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NxStage Medical 10-K 2009 Documents found in this filing:
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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Commission File Number:
000-51567
Registrant’s Telephone Number, Including Area Code:
(978) 687-4700
Securities registered pursuant to Section 12(b) of the
Act:
Common Stock, $0.001 par value
Securities registered pursuant to Section 12(g) of the
Act:
None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
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 if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. þ
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):
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
The aggregate market value of common stock held by
non-affiliates of the registrant was approximately
$52.2 million, as of June 30, 2008, based on the last
reported sale price of the registrant’s common stock on the
NASDAQ Global Market on June 30, 2008.
There were 46,549,764 shares of the registrant’s
common stock issued and outstanding as of the close of business
on March 4, 2009.
Portions of the registrant’s definitive Proxy Statement for
its 2009 Annual Meeting of Stockholders to be held on
May 28, 2009 are hereby incorporated by reference in
response to Part III, Items 10, 11, 12, 13 and 14 of
the Annual Report on
Form 10-K.
NXSTAGE
MEDICAL, INC.
2008 ANNUAL REPORT ON
FORM 10-K
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This report and certain information incorporated by reference
herein contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, concerning
our business, operations and financial condition, including
statements with respect to the market adoption of our products;
the growth of the home, critical care and in-center dialysis
markets in general and the home hemodialysis market in
particular; the development and commercialization of our
products; the adequacy of our funding, our need for and our
ability to obtain additional funding; our ability to negotiate
further amended terms to our credit and security agreement with
General Electric Capital Corporation, or GE, the timing of when
we might achieve improvements to our gross margins and operating
expenses; expectations with respect to our operating expenses
and achieving our business plan; expectations with respect to
achieving profitable operations; expectations with respect to
achieving improvements in product reliability; the timing and
success of the submission, acceptance and approval of regulatory
filings, the scope of patent protection with respect to our
products, expectations with respect to the clinical findings of
our FREEDOM study, the impact of possible future changes to
reimbursement for chronic dialysis treatments and the impact of
current economic conditions on our business. All statements
other than statements of historical facts included in this
report regarding our strategies, prospects, financial condition,
costs, plans and objectives are forward-looking statements. When
used in this report, the words “expect”,
“anticipate”, “intend”, “plan”,
“believe”, “seek”, “estimate”,
“potential”, “continue”,
“predict”, “may”, and similar expressions
are intended to identify forward-looking statements, although
not all forward-looking statements contain these identifying
words. Because these forward-looking statements involve risks
and uncertainties, actual results could differ materially from
those expressed or implied by these forward-looking statements
for a number of important reasons, including those discussed
below in “Risk Factors”, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations”, and elsewhere in this report.
You should read these forward-looking statements carefully
because they discuss our expectations about our future
performance, contain projections of our future operating results
or our future financial condition or state other
“forward-looking” information. You should be aware
that the occurrence of any of the events described under
“Risk Factors” and elsewhere in this report could
substantially harm our business, results of operations and
financial condition and that upon the occurrence of any of these
events, the trading price of our common stock could decline.
We cannot guarantee future results, events, levels of activity,
performance or achievements. The forward-looking statements
contained in this report represent our expectations as of the
date of this report and should not be relied upon as
representing our expectations as of any other date. Subsequent
events and developments will cause our expectations to change.
However, while we may elect to update these forward-looking
statements, we specifically disclaim any obligation to do so,
even if our expectations change.
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For convenience in this Annual Report on
Form 10-K,
“NxStage,” “we,” “us,” and
“the Company” refer to NxStage Medical, Inc. and our
consolidated subsidiaries, taken as a whole.
We are 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. Our
primary product, the NxStage System One, or 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. Given its
design, the System One is particularly well-suited for home
hemodialysis and a range of dialysis therapies including more
frequent, or “daily,” dialysis, which clinical
literature suggests provides patients better clinical outcomes
and improved quality of life. The System One is cleared by the
United States Food and Drug Administration, or FDA, for home
hemodialysis as well as hospital and clinic-based dialysis.
Following our acquisition of Medisystems Corporation and certain
of its affiliated entities, collectively the MDS Entities, we
also sell needles and blood tubing sets primarily to dialysis
clinics for the treatment of End Stage Renal Disease, or ESRD,
which we refer to as the in-center market. 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 care market.
ESRD, which affects nearly 500,000 people in the United
States, is an irreversible, life-threatening loss of kidney
function that is treated predominantly with dialysis. Dialysis
is a kidney replacement therapy that removes toxins and excess
fluids from the bloodstream and, unless the patient receives a
kidney transplant, is required for the remainder of the
patient’s life. Approximately, 70% of ESRD patients in the
United States rely on life-sustaining dialysis treatment.
Hemodialysis, the most widely prescribed type of dialysis,
typically consists of treatments in a dialysis clinic three
times per week, with each session lasting three to five hours.
Approximately 8% of U.S. ESRD dialysis patients receive
some form of dialysis treatment at home, most of whom treat
themselves with peritoneal dialysis, or PD, although surveys of
physicians and healthcare professionals suggest that a larger
proportion of patients could take responsibility for their own
care. We believe there is an unmet need for a hemodialysis
system that allows more frequent and easily administered therapy
at home and have designed our system to address this and other
kidney replacement markets.
Measuring 15x15x18 inches, the System One is the smallest,
commercially available hemodialysis system. It consists of a
compact, portable and easy-to-use cycler, disposable drop-in
cartridge and high purity premixed fluid. The System One has a
self-contained design and simple user interface making it easy
to operate by a trained patient and his or her trained partner
in any setting prescribed by the patient’s physician.
Unlike traditional dialysis systems, our System One does not
require any special disinfection and its operation does not
require specialized electrical or plumbing infrastructure or
modifications to the home. Patients can bring the System One
home, plug it in to a conventional electrical outlet and operate
it, thereby eliminating what can be expensive plumbing and
electrical household modifications required by other traditional
dialysis systems. Given its compact size and lack of
infrastructure requirements, the System One is portable,
allowing patients freedom to travel. We believe these features
provide patients and their physicians new treatment options for
ESRD.
We market the System One to dialysis clinics for chronic
hemodialysis treatment, providing clinics with improved access
to a developing market, the home hemodialysis market, and the
ability to expand their patient base by adding home-based
patients without adding clinic infrastructure. The clinics in
turn provide the System One to ESRD patients. For each month
that a patient is treated with the System One, we bill the
clinic for the purchase of the related disposable cartridges and
treatment fluids necessary to perform treatment. Typically, our
customers rent the System One equipment on a month to month
basis, although early in 2007, two of our dialysis chain
customers elected to purchase rather than rent System One
equipment. DaVita, our
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largest customer in the home market, purchases rather than rents
a significant percentage of its System One equipment. Clinics
receive reimbursement from Medicare, private insurance and
patients for dialysis treatments. We commenced marketing the
System One for chronic hemodialysis treatment in September 2004.
We are not responsible for, and do not provide, patient
training. We provide training to dialysis clinic staff, who, in
turn, train home hemodialysis patients. Training takes place at
the clinic primarily during the patient’s prescribed, often
daily, two to three hour treatment sessions. Patient training,
which typically takes two to three weeks, includes basic
instruction on ESRD, operation of the System One and insertion
by the patient or their partner of needles into the
patient’s vascular access site. Clinics provide testing to
patients and their partners at the conclusion of training to
verify skills and an understanding of System One operation.
Training sessions are reimbursed by Medicare, and there may be a
co-payment requirement to the patient associated with this
training.
Medicare reimburses the same amount per treatment for home and
in-center hemodialysis treatments, up to three treatments per
week. Payment for more than three treatments per week is
available with appropriate medical justification. The adoption
of our System One for more frequent therapy for ESRD would
likely be slowed if Medicare is reluctant or refuses to pay for
these additional treatments.
We also market the System One in the critical care market to
hospitals for treatment of acute kidney failure and fluid
overload. It is estimated that there are over 200,000 cases of
acute kidney failure in the United States each year. The System
One provides an effective, simple-to-operate alternative to
dialysis systems currently used in the hospital to treat these
acute conditions. We commenced marketing the System One to the
critical care market in February 2003.
In addition to the System One, we also sell a line of
extracorporeal disposable products for use primarily in
in-center dialysis treatments for patients with ESRD. These
products, which we obtained in connection with our acquisition
of the MDS Entities, include hemodialysis blood tubing sets,
A.V. fistula needles and apheresis needles. The MDS Entities
have been selling products to dialysis centers for the treatment
of ESRD since 1981, and have achieved leading positions in the
U.S. market for both hemodialysis blood tubing sets and
AV fistula needles. Our blood tubing set products include
the ReadySet High Performance Blood Tubing set, or ReadySet,,
and the Streamline Airless Blood Tubing set, or Streamline.
ReadySet has been on the market since 1993. Streamline is our
next generation product designed to provide improved patient
outcomes and lower costs to dialysis clinics. Our next
generation Streamline product was introduced to the market in
2007. Our needle products line includes AV fistula needle sets
incorporating safety features, first introduced in 1995,
including PointGuard Anti-Stick Needle Protectors and
MasterGuard technology, and ButtonHole needle sets first
introduced in 2002.
We report the results of our operations in two segments: the
System One segment and the In-Center segment. The business we
acquired in connection with our acquisition of the MDS Entities
constitutes the operations of the In-Center segment. This
acquisition was not completed until October 1, 2007, and
therefore, we did not realize In-Center segment revenues until
the fourth quarter of 2007. We distribute our products in three
markets: the home, critical care and in-center. In the System
One segment we derive our revenues from the sale and rental of
equipment and the sale of disposable products in the home and
critical care markets. We define the home market as the market
devoted to the treatment of ESRD patients in the home and the
critical care market as the market devoted to the treatment of
hospital-based patients with acute kidney failure or fluid
overload. In the In-Center segment, we derive our revenues from
the sale of needles and blood tubing sets primarily used for
in-center dialysis treatments.
For the year ended December 31, 2008, our revenues were
$128.8 million and we incurred a net loss of
$51.2 million. As of December 31, 2008, we had cash
and cash equivalents of $26.6 million, total assets of
$212.1 million, long term liabilities of $52.6 million
and total stockholders’ equity of $122.4 million.
Since inception, we have incurred losses every quarter and at
December 31, 2008, we had an accumulated deficit of
approximately $233.2 million. We expect our operating
expenses to continue to increase as we grow our business but
decrease as a percentage of revenue as we leverage our existing
infrastructure. While we have achieved positive gross margins
for our products, in aggregate, since the fourth quarter of
2007, we cannot
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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 the costs
of manufacturing our products, obtaining better purchasing terms
and prices, accessing lower labor cost markets for the
manufacture of our products, growing revenue, increasing
reliability of our products, improving our field equipment
utilization, achieving efficiencies in manufacturing and supply
chain overhead costs, achieving efficiencies in the distribution
of our products and achieving a sufficient scale of operations.
We have experienced negative operating margins and cash flows
from operations and expect to continue to incur net losses in
the foreseeable future based on our projections. On
March 16, 2009, we amended certain terms under our current
credit and security agreement with GE. We believe, based on
current projections, that we have the required resources to fund
operating requirements beyond 2009 provided that we further
restructure our repayment schedule on our current credit and
security agreement with GE. Future capital requirements will
depend on many factors, including the availability of credit,
rate of revenue growth, continued progress on improving gross
margins, the expansion of selling and marketing and research and
development activities, the timing and extent of expansion into
new geographies or territories, the timing of new product
introductions and enhancement to existing products, the
continuing market acceptance of products, and potential
investments in, or acquisitions, of complementary businesses,
services or technologies. There is no assurance that additional
debt or equity capital will be available to us on favorable
terms, if at all.
We were incorporated in Delaware in 1998 under the name QB
Medical, Inc., and later changed our name to NxStage Medical,
Inc. Our principal executive offices are located at 439 South
Union Street, Fifth Floor, Lawrence, Massachusetts 01843.
Additional financial information regarding our business segments
and geographic data about our assets is contained in
Management’s Discussion and Analysis of Financial Condition
and Results of Operations in Item 7 of Part II, and in
our notes to Consolidated Financial Statements included in
Item 8 of Part II of this Annual Report on
Form 10-K.
On March 16, 2009, we, together with our subsidiaries EIR
Medical, Inc., Medisystems Services Corporation and Medisystems
Corporation, entered into an amendment to our current credit and
security agreement with a group of lenders led by GE Business
Financial Services Inc. The amendment postponed principal
payments under the term loan for three months from April through
June 2009, decreased the minimum net revenue covenant and added
certain minimum liquidity and minimum adjusted consolidated
EBITDA targets. Interest rates under the facility were increased
to a rate of 11.12% per annum on the term loan and LIBOR plus
6.5% per annum with a LIBOR floor of 4% on any borrowings under
the revolving credit facility. Additional security was also
provided by expanding the collateral base to include all our
intellectual property. Previously only a negative pledge against
intellectual property had been provided. We paid an amendment
fee of $0.5 million in connection with this amendment.
On January 6, 2008 we entered into a needle purchase
agreement with DaVita pursuant to which DaVita has agreed
to purchase the majority of its safety needle requirements from
us 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, we may terminate
the agreement. The needle purchase agreement provides for
liquidated damages in the event DaVita fails to satisfy its
purchase requirements or we fail to meet our supply obligations
to DaVita.
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On September 4, 2008, DaVita agreed to extend its blood
tubing set agreement with Medisystems, our wholly-owned
subsidiary, originally entered into on December 22, 2003,
for a period of one year, through September 21, 2009.
During this extension, DaVita has agreed to continue to purchase
the majority of its blood tubing set requirements from
Medisystems, subject to certain terms and conditions.
On May 22, 2008 we entered into a $43.0 million
private placement. The private placement closed in two tranches.
The first tranche consisting of 5.6 million shares of
common stock and warrants to purchase 1.1 million shares of
the Company’s common stock was issued and sold on
May 28, 2008 to funds managed or advised by OrbiMed
Advisors LLC for aggregate gross proceeds of $25.0 million.
The second tranche consisting of 4.0 million shares and
warrants to purchase 0.8 million shares of the
Company’s common stock was issued and sold on
August 1, 2008 to existing NxStage institutional investors
for aggregate gross proceeds of $18.0 million. The proceeds
from both tranches, net of transaction costs, were approximately
$42.3 million. We were required to register the common
stock and the common stock issuable upon exercise of the
warrants with the Securities and Exchange Commission, which we
did on August 8, 2008. If the holders of the shares or the
accompanying warrant shares are unable to sell such shares or
warrant shares under the registration statement for more than
30 days in any 365 day period after the effectiveness
of the registration statement, we may be obligated to pay
damages equal to up to 1% of the share purchase price per month
that the registration statement is not effective and the
investors are unable to sell their shares.
We sell the System One in the home and critical care markets.
Following our acquisition of Medisystems Corporation and certain
subsidiaries, the Medisystems Acquisition, which was completed
on October 1, 2007, we also sell blood tubing sets, needles
and other extracorporeal products for use primarily in
hemodialysis therapy to the in-center market.
Our primary product, the NxStage System One, is a small,
portable, easy-to-use hemodialysis system, which incorporates
multiple design technologies and design features. Sales of the
System One and related disposables accounted for approximately
52%, 74% and 100% of our total sales for the years ended
December 31, 2008, 2007 and 2006, respectively.
