e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2006
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 000-51567
NxStage Medical, Inc.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware
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04-3454702 |
(State of Incorporation)
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(I.R.S. Employer Identification No.) |
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439 S. Union Street 5th Floor, Lawrence, MA
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01843 |
(Address of Principal Executive Offices)
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(Zip Code) |
Registrants Telephone Number, Including Area Code: (978) 687-4700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
Indicate by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act: (Check One):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yes o No þ
There were 21,315,096 shares of the registrants common stock issued and outstanding as of the
close of business on April 24, 2006.
NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2006
TABLE OF CONTENTS
2
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
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March 31, |
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December 31, |
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2006 |
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2005 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
35,034,750 |
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$ |
61,223,377 |
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Short-term investments |
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14,692,810 |
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Accounts receivable, net |
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2,589,609 |
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1,367,860 |
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Inventory |
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7,510,939 |
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5,956,336 |
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Prepaid expenses and other current assets |
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359,544 |
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523,160 |
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Total current assets |
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60,187,652 |
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69,070,733 |
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Property and equipment, net |
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2,439,381 |
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2,070,387 |
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Field equipment, net |
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7,361,548 |
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4,843,398 |
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Other assets |
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474,670 |
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446,508 |
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Total assets |
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$ |
70,463,251 |
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$ |
76,431,026 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
5,722,840 |
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$ |
3,027,524 |
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Accrued expenses |
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2,778,648 |
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2,344,318 |
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Deferred rent obligation |
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84,997 |
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84,997 |
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Current portion of long-term debt |
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1,542,600 |
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1,513,480 |
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Total current liabilities |
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10,129,085 |
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6,970,319 |
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Deferred rent obligation |
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453,315 |
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473,268 |
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Long-term debt |
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1,236,342 |
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1,633,070 |
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Total liabilities |
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11,818,742 |
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9,076,657 |
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Commitments and contingencies |
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Stockholders equity: |
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Undesignated preferred stock: par value
$0.001, 5,000,000 shares authorized; zero
shares issued and outstanding as of March
31, 2006 and December 31, 2005 |
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Common stock: par value $0.001, 100,000,000
shares authorized; 21,184,287 and 21,176,554
shares issued and outstanding as of March
31, 2006 and December 31, 2005, respectively |
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21,184 |
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21,177 |
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Additional paid-in capital |
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151,914,501 |
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151,675,548 |
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Deferred compensation |
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(259,910 |
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Accumulated deficit |
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(93,265,639 |
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(84,010,669 |
) |
Accumulated other comprehensive income (loss) |
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(25,537 |
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(71,777 |
) |
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Total stockholders equity |
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58,644,509 |
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67,354,369 |
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Total liabilities and stockholders equity |
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$ |
70,463,251 |
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$ |
76,431,026 |
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See accompanying notes to these condensed consolidated financial statements.
3
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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Three Months Ended |
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March 31, |
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2006 |
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2005 |
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Revenues |
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$ |
3,400,722 |
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$ |
1,033,792 |
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Cost of revenues |
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4,857,254 |
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1,782,166 |
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Gross profit (deficit) |
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(1,456,532 |
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(748,374 |
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Operating expenses: |
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Research and development |
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1,778,894 |
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1,432,040 |
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Selling and marketing |
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3,192,983 |
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1,321,040 |
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Distribution |
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1,289,599 |
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308,925 |
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General and administrative |
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1,974,729 |
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1,025,016 |
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Total operating expenses |
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8,236,205 |
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4,087,021 |
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Loss from operations |
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(9,692,737 |
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(4,835,395 |
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Other income (expense): |
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Interest income |
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595,407 |
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72,086 |
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Interest expense |
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(157,640 |
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(145,824 |
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437,767 |
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(73,738 |
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Net loss |
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$ |
(9,254,970 |
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$ |
(4,909,133 |
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Net loss per share, basic and diluted |
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$ |
(0.44 |
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$ |
(1.91 |
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Weighted-average shares outstanding, basic and diluted |
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21,182,717 |
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2,566,399 |
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See accompanying notes to these condensed consolidated financial statements.
4
NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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Three Months Ended |
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March 31, |
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2006 |
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2005 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(9,254,970 |
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$ |
(4,909,133 |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation and amortization |
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497,740 |
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155,247 |
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Amortization of debt discount |
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35,208 |
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35,208 |
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Stock-based compensation |
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495,406 |
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54,671 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(1,221,270 |
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(141,435 |
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Inventory |
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(4,416,148 |
) |
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(1,256,713 |
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Prepaid expenses and other current assets |
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151,597 |
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3,371 |
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Accounts payable |
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2,689,146 |
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443,489 |
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Accrued expenses |
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543,386 |
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24,915 |
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Net cash used in operating activities |
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(10,479,905 |
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(5,590,380 |
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Cash flows from investing activities: |
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Purchases of property and equipment |
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(512,327 |
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(230,463 |
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Purchases of short-term investments |
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(14,692,810 |
) |
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Sale of marketable securities |
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7,500,000 |
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Increase in other assets |
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(158,555 |
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(300,076 |
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Net cash (used in) provided by investing activities |
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(15,363,692 |
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6,969,461 |
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Cash flows from financing activities: |
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Proceeds from exercise of stock options |
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15,228 |
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Net
repayments on loans and lines of credit |
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(411,707 |
) |
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(226,873 |
) |
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Net cash used in financing activities |
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(396,479 |
) |
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(226,873 |
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Foreign exchange effect on cash and cash equivalents |
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51,449 |
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(36,740 |
) |
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Increase (decrease) in cash and cash equivalents |
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(26,188,627 |
) |
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1,115,468 |
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Cash and cash equivalents, beginning of period |
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61,223,377 |
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5,639,499 |
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Cash and cash equivalents, end of period |
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$ |
35,034,750 |
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$ |
6,754,967 |
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Supplemental Disclosure |
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Cash paid for interest |
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$ |
57,653 |
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$ |
145,824 |
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Noncash Investing Activities |
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Transfers from inventory to field equipment |
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$ |
2,866,506 |
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$ |
530,735 |
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Noncash Financing Activities |
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Deferred compensation and paid-in capital |
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$ |
16,731 |
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$ |
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See accompanying notes to these condensed consolidated financial statements.
5
NXSTAGE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Description of Business
Operations
NxStage Medical, Inc. (the Company) is a medical device company that develops,
manufactures and markets products for the treatment of kidney failure and fluid
overload. The Companys primary product, the NxStage System One (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. The System One is cleared by the United States Food and Drug Administration
(the FDA) and sold commercially in the United States for the treatment of acute and
chronic kidney failure patients and fluid overload. The System One consists of an
electromechanical medical device (cycler), a disposable blood tubing set and a
dialyzer (filter) pre-mounted in a disposable, single-use cartridge, and fluids used
in conjunction with therapy.
The Companys growth has been funded through a combination of private equity,
bank debt, and lease financing and, since November 1, 2005, through proceeds from its
initial public offering of common stock. As of March 31, 2006, the Company had
approximately $49.7 million of unrestricted cash and short-term investments and the
Company believes that it has sufficient cash to meet its funding requirements at
least through 2006. The Company has experienced and continues to experience negative
operating margins and negative cash flows from operations and there can be no
assurance as to the availability or terms upon which additional financing may be
available in the future.
Basis of Presentation
The condensed consolidated financial statements reflect the operations of the
Company and its wholly-owned subsidiaries. The interim financial statements and notes
thereto have been prepared pursuant to the rules of the Securities and Exchange
Commission, or SEC, for quarterly reports on Form 10-Q and do not include all of the
information and note disclosures required by accounting principles generally accepted
in the United States of America. In the opinion of management, the interim financial
statements reflect all adjustments consisting of normal, recurring adjustments
necessary for a fair presentation of the results for interim periods. Operating
results for the three months ended March 31, 2006 are not necessarily indicative of
results that may ultimately be achieved for the entire year ending December 31, 2006.
On September 15, 2005, the Companys board of directors (the Board) declared a
one-for-1.3676 reverse stock split of the outstanding shares of common stock. All
references in the condensed consolidated financial statements to the number of shares
outstanding, per share amounts, and stock option data of the Companys common stock
have been retroactively adjusted to reflect the effect of the reverse stock split for
all periods presented.
6
2. Summary of Significant Accounting Policies
(a) Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All material intercompany
transactions and balances have been eliminated in consolidation.
(b) Use of Estimates
The preparation of the Companys consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(c) Revenue Recognition
The Company recognizes revenue from product sales and services when earned in
accordance with Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, and
Emerging Issues Task Force (EITF) 00-21, Revenue Arrangements with Multiple
Deliverables. Revenues are recognized when: (a) there is persuasive evidence of an
arrangement, (b) the product has been shipped or services and supplies have been
provided to the customer, (c) the sales price is fixed or determinable and (d)
collection is reasonably assured. In the critical care market, sales are structured
as direct product sales or as a disposables based-program in which a customer
acquires the equipment through the purchase of a specific quantity of disposables
over a specific period of time. In the chronic care market, revenues are realized
using short-term rental arrangements.
In the critical care market, the Company recognizes revenue from direct product
sales at the later of the time of shipment or, if applicable, delivery in accordance
with contract terms. For the chronic care market, the Company recognizes revenue
derived from short-term rental arrangements ratably over the rental period. These
rental arrangements combine the use of a system with a specified number of disposable
products supplied to customers for a fixed amount per month. Revenue is recognized on
a monthly basis in accordance with agreed upon contract terms and pursuant to
customer purchase orders with fixed payment terms. Customer contracts are generally
cancelable on 30-days notice and there are no purchase requirements from customers
under the Companys chronic agreements.
Under a disposables-based program, the customer is granted the right to use the
equipment for a period of time, during which the customer commits to purchase a
minimum number of disposable cartridges or fluids at a price that includes a premium
above the otherwise average selling price of the cartridges or fluids to recover the
purchase 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. The Company records the cost of the equipment in inventory
and amortizes the cost of the equipment through charges to cost of revenues
consistent with the customers minimum purchase requirement.
When the Company enters into a multiple-element arrangement, it allocates the
total fee to all elements of the arrangement based on their respective fair values.
Fair value is determined by the price charged when each element is sold separately.
The Companys most common multiple-element arrangements are products sold under a
disposables-based program in the critical care market as described above. The Company
accounts for the disposables-based program as a single economic transaction and
7
has determined that it does not have a basis to separate the transaction into
multiple elements to recognize revenue at the time of shipment of each element.
Rather, the Company recognizes revenue related to all elements over the term of the
arrangement as the disposables are delivered.
The Companys contracts provide for training, technical support and warranty
services to its customers. The Company recognizes training revenue when the related
services are performed. In the case of extended warranty, the revenue is recognized
ratably over the warranty period.
(d) Foreign Currency Translation and Transactions
Assets and liabilities of the Companys foreign operations are translated in
accordance with Statement of Financial Accounting Standards (SFAS) No. 52, Foreign
Currency Translation. In accordance with SFAS No. 52, assets and liabilities of the
Companys foreign operations are translated into U.S. dollars at current exchange
rates, and income and expense items are translated at average rates of exchange
prevailing during the year. Gains and losses realized from transactions, including
intercompany balances not considered permanent investments, are denominated in
foreign currencies and are included in the consolidated statements of operations and
were not material for the periods presented.
(e) Cash, Cash Equivalents and Short-Term Investments
The Company considers all highly-liquid investments purchased with original
maturities of 90 days or less to be cash equivalents. Cash equivalents include
amounts invested in commercial paper and money market funds. Cash equivalents are
stated at cost plus accrued interest, which approximates market value. Short-term
investments represent commercial paper with an original maturity date of more than 90
days, but less than 180 days. Short-term investments have been classified as
held-to-maturity and carried at amortized cost because the Company has the intent and
ability to hold the investments to maturity.
(f) Fair Value of Financial Instruments and Concentration of Credit Risk
Financial instruments consist principally of cash and cash equivalents, accounts
receivable, accounts payable and long-term debt. The estimated fair value of these
instruments approximates their carrying value due to the short period of time to
their maturities. The fair value of the Companys debt is estimated based on the
current rates offered to the Company for debt of the same remaining maturities. The
carrying amount of long-term debt approximates fair value.
(g) Inventory
Inventory is stated at the lower of cost (weighted-average) or market (net
realizable value). The Company regularly reviews its inventory quantities on hand and
related cost and records a provision for any excess or obsolete inventory based on
its estimated forecast of product demand and existing product configurations. The
medical device industry is characterized by rapid development and technological
advances that could result in obsolescence of inventory. Additionally, the Companys
estimates of future product demand may prove to be inaccurate.
Inventories at March 31, 2006 and December 31, 2005 are as follows:
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March 31, |
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December 31, |
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|
2006 |
|
|
2005 |
|
Purchased components |
|
$ |
2,013,932 |
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$ |
2,026,986 |
|
Finished goods |
|
|
5,497,007 |
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|
3,929,350 |
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|
$ |
7,510,939 |
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|
$ |
5,956,336 |
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|
8
Inventory is shown net of a valuation reserve of approximately $518,000 and
$646,000 at March 31, 2006 and December 31, 2005, respectively.
(h) Property and Equipment and Field Equipment
Property and equipment is carried at cost less accumulated depreciation. A
summary of the components of property and equipment is as follows:
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March 31, |
|
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December 31, |
|
|
|
2006 |
|
|
2005 |
|
Computer and office equipment |
|
$ |
904,133 |
|
|
$ |
829,298 |
|
Machinery, equipment and tooling |
|
|
1,748,749 |
|
|
|
1,613,359 |
|
Furniture |
|
|
417,894 |
|
|
|
279,815 |
|
Leasehold improvements |
|
|
964,902 |
|
|
|
930,213 |
|
Construction-in-process |
|
|
391,175 |
|
|
|
246,639 |
|
|
|
|
|
|
|
|
|
|
|
4,426,853 |
|
|
|
3,899,324 |
|
Less accumulated depreciation and amortization |
|
|
(1,987,472 |
) |
|
|
(1,828,937 |
) |
|
|
|
|
|
|
|
Property and equipment, net |
|
$ |
2,439,381 |
|
|
$ |
2,070,387 |
|
|
|
|
|
|
|
|
Depreciation expense for property and equipment was $149,000 and $92,000 for the
three months ended March 31, 2006 and 2005, respectively.
