loan.
The credit facility includes covenants that (a) require us to achieve certain minimum net
revenue and certain minimum EBITDA targets relating to the acquired MDS Entities, (b) place
limitations on our and our subsidiaries ability to incur debt, (c) place limitations on our and
our subsidiaries ability to grant or incur liens, carry out mergers, and make investments and
acquisitions, and (d) place limitations on our and our subsidiaries ability to pay dividends, make
other restricted payments, enter into transactions with affiliates, and amend certain contracts.
The credit agreement contains customary events of default, including nonpayment, misrepresentation,
breach of covenants, material adverse effects, and bankruptcy. In the event we fail to satisfy our
covenants, or otherwise go into default, GE has a number of remedies, including sale of our assets,
control of our cash and cash equivalents and acceleration of all outstanding indebtedness. Any of
these remedies would likely have a material adverse effect on our business.
On February 7, 2007, we entered into a National Service Provider Agreement with DaVita, our
largest customer. Pursuant to the terms of the agreement, we granted to DaVita certain market
rights for the NxStage System One and related supplies for home hemodialysis therapy. Under the
agreement, DaVita committed to purchase all of its existing System One equipment currently being
rented from NxStage (for a purchase price of approximately $5 million) and to buy a significant
percentage of its future System One equipment needs. In connection with the National Service
Provider Agreement, on February 7, 2007, we issued and sold to DaVita 2.0 million shares of our
common stock at a purchase price of $10.00 per share, for an aggregate purchase price of $20.0
million.
The following table sets forth the components of our cash flows for the periods indicated (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
Net cash used in operating activities |
|
$ |
(22,121 |
) |
|
$ |
(10,609 |
) |
Net cash used in investing activities |
|
|
(104 |
) |
|
|
(6,249 |
) |
Net cash provided by financing activities |
|
|
4,987 |
|
|
|
20,199 |
|
Effect of exchange rate changes on cash |
|
|
174 |
|
|
|
(110 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash flow |
|
$ |
(17,064 |
) |
|
$ |
3,231 |
|
|
|
|
|
|
|
|
Net Cash Used in Operating Activities. For each of the periods above, net cash used in
operating activities was attributable primarily to net losses after adjustment for non-cash
charges, such as depreciation, amortization and stock-based compensation expense. Significant uses
of cash from operations include increases in accounts receivable and increased inventory purchases
of the
- 24 -
System One and Pure Flow SL hardware as we began closing out our outside manufacturing
contracts, offset by increases in accounts payable and accrued expenses. Non-cash transfers from
inventory to field equipment for the placement of rental units with our customers represented $7.5
million and $6.6 million, respectively, during the three months ended March 31, 2008 and 2007,
respectively.
Net Cash Used in Investing Activities. For each of the periods above, net cash used in
investing activities reflected purchases of property and equipment, primarily for research and
development, information technology, manufacturing operations and capital improvements to our
facilities, purchases and maturities of short-term investments and changes in other non-current
assets.
Net Cash Provided by Financing Activities. Net cash provided by financing activities during
the three months ended March 31, 2008 included $5.0 million of additional borrowings under our term
GE credit facility. Net cash provided by financing activities during the three months ended March
31, 2007 included $20.0 million of net proceeds received from the sale of 2.0 million shares of
common stock to DaVita and $0.9 million of proceeds from the exercise of stock options, offset by
debt payments of $0.7 million.
We expect to continue to incur net losses for the foreseeable future. We believe we have
sufficient cash and cash available through our credit facility to meet our funding requirements
through 2008. We expect that our existing resources will be insufficient to satisfy our liquidity
requirements beyond 2008, and we will need to sell additional equity,
issue debt securities, obtain capital through strategic investment,
or otherwise obtain additional capital to fund our capital
requirements beyond 2008. Additionally, beginning
in February 2009, we will need to begin paying down the principal on the debt we borrowed from GE.
Any sale of additional equity or issuance of debt securities will likely result in dilution to our
stockholders, and we cannot be certain that additional public or
private financing or other capital will be
available in amounts or on terms acceptable to us, or at all. We
expect to raise additional capital in the second or third quarter of
2008. If we are unable to obtain this
additional capital when needed, we may be required to delay, reduce the scope of, or eliminate
one or more aspects of our business development activities, which would likely harm our business.
Summary of Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States, or GAAP. The preparation of these consolidated
financial statements requires us to make significant estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. These items are regularly monitored
and analyzed by management for changes in facts and circumstances, and material changes in these
estimates could occur in the future. Changes in estimates are recorded in the period in which they
become known. We base our estimates on historical experience and various other assumptions that we
believe to be reasonable under the circumstances. Actual results may differ substantially from our
estimates.
A summary of those accounting policies and estimates that we believe are most critical to
fully understanding and evaluating our financial results is set forth below. This summary should be
read in conjunction with our consolidated financial statements and the related notes included
elsewhere in this Quarterly Report on Form 10-Q.
Revenue Recognition
We recognize revenues from product sales and services when earned in accordance with Staff
Accounting Bulletin, or SAB, No. 104, Revenue Recognition, and Emerging Issues Task Force, or EITF,
00-21, Revenue Arrangements with Multiple Deliverables. Revenues are recognized when: (a) there is
persuasive evidence of an arrangement, (b) the product has been shipped or services and supplies
have been provided to the customer, (c) the sales price is fixed or determinable and (d) collection
is reasonably assured.
System One Segment
Prior to 2007, we derived revenue in the home market from short-term rental arrangements with
our customers as our principal business model. These rental arrangements, which combine the use of
the System One with a specified number of disposable products supplied to customers for a fixed
amount per month, are recognized on a monthly basis in accordance with agreed upon contract terms
and pursuant to a binding customer purchase order and fixed payment terms. Rental arrangements
continue to represent the majority of the arrangements we have with our customers in the home
market. Equipment utilized under the rental arrangements is referred to as Field Equipment.
Beginning in 2007, we entered into long-term customer contracts to sell System One and
PureFlow SL equipment along with the right to purchase disposable products and service on a monthly
basis. Some of these agreements include other terms such as development efforts, training, market
collaborations, limited market exclusivity and volume discounts. The equipment and related items
provided to our customers in these arrangements are considered a multiple-element sales arrangement
pursuant to EITF 00-21. When a sales arrangement involves multiple elements, the deliverables
included in the arrangement are evaluated to determine whether they represent separate units of
accounting. We have determined that we cannot account for the sale of equipment as a separate unit
of accounting. Therefore, fees received upon the completion of delivery of equipment are deferred,
and recognized as revenue on a straight line basis over the expected term of our obligation to
supply disposables and service, which is five to seven years. We have deferred both the
unrecognized revenue and direct costs relating to the delivered equipment, which costs are being
amortized over the same period as the related revenue.
We entered into a national service provider agreement and a stock purchase agreement with
DaVita on February 7, 2007. Pursuant to EITF 00-21, we consider these agreements a single
arrangement. In connection with the stock purchase agreement, DaVita purchased 2.0 million shares
of our common stock for $10.00 per share, which represented a premium of $1.50 per share, or $3.0
million over the current market price. We have recorded the $3.0 million premium as deferred
revenue and will recognize this revenue ratably over seven years, consistent with our equipment
service obligation to DaVita. During the three months ended March 31, 2008, we recognized revenue
of $0.1 million associated with the $3.0 million premium.
- 25 -
In the critical care market, sales are structured as direct product sales or as a
disposables-based program in which a customer acquires the equipment through the purchase of a
specific quantity of disposables over a specific period of time. We recognize
revenues at the later of the time of shipment or, if applicable, delivery in accordance with
contract terms. Under a disposables-based program, the customer is granted the right to use the
equipment for a period of time, during which the customer commits to purchase a minimum number of
disposable cartridges or fluids at a price that includes a premium above the otherwise average
selling price of the cartridges or fluids to recover the cost of the equipment and provide for a
profit. Upon reaching the contractual minimum purchases, ownership of the equipment transfers to
the customer. Revenues under these arrangements are recognized over the term of the arrangement as
disposables are delivered. During the reported periods, the majority of our critical care revenues
were derived from supply contracts and direct product sales.
Our contracts provide for training, technical support and warranty services to our customers.
We recognize training and technical support revenue when the related services are performed. In the
case of extended warranty, the revenue is recognized ratably over the warranty period.
In-Center Segment
In the in-center market, sales are structured primarily through supply and distribution
contracts with distributors. Our distribution contracts for the in-center market contain minimum
volume commitments with negotiated pricing triggers at different volume tiers. Each agreement may
be cancelled upon a material breach, subject to certain curing rights, and in many instances
minimum volume commitments can be reduced or eliminated upon certain events. In addition to
contractually determined volume discounts, we offer rebates based on sales to specific end
customers and discount incentives for early payment. Our sales revenues are presented net of these
rebates, incentives, discounts and returns.
We recognize rebates to customers in the in-center market in accordance with EITF 01-09,
Accounting for Consideration given by a Vendor to a Customer (Including) Reseller of the Vendors
Products. Customer rebates are included as a reduction of sales and trade accounts receivable and
are our best estimate of the amount of probable future rebates on current sales.
Inventory Valuation
Inventories are valued at the lower of cost (weighted-average) or estimated market. We
regularly review our inventory quantities on hand and related cost and record a provision for
excess or obsolete inventory primarily based on an estimated forecast of product demand for each of
our existing product configurations. We also review our inventory value to determine if it reflects
lower of cost or market, with market determined based on net realizable value. Appropriate
consideration is given to inventory items sold at negative gross margins, purchase commitments and
other factors in evaluating net realizable value. The medical device industry is characterized by
rapid development and technological advances that could result in obsolescence of inventory.
Additionally, our estimates of future product demand may prove to be inaccurate.
Field Equipment
Field equipment consists of equipment being utilized under disposable-based rental agreements
and service pool hardware. Service pool hardware is equipment owned and maintained by us that is
swapped for equipment that requires repair or maintenance by us while being rented or owned. We
continually monitor the equipment in the service pool, as well as equipment that is in-transit or
otherwise not being deployed by a patient, and assess whether there are any indicators of
impairment for such equipment. During the three months ended March 31, 2008 and 2007, no such
impairment was recognized.
We capitalize field equipment at cost and amortize field equipment through cost of revenues
using the straight-line method over an estimated useful life of five years. We review the estimated
useful life of five years and the asset carrying value periodically for reasonableness. Factors
considered in determining the reasonableness of the useful life and the asset carrying value
include industry practice and the typical amortization periods used for like equipment, the
frequency and scope of service returns, actual equipment disposal rates, our ability to verify the
equipments existence in the field, and the impact of planned design improvements. We believe the
five-year useful life to be reasonable as of March 31, 2008.
Related-Party Transactions
On June 4, 2007, we entered into a stock purchase agreement with David S. Utterberg under
which we agreed to purchase from Mr. Utterberg the issued and outstanding shares of the MDS
Entities. We refer to our acquisition of the MDS Entities as the Medisystems Acquisition. Mr.
Utterberg is a director and significant stockholder of NxStage. The Medisystems Acquisition was
completed on October 1, 2007 and, as a result, each of the MDS Entities is a direct or indirect
wholly-owned subsidiary of NxStage. In addition, as a result of completion of the Medisystems
Acquisition, the supply agreement, dated January 2007, with Medisystems Corporation, under which
Medisystems Corporation agreed to provide cartridges for use with the System One, was terminated.