The System One includes the following components:
For the home hemodialysis market, the System One is designed to
make home treatment and more frequent treatment easier and more
practical. Although most studies have not been performed using
our product, clinical studies suggest that therapy administered
five to six times per week, commonly referred to as
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daily therapy, better mimics the natural functioning of the
human kidney and can lead to improved clinical outcomes,
including reduction in hypertension, improved anemia status,
reduced reliance on pharmaceuticals, improved nutritional
status, reduced hospitalizations and overall improvement in
quality of life. Published literature also supports the clinical
and quality of life benefits associated with home dialysis
therapy.
For the critical care market, our System One is designed to
offer clinicians an alternative that simplifies the delivery of
acute kidney replacement therapy and makes longer or continuous
critical care therapies easier to deliver. The ability of our
system to perform hemofiltration
and/or
isolated ultrafiltration, for which the System One is also FDA
cleared, is advantageous, as many clinicians choose to prescribe
hemofiltration for patients with acute kidney failure.
The ReadySet High Performance Blood Tubing Set, which was
introduced for use in hemodialysis in 1993, features a pump
segment material designed to deliver reliable, accurate flows
throughout the treatment. The blood tubing is designed to be
easy to handle and to enable relatively fast priming, or removal
of air from the dialysate solution. These technological advances
are intended to optimize dose delivery. Sales of ReadySet
accounted for approximately 27% and 14% of our total sales for
the years ended December 31, 2008 and 2007.
Our latest generation blood tubing set product is Streamline.
Streamline features an efficient and airless design intended to
result in superior clinical and economic performance. It is
designed to reduce treatment time, minimize waste and optimize
dose delivery. Streamline also includes our patented LockSite
needleless access sites, eliminating the need for sharp needles
or costlier guarded needles to be used with the tubing set in
connection with dialysis therapy, thereby intended to facilitate
clinician’s ability to satisfy Occupational Safety and
Health Administration, OSHA, anti-stick requirements.
Our AV fistula and apheresis needles have been designed to
achieve a smooth blood flow throughout the treatment, intended
to result in less clotting, lower pressure drops, and less
stress on the patient’s blood. Sales of AV fistula and
apheresis needles accounted for approximately 18% and 6% of our
total sales for the years ended December 31, 2008 and 2007.
As an alternative to our AV fistula needles with MasterGuard, we
also offer ButtonHole needles for hemodialysis therapies. This
needle is used by patients that employ the “the
constant-site technique”, whereby a fistula needle is
inserted in the same place each treatment. Published clinical
experience supports that the incidence of pain, hematoma,
infection and infiltrations at the needle insertion site can be
reduced by utilizing the constant-site technique. Our ButtonHole
AV fistula needle has an anti-stick, dull bevel design
well-suited for the constant-site technique, while also designed
to reduce the risk of accidental needle sticks.
Transducer protectors are single-use air filter devices used to
protect hemodialysis pressure monitors during treatments. Our
transducer protectors include the ViraGuard membrane, designed
to maintain the sterility of the fluid pathway and act as a
bacterial and viral barrier as well as a unique airflow design,
intended to allow for a quick response time with few false
alarms.
The Medic needle/connector device was engineered to help reduce
the risk of accidental needle sticks, as required by OSHA. Medic
can be used with any standard syringe, and is used in
hemodialysis procedures with
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catheters, AV fistula needles, blood tubing sets and dialysis
priming sets. For apheresis procedures, Medic is designed to
easily access drug vials and blood collection tubes.
Vascular access complications are a leading cause of
complications during dialysis. To facilitate early
identification and intervention for access-related problems,
dialysis clinics have instituted routine measurement and trend
analysis of access pressures. Our Access Alert Pressure
Measurement Filter when used with our AV fistula needles
measures static intra-access pressure, with no interruption of
therapy. These readings can be used to detect venous, mid-graft
and arterial inflow stenosis, which is the narrowing of a vein
or artery that restricts bloodflow.
The dialysis therapy market is mature, consolidated and
competitive. We compete with suppliers of hemodialysis and
peritoneal dialysis devices and certain dialysis device
manufacturers that also provide dialysis services. We currently
face direct competition in the United States primarily from
Fresenius Medical Care AG, or Fresenius, Baxter Healthcare, or
Baxter, Gambro AB, or Gambro, B. Braun and others. Fresenius,
Baxter and Gambro each have large and well-established dialysis
products businesses. Foreign competitors, such as Nipro Medical
Corporation and JMS CO., LTD, also compete with our needle and
blood tubing set businesses.
We believe the competition in the market for kidney dialysis
equipment and supplies is based primarily on:
For the home market, we believe that we compete favorably in
terms of product quality and ease of use due to our System One
design, portability, drop-in cartridge and use of premixed
fluids. We believe we also compete favorably on the basis of
clinical flexibility, given the System One’s ability to
work well in acute and chronic settings and to perform
hemofiltration, hemodialysis and ultrafiltration. We believe we
compete favorably in terms of cost-effectiveness for clinics.
Although our product is priced at a premium compared to some
competitive products in the market, we allow clinics to reduce
labor costs by offering their patients a home treatment
alternative. We compete unfavorably in terms of sales force
coverage and branding because we have a smaller sales force than
most of our competitors.
There is presently an increasing interest in the home
hemodialysis market from our key competitors. 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 relation to their 2006 acquisition of Renal
Solutions, Inc., and Baxter made them in relation to 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.
When additional viable products are introduced to the market, it
could adversely affect our sales and growth.
For the critical care market, we believe we compete favorably in
terms of product quality and ease of use due to our System One
design, portability, drop-in cartridge and use of premixed
fluids. As with the home market, we believe we also compete
favorably on the basis of clinical flexibility, given the System
One’s ability to perform hemofiltration, hemodialysis and
ultrafiltration. The fact that we are not indicated for
hemodiafiltration may be perceived by some clinicians as a
disadvantage of our system over others. We
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believe we compete favorably in terms of cost-effectiveness for
hospitals that perform continuous renal replacement therapies,
or CRRT. For those hospitals that do not perform CRRT or other
types of prolonged therapies, we compete unfavorably in terms of
cost-effectiveness. We compete unfavorably in terms of sales
force coverage and branding, because we have a smaller sales
force than most of our competitors. In the fluid overload
market, which is a very small component of our critical care
business, drug therapy is currently the most common and
preferred treatment. To date, ultrafiltration has not been
broadly adopted and, if the medical community does not accept
ultrafiltration as clinically useful, cost-effective and safe,
we will not be able to successfully compete against existing
pharmaceutical therapies.
For the in-center market, where we sell needles and blood tubing
sets, we believe that we compete favorably in terms of product
quality, ease-of-use, cost effectiveness, clinical flexibility
and performance. We also compete favorably in terms of branding,
as the the MDS Entities have been selling products to dialysis
centers for the treatment of ESRD since 1981. We compete
unfavorably in terms of sales force coverage, as we rely nearly
exclusively on distributors, rather than our own direct sales
force.
Our primary competitors are large, well-established businesses
with significantly more financial and personnel resources and
greater commercial infrastructures than we have. We believe our
ability to compete successfully will depend largely on our
ability to:
Our ability to successfully market our products for the
treatment of kidney failure could also be adversely affected by
pharmacological and technological advances in preventing the
progression of chronic ESRD
and/or in
the treatment of acute kidney failure, technological
developments by others in the area of dialysis, the development
of new medications designed to reduce the incidence of kidney
transplant rejection and progress in using kidneys harvested
from genetically-engineered animals as a source of transplants.
There can be no assurance that competitive pressure or
pharmacological or technological advancements will not have a
material adverse effect on our business.
We sell our products in three markets: home, in-center, and
critical care markets. Substantially all our revenue is
generated from sales to external customers in the United States.
We have a sales force that calls on dialysis clinics,
nephrologists and hospitals. In additions to specialized sales
representatives, we also employ nurses in our sales force to
serve as clinical educators to support our sales efforts. Our
marketing and sales efforts focus almost exclusively on the home
and critical care markets as we rely heavily on distributors to
sell our products in the in-center market. Henry Schein, Inc.,
or Henry Schein, is the primary distributor for our in-center
market. In 2008, sales to DaVita and Henry Schein represented
18% and 39% of our total revenues, respectively, and half of
Henry Schein’s sales of our products in 2008 were derived
from sales to DaVita. DaVita and Henry Schein are expected to
remain significant customers of ours in 2009. No other single
customer represented 10% or more of our revenues in 2008. In
2007, sales to DaVita and Henry Schein represented 20% and 22%
of our total revenues, respectively, and half of Henry
Schein’s sales of our products in 2007 were derived from
sales to DaVita. No other single customer represented 10% or
more of our revenues in 2007. In 2006, sales to DaVita
represented 19% of our total revenues. No other single customer
represented 10% or more of our revenues in 2006.
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We rent or sell the System One to customers in the home market.
In this market, our customers are independent dialysis clinics
as well as dialysis clinics that are part of national chains.
Since Medicare regulations require that all chronic ESRD
patients be under the care of a dialysis clinic, whether they
are treated at-home, in-clinic or with a kidney transplant, we
do not, and cannot, sell the System One directly to patients.
Currently, there are nearly 5,000 Medicare-certified dialysis
outpatient facilities in the United States. Ownership of these
clinics is highly consolidated with DaVita and Fresenius each
controlling approximately 30% of U.S. dialysis patients.
Smaller chains and independent clinics and hospitals represent
the approximately 40% of remaining clinics. Our customers
include independent clinics as well as large and smaller chains.
In February 2007, we entered into a national service provider
agreement with DaVita that grants DaVita certain market rights
for the System One and related supplies for home hemodialysis
therapy. Under this agreement, we granted DaVita 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 DaVita’s
meeting certain requirements, including patient volume
commitments and new patient training rates. We will continue to
sell to other clinics in the majority of geographies. The
agreement limits, but does not prohibit, the sale by NxStage of
the System One for chronic home 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. NxStage is, therefore, limited to
some extent in its ability to sell the System One for chronic
home hemodialysis therapy to Fresenius. Our national service
provider agreement with DaVita extends until December 31,
2009, DaVita has the option of renewing the agreement for four
additional periods of six months if DaVita meets certain patient
volume targets.
After renting or selling a System One to a clinic, our clinical
educators generally train the clinic’s nurses and dialysis
technicians on the proper use of the system using proprietary
training materials. We then rely on the trained technicians and
nurses to train home patients and other technicians and nurses
using the System One. This approach also allows the clinic and
physician to select, train and support the dialysis patients
that will use our system, much the same way as they manage their
patients who are on home peritoneal dialysis therapy.
We began marketing the System One to perform hemodialysis for
ESRD patients in September 2004, and we began marketing our
System One specifically for home use in July 2005, after the
System One was cleared by the FDA for home hemodialysis.
We sell the System One to customers in the critical care market.
The System One cycler is based on the same technology platform
used in the home market, but includes an additional display
module, called OneView, that is designed to facilitate easier
medical record charting and troubleshooting. In the critical
care market, because both acute kidney failure and fluid
overload are typically treated in hospital intensive care units,
our customers are hospitals. We are specifically focusing our
sales efforts in the critical care market on those large
institutions that we believe are most dedicated to increased and
improved dialysis therapy for patients with acute kidney failure
and believe in ultrafiltration as an earlier-stage treatment
option for fluid overload associated with multiple diseases,
including congestive heart failure, CHF.
After selling or placing a System One in a hospital, our
clinical educators train the hospital’s intensive care
unit, or ICU, and acute dialysis nurses on the proper use of the
system using proprietary training materials. We then rely on the
trained nurses to train other nurses. By adopting this
“train the trainer” approach, our sales nurses do not
need to return to the hospital each time a new nurse needs to be
trained.
We began promoting our System One product for use in the
critical care market in February 2003.
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We sell primarily blood tubing sets and needles to customers in
the in-center market. In this market, our customers are also
independent dialysis clinics as well as dialysis clinics that
are part of national chains. The majority of our sales in this
market are made through distributors, in order to leverage
national networks, shipping efficiencies, and existing customer
relationships. Sales through our primary distributor, Henry
Schein, accounted for 39% of net sales for the year ended
December 31, 2008. Our contract with Henry Schein expires
in July 2009. We and Henry Schein have provided notice of intent
to renew the contract and we are currently in discussions with
Henry Schein to extend or renew the contract.
DaVita is also a significant customer for our in-center
products. DaVita has an agreement to purchase our blood tubing
set products that expires in September 2009, and a separate
agreement for needles that expires in January 2013.
We plan production against distributor purchase orders. Finished
goods are shipped directly to distributor warehouses. Our
customer and clinic services team markets the tubing sets
and/or blood
access devices under the Medisystems brand name. To support
blood tubing set and needle sales, our clinic services personnel
regularly visit or call clinic operators.
We primarily use a depot service model for equipment servicing
and repair for the home market. If a device malfunctions and
requires repair, we arrange for a replacement device to be
shipped to the site of care, whether it is a patient’s
home, clinic or hospital, and for pick up and return to us of
the system requiring service. This shipment is done by common
carrier, and, as there are no special installation requirements,
the patient, clinic or hospital can quickly and easily set up
the new machine. In addition, we ship monthly supplies via
common carrier and courier services directly to home patients,
dialysis clinics and hospitals.
In addition to depot service, the critical care market also
demands field service calls for cycler servicing and repair. The
nature of the hospital environment, coupled with the practices
of other ICU dialysis equipment suppliers, frequently
necessitates
on-site
support for our systems installed in this environment.
We maintain telephone service coverage
24-hours a
day, seven days a week, to respond to technical questions raised
by patients, clinics and hospitals concerning all of our
products, including the System One, needles and blood tubing
sets.
Over 100 published articles have reported on the benefits of
daily dialysis therapy. Although most of these publications were
based on studies that did not use our product, the literature
strongly supports that daily hemodialysis therapy can lead to
improved clinical outcomes, including reduction in hypertension,
improved anemia status, reduced reliance on pharmaceuticals,
improved nutritional status, reduced hospitalizations and
overall improvement in quality of life.
In late 2005, we enrolled the first patient in our post-market
FREEDOM (Following Rehabilitation, Economics, and Everyday
Dialysis Outcome Measurements) study, which is designed to
quantify the clinical benefits and cost savings of daily home
therapy administered to Medicare patients with the System One
versus conventional thrice-weekly dialysis. The FREEDOM study is
a prospective, multi-center, observational study, which will
enroll up to 500 Medicare patients in up to 70 clinical centers.
Enrollment is ongoing. The study will compare Medicare patients
using the System One with a matched cohort of patients from the
United States Renal Data System, or USRDS, patient database
treated with traditional in-center thrice weekly dialysis, to
help define differences in the cost of care and patient outcomes
between the daily home setting and the dialysis clinic setting.
Comparing the study group of patients using the System One to a
USRDS database group matched in terms of demographics,
co-morbidities, geography, number of years on dialysis and other
key factors, should allow a valuable comparison to be made
without the time and cost challenges of a crossover study, in
which patients would be followed for a given time on each type
of therapy.
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Our goal is to provide further insights into more frequent
dialysis and its cost-effectiveness as well as to confirm the
significant reported potential benefits of daily therapy on
patient quality of life and rehabilitation. Published
U.S. government data estimates the total health care cost
burden of a Medicare dialysis patient at approximately $65,000
annually, with dialysis services representing approximately 25%
of this cost, while the cost of hospitalizations, drugs and
physician fees make up more than 50%. Studies indicate daily
therapy may materially reduce overall Medicare costs for the
care of chronic dialysis patients, particularly through reduced
hospitalization and drug costs.