Field equipment is carried at cost less accumulated depreciation as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Field equipment |
|
$ |
8,387,865 |
|
|
$ |
5,521,359 |
|
Less accumulated depreciation and amortization |
|
|
(1,026,317 |
) |
|
|
(677,961 |
) |
|
|
|
|
|
|
|
Field equipment, net |
|
$ |
7,361,548 |
|
|
$ |
4,843,398 |
|
|
|
|
|
|
|
|
Depreciation expense for field equipment was $349,000 and $63,000 for the three
months ended March 31, 2006 and 2005, respectively.
The estimated service lives of property and equipment and field equipment are as
follows:
|
|
|
|
|
|
|
Estimated |
|
|
Useful Life |
Leasehold improvements |
|
Lesser of 5 years or lease term |
Computer and office equipment |
|
3 years |
Machinery, equipment and tooling |
|
5 years |
Furniture |
|
7 years |
Field equipment |
|
5 years |
(i) Accounting for Stock-Based Compensation
Stock-Based Compensation
Prior to January 1, 2006, the Company accounted for stock-based employee
compensation in accordance with Accounting Principles Board, or APB,
Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, compensation expense was recorded for stock options awarded to employees
and directors to the extent that the option exercise price was less than the fair
market value of the Companys common stock on the date of grant, where the number of
shares
9
and exercise price were fixed. The difference between the fair value of the Companys
common stock and the exercise price of the stock option, if any, was recorded as
deferred compensation and was amortized to compensation expense over the vesting
period of the underlying stock option. All stock-based awards to nonemployees were
accounted for at their fair value in accordance with SFAS No. 123 and related
interpretations.
On January 1, 2006, the Company adopted SFAS No. 123R Share-Based Payment,
using a combination of the prospective and the modified prospective transition
methods. Under the prospective method, the Company will not recognize the remaining
compensation cost for any stock option awards which had previously been valued using
the minimum value method, which was allowed until the Companys initial filing for
the sale of securities with the SEC (i.e., stock options granted prior to July 19,
2005). Under the modified prospective method, the Company has (a) recognized
compensation expense for all share-based payments granted after January 1, 2006 and
(b) recognized compensation expense for awards granted to employees between July 19,
2005 and December 31, 2005 that remained unvested as of December 31, 2005. The
adoption of SFAS 123R resulted in incremental stock-based compensation expense of $443,350, or
$0.02 basic and diluted net loss per share, for the three months ended March 31,
2006.
The Company recognized the full impact of its share-based payment plans in the
condensed consolidated statement of operations for the three months ended March 31,
2006 under SFAS 123R. The following table presents the captions in which share-based
compensation expenses are included in the Companys condensed consolidated statement
of operations, including stock-based compensation recorded in accordance with APB No.
25:
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
March 31, 2006 |
|
Cost of revenues |
|
$ |
11,250 |
|
Research and development |
|
|
28,036 |
|
Selling and marketing |
|
|
112,069 |
|
Distribution |
|
|
2,297 |
|
General and administrative |
|
|
341,754 |
|
|
|
|
|
Total |
|
$ |
495,406 |
|
|
|
|
|
The Company had previously adopted only the disclosure provisions of SFAS No.
123, Accounting for Stock-Based Compensation. SFAS 123R requires all share-based
payments to employees, including grants of employee stock options, to be recognized
in the statement of operations based on their fair values. In addition, SFAS
123R requires the use of the prospective method for any outstanding stock options
that were previously valued using the minimum value method. Accordingly, with the
adoption of SFAS 123R, the Company will not recognize the remaining compensation cost
for any stock option awards which had previously been valued using the minimum value
method. In addition, SFAS 123R prohibits the use of pro forma disclosures for stock
option awards valued under the minimum value method (i.e., our pre-July 19, 2005
stock option awards). Stock option awards granted prior to July 19, 2005 that are
subsequently modified, repurchased or cancelled after January 1, 2006 shall be
subject to the provisions of SFAS 123R.
The Company filed a registration statement on Form S-1 for an initial public
offering of its common stock on July 19, 2005 and closed the initial public offering
on November 1, 2005. Stock options granted prior to July 19, 2005 were valued using
the minimum value method, while stock options granted after July 19, 2005 were valued
using the Black-Scholes option-pricing model. The minimum value method excludes the
impact of stock volatility, whereas the Black-Scholes option-pricing model includes a
stock volatility assumption in its calculation. The inclusion of a stock volatility
assumption, the principal difference between the two methods, ordinarily yields a
higher fair value.
10
The weighted-average grant date fair value of options granted during the three
months ended March 31, 2006 was $9.06. The fair value of options at date of grant was
estimated with the following assumptions:
|
|
|
|
|
|
|
Three Months |
|
|
Ended |
|
|
March 31, 2006 |
Expected life of the options |
|
4.75 years (1) |
Risk-free interest rate |
|
4.35% 4.75% (2) |
Expected stock price volatility |
|
85% (3) |
Expected dividend yield |
|
|
|
|
|
(1) |
|
The expected term was determined using the simplified method for estimating
expected option life of plain-vanilla options. |
|
(2) |
|
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. |
|
(3) |
|
Because the Company has no options that are traded publicly and because of its
limited trading history as a public company, the stock volatility assumption is
based on an analysis of the stock volatility of comparable companies in the
medical device and technology industries. |
The Company has estimated expected forfeitures of stock options with the
adoption of SFAS 123R. In developing a forfeiture rate estimate, the Company
considered its historical experience, its growing employee base and the limited
liquidity of its common stock.
(j) Warranty Costs
For a period of one year following the delivery of products to its critical care
customers, the Company provides for product repair or replacement if it is determined
that there is a defect in material or manufacture of the product. For sales into the
critical care market, the Company accrues estimated warranty costs at the time of
shipment based on contractual rights and historical experience.
(k) Distribution Expenses
Distribution expenses consist of the costs incurred in shipping products to
customers and are charged to operations as incurred. Prior to 2004, the Company did
not charge any distribution costs to its customers. For the three months ended March
31, 2006 and 2005, shipping and handling costs charged to customers totaled $15,397
and $9,206, respectively, and have been included in revenues.
(l) Research and Development Costs
Research and development costs are charged to operations as incurred.
(m) Income Taxes
The Company accounts for federal and state income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes. Under the liability method specified by SFAS
No. 109, a deferred tax asset or liability is determined based on the difference
between the financial statement and tax basis of assets
11
and liabilities, as measured by the enacted tax rates. The Companys provision for
income taxes represents the amount of taxes currently payable, if any, plus the
change in the amount of net deferred tax assets or liabilities. A valuation allowance
is provided against net deferred tax assets if recoverability is uncertain on a more
likely than not basis.
(n) Net Loss per Share
The Company calculates net loss per share in accordance with SFAS No. 128,
Earnings per Share, and EITF 03-6, Participating Securities and the Two Class
Method under FASB Statement No. 128, Earnings per Share. EITF 03-6 clarifies the use
of the two-class method of calculating earnings per share as originally prescribed
in SFAS No. 128. Effective for periods beginning after March 31, 2004, EITF 03-6
provides guidance on how to determine whether a security should be considered a
participating security for purposes of computing earnings per share and how
earnings should be allocated to a participating security when using the two-class
method for computing earnings per share. The Company has determined that its
redeemable preferred stock represents a participating security because it may
participate in dividends with common stock and, therefore, has calculated net loss
per share consistent with the provisions of EITF 03-6 for all periods in which its
redeemable preferred stock was outstanding.
Net loss per share is calculated based on the weighted average number of shares
of common stock outstanding, excluding unvested shares of restricted common stock.
The following potential common stock equivalents were not included in the computation
of diluted net loss per share as their effect would have been anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Options to purchase common stock |
|
|
1,028,514 |
|
|
|
2,541,381 |
|
Warrants to purchase common stock |
|
|
172,321 |
|
|
|
203,625 |
|
Unvested shares of common stock subject to repurchase |
|
|
|
|
|
|
236 |
|
Redeemable convertible preferred stock |
|
|
|
|
|
|
10,165,920 |
|
|
|
|
|
|
|
|
Total |
|
|
1,200,835 |
|
|
|
12,911,162 |
|
|
|
|
|
|
|
|
(o) Comprehensive Income (Loss)
SFAS
No. 130, Reporting Comprehensive Income, establishes standards for
reporting comprehensive income (loss) and its components in the body of the financial
statements. Comprehensive income (loss) consists of net income (loss) and other
comprehensive income (loss). Other comprehensive income (loss) includes certain
changes in equity that are excluded from results of operations.
The components of accumulated other comprehensive income (loss) are as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Foreign currency translation adjustment |
|
$ |
(25,537 |
) |
|
$ |
(71,777 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
(25,537 |
) |
|
$ |
(71,777 |
) |
|
|
|
|
|
|
|
(p) Recent Accounting Pronouncements
Refer to the Accounting for Stock-Based Compensation footnote above for a
summary of the Companys adoption of SFAS 123R on January 1, 2006.
12
3. Financing Arrangements
Debt
In December 2004, the Company entered into a debt agreement in the principal
amount of $5.0 million, which is payable monthly over a three-year term and is
secured by all the assets of the Company. Interest accrues at a rate of 7.0% annually
and monthly principal and interest payments are made in advance. In addition, a final
interest payment of $650,000 is due at the maturity date in December 2007, or if the
loan is prepaid in advance. This additional interest payment is accrued on a monthly
basis using the interest method over the 36-month life of the loan and is included in
accrued expenses in the accompanying consolidated balance sheets.
Annual maturities of principal under the Companys debt obligations and
reconciliation to amounts included in the consolidated balance sheet as of March 31,
2006 are as follows:
|
|
|
|
|
2006 |
|
$ |
1,251,496 |
|
2007 |
|
|
1,773,904 |
|
|
|
|
|
Total future principal payments |
|
|
3,025,400 |
|
Less: unamortized original issue debt discount |
|
|
(246,458 |
) |
|
|
|
|
|
|
|
2,778,942 |
|
Less: current portion of long-term debt |
|
|
(1,542,600 |
) |
|
|
|
|
Long-term debt |
|
$ |
1,236,342 |
|
|
|
|
|
4. Segment and Enterprise Wide Disclosures
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for reporting information regarding operating
segments in annual financial statements. Operating segments are identified as
components of an enterprise about which separate discrete financial information is
available for evaluation by the chief operating decision-maker in making decisions on
how to allocate resources and assess performance. The Company views its operations
and manages its business as one operating segment. All revenues were generated in the
U.S. and substantially all assets are located in the U.S.
The Company sells products into two markets, critical care and chronic care. The
critical care market consists of hospitals or facilities that treat patients that
have suddenly, and possibly temporarily, lost kidney function. The chronic care
market consists of dialysis centers and hospitals that provide treatment options for
patients that have end-stage renal disease (ESRD). Revenues recognized in these
markets were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Critical care market |
|
$ |
1,583,597 |
|
|
$ |
661,769 |
|
Chronic care market |
|
|
1,817,125 |
|
|
|
372,023 |
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
3,400,722 |
|
|
$ |
1,033,792 |
|
|
|
|
|
|
|
|
For the three months ended March 31, 2006, the Company had one customer which
represented 13% of revenues, while two customers represented 29% of accounts
receivable as of March 31, 2006. For the three months ended March 31, 2005, the
Company had one customer who individually represented
13
greater than 10% of revenues, and which represented 15% of revenues. No customers
represented greater than 10% of accounts receivable as of March 31, 2005.
5. Redeemable Convertible Preferred Stock and Stockholders Equity
Common and Preferred Stock
On November 1, 2005, the Company completed its initial public offering of
6,325,000 shares of its common stock at a price of $10.00 per share. The Company
received approximately $56.5 million in net proceeds from the offering. In connection
with the initial public offering, all shares of all series of the Companys
outstanding preferred stock were automatically converted into an aggregate of
12,124,840 shares of common stock.
On July 8, 2005, the Company amended its certificate of incorporation to (a)
increase the number of authorized shares of preferred stock to 15,759,660 shares and
(b) designate 2,197,801 shares of Series F-1 Preferred Stock. On September 19, 2005,
the Company amended its certificate of incorporation to authorize 30,000,000 shares
of common stock. On October 14, 2005, the Company authorized 5,000,000 shares of
undesignated preferred stock. In connection with its initial public offering, the
Company amended and restated its certificate of incorporation to authorize
100,000,000 shares of common stock, par value $0.001 per share.
Prior to the initial public offering, the Company had authorized several series
of $0.001 par value preferred stock, of which 1,875,000 shares were designated as
Series B, 1,155,169 shares were designated as Series C, 5,011,173 shares were
designated as Series D, 2,690,846 shares were designated as Series E, 2,829,671
shares were designated as Series F and 2,197,801 shares were designated as Series
F-1.