In consideration for the Medisystems Acquisition, we issued Mr. Utterberg 6.5 million shares of our
common stock, which we refer to as the Acquisition Shares. As a result of the Medisystems
Acquisition and the issuance of the Acquisition Shares to Mr. Utterberg, Mr. Utterbergs aggregate
ownership of our outstanding common stock increased to approximately 23%. In addition, we may be
required to issue additional shares of our common stock to Mr. Utterberg. Pursuant to the terms of
the stock purchase agreement, Mr. Utterberg and we have agreed to indemnify each other in the event
of certain breaches or failures, and any such indemnification amounts must be paid in shares of our
common stock, valued at the time of
- 26 -
payment. However, we will not be required to issue shares for
indemnification purposes that in the aggregate would exceed 20% of the then outstanding shares of
our common stock without first obtaining stockholder approval, and any such shares will not be
registered under the Securities Act of 1933, as amended. An aggregate of 1.0 million of the shares
issued to Mr. Utterberg were placed into escrow to cover potential indemnification claims we may
have against him. In connection with the Medisystems Acquisition and as a result of Medisystems
Corporation, becoming a direct wholly-
owned subsidiary of ours, we acquired rights under an existing license agreement between
Medisystems Corporation and DSU Medical Corporation, a Nevada corporation, which is wholly-owned by
Mr. Utterberg, or DSU. We refer to this agreement as the license agreement. Additionally, as a
condition to the parties obligations to consummate the Medisystems Acquisition, Mr. Utterberg and
DSU entered into a consulting agreement with us dated October 1, 2007, which we refer to as the
consulting agreement.
Under the license agreement, Medisystems Corporation received an exclusive, irrevocable,
sublicensable, royalty-free, fully paid license to certain DSU patents, or the licensed patents, in
exchange for a one-time payment of $2.7 million. The licensed patents fall into two categories,
those patents that are used exclusively by the MDS Entities, referred to as the Class A patents,
and those patents that are used by the MDS Entities and other companies owned by Mr. Utterberg,
referred to as the Class B patents. Pursuant to the terms of the license agreement, Medisystems
Corporation has a license to (1) the Class A patents, to practice in all fields for any purpose and
(2) the Class B patents, solely with respect to certain defined products for use in the treatment
of extracorporeal fluid treatments and/or renal insufficiency treatments. The license agreement
further provides that the rights of Medisystems Corporation under the agreement are qualified by
certain sublicenses previously granted to third parties. We have agreed that Mr. Utterberg retains
the right to the royalty income under one of these sublicenses.
Under the consulting agreement, Mr. Utterberg and DSU will provide consulting, advisory and related
services to us for a period of two years following the consummation of the Medisystems Acquisition.
In addition, under the terms of the consulting agreement, Mr. Utterberg and DSU have agreed during
the term of the agreement not to compete with NxStage during the term of the consulting agreement
in the field defined in the consulting agreement and not to encourage or solicit any of our
employees, customers or suppliers to alter their relationship with us. The consulting agreement
further provides that (1) Mr. Utterberg and DSU assign to us certain inventions and proprietary
rights received by him/it during the term of the agreement and (2) we grant Mr. Utterberg and DSU
an exclusive, worldwide, perpetual, royalty-free irrevocable, sublicensable, fully paid license
under such assigned inventions and proprietary rights for any purpose outside the inventing field,
as defined in the consulting agreement. Under the terms of the consulting agreement, Mr. Utterberg
and DSU will receive an aggregate of $200,000 per year, plus expenses, in full consideration for
the services and other obligations provided for under the terms of the consulting agreement. The
consulting agreement also requires Mr. Utterberg and NxStage to indemnify each other in the event
of certain breaches and failures under the agreement and requires that any such indemnification
liability be satisfied with shares of our common stock, valued at the time of payment. However, we
will not be required to issue shares for indemnification purposes that in the aggregate would
exceed 20% of the then outstanding shares of our common stock without first obtaining stockholder
approval, and any such shares will not be registered under the Securities Act of 1933, as amended.
During the quarter ended March 31, 2008, we paid Mr. Utterberg and DSU $50,000 for consulting fees
under this agreement.
We assumed a $2.8 million liability owed to DSU as a result of the acquisition of the MDS
Entities. The amount owed represents consideration owed to DSU by the MDS Entities for the
termination of a royalty-bearing sublicense agreement and the establishment of the royalty-free
license agreement. During the quarter ended March 31, 2008, we paid Mr. Utterberg $2.0 million
of the liability owed. In connection with the Medisystems Acquisition, we also agreed that if Mr.
Utterberg is no longer a director of NxStage, our Board of Directors will nominate for election to
our Board of Directors any director nominee proposed by Mr. Utterberg, subject to certain
conditions.
As of March 31, 2008, we have a receivable for reimbursements of costs related to the
acquisition in the amount of $0.4 million from Mr. Utterberg and DSU.
Consistent with the requirements of our Audit Committee Charter, this transaction was reviewed
and approved by our Audit Committee, which is comprised solely of independent directors, as well as
our Board of Directors.
Off-Balance Sheet Arrangements
Since inception we have not engaged in any off-balance sheet financing activities except for
leases which are properly classified as operating leases and disclosed in the Liquidity and
Capital Resources section in the Annual Report on Form 10-K for the fiscal year ended December 31,
2007.
Recent Accounting Pronouncements
In December 2007, the FASB issued Statement No. 141(R), Business Combination, or Statement 141
(R), a replacement of FASB Statement No. 141. Statement 141(R) is effective for fiscal years
beginning on or after December 15, 2008 and applies to all business combinations. Statement 141(R)
provides that, upon initially obtaining control, an acquirer shall recognize 100 percent of the
fair values of acquired assets, including goodwill, and assumed liabilities, with only limited
exceptions, even if the acquirer has not acquired 100 percent of its target. As a consequence, the
current step acquisition model will be eliminated. Additionally, Statement 141(R) changes current
practice, in part, as follows: (1) contingent consideration arrangements will be fair valued at
the acquisition date and included on that basis in the purchase price consideration; (2)
transaction costs will be expensed as incurred, rather than capitalized as part of the purchase
price; (3) pre-acquisition contingencies, such as legal issues, will generally have to be accounted
for in purchase accounting at fair value; and (4) in order to accrue for a restructuring plan in
purchase accounting, the requirements in FASB Statement No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, would have to be met at the acquisition date. While there is no
expected impact to our consolidated financial statements on the accounting for acquisitions
completed prior to December 31, 2008, the adoption of Statement 141(R) on January 1, 2009 could
materially change the accounting for business combinations consummated subsequent to that date.
- 27 -
In September 2006, the FASB issued Statement 157, Fair Value Measurement or Statement 157.
Statement 157 defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles and establishes a hierarchy that categorizes and prioritizes the
sources to be used to estimate fair value. Statement 157 also expands financial statement
disclosures
about fair value measurements. On February 12, 2008, the FASB issued FASB Staff Position FSP
157-2, which delays the effective date of Statement 157 for one year for all nonfinancial assets
and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually). Statement 157 and FSP 157-2 are
effective for financial statements issued for fiscal years beginning after November 15, 2007. The
adoption of Statement 157 did not have a material impact on us.
In February 2007, the FASB issued Statement 159, The Fair Value Option for Financial Assets
and Financial Liabilities Including an Amendment of SFAS 115 (Statement 159), which allows an
entity the irrevocable option to elect fair value for the initial and subsequent measurement for
certain financial assets and liabilities on a contract-by-contract basis. Unrealized gains and
losses on items for which the fair value option has been elected are reported in earnings. This
statement is effective for financial statements issued for fiscal years beginning after November
15, 2007. We have not adopted Statement 159 and therefore have not elected the fair value option
for any of our financial assets and liabilities.
In December 2007, the Securities and Exchange Commission or SEC, issued Staff Accounting
Bulletin No. 110 or SAB 110. SAB 110 amends and replaces Question 6 of Section D.2 of Topic 14,
Share-Based Payment. SAB 110 expresses the views of the staff regarding the use of the simplified
method in developing an estimate of expected term of plain vanilla share options in accordance
with FASB Statement No. 123(R), Share Based Payment. The use of the simplified method was
scheduled to expire on December 31, 2007. SAB 110 extends the use of the simplified method for
plain vanilla awards in certain situations. We currently use the simplified method to estimate
the expected term for share option grants as we do not have enough historical experience to provide
a reasonable estimate due to the limited period our equity shares have been publicly traded. We
will continue to use the simplified method until we have enough historical experience to provide
a reasonable estimate of expected term in accordance with SAB 110. SAB 110 is effective for options
granted after December 31, 2007.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the three months ended March 31, 2008, there were no material changes in our market
risk exposure. For quantitative and qualitative disclosures about market risk affecting NxStage,
see Item 7A, Quantitative and Qualitative Disclosures About Market Risk, of our Annual Report on
Form 10-K for the fiscal year ended December 31, 2007. As of the date of this report, there have
been no material changes to the market risks described in our Annual Report on Form 10-K for
December 31, 2007.
Item 4. Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial
officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31,
2008. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1943, or Exchange Act, means controls and other procedures of
a company that are designed to ensure that information required to be disclosed by a company in the
reports that it files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SECs rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to ensure that information
required to be disclosed by a company in the reports that it files or submits under the Exchange
Act is accumulated and communicated to the companys management, including its principal executive
and principal financial officers, as appropriate to allow timely decisions regarding required
disclosure. Our management recognizes that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31,
2008, our chief executive officer and chief financial officer concluded that, as of such date, our
disclosure controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rule 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended March 31, 2008 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
- 28 -
PART II OTHER INFORMATION
Item 1A. Risk Factors
In addition to the factors discussed in Managements Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this report, the following are some of the
important risk factors that could cause our actual results to differ materially from those
projected in any forward-looking statements.
Risks Related to our Business
We expect to derive a significant percentage of our future revenues from the rental or sale of our
System One and a limited number of other products.
Since our inception, we have devoted substantially all of our efforts to the development of
the System One and the related products used with the System One. We commenced marketing the System
One and the related disposable products to the critical care market in February 2003. We commenced
marketing the System One for chronic hemodialysis treatment in September 2004. Prior to the
Medisystems Acquisition, nearly 100% of our revenues were derived from the rental or sale of our
System One and the sale of related disposables. Although the Medisystems Acquisition broadens our
product offerings, we expect that nearly all of our revenues will be derived from the sale of a
limited number of key products primarily applicable to the dialysis business. We expect that in
2008 and in the foreseeable future, we will continue to derive a significant percentage of our
revenues from the System One, and that we will derive the remainder of our revenues from the sale
of a few key Medisystems disposable products, including blood tubing sets and needles. To the
extent that any of our primary products is not commercially successful or is withdrawn from the
market for any reason, our revenues will be adversely impacted, and we do not have other
significant products in development that could replace these revenues.
We cannot accurately predict the size of the home hemodialysis market, and it may be smaller, and
may develop more slowly than we expect.
We believe our largest future product market opportunity is the home hemodialysis market.