Interim four month results from our ongoing FREEDOM study show
daily home hemodialysis treatment made possible by the System
One therapy significantly improves patient quality-of-life as
compared to conventional, thrice-weekly in-center treatment.
Specific improvements identified include a reduction in the
average time to resume normal activity, returning significant
quality time to patients each week. Other benefits include a
reduction in mild depressive symptoms. Numerous studies have
shown an association between depressive symptoms and patient
mortality and hospitalization.
More recently, we announced FDA approval of an investigational
device exemption, or IDE, study intended to support a home
nocturnal indication for the System One which started in the
first quarter of 2008. We hope to complete the study and submit
our application for a nocturnal indication to the FDA in late
2009.
In addition to the FREEDOM and nocturnal studies, we completed
two significant clinical trials with the System One for ESRD
therapy, a post-market study of chronic daily hemofiltration and
a study under an FDA-approved IDE. We also completed a study of
ultrafiltration with the System One for fluid overload
associated with CHF.
In the IDE study, we compared center-based and home-based daily
dialysis with the System One. That study was a prospective,
multi-center, two-treatment, two-period, open-label, cross-over
study. The first phase of the study consisted of 48 treatments,
six per week, in an eight-week period performed in-center, while
the second phase consisted of the same number of treatments
performed in an in-home setting. Between the two phases, there
was a two-week transition period conducted primarily in the
patient’s home. Prior to study initiation, enrolled
patients were to have been on at least two weeks of daily
hemodialysis with the System One in an in-center environment.
The objective of the study was to evaluate equivalence on a
per-treatment basis between the delivery of hemodialysis with
our system in-center and at home. The result of the
investigation showed that hemodialysis in each setting was
equivalent.
Our research and development organization has focused on
developing innovative technical approaches that address the
limitations of current dialysis systems and disposable products.
Our development team has skills across the range of technologies
required to develop and maintain dialysis systems and products.
These areas include filters, tubing sets, mechanical systems,
fluids, software and electronics. In response to physician and
patient feedback and our own assessments, we are continually
working on enhancements to our product designs to improve
ease-of-use, functionality, reliability and safety. We also seek
to develop new products that supplement our existing product
offerings and intend to continue to actively pursue
opportunities for the research and development of complementary
products.
For the years ended December 31, 2008, 2007 and 2006, we
incurred research and development expenses of $8.9 million,
$6.3 million and $6.4 million, respectively.
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Intellectual
Property
We seek to protect our investment in the research, development,
manufacturing and marketing of our products through the use of
patent, trademark, copyright and trade secret law. We own or
have rights to a number of patents, trademark, copyrights, trade
secrets and other intellectual property directly related and
important to our business.
As of December 31, 2008, we had 36 issued U.S. and
international patents, 1 issued European Union (EU), industrial
design registration and 43 U.S., international and foreign
pending patent applications.
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Patents for individual products extend for varying periods of
time according to the date a patent application is filed or a
patent is granted and the term of the patent protection
available in the jurisdiction granting the patent. The scope of
protection provided by a patent can vary significantly from
country to country.
In connection with the Medisystems Acquisition, we also acquired
exclusive license rights to a portfolio of patents. The licensed
patents fall into two categories: those that are used
exclusively by the MDS Entities, which we refer to as
Class A patents, and those patents that are used by the MDS
Entities and other companies owned by Mr. Utterberg, which
we refer to as the Class B patents. Pursuant to the terms
of our license agreement with DSU Medical Corporation, we have 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. This license agreement further
provides that our rights under the agreement are qualified by
certain sublicenses previously granted to third parties. We have
agreed that Mr. Utterberg will retain the right to royalty
income under one of these sublicenses.
15
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The following table lists all of the issued patents licensed by
us under the license agreement that are fundamental to the
manufacture and sale of the core products we sell to customers
in the in-center market.
In addition to the issued patents and pending patent
applications owned by us and the issued patents and patent
applications licensed to us, in the United States and selected
non-U.S. markets,
we possess trade secrets and proprietary know-how relating to
our products. Any of our trade secrets, know-how or other
technology not protected by a patent could be misappropriated,
or independently developed by, a competitor and could, if
independently invented and patented by a competitor, under some
circumstances, be used to prevent us from further use of such
information, know-how or technology.
Our strategy is to develop patent portfolios for our research
and development projects. We monitor the activities of our
competitors and other third parties with respect to their use of
intellectual property. We intend to aggressively defend the
patents we hold, and we intend to vigorously contest claims
other patent holders may bring against us.
The medical device industry is characterized by the existence of
a large number of patents and frequent litigation based on
allegations of patent infringement. While we attempt to ensure
that our products and methods do not infringe other
parties’ patents and proprietary rights, our competitors
may assert that our products, or the methods that we employ, are
covered by patents held by them. In addition, our competitors
may assert that future products and methods we may market
infringe their patents.
We require our employees, consultants and advisors to execute
confidentiality agreements in connection with their employment,
consulting or advisory relationship with us. We also require our
employees to agree to disclose and assign to us all inventions
conceived by them during their employment with us. Similar
obligations are imposed upon consultants and advisors performing
work for us relating to the design or manufacture of our
product. Despite efforts taken to protect our intellectual
property, unauthorized parties may attempt to copy aspects of
our products or to obtain and use information that we regard as
proprietary.
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The manufacture of our products is accomplished through a
complementary combination of outsourcing and internal
production. Specifically, we manufacture our System One Cycler
and some PureFlow SL hardware, and assemble, package and label
our PureFlow SL disposables within our facility in Fresnillo,
Mexico. We manufacture components used in our System One
cartridge assembly, and assemble the System One disposable
cartridge and some blood tubing sets, Medics and transducer
protectors in our facility in Tijuana, Mexico. We manufacture
our dialyzers in our Rosdorf, Germany facility. We outsource the
manufacture of premixed dialysate, needles, some blood tubing
sets and some PureFlow SL hardware.
We have a molding facility in Modena, Italy, which molds
components used in the products we manufacture ourselves in
Tijuana, Mexico, as well as supplies the molded components for
finished goods manufactured by Kawasumi Laboratories, Inc., or
Kawasumi, as described below.
We have single-source suppliers of components, but in most
instances there are alternative sources of supply available.
Where obtaining a second source is more difficult, we have tried
to establish supply agreements that better protect our
continuity of supply. These agreements, currently in place with
several key suppliers, are intended to establish commitments to
supply product. We do not have supply agreements in place with
all of our single-source suppliers.
We have certain agreements that grant certain suppliers
exclusive or semi-exclusive supply rights. We contract for the
manufacture of the majority of our finished goods of ReadySet
blood tubing sets and all our needles from Kawasumi,
headquartered in Tokyo, Japan, with manufacturing facilities in
Thailand. The current agreement with Kawasumi for the
manufacture of blood tubing sets expires in January 2010. Under
the terms of this agreement, we supply Kawasumi with molded
component parts and Kawasumi in turn uses these components to
manufacture finished goods blood tubing sets, which are then
purchased by us. We have committed to purchase from Kawasumi a
minimum quantity of blood tubing sets over the term of the
agreement. We believe that this minimum purchase commitment is
less than our anticipated requirements for blood tubing sets.
We also have an agreement with Kawasumi for the manufacture of
needle sets. Virtually all of these needle sets rely on our
patented guarded needle set technology. In February 2007, we
agreed with Kawasumi to extend their needle set supply agreement
through February 2011. We have committed to purchase from
Kawasumi a minimum quantity of needle sets over the three-year
extended term of the contract. We believe that this minimum
purchase commitment is less than our anticipated requirements
for needles.
In January 2007, we entered into a long-term supply agreement
with Membrana pursuant to which Membrana has agreed to supply,
on an exclusive basis for a period of ten years, the capillary
membranes that we use in the filters used with the System One
for ten years. Membrana has agreed to pricing reductions based
on volumes ordered and we have agreed to purchase a base amount
of membranes per year. The agreement may be terminated upon a
material breach, generally following a sixty day cure period.
We purchase bicarbonate-based premixed dialysate from B. Braun
Medizintechnologie GmbH, or B. Braun, and our lactate-based
premixed dialysate from Laboratorios PISA, or PISA. We have a
supply agreement with B. Braun that obligates B. Braun to supply
the dialysate to us through 2009 in exchange for a minimum
purchase commitment, which we believe is less than our
anticipated requirements. The contract may be terminated upon a
material breach, generally following a
30-day cure
period. Our supply agreement with PISA terminated at the end of
2008. We are currently purchasing products from PISA on a
purchase order basis as we negotiate a new agreement with PISA.
Government
Regulation
In the United States, our products are subject to regulation by
the FDA, which regulates our products as medical devices. The
FDA regulates the clinical testing, manufacture, labeling,
distribution, import and export, sale and promotion of medical
devices. Noncompliance with applicable FDA requirements can
result in,
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among other things, fines, injunctions, civil penalties, recall
or seizure of products, total or partial suspension of
production, failure of the government to grant pre-market
clearance or pre-market approval for devices, withdrawal of
marketing clearances or approvals and criminal prosecution.
Unless an exemption applies, all medical devices must receive
either prior 510(k) clearance or pre-market approval from the
FDA before they may be commercially distributed in the United
States. Submissions to obtain 510(k) clearance and pre-market
approval must be accompanied by a user fee, unless exempt. In
addition, the FDA can also impose restrictions on the sale,
distribution or use of devices at the time of their clearance or
approval, or subsequent to marketing.
The FDA classifies medical devices into one of three classes:
Class I, Class II or Class III —
depending on the FDA’s assessment of the degree of risk
associated with the device and the controls it deems necessary
to reasonably ensure the device’s safety and effectiveness.
The FDA has deemed our System One to be a Class II medical
device and we have marketed it as such in the United States.
Class I devices are those for which safety and
effectiveness can be assured by adherence to a set of general
controls, which include compliance with facility registration
and product listing requirements, reporting of adverse events,
and appropriate, truthful and non-misleading labeling,
advertising and promotional materials. Class II devices are
also subject to these same general controls, as well as any
other special controls deemed necessary by the FDA to ensure the
safety and effectiveness of the device. These special controls
can include performance standards, post-market surveillance,
patient registries and FDA guidelines. Pre-market review and
clearance by the FDA for Class II devices is accomplished
through the 510(k) pre-market notification procedure, unless the
device is exempt. When 510(k) clearance is required, a
manufacturer must submit a pre-market notification to the FDA
demonstrating that the proposed device is substantially
equivalent in intended use and in safety and effectiveness to a
legally marketed device that is not subject to premarket
approval, i.e., a device that was legally marketed prior to
May 28, 1976 and for which the FDA has not yet required
premarket approval; a device which has been reclassified from
Class III to Class II or I; or a novel device
classified into Class I or II through de novo
classification. If the FDA agrees that the device is
substantially equivalent to the predicate, it will subject the
device to the same classification and degree of regulation as
the predicate device, thus effectively granting clearance to
market it. After a device receives 510(k) clearance, any
modification that could significantly affect its safety or
effectiveness, or that would constitute a major change in its
intended use, requires a new 510(k) clearance or possibly a
pre-market approval. Class III devices are devices for
which insufficient information exists that general or special
controls will provide reasonable assurance of safety and
effectiveness, and the devices are life-sustaining,
life-supporting, or implantable, or of substantial importance in
preventing the impairment of human health, or present a
potential, unreasonable risk of illness or injury.
Class III devices requiring an approved pre-market approval
application to be marketed are devices that were regulated as
new drugs prior to May 28, 1976, devices not found
substantially equivalent to devices marketed prior to
May 28, 1976 and Class III
pre-amendment
devices, which are devices introduced in the U.S. market
prior to May 28, 1976, that by regulation require
pre-market approval.
We currently have all of the regulatory clearances required to
market the System One in the United States in both the home and
critical care markets. The FDA has cleared the System One for
the treatment, under a physician’s prescription, of renal
failure or fluid overload using hemofiltration, hemodialysis
and/or
ultrafiltration. The FDA has also specifically cleared the
System One for home hemodialysis use under a physician’s
prescription.
We received our first clearance from the FDA for a predecessor
model to the System One in January 2001 for hemofiltration
and ultrafiltration. In July 2003, we received expanded
clearance from the FDA for the System One for hemodialysis,
hemofiltration and ultrafiltration. Then in June 2005, we
received FDA clearance specifically allowing us to promote home
hemodialysis using the System One. To date we have received a
total of 25 product clearances from the FDA since our inception
in December 1998 for our System One and related products. We
continue to seek opportunities for product improvements and
feature enhancements, which will, from time to time, require FDA
clearance before market launch.
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We have received a total of 23 product clearances to market
Medisystems products that support the in-center market. These
clearances, the first of which was received in 1981, cover blood
tubing sets used for hemodialysis, needle sets used in
hemodialysis and apherisis, and other components such as
intravenous administration sites, Medics and transducer
protectors, used primarily for hemodialysis.
510(k) Clearance Pathway. When we are required
to obtain a 510(k) clearance for a device that we wish to
market, we must submit a pre-market notification to the FDA
demonstrating that the device is substantially equivalent to
(1) a device that was legally marketed prior to
May 28, 1976 and for which the FDA has not yet required
premarket approval; (2) a device which has been
reclassified from Class III to Class II or I; or
(3) a novel device classified into Class I or II
through de novo classification. The FDA attempts to respond to a
510(k) pre-market notification within 90 days of submission
of the notification (or in some instances 30 days under
what is referred to as “special” 510(k) submission),
but the response may be a request for additional information or
data, sometimes including clinical data. As a practical matter,
pre-market clearance can take significantly longer, including up
to one year or more.
After a device receives 510(k) clearance for a specific intended
use, any modification that could significantly affect its safety
or effectiveness, or that constitutes a major change in its
intended use, would require a new 510(k) clearance or could
require pre-market approval. In the first instance, the
manufacturer may determine that a change does not require a new
510(k) clearance. The FDA can review any such decision and can
disagree with a manufacturer’s determination. If the FDA
disagrees with a manufacturer’s determination that a new
clearance or approval is not required for a particular
modification, the FDA can require the manufacturer to cease
marketing
and/or
recall the modified device until 510(k) clearance or pre-market
approval is obtained.
Pre-market Approval Pathway. A pre-market
approval application must be submitted if the device cannot be
cleared through the 510(k) process. The pre-market approval
process is much more demanding than the 510(k) pre-market
notification process. A pre-market approval application must be
supported by extensive data and information including, but not
limited to, technical, preclinical and clinical trials,
manufacturing and labeling to demonstrate to the FDA’s
satisfaction the safety and effectiveness of the device. After
the FDA determines that a pre-market approval application is
complete, the FDA accepts the application and begins an in-depth
review of the submitted information. The FDA, by statute and
regulation, has 180 days to review an accepted pre-market
approval application, although the review generally occurs over
a significantly longer period of time, and can take up to
several years. During this review period, the FDA may request
additional information or clarification of information already
provided. Also during the review period, an advisory panel of
experts from outside the FDA may be convened to review and
evaluate the application and provide recommendations to the FDA
as to the approvability of the device. In addition, the FDA will
conduct a pre-approval inspection of the manufacturing facility
to ensure compliance with the Quality System Regulations. New
pre-market approval applications or supplemental pre-market
approval applications are required for significant modifications
to the manufacturing process, labeling, use and design of a
device that is approved through the pre-market approval process.