During 1999, the Company sold 1,875,000 shares of Series B Preferred Stock at
$2.67 per share, resulting in net proceeds of $4,968,250. Upon the closing of the
Series B Preferred Stock financing, all shares of the Companys Series A Preferred
Stock converted into an equal number of shares of the Companys common stock. On
January 22, 2000, the Company sold 1,151,632 shares of Series C Preferred Stock at
$5.21 per share, resulting in net proceeds of $5,957,891. On May 21, 2001, the
Company sold 4,857,622 shares of Series D Preferred Stock at $5.97 per share,
resulting in net proceeds of $24,218,379. On April 15, 2003, the Company sold
2,669,908 shares of Series E Preferred Stock at $5.97 per share, resulting in net
proceeds of $15,892,537. On August 18, 2004, the Company sold 2,747,253 shares of
Series F Preferred Stock at $7.28 per share, resulting in net proceeds of
$19,968,522. On July 8, 2005 and July 15, 2005, the Company sold an aggregate of
2,197,801 shares of Series F-1 Preferred Stock at $7.28 per share, resulting in net
proceeds of approximately $15,965,003.
Warrants
At March 31, 2006, warrants to purchase a total of 172,321 shares of common
stock were outstanding. These warrants have a weighted average exercise price of
$7.66 and expire at various dates from May 2006 to 2011.
6. Stock-Based Awards
Stock Options
The Company maintains the 1999 Stock Option and Grant Plan (1999 Plan) under
which 4,085,009 shares of common stock were authorized for the granting of incentive
stock options (ISOs) and nonqualified stock options to employees, officers,
directors, advisors, and consultants of the Company. ISOs under the 1999 Plan were
granted only to employees, while nonqualified stock options under the
14
1999 Plan were granted to officers, employees, consultants and advisors of the
Company. The Board determined the option exercise price for incentive and
nonqualified stock options, grants, and in no event were the option exercise prices
of an incentive stock option less than 100% of the fair market value of common stock
at the time of grant, or less than 110% of the fair market value of the common stock
in the event that the employee owned 10% or more of the Companys capital stock. All
stock options issued under the 1999 Plan expire 10 years from the date of grant and
the majority of these grants were exercisable upon the date of grant into restricted
common stock, which vests over a period of four years. Prior to the adoption of the
1999 Plan, the Company issued non-qualified options to purchase 55,252 shares of
common stock, of which 45,755 shares remain outstanding at March 31, 2006. Effective
upon the closing of the Companys initial public offering, no further grants were or
will be made under the 1999 Plan.
In October 2005, the Company adopted the 2005 Stock Incentive Plan (2005 Plan)
which became effective upon the closing of the initial public offering. Concurrently,
the Company ceased granting stock options and other equity incentive awards under the
1999 Plan and 971,495 shares, which were then still available for grant under the
1999 Plan, were transferred and became available for grant under the 2005 Plan. The
number of shares available for grant under the 2005 Plan will be increased annually
beginning in 2007 by the lesser of (a) 600,000 shares, or (b) 3% of the then
outstanding shares of the Companys common stock, or (c) a number determined by the
Board. Unless otherwise specified by the Board or Compensation Committee, stock
options issued to employees under the 2005 Plan expire seven years from the date of
grant and generally vest over a period of four years. At March 31, 2006, options for
the purchase of 669,549 shares of common stock are available for future grant under
the 2005 Plan.
The following table summarizes activity of the Companys stock plans since
December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Exercise |
Fixed Options |
|
Shares |
|
Price |
Outstanding at December 31, 2005 |
|
|
2,683,286 |
|
|
$ |
6.22 |
|
Granted |
|
|
50,700 |
|
|
$ |
13.25 |
|
Exercised |
|
|
(7,733 |
) |
|
$ |
1.97 |
|
Forfeited |
|
|
(3,248 |
) |
|
$ |
8.25 |
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2006 |
|
|
2,723,005 |
|
|
$ |
6.46 |
|
|
|
|
|
|
|
|
|
|
Vested at March 31, 2006 |
|
|
1,494,808 |
|
|
$ |
4.90 |
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2006 |
|
|
1,797,193 |
|
|
$ |
4.97 |
|
|
|
|
|
|
|
|
|
|
The weighted-average grant date fair value of options granted during the three
months ended March 31, 2006 was $9.06. The aggregate intrinsic value at March 31,
2006 was $17.1 million for stock options outstanding, $11.9 million for stock options
vested and $14.1 million for stock options exercisable. The total intrinsic value of
options exercised during the three months ended March 31, 2006 was $84,000. There
were no stock option exercises during the three months ended March 31, 2005. The
intrinsic value for stock options is calculated based on the exercise price of the
underlying awards and the market price of our common stock as of March 31, 2006.
15
The following table summarizes information about stock options outstanding at
March 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
Options Exercisable |
|
|
|
|
|
|
Weighted |
|
Weighted |
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
Average |
|
|
|
|
|
Average |
|
|
Number |
|
Remaining |
|
Exercise |
|
Number |
|
Exercise |
Range of Exercise Prices |
|
Outstanding |
|
Contractual Life |
|
Price |
|
Exercisable |
|
Price |
$0.34 to $0.55 |
|
|
102,035 |
|
|
3.1 years |
|
$ |
0.37 |
|
|
|
102,035 |
|
|
$ |
0.37 |
|
$1.37 |
|
|
2,924 |
|
|
4.2 years |
|
$ |
1.37 |
|
|
|
2,924 |
|
|
$ |
1.37 |
|
$2.74 to $4.10 |
|
|
965,072 |
|
|
5.1 years |
|
$ |
3.91 |
|
|
|
965,072 |
|
|
$ |
3.91 |
|
$5.47 to $6.84 |
|
|
620,839 |
|
|
8.3 years |
|
$ |
6.04 |
|
|
|
615,640 |
|
|
$ |
6.04 |
|
$8.21 to $9.10 |
|
|
743,985 |
|
|
7.4 years |
|
$ |
8.56 |
|
|
|
3,289 |
|
|
$ |
8.21 |
|
$12.28 to $13.65 |
|
|
288,150 |
|
|
6.1 years |
|
$ |
12.71 |
|
|
|
108,233 |
|
|
$ |
12.59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.34 to $13.65 |
|
|
2,723,005 |
|
|
6.5 years |
|
$ |
6.46 |
|
|
|
1,797,193 |
|
|
$ |
4.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the status of the Companys nonvested shares since
December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Exercise |
Fixed Options |
|
Shares |
|
Price |
Nonvested at December 31, 2005 |
|
|
1,234,251 |
|
|
$ |
7.87 |
|
Granted |
|
|
50,700 |
|
|
$ |
13.25 |
|
Vested |
|
|
(53,506 |
) |
|
$ |
5.35 |
|
Forfeited |
|
|
(3,248 |
) |
|
$ |
8.25 |
|
|
|
|
|
|
|
|
|
|
Nonvested at March 31, 2006 |
|
|
1,228,197 |
|
|
$ |
7.82 |
|
|
|
|
|
|
|
|
|
|
Certain outstanding stock option awards are subject to an early exercise
provision. Upon exercise, the award is subject to a repurchase right in favor of the
Company. The repurchase right terminated upon the closing of the Companys initial
public offering.
As of March 31, 2006, approximately $3.8 million of unrecognized stock
compensation cost related to nonvested awards (net of estimated forfeitures) is
expected to be recognized over a weighted-average period of 3.8 years.
Employee Stock Purchase Plan
The Companys 2005 Employee Stock Purchase Plan (2005 Purchase Plan) authorizes
the issuance of up to 50,000 shares of common stock to participating employees
through a series of periodic offerings. Each six-month offering period begins in
January or July. The first offering under the 2005 Purchase Plan extends from January
3, 2006 through June 30, 2006. An employee becomes eligible to participate in the
2005 Purchase Plan once he or she has been employed for at least six months and is
regularly employed for at least 20 hours per week for more than five months in a
calendar year. Beginning with the second offering scheduled to begin in July 2006,
the length of employment eligibility requirement has been reduced to three months
from six months and from five months to three months for employees working at least
20 hours per week. The price at which employees can purchase common stock in an
offering is 95 percent of the closing price of the common stock on the Nasdaq
National Market on the day the offering terminates, unless otherwise determined by
the Board or Compensation Committee.
16
The weighted-average fair value of stock purchase rights granted as part of the
Companys 2005 Purchase Plan during the three months ended March 31, 2006 was $2.45.
The fair value of the employees stock purchase rights was estimated using the
Black-Scholes option-pricing model with the following assumptions:
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, 2006 |
Expected life of the purchase rights |
|
6 months |
Risk-free interest rate |
|
|
4.42 |
% |
Expected stock price volatility |
|
|
50.9 |
% |
Expected dividend yield |
|
|
|
|
The Company recognized stock-based compensation expense of $12,000 for the three
months ended March 31, 2006 relating to the 2005 Purchase Plan.
The Company has reserved 3,392,554 shares of common stock for issuance upon
exercise of stock options, 50,000 shares for issuance under the 2005 Purchase Plan
and 172,321 shares for issuance upon exercise of warrants.
7. Related-Party Transactions
The Company purchases completed cartridges, tubing and certain other components used in the System One
disposable cartridge from Medisystems
Corporation, an entity owned by a member of the Companys Board. Purchases from
Medisystems Corporation for the three months ended March 31, 2006 and 2005 totaled
approximately $759,000 and $126,000, respectively. Amounts owed to Medisystems
Corporation totaled $21,780 and $81,000 at March 31, 2006 and December 31, 2005,
respectively, and are included in accounts payable in the accompanying condensed
consolidated balance sheets.
17
Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
Special Note Regarding Forward Looking Statements
The following discussion should be read with our unaudited condensed
consolidated financial statements and notes included in Part I, Item 1 of this
Quarterly Report for the three months ended March 31, 2006 and 2005, as well as the
audited financial statements and notes and Managements Discussion and Analysis of
Financial Condition and Results of Operations for the fiscal year ended December 31,
2005, included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission, or SEC. This Managements Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended. These forward-looking statements regarding future events and our
future results are based on current expectations, estimates, forecasts, and
projections and the beliefs and assumptions of our management including, without
limitation, our expectations regarding our results of operations, general and
administrative expenses, research and development expenses, and the sufficiency of
our cash for future operations. Words such as we expect, anticipate, target,
project, believe, goals, estimate, potential, predict, may, will,
expect, might, could, intend, variations of these terms or the negative of
those terms and similar expressions are intended to identify these forward-looking
statements. Readers are cautioned that these forward-looking statements are
predictions and are subject to risks, uncertainties, and assumptions that are
difficult to predict. Therefore, actual results may differ materially and adversely
from those expressed in any forward-looking statements.
Among the important factors that could cause actual results to differ materially
from those indicated by our forward-looking statements are those discussed under the
heading Risk Factors in Item 1A of Part II and elsewhere in this report. We
undertake no obligation to revise or update publicly any forward-looking statement
for any reason. Readers should carefully review the risk factors described under the
heading Risk Factors in Item 1A of Part II, as well as in the documents filed by us
with the Securities and Exchange Commission, as they may be amended from time to
time, including our Annual Report on Form 10-K.
Overview
We are a medical device company that develops, manufactures and markets
innovative systems for the treatment of end-stage renal disease, or ESRD, acute
kidney failure and fluid overload. Our primary product, the NxStage System One, is a
small, portable, easy-to-use hemodialysis system designed to provide physicians and
patients improved flexibility in how hemodialysis therapy is prescribed and
delivered. We believe the largest market opportunity for our product is the home
hemodialysis market for the treatment of ESRD.
From our inception in 1998 until 2002 our operations consisted primarily of
start-up activities, including designing and developing the System One, recruiting
personnel and raising capital. Historically, research and development costs have been
our single largest operating expense. However, with the launch of the System One in
the home chronic care market, selling and marketing costs became our largest
operating expense in 2005 and this trend continued during the three months ended
March 31, 2006 as we expanded our United States sales force to penetrate our markets
and grow revenues.
Our overall strategy since inception has been to (a) design and develop new
products for the treatment of kidney failure, (b) establish that the products are
safe, effective and cleared for use in the United States, (c) further enhance the
product design through field experience from a limited number of customers, (d)
establish reliable manufacturing and sources of supply, (e) execute a market launch
in both the chronic and critical care markets and establish the System One as a
preferred system for the treatment
18
of kidney failure, (f) obtain the capital necessary to finance our working capital
needs and build our business and (g) achieve profitability. The evolution of NxStage,
and the allocation of our resources since we were founded, reflects this plan. We
believe we have largely completed steps (a) through (d), and we plan to continue to
pursue the other strategic objectives described above.
We sell our products in two markets: the chronic care market and the critical
care market. We define the chronic care market as the market devoted to the treatment
of patients with ESRD and the critical care market as the market devoted to the
treatment of hospital-based patients with acute kidney failure or fluid overload. We
offer a different configuration of the System One for each market. The Food and Drug
Administration, or FDA, has cleared both configurations for hemodialysis,
hemofiltration and ultrafiltration. Our products may be used by our customers to
treat patients suffering from either condition, although the site of care, the method
of delivering care and the duration of care are sufficiently different that we have
separate marketing and sales efforts dedicated to each market.
We received clearance from the FDA in July 2003 to market the System One for
treatment of renal failure and fluid overload using hemodialysis as well as
hemofiltration and ultrafiltration. In the first quarter of 2003, we initiated sales
of the System One in the critical care market to hospitals and medical centers in the
United States. In late 2003, we initiated sales of the System One in the chronic care
market and commenced full commercial introduction in the chronic care market in
September 2004 in the United States. 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 our System One in June 2005 for hemodialysis in the home.
During the three months ended March 31, 2006 we received clearance from the FDA
to market our PureFlow SL product as an alternative to the bagged fluid presently
used with our System One in the chronic care market. This accessory to the System One
prepares high purity dialysate, which meets and exceeds dialysis industry standards
for purity, from ordinary tap water in the dialysis patients home. This product is
designed to help patients with ESRD more conveniently and effectively manage their
home hemodialysis therapy by eliminating the need to store and hang bagged fluids.
Instead, our PureFlow SL product automatically produces a batch of dialysate fluid
ready for use with the System One. We expect a commercial release of this product in
July 2006. We expect that our chronic home patients will predominantly use our
PureFlow SL product at home and will use bagged fluid for travel and outside of the
home.
