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 June 30, 2007
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
(State of Incorporation)
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04-3454702
(I.R.S. Employer Identification No.) |
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439 S. Union Street 5th Floor, Lawrence, MA
(Address of Principal Executive Offices)
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01843
(Zip Code) |
Registrants Telephone Number, Including Area Code: (978) 687-4700
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, 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 þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
There
were 29,995,126 shares of the registrants common stock issued and outstanding as of the
close of business on August 5, 2007.
NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2007
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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June 30, |
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December 31, |
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2007 |
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2006 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
42,045,621 |
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$ |
49,958,540 |
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Short-term investments |
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10,921,716 |
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11,843,275 |
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Accounts receivable, net |
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6,009,991 |
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4,301,557 |
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Inventory |
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15,143,662 |
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10,419,030 |
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Prepaid expenses and other current assets |
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479,166 |
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1,014,688 |
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Total current assets |
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74,600,156 |
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77,537,090 |
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Property and equipment, net |
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4,018,133 |
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3,025,560 |
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Field equipment, net |
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23,685,353 |
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20,615,952 |
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Deferred cost of revenues |
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9,081,431 |
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139,893 |
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Other assets |
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1,784,195 |
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406,285 |
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Total assets |
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$ |
113,169,268 |
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$ |
101,724,780 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
9,565,724 |
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$ |
5,918,437 |
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Accrued expenses |
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5,371,904 |
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4,104,058 |
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Current portion of long-term debt |
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2,800,000 |
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2,800,000 |
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Total current liabilities |
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17,737,628 |
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12,822,495 |
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Deferred rent obligation |
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618,214 |
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648,604 |
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Deferred revenue |
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13,323,698 |
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228,542 |
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Long-term debt |
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3,216,668 |
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4,616,667 |
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Total liabilities |
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34,896,208 |
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18,316,308 |
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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 June 30,
2007 and December 31, 2006 |
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Common stock: par value $0.001, 100,000,000
shares authorized: 29,989,461 and
27,806,543 shares issued and outstanding as
of June 30, 2007 and December 31, 2006,
respectively |
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29,990 |
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27,807 |
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Additional paid-in capital |
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226,544,271 |
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206,848,097 |
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Accumulated deficit |
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(148,515,867 |
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(123,640,441 |
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Accumulated other comprehensive income |
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214,666 |
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173,009 |
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Total stockholders equity |
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78,273,060 |
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83,408,472 |
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Total liabilities and stockholders equity |
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$ |
113,169,268 |
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$ |
101,724,780 |
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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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Six Months Ended |
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June 30, |
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June 30, |
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2007 |
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2006 |
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2007 |
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2006 |
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Revenues |
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$ |
10,031,184 |
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$ |
4,546,273 |
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$ |
18,405,177 |
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$ |
7,946,995 |
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Cost of revenues |
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11,511,184 |
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6,003,629 |
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21,428,345 |
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10,860,883 |
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Gross profit (deficit) |
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(1,480,000 |
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(1,457,356 |
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(3,023,168 |
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(2,913,888 |
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Operating expenses: |
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Selling and marketing |
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5,119,820 |
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3,758,537 |
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9,851,400 |
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6,951,520 |
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Research and development |
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1,418,441 |
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1,576,295 |
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2,854,247 |
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3,355,189 |
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Distribution |
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2,997,348 |
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1,518,685 |
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5,341,789 |
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2,808,284 |
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General and administrative |
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2,525,834 |
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2,149,016 |
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5,192,856 |
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4,123,745 |
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Total operating expenses |
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12,061,443 |
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9,002,533 |
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23,240,292 |
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17,238,738 |
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Loss from operations |
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(13,541,443 |
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(10,459,889 |
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(26,263,460 |
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(20,152,626 |
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Other income (expense): |
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Interest income |
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831,831 |
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607,921 |
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1,735,791 |
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1,203,328 |
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Interest expense |
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(172,689 |
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(535,863 |
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(347,757 |
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(693,503 |
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659,142 |
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72,058 |
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1,388,034 |
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509,825 |
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Net loss |
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$ |
(12,882,301 |
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$ |
(10,387,831 |
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$ |
(24,875,426 |
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$ |
(19,642,801 |
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Net loss per share, basic and diluted |
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$ |
(0.43 |
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$ |
(0.46 |
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$ |
(0.84 |
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$ |
(0.90 |
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Weighted-average shares outstanding,
basic and diluted |
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29,933,141 |
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22,440,529 |
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29,488,097 |
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21,815,098 |
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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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Six Months Ended |
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June 30, |
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2007 |
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2006 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(24,875,426 |
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$ |
(19,642,801 |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Loss on disposal of equipment |
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89,674 |
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26,959 |
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Depreciation and amortization |
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3,016,893 |
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1,227,571 |
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Amortization/write-off of debt discount |
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281,666 |
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Stock-based compensation |
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1,497,078 |
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1,270,266 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(1,713,265 |
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(2,053,482 |
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Inventory |
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(16,690,885 |
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(9,871,716 |
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Prepaid expenses and other current assets |
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537,830 |
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31,489 |
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Deferred cost of revenues |
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(2,704,499 |
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Accounts payable |
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3,621,379 |
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2,203,906 |
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Accrued expenses |
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484,699 |
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1,054,087 |
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Deferred rent obligation |
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(30,390 |
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(19,865 |
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Deferred revenue |
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10,095,156 |
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Net cash used in operating activities |
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(26,671,756 |
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(25,491,920 |
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Cash flows from investing activities: |
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Purchases of property and equipment |
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(1,394,421 |
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(802,046 |
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Sales (purchases) of short-term investments, net |
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921,559 |
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(29,463,588 |
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Increase in other assets |
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(586,967 |
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(421,311 |
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Net cash used in investing activities |
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(1,059,829 |
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(30,686,945 |
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Cash flows from financing activities: |
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Net proceeds from issuance of common stock |
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19,938,683 |
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51,380,309 |
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Proceeds from stock option and purchase plans |
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1,262,594 |
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727,019 |
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Proceeds from exercise of warrants |
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502,901 |
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Net repayments on loans and lines of credit |
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(1,399,999 |
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(37,107 |
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Net cash provided by financing activities |
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19,801,278 |
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52,573,122 |
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Foreign exchange effect on cash and cash equivalents |
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17,388 |
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44,084 |
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Decrease in cash and cash equivalents |
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(7,912,919 |
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(3,561,659 |
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Cash and cash equivalents, beginning of period |
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49,958,540 |
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61,223,377 |
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Cash and cash equivalents, end of period |
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$ |
42,045,621 |
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$ |
57,661,718 |
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Supplemental Disclosure |
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Cash paid for interest |
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$ |
342,211 |
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$ |
750,840 |
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Noncash Investing Activities |
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Transfers from inventory to field equipment |
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$ |
11,987,427 |
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$ |
7,391,692 |
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Noncash Financing Activities |
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Deferred compensation and paid-in capital |
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$ |
1,517 |
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$ |
1,984 |
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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 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 Company has experienced and continues to experience negative operating margins and cash
flow from operations and it expects to continue to incur net losses in the foreseeable future. The
Company believes that it has sufficient cash and availability under its equipment line of credit to
meet its funding requirements at least through 2007. There can be no assurance as to the
availability of additional financing or the terms upon which additional financing may be available
in the future if, and when, it is needed. If the Company is unable to obtain additional financing
when needed, it may be required to delay, reduce the scope of, or eliminate one or more aspects of
its business development activities, which could harm the growth of its business. As of June 30,
2007, the Company had approximately $53.0 million of unrestricted cash and short-term investments.
Basis of Presentation
The condensed consolidated financial statements reflect the operations of the Company and its
wholly-owned subsidiaries. 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 and six month periods ended June
30, 2007 are not necessarily indicative of results that may ultimately be achieved for the entire
year ending December 31, 2007. These condensed consolidated financial statements should be read in
conjunction with the audited financial statements and notes included in the Companys Annual Report
on Form 10-K for the year ended December 31, 2006.
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) Revenue Recognition
The Company recognizes revenue from product sales and services when earned in accordance with
Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, and Emerging Issues Task Force,
(EITF) 00-21, Revenue Arrangements with Multiple Deliverables(EITF 00-21). Revenues are
recognized when: (a) there is persuasive evidence of an arrangement, (b) the product has been
shipped or services and supplies have been provided to the customer, (c) the sales price is fixed
or determinable and (d) collection is reasonably assured.
6
Chronic Care Market
Prior to 2007, the Company derived revenue in the chronic care market from short-term rental
arrangements with its customers as its principal business model in the chronic care market. These
rental arrangements, which combine the use of the System One with a specified number of disposable
products supplied to customers for a fixed amount per month, are recognized on a monthly basis in
accordance with agreed upon contract terms and pursuant to a binding customer purchase order and
fixed payment terms. In the chronic care market, rental arrangements continue to represent the
majority of the arrangements the Company has with its customers.