Pre-market approval supplements often require submission of the
same type of information as a pre-market approval application,
except that the supplement is limited to information needed to
support any changes from the device covered by the original
pre-market approval application, and may not require as
extensive clinical data or the convening of an advisory panel.
Clinical Trials. A clinical trial is almost
always required to support a pre-market approval application and
is sometimes required for a 510(k) pre-market notification.
Clinical trials for devices that involve significant risk,
referred to as significant risk devices, require submission of
an application for an IDE to the FDA. The IDE application must
be supported by appropriate data, such as animal and laboratory
testing results, showing that it is safe to test the device in
humans and that the testing protocol is scientifically sound.
Clinical trials for a significant risk device may begin once the
IDE application is approved by the FDA and the institutional
review board, or IRB, overseeing the clinical trial. If FDA
fails to respond to an IDE application within 30 days of
receipt, the application is deemed approved, but IRB approval
would still be required before a study could begin. Products
that are not significant risk devices are deemed to be “non-
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significant risk devices” under FDA regulations, and are
subject to abbreviated IDE requirements, including informed
consent, IRB approval of the proposed clinical trial and
submission of certain reports to the IRB. Clinical trials are
subject to extensive recordkeeping and reporting requirements.
Our clinical trials must be conducted under the oversight of an
IRB at each clinical study site and in accordance with
applicable regulations and policies including, but not limited
to, the FDA’s good clinical practice, or GCP, requirements.
After a device is placed on the market, numerous regulatory
requirements apply. These include, among others:
MDR Regulations. The MDR regulations require
that we report to the FDA any incident in which our product may
have caused or contributed to a death or serious injury, or in
which our product malfunctioned and, if the malfunction were to
recur, would likely cause or contribute to a death or serious
injury. To date, a majority of our MDRs have been submitted to
comply with FDA’s blood loss policy for routine dialysis
treatments. This policy requires manufacturers to file MDR
reports related to routine dialysis treatments if the patient
experiences blood loss greater than 20cc.
FDA Inspections. We have registered with the
FDA as a medical device manufacturer. The FDA seeks to ensure
compliance with regulatory requirements through periodic,
unannounced facility inspections and these inspections may
include the manufacturing facilities of our subcontractors.
Failure to comply with applicable regulatory requirements can
result in enforcement action by the FDA, which may include any
of the following:
The FDA has inspected our Lawrence, Massachusetts facility and
quality system three times. In our first inspection, one
observation was made, but was rectified during the inspection,
requiring 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
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Clearance or approval of our products by regulatory authorities
comparable to the FDA may be necessary in foreign countries
prior to marketing the product in those countries, whether or
not FDA clearance has been obtained. The regulatory requirements
for medical devices vary significantly from country to country.
They can involve requirements for additional testing and may be
time consuming and expensive. We have not sought approval for
our products outside of the United States, Canada and the
European Union, or EU. We cannot provide assurance that we will
be able to obtain regulatory approvals in any other markets.
The System One cycler and related cartridges are regulated as
medical devices in Canada under the Canadian Medical Device
Regulations and in the EU under the Medical Device Directive. We
have received four product licenses from Canada. We have
obtained CE marking approval in the EU for our System One.
However, we are not currently marketing the System One in the
European Union.
Our blood tubing sets, AV fistula needles, apheresis needles,
dialysis priming sets, transducer protectors, Reverso, and Medic
are regulated as medical devices in Canada under the Canadian
Medical Device Regulations and in the EU, under the Medical
Device Directive. We maintain six Medical Device Licenses in
Canada under the Medisystems brandname for these products. We
have received CE marking in the EU for AV fistula needles,
apheresis needles, Medic and its Reverso product. At this time
none of our other products sold to customers in the in-center
market have been approved for CE marking.
The federal healthcare program Anti-Kickback Statute prohibits
persons from knowingly and willfully soliciting, offering,
receiving or providing remuneration, directly or indirectly, in
exchange for or to induce either the referral of an individual
for, or the furnishing, arranging for or recommending a good or
service for which payment may be made in whole or part under a
federal healthcare program such as Medicare or Medicaid. The
definition of remuneration has been broadly interpreted to
include anything of value, including for example gifts,
discounts, the furnishing of supplies or equipment, credit
arrangements, payments of cash and waivers of payments. Several
courts have interpreted the statute’s intent requirement to
mean that if any one purpose of an arrangement involving
remuneration is to induce referrals or otherwise generate
business involving goods or services reimbursed in whole or in
part under federal healthcare programs, the statute has been
violated. The law contains a few statutory exceptions, including
payments to bona fide employees, certain discounts and certain
payments to group purchasing organizations. Violations can
result in significant penalties, imprisonment and exclusion from
Medicare, Medicaid and other federal healthcare programs.
Exclusion of a manufacturer would preclude any federal
healthcare program from paying for its products. In addition,
kickback arrangements can provide the basis for an action under
the Federal False Claims Act, which is discussed in more detail
below.
The Anti-Kickback Statute is broad and potentially prohibits
many arrangements and practices that are lawful in businesses
outside of the healthcare industry. Recognizing that the
Anti-Kickback Statute is broad and may technically prohibit many
innocuous or beneficial arrangements, the Office of Inspector
General of Health and Human Services, or OIG, issued a series of
regulations, known as the safe harbors, beginning in July 1991.
These safe harbors set forth provisions that, if all the
applicable requirements are met, will assure healthcare
providers and other parties that they will not be prosecuted
under the Anti-Kickback Statute. The failure of a transaction or
arrangement to fit precisely within one or more safe harbors
does not necessarily mean that it is illegal or that prosecution
will be pursued. However, conduct and business arrangements that
do not fully satisfy each applicable safe harbor may result in
increased scrutiny by government enforcement authorities such as
the OIG. Arrangements that implicate the Anti-Kickback Law, and
that do not fall within a safe harbor, are analyzed by the OIG
on a
case-by-case
basis.
Government officials have focused recent enforcement efforts on,
among other things, the sales and marketing activities of
healthcare companies, and recently have brought cases against
individuals or entities with personnel who allegedly offered
unlawful inducements to potential or existing customers in an
attempt to
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procure their business. Settlements of these cases by healthcare
companies have involved significant fines
and/or
penalties and in some instances criminal pleas.
In addition to the Federal Anti-Kickback Statute, many states
have their own anti-kickback laws. Often, these laws closely
follow the language of the federal law, although they do not
always have the same exceptions or safe harbors. In some states,
these anti-kickback laws apply with respect to all payors,
including commercial health insurance companies.
Federal false claims laws prohibit any person from knowingly
presenting, or causing to be presented, a false claim for
payment to the federal government or knowingly making, or
causing to be made, a false statement to get a false claim paid.
Manufacturers can be held liable under false claims laws, even
if they do not submit claims to the government, if they are
found to have caused submission of false claims. The Federal
Civil False Claims Act also includes whistle blower provisions
that allow private citizens to bring suit against an entity or
individual on behalf of the United States and to recover a
portion of any monetary recovery. Many of the recent highly
publicized settlements in the healthcare industry related to
sales and marketing practices have been cases brought under the
False Claims Act. The majority of states also have statutes or
regulations similar to the federal false claims laws, which
apply to items and services reimbursed under Medicaid and other
state programs, or, in several states, apply regardless of the
payor. Sanctions under these federal and state laws may include
civil monetary penalties, exclusion of a manufacturer’s
products from reimbursement under government programs, criminal
fines and imprisonment.
The Health Insurance Portability and Accountability Act of 1996,
or HIPAA, and the rules promulgated there under require certain
entities, referred to as covered entities, to comply with
established standards, including standards regarding the privacy
and security of protected health information, or PHI. HIPAA
further requires that covered entities enter into agreements
meeting certain regulatory requirements with their business
associates, as such term is defined by HIPAA, which, among other
things, obligate the business associates to safeguard the
covered entity’s PHI against improper use and disclosure.
While not directly regulated by HIPAA, a business associate may
face significant contractual liability pursuant to such an
agreement if the business associate breaches the agreement or
causes the covered entity to fail to comply with HIPAA. In the
course of our business operations, we have entered into several
business associate agreements with certain of our customers that
are also covered entities. Pursuant to the terms of these
business associate agreements, we have agreed, among other
things, not to use or further disclose the covered entity’s
PHI except as permitted or required by the agreements or as
required by law, to use reasonable safeguards to prevent
prohibited disclosure of such PHI and to report to the covered
entity any unauthorized uses or disclosures of such PHI.
Accordingly, we incur compliance related costs in meeting
HIPAA-related obligations under business associate agreements to
which we are a party. Moreover, if we fail to meet our
contractual obligations under such agreements, we may incur
significant liability.
In addition, HIPAA’s criminal provisions could potentially
be applied to a non-covered entity that aided and abetted the
violation of, or conspired to violate HIPAA, although we are
unable at this time to determine conclusively whether our
actions could be subject to prosecution in the event of an
impermissible disclosure of health information to us. Also, many
state laws regulate the use and disclosure of health
information, and are not necessarily preempted by HIPAA, in
particular those laws that afford greater protection to the
individual than does HIPAA. Finally, in the event we change our
business model and become a HIPAA covered entity, we would be
directly subject to HIPAA, its rules and its civil and criminal
penalties.
Medicare regulations require that all chronic ESRD patients be
under the care of a dialysis clinic, whether they are treated at
home or in-clinic. We rent or sell our System One to dialysis
clinics and sell our needles
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and blood tubing sets to dialysis clinics. These clinics are, in
turn, reimbursed by Medicare, Medicaid and private insurers.
According to the 2005 USRDS report, Medicare is the primary
payor for approximately 81% of patients using hemodialysis and
PD. It is believed that 15% of patients are covered by
commercial insurance, with the remaining 4% of patients
classified by the USRDS as “other” or
“unknown”. Certain centers have reported that the
NxStage daily home dialysis therapy attracts a higher percentage
of commercial insurance patients than other forms of dialysis.
Medicare. Medicare generally provides health
insurance coverage for persons who are age 65 or older and
for persons who are completely disabled. For ESRD patients,
however, Medicare coverage is not dependent on age or
disability. For patients eligible for Medicare based solely on
ESRD, generally patients under age 65, Medicare eligibility
begins three months after the month in which the patient begins
dialysis treatments. During this three-month waiting period
either Medicaid, private insurance or the patient is responsible
for payment for dialysis services. Medicare generally waives
this waiting period for individuals who participate in a
self-care dialysis training program, or are hospitalized for a
kidney transplant and the surgery occurs within a specified time
period.
For ESRD patients under age 65 who have any employer group
health insurance coverage, regardless of the size of the
employer or the individual’s employment status, Medicare
coverage is generally secondary to the employer coverage during
the 30-month
period that follows the establishment of Medicare eligibility or
entitlement based on ESRD. During the period, the patient’s
existing insurer is responsible for paying primary benefits at
the rate specified in the plan, which may be a negotiated rate
or the healthcare provider’s usual and customary rate. As
the secondary payor during this period, Medicare will make
payments up to the applicable composite rate for dialysis
services reimbursed based on the composite rate to supplement
any primary payments by the employer group health plan if the
plan covers the services but pays only a portion of the charge
for the services.
Medicare generally is the primary payor for ESRD patients after
the 30-month
period. Under current rules, Medicare is also the primary payor
for ESRD patients during the
30-month
period under certain circumstances. Medicare remains the primary
payor when an individual becomes eligible for Medicare on the
basis of ESRD if, (1) the individual was already
age 65 or over or was eligible for Medicare based on
disability and (2) the individual’s private insurance
coverage is not by reason of current employment or, if it is,
the employer has fewer than 20 employees in the case of
eligibility by reason of age, or fewer than 100 employees
in the case of eligibility by reason of disability. The rules
regarding entitlement to primary Medicare coverage when the
patient is eligible for Medicare on the basis of both ESRD and
age, or disability, have been the subject of frequent
legislative and regulatory changes in recent years and there can
be no assurance that these rules will not be unfavorably changed
in the future.
When Medicare is the primary payor for services furnished by
dialysis clinics, it reimburses dialysis clinics for 80% of the
composite rate, leaving the secondary insurance or the patient
responsible for the remaining 20%. The Medicare composite rate
is set by Congress and is intended to cover virtually all costs
associated with each dialysis treatment, excluding physician
services and certain separately billable drugs and laboratory
services. There is some regional variation in the composite
rate, but, the national average for the last three quarters of
2008 was $152 per treatment for independent clinics and $157 per
treatment for hospital-based dialysis facilities. This was an
increase from approximately $149 per treatment for independent
clinics and $154 per treatment for hospital-based dialysis
facilities in 2006, due to two recent changes in Medicare
reimbursement. As a result of legislation enacted in 2003 and
first implemented in 2005, the Centers for Medicare and Medicaid
Services, or CMS, shifted a portion of Medicare reimbursement
dollars for dialysis from separately billable drugs to the
composite rate for dialysis services. This drug add-on to the
composite rate is subject to an increase based on the estimated
rate of growth of drugs and biologicals. For 2007, an additional
0.5% has been shifted from separately billable drugs to the
composite rate. In addition, Congress passed an additional 1.6%
increase to the composite rate for treatments received on or
after April, 2007. For 2008, CMS again shifted an additional
0.5% from separately billable drugs to the composite rate such
that the 2008 national average composite rate is about $153 per
treatment for independent clinics and about $158 per treatment
for hospital-based dialysis facilities. Depending upon patient
case mix, reimbursement may be further improved, based on the
case-mix adjustment to the composite rate implemented as a
result of the 2003
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legislation. Under the case-mix adjustment, Medicare now pays
more for larger patients and those under the age of 65. This may
be beneficial to our customers, as to date our patient
population has tended to be younger and larger than the ESRD
national average. CMS has announced that it will implement a new
“bundled” payment for dialysis treatment in 2011 where
Medicare reimbursement for billable drugs and other treatment
costs will be rolled into one composite rate. It is not possible
at this time to determine what impact this will have on the
adoption of home
and/or daily
hemodialysis.
CMS rules limit the number of hemodialysis treatments paid for
by Medicare to three per week, unless there is medical
justification provided by the patient’s physician, for the
additional treatments. The determination of medical
justification must be made at the local Medicare contractor
level on a
case-by-case
basis. A clinic’s 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 clinic’s patients.
Medicaid. Medicaid programs are
state-administered programs partially funded by the federal
government. These programs are intended to provide coverage for
certain categories of patients whose income and assets fall
below state defined levels and who are otherwise uninsured. For
those who are eligible, the programs serve as supplemental
insurance programs for the Medicare co-insurance portion and
provide certain coverage, for example, self-administered
outpatient prescription medications, that is not covered by
Medicare. For ESRD treatment, state regulations generally follow
Medicare reimbursement levels and coverage without any
co-insurance amounts, which is pertinent mostly for the
three-month waiting period. Certain states, however, require
beneficiaries to pay a monthly share of the cost based upon
levels of income or assets.
Private Insurers. Some ESRD patients have
private insurance that covers dialysis services. Healthcare
providers receive reimbursement for ESRD treatments from the
patient or private insurance during a waiting period of up to
three months before the patient becomes eligible for Medicare.