Medicare provides comprehensive and well-established reimbursement in the United
States for ESRD. Reimbursement claims for the System One therapy are typically
submitted by the dialysis clinic or hospital to Medicare and other third-party payors
using established billing codes for dialysis treatment or, in the critical care
setting, based on the patients primary diagnosis. Expanding Medicare reimbursement
over time to cover more frequent therapy may be critical to our market penetration
and revenue growth in the future.
Our System One is produced through internal and outsourced manufacturing. We
purchase many of the components and subassemblies included in the System One, as well
as the disposable cartridges used with the System One, from third-party
manufacturers, some of which are single source suppliers. In addition to outsourcing
with third-party manufacturers, we assemble, package and label some of our disposable
cartridges in our leased facility in Lawrence, Massachusetts. NxStage GmbH & Co. KG,
our wholly-owned German subsidiary, is the sole manufacturer of the dialyzing filter
that is a component of the disposable cartridge used with the System One.
19
We market the System One through a direct sales force in the United States
primarily to dialysis clinics and hospitals, and we expect revenues from this source
to continue to increase in the near future. Our revenues were $3.4 million for the
three months ended March 31, 2006, a 229% increase from revenues of $1.0 million in
the three months ended March 31, 2005 and a 61% increase from revenues of $2.1
million in the fourth quarter of 2005. We have increased the number of sales
representatives in our combined sales force from 10 at March 31, 2005 to 20 at
December 31, 2005, and to 25 at March 31, 2006. We expect to add additional sales and
marketing personnel as needed for the remainder of 2006. As of March 31, 2006, 459
ESRD patients were using the System One at 97 dialysis clinics, compared to 82 ESRD
patients at 19 dialysis clinics as of March 31, 2005, and compared to 292 ESRD
patients at 70 dialysis clinics as of December 31, 2005. In addition, as of March 31,
2006, 54 hospitals were using the System One for critical care therapy, compared to
25 and 50 hospitals as of March 31, 2005 and December 31, 2005, respectively.
The following table sets forth the amount and percentage of revenues derived
from each market for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
|
|
|
|
2005 |
|
|
|
|
|
Critical care |
|
$ |
1,583,597 |
|
|
|
46.6 |
% |
|
$ |
661,769 |
|
|
|
64.0 |
% |
Chronic care |
|
|
1,817,125 |
|
|
|
53.4 |
% |
|
|
372,023 |
|
|
|
36.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,400,722 |
|
|
|
100 |
% |
|
$ |
1,033,792 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended March 31, 2006, we generated a net loss of $(9.3)
million, bringing our accumulated deficit balance to $(93.3) million. We have not
been profitable since inception, and we expect to incur net losses for the
foreseeable future as we expand our sales efforts and our operations. Our goal is to
increase our sales volume and revenues to gain scale of operation and to drive
product cost reductions, which we believe, when combined with other design
improvements, will allow us to reach profitability. We expect our revenues in the
chronic care market to increase faster than those in the critical care market and
believe they will continue to represent the majority of our revenues.
Statement of Operations Components
Revenues
Our products consist of the System One, an electromechanical device used to
circulate the patients blood during therapy; a single-use, disposable cartridge,
which contains a preattached dialyzer, and dialysate fluid used in our therapy, sold
either in premixed bags or prepared with our PureFlow SL product. We distribute our
products in two markets: the chronic care market and the critical care market. We
define the chronic care 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. We
offer a different configuration of the System One for each market. The FDA has
cleared both configurations for hemodialysis, hemofiltration and ultrafiltration. Our
products may be used by our customers to treat patients suffering from either
condition, although the site of care, the method of delivering care and the duration
of care are sufficiently different that we have separate marketing and sales efforts
dedicated to each market.
We derive our revenues from the sale and rental of equipment and the sale of the
related disposable products. In the critical care market, we generally sell the
System One and disposables to hospital customers. In the chronic care market,
customers generally rent the machine and then purchase the related disposable
products based on a specific patient prescription. We generally recognize revenues
when a
20
product has been delivered to our customer, or, in the chronic care market, on a
monthly basis in accordance with a contract under which we supply the use of a cycler
and the amount of disposables needed to perform a set number of dialysis therapy
sessions during a month.
Our contracts with dialysis centers for ESRD patients include terms providing
for the sale of disposable products to accommodate up to 26 treatments a month per
patient and the monthly rental of System One cyclers and our PureFlow SL product.
These contracts typically have a term of one year and are cancelable at any time by
the dialysis clinic with 30 days notice. Under the contract, 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. We do not currently derive any revenues from service contracts.
Over time, as more chronic patients are treated with the System One and more systems
are placed in patient homes under monthly agreements that provide for the rental of
the machine and the purchase of the related disposables, we expect that a recurring
revenue stream will become a meaningful component of our revenues.
Cost of Revenues
Cost of revenues consists primarily of direct product costs, including material
and labor required to manufacture our products, depreciation and maintenance of
System One cyclers that we rent to customers, production overhead and the cost of
purchasing system components from vendors which we then sell to our customers. It
also includes the cost of inspecting, servicing and repairing 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 products from third party suppliers, and the design
of the products.
We are currently operating at negative gross profit as we are building a base of
recurring revenues. We expect the cost of revenues as a percentage of revenues to
decline over time for two general reasons: first, we anticipate that increased sales
volume will lead to better purchasing terms and prices, and efficiencies in indirect
manufacturing overhead costs. For example, during the three months ended March 31,
2006 we have transitioned our purchases of dialysate to a new lower cost vendor.
Second, we have plans to introduce several process and product design changes that
have inherently lower cost than our current products. In addition, we plan to release
our PureFlow SL product commercially in July 2006 which should reduce our cost of
revenues and distribution costs by reducing the volume of dialysate fluid which we
currently manufacture and ship to customers. We expect that over time unit cost of
revenues will become less than unit revenues as we expand the scale of our
operations.
Operating Expenses
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 continue to increase in the foreseeable future as we seek to further enhance our
System One and related products, but not as rapidly as other expense categories as we
have substantially completed basic development of the System One.
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
21
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 the System One. 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 chronic care market, and as we add
additional sales and marketing personnel.
Distribution. Distribution expenses include salary, benefits and stock-based
compensation for distribution personnel, the cost of delivering our products to our
customers, or our customers patients, depending on the market and the specific
agreement with our customers. We use common carriers and freight companies to deliver
our products and we do not operate our own delivery service. Also included in this
category are the expenses of shipping products from customers back to our service
center for repair if the product is under warranty, and the related expense of
shipping a replacement product to our customers. We expect that distribution expenses
will increase at a lower rate than revenues, due to expected efficiencies gained from
increased business volume and the expected launch of our PureFlow SL product.
General and Administrative. General and administrative expenses consist
primarily of salary, benefits and stock-based compensation for our executive
management, legal and finance and accounting staff, fees from outside legal counsel,
fees for our annual audit and tax services, and general expenses to operate the
business, including insurance and other corporate-related expenses. Rent and
utilities are initially included in general and administrative expense and, within
the same reporting period, are allocated to operating expenses based on personnel and
square footage usage. We expect that general and administrative expenses will
increase in the near term as we add support structure for our growing business.
Results of Operations
The following table presents, for the periods indicated, information expressed
as a percentage of revenues. This information has been derived from our consolidated
statements of operations included elsewhere in this Quarterly Report on Form 10-Q.
You should not draw any conclusions about our future results from the results of
operations for any period.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Revenues |
|
|
100 |
% |
|
|
100 |
% |
Cost of revenues |
|
|
143 |
|
|
|
172 |
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
|
(43 |
) |
|
|
(72 |
) |
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
Research and development |
|
|
52 |
|
|
|
139 |
|
Selling and marketing |
|
|
94 |
|
|
|
128 |
|
Distribution |
|
|
38 |
|
|
|
30 |
|
General and administrative |
|
|
58 |
|
|
|
99 |
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
242 |
|
|
|
396 |
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(285 |
) |
|
|
(468 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense): |
|
|
|
|
|
|
|
|
Interest income |
|
|
18 |
|
|
|
7 |
|
Interest expense |
|
|
(5 |
) |
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
13 |
|
|
|
(7 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(272 |
)% |
|
|
(475 |
)% |
|
|
|
|
|
|
|
22
Comparison of Three Months Ended March 31, 2006 to Three Months Ended March 31, 2005
Revenues
Our revenues for the three month periods ended March 31, 2006 and 2005 were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Revenues |
|
$ |
3,401 |
|
|
$ |
1,034 |
|
|
$ |
2,367 |
|
|
|
229 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in revenues was attributable to increased sales and rentals of the
System One in both the critical care and chronic markets, primarily as a result of
increased sales and marketing efforts as we continue our commercial launch of the
System One. Revenues in the chronic care market increased to $1.8 million in the
three months ended March 31, 2006 compared to $0.4 million in the three months ended
March 31, 2005, an increase of 388%, while revenues in the critical care market
increased 139% to $1.6 million in the three months ended March 31, 2006, compared to
$0.7 million in the three months ended March 31, 2005.
Cost of Revenues and Gross Profit (Deficit)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Cost of revenues |
|
$ |
4,857 |
|
|
$ |
1,782 |
|
|
$ |
3,075 |
|
|
|
173 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
$ |
(1,456 |
) |
|
$ |
(748 |
) |
|
$ |
708 |
|
|
|
95 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit percentage |
|
|
(42.8 |
%) |
|
|
(72.4 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in absolute cost of revenues was attributable to our increased
revenues. We added 167 net patients during the three months ended March 31, 2006 and
377 since the three months ended March 31, 2005, which resulted in a $2.2 million
increase in cost of revenues. A 63% larger employee base resulted in additional
salaries, health benefits and payroll taxes of $0.3 million during the three months
ended March 31, 2006 compared to the same period in 2005. In addition, inbound
freight costs to support our higher production volume increased $0.2 million during
the three months ended March 31, 2006 compared to the same period in 2005. We are
currently operating at negative gross profit as we are building a base of recurring
revenues. We expect the cost of revenues as a percentage of revenues to decline over
time as increased sales volume should lead to better purchasing terms and prices, and
efficiencies in indirect manufacturing overhead costs. We expect that over time unit
cost of revenues will become less than unit revenues as we build the scale of our
operations. Inventory on hand at March 31, 2006 and December 31, 2005 have been
appropriately reduced to net realizable value through charges to cost of revenues.
Research and Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Research and development |
|
$ |
1,779 |
|
|
$ |
1,432 |
|
|
$ |
347 |
|
|
|
24 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development as
a percentage of revenues |
|
|
52 |
% |
|
|
139 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23
The increase in research and development expenses was
attributable to increased salary, benefits and payroll taxes of $166,000 as a result
of increased headcount, approximately $28,000 of stock-based compensation (no
comparable charge in 2005) and $190,000 of development costs associated with our
PureFlow SL product. We expect research and development expenses will continue to
increase in the foreseeable future as we seek to further enhance our System One and
related products, but not as rapidly as other expense categories as we have
substantially completed basic development of the System One. We expect research and
development expenses to continue to decline as a percentage of revenues.
Selling and Marketing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Selling and marketing |
|
$ |
3,193 |
|
|
$ |
1,321 |
|
|
$ |
1,872 |
|
|
|
142 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing as
a percentage of revenues |
|
|
94 |
% |
|
|
128 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in selling and marketing expenses was the result of several
factors. Approximately $1.2 million of the increase was due to higher salary and
benefits resulting from increased headcount, stock-based compensation amounted to
$112,000 (no comparable charge in 2005), approximately $348,000 of the increase
related to higher travel expenses and the balance of the increase was due to a
general higher level of sales and marketing activity in both the chronic and critical
care markets. We increased our sales force from 10 sales representatives as of March
31, 2005, to 25 sales representatives as of March 31, 2006. 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 chronic care market and as we add additional sales and marketing personnel.
Distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Distribution |
|
$ |
1,290 |
|
|
$ |
309 |
|
|
$ |
981 |
|
|
|
317 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution as a percentage of revenues |
|
|
38 |
% |
|
|
30 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in distribution expenses was due to increased volume of shipments
of disposable products to a growing number of patients in the chronic care market. We
expect that distribution expenses will increase at a lower rate than revenues in the
later half of 2006 due to expected shipping efficiencies gained from increased
business volume and density of customers, the reduction of higher cost deliveries
associated with bagged fluid due to the commercial launch of our PureFlow SL product
scheduled for July 2006 and the use of an outsourced logistics provider located in
the central part of the continental United States.
24
General and Administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
March 31, |
|
|
|
|
|
|
Percentage |
|
|
|
2006 |
|
|
2005 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
General and administrative |
|
$ |
1,975 |
|
|
$ |
1,025 |
|
|
$ |
950 |
|
|
|
93 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative as
a percentage of revenues |
|
|
58 |
% |
|
|
99 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in general and administrative expenses was primarily due to an
increase in salary and benefits as a result of the addition of three employees to
headcount, approximately $342,000 of stock-based compensation recorded in the three
months ended March 31, 2006 (no comparable charge in 2005), and approximately
$392,000 of legal and corporate expenses incurred as a result of operating as a
public company. We expect that general and administrative expenses will continue to
increase in the near term as we add support structure for our growing business and as
a result of costs related to operating a public company.
Interest Income and Interest Expense
Interest income is derived primarily from U.S. government securities,
certificates of deposit commercial paper and money market accounts. For the three
months ended March 31, 2006, interest income increased to $595,000 from $72,000 in
the same period in 2005 primarily due to increased cash and investment balances after
our initial public offering and higher interest rates during the three months ended
March 31, 2006.
Interest expense relates to a debt agreement signed in December 2004. Interest
expense increased slightly from $146,000 to $158,000 in the three months ended March
31, 2006 compared to the three months ended March 31, 2005.