However this market is presently very small and adoption of the home hemodialysis treatment options
has been limited. The most widely adopted form of dialysis therapy used in a setting other than a
dialysis clinic is peritoneal dialysis. Based on the most recently available data from the United
States Renal Data System, or USRDS, the number of patients receiving peritoneal dialysis was
approximately 26,000 in 2005, representing approximately 8% of all patients receiving dialysis
treatment for ESRD in the United States. Very few ESRD patients receive hemodialysis treatment
outside of the clinic setting. Because the adoption of home hemodialysis has been limited to date,
the number of patients who desire to, and are capable of, administering their own hemodialysis
treatment with a system such as the System One is unknown and there is limited data upon which to
make estimates. Further, the number of nephrologists and dialysis
clinics able or willing to prescribe home
hemodialysis or establish and support home hemodialysis programs is
also unknown. Many dialysis clinics do not presently have the
infrastructure in place to support home hemodialysis and most dont
have the infrastructure in place to support a significant home
hemodialysis patient population. Our long-term
growth will depend on the number of patients who adopt home-based hemodialysis and how quickly they
adopt it, which in turn is driven by the number of physicians willing to prescribe home
hemodialysis and the number of dialysis clinics able or willing to establish and support home hemodialysis
therapies. We do not know whether the number of home-based dialysis patients will be greater or
fewer than the number of patients performing peritoneal dialysis.
Because nearly all our home
hemodialysis patients are also receiving more frequent dialysis, meaning dialysis delivered five or
more times a week, the market adoption of our System One for home hemodialysis is also dependent
upon the penetration and market acceptance of more frequent hemodialysis. Given the increased
costs associated with providing more frequent dialysis, market acceptance will be impacted,
especially for Medicare patients, at least in part by whether dialysis clinics are able to obtain reimbursement for
additional dialysis treatments provided in excess of three times a week. Presently, we understand
that a number of our customers are unable to obtain such additional reimbursement,
and that there are increased administrative burdens associated with
articulating the medical justification for treatments beyond three
times per week. Both of these facts will likely negatively impact the rate and extent of any further market expansion of our
System One for home hemodialysis. Expanding Medicare reimbursement
over time to predictably cover more frequent therapy, with less
administrative burden for our customers, may be critical to our
ability to significantly expand the market penetration of the System
One in
the home market and to grow our revenue in the future.
New regulations particularly impacting home hemodialysis technologies can also negatively impact
the rate and extent of any further market expansion of our System One for home hemodialysis. In
2008, the Centers for Medicare and Medicaid Services released new
Conditions for Coverage applicable to our
customers. Among other things, the new Conditions for Coverage impose
additional water testing requirements on our patients using our PureFlow SL product. These
additional water testing requirements increase the burden of our therapy for our patients and may
impair market adoption, especially for our PureFlow SL product. To
the extent additional regulations
are introduced unique to the home environment, market adoption could
be even further impaired.
Finally we are still early in the market launch of the System
One for home hemodialysis. We received our home use clearance for the System One from the FDA in
June 2005 and we will need to continue to devote significant resources to developing the market. We
cannot be certain that this market will develop, how quickly it will develop or how large it will
be.
We will require significant capital to build our business, and financing may not be available to us
on reasonable terms, if at all.
We believe that the home hemodialysis market is the largest market opportunity for our System
One. In this market, a significant percentage of our home customers rent rather than purchase
System One equipment. As a result, we generate, and expect to continue generating in the future, a
significant percentage of our revenues and cash flow from the use of System One equipment over time
rather than upfront from the sale of System One equipment. This sales model requires significant
amounts of working capital to manufacture System One equipment for rental to dialysis clinics. Our
agreement with DaVita signed in early 2007 departs from the rental model, which helps us to
conserve cash flow. In that agreement, DaVita agreed to purchase all of its System One equipment
then being rented from us and to buy a significant percentage of its future System One equipment
needs. It is not clear whether we will be able to replicate this sales model with a significant
number of other
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customers in the future. In 2007, only two of our customers, one of which was
DaVita, purchased equipment. However, approximately 53% of our home patients are using purchased
systems. We have also not yet achieved profitability, which imposes additional requirements for
cash.
We
will need to sell additional equity, issue debt securities, obtain
capital through strategic investments or otherwise obtain additional
capital to fund our capital
requirements beyond 2008. Any sale of additional
equity or issuance of debt securities will likely result in dilution to our stockholders, and we
cannot be certain that additional public or private financing or
other capital will be available in amounts or on
terms acceptable to us, or at all. We expect to raise additional
capital in the second or third quarters of 2008. If we are unable to
obtain this additional capital when
needed, we may be required to delay, reduce the scope of, or eliminate one or more aspects of our
business development activities, which would likely harm our business. Additionally, beginning in
February 2009, we will need to begin paying down the principal
on the debt we borrowed under our GE Credit Facility. To
the extent we are unable to obtain additional capital, this obligation to repay debt will only
further increase the need to further delay, reduce the scope of, or eliminate one or more aspects
of our business, which would likely harm our business.
We have limited operating experience, a history of net losses and an accumulated deficit of $196.0
million at March 31, 2008. We cannot guarantee if, when and the extent that we will become
profitable, or that we will be able to maintain profitability once it is achieved.
Since inception, we have incurred losses every quarter and at March 31, 2008, we had an
accumulated deficit of approximately $196.0 million. We expect to incur increasing operating
expenses as we continue to grow our business. Additionally, although we have achieved positive
gross margins for our products, in aggregate, as of March 31, 2008, we can not provide assurance
that our gross margins will remain positive, continue to improve or, if they do improve, the rate
at which they will improve. We cannot provide assurance that we will achieve profitability, when
we will become profitable, the sustainability of profitability should it occur, or the extent to
which we will be profitable. Our ability to become profitable is dependent principally upon
implementing design and process improvements to lower our costs of manufacturing our products,
accessing lower labor cost markets for the manufacture of our products, increasing our reliability,
improving our field equipment utilization, achieving efficiencies in manufacturing and supply chain
overhead costs, achieving efficient distribution of our products, achieving a sufficient scale of
operations, and obtaining better purchasing terms and prices.
Our PureFlow SL hardware, introduced into the market in July 2006, is a recently implemented
design improvement intended to improve our profitability. PureFlow SL is an accessory module to
the System One that allows for the preparation of high purity dialysate in the patients home using
ordinary tap water and dialysate concentrate, allowing patients with ESRD to more conveniently and
effectively manage their home hemodialysis therapy by eliminating the need for bagged fluids. The
gross margin of this product is expected to be more favorable to NxStage than the gross margin on
our bagged fluids and is an important part of our strategy to achieve profitability. Since its
launch, PureFlow SL penetration has reached approximately 70% of all of our home patients. The
product is still early in its commercial launch and we continue to work to improve product
reliability, and to introduce PureFlow SL product design enhancements that will improve utilization
of disposables and user experience. Any failure to further improve reliability and user experience,
and to reduce the utilization of disposables, each of which is critical to achieving improved
margins for PureFlow SL, would impair our ability to achieve profitability. Failure to further
improve reliability will also negatively impact our distribution costs, which would adversely
affect our ability to achieve profitability.
In March 2007, we began moving the manufacture of our products from Massachusetts to Mexico.
At the end of 2007, we were manufacturing our Pureflow SL disposables and a limited percentage of
our System One cyclers in Mexico as well as servicing a limited percentage of our System One
cyclers in Mexico. Our System One cartridge had already been manufactured in Mexico by Medisystems
at the time of the Medisystems Acquisition. Our ability to continue to shift manufacturing and
servicing to Mexico, in order to take advantage of lower labor costs, is an important part of our
strategy to achieve profitability. Any failure or unforeseen difficulties in transitioning
additional manufacturing and servicing to Mexico and to maintain or improve product reliability in
the process, would adversely affect our ability to achieve profitability.
We entered into a secured credit facility in November 2007, and as of March 31,
2008, we had borrowed $30 million thereunder. We may not be able to borrow the full amount
available under that credit facility, and we will need to begin repaying principal on the amounts
we have already borrowed under that credit facility in February 2009. Further, if we fail to
comply with all terms and covenants under our credit agreement, we may go into default under the
credit facility which could trigger, among other things, the acceleration of all of our
indebtedness thereunder or the sale of our assets.
On November 21, 2007 we obtained a $50.0 million credit and security agreement from a group of
lenders led by Merrill Lynch Capital, which was acquired by GE, for a term of 42 months. The credit
facility is secured by nearly all of our assets, other than intellectual property and consists of a
$30.0 million term loan and a $20.0 million revolving credit facility. We borrowed $25.0 million
under the term loan in November 2007, and borrowed the remaining $5.0 million in March 2008. We
used $4.9 million of the proceeds from the term loan to repay all amounts owed under a term loan
dated May 15, 2006 with Silicon Valley Bank. Borrowings under the term loan bear interest equal to
LIBOR plus 6% per annum, fixed on November 21 for our first borrowings (at a rate of 10.77% per
annum) and fixed on March 25 for our second borrowings (at a rate of 8.61% per annum) Interest on
the term loan must be paid on a monthly basis. Beginning on February 1, 2009, we must repay
principal under the term loan in 29 equal monthly installments. We will also be required to pay a
maturity premium of $0.9 million at the time of loan payoff. Our borrowing capacity under the
revolving credit facility is subject to the satisfaction of certain conditions and calculation of
the borrowing amount. There is no guarantee that we will be able to borrow the full amount, or any
funds under the revolving credit facility. Any borrowings under the revolving credit facility will
bear interest at LIBOR plus 4.25% per annum. There is an unused line fee of 0.75% per
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annum and descending deferred revolving credit facility commitment fees, which are charged in the event the
revolving credit facility is terminated prior to May 21, 2011 of 4% in year one, 2% in year two,
and 1% thereafter.
The credit facility includes covenants that (a) require us to achieve certain minimum net
revenue and certain minimum EBITDA targets relating to the acquired MDS Entities, (b) place
limitations on our and our subsidiaries ability to incur debt, (c) place limitations on our and
our subsidiaries ability to grant or incur liens, carry out mergers, and make investments and
acquisitions, and (d) place limitations on our and our subsidiaries ability to pay dividends, make
other restricted payments, enter into transactions with affiliates, and amend certain contracts.
The credit agreement contains customary events of default, including nonpayment, misrepresentation,
breach of covenants, material adverse effects, and bankruptcy. In the event we fail to satisfy
our covenants, or otherwise go into default, GE has a number of remedies, including sale of our
assets, control of our cash and cash equivalents, and acceleration of all outstanding indebtedness.
Any of these remedies would likely have a material adverse effect on our business.
We compete against other dialysis equipment manufacturers with much greater financial resources and
established products and customer relationships, which may make it difficult for us to penetrate
the market and achieve significant sales of our products.
Our product lines compete directly against products produced by Fresenius Medical Care AG,
Baxter Healthcare, Gambro AB, B. Braun and others, each of which markets one or more FDA-cleared
medical devices for the treatment of acute or chronic kidney failure. Each of these competitors
offers products that have been in use for a longer time than our System One, and in some instances
many of our Medisystems products, and are more widely recognized by physicians, patients and
providers. These competitors have significantly more financial and human resources, more
established sales, service and customer support infrastructures and spend more on product
development and marketing than we do. Many of our competitors also have established relationships
with the providers of dialysis therapy and, Fresenius owns and operates a chain of dialysis
clinics. The product lines of most of these companies are broader than ours, enabling them to offer
a broader bundle of products and have established sales forces and distribution channels that may
afford them a significant competitive advantage. Finally, one of our competitors, Gambro AB, has
been, until recently, subject to an import hold imposed by the FDA on its acute and chronic
dialysis machines. It is not clear what the home and critical care market impact will be now that
the import hold is lifted. We believe the overall impact of the import hold has been positive to
us, however, we cannot be sure of the magnitude of the impact the import hold has had on revenues.