Beginning in 2007, the Company entered into long-term customer contracts to sell the System
One and PureFlow SL equipment along with the right to purchase disposable products and service on a
monthly basis. Some of these agreements include other terms such as development efforts, training,
market collaborations, limited market exclusivity and volume discounts. The equipment and related
items provided to the Companys customers in these arrangements are considered a multiple-element
sales arrangement pursuant to EITF 00-21. When a sales arrangement involves multiple elements, the
deliverables included in the arrangement are evaluated to determine whether they represent separate
units of accounting. The Company has determined that it cannot account for the sale of equipment
as a separate unit of accounting. Therefore, fees received upon the completion of delivery of
equipment are deferred, and are recognized as revenue on a straight-line basis over the expected
term of the Companys obligation to supply disposables and service, which is five to seven years.
The Company has deferred both the unrecognized revenue and direct costs relating to the delivered
equipment, which costs are being amortized over the same period as the related revenue.
The Company entered into a National Service Provider Agreement and a Stock Purchase Agreement
with DaVita, Inc. on February 7, 2007. Pursuant to EITF 00-21, the Company considers these
agreements a single arrangement. In connection with the Stock Purchase Agreement, DaVita purchased
2,000,000 shares of the Companys common stock for $10.00 per share, which represented a premium of
$1.50 per share, or $3.0 million. The Company has recorded the $3.0 million premium as deferred
revenue and will recognize this revenue ratably over seven years, consistent with its equipment
service obligation to DaVita. During the three and six months ended June 30, 2007, the Company
recognized revenue of $107,000 and $179,000 associated with the $3.0 million premium, respectively.
Critical Care Market
In the critical care market, the Company structures sales as direct product sales or as a
disposables-based program in which a customer acquires the equipment through the purchase of a
specific quantity of disposables over a specific period of time. The Company recognizes revenue
from direct product sales at the later of the time of shipment or, if applicable, delivery in
accordance with contract terms. Under a disposables-based program, the customer is granted the
right to use the equipment for a period of time, during which the customer commits to purchase a
minimum number of disposable cartridges or fluids at a price that includes a premium above the
otherwise average selling price of the cartridges or fluids to recover the cost of the equipment
and provide for a profit. Upon reaching the contractual minimum purchases, ownership of the
equipment transfers to the customer. Revenue under these arrangements is recognized over the term
of the arrangement as disposables are delivered. During the reported periods, the majority of our
critical care revenue is derived from direct product sales.
Our contracts provide for training, technical support and warranty services to our customers.
We recognize training and technical support revenue when the related services are performed. In the
case of extended warranties, the revenue is recognized ratably over the warranty period.
(c) 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, denominated in
foreign currencies are included in the consolidated statements of operations and were not material
for the periods presented.
7
(d) 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.
(e) 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 with the
same remaining maturities. The carrying amount of long-term debt approximates fair value.
(f) Inventory
Inventory is stated at the lower of cost 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 Company also reviews its 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. Additionally, the Companys
estimates of future product demand may prove to be inaccurate.
Inventories at June 30, 2007 and December 31, 2006 are as follows:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Purchased components |
|
$ |
7,177,250 |
|
|
$ |
2,864,892 |
|
Finished units |
|
|
7,966,412 |
|
|
|
7,554,138 |
|
|
|
|
|
|
|
|
|
|
$ |
15,143,662 |
|
|
$ |
10,419,030 |
|
|
|
|
|
|
|
|
Inventory is shown net of a valuation reserve of approximately $425,000 and $492,000 at June
30, 2007 and December 31, 2006, respectively.
(g) 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:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Machinery, equipment and tooling |
|
$ |
3,291,328 |
|
|
$ |
2,572,332 |
|
Leasehold improvements |
|
|
1,112,496 |
|
|
|
987,307 |
|
Computer and office equipment |
|
|
1,168,178 |
|
|
|
958,916 |
|
Furniture |
|
|
493,595 |
|
|
|
408,694 |
|
Construction-in-process |
|
|
730,928 |
|
|
|
436,902 |
|
|
|
|
|
|
|
|
|
|
|
6,796,525 |
|
|
|
5,364,151 |
|
Less accumulated depreciation and amortization |
|
|
(2,778,392 |
) |
|
|
(2,338,591 |
) |
|
|
|
|
|
|
|
Property and equipment, net |
|
$ |
4,018,133 |
|
|
$ |
3,025,560 |
|
|
|
|
|
|
|
|
Depreciation expense for property and equipment was $224,000 and $167,000 for the three months
ended June 30, 2007 and 2006, respectively, and $427,000 and $316,000 for the six months ended June
30, 2007 and 2006, respectively.
8
Field equipment is carried at cost less accumulated depreciation as follows:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Field equipment |
|
$ |
28,797,513 |
|
|
$ |
24,101,844 |
|
Less accumulated depreciation and amortization |
|
|
(5,112,160 |
) |
|
|
(3,485,892 |
) |
|
|
|
|
|
|
|
Field equipment, net |
|
$ |
23,685,353 |
|
|
$ |
20,615,952 |
|
|
|
|
|
|
|
|
Depreciation expense for field equipment was $1,352,000 and $563,000 for the three months
ended June 30, 2007 and 2006, respectively, and $2,591,000 and $912,000 for the six months ended
June 30, 2007 and 2006, 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 |
(h) Deferred Cost of Revenues
Costs relating to equipment sold for which deferral of revenue is required are capitalized and
amortized ratably over the same period in which the associated revenue is being recognized.
Deferred costs relating to equipment sold at June 30, 2007 and December 31, 2006 totaled $9.1
million and $0.1, respectively, and are separately presented in the accompanying condensed
consolidated balance sheets. Amortization of deferred costs charged to cost of revenue was $211,000
and $290,000 for the three and six months ended June 30, 2007 and $12,000 and 41,000 for the three
and six months ended June 30, 2006, respectively.
(i) 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. Warranty expense is included in cost of revenues in the consolidated statements of
operations. The Company periodically assesses the adequacy of its recorded liability and adjusts
the amount as necessary. Changes in the Companys product
warranty reserve are as follows:
|
|
|
|
|
Balance at December 31, 2006 |
|
$ |
172,244 |
|
Provision |
|
|
194,310 |
|
Usage |
|
|
(160,972 |
) |
|
|
|
|
Balance at June 30,, 2007 |
|
$ |
205,582 |
|
|
|
|
|
(j) Distribution Expenses
Distribution expenses consist of the costs incurred in shipping products to customers and are
charged to operations as incurred. Shipping and handling costs billed to customers are included in
revenues and totaled $39,000 and $5,000 for the three months ended June 30, 2007 and 2006,
respectively, and $48,000 and $21,000 for the six months ended June 30, 2007 and 2006,
respectively.
(k) Research and Development Costs
Research and development costs are charged to operations as incurred.
9
(l) Income Taxes
The Company accounts for federal and state income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes. Under the liability method specified by SFAS No. 109, a deferred tax
asset or liability is determined based on the difference between the financial statement and tax
basis of assets and liabilities, as measured by the enacted tax rates. The Companys provision for
income taxes represents the amount of taxes currently payable, if any, plus the change in the
amount of net deferred tax assets or liabilities. A valuation allowance is provided against net
deferred tax assets if recoverability is uncertain on a more likely than not basis.
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
(FIN) No. 48, Accounting for Uncertainty in Income Taxes", which clarifies the accounting for
uncertainty in income taxes recognized in an entitys financial statements in accordance with SFAS
No. 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be taken in a tax
return. In addition, FIN 48 provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company adopted FIN 48 on January 1, 2007. The
adoption of FIN 48 did not have a material impact on the Companys financial position or results of
operations. Upon adoption and as of June 30, 2007, the Company had no unrecognized tax benefits
recorded.
The Company files federal, state and foreign tax returns. The Company has accumulated
significant losses since its inception in 1998. Since the net operating losses may potentially be
utilized in future years to reduce taxable income, all of the Companys tax years remain open to
examination by the major taxing jurisdictions to which the Company is subject.
The Company recognizes interest and penalties for uncertain tax positions in income tax
expense. Upon adoption and as of June 30, 2007, the Company had no interest and penalty accrual or
expense.
(m) Share-based Compensation Cost
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 with the SEC for the sale of securities (i.e., stock options
granted prior to July 19, 2005). Under the modified prospective method, the Company has (a)
recognized compensation expense for all share-based payments granted after January 1, 2006 and (b)
recognized compensation expense for awards granted to employees between July 19, 2005 and December
31, 2005 that remained unvested at December 31, 2005.
The captions in the Companys consolidated statement of operations for the three and six
months ended June 30, 2007 and 2006 include share-based compensation as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Cost of revenue |
|
$ |
43,276 |
|
|
$ |
16,251 |
|
|
$ |
84,061 |
|
|
$ |
27,501 |
|
Selling and marketing |
|
|
242,064 |
|
|
|
138,689 |
|
|
|
451,270 |
|
|
|
253,055 |
|
Research and development |
|
|
41,116 |
|
|
|
28,828 |
|
|
|
82,239 |
|
|
|
56,864 |
|
General and administrative |
|
|
410,529 |
|
|
|
591,092 |
|
|
|
880,508 |
|
|
|
932,846 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
736,985 |
|
|
$ |
774,860 |
|
|
$ |
1,497,078 |
|
|
$ |
1,270,266 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(n) Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements", which addresses
the measurement of fair value where such measure is required for recognition or disclosure
purposes under GAAP.