Liquidity and Capital Resources
We have operated at a loss since our inception in 1998. As of March 31, 2006,
our accumulated deficit was $(93.3) million and we had cash, cash equivalents and
short-term investments of approximately $49.7 million. 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 $56.5 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. In December 2004, we obtained
$5.0 million of debt financing, which is repayable monthly with interest over three
years through December 2007. In connection with this debt financing, we granted the
lender a security interest in our assets.
25
The following table sets forth the components of our cash flows for the periods
indicated (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Net cash used in operating activities |
|
$ |
(10,480 |
) |
|
$ |
(5,590 |
) |
Net cash used in investing activities |
|
|
(671 |
) |
|
|
(531 |
) |
Net cash used in financing activities |
|
|
(396 |
) |
|
|
(227 |
) |
Effect of exchange rate changes on cash |
|
|
51 |
|
|
|
(37 |
) |
|
|
|
|
|
|
|
Net cash flow |
|
$ |
(11,496 |
) |
|
$ |
(6,385 |
) |
|
|
|
|
|
|
|
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, offset by increases in accounts payable and accrued
expenses. Non-cash transfers from inventory for the placement of rental units with
our customers represented $2.9 million and $0.5 million, respectively, during the
three months ended March 31, 2006 and 2005.
Net Cash Used in Investing Activities. For each of the periods above, net
cash used in investing activities reflected purchases of property and equipment,
primarily for research and development, information technology, manufacturing
operations and capital improvements to our facilities. Excluded from these figures is
the purchase of $14.7 million of commercial paper during the three months ended March
31, 2006 and the sale of our marketable securities in the amount of $7.5 million
during the three months ended March 31, 2005.
Net Cash Used In Financing Activities. Net cash used in financing activities
reflected the exercise of stock options during the three months ended March 31, 2006,
offset by the repayment of debt of $412,000 and $227,000 during the three months
ended March 31, 2006 and 2005, respectively.
We expect to continue to incur net losses for the
foreseeable future. We expect that our current cash position is sufficient to support
operations at least through 2006. In the longer term, we expect to fund the working
capital needs of our operations with revenue generated from product placements and
sales but these resources may prove insufficient. If our existing resources are
insufficient to satisfy our liquidity requirements, we may need to sell additional
equity or issue debt securities. Any sale of additional equity or issuance of debt
securities may 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 this additional financing
when needed, we may be required to delay, reduce the scope of, or eliminate one or
more aspects of our business development activities, which could harm the growth of
our business.
26
The following table summarizes our contractual commitments as of March 31, 2006
(unaudited) and the effect those commitments are expected to have on liquidity and
cash flow in future periods:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
|
|
|
|
Less Than |
|
|
|
|
|
|
|
|
|
|
More Than |
|
|
|
Total |
|
|
One Year |
|
|
1-3 Years |
|
|
3-5 Years |
|
|
5 Years |
|
|
|
|
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
|
|
|
|
Notes payable(1) |
|
$ |
3,675 |
|
|
$ |
1,683 |
|
|
$ |
1,992 |
|
|
$ |
|
|
|
$ |
|
|
Operating leases |
|
|
3,403 |
|
|
|
503 |
|
|
|
1,049 |
|
|
|
1,099 |
|
|
|
752 |
|
Purchase obligations(2) |
|
|
25,766 |
|
|
|
21,222 |
|
|
|
2,200 |
|
|
|
2,344 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
32,844 |
|
|
$ |
23,408 |
|
|
$ |
5,241 |
|
|
$ |
3,443 |
|
|
$ |
752 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Notes payable includes a balloon payment of $650,000 in accrued interest due in
December 2007. |
|
(2) |
|
Purchase obligations include purchase commitments for System One components,
primarily for equipment and fluids pursuant to contractual agreements with several of
our suppliers. |
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. The
preparation of these consolidated financial statements requires us to make
significant estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses. These items are regularly monitored and analyzed
by management for changes in facts and circumstances, and material changes in these
estimates could occur in the future. Changes in estimates are recorded in the period
in which they become known. We base our estimates on historical experience and
various other assumptions that we believe to be reasonable under the circumstances.
Actual results may differ substantially from our estimates.
A summary of those accounting policies and estimates that we believe are most
critical to fully understanding and evaluating our financial results is set forth
below. This summary should be read in conjunction with our consolidated financial
statements and the related notes included elsewhere in this Annual Report on Form
10-K.
Revenue Recognition
We recognize revenues from product sales and services when earned in accordance
with Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, and Emerging
Issues Task Force, or EITF, 00-21, Revenue Arrangements with Multiple Deliverables.
Revenues are recognized when: (a) there is persuasive evidence of an arrangement, (b)
the product has been shipped or services and supplies have been provided to the
customer, (c) the sales price is fixed or determinable and (d) collection is
reasonably assured. In the critical care market, sales are structured as direct
product sales or as a disposables-based program in which a customer acquires the
equipment through the purchase of a specific quantity of disposables over a specific
period of time. In the chronic care market, revenues are realized using the short or
long-term rental arrangements.
In the critical care market, we recognize revenues from direct product sales at
the later of the time of shipment or, if applicable, delivery in accordance with
contract terms. For the chronic care market we recognize revenues derived from short
or long-term rental arrangements on a straight-line basis. These rental arrangements,
which combine the use of a system with a specified number of disposable products
supplied to customers for a fixed amount per month, are recognized on a monthly basis
in accordance
27
with agreed upon contract terms and pursuant to a binding customer purchase order and
fixed payment 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 disposables at a price that includes a premium above the otherwise
average selling price of the disposables to recover the purchase 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.
When we enter into a multiple element arrangement, we allocate the total fee to
all elements of the arrangement based on their respective fair values. Fair value is
determined by the price charged when each element is sold separately.
We provide for estimated product returns at the time of revenue recognition.
Payments received for products or services prior to shipment or prior to completion
of the related services are recorded as deferred revenue.
Inventory Valuation
Inventories are valued at the lower of cost (weighted-average) or estimated
market. We regularly review our inventory quantities on hand and related cost and
record a provision for excess or obsolete inventory primarily based on an estimated
forecast of product demand for each of our existing product configurations. We also
review our inventory value to determine if it reflects lower of cost or market, with
market determined based on net realizable value. Appropriate consideration is given
to inventory items sold at negative gross margins 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.
Field Equipment
We amortize field equipment 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, actual equipment
disposal rates, and the impact of planned design improvements. We believe the five
year useful life is appropriate as of March 31, 2006.
Accounting for Stock-Based Awards
Prior to January 1, 2006, we accounted for stock-based employee compensation in
accordance with Accounting Principles Board, or APB, Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. Accordingly, compensation
expense was recorded for stock options awarded to employees and directors to the
extent that the option exercise price was less than the fair market value of our
common stock on the date of grant, where the number of shares and exercise price were
fixed. The difference between the fair value of our common stock and the exercise
price of the stock option, if any, was recorded as deferred
compensation and was
amortized to compensation expense over the vesting period of the underlying stock
option. Prior to becoming a public company on October 27, 2005, there had been no
public market for our common stock. Absent an objective measure of the fair value of
our common stock, the determination of fair value required judgment. Our board of
directors (the Board) periodically estimated the fair value of our common stock in
connection with any issuance of stock options. The fair
28
value of our common stock was estimated based on factors such as independent
valuations, sales of preferred stock, the liquidation preference, dividends, voting
rights of the various classes of stock, our financial and operating performance,
progress on development goals, the issuance of patents, the value of other companies
involved in dialysis, general economic and market conditions and other factors that
we believed would reasonably have a significant bearing on the value of our common
stock.
Prior to January 1, 2006, we followed the disclosure requirements of Statement
of Financial Accounting Standard, or SFAS No. 123, Accounting for Stock-Based
Compensation for stock-based awards to employees. All stock-based awards to
non-employees were accounted for at their fair value in accordance with SFAS No. 123
and related interpretations. For purposes of the pro forma disclosures required by
SFAS No. 123, stock options granted subsequent to July 19, 2005, the date of filing
our initial registration statement with the SEC, were valued using the Black-Scholes
option-pricing model.
We adopted SFAS No. 123R, Share-Based Payment, effective January 1, 2006. SFAS
123R requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the statement of operations based on their fair
values. In addition, SFAS 123R requires the use of the prospective method
for any outstanding stock options that were previously valued using the minimum value
method. Accordingly, with the adoption of SFAS 123R, we will not recognize the
remaining compensation cost for any stock option awards which had previously been
valued using the minimum value method. In addition, SFAS 123R prohibits the use of
pro forma disclosures for stock option awards valued under the minimum value method
(i.e., our pre-July 19, 2005 stock option awards). Stock option awards granted prior
to July 19, 2005, the date on which we filed our preliminary prospectus with the SEC,
that are subsequently modified, repurchased or cancelled after January 1, 2006 shall
be subject to the provisions of SFAS 123R.
We will use the modified prospective method under SFAS 123R for any stock
options granted after July 19, 2005. The aggregate value of the unvested portion of
stock options issued between July 19, 2005 and December 31, 2005 totaled $4.4 million
as of December 31, 2005, net of estimated forfeitures. Beginning in 2006, this
aggregate value will be recognized as compensation expense in our consolidated
statement of operations ratably over the remaining vesting period. The adoption of
SFAS 123R resulted in stock-based compensation expense of $443,350, or $0.02 basic
and diluted net loss per share, for the three months ended March 31, 2006. Management
continues to evaluate the use of stock-based equity awards and may consider other
forms of equity-based compensation arrangements (such as restricted stock units), or
reduce the volume of stock option award grants in the future.
Prospectively, we will use the Black-Scholes option-pricing model to estimate
the fair value of equity-based compensation awards on the dates of grant. In
accordance with SAB 107, based upon our stage of development and the short period of
time that our common stock has been publicly traded on the Nasdaq National Market, 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 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.
29
Volatility the objective in estimating expected volatility is to ascertain
the assumption about expected volatility that marketplace participants would
likely use in determining an exchange price for an option. Because we have no
options that are traded publicly and because of our limited trading history as
a public company, our volatility assumption has been based upon an analysis of
the trading of similar companies in the medical device and technology
industries, consistent with the methodology used in 2005. We may change our
volatility assumption in the future once we have a sufficient amount of
historical information regarding the volatility of our share price. For the
three months ended March 31, 2006, we have used a volatility rate assumption of
85% for stock option grants. We expect to use a volatility rate assumption of
85% for stock options granted during the remainder of 2006.
We have also estimated expected forfeitures of stock options upon adoption of
SFAS 123R. In developing a forfeiture rate estimate, we have considered our
historical experience, our growing employee base and the limited liquidity of our
common stock. Actual forfeiture activity may differ from our estimated forfeiture
rate.
Accounting for Income Taxes
We account for federal and state income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. Under the liability method specified by SFAS No. 109,
a deferred tax asset or liability is determined based on the difference between the
financial statement and tax basis of assets and liabilities, as measured by the
enacted tax rates. 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 March 31, 2006 and 2005 to reflect these
uncertainties.
Related-Party Transactions
Medisystems Corporation is our primary supplier of completed
cartridges, tubing and certain other
components used in the System One disposable cartridge. The
chief executive officer and sole stockholder of Medisystems is a member of our board
of directors and owns approximately 9.4% of our outstanding common stock as of March
31, 2006. We purchased approximately $759,000 and $126,000 of goods from Medisystems
during the three months ended March 31, 2006 and 2005, respectively. We anticipate
significantly increasing the amount of products that we purchase from Medisystems
over the next few years. We do not have a long-term supply agreement with
Medisystems, and we purchase products from Medisystems through purchase orders. We
are currently negotiating a long-term supply agreement with Medisystems covering
components, subassemblies and completed cartridges, although we cannot be certain
that we will enter into an agreement with Medisystems. We believe that our purchases
from Medisystems have been on terms no less favorable to us than could be obtained
from unaffiliated third parties or through internal operations.
Off-Balance Sheet Arrangements
Since inception we have not engaged in any off-balance sheet financing
activities except for leases which are properly classified as operating leases and
disclosed in the Liquidity and Capital Resources section above.
30
Recent Accounting Pronouncements
Refer to Accounting for Stock-Based Awards in the Summary of Critical
Accounting Policies and Estimates section above for a summary of the impact of
adopting SFAS 123R to our consolidated financial statements during the three months
ended March 31, 2006.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the three months ended March 31, 2006, there were no material changes in
our market risk exposure. For quantitative and qualitative disclosures about market
risk affecting NxStage, see Item 7A, Quantitative and Qualitative Disclosures About
Market Risk, of our Annual Report on Form 10-K for the fiscal year ended December
31, 2005, which is incorporated herein by reference.
Item 4. Controls and Procedures
Our management, with the participation of our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls and
procedures as of March 31, 2006. The term disclosure controls and procedures, as
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and
other procedures of a company that are designed to ensure that information required
to be disclosed by a company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time periods
specified in the SECs rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by a company in the reports that it files or submits under
the Exchange Act is accumulated and communicated to the companys management,
including its principal executive and principal financial officers, as appropriate to
allow timely decisions regarding required disclosure. Our management recognizes that
any controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and management necessarily
applies its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. Based on the evaluation of our disclosure controls and procedures as
of March 31, 2006, our chief executive officer and chief financial officer concluded
that, as of such date, our disclosure controls and procedures were effective at the
reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rule
13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal
quarter ended March 31, 2006 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
31
PART II OTHER INFORMATION
Item 1A. Risk Factors
In addition to the factors discussed in Managements Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this report, the
following are some of the important risk factors that could cause our actual results
to differ materially from those projected in any forward-looking statements.
Risks Related to our Business
We expect to derive substantially all of our future revenues from the rental or sale
of our System One and the sale of our related disposable products used with the
System One.