The market for our products is competitive, subject to change and affected by new product
introductions and other market activities of industry participants, including increased
consolidation of ownership of clinics by large dialysis chains. If we are successful, our
competitors are likely to develop products that offer features and functionality similar to our
products, including our System One. Improvements in existing competitive products or the
introduction of new competitive products may make it more difficult for us to compete for sales,
particularly if those competitive products demonstrate better reliability, convenience or
effectiveness or are offered at lower prices. Fresenius and Baxter have each made public statements
that they are either contemplating or actively developing new and/or improved systems for home
hemodialysis. Fresenius made these statements in connection with their recent acquisition of Renal
Solutions, Inc., and Baxter made them in connection with the announcement of a research and
development collaboration with DEKA Research & Development Corporation and HHD, LLC. We are unable
to predict if or when products from these or other companies may attain regulatory clearance and
appear in the market, or how successful they may be should they be introduced, but if additional
viable products are introduced to the market, it would adversely affect our sales and growth. Our
ability to successfully market our products could also be adversely affected by pharmacological and
technological advances in preventing the progression of ESRD and/or in the treatment of acute
kidney failure or fluid overload. If we are unable to compete effectively against existing and
future competitors and existing and future alternative treatments and pharmacological and
technological advances, it will be difficult for us to penetrate the market and achieve significant
sales of our products.
The success and growth of our business will depend upon our ability to achieve expanded market
acceptance of our System One and Streamline products.
Our System One products still have limited product and brand recognition and have only been
used at a limited number of dialysis clinics and hospitals. In the home market, we have to convince
four distinct constituencies involved in the choice of dialysis therapy, namely operators of
dialysis clinics, nephrologists, dialysis nurses and patients, that our system provides an
effective alternative to other existing dialysis equipment. Each of these constituencies use
different considerations in reaching their decision. Lack of acceptance by any of these
constituencies will make it difficult for us to grow our business. We may have difficulty gaining
widespread or rapid acceptance of the System One for a number of reasons including:
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the failure by us to demonstrate to patients, operators of dialysis clinics, nephrologists,
dialysis nurses and others that our product is equivalent or superior to existing therapy
options, or that the cost or risk associated with use of our product is not greater than
available alternatives; |
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competition from products sold by companies with longer operating histories and greater
financial resources, more recognizable brand names and better established distribution networks
and relationships with dialysis clinics; |
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the failure by us to continue to improve product reliability and the ease of use of our products; |
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limitations on the existing infrastructure in place to support home hemodialysis, including without limitation, home hemodialysis training
nurses, and the willingness, cost associated with, and ability of dialysis clinics to build that infrastructure; |
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the ownership and operation of some dialysis providers by companies that also manufacture and
sell competitive dialysis products; |
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the introduction of competing products or treatments that may be more effective, easier to use
or less expensive than ours; |
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regulations that impose additional burden on patients and their caregivers, such as the newly adopted Medicare conditions for coverage
which impose additional water testing requirements in connection with the use of our PureFlow SL; |
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the number of patients willing and able to perform therapy independently, outside of a
traditional dialysis clinic, may be smaller than we estimate; and |
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the continued availability of satisfactory reimbursement from healthcare payors, including Medicare. |
In addition, the future growth of our business depends, to a lesser degree, upon the
successful launch and market acceptance of our latest generation blood tubing set product,
Streamline. Streamline is designed to be a high-quality, high-performance blood tubing set that
promises to yield valuable savings and improved patient outcomes for those clinics that adopt it
for use. Market penetration of this product is quite limited to date, and it is not possible to
predict whether and to what extent current and future customers will elect to use this product
instead of more established or competitive blood tubing sets. If we are unable to convert customers
to the Streamline product and receive more widespread commercial acceptance of this product, our
ability to achieve our growth objectives could be impaired.
Current Medicare reimbursement rates, at three times per week, limit the price at which we can
market our home products, and adverse changes to reimbursement would likely negatively affect the
adoption or continued sale of our home products.
Our ability to attain profitability will be driven in part by our ability to set or maintain
adequate pricing for our products. As a result of legislation passed by the U.S. Congress more than
30 years ago, Medicare provides comprehensive and well-established reimbursement in the United
States for ESRD. With over 80% of U.S. ESRD patients covered by Medicare, the reimbursement rate is
an important factor in a potential customers decision to use the System One or our other products
and limits the fee for which we can rent or sell our products. Additionally, current CMS rules
limit the number of hemodialysis treatments paid for by Medicare to three times a week, unless
there is medical justification for additional treatments. Most patients using the System One in the
home treat themselves, with the help of a partner, up to six times per week. To the extent that
Medicare contractors elect not to pay for the additional treatments, adoption of the System One
would likely be impaired. The determination of medical justification must be made at the local
Medicare contractor level on a case-by-case basis, based on
documentation provided by our customers. If daily therapy is prescribed, a clinics
decision as to how much it is willing to spend on dialysis equipment and services will be at least
partly dependent on whether Medicare will reimburse more than three treatments per week for the
clinics patients. In the next two years, Medicare will be switching from intermediaries to
Medicare authorized contractors. This change in the reviewing entity for Medicare claims could
lead to a change in whether a customer receives Medicare reimbursement for additional treatments.
If an adverse change to historical payment practices occurs, market adoption of our System One in
the home market may be impaired. Presently, we understand that a number
of our customers are unable to obtain additional reimbursement for
more frequent therapy, and that there are increased administrative
burdens associated with articulating the medical justification for
treatments beyond three times a week. Both of these facts will likely
negatively impact the rate and extent of any further market
expansion of our System One for home hemodialysis. Expanding Medicare
reimbursement over time to more predictably cover more frequent
therapy, with less administrative burden for our customers, may be critical to our ability to significantly expand the market penetration of the System
One in the home market and to our revenue growth in the future.
Additionally, any adverse changes in the rate paid by Medicare for ESRD treatments in general
would likely negatively affect demand for our products in the home market and the prices we charge
to them.
As we continue to commercialize the System One, Streamline and our other products, we may have
difficulty managing our growth and expanding our operations successfully.
As the commercial launch of the System One and Streamline continues, we will need to expand
our regulatory, manufacturing, sales and marketing and on-going development capabilities or
contract with other organizations to provide these capabilities for us. As our operations expand,
we expect that we will need to manage additional relationships with various partners, suppliers,
manufacturers and other organizations. Our ability to manage our operations and growth requires us
to continue to improve our information technology infrastructure, operational, financial and
management controls and reporting systems and procedures. Such growth could place a strain on our
administrative and operational infrastructure. We may not be able to make improvements to our
management information and control systems in an efficient or timely manner and may discover
deficiencies in existing systems and controls.
If we are unable to improve on the product reliability of our System One product, our ability to
grow our business and achieve profitability could be impaired.
Our System One is still early in its product launch, and our PureFlow SL hardware was only
introduced during the third quarter of 2006. We continue to experience product reliability issues
associated with these products that are higher than we expect long-term, and have led us to incur
increased service and distribution costs, as well as increase the size of our field equipment base.
This, in turn, negatively impacts our gross margins and increases our working capital requirements.
Additionally, product reliability issues can also lead to decreases in customer satisfaction and
our ability to grow or maintain our revenues. We continue to work to improve product reliability
for these products, and have achieved some improvements to date. If we are unable to continue to
improve product reliability of our System One products, our ability to achieve our growth
objectives as well as profitability could be significantly impaired.
In the second quarter of 2007, we started to experience an increased incidence of reported
dialysate leaks associated with our System One cartridges. The reported incidence of leaks was
higher than we have historically observed. When the System One was used in accordance with its
instructions, these leaks presented no risk to patient health. System One device labeling
anticipates the
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potential for leaks to occur and specifically warns against leaks and alerts users
of the need to observe treatments in order to detect leaks. Six patients with reported leaks, that
were unobserved by these patients or their partners until after their treatments were completed,
reported hypotension, or low blood pressure, resolved by a fluid bolus, with no lasting clinical
effect. In early August 2007, we sent a letter to our patients and customers informing them of the
increased incidence in leaks and reminding them of existing System One labeling alerting users of
the
potential for leaks and instructing them to observe treatments in order to detect any leaks. We
characterized this notification as a voluntary recall. On August 24, 2007, we elected to initiate a
second step in our recall actions,
and decided to physically recall the affected lots of cartridge inventory being held by home
market customers and patients, and replace the affected inventory with newer lots of cartridges at
no charge. We instructed patients and customers to destroy all inventory of affected cartridges
they had on hand. During 2007, we incurred $2.3 million of charges for the recall, which consisted
of a $1.5 million write off of inventory on hand at the time and $0.8 million in other costs
related to the return or replacement of cartridges.
We have a significant amount of SystemOne field equipment, and our ability to effectively manage
this asset could negatively impact our working capital requirements and future profitability.
Because a significant percentage of our System One home care business continues to rely upon
an equipment rental model, our ability to manage System One equipment is important to minimizing
our working capital requirements. In addition, our gross margins may be negatively impacted if we
have excess equipment deployed, and unused, in the field. If we are unable to successfully track,
service and redeploy equipment, we could (1) incur increased costs, (2) realize increased cash
requirements and/or (3) have material write-offs of equipment. This barrier would negatively impact
our working capital requirements and future profitability.
Our national service provider agreement with DaVita confers certain geographic market rights to
DaVita and limits our ability to sell the System One in the home market to Fresenius, both of which
may present a barrier to adoption of the System One in the home.
Fresenius and DaVita own and operate the two largest chains of dialysis clinics in the United
States. Fresenius controls approximately 33% of the U.S. dialysis clinics and is the largest
worldwide manufacturer of dialysis systems. DaVita controls approximately 27% of the U.S. dialysis
clinics, and has entered into a preferred supplier agreement with Gambro pursuant to which Gambro
will provide a significant majority of DaVitas dialysis equipment and supplies for a period of at
least 10 years. Each of Fresenius and DaVita may choose to offer their dialysis patients only the
dialysis equipment manufactured by them or their affiliates, to offer the equipment they
contractually agreed to offer or to otherwise limit access to the equipment manufactured by
competitors.
Our recent agreement with DaVita confers certain market rights for the System One and related
supplies for home hemodialysis therapy. DaVita is granted exclusive rights in a small percentage of
geographies, which geographies collectively represent less than 10% of the U.S. ESRD patient
population, and limited exclusivity in the majority of all other U.S. geographies, subject to
DaVitas meeting certain requirements, including patient volume commitments and new patient
training rates. Under the agreement, we can continue to sell to other clinics in the majority of
geographies. If certain minimum patient numbers or training rates are not achieved, DaVita can lose
all or part of its preferred geographic rights. The agreement further limits, but does not
prohibit, the sale by NxStage of the System One for chronic home patient hemodialysis therapy to
any provider that is under common control or management of a parent entity that collectively
provides dialysis services to more than 25% of U.S. chronic dialysis patients and that also
supplies dialysis products. Therefore, our ability to sell the System One for chronic home patient
hemodialysis therapy to Fresenius is presently limited.
For the three months ended March 31, 2008, approximately 46% of our home hemodialysis patients
in the home market received treatment through clinics owned by DaVita. Although we expect that
DaVita will continue to be a significant customer of ours, the agreement imposes no purchase
obligations upon DaVita and we cannot be certain whether DaVita will continue to purchase and/or
rent the System One from us in the future. We believe that any future decision by DaVita to stop or
limit the use of the System One would adversely affect our business, at least in the near term.
We rely heavily upon DaVita as a key customer for our SystemOne and Medisystems product lines. The
partial or complete loss of DaVita as a customer would materially impair our financial results, at
least in the near term.