In addition, if the private payor is an employer group health
plan, it is generally required to continue to make primary
payments for dialysis services during the
30-month
period following eligibility or entitlement to Medicare. In
general, employers may not reduce coverage or otherwise
discriminate against ESRD patients by taking into account the
patient’s eligibility or entitlement to Medicare benefits.
It is generally believed that private insurance pays
significantly more for dialysis services than Medicare and these
patients with private insurance are generally viewed as more
profitable to dialysis service providers.
For Medicare patients, both acute kidney failure and fluid
overload therapies provided in an in-patient hospital setting
are reimbursed under a traditional diagnosis related group, or
DRG, system. Under this system, reimbursement is determined
based on a patient’s 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, could increase the amount
reimbursed. The longer hospitalization stays and higher labor
needs, which are typical for patients with acute kidney failure
and fluid overload, must be managed for care of these patients
to be cost-effective. We believe that there is a significant
incentive for hospitals to find a more cost-efficient way to
treat these patients in order to improve hospital economics for
these therapies.
As of December 31, 2008, we had 1,260 full-time
employees, 11 part-time employees and 16 seasonal or
temporary employees. From time to time we also employ
independent contractors to support our engineering, marketing,
sales, clinical and administrative organizations.
Our Annual Report on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K
and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of
1934 are available free of charge through our website
(www.nxstage.com) under the “Investor Information”
caption as soon as reasonably practicable after we
electronically file such material with, or
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furnish it to, the Securities and Exchange Commission, or SEC.
In addition, we intend to disclose on our website any amendments
to, or waivers from, our code of business conduct and ethics
that are required to be disclosed pursuant to the rules of the
SEC. We are not including the information contained on our
website as part of, or incorporating it by reference into, this
report. You may read and copy materials that we have filed with
the SEC at the SEC’s public reference room located at
450 Fifth Street, N.W., Washington, D.C. 20549. In
addition, our SEC filings are available to the public on the
SEC’s website (www.sec.gov).
In addition to the factors discussed in “Management’s
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
Since our inception, we have devoted a substantial amount 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 2009 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 disposable products acquired
in the Medisystems Acquisition, 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 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 2006, 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 don’t 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.
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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 provider supply costs associated with providing more
frequent dialysis versus conventional three-times per week
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. The new Conditions for Coverage impose water testing
requirements on our patients using our PureFlow SL product.
These 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 have experienced negative operating margins and cash flows
from operations and we expect to continue to incur net losses in
the foreseeable future. In addition, our System One home market
relies heavily upon a rental sales model whereby approximately
half of our sales to customers in the home market include the
rental rather than the purchase 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 equipments needs. However,
it is not clear whether we will be able to replicate this sales
model with a significant number of other customers in the
future. In addition to these cash requirements, at the beginning
of 2009, we commenced paying down the principal in 2009 on the
debt we borrowed under our credit and security agreement with
GE. We believe, based on current projections, that we have the
required resources to fund operating requirements beyond 2009
provided that we further restructure our repayment schedule on
our current credit and security agreement with GE. Future
capital requirements will depend on many factors, including
availability of credit, the rate of revenue growth, continued
progress on improving gross margins, the expansion of selling
and marketing activities and research and development
activities, the timing and extent of expansion into new
geographies or territories, the timing of new product
introductions and enhancement to existing products, the
continuing market acceptance of products, and potential
investments in, or acquisitions of complementary businesses,
services or technologies. There is no assurance that additional
debt or equity capital will be available to us on favorable
terms, if at all.
If we sell additional equity or issue debt securities to fund
future capital requirements, it will likely result in dilution
to our stockholders, and we cannot be certain that additional
public or private financing will be available in amounts or on
terms acceptable to us, or at all. If we are unable to obtain
additional financing
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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.
Since inception, we have incurred losses every quarter and at
December 31, 2008, we had an accumulated deficit of
approximately $233.2 million. We expect to incur increasing
operating expenses as we continue to grow our business.
Additionally, while we have achieved positive gross margins for
our products, in aggregate, since the fourth quarter of 2007, we
cannot 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, growing revenue, 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 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 patient’s 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 over 70% of all of our home patients. We continue to
work to improve product reliability, and to introduce PureFlow
SL product design enhancements that will reduce 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.
We have completed the transition of manufacturing of our Cycler
and PureFlow SL equipment to Mexico and continue to transfer
servicing to Mexico in order to take advantage of lower labor
costs. Any failure or unforeseen difficulties in connection with
these transitions or to maintain or improve product reliability
in the process, would adversely affect our ability to achieve
profitability.
We
entered into a credit and security agreement in November 2007,
and as of December 31, 2008, we had borrowed $30 million
there under. We may not be able to borrow the full amount
available under that credit facility, and we are obligated to
repay principal on the amounts we have already borrowed under
that credit facility in 2009 and beyond. 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 there under 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 subsequently acquired by GE,
for a term of 42 months. The credit and security agreement
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. In March 2009, the Company amended its
credit and security agreement with GE. The amendment postponed
principal payments under the term loan for three months, from
April through June 2009, and modified certain covenants and the
interest rate on the term loan and revolving credit facility. In
connection with this amendment, we also granted our facility
lenders a security interest in all of our
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intellectual property, increasing the collateral securing this
facility to include nearly all of our assets. Borrowings under
the term loan, as amended in March 2009, bear interest at a rate
of 11.12% per annum. Interest on the term loan is paid on a
monthly basis and principal payments of $9.1 million,
$14.0 million and $6.9 million are due in 2009, 2010
and 2011, respectively. 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 6.5%
per annum with a LIBOR floor of 4.0%. 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 and security agreement, as amended, includes
covenants that (a) require us to achieve certain minimum
net revenue and certain minimum adjusted consolidated EBITDA
targets and maintain certain minimum liquidity, including
revolving loan availability, unrestricted cash, cash reserved
for compliance with this covenant and cash equivalents,
(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.
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, had been subject to an import hold
imposed by the FDA on its acute and chronic dialysis machines.
Since the import hold has lifted, competition from Gambro has
increased, which could impair our performance in the future in
the critical care market.
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
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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.
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:
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 is expected 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.
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The world’s financial markets are currently experiencing
significant turmoil, resulting in reductions in available
credit, increased costs of credit, increased volatility in
security prices, rating downgrades of investments and reduced
valuations of securities generally. These events have
materiality and adversely impacted the availability of financing
to a wide variety of businesses and the resulting uncertainty
has led to reductions in capital investments, overall spending
levels and future product plans and sales projections. In
general, we believe demand for our products in the home and
in-center market will not be substantially affected by the
current market conditions as regular dialysis is a
life-sustaining, non-elective therapy. However, revenues in the
in-center market could be impacted as distributors look to
better manage inventory levels. In addition, the impact of
tightened credit markets on hospitals could impair the manner in
which we sell equipment in the critical care market or delay
equipment placements. Hospitals facing pressure to reduce
capital spending may choose to rent equipment rather than
purchase it outright, or to enter into other less-capital
intensive purchase structures with us, which may, in turn, have
a negative impact on our cash flows.
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 broad 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 customer’s 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
provided by the patient’s physician 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 clinic’s 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
clinic’s patients. Medicare is 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. In 2011, CMS has announced that it will
implement a new “bundled” payment for dialysis
treatment. It is not possible at this time to determine what
impact this will have, if any, on the adoption of home
and/or daily
hemodialysis.
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
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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.
We continue to experience product reliability issues associated
with our System One and PureFlow SL 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.
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.
Fresenius and DaVita own and operate the two largest chains of
dialysis clinics in the United States. Fresenius controls
approximately 30% of the U.S. dialysis clinics and is the
largest worldwide manufacturer of dialysis systems. DaVita
controls approximately 30% of the U.S. dialysis clinics,
and has entered into a preferred supplier agreement with Gambro
that expires in 2015 pursuant to which Gambro will provide a
significant majority of certain of DaVita’s dialysis
supplies through 2015. 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 DaVita’s 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.
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As of December 31, 2008, approximately 50% 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.
DaVita is our most significant customer. Sales through
distributors to DaVita of products accounted for nearly half of
In-Center segment revenues in the year ended December 31,
2008, and direct sales to DaVita accounted for approximately 35%
of our System One segment revenues in the year ended
December 31, 2008. Our contract for blood tubing sets and
needles with DaVita includes certain minimum order requirements;
however, these can be reduced significantly under certain
circumstances. DaVita’s commitment to purchase blood tubing
sets was originally set to expire in September 2008. However, in
September 2008, prior to the expiration of the contract, we
signed an amendment to the DaVita agreement which extended the
term with respect to blood tubing sets for one year through
September 2009. We cannot guarantee we will be able to negotiate
a new contract with DaVita or an additional extension of the
existing agreement on favorable terms, if at all, or the extent
to which DaVita will purchase our products. DaVita’s
preferred supplier agreement with Gambro may impair our ability
to obtain DaVita’s blood tubing set business beyond
September 2009. NxStage’s 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 DaVita’s ordering or
clinical practices can have a significant impact on our
revenues, especially in the near term.
While kidney transplantation is the treatment of choice for most
ESRD patients, it is not currently a viable treatment for
most-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.
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. In addition, the impact
of tightened credit markets on hospitals could impair the manner
in which we sell products in the Critical Care market. Hospitals
facing pressure to reduce capital spending may choose to delay
capital equipment purchases or seek alternative financing
options. One of our competitors in the critical care market,
Gambro AB, had been subject to an
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FDA import hold that was lifted in late 2007. Since the import
hold has lifted, competition from Gambro has increased, which
could impair our performance in the future in the critical care
market.
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. 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. In addition, due to the
recent tightening of global credit and the disruption in the
financial markets, there may be a disruption in our insurance
coverage or delay or disruption in the payment of claims by our
insurance providers. 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 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 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 Euro, Peso and
Thai Baht,. 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. Kawasumi’s
contractual obligation to manufacture blood tubing sets expires
in 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. In May 2008
we negotiated
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a new agreement with Kawasumi extending their obligation to
supply blood tubing sets to us through January 31, 2010. We
cannot be certain that this 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. Kawasumi’s
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.
We sell the majority of our In-Center products through three
distributors, which collectively accounted for substantially all
of In-Center revenues for the year ended December 31, 2008,
with our primary distributor, Henry Schein, accounting for
approximately 80% of In-Center revenues for the year ended
December 31, 2008. Our distribution agreement with Henry
Schein expires in July 2009. The contracts with the other two
distributors of our In-Center products are scheduled to expire
in July 2011 and July 2009. We cannot be certain that these
agreements will be renewed or extended beyond their term on
favorable terms, if at all. Our relationship with Henry 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 60%
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, DaVita’s preferred supplier
agreement with Gambro may impair our ability to obtain
DaVita’s blood tubing set business beyond the expiration of
our blood tubing set agreement with DaVita that expires in
September 2009.
The
activities of our business involve 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 Germany, 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 Germany, 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
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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.
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.
We
have filed a resale registration statement covering shares of
our common stock that we recently sold in a private placement.
If the holders of these shares are unable to sell the shares
under the registration statement, we may be obligated to pay
them damages, which could harm our financial
condition.
We recently sold an aggregate of 9,555,556 shares of our
common stock and warrants to purchase an additional
1,911,111 shares of our common stock in a private
placement. We were required to register the common stock and the
common stock issuable upon exercise of the warrants with the
Securities and Exchange Commission, which we did on
August 8, 2008. If the holders of the shares or the
accompanying warrant shares are unable to sell such shares or
warrant shares under the registration statement for more than
30 days in any 365 day period after the effectiveness
of the registration statement, we may be obligated to pay
damages equal to up to 1% of the share purchase price per month
that the registration statement is not effective and the
investors are unable to sell their shares.
Risks
Related to the Regulatory Environment
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.
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
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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 FDA’s 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.
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 FDA’s 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:
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
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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.
Our finished goods manufacturing processes, and those of some of
our contract manufacturers, are required to comply with the
FDA’s 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.
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
patient’s 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.
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
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ultimate effect on us. Our business could be adversely affected
by future healthcare reforms or changes in Medicare.
Presently we do not sell or market the System One outside the
United States and Canada, but we intend to look to other markets
in the future. Our Medisystems products are presently sold in
the United States as well as in several other countries, through
distributors. In order to market directly 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.
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 customer’s
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
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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.
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.
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.
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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 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.
Our prior agreement with PISA expired late in 2008. We are
currently negotiating a new agreement with PISA. We can not be
certain that this agreement will be entered into on favorable
terms that we would be able to obtain lactate based bagged
premixed dialysate from another third party supplier on
favorable terms, if at all, that we would be able to meet our
customer demand for bagged premixed dialysate, either through a
third party or by manufacturing bagged premixed dialysate
ourselves, or some combination thereof, the failure of any of
which would likely impair our business.
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
Membrana, for fiber, we are contractually prevented from
obtaining an alternative source of supply for our System One
products. 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. Oil prices affect both the pricing and
availability of this material. 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.
We currently incur significant inbound and outbound distribution
costs. Our distribution costs are dependent upon fuel prices.
Increases in fuel prices could lead to increases in our
distribution costs, which could impair our ability to achieve
profitability.
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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.
Our wholly-owned subsidiary in Italy has a national labor
contract with Contratto collettivo nazionale di lavoro per gli
addetti all’industria della gomma cavi elettrici ed affini
e all’industria delle materie plastiche, and our
wholly-owned subsidiary in Mexico has entered into a collective
bargaining agreement with a Union named Mexico Moderno de
Trabajadores de la Baja California C.R.O.C. We have 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 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 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.
We continue to develop new products and make improvements to
existing products. We have also relocated the manufacture of
certain of our products to Mexico. 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.
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:
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
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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 December 31, 2008, we had 43 pending patent
applications, including foreign, international and
U.S. applications, and 37 U.S. and international
issued patents. Under our license agreement with DSU Medical
Corporation, we also license approximately 38 pending patent
applications, including foreign, international and
U.S. applications, and approximately 83 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.
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:
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
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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.
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
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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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 company’s 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.
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:
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 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
46,548,585 shares of common stock outstanding as of
December 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 465,486 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.
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At December 31, 2008, subject to certain conditions,
holders of an aggregate of approximately 24,280,888 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 December 31, 2008, 7,013,406 shares of common
stock are authorized for issuance under our stock incentive
plan, employee stock purchase plan and outstanding stock
options. As of December 31, 2008, 5,437,097 shares
were subject to outstanding options, of which 2,737,861 were
exercisable and which can be freely sold in the public market
upon issuance, subject to the restrictions imposed on our
affiliates under Rule 144.
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 65% of our outstanding common stock.
David S. Utterberg, one of our directors, holds approximately
18% 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:
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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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.
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.
Not Applicable.
We are headquartered in Lawrence, Massachusetts, where we lease
approximately 45,000 square feet under a lease expiring in
2012. We have manufacturing facilities consisting of a
118,000 square foot facility in Tijuana, Mexico with a
lease expiring in 2011, a 32,000 square foot facility in
Modena, Italy with a lease expiring in 2012, a
35,000 square foot facility through our relationship with
Entrada with a lease expiring in 2012, and a 12,369 square
foot facility in Rosdorf, Germany with a term expiring in 2011.
We believe that our existing facilities are adequate for our
current needs and that suitable additional or alternative space
will be available at such time as it becomes needed on
commercially reasonable terms. In addition to these facilities
we lease a number of small offices for administrative purposes.
From time to time we may be a party to various legal proceedings
arising in the ordinary course of our business. We are not
currently subject to any material legal proceedings.