10
Among other provisions, SFAS No. 157 includes (1) a new definition of fair value, (2) a fair
value hierarchy used to classify the source of information used in fair value measurements, (3) new
disclosure requirements of assets and liabilities measured at fair value based on their level in
the hierarchy, and (4) a modification of the accounting presumption that the transaction price of
an asset or liability equals its initial fair value. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007 (i.e., beginning in 2008 for NxStage). The Company is currently
evaluating the expected impact of SFAS No. 157 on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities Including an amendment of FASB Statement No. 115, which permits
entities to choose to measure many financial instruments and certain other items at fair value.
SFAS No. 159 is effective as of the beginning of an entitys first fiscal year that begins after
November 15, 2007. The Company is currently evaluating if it will elect the fair value option for
any of its eligible financial instruments and other items.
(o) Reclassifications
Certain reclassifications were made to prior periods to conform to current year presentation.
3. Stockholders Equity
Common and Preferred Stock
On February 7, 2007, the Company sold 2,000,000 shares of its common stock to DaVita in a
private placement at a price of $10.00 per share and with aggregate net proceeds of approximately
$20.0 million. The shares sold to DaVita represented, at the time of issuance, approximately seven
percent (7%) of the Companys issued and outstanding shares of common stock.
On June 14, 2006, the Company completed a follow-on public offering of 6,325,000 shares of its
common stock at a price of $8.75 per share and with aggregate net proceeds of approximately $51.4
million. 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 and with aggregate net proceeds of approximately
$56.5 million. 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.
Warrants
At June 30, 2007, warrants to purchase a total of 73,460 shares of common stock were
outstanding. These warrants have a weighted average exercise price of $8.17 and expire in December
2011. There were no grants or warrant exercises during the six months ended June 30, 2007.
2005 Stock Purchase Plan and Employee Stock Purchase Plan
The Company grants options and restricted stock to its employees under the Companys 2005
Stock Incentive Plan. As of June 30, 2007, the Company has reserved 3,153,724 shares of common
stock for issuance upon exercise of stock options, 49,478 shares for issuance under the 2005
Purchase Plan and 73,460 shares for issuance upon exercise of warrants.
The Companys 2005 Employee Stock Purchase Plan (the 2005 Purchase Plan) originally
authorized the issuance of up to 50,000 shares of common stock to participating employees through a
series of periodic offerings. An incremental 50,000 shares was approved by the Companys
stockholders on May 30, 2007. Each six-month offering period begins in January or July. The first
offering under the 2005 Purchase Plan began on January 3, 2006 and ended on June 30, 2006. An
employee becomes eligible to participate in the 2005 Purchase Plan once he or she has been employed
for at least three months and is regularly employed for at least 20 hours per week for more than
three months in a calendar year. The price at which employees can purchase common stock in an
offering is 95 percent of the closing price of the common stock on the NASDAQ Global Market on the
day the offering terminates, unless otherwise determined by the Board or Compensation Committee.
11
4. Net Loss per Share
The Company calculates net loss per share based on the weighted-average number of shares of
common stock outstanding, excluding unvested shares of restricted common stock. For the periods
ended June 30 2007 and 2006; 3,227,184 and 2,769,570, respectively, shares of common stock
equivalents were not included in the computation of net loss per share because the effect would
have been anti-dilutive.
5. Comprehensive Income (Loss)
SFAS No. 130, Reporting Comprehensive Income", establishes standards for reporting
comprehensive income (loss) and its components in the body of the financial statements.
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss).
Other comprehensive income (loss) includes certain changes in equity, such as foreign currency
translation adjustments, that are excluded from results of operations.
At June 30, 2007 and December 31, 2006, accumulated other comprehensive income (loss) consists
of foreign currency translation adjustments.
6. Financing Arrangements
Debt
In December 2004, the Company entered into a debt agreement in the principal amount of $5.0
million, which was payable monthly over a three-year term and was secured by all the assets of the
Company. Interest accrued at a rate of 7.0% annually and monthly principal and interest payments
were made in advance. In addition, a final interest payment of $650,000 was due at the scheduled
maturity date of December 2007, or earlier if the loan was prepaid in advance. This additional
interest payment was accrued on a monthly basis using the interest method over the 36-month life of
the loan and was included in accrued expenses in the accompanying condensed consolidated balance
sheets. Concurrent with entering into a new equipment line of credit in May 2006, the Company
repaid all outstanding borrowings under the agreement in the aggregate amount of $3.4 million,
which included principal and accrued interest and the final interest payment of $650,000. This
extinguishment of debt gave rise to the early recognition of approximately $434,000 of interest
expense for the year ended December 31, 2006.
On May 15, 2006, the Company entered into an equipment line of credit agreement for the
purpose of financing field equipment purchases and placements. The line of credit agreement
provides for the availability of up to $20.0 million through December 31, 2007, and borrowings bear
interest at the prime rate plus 0.5% (8.4% at June 30, 2007). Under the line of credit agreement,
$10.0 million was available through December 31, 2006 and an additional $10.0 million is available
from January 1, 2007 through December 31, 2007. The availability of the line of credit is subject
to a number of covenants, including maintaining certain levels of liquidity, adding specified
numbers of patients and operating within certain net loss parameters. The Company is also required
to maintain operating and/or investment accounts with the lender in an amount at least equal to the
outstanding debt obligation. Borrowings are secured by all assets of the Company other than
intellectual property and are payable ratably over a three-year period from the date of each
borrowing. At June 30, 2007, the Company had outstanding borrowings of $6.0 million and $11.6
million of borrowing availability under the equipment line of credit.
Annual maturities of principal under the Companys debt obligations at June 30, 2007 are as
follows:
|
|
|
|
|
2007 |
|
$ |
1,400,000 |
|
2008 |
|
|
2,800,000 |
|
2009 |
|
|
1,816,668 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
6,016,668 |
|
|
|
|
|
7. 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
12
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 United States and
substantially all assets are located in the United States.
The Company sells products into two markets, critical care and chronic care in the United
States. 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 |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Critical care market |
|
$ |
3,285,130 |
|
|
$ |
1,881,198 |
|
|
$ |
6,224,427 |
|
|
$ |
3,464,795 |
|
Chronic care market |
|
|
6,746,054 |
|
|
|
2,665,075 |
|
|
|
12,180,750 |
|
|
|
4,482,200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
10,031,184 |
|
|
$ |
4,546,273 |
|
|
$ |
18,405,177 |
|
|
$ |
7,946,995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three and six months ended June 30, 2007, the Company had one customer who
individually represented 30% and 27% of revenues, respectively, and 23% of accounts receivable as
of June 30, 2007. For the three and six months ended June 30, 2006, the Company had one customer
who individually represented 18% and 16% of revenues, respectively. One customer represented 17% of
the Companys accounts receivable as of December 31, 2006.
8. Related-Party Transactions
Medisystems Corporation
Supply Agreement
The Company purchases completed cartridges, tubing and certain other components used in the
System One disposable cartridge from Medisystems Corporation, an entity owned by David S.
Utterberg, a 6.7% stockholder of the Company and member of the Companys Board of Directors. The
Company purchased approximately $2.1 million and $3.8 million during the three and six months ended
June 30, 2007, and $1.2 million and $1.9 million for the three and six months ended June 30, 2006,
respectively, of goods and services from this related party. Amounts owed to Medisystems
Corporation totaled $665,000 and $926,000 at June 30, 2007 and December 31, 2006, respectively, and
are included in accounts payable in the accompanying condensed consolidated balance sheets. At June
30, 2007, the Company had commitments to purchase approximately $3.2 million of products from
Medisystems Corporation.
On January 4, 2007, the Company entered into a seven-year Supply Agreement (the Medisystems
Supply Agreement), with Medisystems that expires on December 31, 2013. Prior to entering into the
Medisystems Supply Agreement, the Company purchased products from Medisystems through purchase
orders. Pursuant to the terms of the Medisystems Supply Agreement, the Company will purchase no
less than ninety percent (90%) of its North American requirements for disposal cartridges, or
Medisystems products, for use with its System One from Medisystems. The Supply Agreement was
approved by the Companys Audit Committee and Board of Directors.
Stock Purchase Agreement
On June 4, 2007, the Company entered into a Stock Purchase Agreement with David S. Utterberg to
purchase all of the issued and outstanding shares of Medisystems Services Corporation, a Nevada
corporation, Medisystems Corporation, a Washington corporation, Medisystems Europe S.p.A, a company
organized under the laws of Italy, and Medimexico s. de R.L. de C.V., a company organized under the
laws of Mexico, (referred to collectively as the Medisystems Entities), all of which entities are
owned directly or indirectly by Mr. Utterberg, in exchange for 6,500,000 shares of the Company (the
Stock Purchase), and a Consulting Agreement with David S. Utterberg and DSU Medical, Inc.