Since our inception, we have devoted substantially all of our efforts to the
development of the System One and the related products used with the System One. We
commenced marketing the System One and the related disposable products to the
critical care market in February 2003. We commenced marketing the System One for
chronic hemodialysis treatment in September 2004. We expect that the rental or sale
of the System One and the sale of related products will account for substantially all
of our revenues for the foreseeable future. Most of our related products cannot be
used with any other dialysis systems and, therefore, we will derive little or no
revenues from related products unless we sell or otherwise place the System One. To
the extent that the System One is not a successful product or is withdrawn from the
market for any reason, we do not have other products in development that could
replace revenues from the System One.
We cannot accurately predict the size of the home hemodialysis market, and it may be
smaller or slower to develop than we expect.
Although home hemodialysis treatment options are available, adoption 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 25,000 in 2002, 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; USRDS data indicates approximately 1,200 patients were receiving home-based
hemodialysis in 2002. 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. Our long-term growth will depend on the
number of patients who adopt home-based hemodialysis and how quickly they adopt it,
and 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 or how many
peritoneal dialysis patients will switch to home-based hemodialysis. We received our
home use clearance for the System One from the FDA in June 2005 and we will need to
devote significant resources to developing the market. We cannot be certain that this
market will develop, how quickly it will develop or how large it will be.
We will require significant capital to build our business, and financing may not be
available to us on reasonable terms, if at all.
We believe that the chronic care market is the largest market opportunity for
our System One hemodialysis system. We typically bill the dialysis clinic for the
rental of the equipment and the sale of the related disposable cartridges and
treatment fluids. As a result, we expect that we will generate revenues and cash flow
from the use of the System One over time rather than upfront from the sale of the
32
System One
equipment, and we will need significant amounts of working capital to manufacture
System One
equipment for rental to dialysis clinics.
We only recently began marketing our System One to dialysis clinics for the
treatment of ESRD, and we have not achieved widespread market acceptance of our
product. We may not be able to generate sufficient cash flow to meet our
capital needs. If our existing resources are insufficient to satisfy our liquidity
requirements, we may need to sell additional equity or debt securities. Any sale of
additional equity or debt securities may result in additional 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 this additional financing, we may be required to delay, reduce the
scope of, or eliminate one or more aspects of our business strategy, which could harm
the growth of our business.
We have limited operating experience, a history of net losses and an accumulated
deficit of $93.3 million at March 31, 2006. We cannot guarantee if, when and the
extent that we will become profitable, or that we will be able to maintain
profitability once it is achieved.
Since inception, we have incurred losses every quarter and at March 31, 2006, we
had an accumulated deficit of approximately $(93.3) million. We expect to incur
increasing operating expenses as we continue to grow our business. Additionally, in
the ESRD chronic market, the cost of manufacturing the System One and related
disposables currently exceeds the market price. We cannot provide assurance that we
will be able to lower the cost of manufacturing the System One and related
disposables below the current chronic market price, 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 in part upon achieving a sufficient scale of operations,
obtaining better purchasing terms and prices, achieving efficiencies in manufacturing
overhead costs, the implementing of design and process improvements to lower our
costs of manufacturing our products and our ability to achieve an efficient
distribution of our products.
Our PureFlow SL product, which we hope to commercially launch extensively in the
chronic care market in July 2006, is an important part of our cost reduction plans.
Any delay in our plans to launch the PureFlow SL, or any failure to gain rapid market
acceptance of the PureFlow SL, including converting our installed
base of patients on bagged
fluid, could adversely effect our ability to achieve profitability.
We only recently began marketing our System One hemodialysis system to dialysis
clinics for the treatment of ESRD, and our success will depend on our ability to
achieve market acceptance of our System One.
We only recently began marketing our System One for the treatment of ESRD. Our
products have limited product and brand recognition and have only been used at a
limited number of dialysis clinics and hospitals. In the ESRD market, we will 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 will use different considerations in reaching
their decision. Lack of acceptance by any of these constituencies will make it
difficult for us to grow our business. We may have difficulty gaining widespread or
rapid acceptance of the System One for a number of reasons including:
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the failure by us to demonstrate to patients, operators of dialysis
clinics, nephrologists, dialysis nurses and others that our product is
equivalent or superior to existing therapy options or, that the cost or
risk associated with use of our product is not greater than available
alternatives; |
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competition from products sold by companies with longer operating
histories and greater financial resources, more recognizable brand
names and better established distribution networks and relationships
with dialysis clinics; |
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the ownership and operation of some dialysis providers by companies
that also manufacture and sell competitive dialysis products; |
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the introduction of competing products or treatments that may be
more effective, safer, easier to use or less expensive than ours; |
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the number of patients willing and able to perform therapy
independently, outside of a traditional dialysis clinic, may be smaller
than we estimate; and |
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the continued availability of satisfactory reimbursement from
healthcare payors, including Medicare. |
Current Medicare reimbursement rates limit the price at which we can market the
System One, and adverse changes to reimbursement could affect the adoption of the
System One.
Our ability to attain profitability will be driven in part by our ability to set
or maintain adequate pricing for our System One. As a result of legislation passed by
the U.S. Congress more than 30 years ago, Medicare provides comprehensive and
well-established reimbursement in the United States for ESRD. With over 80% of U.S.
ESRD patients covered by Medicare, the reimbursement rate is an important factor in a
potential customers decision to use the System One and limits the fee for which we
can rent the System One and sell the related disposable cartridges and treatment
fluids. Current CMS rules limit the number of hemodialysis treatments paid for by
Medicare to three times a week, unless there is medical justification for additional
treatments. Most patients using the System One in the home treat themselves, with the
help of a partner, up to six times per week. To the extent that Medicare contractors
elect not to pay for the additional treatments, adoption of the System One may be
slowed.
Although changes to the composite rate have been relatively infrequent, changes
in Medicare reimbursement rates could negatively affect demand for our products and
the prices we charge for them.
As we evolve from a company primarily involved in the development of dialysis
products into one that is also involved in the commercialization of those products,
we may have difficulty managing our growth and expanding our operations successfully.
As the commercial launch of the System One continues, we will need to expand our
regulatory, manufacturing, sales and marketing and on-going development capabilities
or contract with other organizations to provide these capabilities for us. As our
operations expand, we expect that we will need to manage additional relationships
with various partners, suppliers, manufacturers and other organizations. Our ability
to manage our operations and growth requires us to continue to improve our
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.
34
We compete against other dialysis equipment manufacturers with much greater financial
resources and better established products and customer relationships, which may make
it difficult for us to penetrate the market and achieve significant sales of our
products.
Our System One competes directly against equipment produced by Fresenius Medical
Care AG, Baxter Healthcare Corporation, Gambro AB, and others, each of which markets
one or more FDA-cleared medical devices for the treatment of acute or chronic kidney
failure. In addition, Aksys, Ltd. sells a hemodialysis machine, which is also
specifically cleared by the FDA for home use. Each of our competitors offers products
that have been in use for a longer time than our products and are more widely
recognized by physicians, patients and providers. Most of our 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, in the case of Fresenius, own and operate a chain
of dialysis clinics. Most of these companies manufacture additional complementary
products enabling them to offer a bundle of products and have established sales
forces and distribution channels that may afford them a significant competitive
advantage.
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 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 safety, convenience or effectiveness or are offered at lower
prices than our System One. Our ability to successfully market our products could
also be adversely affected by pharmacological and technological advances in
preventing the progression of ESRD and/or in the treatment of acute kidney failure or
fluid overload. If we are unable to compete effectively against existing and future
competitors and existing and future alternative treatments and pharmacological and
technological advances, it will be difficult for us to penetrate the market and
achieve significant sales of our products.
The two largest dialysis clinic chains in the United States are affiliated with, or
have contractual arrangements with, other dialysis equipment manufacturers, which may
present a barrier to adoption of the System One at these chains.
Fresenius and DaVita own and operate the two largest chains of dialysis clinics
in the United States. Fresenius controls approximately 35% of the U.S. dialysis
clinics, on a pro forma basis assuming the completion of its pending acquisition of
Renal Care Group and the completion of the recently announced sale of 100 clinics to
National Renal Institutes. Fresenius is also the largest worldwide manufacturer of
dialysis systems. DaVita controls approximately 28% of the U.S. dialysis clinics, and
has entered into a preferred supplier agreement with Gambro pursuant to which Gambro
will provide a significant majority of DaVitas dialysis equipment and supplies for a
period of at least 10 years. Each of Fresenius and DaVita may choose to offer to
patients in their dialysis clinics 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. We are presently
renting the System One to several DaVita dialysis clinics. Revenues from DaVita
dialysis clinics represented 13% of our revenues during the three months ended March
31, 2006. We cannot be sure that DaVita will continue to rent the System One from us
or that any future decision by DaVita to stop or limit the use of the System One
would not adversely affect our business.
35
If kidney transplantation becomes a viable treatment option for more patients with
ESRD, the market for our System One may be limited.
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 2002 approximately 15,700 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 System One.
If we are unable to convince hospitals and healthcare providers of the benefits of
our products for the treatment of acute kidney failure and fluid overload, we may not
be successful in penetrating the critical care market.
We sell the System One for use in the treatment of acute kidney failure and
fluid overload associated with, among other conditions, congestive heart failure.
Physicians currently treat most acute kidney failure patients using conventional
hemodialysis systems or dialysis systems designed specifically for use in the ICU. We
will need to convince hospitals and healthcare providers that using the System One is
as effective as using conventional hemodialysis systems or ICU specific dialysis
systems for treating acute kidney failure and that it provides advantages over
conventional systems or other ICU specific systems because of its significantly
smaller size and ease of operation.
Fluid overload resulting from congestive heart failure is most often treated
with a variety of drugs rather than with ultrafiltration because ultrafiltration is a
less well-known, less studied treatment option and as a result, there is a lack of
clinical evidence to support its effectiveness. Because the System One would be used
to deliver ultrafiltration, we will need to convince hospitals, healthcare providers
and third-party payors that ultrafiltration using the System One is as effective and
cost-efficient as existing treatments for fluid overload resulting from congestive
heart failure.
We are subject to the risk of costly and damaging product liability claims and may
not be able to maintain sufficient product liability insurance to cover claims
against us.
If our System One 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. As is
the case with a number of other medical device companies, it is likely that product
liability claims will be brought against us. Since their introduction into the
market, our products have been subject to two voluntary recalls and one voluntary
product withdrawal. Our first voluntary recall occurred in February 2001 in Canada
and related to a software glitch that we detected in our predecessor system, which
could have increased the likelihood of a clotted filter during treatment. There were
no patient injuries associated with this recall, and the software glitch was remedied
with a subsequent software release. The second voluntary recall occurred in April
2004 in the United States relating to pinhole-sized dialysate leaks in our cartridge.
The leaks were readily observable and required a cartridge replacement to continue
treatment. There were no patient injuries associated with this recall; we
subsequently switched suppliers and instituted additional testing requirements to
minimize the chance for pinhole-sized leaks in our cartridges. The voluntary market
withdrawal occurred in the United States in May 2002 when we suspended sales of our
predecessor system while we addressed issues involving limited instances of
contaminated hemofiltration fluids compounded by a pharmacy and supplied by a
third-party. Six patients exposed to contaminated fluids reported fevers and/or
chills, with no lasting clinical effect. We subsequently modified our cartridge to
allow for an additional filter to remove contaminants from fluids used with our
product. Our products may be subject to further recalls or
36
withdrawals, which could increase the likelihood of product liability claims. We have
also received several reports of operator error from both patients in the home
hemodialysis setting and nurses in the critical care setting. We have addressed
many potential sources of operator error with product design changes to simplify the
operator processes through improvements to both training materials and user
literature. However, instances of operator error could also increase the likelihood
of product liability claims.
Although we maintain insurance, including product liability insurance, we cannot
provide assurance that any claim that may be brought against us will not result in
court judgments or settlements in amounts that are in excess of the limits of our
insurance coverage. Our insurance policies also have various exclusions, and we may
be subject to a product liability claim for which we have no coverage. We will have
to pay any amounts awarded by a court or negotiated in a settlement that exceed our
coverage limitations or that are not covered by our insurance.
Any product liability claim brought against us, with or without merit, could
result in the increase of our product liability insurance rates or the inability to
secure additional insurance coverage in the future. A product liability claim,
whether meritorious or not, could be time consuming, distracting and expensive to
defend and could result in a diversion of management and financial resources away
from our primary business, in which case our business may suffer.
We have had limited sales, marketing, customer service and distribution experience.
We need to expand our sales and marketing, customer service and distribution
infrastructures to be successful in penetrating the dialysis market.
We currently market and sell the System One through our own sales force, and we
have had limited experience in sales, marketing and distribution of dialysis
products. As of March 31, 2006, we had 73 employees in our sales, marketing and
distribution organization, including 25 direct sales representatives. We plan to
expand our sales, marketing, customer service and distribution infrastructures. We
cannot provide assurance that we will be able to attract experienced personnel to our
early-stage company and build an adequate sales and marketing, customer service and
distribution staff or that the cost will not be prohibitive.
We face risks associated with having international manufacturing operations, and if
we are unable to manage these risks effectively, our business could suffer.
In addition to our operations in Lawrence, Massachusetts, we operate a
manufacturing facility in Rosdorf, Germany and we 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. These risks include
fluctuations in foreign currency exchange rates that may increase the U.S. dollar
cost of the disposables we purchase from foreign third-party suppliers, 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.
37
Risks Related to the Regulatory Environment
We are subject to significant regulation, primarily by the FDA. We cannot market or
commercially distribute our products without obtaining and maintaining necessary
regulatory clearances or approvals.