DaVita is our most significant customer. Sales through distributors to DaVita of products
accounted for approximately 48% of in-center segment revenues in the quarter ended March 31, 2008,
and direct sales to DaVita accounted for approximately 32% of our System One segment revenues in
the quarter ended March 31, 2008. Our contract for Medisystems blood tubing sets and needles with
DaVita includes certain minimum order requirements; however, these can be reduced significantly
under certain circumstances. Further, DaVitas commitments to purchase Medisystems blood tubing
sets expire in September 2008. We cannot guarantee we will be able to negotiate an extension of
this agreement with DaVita on favorable terms, if at all, or the extent to which DaVita will
purchase Medisystems products. DaVitas preferred supplier
agreement with Gambro may impair our ability to obtain DaVitas
blood tubing set business beyond September 2008. NxStages national service provider agreement with DaVita does not
impose minimum purchase requirements, and expires as early as the end of 2009. The partial or
complete loss of DaVita as a customer for either of these product lines would adversely affect our
business, at least in the near term. Further, given the significance of DaVita as a customer, any
change in DaVitas ordering or clinical practices can have a significant impact on our revenues,
especially in the near term.
If kidney transplantation becomes a viable treatment option for more patients with ESRD, or if
medical or other solutions for renal replacement become viable, the market for our products may be
limited.
While kidney transplantation is the treatment of choice for most ESRD patients, it is not
currently a viable treatment for most
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patients due to the limited number of donor kidneys, the high
incidence of kidney transplant rejection and the higher surgical risk associated with older ESRD
patients. According to the most recent USRDS data, in 2004, approximately 17,000 patients received
kidney transplants in the United States. The development of new medications designed to reduce the
incidence of kidney transplant rejection, progress in using kidneys harvested from genetically
engineered animals as a source of transplants or any other advances in kidney transplantation could
limit the market for our products. The development of viable medical or other solutions for renal
replacement may also limit the market for our products.
If we are unable to convince additional hospitals and healthcare providers of the benefits of our
products for the treatment of acute kidney failure and fluid overload, we will not be successful in
increasing our market share in the critical care market.
We sell the System One for use in the treatment of acute kidney failure and fluid overload
associated with, among other conditions, congestive heart failure. Physicians currently treat most
acute kidney failure patients using conventional hemodialysis systems or dialysis systems designed
specifically for use in the ICU. We will need to convince hospitals and healthcare providers that
using the System One is as effective as using conventional hemodialysis systems or ICU specific
dialysis systems for treating acute kidney failure and that it provides advantages over
conventional systems or other ICU specific systems because of its significantly smaller size, ease
of operation and clinical flexibility. One of our competitors in the critical care market, Gambro
AB, has been subject to an FDA import hold that was recently lifted. Although it is unclear what
the impact of this import hold has been on our revenues, we expect competition in this market to
increase with the reintroduction of Gambro products to the U.S. critical care market.
We could be subject to costly and damaging product liability claims and may not be able to maintain
sufficient product liability insurance to cover claims against us.
If any of our products is found to have caused or contributed to injuries or deaths, we could
be held liable for substantial damages. Claims of this nature may also adversely affect our
reputation, which could damage our position in the market. Although NxStage has not been a party to
any such claims, Medisystems and certain of its affiliated entities have been parties to such
claims prior to the Medisystems Acquisition. While we maintain insurance, including product and
excess liability insurance, claims may be brought against us that could result in court judgments
or settlements in amounts that are in excess of the limits of our insurance coverage. Our insurance
policies also have various exclusions, and we may be subject to a product liability claim for which
we have no coverage. We will have to pay any amounts awarded by a court or negotiated in a
settlement that exceed our coverage limitations or that are not covered by our insurance.
Any product liability claim brought against us, with or without merit, could result in the
increase of our product liability insurance rates or the inability to secure additional insurance
coverage in the future. A product liability claim, whether meritorious or not, could be time
consuming, distracting and expensive to defend and could result in a diversion of management and
financial resources away from our primary business, in which case our business may suffer.
We maintain insurance at levels deemed adequate by management; however, future claims could exceed
our applicable insurance coverage.
We maintain insurance for property and general liability, directors and officers liability,
workers compensation, and other coverage in amounts and on terms deemed adequate by management
based on our expectations for future claims. Future claims could, however, exceed our applicable
insurance coverage, or our coverage could not cover the applicable claims.
We face risks associated with having international manufacturing operations, and if we are unable
to manage these risks effectively, our business could suffer.
In addition to our operations in Massachusetts, we operate manufacturing facilities in
Germany, Italy and Mexico. We also purchase components and supplies from foreign vendors. We are
subject to a number of risks and challenges that specifically relate to these international
operations, and we may not be successful if we are unable to meet and overcome these challenges.
Significant among these risks are risks relating to foreign currency, in particular the Thai Baht,
Euro and Peso. The U.S. dollar has weakened materially against the Thai Baht and Euro over the last
five years and may continue to do so. To the extent we fail to control our exchange rate risk, our
profitability could suffer and our ability to maintain mutually beneficial and profitable
relationships with foreign vendors could be impaired. In addition to these risks, through our
international operations, we are exposed to costs associated with sourcing and shipping goods
internationally, difficulty managing operations in multiple locations and local regulations that
may restrict or impair our ability to conduct our operations.
We currently rely upon a third-party manufacturer to manufacture a significant percentage of our
blood tubing set products using our supplied components and all of our needles. Kawasumis
contractual obligation to manufacture blood tubing sets expires on January 2010 and its
obligation to supply needles expires in February 2011. In the event these agreements are not
renewed or extended upon favorable terms, if at all, or in the event we are unable to sufficiently
expand our manufacturing capabilities, or obtain alternative third party supply prior to the
expiration of these agreements, our growth and ability to meet customer demand would be impaired.
Historically,
Medisystems has relied upon a third-party manufacturer, Kawasumi, to manufacture a significant percentage of its blood tubing set
products using Medisystems supplied components. This third party has a strong history of
manufacturing high-quality product for Medisystems. We recently negotiated a new agreement with
Kawasumi extending their obligation to supply blood tubing sets to us through January 31, 2010. We
can not be certain that this
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agreement will be renewed or extended beyond this term on favorable
terms, if at all, that we would be able to manufacture independently the volume of products
currently manufactured by Kawasumi, and therefore whether we would have sufficient capacity to meet
all of our customer demand, that we would be able to manufacture products at the same cost at which
we currently purchase products from Kawasumi or that we could find a third party to supply blood
tubing sets on favorable terms, if at all, the failure of any of which could impair our business.
We also depend solely on Kawasumi for all of our finished goods needles. Kawasumis obligation to
supply needles to us expires in February 2011. In the event this agreement is not renewed or
extended upon favorable
terms, if at all, if we are unable to manufacture comparable needles for ourselves prior to the
contract expiration, or if we are unable to obtain comparable needles from another third party on
favorable terms, if at all, the revenues and profitability of our business will be impaired.
Our in-center business relies heavily upon third-party distributors.
We sell the majority of our in-center products through three distributors, which collectively
accounted for approximately 96% of in-center revenues for the quarter ended March 31, 2008, with
our primary distributor, Schein, accounting for 81% of in-center revenues for the quarter ended
March 31, 2008. Schein recently agreed to extend their distribution relationship with us through
July 2009. The contracts with the other two distributors of our products are scheduled to expire in
October 2008 and July 2009. Our relationship with Schein, in particular, is very significant for
our business and any failure to continue this relationship would be harmful to our business,
because our current sales force has limited experience selling blood tubing sets or needles.
Unless we can demonstrate sufficient product differentiation in our blood tubing set business
through Streamline or products that we introduce in the future, we will continue to be susceptible
to further pressures to reduce product pricing and more vulnerable to the loss of our blood tubing
set business to competitors in the dialysis industry.
Our blood tubing set business has historically been a commodities business. Prior to the
Medisystems Acquisition, Medisystems competed favorably and gained share through the development of
a high quality, low-cost, standardized blood tubing set, which could be used on several different
dialysis machines. Our products continue to compete favorably in the dialysis blood tubing set
business, but are increasingly subject to pricing pressures, especially given recent market
consolidation in the U.S. dialysis services industry, with Fresenius and DaVita collectively
controlling approximately 61% of U.S. dialysis services business. Unless we can successfully
demonstrate to customers the differentiating features of the Streamline product or products that we
introduce in the future, we may be susceptible to further pressures to reduce our product pricing
and more vulnerable to the loss of our blood tubing set business to competitors in the dialysis
industry. In addition, DaVitas preferred supplier agreement
with Gambro may impair our ability to obtain DaVitas blood
tubing set business beyond the expiration of our blood tubing set
agreement with DaVita that expires in September 2008.
The activities of our business involves the import of finished goods into the United States from
foreign countries, subject to customs inspections and duties, and the export of components and
certain other products from other countries into Mexico and Thailand. If we misinterpret or violate
these laws, or if laws governing our exemption from certain duties changes, we could be subject to
significant fines, liabilities or other adverse consequences.
We import into the United States disposable medical supplies from Thailand and Mexico. We also
import into the United States disposable medical components from China, Germany and Italy and
export components and assemblies into Mexico, Thailand and Italy. The import and export of these
items are subject to extensive laws and regulations with which we will need to comply. To the
extent we fail to comply with these laws or regulations, or fail to interpret our obligations
accurately, we may be subject to significant fines, liabilities and a disruption to our ability to
deliver product, which could cause our combined businesses and operating results to suffer. To the
extent there are modifications to the Generalised System of Preferences or cancellation of the
Nairobi Protocol Classification such that our products would be subject to duties, our
profitability would also be negatively impacted.
The inability to successfully integrate the operations and personnel of Medisystems and NxStage, or
any significant delay in achieving integration, could have a material adverse effect on our
business.
Integrating the operations and personnel of Medisystems and NxStage has required, and
continues to require, a significant investment of managements time and effort as well as the
investment of capital, particularly with respect to information systems. The continued successful
integration of Medisystems and NxStage will require, among other things, coordination of certain
manufacturing operations and sales and marketing operations and the integration of Medisystems
operations into our existing organization. The diversion of the attention of our senior management
and any difficulties encountered in the process of combining the companies could cause the
disruption of, or a loss of momentum in, the activities of our business. The inability to
successfully integrate the operations and personnel of Medisystems and NxStage, or any significant
delay in achieving integration, could have a material adverse effect on our business and, as a
result, on the market price of our common stock.
The success of the our business depends on the services of each of our senior executives as well as
certain key engineering, scientific, manufacturing, clinical and marketing personnel, the loss of
whom could negatively affect the combined businesses.
Our success has always depended upon the skills, experience and efforts of our senior
executives and other key personnel, including our research and development and manufacturing
executives and managers. Much of our expertise is concentrated in relatively few employees, the
loss of whom for any reason could negatively affect our business. Competition for our highly
skilled employees is intense and we cannot prevent the future resignation of any employee. We
maintain key person insurance for only one of our executives, Jeffrey Burbank, our Chief Executive
Officer.
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Risks Related to the Regulatory Environment
We are subject to significant regulation, primarily by the FDA. We cannot market or commercially
distribute our products without obtaining and maintaining necessary regulatory clearances or
approvals.