(DSU), a company owned by Mr. Utterberg, to provide consulting, advisory and related services to
the Company for two years following the consummation of the Stock Purchase. Under the terms of the
Consulting Agreement, the Company will pay Mr. Utterberg $200,000 annually, plus reasonable
expenses and Mr.
13
Utterberg and DSU will agree (i) not to compete with the Company and will not encourage or
solicit any of the Companys employees, customers or suppliers, and (ii) will assign to the Company
certain inventions and proprietary rights received during the term of the Consulting Agreement and
will grant certain exclusive, worldwide, perpetual, royalty-free irrevocable, sublicensable, fully
paid licenses for such inventions and proprietary rights. In the event the Stock Purchase is
consummated, Mr. Utterberg will own approximately 23.4% of the outstanding common stock of the
Company and will continue to be a director of the Company.
The consummation of the Stock Purchase is subject to a number of conditions, including, among
other things, the termination of applicable waiting periods under the Hart-Scott-Rodino Act, the
approval by our stockholders of the issuance of shares of our common stock to Mr. Utterberg in
connection with the Stock Purchase, and the effectiveness of our registration and proxy
statement/prospectus on Form S-4, as determined by the SEC, seeking stockholder approval of this
stock issuance. None of these conditions has yet been satisfied. We filed our registration and
proxy statement/prospectus on Form S-4 seeking stockholder approval in connection with the Stock
Purchase with the SEC on July 27, 2007. This registration and proxy statement/prospectus on Form
S-4 has not yet been declared effective by the SEC.
Consistent with the Companys Audit Committee Charter and Related Person Transaction Policy,
the Stock Purchase Agreement and Consulting Agreement were each approved by the Companys Audit
Committee and Board of Directors.
As of June 30, 2007, the Company has capitalized approximately $1.2 million of direct costs
incurred in conjunction with the pending Medisystems Stock Purchase. These costs are included in
other assets in the accompanying condensed consolidated balance sheets.
9. Commitments and Contingencies
On March 1, 2007, the Company entered into a long-term agreement with the Entrada Group
(Entrada), to establish manufacturing and service operations in Mexico, initially for its cycler
and PureFlow SL disposables and later for its PureFlow SL hardware. The agreement obligates Entrada
to provide the Company with manufacturing space, support services and a labor force through 2012.
Subject to certain exceptions, the Company is obligated for the facility fees through the term of
the agreement. The agreement may be terminated upon material breach, generally following a 30-day
cure period.
In the second quarter of 2007, the Company started to experience an increased incidence of
reported dialysate leaks associated with System One cartridges. The reported incidence of leaks is higher than the Company has
historically observed. In early August 2007, the Company sent a letter to patients and customers
informing them of the increased incidence in leaks and reminding them of existing System One
labeling responsive to the risk of leaks. The Company has characterized this notification as a
voluntary recall.
These cartridge leaks have resulted in dissatisfaction with the System One for certain of our
customers and could impair our future growth and patient retention. The incremental leaks have also been associated with increased cycler service costs, which have imposed additional service pool requirements, and could
impair the Companys ability to meet future demand. If the incidence of leaks
persists or increases or if patient satisfaction declines, the
Company may incur additional costs, however the Company deems any loss to the approximate $2.5 million of affected inventory to be improbable at this time,
therefore no amount has been accrued to date. Additionally, costs related to the return or replacement of cartridges, and costs incurred to rework inventory on-hand
and/or returned by customers, may also be incurred and could be material to the Company. The Company has not
incurred any material costs to date in connection with this matter.
14
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 and six
months ended June 30, 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, 2006, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC. This Quarterly Report
contains forward-looking statements within the meaning of the Private Securities Litigation Reform
Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements regarding future
events and our future results are based on current expectations, estimates, forecasts and
projections and the beliefs and assumptions of our management including, without limitation, our
expectations regarding our results of operations, revenues, cost of revenues, distribution
expenses, sales and marketing expenses, general and administrative expenses, research and
development expenses 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. 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 of this Quarterly Report, as well as in the documents
filed by us with the SEC, as they may be amended from time to time, including our Annual Report on
Form 10-K and Quarterly Reports on Form 10-Q.
Overview
We are a medical device company that develops, manufactures and markets innovative systems for
the treatment of end-stage renal disease, or ESRD, acute kidney failure and fluid overload. Our
primary product, the 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 and six months ended June 30, 2007 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 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 United States 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
15
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.
In March 2006, we received clearance from the FDA to market our PureFlow SL module as an
alternative to the bagged fluid presently used with our System One in the chronic care market. This
accessory to the System One allows for the automated preparation of high purity dialysate in the
patients home using ordinary tap water and dialysate concentrate. The PureFlow SL is designed to
help patients with ESRD more conveniently and effectively manage their home hemodialysis therapy by
eliminating the need for bagged fluids. In July 2006, we released the PureFlow SL for commercial
use and began shipping the PureFlow SL product. Our experience suggests that our chronic care home
patients will predominantly use our PureFlow SL module at home and will use bagged fluid for travel
and outside of the home. Bagged fluids will continue to be used in the critical care market.
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 could accelerate 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 in 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 a
quantity of disposable products in our leased facilities in Lawrence, Massachusetts and North
Andover, Massachusetts as well as in our facilities in Mexico provided to us by the Entrada Group.
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 in the System One and the
ultrafilter used in the PureFlow SL.
We market the System One through a direct sales force in the United States primarily to
dialysis clinics and hospitals, and we expect revenues to continue to increase in the near future.
Our revenues were $10.0 million for the three months ended June 30, 2007, a 121% increase from
revenues of $4.5 million in the three months ended June 30, 2006, and a 20% increase from revenues
of $8.4 million in the first quarter of 2007. Our revenues were $18.4 million for the six months
ended June 30, 2007, a 132% increase from revenues of $7.9 million in the six months ended June 30,
2006. We have increased the number of sales representatives in our combined sales force from 27 at
June 30, 2006 to 31 at June 30, 2007. During the remainder of 2007, we expect to add additional
sales and marketing personnel as needed for the remainder of 2007. As of June 30, 2007, 1,615 ESRD
patients were using the System One at 265 dialysis clinics, compared to 663 ESRD patients at 126
dialysis clinics as of June 30, 2006, and compared to 1,022 ESRD patients at 174 dialysis clinics
as of December 31, 2006. In addition, as of June 30, 2007, 93 hospitals were using the System One
for critical care therapy, compared to 58 and 77 hospitals as of June 30, 2006 and December 31,
2006, respectively.
The following table sets forth the amount and percentage of revenues derived from each market
for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2007 |
|
|
|
|
|
|
2006 |
|
|
|
|
|
|
2007 |
|
|
|
|
|
|
2006 |
|
|
|
|
|
Chronic care |
|
|
6,746,054 |
|
|
|
67.3 |
% |
|
|
2,665,075 |
|
|
|
58.6 |
% |
|
|
12,180,750 |
|
|
|
66.2 |
% |
|
|
4,482,200 |
|
|
|
56.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Critical care |
|
$ |
3,285,130 |
|
|
|
32.7 |
% |
|
$ |
1,881,198 |
|
|
|
41.4 |
% |
|
$ |
6,224,427 |
|
|
|
33.8 |
% |
|
$ |
3,464,795 |
|
|
|
43.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
10,031,184 |
|
|
|
100.0 |
% |
|
$ |
4,546,273 |
|
|
|
100.0 |
% |
|
$ |
18,405,177 |
|
|
|
100.0 |
% |
|
$ |
7,946,995 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
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 grow our operations. Our accumulated deficit
at June 30, 2007 was $148.5 million. 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.
2007 Recent Developments
Medisystems
On January 4, 2007, the Company entered into a seven-year supply agreement, with Medisystems
Corporation pursuant to which Medisystems will supply no less than 90% of our North American
requirements for disposable cartridges for use with the System One. The agreement may be
terminated upon material breach, generally following a 120-day cure period. Medisystems is a
related party to NxStage. David Utterberg, the president and sole stockholder of Medisystems, is a
director and stockholder of NxStage.
On June 4, 2007, we entered into a stock purchase agreement with Mr. Utterberg, who is a
member of our board of directors and owns approximately 6.7% of our outstanding common stock,
pursuant to which we will acquire all of the outstanding equity of four entities, referred to as
the Medisystems Entities, and each Medisystems Entity will become a direct or indirect wholly-owned
subsidiary of ours. Mr. Utterberg will receive 6,500,000 shares of our common stock, subject to a
post-closing working capital adjustment as consideration for the stock purchase.