No matters were submitted to a vote of our security holders
during the fourth quarter of the fiscal year ended
December 31, 2008.
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EXECUTIVE
OFFICERS OF THE REGISTRANT
The following is a list of names, ages and background of our
executive officers as of December 31, 2008:
Jeffrey H. Burbank has been our President and Chief
Executive Officer and a director of the Company since December
1998. Prior to joining NxStage, Mr. Burbank was a founder
and the CEO of Vasca, Inc., a medical device company that
developed and marketed a new blood access device for dialysis
patients. Mr. Burbank also served in roles of increasing
responsibility in areas of manufacturing, and sales and
marketing at Gambro, a leading dialysis products company.
Mr. Burbank is on the Board of the National Kidney
Foundation. He holds a B.S. from Lehigh University.
Robert S. Brown has been our Senior Vice President, Chief
Financial Officer and Treasurer since November 2006. Prior to
joining NxStage, Mr. Brown held several leadership
positions in Boston Scientific’s financial group including
Vice President, Corporate Analysis & Control from 2005
until he joined us in 2006, where he and his team were
responsible for Boston Scientific’s financial, compliance
and operational audits and reported directly to the Audit
Committee of the Board of Directors. Mr. Brown also served
as Vice President, International from 1999 through 2004, where
he was responsible for the financial functions of Boston
Scientific’s international division in over forty
countries. Previous experience also includes financial reporting
and special projects at United Technologies and public
accounting and consulting at Deloitte & Touche. He
holds a B.B.A. degree in Accounting from the University of
Toledo and an M.B.A. from the University of Michigan, and is a
certified public accountant.
Tom Shea has been our Senior Vice President of
Manufacturing Operations since March 2008. Prior to joining
NxStage, he held several leadership positions at Jabil
Incorporated, a $12 billion Tier I contract
manufacturer. Most recently, Tom served as Jabil’s Global
Business Unit Manager, supporting clients in the aerospace,
defense and telecommunications industries. In this capacity, he
developed and implemented global operations, logistics and
pricing strategies for his sector. He previously served as
Operations Manager at Jabil where he had full plant profit and
loss responsibility for their Massachusetts facility.
Mr. Shea earned his M.B.A. at The University of
Massachusetts and his B.S. in Production and Operations
Management at Bryant University.
Winifred L. Swan has been our Senior Vice President since
January 2005 and our Vice President and General Counsel since
November 2000. From July 1995 to November 2000, Ms. Swan
was Senior Corporate Counsel at Boston Scientific Corporation.
She holds a B.A., cum laude , in Economics and Public Policy
from Duke University and a J.D., cum laude and Order of the Coif
, from the University of Pennsylvania Law School.
Joseph E. Turk, Jr. has been our Senior Vice
President, Commercial Operations since January 2005 and our Vice
President, Sales and Marketing since May 2000. From August 1998
to May 2000, Mr. Turk was employed at Boston Scientific
Corporation as Director of New Business Development.
Mr. Turk holds an A.B. degree in Economics from Wabash
College and an M.B.A. in Marketing and Finance from Northwestern
University’s Kellogg School of Management.
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Michael J. Webb has been our Senior Vice President of
Quality, Regulatory and Clinical Affairs since August 2007, Vice
President of Disposables Operations from January 2007 through
August 2007, Vice President of Quality Assurance and Regulatory
Affairs from July 2002 through January 2007, and our Vice
President of Operations from July 2001 through July 2002. Prior
to joining NxStage, Mr. Webb was Vice President of
Operations for Mosaic Technologies, a developer of gene-based
diagnostic products. Other previous positions include Director
of Operations for TFX Medical and Director of Disposables
Manufacturing and Logistics for Haemonetics Corporation.
Mr. Webb received a B.S. degree in Industrial and
Management Engineering and his M.B.A. in Manufacturing
Management from Rensselaer Polytechnic Institute.
Our common stock has been quoted on the NASDAQ Global Market
under the symbol “NXTM” since July 1, 2006 and
prior to that was quoted on the NASDAQ National Market since
October 27, 2005. Prior to that time, there was no public
market for our stock. The following table sets forth, for the
periods indicated, the high and low intraday sale prices of our
common stock.
On March 3, 2009, the last reported sale price of our
common stock was $2.55 per share. As of March 3, 2009,
there were approximately 74 holders of record of our common
stock and approximately 3,400 beneficial holders of our common
stock.
We have never paid or declared any cash dividends on our common
stock. We anticipate that we will retain our earnings for future
growth and therefore do not anticipate paying cash dividends in
the future. Our credit and security agreement with GE restricts
our ability to pay dividends.
We made no repurchases of our equity securities during the
fourth quarter ended December 31, 2008.
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The following performance graph and related information shall
not be deemed “soliciting material” or to be
“filed” with the Securities and Exchange Commission,
nor shall such information be incorporated by reference into any
future filing under the Securities Act of 1933 or Securities
Exchange Act of 1934, each as amended, except to the extent that
we specifically incorporate it by reference into such filing.
The comparative stock performance graph below compares the
cumulative stockholder return on our common stock for the period
from the first day that our common stock was publicly traded,
October 27, 2005, through December 31, 2008 with the
cumulative total return on (i) the Total Return Index for
the Nasdaq Stock Market (U.S. Companies), which we refer to
as the Nasdaq Composite Index, and (ii) the Nasdaq Medical
Equipment Index. This graph assumes the investment of $100 on
October 27, 2005 in our common stock, the Nasdaq Composite
Index and the Nasdaq Medical Equipment Index and assumes all
dividends are reinvested. Measurement points are the last
trading days of the years ended December 31, 2008 and 2007,
the quarters ended March 31, 2008 and 2007, June 30,
2008 and 2007 and September 30, 2008 and 2007.
* $100 invested on 10/27/05 in stock or 9/30/05 in index,
including reinvestment of dividends.
Fiscal year ending December 31.
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SELECTED
CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be
read together with the information under “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” and our consolidated financial statements and
the notes to those consolidated financial statements included
elsewhere in this Annual Report. The selected statements of
operations data for the years ended December 31, 2008, 2007
and 2006 and balance sheet data as of December 31, 2008 and
2007 set forth below have been derived from our audited
consolidated financial statements included elsewhere in this
Annual Report on
Form 10-K.
The selected statements of operations data for the years ended
December 31, 2005 and 2004 and balance sheet data as of
December 31, 2006, 2005 and 2004 set forth below have been
derived from the audited consolidated financial statements for
such years not included in this Annual Report.
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We are 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. Our
primary product, the 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. Given its design, the System One
is particularly well-suited for home hemodialysis and more
frequent, or “daily,” dialysis, which clinical
literature suggests provides patients better clinical outcomes
and improved quality of life. The System One is cleared by the
United States Food and Drug Administration, or FDA, for home
hemodialysis as well as hospital and clinic-based dialysis.
Following our acquisition of Medisystems Corporation and certain
of its affiliated entities, 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. 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 report the results of our operations in two segments: the
System One segment and the In-Center segment. The business we
acquired in connection with our Medisystems Acquisition
constitutes the operations of the In-Center segment. This
acquisition was not completed until October 1, 2007, and
therefore, we did not realize In-Center segment revenues until
the fourth quarter of 2007.
We distribute our products in three markets: the home, critical
care and in-center. In the System One segment we derive our
revenues from the sale and rental of equipment and the sale of
disposable products in the home and critical care markets. We
define the home market as the market devoted to the treatment of
ESRD patients in the home and the critical care market as the
market devoted to the treatment of hospital-based patients with
acute kidney failure or fluid overload. In the In-Center
segment, we derive our revenues from the sale of needles and
blood tubing sets primarily used for in-center dialysis
treatments.
Within the System One segment, we offer a similar technology
platform of the System One for the home and critical care
markets with different features. 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 market,
although nearly all sales in the In-Center segment 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
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United States. In late 2003, we initiated sales of the System
One for the 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 the acquisition of Medisystems Corporation and certain
affiliated entities, collectively the MDS Entities. With that
acquisition, we acquired our needle and blood tubing set product
lines for use predominantly in hemodialysis performed in-center
as well as apheresis. The In-Center segment is significantly
more mature than our System One segment. Our MDS Entities have
been selling products to dialysis centers for the treatment of
ESRD since 1981, and they have 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 Airless Blood Tubing sets.
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 product 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 typically from Medicare, and to a
lesser degree from private insurers. Medicare provides
comprehensive and well-established reimbursement in the United
States for ESRD. Reimbursement claims for 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 patient’s primary diagnosis. Medicare
presently limits reimbursement for chronic hemodialysis to three
treatments per week, absent a finding of medical justification.
Because most of our System One home dialysis patients are
treated more than three times a week, expanding Medicare
reimbursement over time to cover more frequent therapy may be
critical to 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 manufacture our System One Cycler
and some PureFlow SL hardware, and assemble, package and label
our PureFlow SL disposables within our Fresnillo, Mexico
facility. We manufacture components used in our System One
cartridge assembly, and assemble the System One disposable
cartridge and some blood tubing sets, Medics and transducer
protectors in Tijuana, Mexico. We manufacture our dialyzers in
Rosdorf, Germany. We outsource the manufacture of premixed
dialysate, needles, some blood tubing sets and some PureFlow 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. At present, we
believe we have an appropriately sized sales force, although
this may change as market conditions warrant.
Since inception, we have incurred losses every quarter and at
December 31, 2008, we had an accumulated deficit of
approximately $233.2 million. We expect our operating
expenses to continue to increase as we grow our business. While
we have achieved positive gross margins for our products, in
aggregate, since the fourth quarter of 2007, we cannot 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
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improvements to lower the costs of manufacturing our products,
obtaining better purchasing terms and prices, accessing lower
labor cost markets for the manufacture of our products, growing
revenue, increasing reliability of our products, improving our
field equipment utilization, achieving efficiencies in
manufacturing and supply chain overhead costs, achieving
efficiencies in the distribution of our products and achieving a
sufficient scale of operations.
We have experienced negative operating margins and cash flows
from operations and expect to continue to incur net losses in
the foreseeable future based on our projections. On
March 16, 2009, we amended certain terms under our current
credit and security with GE. We believe, based on current
projections, that we have the required resources to fund
operating requirements beyond 2009 provided that we further
restructure our repayment schedule on our current credit and
security agreement with GE. Future capital requirements will
depend on many factors, including the availability of credit,
rate of revenue growth, continued progress on improving gross
margins, the expansion of selling and marketing and research and
development activities, the timing and extent of expansion into
new geographies or territories, the timing of new product
introductions and enhancement to existing products, the
continuing market acceptance of products, and potential
investments in, or acquisitions, of complementary businesses,
services or technologies. There is no assurance that additional
debt or equity capital will be available to us on favorable
terms, if at all.
Statement
of Operations Components
In the System One segment we derive our revenues from the sale
and rental of equipment and the sale of disposable products in
the home and critical care markets. In the critical care market,
we sell the System One and related disposables to hospital
customers. In the home market, customers 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 segment, 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 customer contracts under which
we supply the use of hardware and disposables needed to perform
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 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
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 home market, we expect, at least in the near term, that
the majority of dialysis providers will choose to rent rather
than purchase the System One. As of December 31, 2008, we
had deferred approximately $29.6 million of revenues
related to the sale of equipment in the home market.
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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. We expect, at
least in the near term, as hospitals face increased pressure to
reduce capital spending, more of our sales will include the
rental rather than the sale of our System One hardware than we
have experienced in the past. As our business matures, we are
starting to derive a small amount of revenue from the sale of
one and two 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.
Our In-Center segment revenues are highly concentrated in
several significant purchasers. Revenues from Henry Schein our
primary distributor, represented approximately 80% of our
In-Center segment revenues during both 2008 and 2007, as
measured from October 1, 2007. Revenues from our two other
significant distributors over the same periods were
approximately 20% and 10%, respectively, of our In-Center
segment revenues. Sales to DaVita, through Henry 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. DaVita’s purchase obligations with respect to needles
expire in January 2013. Its purchase obligations with respect to
blood tubing sets expire in September 2009.
Our distribution contracts for our In-Center segment contain
minimum volume commitments with negotiated pricing triggers at
different volume tiers. Future demand for our products is
expected to remain strong in the long-term as chronic dialysis
is a life-sustaining, non-elective therapy. However, we expect
demand in the short-term will be susceptible to some variations
as distributors look to better manage inventory levels. 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 Henry Schein, our primary distributor for the
In-Center segment, will expire in July 2009 and our
agreements with the other primary two distributors for the
In-Center segment are scheduled to expire in July 2011 and July
2009, respectively. We and Henry Schein have provided notice of
intent to renew the agreement and we are currently in
discussions with Henry Schein to extend or renew the agreement.
However, we have no assurance that we will be able to negotiate
an extension of any of these agreements.
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 our 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 additional process and product design changes that
have inherently lower cost than our current products. Second,
although substantially complete, we plan to continue the
transition of some service capabilities pertaining to certain
products, including the System One cycler and PureFlow SL, to
lower labor cost markets. Third, we expect to continue to
improve product reliability, which would reduce service costs.
Finally, we anticipate that increased sales volume and
realization of economies of scale will lead to better purchasing
terms and prices and efficiencies in manufacturing and supply
chain overhead costs. We cannot, however, guarantee that our
expectations will be achieved with respect to our cost reduction
plans.
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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 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 agreements with our customers, salary, benefits and
stock-based compensation for distribution personnel and the cost
of any equipment lost or damaged in the distribution process. 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
under warranty from customers back to our service center for
repair 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. We cannot predict the estimated impact, if any, of
fuel costs on future distribution costs.
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 of 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 foot usage. We expect that general and administrative
expenses will continue to increase in the near term as we add
additional administrative support for our business.
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The following table presents, for the periods indicated,
information expressed as a percentage of revenues. This
information has been derived from our consolidated statements of
operations included elsewhere in this Annual Report on
Form 10-K.
You should not draw any conclusions about our future results
from the results of operations for any period.
Comparison
of Years Ended December 31, 2008 and 2007 (in thousands,
except percentages)
Our revenues for 2008 and 2007 were as follows (in thousands,
except percentages):
The increase in revenues was attributable to the addition of the
In-Center segment as a result of the Medisystems Acquisition and
increased sales and rentals of the System One and related
disposables in both the critical care and home markets,
primarily as a result of increased patient count as we continue
to penetrate the marketplace.
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In the home market, revenue increased $18.5 million, or
62%, in 2008 compared to 2007 as a result of an increase in the
number of patients using and centers offering the System One.
Critical care market revenue increased $4.2 million, or
29%, in 2008 compared to 2007 as a result of an increase in
hospitals purchasing and using the System One.
Revenue in the In-Center segment was $61.9 million for the
twelve months ended December 31, 2008 and
$15.7 million for the three months ended December 31,
2007. We completed the Medisystems Acquisition on
October 1, 2007 and do not have comparable results for the
In-Center segment for the twelve months ended December 31,
2007.
Our cost of revenues for 2008 and 2007 were as follows (in
thousands, except percentages):
The increase in cost of revenues was attributable primarily to
increased sales volume in the home and critical care markets and
the addition of the In-Center segment as a result of the
Medisystems acquisition. Gross margin increased to 16% in 2008
compared to a deficit of 10% in 2007. The improvement in gross
margin is a result of the Medisystems Acquisition, manufacturing
cost improvements to the System One equipment and disposables
and the leveraging of our manufacturing overhead. Additionally,
we incurred a one time charge of $2.0 million relating to a
voluntary recall of our chronic cartridges during 2007. We
expect cost of revenue will continue to decrease as a percentage
of revenue as we continue to introduce manufacturing cost
improvements, improve product reliability and leverage
manufacturing overhead.