Our products are medical devices subject to extensive regulation in the United States, and in
foreign markets we may wish to enter. To market a medical device in the United States, approval or
clearance by the FDA is required, either through the pre-market approval process or the 510(k)
clearance process. We have obtained the FDA clearances necessary to sell our current products under
the 510(k) clearance process. Medical devices may only be promoted and sold for the indications for
which they are approved or cleared. In addition, even if the FDA has approved or cleared a product,
it can take action affecting such product approvals or clearances if serious safety or other
problems develop in the marketplace. We may be required to obtain 510(k) clearances or pre-market
approvals for additional products, product modifications, or for new
indications for our products. Presently, we are pursuing a nocturnal
indication for the System One under an IDE study started in the first
quarter of 2008. We cannot provide assurance that this or other
clearances or approvals will be forthcoming, or, if
forthcoming, what the timing and expense of obtaining such clearances or approvals might be. Delays
in obtaining clearances or approvals could adversely affect our ability to introduce new products
or modifications to our existing products in a timely manner, which would delay or prevent
commercial sales of our products.
Modifications to our marketed devices may require new regulatory clearances or pre-market
approvals, or may require us to cease marketing or recall the modified devices until clearances or
approvals are obtained.
Any modifications to a 510(k) cleared device that could significantly affect its safety or
effectiveness, or would constitute a major change in its intended use, requires the submission of
another 510(k) pre-market notification to address the change. Although in the first instance we may
determine that a change does not rise to a level of significance that would require us to make a
pre-market notification submission, the FDA may disagree with us and can require us to submit a
510(k) for a significant change in the labeling, technology, performance specifications or
materials or major change or modification in intended use, despite a documented rationale for not
submitting a pre-market notification. We have modified various aspects of our products and have
filed and received clearance from the FDA with respect to some of the changes in the design of our
products. If the FDA requires us to submit a 510(k) for any modification to a previously cleared
device, or in the future a device that has received 510(k) clearance, we may be required to cease
marketing the device, recall it, and not resume marketing until we obtain clearance from the FDA
for the modified version of the device. Also, we may be subject to regulatory fines, penalties
and/or other sanctions authorized by the Federal Food, Drug, and Cosmetic Act. In the future, we
intend to introduce new products and enhancements and improvements to existing products. We cannot
provide assurance that the FDA will clear any new product or product changes for marketing or what
the timing of such clearances might be. In addition, new products or significantly modified
marketed products could be found to be not substantially equivalent and classified as products
requiring the FDAs approval of a pre-market approval application, or PMA, before commercial
distribution would be permissible. PMAs usually require substantially more data than 510(k)
submissions and their review and approval or denial typically takes significantly longer than a
510(k) decision of substantial equivalence. Also, PMA products require approval supplements for any
change that affects safety and effectiveness before the modified device may be marketed. Delays in
our receipt of regulatory clearance or approval will cause delays in our ability to sell our
products, which will have a negative effect on our revenues growth.
Even if we obtain the necessary FDA clearances or approvals, if we or our suppliers fail to comply
with ongoing regulatory requirements our products could be subject to restrictions or withdrawal
from the market.
We are subject to the MDR regulations that require us to report to the FDA if our products may
have caused or contributed to patient death or serious injury, or if our device malfunctions and a
recurrence of the malfunction would likely result in a death or serious injury. We must also file
reports of device corrections and removals and adhere to the FDAs rules on labeling and promotion.
Our failure to comply with these or other applicable regulatory requirements could result in
enforcement action by the FDA, which may include any of the following:
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untitled letters, warning letters, fines, injunctions and civil penalties; |
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administrative detention, which is the detention by the FDA of medical devices believed to be
adulterated or misbranded; |
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customer notification, or orders for repair, replacement or refund; |
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voluntary or mandatory recall or seizure of our products; |
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operating restrictions, partial suspension or total shutdown of production; |
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refusal to review pre-market notification or pre-market approval submissions; |
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rescission of a substantial equivalence order or suspension or withdrawal of a pre-market approval; and |
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criminal prosecution. |
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Our products are subject to market withdrawals or product recalls after receiving FDA clearance or
approval, and market withdrawals and product recalls could cause the price of our stock to decline
and expose us to product liability or other claims or could otherwise harm our reputation and
financial results.
Medical devices can experience performance problems in the field that require review and
possible corrective action by us or the product manufacturer. We cannot provide assurance that
component failures, manufacturing errors, design defects and/or labeling
inadequacies, which could result in an unsafe condition or injury to the operator or the patient
will not occur. These could lead to a government mandated or voluntary recall by us. The FDA has
the authority to require the recall of our products in the event a product presents a reasonable
probability that it would cause serious adverse health consequences or death. Similar regulatory
agencies in other countries have similar authority to recall devices because of material
deficiencies or defects in design or manufacture that could endanger health. We believe that the
FDA would request that we initiate a voluntary recall if a product was defective or presented a
risk of injury or gross deception. Any recall would divert management attention and financial
resources, could cause the price of our stock to decline and expose us to product liability or
other claims and harm our reputation with customers.
If we or our contract manufacturers fail to comply with FDAs Quality System regulations, our
manufacturing operations could be interrupted, and our product sales and operating results could
suffer.
Our finished goods manufacturing processes, and those of some of our contract manufacturers,
are required to comply with the FDAs Quality System Regulations, or QSRs, which cover the
procedures and documentation of the design, testing, production, control, quality assurance,
labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces its QSRs
through periodic unannounced inspections of manufacturing facilities. We and our contract
manufacturers have been, and anticipate in the future being, subject to such inspections. Our
Lawrence, MA U.S. manufacturing facility has previously had three FDA QSR inspections. The first
resulted in one observation, which was rectified during the inspection and required no further
response from us. Our last two inspections, including our most recent inspection in March 2006,
resulted in no observations. Medisystems has been inspected by the FDA on eight occasions, and all
inspections resulted in no action indicated. We cannot provide assurance that we can maintain a
comparable level of regulatory compliance in the future at our facilities
We cannot provide assurance that any future inspections would have the same result. If one of
our manufacturing facilities or those of any of our contract manufacturers fails to take
satisfactory corrective action in response to an adverse QSR inspection, FDA could take enforcement
action, including issuing a public warning letter, shutting down our manufacturing operations,
embargoing the import of components from outside of the United States, recalling our products,
refusing to approve new marketing applications, instituting legal proceedings to detain or seize
products or imposing civil or criminal penalties or other sanctions, any of which could cause our
business and operating results to suffer.
Changes in reimbursement for acute kidney failure could negatively affect the adoption of our
critical care products and the level of our future critical care product revenues.
Unlike Medicare reimbursement for ESRD, Medicare only reimburses healthcare providers for
acute kidney failure and fluid overload treatment if the patient is otherwise eligible for
Medicare, based on age or disability. Medicare and many other third-party payors and private
insurers reimburse these treatments provided to hospital inpatients under a traditional DRG system.
Under this system, reimbursement is determined based on a patients primary diagnosis and is
intended to cover all costs of treating the patient. The presence of acute kidney failure or fluid
overload increases the severity of the primary diagnosis and, accordingly, may increase the amount
reimbursed. For care of these patients to be cost-effective, hospitals must manage the longer
hospitalization stays and significantly more nursing time typically necessary for patients with
acute kidney failure and fluid overload. If we are unable to convince hospitals that our System One
provides a cost-effective treatment alternative under this diagnosis related group reimbursement
system, they may not purchase our product. In addition, changes in Medicare reimbursement rates for
hospitals could negatively affect demand for our products and the prices we charge for them.
Legislative or regulatory reform of the healthcare system may affect our ability to sell our
products profitably.
In both the United States and foreign countries, there have been legislative and regulatory
proposals to change the healthcare system in ways that could affect our ability to sell our
products profitably. The federal government and some states have enacted healthcare reform
legislation, and further federal and state proposals are likely. We cannot predict the exact form
this legislation may take, the probability of passage, or the ultimate effect on us. Our business
could be adversely affected by future healthcare reforms or changes in Medicare.
Failure to obtain regulatory approval in foreign jurisdictions would prevent us from marketing our
products outside the United States.
Although we have not initiated any marketing efforts in jurisdictions outside of the United
States and Canada, we intend in the future to market our products in other markets. In order to
market our products in the EU or other foreign jurisdictions, we must obtain separate regulatory
approvals and comply with numerous and varying regulatory requirements. The approval procedure
varies from country to country and can involve additional testing. The time required to obtain
approval abroad may be longer than the time required to obtain FDA clearance. The foreign
regulatory approval process includes many of the risks associated with obtaining FDA clearance and
we may not obtain foreign regulatory approvals on a timely basis, if at all. FDA clearance does not
ensure approval by regulatory authorities in other countries, and approval by one foreign
regulatory authority does not ensure approval by regulatory authorities in other foreign countries.
We may not be able to file for regulatory approvals and may not receive necessary approvals to
commercialize our products in any market outside the United States, which could negatively effect
our overall market penetration.
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We currently have obligations under our contracts with dialysis clinics and hospitals to protect
the privacy of patient health information.
In the course of performing our business we obtain, from time to time, confidential patient
health information. For example, we learn patient names and addresses when we ship our System One
supplies to home hemodialysis patients. We may learn patient names
and be exposed to confidential patient health information when we provide training on our products
to our customers staff. Our home hemodialysis patients may also call our customer service
representatives directly and, during the call, disclose confidential patient health information.
U.S. Federal and state laws protect the confidentiality of certain patient health information, in
particular individually identifiable information, and restrict the use and disclosure of that
information. At the federal level, the Department of Health and Human Services promulgated health
information and privacy and security rules under the Health Insurance Portability and
Accountability Act of 1996, or HIPAA. At this time, we are not a HIPAA covered entity and
consequently are not directly subject to HIPAA. However, we have entered into several business
associate agreements with covered entities that contain commitments to protect the privacy and
security of patients health information and, in some instances, require that we indemnify the
covered entity for any claim, liability, damage, cost or expense arising out of or in connection
with a breach of the agreement by us. If we were to violate one of these agreements, we could lose
customers and be exposed to liability and/or our reputation and business could be harmed. In
addition, conduct by a person that is not a covered entity could potentially be prosecuted under
aiding and abetting or conspiracy laws if there is an improper disclosure or misuse of patient
information.
Many state laws apply to the use and disclosure of health information, which could affect the
manner in which we conduct our business. Such laws are not necessarily preempted by HIPAA, in
particular those laws that afford greater protection to the individual than does HIPAA. Such state
laws typically have their own penalty provisions, which could be applied in the event of an
unlawful action affecting health information.
We are subject to federal and state laws prohibiting kickbacks and false and fraudulent claims
which, if violated, could subject us to substantial penalties. Additionally, any challenges to or
investigation into our practices under these laws could cause adverse publicity and be costly to
respond to, and thus could harm our business.
The Medicare/ Medicaid anti-kickback laws, and several similar state laws, prohibit payments
that are intended to induce physicians or others either to refer patients or to acquire or arrange
for or recommend the acquisition of healthcare products or services. These laws affect our sales,
marketing and other promotional activities by limiting the kinds of financial arrangements,
including sales programs; we may have with hospitals, physicians or other potential purchasers or
users of medical devices. In particular, these laws influence, among other things, how we structure
our sales and rental offerings, including discount practices, customer support, education and
training programs and physician consulting and other service arrangements. Although we seek to
structure such arrangements in compliance with applicable requirements, these laws are broadly
written, and it is often difficult to determine precisely how these laws will be applied in
specific circumstances. If one of our sales representatives were to offer an inappropriate
inducement to purchase our products to a customer, we could be subject to a claim under the
Medicare/ Medicaid anti-kickback laws.