The consummation of the stock purchase is subject to a number of conditions, including, among
other things, the termination of applicable waiting periods under the Hart-Scott-Rodino Act, the
approval by our stockholders of the issuance of shares of our common stock to Mr. Utterberg in
connection with the stock purchase, and the effectiveness of our registration and proxy
statement/prospectus on Form S-4, as determined by the SEC, seeking stockholder approval of this
stock issuance. None of these conditions has yet been satisfied. We filed our registration and
proxy statement/prospectus on Form S-4 seeking stockholder approval in connection with the Stock
Purchase with the SEC on July 27, 2007. This registration and proxy statement/prospectus on Form
S-4 has not yet been declared effective by the SEC.
Membrana
In January 2007, we entered into a long-term supply agreement with Membrana, pursuant to which
Membrana has agreed to supply, on an exclusive basis, capillary membranes for use in the filters
used with the System One for ten years. In exchange, for Membranas agreement to pricing
reductions based on volumes ordered, we have agreed to purchase a base amount of membranes per
year. The agreement may be terminated upon a material breach, generally following a 60-day cure
period.
DaVita
On February 7, 2007, we entered into a National Service Provider Agreement and a Stock
Purchase Agreement with DaVita, Inc. Pursuant to the National Service Provider Agreement, we
granted DaVita certain market rights for the System One and related supplies for home hemodialysis
therapy. We granted DaVita exclusive rights in a small percentage of geographies, which
geographies collectively represent less than 10% of the U.S. ESRD patient population, and limited
exclusivity in the majority of all other U.S. geographies, subject to DaVitas meeting certain
requirements, including patient volume commitments and new patient training rates. Under the
agreement, we can continue to sell to other clinics in the majority of geographies. If certain
minimum patient numbers or training rates are not achieved, DaVita can lose all or part of its
preferred geographic rights. The agreement further limits, but does not prohibit, the sale by us
of the System One for chronic home patient hemodialysis therapy to any provider that is under
common control or management of a parent entity that collectively provides dialysis services to
more than 25% of the U.S. chronic dialysis patient population and that also supplies dialysis
products. Therefore, our ability to sell the System One for chronic home patient hemodialysis
therapy to Fresenius is presently limited.
17
Under the National Service Provider Agreement, DaVita committed to purchase all of its
existing System One equipment as of February 7, 2007 (for a total purchase price of approximately
$5.0 million) and to buy a significant percentage of its future System One equipment needs. The
agreement has a term of three years, terminating on December 31, 2009, and DaVita has the option of
renewing the agreement for four additional periods of six months if DaVita meets certain patient
volume targets. In connection with the National Service Provider Agreement, on February 7, 2007,
DaVita also purchased, pursuant to a Stock Purchase Agreement, 2,000,000 shares of our common stock
for a purchase price of $10.00 per share, a premium of $1.50 per share over the then-current
closing price of our common stock. As of August 6, 2007, DaVita had sold all of its NxStage common
stock purchased under that agreement.
Entrada
On March 13, 2007, we entered into a long-term agreement with the Entrada Group, or Entrada,
to establish manufacturing and service operations in Mexico, initially for our cycler and PureFlow
SL disposables and later for our PureFlow SL hardware. The agreement obligates Entrada to provide
us with manufacturing space, support services and a labor force through 2012.
Product Reliability Issue
In the second quarter of 2007, we started to experience an increased incidence of reported
dialysate leaks associated with our System One cartridges. The reported incidence of leaks is higher than we have historically observed. When
the System One is used in accordance with its instructions, these leaks present no risk to patient
health. System One device labeling anticipates the potential for leaks to occur and specifically
warns against leaks and alerts users of the need to observe treatments in order to detect leaks.
Four patients with reported leaks, that were unobserved by these patients or their partners until
after their treatments were terminated, reported hypotension, or low blood pressure,
resolved by a fluid bolus, with no lasting clinical effect. In early August 2007, we sent a letter
to our patients and customers informing them of the increased incidence in leaks and reminding them
of existing System One labeling alerting users of the potential for leaks and instructing them to
observe treatments in order to detect any leaks. We have characterized this notification as a
voluntary recall. In response to the reported increase in incidence of leaks, we are also
currently developing a test to better evaluate the susceptibility of our cartridges to leaks prior to release, with the
goal of reducing the chance for pinhole-sized leaks in our cartridges.
These cartridge leaks have resulted in dissatisfaction with our System One for certain of our
customers and could impair our future growth and patient retention.
The incremental leaks have also been associated with increased
cycler service costs, which have imposed additional service pool
requirements, and could impair our ability to meet future demand. If the incidence of leaks
persists or increases or if patient satisfaction declines, we may
incur additional costs, however we deem any loss to the approximate
$2.5 million of affected inventory to be improbable at this
time, therefore no amount has been accrued to date. Additionally,
costs related to the return or replacement of
cartridges, and costs incurred to rework inventory on-hand and/or returned
by customers, may also be incurred and could be material. We have not incurred any material costs to date
in connection with this matter. We are working to address the product leaks quickly, but they
still remain an issue with our customer base.
Statement of Operations Components
Revenues
Our product consists of the System One, an electromechanical device used to circulate the
patients blood during therapy (the cycler); 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 module. 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 product may be used by our customers to
treat patients suffering from either condition and we have separate marketing and sales efforts
dedicated to each market.
We derive our revenue 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
18
market, customers rent or purchase the machine and then purchase the related disposable
products based on a specific patient prescription. We generally recognize revenue when a product
has been delivered to our customer, or, in the chronic care market, for those customers that rent
the System One, we recognize revenue on a monthly basis in accordance with a contract under which
we supply the use of a cycler and the amount of disposables needed to perform a set number of
dialysis therapy sessions during a month. For customers that purchase the System One in the chronic
care market, we recognize revenue from the equipment sale ratably over the expected service
obligation period, while disposable product revenue is recognized upon delivery.
Our rental contracts with dialysis centers for ESRD patients generally include terms providing
for the sale of disposable products to accommodate up to 26 treatments per month per patient and
the purchase or monthly rental of System One cyclers and, in the majority of instances, our
PureFlow SL module. These contracts typically have a term of one year and are cancelable at any
time by the dialysis clinic with 30 days notice. Under these contracts, if home hemodialysis is
prescribed, supplies are shipped directly to patient homes and paid for by the treating dialysis
clinic. We also include vacation delivery terms, providing for the free shipment of products to a
designated vacation destination. We derive an insignificant amount of revenues from the sale of
ancillary products, such as extra lengths of tubing. Over time, as more 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
this recurring revenue stream to continue to grow.
In the first quarter of 2007, we entered into long-term contracts with three larger dialysis
chains, including DaVita, which was our largest customer during the three months ended June 30,
2007. Revenues from DaVita represented approximately 30% of our revenues during the three months
ended June 30, 2007, and we expect revenue from DaVita will continue to account for a significant
portion of our revenues for the remainder of 2007. Each of these agreements has a term of at least
three years, and may be cancelled upon a material breach, subject to certain curing rights. These
contracts provide the customer the option to purchase as well as rent the System One equipment,
and, in the case of the DaVita contract, DaVita has agreed to purchase rather than rent a
significant percentage of its future System One equipment needs. It is not clear what percentage of
our customers, if any, will migrate to this model, and we expect, at least in the near term, that
the majority of our customers will continue to rent the System One in the chronic care market.
Cost of Revenues
Cost of revenues consists primarily of direct product costs, including material and labor
required to manufacture our products, service of System One equipment that we rent and sell to
customers, production overhead and stock-based compensation. The cost of our products depends on
several factors, including the efficiency of our manufacturing operations, the cost at which we can
obtain labor and products from third party suppliers, product reliability and related servicing
costs and the design of the products.
We are currently operating at negative gross profit as we continue to build a base of
recurring revenue and reduce product costs. We expect the cost of revenues as a percentage of
revenues to decline over time for several reasons. First, we continue to realize increased sales
volume and realization of economies of scale that are bringing improved purchasing terms and
prices, and we are realizing economies of scale that are providing us with broader options and
efficiencies in indirect manufacturing overhead costs. Second, we have introduced, and are
continuing to introduce, several process and product design changes, such as our new PureFlow SL
module, that are expected to have inherently lower cost than our current products. Third, through
our relationship with the Entrada Group, we opened a facility that will move the manufacture of
certain of our products, including the System One cycler and certain disposables, to lower labor
cost markets. Fourth, we are working to improve product reliability. And finally, we continue to
look for opportunities to vertically integrate the manufacture of our products that will lead to
lower cost, such as with the pending Medisystems acquisition.
Operating Expenses
Selling and Marketing. Selling and marketing expenses consist primarily of salary, benefits
and stock-based compensation for sales and marketing personnel, travel, promotional and marketing
materials and other expenses associated with providing clinical training to our customers. Included
in selling and marketing are the costs of clinical educators, usually nurses, we employ to teach
our customers about our products and prepare our customers
19
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.
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 limited research and development expense
increases in the foreseeable future as we continue to improve and enhance our core products.