Our System One and related products, including the disposables required for its
use, are all 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 the System One. We cannot provide assurance that such clearances or
approvals would be forthcoming, or, if forthcoming, what the timing and expense of
obtaining such clearances or approvals might be. Delays in obtaining clearances or
approvals could adversely affect our ability to introduce new products or
modifications to our existing products in a timely manner, which would delay or
prevent commercial sales of our products.
Modifications to our marketed devices may require new regulatory clearances or
pre-market approvals, or may require us to cease marketing or recall the modified
devices until clearances or approvals are obtained.
Any modifications to a 510(k) cleared device that could significantly affect its
safety or effectiveness, or would constitute a major change in its intended use,
requires the submission of another pre-market notification to address the change.
Although in the first instance we may determine that a change does not rise to a
level of significance that would require us to make a pre-market notification
submission, the FDA may disagree with us and can require us to submit a 510(k) for a
significant technological change 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 the System One and have filed and received clearance from
the FDA with respect to some of the changes in the design of our products. If the FDA
requires us to submit a 510(k) for any modification to a previously cleared device,
or in the future a device that has received 510(k) clearance, we may be required to
cease marketing the device, recall it, and not resume marketing until we obtain
clearance from the FDA for the modified version of the device. Also, we may be
subject to regulatory fines, penalties and/or other sanctions authorized by the
Federal Food, Drug, and Cosmetic Act. In the future, we intend to introduce new
products and enhancements and improvements to existing products. We cannot provide
assurance that the FDA will clear any new product or product changes for marketing or
what the timing of such clearances might be. In addition, new products or
significantly modified marketed products could be found to be not substantially
equivalent and classified as products requiring the FDAs approval of a pre-market
approval application, or PMA, before commercial distribution would be permissible.
PMAs usually require substantially more data than 510(k) submissions and their review
and approval or denial typically takes significantly longer than a substantially
equivalent 510(k) decision. 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.
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Even if we obtain the necessary FDA clearances or approvals, if we or our suppliers
fail to comply with ongoing regulatory requirements our products could be subject to
restrictions or withdrawal from the market.
We are subject to the Medical Device Reporting, or MDR, regulations that require
us to report to the FDA if our products may have caused or contributed to patient
death or serious injury, or if our device malfunctions and a recurrence of the
malfunction would likely result in a death or serious injury. We must also file
reports of device corrections and removals and adhere to the FDAs rules on labeling
and promotion. Our failure to comply with these or other applicable regulatory
requirements could result in enforcement action by the FDA, which may include any of
the following:
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untitled letters, warning letters, fines, injunctions and civil
penalties; |
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administrative detention, which is the detention by the FDA of
medical devices believed to be adulterated or misbranded; |
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customer notification, or orders for repair, replacement or refund; |
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voluntary or mandatory recall or seizure of our products; |
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operating restrictions, partial suspension or total shutdown of production; |
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refusal to review pre-market notification or pre-market approval submissions; |
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rescission of a substantial equivalence order or suspension or
withdrawal of a pre-market approval; and |
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criminal prosecution. |
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.
Complex medical devices, such as the System One, can experience performance
problems in the field that require review and possible corrective action by us or the
product manufacturer. We cannot provide assurance that component failures,
manufacturing errors, design defects and/or labeling inadequacies, which could result
in an unsafe condition or injury to the operator or the patient will not occur. These
could lead to a government mandated or voluntary recall by us. The FDA has the
authority to require the recall of our products in the event a product presents a
reasonable probability that it would cause serious adverse health consequences or
death. Similar regulatory agencies in other countries have similar authority to
recall devices because of material deficiencies or defects in design or manufacture
that could endanger health. We believe that the FDA would request that we initiate a
voluntary recall if a product was defective or presented a risk of injury or gross
deception. Any recall would divert management attention and financial resources,
could cause the price of our stock to decline and expose us to product liability or
other claims and harm our reputation with customers. A recall involving the System
One could be particularly harmful to our business and financial results, because the
System One is our only product.
39
If we or our contract manufacturers fail to comply with FDAs Quality System
regulations, our manufacturing operations could be interrupted, and our product sales
and operating results could suffer.
Our finished goods manufacturing processes, and those of some of our contract
manufacturers, are required to comply with the FDAs Quality System regulations, or
QSRs, which cover the procedures and documentation of the design, testing,
production, control, quality assurance, labeling, packaging, sterilization, storage
and shipping of our devices. The FDA enforces its QSRs through periodic unannounced
inspections of manufacturing facilities. We and our contract manufacturers have been,
and anticipate in the future being, subject to such inspections. Our 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. The second and third inspections resulted in no
observations. 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 the U.S., recalling of our products, refusing to approve new
marketing applications, instituting legal proceedings to detain or seize products or
imposing civil or criminal penalties or other sanctions, any of which could cause our
business and operating results to suffer.
Changes in reimbursement for treatment for ESRD could affect the adoption of our
System One and the level of our future product revenues.
In the United States, all patients who suffer from ESRD, regardless of age, are
eligible for coverage under Medicare, after a requisite waiting period if other
insurance is available. As a result, more than 80% of patients with ESRD are covered
by Medicare. Although we rent and sell our products to hospitals, dialysis centers
and other healthcare providers and not directly to patients, the reimbursement rate
for ESRD treatments is an important factor in a potential customers decision to
purchase the System One. The dialysis centers that purchase our product rely on
adequate third-party payor coverage and reimbursement to maintain their ESRD
facilities. There is some regional variation in the composite rate for dialysis
services, but the national average rate is currently approximately $155 per
treatment, which is intended to cover most items and services related to the
treatment of ESRD, but does not include payment for physician services or separately
billable laboratory services or drugs. Although Congress has periodically adjusted
the composite rate, changes have been infrequent. Changes in Medicare reimbursement
rates could negatively affect demand for our products and the prices we charge for
them.
Most ESRD patients who use our product for dialysis therapy in the home treat
themselves six times per week. CMS rules, however, limit the number of hemodialysis
treatments paid for by Medicare to three a week, unless there is medical
justification for the additional treatments. The determination of medical
justification must be made at the local Medicare contractor level on a case-by-case
basis. If daily therapy is prescribed, a clinics decision as to how much it is
willing to spend on dialysis equipment and services will be at least partly dependent
on whether Medicare will reimburse more than three treatments per week for the
clinics patients.
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 diagnosis related system. Under this system,
reimbursement is determined based on a patients primary diagnosis and is intended to
cover all costs of treating the patient. The presence of acute kidney failure or
fluid overload increases the severity of the
40
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.
Legislative or regulatory reform of the healthcare system may affect our ability to
sell our products profitably.
In both the United States and foreign countries, there have been legislative and
regulatory proposals to change the healthcare system in ways that could affect our
ability to sell our products profitably. The federal government and some states have
enacted healthcare reform legislation, and further federal and state proposals are
likely. We cannot predict the exact form this legislation may take, the probability
of passage, and the ultimate effect on NxStage. Our business could be adversely
affected by future healthcare reforms or changes in Medicare.
Failure to obtain regulatory approval in foreign jurisdictions would prevent us from
marketing our products outside the United States.
Although we have not initiated any marketing efforts in jurisdictions outside of
the United States and Canada, we intend in the future to market our products in other
markets. In order to market our products in the European Union 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.
We currently have obligations under our contracts with dialysis clinics to protect
the privacy of patient health information.
In the course of performing our business we obtain, from time to time,
confidential patient health information. For example, we learn patient names and
addresses when we ship our System One supplies to home hemodialysis patients. We may
learn patient names and be exposed to confidential patient health information when we
provide training on System One operations to our customers staff. Our home
hemodialysis patients may also call our customer service representatives directly
and, during the call, disclose confidential patient health information. U.S. Federal
and state laws protect the confidentiality of certain patient health information, in
particular individually identifiable information, and restrict the use and disclosure
of that information. At the federal level, the Department of Health and Human
Services promulgated health information and privacy and security rules under 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 NxStage. 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,
41
conduct by a person that is not a covered entity could potentially be prosecuted
under aiding and abetting or conspiracy laws if there is an improper disclosure or
misuse of patient information.
Many state laws apply to the use and disclosure of health information, which
could affect the manner in which we conduct our business. Such laws are not
necessarily preempted by HIPAA, in particular those laws that afford greater
protection to the individual than does HIPAA. Such state laws typically have their
own penalty provisions, which could be applied in the event of an unlawful action
affecting health information.
We are subject to federal and state laws prohibiting kickbacks and false and
fraudulent claims which, if violated, could subject us to substantial penalties.
Additionally, any challenges to or investigation into our practices under these laws
could cause adverse publicity and be costly to respond to, and thus could harm our
business.
The Medicare/ Medicaid anti-kickback laws, and several similar state laws,
prohibit payments that are intended to induce physicians or others either to refer
patients or to acquire or arrange for or recommend the acquisition of healthcare
products or services. These laws affect our sales, marketing and other promotional
activities by limiting the kinds of financial arrangements, including sales programs,
we may have with hospitals, physicians or other potential purchasers or users of
medical devices. In particular, these laws influence, among other things, how we
structure our sales and rental offerings, including discount practices, customer
support, education and training programs and physician consulting and other service
arrangements. Although we seek to structure such arrangements in compliance with
applicable requirements, these laws are broadly written, and it is often difficult to
determine precisely how these laws will be applied in specific circumstances. If one
of our sales representatives were to offer an inappropriate inducement to purchase
our System One 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.
42
Foreign governments tend to impose strict price controls, which may adversely affect
our future profitability.
Although we have not initiated any marketing efforts in jurisdictions outside of
the United States and Canada, we intend in the future to market our products in other
markets. 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 the System One 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 business activities involve the use of hazardous materials, which require
compliance with environmental and occupational safety laws regulating the use of such
materials. If we violate these laws, we could be subject to significant fines,
liabilities or other adverse consequences.
Our research and development programs as well as our manufacturing operations
involve the controlled use of hazardous materials. Accordingly, we are subject to
federal, state and local laws governing the use, handling and disposal of these
materials. Although we believe that our safety procedures for handling and disposing
of these materials comply in all material respects with the standards prescribed by
state and federal regulations, we cannot completely eliminate the risk of accidental
contamination or injury from these materials. In the event of an accident or failure
to comply with environmental laws, we could be held liable for resulting damages, and
any such liability could exceed our insurance coverage.
Risks Related to Operations
We depend on the services of our senior executives and certain key engineering,
scientific, clinical and marketing personnel, the loss of whom could negatively
affect our business.
Our success depends upon the skills, experience and efforts of our senior
executives and other key personnel, including our chief executive officer, certain
members of our engineering staff, our marketing executives and managers and our
clinical educators. Much of our corporate expertise is concentrated in relatively few
employees, the loss of which for any reason could negatively affect our business.
Competition for our highly skilled employees is intense and we cannot prevent the
resignation of any employee. We have agreements with all of our executive officers
that contain non-competition provisions that may prevent a former employee of ours
from working for a competitor for a period of time; however, these clauses may not be
enforceable, or enforceable only in part, or the company may choose not to seek
enforcement. We do not maintain key man life insurance on any of our senior
executives, other than our chief executive officer.
We obtain some of the components, subassemblies and completed products included in
the System One from a single source or a limited group of manufacturers or suppliers,
and the partial or complete loss of one of these manufacturers or suppliers could
cause significant production delays, an inability to meet customer demand and a
substantial loss in revenues.
We depend on single source suppliers for some of the components and
subassemblies we use in the System One. KMC Systems, Inc. is our only contract
manufacturer of the System One cycler; B. Braun Medizintechnologie GmbH 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 a primary supplier of
43
lactate-based dialysate and Medisystems Corporation is our primary supplier of our
disposable cartridge and several cartridge components. We also obtain certain other
components included in the System One from other single source suppliers or a limited
group of suppliers. Medisystems is a related party to NxStage. David Utterberg, the
chief executive officer and sole stockholder of Medisystems, is a member of our board
of directors and as of March 31, 2006, held approximately 9.4% of our common stock.
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, or an inability to meet customer demand. This could lead to customer
dissatisfaction, damage to our reputation, or cause customers to switch 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 weekly access
to the System One and related disposables.
Finding alternative sources for these components and subassemblies would be
difficult in many cases and may entail a significant amount of time and disruption.
In some cases, 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 and, potentially, further FDA clearance or approval of any modification,
thereby causing further costs and delays.
We do not have long-term supply contracts with many of our third-party
suppliers.
We purchase components and subassemblies from third-party suppliers, including
some of our 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 to us 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 these suppliers. If we inaccurately forecast
demand for components or subassemblies, our ability to manufacture and commercialize
the System One 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.
Risks Related to Intellectual Property
If we are unable to protect our intellectual property and prevent its use by third
parties, we will lose a significant competitive advantage.
We rely on patent protection, as well as a combination of copyright, trade
secret and trademark laws to protect our proprietary technology and prevent others
from duplicating our products. However, these means may afford only limited
protection and may not:
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prevent our competitors from duplicating our products; |
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prevent our competitors from gaining access to our proprietary
information and technology; or |
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permit us to gain or maintain a competitive advantage. |
Any of our patents may be challenged, invalidated, circumvented or rendered
unenforceable. We cannot provide assurance that we will be successful should one or
more of our patents be challenged for any reason. If our patent claims are rendered
invalid or unenforceable, or narrowed in scope, the patent coverage afforded our
products could be impaired, which could make our products less competitive.
As of March 31, 2006, we had 51 pending patent applications, including foreign,
international and U.S. applications, and 21 U.S. and international issued patents. We
cannot specify which of these patents
44
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 sales and
market share.
Our products could infringe the intellectual property rights of others, which may
lead to litigation that could itself be costly, could result in the payment of
substantial damages or royalties, and/or prevent us from using technology that is
essential to our products.