Other federal and state laws generally prohibit individuals or entities from knowingly
presenting, or causing to be presented, claims for payments from Medicare, Medicaid or other
third-party payors that are false or fraudulent, or for items or services that were not provided as
claimed. Although we do not submit claims directly to payors, manufacturers can be held liable
under these laws if they are deemed to cause the submission of false or fraudulent claims by
providing inaccurate billing or coding information to customers, or through certain other
activities. In providing billing and coding information to customers, we make every effort to
ensure that the billing and coding information furnished is accurate and that treating physicians
understand that they are responsible for all billing and prescribing decisions, including the
decision as to whether to order dialysis services more frequently than three times per week.
Nevertheless, we cannot provide assurance that the government will regard any billing errors that
may be made as inadvertent or that the government will not examine our role in providing
information to our customers concerning the benefits of daily therapy. Anti-kickback and false
claims laws prescribe civil, criminal and administrative penalties for noncompliance, which can be
substantial. Moreover, an unsuccessful challenge or investigation into our practices could cause
adverse publicity, and be costly to respond to, and thus could harm our business and results of
operations.
Foreign governments tend to impose strict price controls, which may adversely affect our future
profitability.
Although we have not initiated any marketing efforts in jurisdictions outside of the United
States and Canada, we intend in the future to market our products in other markets. Certain
products of ours are distributed outside the United States and Canada via distributors and
customers. In some foreign countries, particularly in the European Union, the pricing of medical
devices is subject to governmental control. In these countries, pricing negotiations with
governmental authorities can take considerable time after the receipt of marketing approval for a
product. To obtain reimbursement or pricing approval in some countries, we may be required to
supply data that compares the cost-effectiveness of our products to other available therapies. If
reimbursement of our products is unavailable or limited in scope or amount, or if pricing is set at
unsatisfactory levels, it may not be profitable to sell our products outside of the United States,
which would negatively affect the long-term growth of our business.
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Our business activities involve the use of hazardous materials, which require compliance with
environmental and occupational safety laws regulating the use of such materials. If we violate
these laws, we could be subject to significant fines, liabilities or other adverse consequences.
Our research and development programs as well as our manufacturing operations involve the
controlled use of hazardous materials. Accordingly, we are subject to federal, state and local laws
governing the use, handling and disposal of these materials. Although we believe that our safety
procedures for handling and disposing of these materials comply in all material respects with the
standards prescribed by state and federal regulations, we cannot completely eliminate the risk of
accidental contamination or injury from these materials. In the event of an accident or failure to
comply with environmental laws, we could be held liable for resulting damages, and
any such liability could exceed our insurance coverage.
Risks Related to Operations
We obtain some of our raw materials or components from a single source or a limited group of
suppliers. We also obtain sterilization services from a single supplier. The partial or complete
loss of one of these suppliers could cause significant production delays, an inability to meet
customer demand and a substantial loss in revenues.
We depend on a number of single-source suppliers for some of the raw materials and components
we use in its products. We also obtain sterilization services from a single supplier. Presently, B.
Braun Avitum AG is our only supplier of bicarbonate-based dialysate used with the System One;
Membrana GmbH is our only supplier of the fiber used in our filters; PISA is our sole supplier of
lactate-based dialysate, and Kawasumi is our only supplier of needles. We also obtain certain other
components from other single source suppliers or a limited group of suppliers. Our dependence on
single source suppliers of components, subassemblies and finished goods exposes us to several
risks, including disruptions in supply, price increases, late deliveries, and an inability to meet
customer demand. This could lead to customer dissatisfaction, damage to our reputation, or
customers switching to competitive products. Any interruption in supply could be particularly
damaging to our customers using the System One to treat chronic ESRD and who need access to the
System One and related disposables.
Finding alternative sources for these components and subassemblies would be difficult in many
cases and may entail a significant amount of time and disruption. In the case of B. Braun, for
bicarbonate, and Membrana, for fiber, we are contractually prevented from obtaining an alternative
source of supply, except in certain limited instances. In the case of other suppliers, we would
need to change the components or subassemblies if we sourced them from an alternative supplier.
This, in turn, could require a redesign of our System One or other products and, potentially,
further FDA clearance or approval of any modification, thereby causing further costs and delays.
Resin is a key input material to the manufacture of our products and System One cartridge. Rising
oil prices affect both the pricing and availability of this material. Continued escalation of oil
prices could affect our ability to obtain sufficient supply of resin at the prices we need to
manufacture our products at current rates of profitability.
We currently source resin from a small number of suppliers. Rising oil prices over the last
several years have resulted in significant price increases for this material. We cannot guarantee
that prices will not continue to increase. Our contracts with customers restrict our ability to
immediately pass on these price increases, and we cannot guarantee that future pricing to customers
will be sufficient to accommodate increasing input costs.
Distribution costs represent a significant percentage of our overall costs, and these costs are
dependent upon fuel prices. Increases in fuel prices could lead to increases in our distribution
costs, which, in turn, could impair our ability to achieve profitability.
We currently incur significant inbound and outbound distribution costs. Our distribution
costs are dependent upon fuel prices. Further increases in fuel prices could lead to increases in
our distribution costs, which could impair our ability to achieve profitability.
We have labor agreements with our production employees in Italy and in Mexico. We cannot guarantee
that we will not in the future face strikes, work stoppages, work slowdowns, grievances,
complaints, claims of unfair labor practices, other collective bargaining disputes or in Italy,
anti-union behavior, that may cause production delays and negatively impact our ability to deliver
our products on a timely basis.
MDS Italy has a national labor contract with Contratto collettivo nazionale di lavoro per gli
addetti allindustria della gomma cavi elettrici ed affini e allindustria delle materie plastiche,
and MDS Mexico has entered into a collective bargaining agreement with a Union named Mexico Moderno
de Trabajadores de la Baja California C.R.O.C. Medisystems has not to date experienced strikes,
work stoppages, work slowdowns, grievances, complaints, claims of unfair labor practices, other
collective bargaining disputes, or in Italy, anti-union behavior, however we cannot guarantee that
we will not be subject to such activity in the future. Any such activity would likely cause
production delays, and negatively affect our ability to deliver our production commitments to
customers, which could adversely affect our reputation and cause our combined businesses and
operating results to suffer. Additionally, some of our key single source suppliers have labor
agreements. We cannot guarantee that we will not have future disruptions, which could adversely
affect our reputation and cause our business and operating results to suffer.
We do not have long-term supply contracts with many of our third-party suppliers.
We purchase raw materials and components from third-party suppliers, including some single
source suppliers, through purchase orders and do not have long-term supply contracts with many of
these third-party suppliers. Many of our third-party suppliers, therefore, are not obligated to
perform services or supply products for any specific period, in any specific quantity or at any
specific price, except as may be provided in a particular purchase order. We do not maintain large
volumes of inventory from most of our
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suppliers. If we inaccurately forecast demand for finished
goods, our ability to meet customer demand could be delayed and our competitive position and
reputation could be harmed. In addition, if we fail to effectively manage our relationships with
these suppliers, we may be required to change suppliers, which would be time consuming and
disruptive and could lead to disruptions in product supply, which could permanently impair our
customer base and reputation.
Certain of our products are recently developed and we are transitioning manufacturing to new
locations. We, and certain of our
third party manufacturers, have limited manufacturing experience with these products.
We continue to develop new products and make improvements to existing products. We are also
expanding our manufacturing capacity which requires us to relocate our manufacturing operations to
other locations. As such, we and certain of our third party manufacturers, have limited
manufacturing experience with certain of our products, including key products such as the PureFlow
SL, related disposables and our Streamline. We are, therefore, more exposed to risks relating to
product quality and reliability until the manufacturing processes for these new products mature.
Risks Related to Intellectual Property
If we are unable to protect our intellectual property and prevent its use by third parties, we will
lose a significant competitive advantage.
We rely on patent protection, as well as a combination of copyright, trade secret and
trademark laws to protect our proprietary technology and prevent others from duplicating our
products. However, these means may afford only limited protection and may not:
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prevent our competitors from duplicating our products; |
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prevent our competitors from gaining access to our proprietary information and technology; or |
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permit us to gain or maintain a competitive advantage. |
Any of our patents, including those we license, may be challenged, invalidated, circumvented
or rendered unenforceable. We cannot provide assurance that we will be successful should one or
more of our patents be challenged for any reason. If our patent claims are rendered invalid or
unenforceable, or narrowed in scope, the patent coverage afforded our products could be impaired,
which could make our products less competitive.
As of March 31, 2008, we had 50 pending patent applications, including foreign, international
and U.S. applications, and 33 U.S. and international issued patents. Under our license agreement
with DSU Medical Corporation, we also license 99 pending patent applications, including foreign,
international and U.S. applications, and 31 U.S. and international issued patents. We cannot
specify which of these patents individually or as a group will permit us to gain or maintain a
competitive advantage. We cannot provide assurance that any pending or future patent applications
we hold will result in an issued patent or that if patents are issued to us, that such patents will
provide meaningful protection against competitors or against competitive technologies. The issuance
of a patent is not conclusive as to its validity or enforceability. The United States federal
courts or equivalent national courts or patent offices elsewhere may invalidate our patents or find
them unenforceable. Competitors may also be able to design around our patents. Our patents and
patent applications cover particular aspects of our products. Other parties may develop and obtain
patent protection for more effective technologies, designs or methods for treating kidney failure.
If these developments were to occur, it would likely have an adverse effect on our sales.
The laws of foreign countries may not protect our intellectual property rights effectively or
to the same extent as the laws of the United States. If our intellectual property rights are not
adequately protected, we may not be able to commercialize our technologies, products or services
and our competitors could commercialize similar technologies, which could result in a decrease in
our revenues and market share.
Our products could infringe the intellectual property rights of others, which may lead to
litigation that could itself be costly, could result in the payment of substantial damages or
royalties, and/or prevent us from using technology that is essential to our products.
The medical device industry in general has been characterized by extensive litigation and
administrative proceedings regarding patent infringement and intellectual property rights. Products
to provide kidney replacement therapy have been available in the market for more than 30 years and
our competitors hold a significant number of patents relating to kidney replacement devices,
therapies, products and supplies. Although no third party has threatened or alleged that our
products or methods infringe their patents or other intellectual property rights, we cannot provide
assurance that our products or methods do not infringe the patents or other intellectual property
rights of third parties. If our business is successful, the possibility may increase that others
will assert infringement claims against us.
Infringement and other intellectual property claims and proceedings brought against us,
whether successful or not, could result in substantial costs and harm to our reputation. Such
claims and proceedings can also distract and divert management and key personnel from other tasks
important to the success of the business. In addition, intellectual property litigation or claims
could force us to do one or more of the following:
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cease selling or using any of our products that incorporate the asserted
intellectual property, which would adversely affect our revenues; |
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pay substantial damages for past use of the asserted intellectual property; |
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obtain a license from the holder of the asserted intellectual
property, which license may not be available on reasonable terms, if
at all and which could reduce profitability; and |
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redesign or rename, in the case of trademark claims, our products to
avoid infringing the intellectual property rights of third parties,
which may not be possible and could be costly and time-consuming if it
is possible to do so. |
Confidentiality agreements with employees and others may not adequately prevent disclosure of trade
secrets and other proprietary information.
In order to protect our proprietary technology and processes, we also rely in part on
confidentiality agreements with our corporate partners, employees, consultants, outside scientific
collaborators and sponsored researchers, advisors and others. These agreements may not effectively
prevent disclosure of confidential information and trade secrets and may not provide an adequate
remedy in the event of unauthorized disclosure of confidential information. In addition, others may
independently discover or reverse engineer trade secrets and proprietary information, and in such
cases we could not assert any trade secret rights against such party. Costly and time consuming
litigation could be necessary to enforce and determine the scope of our proprietary rights, and
failure to obtain or maintain trade secret protection could adversely affect our competitive
position.