Distribution. Distribution expenses include the freight cost of delivering our products to our
customers or our customers patients, depending on the market and the specific agreement with our
customers, and salary, benefits and stock-based compensation for distribution personnel. We use
common carriers and freight companies to deliver our products, and we do not operate our own
delivery service. Also included in this category are the expenses of shipping products from
customers back to our service center for repair if the product is under warranty, and the related
expense of shipping a replacement product to our customers. We expect that distribution expenses
will increase at a lower rate than revenue due to expected efficiencies gained from increased
business volume, improvements in product reliability, and the continued penetration of our PureFlow
SL module in the chronic market, which significantly reduces the weight and quantity of monthly
disposable shipments.
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 for outside legal counsel, fees for our annual audit and tax services and
general expenses to operate the business, including insurance and other corporate-related expenses.
Rent, utilities and depreciation expense are allocated to operating expenses based on personnel and
square footage usage. We expect that general and administrative expenses will increase in the near
term as we add additional administrative support for our 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 condensed consolidated statements of
operations included elsewhere in this Quarterly Report on Form 10-Q. You should not draw any
conclusions about our future results from the results of operations for any period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Revenues |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
Cost of revenues |
|
|
115 |
|
|
|
132 |
|
|
|
116 |
|
|
|
137 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
|
(15 |
) |
|
|
(32 |
) |
|
|
(16 |
) |
|
|
(37 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing |
|
|
51 |
|
|
|
83 |
|
|
|
54 |
|
|
|
87 |
|
Research and development |
|
|
14 |
|
|
|
35 |
|
|
|
16 |
|
|
|
42 |
|
Distribution |
|
|
30 |
|
|
|
33 |
|
|
|
29 |
|
|
|
35 |
|
General and administrative |
|
|
25 |
|
|
|
47 |
|
|
|
28 |
|
|
|
52 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
120 |
|
|
|
198 |
|
|
|
127 |
|
|
|
216 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(135 |
) |
|
|
(230 |
) |
|
|
(143 |
) |
|
|
(253 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
|
9 |
|
|
|
13 |
|
|
|
10 |
|
|
|
15 |
|
Interest expense |
|
|
(2 |
) |
|
|
(12 |
) |
|
|
(2 |
) |
|
|
(9 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7 |
|
|
|
1 |
|
|
|
8 |
|
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(128 |
)% |
|
|
(229 |
)% |
|
|
(135 |
)% |
|
|
(247 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparison of Three and Six Months Ended June 30, 2007 to Three and Six Months Ended June 30, 2006
Revenues
Our revenues for the three and six months ended June 30, 2007 and 2006 were as follows:
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Revenues |
|
$ |
10,031 |
|
|
$ |
4,546 |
|
|
$ |
5,485 |
|
|
|
121 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Revenues |
|
$ |
18,405 |
|
|
$ |
7,947 |
|
|
$ |
10,458 |
|
|
|
132 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in revenues for both the three and six months ended June 30, 2007 as compared to
the same periods in 2006 was attributable to increased sales and rentals of the System One in both
the critical care and chronic care 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 $6.7 million in the three months ended June 30, 2007 compared to $2.7 million in the
three months ended June 30, 2006, an increase of 153%, while revenues in the critical care market
increased 75% to $3.3 million in the three months ended June 30, 2007, compared to $1.9 million in
the three months ended June 30, 2006. Revenues in the chronic care market increased to $12.2
million during the six months ended June 30, 2007 compared to $4.5 million during the six months
ended June 30, 2006, an increase of 172%, while revenues in the critical care market increased 80%
to $6.2 million during the six months ended June 30, 2007, compared to $3.5 million during the six
months ended June 30, 2006.
Cost of Revenues and Gross Profit (Deficit)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Cost of revenues |
|
$ |
11,511 |
|
|
$ |
6,004 |
|
|
$ |
5,507 |
|
|
|
92 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
$ |
(1,480 |
) |
|
$ |
(1,457 |
) |
|
$ |
23 |
|
|
|
2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) percentage |
|
|
(15 |
%) |
|
|
(32 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Cost of revenues |
|
$ |
21,428 |
|
|
$ |
10,861 |
|
|
$ |
10,567 |
|
|
|
97 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) |
|
$ |
(3,023 |
) |
|
$ |
(2,914 |
) |
|
$ |
109 |
|
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (deficit) percentage |
|
|
(16 |
%) |
|
|
(37 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in cost of revenues was attributable primarily to our increased revenues. We
ended June 30, 2007 with 1,615 patients compared to 663 patients ending June 30, 2006, contributing
to an increase in material cost of revenues of $4.6 million for the quarter ending June 30, 2007
compared to the same quarter in 2006. In addition, cost of revenues increased during the three
months ended June 30, 2007 as compared to the three months ended June 30, 2006 because of a larger
employee base that resulted in additional salaries, health benefits and payroll taxes of $647, 000,
increased inbound freight costs of $427,000 to support our higher production volume, offset by
$392,000 of favorable materials cost due to volume based supplier contacts. We added 593 net
patients during the six months ended June 30, 2007 to arrive at 1,615 patients compared to 663
patients ending June 30, 2006, contributing to an additional material cost of revenues of $8.5
million compared to the same period in 2006. In addition, cost of revenues increased during the six
months ended June 30, 2007 as compared to the six months ended June 30, 2006 because of a larger
employee base which resulted in additional salaries, health benefits and payroll taxes of $1.5
million, and increased inbound freight costs of $825,000 to support our higher production volume,
offset by $615,000 of favorable materials cost due to volume based supplier contracts. We continue
to see incremental improvement in our direct product costs; however, this is currently being offset
somewhat by an increase in disposables per patient due to product reliability issues. We expect
that over time as our reliability improves, the disposables per patient will decline.
21
Selling and Marketing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Selling and marketing |
|
$ |
5,120 |
|
|
$ |
3,759 |
|
|
$ |
1,361 |
|
|
|
36 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing as a percentage of revenues |
|
|
51 |
% |
|
|
83 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Selling and marketing |
|
$ |
9,851 |
|
|
$ |
6,952 |
|
|
$ |
2,899 |
|
|
|
42 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing as a percentage of revenues |
|
|
54 |
% |
|
|
87 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in selling and marketing expenses was the result of several factors. For the
three months ended June 30, 2007 compared to the same period in 2006, approximately $1.1 million of
the increase was due to additional salaries, health benefits and payroll taxes resulting from
increased headcount and $236,000 related to a higher level of sales and marketing activity in both
the chronic and critical care markets. We increased our combined sales force from 27 sales
representatives as of June 30, 2006 to 31 sales representatives as of June 30, 2007. For the six
months ended June 30, 2007 compared to the same period in 2006, approximately $2.4 million of the
increase was due to additional salaries, health benefits and payroll taxes resulting from increased
headcount and $524,000 related to a higher level of sales and marketing activity in both the
chronic and critical care markets. 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.
Research and Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Decrease |
|
|
Decrease |
|
|
|
(In thousands, except percentages) |
|
Research and development |
|
$ |
1,418 |
|
|
$ |
1,576 |
|
|
$ |
(158 |
) |
|
|
(10 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development as a percentage of revenues |
|
|
14 |
% |
|
|
35 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Decrease |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Research and development |
|
$ |
2,854 |
|
|
$ |
3,355 |
|
|
$ |
(501 |
) |
|
|
(15 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development as a percentage of revenues |
|
|
16 |
% |
|
|
42 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in research and development expenses during the three months ended June 30, 2007
compared to the same period in 2006 was attributable to $71,000 resulting from lower clinical trial
activities, decrease in salary, benefits and payroll taxes of $51,000 as a result of decreased
headcount, and a $30,000 decrease in consulting costs relating to the development of the Pure Flow
SL module. The decrease in research and development expenses during the six months ended June 30,
2007 compared to the same period in 2006 was attributable to $247,000 of lower development costs
associated with our PureFlow SL module, decreased salary, benefits and payroll taxes of $175,000 as
a result of decreased headcount, and a decrease of $54,000 resulting from lower clinical trial
activities. We expect research and development expenses will increase in the foreseeable future as
we seek to further enhance our System One and related products, and their reliability, but we do
not expect that research and development expenses will increase 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.
22
Distribution
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Distribution |
|
$ |
2,997 |
|
|
$ |
1,519 |
|
|
$ |
1,478 |
|
|
|
97 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution as a percentage of revenues |
|
|
30 |
% |
|
|
33 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
Distribution |
|
$ |
5,342 |
|
|
$ |
2,808 |
|
|
$ |
2,534 |
|
|
|
90 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution as a percentage of revenues |
|
|
29 |
% |
|
|
35 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in distribution expenses for the three and six month periods ended June 30, 2007
compared to the same period in 2006 was due to increased volume of shipments of disposable products
to a growing number of patients in the chronic care market, and due to product reliability issues.
We expect that distribution expenses will increase at a lower rate than revenues in the second half
of 2007 due primarily 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 module, which began in July 2006, and the use of an outsourced logistics provider located in the central part of the
continental United States.