Our selling and marketing expenses for 2008 and 2007 were as
follows (in thousands, except percentages):
The increase in selling and marketing expense was primarily the
result of the increase in salary, benefits, payroll taxes and
stock- based compensation for the additional selling and
marketing personnel and the addition of the In-Center segment as
a result of the Medisystems acquisition. Total headcount related
expenses increased $5.0 million in 2008 compared to 2007.
In addition, travel expense and consulting increased
$1.4 million in 2008 compared to 2007. We anticipate that
selling and marketing expenses will continue to increase in
absolute dollars, but decrease as a percentage of revenue 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.
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Our research and development expenses for 2008 and 2007 were as
follows (in thousands, except percentages):
The increase in research and development expense was primarily
the result of an increase in headcount and related salary,
benefits, payroll taxes and stock-based compensation for
research and development personnel from 2007 to 2008 and
increased clinical trials expenses. Total headcount related
expenses increased $2.1 million in 2008 compared to 2007.
We expect research and development expenses will increase in
absolute dollars but decrease as a percentage of sales 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.
Our distribution expenses for 2008 and 2007 were as follows (in
thousands, except percentages):
Distribution expense was 11% of revenue in 2008 compared to 22%
in 2007. The decreased cost of distribution as a percentage of
revenue was due to lower cost of distribution for the In-Center
segment as well as improved shipping rates resulting from our
efforts to successfully negotiate better shipping terms, better
product reliability resulting in fewer expedited shipments and
reduction in cost of shipping bagged fluids as we convert more
patients to our PureFlow SL products. We expect that
distribution expenses as a percentage of sales will continue to
decrease due to further distribution efficiencies gained from
increased business volume and density of customers within
geographic areas, the reduction of higher cost monthly
deliveries associated with bagged fluid due to the lower monthly
volumes of disposables on our PureFlow SL module and improved
product reliability.
Our general and administrative expenses for 2008 and 2007 were
as follows (in thousands, except percentages):
The increase in general and administrative expenses in 2008
compared to 2007 was primarily due to $2.8 million of
amortization of intangible assets acquired in the Medisystems
Acquisition and an increase in headcount and associated
infrastructure costs of $2.8 million and professional
services including legal, tax and audit fees of
$0.5 million.
General and administrative expenses as a percentage of revenue
decreased to 15% in 2008 compared to 22% in 2007. The decrease
was due to our continued initiative to leverage our overhead
structure.
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Interest income decreased $2.4 million, or 83%, in 2008
compared to 2007 due to decreased cash and investments which
were used to fund operations and lower interest rates on
investments. Interest income is derived primarily from
investments in money market funds.
Interest expense increased $2.8 million, or 251%, in 2008
compared to 2007 due to an increase in outstanding borrowings.
Interest expense is derived primarily from borrowings under our
credit and security agreement with GE that we entered into in
November 2007.
The change in fair value of the warrants issued on May 22,
2008 and August 1, 2008 in connection with the private
placement resulted in the recognition of a $3.2 million
gain and the change in fair value of the obligation entered into
on May 22, 2008 in connection with the second tranche
resulted in the recognition of a $0.7 million loss during
2008. The obligation relating to the second tranche was settled
on August 1, 2008 and the fair value on settlement of
$0.6 million was recorded in equity. The exercise price of
the warrants was fixed at $5.50 per share on December 31,
2008 based on the Company’s ability to achieve over 3,100
ESRD patients prescribed to receive therapy using the System
One. As a result, beginning January 1, 2009, the warrants
will be classified in equity and will no longer result in the
recognition of changes in fair value in earnings.
The provision for income taxes of $0.4 million in 2008 and
$0.1 million in 2007 relates to the profitable operations
of certain of our foreign entities acquired in the Medisystems
Acquisition on October 1, 2007.
Comparison
of Years Ended December 31, 2007 and 2006 (in thousands,
except percentages)
Our revenues for 2007 and 2006 were as follows (in thousands,
except percentages):
The increase in revenues was attributable to increased sales and
rentals of the System One and related disposables of
$23.4 million in both the critical care and home markets,
primarily as a result of increased sales and marketing efforts
as we continue to commercialize the System One, and
$15.7 million of In-Center segment sales following the
closing of our Medisystems Acquisition on October 1, 2007.
Revenues in the home market increased to $29.8 million for
2007 compared to $12.7 million in 2006, an increase of
134%, while revenues in the critical care market increased 78%
to $14.4 million in 2007, compared to $8.1 million in
2006. Revenues in the In-Center segment represented
$15.7 million for the three months ended December 31,
2007. We do not have comparable results for 2006 because we
completed the Medisystems Acquisition on October 1, 2007.
Our cost of revenues and gross deficit for 2007 and 2006 were as
follows (in thousands, except percentages):
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The increase in cost of revenues was attributable primarily to
our increased revenues from the home and critical care markets,
the cost of sales associated with the Medisystems Acquisition, a
charge of $2.0 million associated with our home cartridge
recall in August 2007, and $1.6 million for the
write-up of
Medisystems inventory to fair value less a reasonable profit on
remaining efforts to sell. The increase in product cost of
approximately $39.8 million from 2006 to 2007 was due
primarily to the Medisystems Acquisition and the increase in
revenues in the System One segment. In addition, cost of
revenues increased during the twelve months ended
December 31, 2007 as compared to the same period in 2006
due to a larger employee base that resulted in additional
salaries, health benefits and payroll taxes of
$2.8 million, increased inbound freight costs of
$2.0 million to support our higher production volume,
increased service costs of $1.3 million, and the
unfavorable impact of the declining dollar $0.4 million. We
continue to see incremental improvement in our direct product
costs; however, this is currently being partially offset
somewhat by an increase in disposable usage per patient and
overhead costs due to product reliability issues. We expect that
over time as our reliability improves and as we implement
further design enhancements, the disposables per patient and
overhead support costs will decline.
Our selling and marketing expenses for 2007 and 2006 were as
follows (in thousands, except percentages):
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 2006 to 2007. Total compensation and
associated travel costs increased by $6.3 million.
Professional service fees for our scientific advisory board,
process improvements, and reimbursement efforts increased by
$0.5 million. We anticipate that selling and marketing
expenses will continue to increase in absolute dollars as we
broaden our marketing initiatives to increase public awareness
of the System One in the home market and our other products,
particularly Streamline in the In-Center segment, and as we add
additional sales support personnel.
Our research and development expenses for 2007 and 2006 were as
follows (in thousands, except percentages):
The slight decrease in research and development expenses during
the year ended December 31, 2007 compared to the same
period in 2006 was attributable to a shift in spending from
research and development efforts associated with PureFlow SL
module to an increase in clinical efforts associated with our
Freedom study. 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, but we do not expect that research and
development expenses will increase as rapidly as other expense
categories as we have substantially completed
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basic development of the System One. We expect research and
development expenses to continue to decline as a percentage of
revenues.
Our distribution expenses for 2007 and 2006 were as follows (in
thousands, except percentages):
The increase in distribution expenses for the twelve months
ended December 31, 2007 compared to the same period in 2006
was due primarily to an increased volume of shipments of
disposable products to a growing number of patients in the home
market, the delivery of additional product, on an expedited
basis due to reliability issues, the delivery of product on an
expedited basis due to periodic inventory shortages, and the
increased equipment deliveries for the PureFlow SL module. We
expect that distribution expenses will increase at a lower rate
than revenues due to expected shipping efficiencies gained from
increased business volume and density of customers within
geographic areas, the reduction of higher cost monthly
deliveries associated with bagged fluid due to the lower monthly
volumes of disposables on our PureFlow SL module and improved
product reliability.
Our general and administrative expenses for 2007 and 2006 were
as follows (in thousands, except percentages):
The increase in general and administrative expenses during the
twelve months ended December 31, 2007 compared to the same
period in 2006 was primarily due to an increase of
$2.2 million of professional fees, $0.7 million for
the amortization of intangible assets acquired in the
Medisystems Acquisition, $0.4 million of headcount related
expenses including salary, benefits, payroll taxes and
stock-based compensation, due to increased headcount to support
growth of infrastructure, $0.5 million relating to the
acquired Medisystems business and $0.5 million of other
corporate expenses. The increased professional fees related to
increased legal expenses associated with higher contract
activity in 2007, increased professional fees associated with
acquisition related services for Medisystems, and increased
hiring activity for board and senior level positions. We expect
that general and administrative expenses will continue to
increase in the near term as we add support structure for our
growing business.
Interest income is derived primarily from U.S. government
securities, certificates of deposit, commercial paper and money
market accounts. For the year ended December 31, 2007,
interest income decreased by $0.4 million due to decreased
cash and investments over the comparable period ending
December 31, 2006.
For the year ended December 31, 2007, interest expense
increased by $0.1 million over the comparable period ending
December 31, 2006 due to our credit and security agreement
with GE. We expect interest expense will increase due to the new
credit facility we entered into in November 2007.
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The provision for foreign income taxes of $0.1 million
relates to our operations of the foreign entities we acquired in
the Medisystems Acquisition on October 1, 2007. We expect
the expense will increase in 2008 as we will own these foreign
entities for a full year.
Liquidity
and Capital Resources
We have operated at a loss since our inception in 1998. As of
December 31, 2008, our accumulated deficit was
$233.2 million and we had cash and cash equivalents of
approximately $26.6 million.
On May 22, 2008, we entered into a $43 million private
placement agreement to sell an aggregate of 9.6 million
shares of our common stock at a price of $4.50 per share and
warrants to purchase 1.9 million shares of our common stock
at an exercise price of $5.50 per share. The first tranche of
the financing, consisting of approximately 5.6 million
newly-issued and unregistered shares of common stock and
warrants to purchase 1.1 million shares of our common
stock, was sold on May 28, 2008 for aggregate gross
proceeds of $25.0 million to certain accredited investors
managed by a single advisor, OrbiMed Advisors LLC. The second
tranche, consisting of 4.0 million shares and warrants to
purchase 0.8 million shares of common stock, was sold on
August 1, 2008 for aggregate gross proceeds of
$18 million to existing NxStage institutional investors.
The proceeds from both tranches of the financing, net of
transaction costs were approximately $42.3 million.
The exercise price of the warrants was fixed at $5.50 per share
on December 31, 2008 based on the Company’s ability to
achieve over 3,100 ESRD patients prescribed to receive therapy
using the System One. The warrants have a term of 5 years
and expire on May 28, 2013 and August 1, 2013 for the
first and second tranche respectively. The warrants also contain
a net share settlement feature that is available to investors
once the underlying shares are registered. Additional provisions
require the Company, in the event of a change of control, to pay
promptly to the warrant holder an amount calculated by the
Black-Scholes option pricing formula. Such payment is required
to be in cash or shares in the same proportion that other
stockholders receive in such change of control transaction.
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 subsequently acquired by GE,
for a term of 42 months. The credit facility 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. On
March 16, 2009, we amended our credit and security
agreement with GE. The amendment postponed principal payments
under the term loan for three months, from April through June
2009, and modified certain covenants and the interest rate on
the term loan and revolving credit facility. In connection with
this amendment, we also granted our facility lenders a security
interest in all of our intellectual property, increasing the
collateral securing this facility to include nearly all of our
assets. Borrowings under the term loan, as amended in March
2009, bear interest at a rate of 11.12% per annum. Interest on
the term loan is paid on a monthly basis and principal payments
of $9.1 million, $14.0 million and $6.9 million
are due in 2009, 2010 and 2011, respectively. 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
6.5% per annum with a LIBOR floor of 4.0%. 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 and security agreement, as amended, includes
covenants that (a) require us to achieve certain minimum
net revenue and certain minimum adjusted consolidated EBITDA
targets and maintain certain minimum liquidity, including
revolving loan availability, unrestricted cash, cash reserved
for compliance with this covenant and cash equivalents,
(b) place limitations on our and our subsidiaries’
ability to incur debt, (c) place
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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 are in compliance with all
debt covenants as of December 31, 2008.
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 System One and related supplies for home
hemodialysis therapy. Under the agreement, DaVita committed to
purchase all of its existing System One equipment then 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. DaVita has since
sold those shares.
We maintain postemployment benefit plans for employees in
certain foreign subsidiaries. The plans provide lump sum
benefits, payable based on statutory regulations for voluntary
or involuntary termination. Where required, we obtain an annual
actuarial valuation of the benefit plans. We have recorded a
liability of $1.4 million as other long-term liabilities at
December 31, 2008 for costs associated with these plans.
The expense record in connection with these plans was not
significant during 2008 or 2007.
On June 14, 2006, we closed a follow-on public offering in
which we received net proceeds, after deducting underwriting
discounts, commissions and expenses, of approximately
$51.3 million from the sale and issuance of
6.3 million shares of common stock.
On November 1, 2005, we closed our initial public offering
in which we received net proceeds, after deducting underwriting
discounts, commissions and expenses, of approximately
$56.0 million from the sale and issuance of
6,325,000 shares of common stock. Prior to the initial
public offering, we had financed our operations primarily
through private sales of redeemable convertible preferred stock
resulting in aggregate net proceeds of approximately
$91.9 million as of December 31, 2005.
The following table sets forth the components of our cash flows
for the periods indicated (in thousands):
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 requirements for production and placements
of the System One and PureFlow SL hardware, offset by increases
in deferred revenue related to equipment sales in the home
market. Non-cash transfers from inventory to field equipment for
the placement of rental units with our customers represented
$22.8 million, $32.3 million and $18.6 million,
respectively, during the years ended December 31, 2008,
2007 and 2006.
Net Cash Provided by (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. Net maturities of
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short-term investments were $1.1 million in 2008 and
$10.7 million in 2007. This activity varies from period to
period based upon our cash requirements and investments. During
2007 net cash provided by investing activities included
$2.7 million of cash, net of acquisition costs, acquired
from Medisystems at the close of the transaction on
October 1, 2007.
Net Cash Provided by Financing Activities. Net
cash provided by financing activities during 2008 included
$5.0 million of additional borrowings under our credit and
security agreement with GE and $42.3 million net proceeds
from the sale of 9.6 million shares of our common stock and
warrants to purchase 1.9 million shares of our common
stock. Net cash provided by financing activities during 2007
included $19.9 million of net proceeds received from the
sale to DaVita of our common stock, $2.7 million of
proceeds from the exercise of stock options and warrants and net
borrowings of $17.6 million. Net cash provided by financing
activities during 2006 included $51.3 million of net
proceeds received from the follow-on public offering that closed
in June 2006, $1.5 million of proceeds from the exercise of
stock options and warrants and net borrowings of
$4.0 million.
We have experienced negative operating margins and cash flows
from operations and we expect to continue to incur net losses in
the foreseeable future. On March 16, 2009, we amended
certain terms under our current credit and security agreement
with GE. We believe, based on current projections, that we have
the required resources to fund operating requirements beyond
2009 provided that we further restructure our repayment schedule
on our current credit and security agreement with GE. Future
capital requirements will depend on many factors, including the
availability of credit, rate of revenue growth, continued
progress on improving gross margins, the expansion of selling
and marketing activities and research and development
activities, the timing and extent of expansion into new
geographies or territories, the timing of new product
introductions and enhancement to existing products, the
continuing market acceptance of products, and potential
investments in, or acquisitions of complementary businesses,
services or technologies. There is no assurance that additional
debt or equity capital will be available to us on favorable
terms, if at all.