The medical device industry in general has been characterized by extensive
litigation and administrative proceedings regarding patent infringement and
intellectual property rights. Products to provide kidney replacement therapy have
been available in the market for more than 30 years and our competitors hold a
significant number of patents relating to kidney replacement devices, therapies,
products and supplies. Although no third party has threatened or alleged that our
products or methods infringe their patents or other intellectual property rights, we
cannot provide assurance that our products or methods do not infringe the patents or
other intellectual property rights of third parties. If our business is successful,
the possibility may increase that others will assert infringement claims against us.
Infringement and other intellectual property claims and proceedings brought
against us, whether successful or not, could result in substantial costs and harm to
our reputation. Such claims and proceedings can also distract and divert management
and key personnel from other tasks important to the success of the business. In
addition, intellectual property litigation or claims could force us to do one or more
of the following:
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cease selling or using any of our products that incorporate the
asserted intellectual property, which would adversely affect our
revenues; |
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pay substantial damages for past use of the asserted intellectual
property; |
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obtain a license from the holder of the asserted intellectual
property, which license may not be available on reasonable terms, if at
all and which could reduce profitability; and |
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redesign or rename, in the case of trademark claims, our products to
avoid infringing the intellectual property rights of third parties,
which may not be possible and could be costly and time-consuming if it
is possible to do so. |
Confidentiality agreements with employees and others may not adequately prevent
disclosure of trade secrets and other proprietary information.
In order to protect our proprietary technology and processes, we also rely in
part on confidentiality agreements with our corporate partners, employees,
consultants, outside scientific collaborators and sponsored researchers, advisors and
others. These agreements may not effectively prevent disclosure of
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confidential information and trade secrets and may not provide an adequate remedy in
the event of unauthorized disclosure of confidential information. In addition, others
may independently discover or reverse engineer trade secrets and proprietary
information, and in such cases we could not assert any trade secret rights against
such party. Costly and time consuming litigation could be necessary to enforce and
determine the scope of our proprietary rights, and failure to obtain or maintain
trade secret protection could adversely affect our competitive position.
We may be subject to damages resulting from claims that our employees or we have
wrongfully used or disclosed alleged trade secrets of other companies.
Many of our employees were previously employed at other medical device companies
focused on the development of dialysis products, including our competitors. Although
no claims against us are currently pending, we may be subject to claims that these
employees or we have inadvertently or otherwise used or disclosed trade secrets or
other proprietary information of their former employers. Litigation may be necessary
to defend against these claims. If we fail in defending such claims, in addition to
paying monetary damages, we may lose valuable intellectual property rights. Even if
we are successful in defending against these claims, litigation could result in
substantial costs, damage to our reputation and be a distraction to management.
Risks Related to Ownership
Our stock price is likely to be volatile, and the market price of our common stock
may drop.
The market price of our common stock could be subject to significant
fluctuations. Market prices for securities of early stage companies have historically
been particularly volatile. As a result of this volatility, you may not be able to
sell your common stock at or above the price you paid for the stock. Some of the
factors that may cause the market price of our common stock to fluctuate include:
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timing of market acceptance of our products; |
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timing of achieving profitability and positive cash flow from operations; |
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changes in estimates of our financial results or recommendations by
securities analysts or the failure to meet or exceed securities
analysts expectations; |
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actual or anticipated variations in our quarterly operating results; |
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reports by officials or health or medical authorities, the general
media or the FDA regarding the potential benefits of the System One or
of similar dialysis products distributed by other companies or of daily
or home dialysis; |
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announcements by the FDA of non-clearance or non-approval of our
products, or delays in the FDA or other foreign regulatory agency
review process; |
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product recalls; |
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regulatory developments in the United States and foreign countries; |
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changes in third-party healthcare reimbursements, particularly a
decline in the level of Medicare reimbursement for dialysis treatments; |
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litigation involving our company or our general industry or both; |
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announcements of technical innovations or new products by us or our competitors; |
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developments or disputes concerning our patents or other proprietary rights; |
46
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our ability to manufacture and supply our products to commercial standards; |
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significant acquisitions, strategic partnerships, joint ventures or
capital commitments by us or our competitors; |
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departures of key personnel; and |
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investors general perception of our company, our products, the
economy and general market conditions. |
The stock markets in general have experienced substantial volatility that has
often been unrelated to the operating performance of individual companies. These
broad market fluctuations may adversely affect the trading price of our common stock.
In the past, following periods of volatility in the market price of a companys
securities, stockholders have often instituted class action securities litigation
against those companies. Such litigation, if instituted, could result in substantial
costs and diversion of management attention and resources, which could significantly
harm our profitability and reputation.
Our executive officers, directors and current and principal stockholders own a large
percentage of our voting common stock and could limit new stockholders influence on
corporate decisions or could delay or prevent a change in corporate control.
Our directors, executive officers and current holders of more than 5% of our
outstanding common stock, together with their affiliates and related persons,
beneficially own, in the aggregate, approximately 60% of our outstanding common
stock. As a result, these stockholders, if acting together, will have the ability to
determine the outcome of all matters submitted to our stockholders for approval,
including the election and removal of directors and any merger, consolidation or sale
of all or substantially all of our assets and other extraordinary transactions. The
interests of this group of stockholders may not always coincide with our corporate
interests or the interests of other stockholders, and they may act in a manner with
which you may not agree or that may not be in the best interests of other
stockholders. This concentration of ownership may have the effect of:
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delaying, deferring or preventing a change in control of our company; |
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entrenching our management and/or Board; |
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impeding a merger, consolidation, takeover or other business
combination involving our company; or |
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discouraging a potential acquirer from making a tender offer or
otherwise attempting to obtain control of our company. |
Anti-takeover provisions in our restated certificate of incorporation and amended and
restated bylaws and under Delaware law could make an acquisition of us more difficult
and may prevent attempts by our stockholders to replace or remove our current
management.
Provisions in our restated certificate of incorporation and our amended and
restated bylaws may delay or prevent an acquisition of us. In addition, these
provisions may frustrate or prevent attempts by our stockholders to replace or remove
members of our board of directors. Because our board of directors is responsible for
appointing the members of our management team, these provisions could in turn affect
any attempt by our stockholders to replace current members of our management team.
These provisions include:
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a prohibition on actions by our stockholders by written consent; |
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the ability of our board of directors to issue preferred stock
without stockholder approval, which could be used to institute a
poison pill that would work to dilute the stock ownership of a
potential hostile acquirer, effectively preventing acquisitions that
have not been approved by our board of directors; |
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advance notice requirements for nominations of directors or
stockholder proposals; and |
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the requirement that board vacancies be filled by a majority of our
directors then in office. |
In addition, because we are incorporated in Delaware, we are governed by the
provisions of Section 203 of the Delaware General Corporation Law, which prohibits a
person who owns in excess of 15% of our outstanding voting stock from merging or
combining with us for a period of three years after the date of the transaction in
which the person acquired in excess of 15% of our outstanding voting stock, unless
the merger or combination is approved in a prescribed manner. These provisions would
apply even if the offer may be considered beneficial by some stockholders.
If there are substantial sales of our common stock in the market by our existing
stockholders, our stock price could decline.
If our existing stockholders sell a large number of shares of our common stock
or the public market perceives that existing stockholders might sell shares of common
stock, the market price of our common stock could decline significantly. We have
21,184,287 shares of common stock outstanding as of March 31, 2006. 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 211,843 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. Approximately 14,692,000 shares, or 69.4%, of
our outstanding shares are currently restricted as a result of securities laws or
lock-up agreements. In connection with our initial public offering of common stock,
officers, directors and a substantial majority of our other stockholders agreed, with
exceptions, not to sell or transfer any common stock until
April 24, 2006.
On April 20, 2006, Merrill Lynch, Pierce, Fenner & Smith
Incorporated notified us, on behalf of the other underwriters, in
accordance with that certain Underwriting Agreement by and among
NxStage, Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner
& Smith Incorporated, William Blair & Company,
L.L.C. and Thomas Weisel Partners LLC, dated October 27, 2005
and the related lock-up agreements with individual stockholders of
NxStage (the Lock-up Agreements), that the lock-up period
would be extended, in accordance with the terms of the Lock-up
Agreements, through May 13, 2006 (the Lock-up
Extension). The Lock-up Extension was affected in light of our
announcement on March 22, 2006 that we intended to release our
earnings for the first quarter of fiscal 2006 on April 25, 2006. Upon expiration or termination of these lock-up agreements, approximately 2,500,000
more shares of common stock will be freely tradeable.
Subject to certain conditions, holders of an aggregate of approximately
13,401,000 shares of common stock have rights with respect to the registration of
these shares of common stock with the Securities and Exchange Commission, or SEC. If
we register their shares of common stock following the expiration of the lock-up
agreements, they can sell those shares in the public market.
As of March 31, 2006, 3,442,554 shares of common stock are authorized for
issuance under our stock incentive plan, employee stock purchase plan and outstanding
stock options. As of March 31, 2006, 2,723,005 shares were subject to outstanding
options, of which 1,797,193 were exercisable and which can be freely sold in the
public market upon issuance, subject to the lock-up agreements referred to above and
the restrictions imposed on our affiliates under Rule 144.
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Our costs have increased significantly as a result of operating as a public company,
and our management is required to devote substantial time to comply with public
company regulations.
As a public company, we incur significant legal, accounting and other expenses
that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of
2002, or the Sarbanes-Oxley Act, as well as new rules subsequently implemented by the
SEC and the Nasdaq National Market, have imposed various new requirements on public
companies, including changes in corporate governance practices. Our management and
other personnel now need to devote a substantial amount of time to these new
requirements. Moreover, these rules and regulations increase our legal and financial
compliance costs and make some activities more time-consuming and costly.
In addition, the Sarbanes-Oxley Act requires, among other things, that we
maintain effective internal controls for financial reporting and disclosure controls
and procedures. In particular, commencing in fiscal 2006, we must perform system and
process evaluation and testing of our internal controls over financial reporting to
allow management and our independent registered public accounting firm to report on
the effectiveness of our internal controls over financial reporting, as required by
Section 404 of the Sarbanes-Oxley Act. Our compliance with Section 404 will require
that we incur substantial accounting expense and expend significant management
efforts. If we are not able to comply with the requirements of Section 404 in a
timely manner, or if we or our independent registered public accounting firm identify
deficiencies in our internal controls over financial reporting that are deemed to be
material weaknesses, the market price of our stock could decline and we could be
subject to sanctions or investigations by the Nasdaq National Market, SEC or other
regulatory authorities.
We do not anticipate paying cash dividends, and accordingly stockholders must rely on
stock appreciation for any return on their investment in us.
We anticipate that we will retain our earnings for future growth and therefore
do not anticipate paying cash dividends in the future. As a result, only appreciation
of the price of our common stock will provide a return to investors. Investors
seeking cash dividends should not invest in our common stock.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We registered shares of our common stock in connection with our initial public
offering under the Securities Act of 1933, as amended. The Registration Statement on
Form S-1 (File No. 333-126711) filed in connection with our initial public offering
was declared effective by the SEC on October 27, 2005. The offering commenced on
October 27, 2005 and did not terminate before any securities were sold. We sold
5,500,000 shares of our registered common stock in the initial public offering and an
additional 825,000 shares of our registered common stock in connection with the
underwriters exercise of their over-allotment option. The underwriters of the
offering were Merrill Lynch, Pierce, Fenner & Smith Incorporated, Thomas Weisel
Partners LLC, William Blair & Company and JMP Securities LLC.
All 6,325,000 shares of our common stock registered in the offering were sold at
the initial public offering price of $10 per share. The aggregate purchase price of
the offering was $63,250,000. The net offering proceeds received by us, after
deducting expenses incurred in connection with the offering was approximately $56.5
million. These expenses consisted of direct payments of:
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(a) $4.4 million in underwriters discounts, fees and commissions,, |
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ii.
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(b) $1.6 million in legal, accounting and printing fees, and |
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iii.
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(c) $0.7 million in miscellaneous expenses. |
No payments for such expenses were directly or indirectly to (i) any of our
directors, officers or their associates, (ii) any person(s) owning 10% or more of any
class of our equity securities or (iii) any of our affiliates.
We closed our initial public offering on November 1, 2005, and we have invested
the aggregate net proceeds in short-term investment-grade securities and money market
accounts.
From the effective date of our Registration Statement on Form S-1, October 27,
2005, through March 31, 2006, we have used approximately $6.8 million of the net
proceeds of our initial public offering to finance working capital needs. The net
unused offering proceeds have been invested into short-term investment grade
securities and money market accounts.
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Item 6. Exhibits
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Exhibit |
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Number |
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10.1 ±
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Supply Agreement, dated March 27, 2006, between the Registrant and
Laboratorios PISA S.A. de C.V. |
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10.2
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Compensation Policy for Non-Employee Directors |
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10.3
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Philip R. Licari Amendment to Non-Qualified Stock Option Agreement
dated March 24, 2006 |
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10.4
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Philip R. Licari Restricted Stock Agreement Granted Under 2005
Stock Incentive Plan dated March 24, 2006 |
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31.1
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Certification of Chief Executive Officer pursuant to Exchange Act
Rules 13a-14 or 15d-14, as adopted pursuant to Section 302 of
Sarbanes-Oxley Act of 2002. |
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31.2
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Certification of Chief Financial Officer pursuant to Exchange Act
Rules 13a-14 or 15d-14, as adopted pursuant to Section 302 of
Sarbanes-Oxley Act of 2002. |
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32.1
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Certification of Chief Executive Officer pursuant to Exchange Act
Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |
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32.2
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Certification of Chief Financial Officer pursuant to Exchange Act
Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |
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Confidential treatment requested as to certain portions, which portions have been
filed separately with the Securities and Exchange Commission. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
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NXSTAGE MEDICAL, INC. |
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By:
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/s/ David N. Gill |
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David N. Gill
Chief Financial Officer and Senior
Vice President (Duly authorized
officer and principal financial
officer)
May 4, 2006 |
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