General and Administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
General and administrative |
|
$ |
2,526 |
|
|
$ |
2,149 |
|
|
$ |
377 |
|
|
|
18 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative as a percentage of revenues |
|
|
25 |
% |
|
|
47 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
June 30, |
|
|
|
|
|
|
Percentage |
|
|
|
2007 |
|
|
2006 |
|
|
Increase |
|
|
Increase |
|
|
|
(In thousands, except percentages) |
|
General and administrative |
|
$ |
5,193 |
|
|
$ |
4,124 |
|
|
$ |
1,069 |
|
|
|
26 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative as a percentage of revenues |
|
|
28 |
% |
|
|
52 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in general and administrative expenses during the three months ended June 30,
2007 compared to the same period in 2006 was primarily due to an increase of $506,000 of
professional fees and corporate expenses offset by $158,000 in lower salary and benefits. The
increase in general and administrative expenses during the six months ended June 30, 2007 compared
to the same period in 2006 was primarily due to an increase of $910,000 of professional fees and
corporate expenses and $112,000 in higher salary and benefits. 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 and six month periods ended June 30,
2007, interest income increased by $224,000 and $532,000, respectively, due to increased cash and
investment balances resulting from our follow-on public offering in June 2006 and our sale of stock
to DaVita in February 2007.
For the three and six month periods ended June 30, 2007, interest expense decreased by
$363,000 and $346,000, respectively, based on the repayment of certain long-term debt arrangements
in the three and six month periods ended June 30, 2006.
23
Liquidity and Capital Resources
We have operated at a loss since our inception in 1998. As of June 30, 2007, our accumulated
deficit was $148.5 million and we had cash, cash equivalents and short-term investments of
approximately $53.0 million. On February 7, 2007, we issued and sold 2,000,000 shares of common
stock to DaVita in which we received net proceeds, after deducting legal expenses, of approximately
$19.9 million. On June 14, 2006, we closed a follow-on public offering in which we received net
proceeds after deducting underwriting discounts, commissions and expenses of approximately $51.4
million from the sale and issuance of 6,325,000 shares of common stock.
On May 15, 2006, we entered into an equipment line of credit agreement for the purpose of
financing field equipment purchases and placements. The line of credit agreement provides for the
availability of up to $20.0 million through December 31, 2007, and borrowings bear interest at the
prime rate plus 0.5% (8.4% as of June 30, 2007). Under the line of credit agreement, $10.0 million
is available through December 31, 2006 and a further $10.0 million is available from January 1,
2007 through December 31, 2007. The availability of the line of credit is subject to a number of
covenants, including maintaining certain levels of liquidity, adding specified numbers of patients
and operating within net loss parameters. We are also required to maintain operating and/or
investment accounts with the lender in an amount at least equal to the outstanding debt obligation.
Borrowings are secured by all of our assets other than intellectual property and are payable
ratably over a three-year period from the date of each borrowing. At June 30, 2007, we had
outstanding borrowings of $6.0 million and $11.6 million of borrowings available under the
equipment line of credit.
The following table sets forth the components of our cash flows for the periods indicated (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2007 |
|
|
2006 |
|
Net cash used in operating activities |
|
$ |
(26,672 |
) |
|
$ |
(25,492 |
) |
Net cash used in investing activities |
|
|
(1,981 |
) |
|
|
(1,223 |
) |
Net cash provided by (used in) financing activities |
|
|
19,801 |
|
|
|
52,573 |
|
Effect of exchange rate changes on cash |
|
|
17 |
|
|
|
44 |
|
|
|
|
|
|
|
|
Net cash flow |
|
$ |
(8,835 |
) |
|
$ |
25,902 |
|
|
|
|
|
|
|
|
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 deferred
accounts payable and accrued expenses. Non-cash transfers from inventory for the placement of
rental units with our customers represented $12.0 million and $7.4 million, respectively, during
the six months ended June 30, 2007 and 2006.
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 net cash provided by short-term investments and
marketable securities of $0.9 million during the six months ended June 30, 2007 and net cash used
of $29.5 million of short-term investments during the six months ended June 30, 2006.
Net Cash Provided By Financing Activities. Net cash provided by financing activities reflected
$19.9 million of net proceeds received from the issuance of common stock to DaVita in February
2007, and $1.3 million of proceeds from the exercise of stock options and warrants during the six
months ended June 30, 2007, offset by the net repayment of debt of $1.4 million and $37,000 during
the six months ended June 30, 2007 and 2006, respectively.
We expect to continue to incur net losses for the foreseeable future. We expect that our
current cash position, and the availability under our equipment line of credit, is sufficient to
support operations at least through 2007. 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
24
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. We anticipate that
the pending acquisition with Medisystems, if consummated, will have a positive effect on our
working capital.
The following table summarizes our contractual commitments as of June 30, 2007 (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) |
|
|
|
|
|
|
|
|
|
Equipment line of credit |
|
$ |
6,017 |
|
|
$ |
2,800 |
|
|
$ |
3,217 |
|
|
$ |
|
|
|
$ |
|
|
Operating leases |
|
|
3,909 |
|
|
|
753 |
|
|
|
1,567 |
|
|
|
1,543 |
|
|
|
46 |
|
Purchase obligations(1) |
|
|
40,674 |
|
|
|
22,401 |
|
|
|
10,131 |
|
|
|
2,442 |
|
|
|
5,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
50,600 |
|
|
$ |
25,954 |
|
|
$ |
14,915 |
|
|
$ |
3,985 |
|
|
$ |
5,746 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Purchase obligations include purchase commitments for System One components, primarily for
equipment and fluids pursuant to contractual agreements with several of our suppliers.
Certain of these commitments may be extended and/or canceled at our option. |
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 U.S.
generally accepted accounting principles. The preparation of these consolidated financial
statements requires us to make significant estimates and judgments that affect the reported amounts
of assets, liabilities, revenues and expenses. These items are regularly monitored and analyzed by
management for changes in facts and circumstances, and material changes in these estimates could
occur in the future. Changes in estimates are recorded in the period in which they become known. We
base our estimates on historical experience and various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ substantially from our estimates.
A summary of those accounting policies and estimates that we believe are most critical to
fully understanding and evaluating our financial results is set forth below. This summary should be
read in conjunction with our consolidated financial statements and the related notes included
elsewhere in this Quarterly Report on Form 10-Q.
Revenue Recognition
We recognize revenues from product sales and services when earned in accordance with Staff
Accounting Bulletin, or SAB, No. 104, Revenue Recognition", and Emerging Issues Task Force, or
EITF 00-21, Revenue Arrangements with Multiple Deliverables. Revenues are recognized when: (a)
there is persuasive evidence of an arrangement, (b) the product has been shipped or services and
supplies have been provided to the customer, (c) the sales price is fixed or determinable and (d)
collection is reasonably assured.
Chronic Care Market
Prior to 2007, we derived revenue in the chronic care market from short-term rental
arrangements with our customers as our principal business model in the chronic care market. These
rental arrangements, which combine the use of the System One with a specified number of disposable
products supplied to customers for a fixed amount per month, are recognized on a monthly basis in
accordance with agreed upon contract terms and pursuant to a binding customer purchase order and
fixed payment terms. Rental arrangements continue to represent the majority of the arrangements we
have with our customers in the chronic care market.
Beginning in 2007, we entered into long-term customer contracts to sell System One and
PureFlow SL equipment along with the right to purchase disposable products and service on a monthly
basis. Some of these agreements
25
include other terms such as development efforts, training, market collaborations, limited
market exclusivity, and volume discounts. The equipment and related items provided to our customers
in these arrangements are considered a multiple-element sales arrangement pursuant to EITF 00-21.
When a sales arrangement involves multiple elements, the deliverables included in the arrangement
are evaluated to determine whether they represent separate units of accounting. We have determined
that we cannot account for the sale of equipment as a separate unit of accounting. Therefore, fees
received upon the completion of delivery of equipment are deferred, and recognized as revenue on a
straight line basis over the expected term of our obligation to supply disposables and service,
which is five to seven years. We have deferred both the unrecognized revenue and direct costs
relating to the delivered equipment, which costs are being amortized over the same period as the
related revenue.
We entered into a national service provider agreement and a stock purchase agreement with
DaVita on February 7, 2007. Pursuant to EITF 00-21, we consider these agreements a single
arrangement. In connection with the stock purchase agreement, DaVita purchased 2,000,000 shares of
our common stock for $10.00 per share, which represented a premium of $1.50 per share, or $3.0
million over the current market price. We have recorded the $3.0 million premium as deferred
revenue and will recognize this revenue ratably over seven years, consistent with our equipment
service obligation to DaVita. During the three and six months ended June 30, 2007, we recognized
revenue of $107,000 and $179,000, respectively, associated with the $3.0 million premium.
Critical Care Market
In the critical care market, sales are structured as direct product sales or as a
disposables-based program in which a customer acquires the equipment through the purchase of a
specific quantity of disposables over a specific period of time. We recognize revenues from direct
product sales at the later of the time of shipment or, if applicable, delivery in accordance with
contract terms. Under a disposables-based program, the customer is granted the right to use the
equipment for a period of time, during which the customer commits to purchase a minimum number of
disposable cartridges or fluids at a price that includes a premium above the otherwise average
selling price of the cartridges or fluids to recover the cost of the equipment and provide for a
profit. Upon reaching the contractual minimum purchases, ownership of the equipment transfers to
the customer. Revenues under these arrangements are recognized over the term of the arrangement as
disposables are delivered. During the reported periods, the majority of our critical care revenues
were derived from direct product sales.