The following table summarizes our contractual commitments as of
December 31, 2008 and the effect those commitments are
expected to have on liquidity and cash flow in future periods
(in thousands):
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.
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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 Annual Report
on
Form 10-K.
We recognize revenues from product sales and services when
earned in accordance with Staff Accounting
Bulletin No. 104 or SAB, No. 104, Revenue
Recognition, and Emerging Issues Task Force Issue,
Revenue Arrangements with Multiple Deliverables, or
EITF 00-21.
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.
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 binding customer
purchase orders and fixed payment terms. Rental arrangements
continue to represent approximately half 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 multiple-element sales arrangements 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 on that date. 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. We
recognized revenue of $0.4 million in both 2008 and 2007
associated with the amortization of the $3.0 million
premium.
In the critical care market, sales are structured as direct
product sales or as disposables-based programs 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
allowing us 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.
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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 the In-Center segment, nearly all sales are structured
through supply and distribution contracts with distributors. Our
distribution contracts for the In-Center segment 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 segment 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.
Inventories are valued at the lower of cost 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 consists of equipment being utilized under
disposable-based rental agreements as well as “service
pool” cyclers. Service pool cyclers are cyclers owned and
maintained by us that are swapped for cyclers that need repairs
or maintenance by us while being rented or owned by a patient.
We continually monitor the number of cyclers in the service
pool, as well as cyclers that are in-transit or otherwise not
being used by a patient, and assess whether there are any
indicators of impairment for such equipment.
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 periodically for
reasonableness. Factors considered in determining the
reasonableness of the useful life include industry practice and
the typical amortization periods used for like equipment, the
frequency and scope of service returns and the impact of planned
design improvements. We also review field equipment carrying
value for reasonableness. We consider factors such as actual
equipment disposals and our ability to verify the
equipment’s existence in the field to identify lost
equipment. Charges for lost equipment are included in
distribution expenses.
Stock-based compensation expense is estimated as of the grant
date based on the fair value of the award and is recognized as
expense on a straight-line basis over the requisite service
period, which generally equals the vesting period, net of
forfeitures. Forfeiture rates are estimated based on historical
pre-vesting forfeiture history and are updated on a quarterly
basis to reflect actual forfeitures of unvested awards and other
known events. We use the Black-Scholes option-pricing model to
estimate the fair value of our stock options and the quoted
market price of our common stock at the time of grant to
estimate the fair value of our restricted stock
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units. We have used the following assumptions in the
Black-Scholes option-pricing model to estimate the fair value of
equity-based compensation awards:
Expected Term — the expected term has been determined
using the simplified method, as defined in Staff Accounting
Bulletin No. 107, for estimating expected option life
of “plain-vanilla” options. Unless otherwise
determined by the Board or the Compensation Committee, stock
options granted under the 2005 Stock Incentive Plan have a
contractual term of seven years, resulting in an expected term
of 4.75 years calculated under the simplified method.
Risk-Free Interest Rate — the risk-free interest rate
for each grant is equal to the U.S. Treasury rate in effect
at the time of grant for instruments with an expected life
similar to the expected option term.
Volatility — our volatility assumption is based on a
combination of the stock volatility experienced by similar
companies in the medical device and technology industries and
the historical volatility of our publically traded stock over a
period of time that approximates the expected term of the
options.
We record tangible and intangible assets acquired and
liabilities assumed in recent business combination under the
purchase method of accounting. Amounts paid for each acquisition
are allocated to the assets acquired and liabilities assumed
based on their fair values at the dates of acquisition. We then
allocate the purchase price in excess of net tangible assets
acquired to identifiable intangible assets based on detailed
valuations that use information and assumptions provided by
management. We allocate any excess purchase price over the fair
value of the net tangible and intangible assets acquired and
liabilities assumed to goodwill. We have also used the income
approach, as described above, to determine the estimated fair
value of certain other identifiable intangibles assets including
developed technology, customer relationships and tradenames.
Developed technology represents patented and unpatented
technology and know-how. Customer relationships represent
established relationships with customers, which provides a ready
channel for the sale of additional products and services.
Tradenames represent acquired product names that we intend to
continue to utilize.
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.
Furthermore, periodically we assess whether our 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.
We account for goodwill in accordance with
SFAS No. 142, Goodwill and Other Intangible
Assets, or SFAS 142. SFAS 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 at the reporting unit level. Goodwill may be
considered impaired if we determine that the carrying value of
our reporting unit, including goodwill, exceeds the reporting
unit’s fair value. When testing goodwill for impairment we
primarily look to the fair value of the System One segment. We
estimate reporting unit fair value using a discounted cash flow
approach which requires the use of assumptions and judgments
including estimates of future cash flows and the selection of
discount rates. Changes in these estimates and assumptions could
materially affect the estimated fair values of reporting units.
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We account for federal and state income taxes in accordance with
SFAS No. 109, Accounting for Income Taxes, or
SFAS 109. Under the liability method specified by
SFAS 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.
Due to uncertainty surrounding the realization of deferred tax
assets through future taxable income, we have provided a full
valuation allowance and no benefit has been recognized for the
net operating loss and other deferred tax assets. Accordingly, a
valuation allowance for the full amount of the deferred tax
asset has been established as of December 31, 2008 and 2007
to reflect these uncertainties.
We adopted Financial Accounting Standards Board, or FASB,
Interpretation No. 48, Accounting for Uncertainty in
Income Taxes, on January 1, 2007. Under FIN 48, we
recognize the tax benefit from an uncertain tax position only if
it is more likely than not that the tax position will be
sustained upon examination by the taxing authorities, based on
the technical merits of the tax position. The tax benefits
recognized in our financial statements from such a position are
measured based on the largest benefit that has a greater than
50% likelihood of being realized upon ultimate resolution. For
those income tax positions where it is not more likely than not
that a tax benefit will be sustained, no tax benefit is
recognized in the financial statements.
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
Company’s tax years remain open to examination by the major
taxing jurisdictions to which the Company is subject.
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 with no resulting gain or loss recognized.
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. Utterberg’s
aggregate ownership of our outstanding common stock increased to
approximately 20%. 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 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 0.5 million of the
Acquisition Shares remain in escrow to cover potential
indemnification claims we 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 wholly-owned subsidiary of ours, we acquired rights under
an existing license agreement between Medisystems Corporation
and DSU Medical Corporation, or DSU, a Nevada corporation, which
is wholly-owned by Mr. Utterberg. 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
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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 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 during the term of
the agreement. 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 during the term of the agreement, 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. We paid Mr. Utterberg and DSU
$0.2 million and $0.1 million in fees during 2008 and
2007, respectively, for consulting services 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 of
$0.1 million and the one-time payment for the establishment
of the royalty-free license agreement of $2.7 million. We
paid $2.0 million of the liability owed during the quarter
ended March 31, 2008 and the remaining liability of
$0.6 million, net of receivable from DSU for reimbursements
of costs related to the acquisition of $0.2 million, during
the quarter ended September 30, 2008.
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.
On May 22, 2008, the Company entered into Securities
Purchase Agreement relating to a private placement of shares of
its common stock and warrants to purchase shares of its common
stock. The private placement took place in two closings, on
May 28, 2008 and August 1, 2008, and raised
$25.0 million and $18.0 million, respectively, in
gross proceeds. Participants in the private placement consist of
unaffiliated accredited institutional investors and affiliated
accredited institutional investors. One of these investors, the
Sprout Group, is affiliated with one of the Company’s Board
members, Dr. Philippe O. Chambon. Under applicable rules of
the NASDAQ Global Market, the second closing of the private
placement, which included all shares issued to the Sprout Group
and other affiliated accredited institutional investors, was
subject to stockholder approval, which was obtained at a special
meeting on July 31, 2008
Consistent with the requirements of our Audit Committee Charter,
these transactions were reviewed and approved by our Audit
Committee, which is comprised solely of independent directors,
as well as our Board of Directors.
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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 above.
Effective January 1, 2008, we adopted the provisions of
SFAS No. 157, Fair Value Measurements, or
SFAS 157, for financial assets and liabilities. We will
adopt the provisions of SFAS 157 for non-financial assets
and liabilities that are measured or recognized at fair value on
a non-recurring basis on January 1, 2009, in accordance
with the partial deferral of this standard by FASB. We are
currently evaluating the effects the provisions of SFAS 157
will have on non-financial assets and liabilities that are
measured or recognized at fair value on a non-recurring basis.
SFAS 157 defines fair value, establishes a framework for
measuring fair value under accounting principles generally
accepted in the United States of America, and enhances
disclosures about fair value measurements. Fair value is defined
under SFAS 157 as the exchange price that would be received
for an asset or paid to transfer a liability (an exit price) in
the principal or most advantageous market for the asset or
liability in an orderly transaction between market participants
on the measurement date. The adoption of SFAS 157 had no
impact on previously reported results as all of the provisions
were adopted prospectively.
We also adopted the provisions of SFAS No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities, or SFAS 159, effective January 1,
2008. SFAS 159 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. We have opted not to apply the fair value option to any
financial assets or liabilities in 2008.
In December 2007, the Financial Accounting Standards Board, or
FASB, issued Statement No. 141(R), Business Combination,
or SFAS 141(R), a replacement of
SFAS No. 141. SFAS 141(R) is effective for fiscal
years beginning on or after December 15, 2008 and applies
to all business combinations. SFAS 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,
SFAS 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; (4) changes in deferred
tax asset valuation allowances and income tax uncertainties
after the acquisition date generally will affect income tax
expense; and (5) in order to accrue for a restructuring
plan in purchase accounting, the requirements in
SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, would have to be met at the
acquisition date. SFAS 141(R) is effective on a prospective
basis for all business combinations for which the acquisition
date is on or after the beginning of the first annual period
subsequent to December 15, 2008, with the exception of the
accounting for valuation allowances on deferred taxes and
acquired tax contingencies. We have not determined the effect
that the adoption of SFAS 141(R) will have on our
consolidated financial statements, but the effect will generally
be limited to future acquisitions in 2009, except for certain
tax treatment of previous acquisitions. SFAS 141(R) amends
SFAS 109 such that adjustments made to valuation allowances
on deferred taxes and acquired tax contingencies associated with
acquisitions that closed prior to the effective date of
SFAS 141(R) would also follow the provisions of
SFAS 141(R).
In December 2007, the 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 SFAS 123R.
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.
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In March 2008, the FASB issued SFAS No. 161,
Disclosures About Derivative Instruments and Hedging
Activities, or SFAS 161. SFAS 161 enhances the
disclosure requirements for derivative instruments and hedging
activities. This Standard is effective January 1, 2009.
Since SFAS 161 requires only additional disclosures
concerning derivatives and hedging activities, adoption of
SFAS 161 will not affect our financial condition or results
of operation.
In April 2008, the FASB issued FASB Staff Position
142-3,
Determination of the Useful Life of Intangible Assets, or
FSP 142-3.
FSP 142-3
amends SFAS No. 142, Goodwill and Other Intangible
Assets, or SFAS 142, to improve the consistency between
the useful life of a recognized intangible asset under
SFAS 142 and the period of expected cash flows used to
measure the fair value of the asset under
SFAS No. 141, Business Combinations, or
SFAS 141, and other GAAP.
FSP 142-3
is effective for fiscal years beginning after December 15,
2008. The guidance for determining the useful life of a
recognized intangible asset is to be applied prospectively,
therefore, the impact of the implementation of this
pronouncement cannot be determined until the transactions occur.
In June 2008, the FASB reached a consensus on EITF Issue
No. 07-5,
Determining Whether an Instrument (or an Embedded Feature) Is
Indexed to an Entity’s Own Stock, or
EITF 07-5.
EITF 07-5
requires that we apply a two-step approach in evaluating whether
an equity-linked financial instrument (or embedded feature) is
indexed to our own stock, including evaluating the
instrument’s contingent exercise and settlement provisions.
EITF 07-5
is effective for fiscal years beginning after December 15,
2008. We are currently evaluating the effects, if any, that
EITF 07-5
will have on our consolidated financial statements.
Our investment portfolio consists primarily of money market
funds. We manage our investment portfolio in accordance with our
investment policy. The primary objectives of our investment
policy are to preserve principal, maintain a high degree of
liquidity to meet operating needs and obtain competitive returns
subject to prevailing market conditions. Our investments are
subject to changes in credit rating and changes in market value.
These investments are also subject to interest rate risk and
will decrease in value if market interest rates increase. Due to
the conservative nature of our investments, we believe interest
rate risk is mitigated. Our investment policy specifies the
credit quality standards for our investments and limits the
amount of exposure from any single issue, issuer or type of
investment.
We have a $30.0 million loan with a fixed interest rate
equal to 11.12% and a $0.2 million loan with an interest
equal to the EURIBOR for 3 months (plus 1.15%) subject to
an interest rate swap agreement at rates greater than 4%. When
EURIBOR (3 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 (3 months) plus 1.15%. As
of December 31, 2008, the carrying amount of our debt
approximated fair value.
We operate a manufacturing and research facility in Rosdorf,
Germany as well as manufacturing facilities in Italy and Mexico.
We purchase materials for those facilities and pay our employees
at those facilities in Euros and Pesos. In addition, we purchase
products for resale in the United States from foreign companies
and have agreed to pay them in currencies other than the
U.S. dollar, including the Euro and Peso. We also have
contracts with key suppliers that expose us to foreign currency
risks. As a result, our expenses and cash flows are subject to
fluctuations due to changes in foreign currency exchange rates.
In periods when the U.S. dollar declines in value as
compared to the foreign currencies in which we incur expenses,
our foreign-currency based expenses increase when translated
into U.S. dollars. Although it is possible to do so and we
may in the future, we do not currently hedge our foreign
currency since the exposure has not been material to our
historical operating results. A 10% movement in the Euro and
Peso would have an overall impact to the statement of operations
of approximately $2.2 million for 2008, which would have
been approximately 1.0% of total annual expenses.
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The Board of Directors and Stockholders of NxStage Medical, Inc.
We have audited the accompanying consolidated balance sheets of
NxStage Medical, Inc. as of December 31, 2008 and 2007, and
the related consolidated statements of operations, changes in
stockholders’ equity, and cash flows for each of the three
years in the period ended December 31, 2008. These
financial statements are the responsibility of the
Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of NxStage Medical, Inc. at December 31,
2008 and 2007, and the consolidated results of its operations
and its cash flows for each of the three years in the period
ended December 31, 2008, in conformity with
U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
NxStage Medical, Inc.’s internal control over financial
reporting as of December 31, 2008, based on criteria
established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 16, 2009 expressed an
unqualified opinion thereon.
/s/ Ernst & Young LLP
Boston, Massachusetts
March 16, 2009
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NXSTAGE
MEDICAL, INC.
See accompanying notes to these consolidated financial
statements.
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NXSTAGE
MEDICAL, INC.
See accompanying notes to these consolidated financial
statements.
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NXSTAGE
MEDICAL, INC.
See accompanying notes to these consolidated financial
statements.
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NXSTAGE
MEDICAL, INC.
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