We may be subject to damages resulting from claims that our employees or we have wrongfully used or
disclosed alleged trade secrets of other companies.
Many of our employees were previously employed at other medical device companies focused
on the development of dialysis products, including our competitors. Although no claims against us
are currently pending, we may be subject to claims that these employees or we have inadvertently or
otherwise used or disclosed trade secrets or other proprietary information of their former
employers. Litigation may be necessary to defend against these claims. If we fail in defending such
claims, in addition to paying monetary damages, we may lose valuable intellectual property rights.
Even if we are successful in defending against these claims, litigation could result in substantial
costs, damage to our reputation and be a distraction to management.
Risks Related to our Common Stock
Our stock price is likely to be volatile, and the market price of our common stock may drop.
The market price of our common stock could be subject to significant fluctuations. Market
prices for securities of early stage companies have historically been particularly volatile. As a
result of this volatility, you may not be able to sell your common stock at or above the price you
paid for the stock. Some of the factors that may cause the market price of our common stock to
fluctuate include:
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timing of market acceptance of our products; |
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timing of achieving profitability and positive cash flow from operations; |
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changes in estimates of our financial results or recommendations by
securities analysts or the failure to meet or exceed securities
analysts expectations; |
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actual or anticipated variations in our quarterly operating results; |
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disruptions in product supply for any reason, including product recalls,
our failure to appropriately forecast supply or demand, difficulties in
moving products across the border, or the failure of third party
suppliers to produce needed products or components; |
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reports by officials or health or medical authorities, the general media
or the FDA regarding the potential benefits of the System One or of
similar dialysis products distributed by other companies or of daily or
home dialysis; |
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announcements by the FDA of non-clearance or non-approval of our
products, or delays in the FDA or other foreign regulatory agency review
process; |
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product recalls; |
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regulatory developments in the United States and foreign countries; |
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changes in third-party healthcare reimbursements, particularly a decline in the level of Medicare reimbursement
for dialysis treatments; |
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litigation involving our company or our general industry or both; |
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announcements of technical innovations or new products by us or our competitors; |
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developments or disputes concerning our patents or other proprietary rights; |
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our ability to manufacture and supply our products to commercial standards; |
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significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors; |
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departures of key personnel; and |
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investors general perception of our company, our products, the economy and general market conditions. |
The stock markets in general have experienced substantial volatility that has often been
unrelated to the operating performance of individual companies. These broad market fluctuations may
adversely affect the trading price of our common stock. In the past, following periods of volatility in the market price of a companys
securities, stockholders have often instituted class action securities litigation against those
companies. Such litigation, if instituted, could result in substantial costs and diversion of
management attention and resources, which could significantly harm our profitability and
reputation.
Anti-takeover provisions in our restated certificate of incorporation and amended and restated
bylaws and under Delaware law could make an acquisition of us more difficult and may prevent
attempts by our stockholders to replace or remove our current management.
Provisions in our restated certificate of incorporation and our amended and restated
bylaws may delay or prevent an acquisition of us. In addition, these provisions may frustrate or
prevent attempts by our stockholders to replace or remove members of our board of directors.
Because our board of directors is responsible for appointing the members of our management team,
these provisions could in turn affect any attempt by our stockholders to replace current members of
our management team. These provisions include:
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a prohibition on actions by our stockholders by written consent; |
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the ability of our board of directors to issue preferred stock without stockholder approval,
which could be used to institute a poison pill that would work to dilute the stock
ownership of a potential hostile acquirer, effectively preventing acquisitions that have not
been approved by our board of directors; |
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advance notice requirements for nominations of directors or stockholder proposals; and |
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the requirement that board vacancies be filled by a majority of our directors then in office. |
In addition, because we are incorporated in Delaware, we are governed by the provisions
of Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess
of 15% of our outstanding voting stock from merging or combining with us for a period of three
years after the date of the transaction in which the person acquired in excess of 15% of our
outstanding voting stock, unless the merger or combination is approved in a prescribed manner.
These provisions would apply even if the offer may be considered beneficial by some stockholders.
If there are substantial sales of our common stock in the market by our existing stockholders, our
stock price could decline.
If our existing stockholders sell a large number of shares of our common stock or the
public market perceives that existing stockholders might sell shares of common stock, the market
price of our common stock could decline significantly. We have 36,793,409 shares of common stock
outstanding as of March 31, 2008. Shares held by our affiliates may only be sold in compliance with
the volume limitations of Rule 144. These volume limitations restrict the number of shares that may
be sold by an affiliate in any three-month period to the greater of 1% of the number of shares then
outstanding, which approximates 367,934 shares, or the average weekly trading volume of our common
stock during the four calendar weeks preceding the filing of a notice on Form 144 with respect to
the sale.
At March 31, 2008, subject to certain conditions, holders of an aggregate of
approximately 12,814,221 shares of our common stock have rights with respect to the registration of
these shares of common stock with the Securities and Exchange Commission, or SEC. If we register
their shares of common stock following the expiration of the lock-up agreements, they can sell
those shares in the public market.
As of March 31, 2008, 7,199,667 shares of common stock are authorized for issuance under
our stock incentive plan, employee stock purchase plan and outstanding stock options. As of March
31, 2008, 5,276,313 shares were subject to outstanding options, of which 2,120,782 were exercisable
and which can be freely sold in the public market upon issuance, subject to the lock-up agreements
referred to above and the restrictions imposed on our affiliates under Rule 144.
Our costs have increased significantly as a result of operating as a public company, and our
management is required to devote substantial time to comply with public company regulations
As a public company, we incur significant legal, accounting and other expenses that we
did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, or the
Sarbanes-Oxley Act, as well as new rules subsequently implemented by the SEC and the NASDAQ Global
Market, have imposed various new requirements on public companies, including changes in corporate
governance practices. Our management and other personnel now need to devote a substantial amount of
time to these new requirements. Moreover, these rules and regulations increase our legal and
financial compliance costs and make some activities more time-consuming and costly.
In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain
effective internal controls for financial
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reporting and disclosure controls and procedures. In particular, commencing in fiscal 2006, we must
perform system and process evaluation and testing of our internal controls over financial reporting
to allow management and our independent registered public accounting firm to report on the
effectiveness of our internal controls over financial reporting, as required by Section 404 of the
Sarbanes-Oxley Act. Our compliance with Section 404 will require that we incur substantial
accounting expense and expend significant management efforts. If we are not able to comply with the
requirements of Section 404 in a timely manner, or if we or our independent registered public
accounting firm identify deficiencies in our internal controls over financial reporting that are
deemed to be material weaknesses, the market price of our stock could decline and we could be
subject to sanctions or investigations by the NASDAQ Global Market, SEC or other regulatory
authorities.
We do not anticipate paying cash dividends, and accordingly stockholders must rely on stock
appreciation for any return on their investment in us.
We anticipate that we will retain our earnings for future growth and therefore do not
anticipate paying cash dividends in the future. As a result, only appreciation of the price of our
common stock will provide a return to investors. Investors seeking cash dividends should not invest
in our common stock.
Our executive officers, directors and current and principal stockholders own a large percentage of
our voting common stock and could limit new stockholders influence on corporate decisions or could
delay or prevent a change in corporate control.
Our directors, executive officers and current holders of more than 5% of our outstanding common
stock, together with their affiliates and related persons, beneficially own, in the aggregate,
approximately 46% of our outstanding common stock. David S. Utterberg, one of our directors, holds
approximately 23% of our outstanding common stock. As a result, these stockholders, if acting
together, may have the ability to determine the outcome of matters submitted to our stockholders
for approval, including the election and removal of directors and any merger, consolidation or sale
of all or substantially all of our assets and other extraordinary transactions. The interests of
this group of stockholders may not always coincide with our corporate interests or the interests of
other stockholders, and they may act in a manner with which you may not agree or that may not be in
the best interests of other stockholders. This concentration of ownership may have the effect of:
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delaying, deferring or preventing a change in control of our company; |
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entrenching our management and/or Board; |
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impeding a merger, consolidation, takeover or other business combination involving our company; or |
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discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain
control of our company. |
We may grow through additional acquisitions, which could dilute our existing shareholders and could
involve substantial integration risks.
As part of our business strategy, we may acquire, other businesses and/or technologies in
the future. We may issue equity securities as consideration for future acquisitions that would
dilute our existing stockholders, perhaps significantly depending on the terms of the acquisition.
We may also incur additional debt in connection with future acquisitions, which, if available at
all, may place additional restrictions on our ability to operate our business. Acquisitions may
involve a number of risks, including:
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difficulty in transitioning and integrating the operations and personnel of the acquired businesses,
including different and complex accounting and financial reporting systems; |
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potential disruption of our ongoing business and distraction of management; |
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potential difficulty in successfully implementing, upgrading and deploying in a timely and effective
manner new operational information systems and upgrades of our finance, accounting and product
distribution systems; |
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difficulty in incorporating acquired technology and rights into our products and technology; |
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unanticipated expenses and delays in completing acquired development projects and technology integration; |
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management of geographically remote units both in the United States and internationally; |
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impairment of relationships with partners and customers; |
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customers delaying purchases of our products pending resolution of product integration between our
existing and our newly acquired products; |
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entering markets or types of businesses in which we have limited experience; |
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potential loss of key employees of the acquired company; and |
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Inaccurate assumptions of acquired companys product quality and/or product reliability. |
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As a result of these and other risks, we may not realize anticipated benefits from our
acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired
businesses and technologies could seriously harm our business.
Purchase accounting treatment of acquisitions could decrease our net income in the foreseeable
future, which could have a material and adverse effect on the market value of our common stock.
Under U.S. generally accepted accounting principals, we account for acquisitions using
the purchase method of accounting. Under purchase accounting, we record the consideration issued in
connection with the acquisition and the amount of direct transaction costs as the cost of acquiring
the company or business. We allocate that cost to the individual assets acquired and liabilities
assumed, including various identifiable intangible assets such as acquired technology, acquired
trade names and acquired customer relationships based on their respective fair values. Intangible
assets generally will be amortized over a three to fifteen year period. Goodwill and certain
intangible assets with indefinite lives are not subject to amortization but are subject to at least
an annual impairment analysis, which may result in an impairment charge if the carrying value
exceeds their implied fair value. These potential future amortization and impairment charges may
significantly reduce net income, if any, and therefore may adversely affect the market value of our
common stock.
Item 6. Exhibits
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Exhibit |
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Number |
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31.1
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Certification of Chief Executive Officer pursuant to Exchange Act
Rules 13a-14 or 15d-14, as adopted pursuant to Section 302 of
Sarbanes-Oxley Act of 2002. |
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31.2
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Certification of Chief Financial Officer pursuant to Exchange Act
Rules 13a-14 or 15d-14, as adopted pursuant to Section 302 of
Sarbanes-Oxley Act of 2002. |
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32.1
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Certification of Chief Executive Officer pursuant to Exchange Act
Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |
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32.2
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Certification of Chief Financial Officer pursuant to Exchange Act
Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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NXSTAGE MEDICAL, INC.
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By: |
/s/ Robert S. Brown
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Robert S. Brown |
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Chief Financial Officer
(Duly authorized officer and principal
financial and accounting officer) |
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May 12, 2008
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