Our contracts provide for training, technical support and warranty services to our customers.
We recognize training and technical support revenue when the related services are performed. In the
case of extended warranty, the revenue is recognized ratably over the warranty period.
Inventory Valuation
Inventories are valued at the lower of cost or estimated market. We regularly review our
inventory quantities on hand and related cost and record a provision for excess or obsolete
inventory primarily based on an estimated forecast of product demand for each of our existing
product configurations. We also review our inventory value to determine if it reflects lower of
cost or market, with market determined based on net realizable value. Appropriate consideration is
given to inventory items sold at negative gross margins 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 June 30, 2007.
26
Related-Party Transactions
Medisystems Corporation
Supply Agreement
We purchase completed cartridges, tubing and certain other components used in the System One
disposable cartridge from Medisystems Corporation, an entity owned by David S. Utterberg, a member
of our Board of Directors and the owner of approximately 6.7% of our outstanding common stock. We
purchased approximately $2.1 million and $3.8 million during the three and six months ended June
30, 2007, and $1.2 million and $1.9 million for the three and six months ended June 30, 2006,
respectively, of goods and services from this related party. Amounts owed to Medisystems
Corporation totaled $665,000 and $926,000 at June 30, 2007 and December 31, 2006, respectively, and
are included in accounts payable in the accompanying condensed consolidated balance sheets. At June
30, 2007, we had commitments to purchase approximately $3.2 million of products from Medisystems
Corporation.
On January 4, 2007, we entered into a supply agreement with Medisystems that expires on
December 31, 2013. Prior to entering into the supply agreement, we purchased products from
Medisystems through purchase orders. Pursuant to the terms of the supply agreement, we will
purchase no less than ninety percent (90%) of our North American requirements for disposal
cartridges, or Medisystems products, for use with its System One from Medisystems.
Stock Purchase Agreement
On June 4, 2007, we entered into a stock purchase agreement with Mr. Utterberg to purchase all
of the issued and outstanding shares of the Medisystems Entities in exchange for 6,500,000 shares
of our common stock, which we refer to as the stock purchase, and agreed to enter into a consulting
agreement with Mr. Utterberg and DSU, a company owned by Mr. Utterberg, upon the consummation of
the stock purchase, to provide us with consulting, advisory and related services for two years
following the consummation of the Stock Purchase. Under the terms of the Consulting Agreement, we
will pay Mr. Utterberg $200,000 annually, plus reasonable expenses and Mr. Utterberg and DSU will
agree (1) not to compete with us and will not encourage or solicit any of our employees, customers
or suppliers, and (2) will assign to us certain inventions and proprietary rights received during
the term of the Consulting Agreement and will grant certain exclusive, worldwide, perpetual,
royalty-free irrevocable, sublicensable, fully paid licenses for such inventions and proprietary
rights. In the event the Stock Purchase is consummated, Mr. Utterberg will own approximately 23.4%
of our outstanding common stock and will continue to be a member of our Board of Directors.
The consummation of the stock purchase is subject to a number of conditions, including, among
other things, the termination of applicable waiting periods under the Hart-Scott-Rodino Act, the
approval by our stockholders of the issuance of shares of our common stock to Mr. Utterberg in
connection with the stock purchase, and the effectiveness of our registration and proxy
statement/prospectus on Form S-4, as determined by the SEC, seeking stockholder approval of this
stock issuance. None of these conditions has yet been satisfied. We filed our registration and
proxy statement/prospectus on Form S-4 seeking stockholder approval in connection with the Stock
Purchase with the SEC on July 27, 2007. This registration and proxy statement/prospectus on Form
S-4 has not yet been declared effective by the SEC.
Consistent with our Audit Committee Charter and Related Person Transaction Policy, the Stock
Purchase Agreement and Consulting Agreement were each approved by our Audit Committee and Board of
Directors. The Supply Agreement was also approved by the Audit Committee and Board of Directors.
As of June 30, 2007, we have capitalized approximately $1.2 million of direct costs incurred
in conjunction with the pending Medisystems stock purchase. These costs are included in other
assets in the accompanying condensed consolidated balance sheets.
27
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.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements", which addresses
the measurement of fair value where such measure is required for recognition or disclosure
purposes under GAAP. Among other provisions, SFAS No. 157 includes (i) a new definition of fair
value, (ii) a fair value hierarchy used to classify the source of information used in fair value
measurements, (iii) new disclosure requirements of assets and liabilities measured at fair value
based on their level in the hierarchy, and (iv) a modification of the accounting presumption that
the transaction price of an asset or liability equals its initial fair value. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007 (i.e., beginning in 2008 for NxStage).
We are currently evaluating the impact of SFAS No. 157 on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities Including an amendment of FASB Statement No. 115, which permits
entities to choose to measure many financial instruments and certain other items at fair value.
SFAS No. 159 is effective as of the beginning of an entitys first fiscal year that begins after
November 15, 2007. We are currently evaluating if we will elect the fair value option for any of
our eligible financial instruments and other items.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the three and six months ended June 30, 2007, 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, 2006. As of the date of this report,
there have been no material changes to the market risks described in our Annual Report on Form 10-K
for December 31, 2006.
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 June 30, 2007. 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 June 30, 2007, 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 June 30, 2007
that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
28
PART II OTHER INFORMATION
Item 1A. Risk Factors
In addition to the factors discussed in Managements Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this report, the following are some of the
important risk factors that could cause our actual results to differ materially from those
projected in any forward-looking statements.
Risks Related to our Business
We expect to derive 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 26,000 in
2004, 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 2,000 patients were receiving home-based hemodialysis in 2004.
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. Historically, we have typically billed the dialysis clinic for the rental of
the equipment and the sale of the related disposable cartridges and treatment fluids. In our recent
DaVita agreement, DaVita agreed to purchase all of its System One equipment then being rented from
us and to buy a significant percentage of its future System One equipment needs. It is not clear
what percentage of our future chronic customers will purchase rather than rent System One
equipment. However, it is possible that a significant percentage of our chronic customers will
continue to rent rather than purchase System One equipment and that, as a result, we will generate
a significant percentage of our revenues and cash flow from the use of the System One over time
rather than upfront from the sale of the System One equipment. In this event, we will need
significant amounts of working capital to manufacture System One equipment for rental to dialysis
clinics.
29
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 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.
We have limited operating experience, a history of net losses and an accumulated deficit of $148.5
million at June 30, 2007. 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 June 30, 2007, we had an
accumulated deficit of approximately $(148.5) million. We expect to incur increasing operating
expenses as we continue to grow our business. Additionally, in the chronic care 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 care 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, implementing design and process
improvements to lower our costs of manufacturing our products and achieving efficient distribution
of our products.
In March 2006, we received clearance from the FDA to market our PureFlow SL module as an
alternative to the bagged fluid presently used with our System One in the chronic care market, and
we commercially launched the PureFlow SL module in July 2006. This accessory to the System One
allows for the preparation of high purity dialysate in the patients home using ordinary tap water
and dialysate concentrate. The PureFlow SL is designed to help patients with ESRD more conveniently
and effectively manage their home hemodialysis therapy by eliminating the need for bagged fluids.
Since its launch, PureFlow SL penetration has reached approximately 58% of all of our chronic
patients. The product is still early in its commercial launch and we continue to work to improve
product reliability and user experience, based upon customer feedback. Any failure to further
improve reliability and user experience, and thereby gain rapid market acceptance of the PureFlow
SL module, including converting our installed base of patients currently using bagged fluid, could
adversely affect our ability to achieve profitability.
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, Gambro AB, B. Braun and others, each of which markets one or more FDA-cleared
medical devices for the treatment of acute or chronic kidney failure.
To date, only one other company has had a hemodialysis product specifically cleared for
home use, Aksys Ltd., announced in January the withdrawal of its product from the market. Products
sold by our other competitors have also been used in the home, in particular Fresenius systems.
Each of these competitors offers products that have been in use for a longer time than our System
One and are more widely recognized by physicians, patients and providers. These competitors have
significantly more financial and human resources, more established sales, service and customer
support infrastructures and spend more on product development and marketing than we do. Many of our
competitors also have established relationships with the providers of dialysis therapy and,
Fresenius owns and operates a chain of dialysis clinics. 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.
Finally, one of our competitors, Gambro AB, is subject to an import hold imposed by the FDA on its
acute and chronic dialysis machines. It is not clear what the chronic and acute market impact will
be when the import hold is lifted. We believe the overall impact of the import hold has been
positive to us, however, we are not sure of the magnitude of the impact this import hold has had on
revenues.
30
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 the System One 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 the System One.
Our success will depend on our ability to achieve market acceptance of our System One.
Our products have limited product and brand recognition and have only been used at a limited
number of dialysis clinics and hospitals. In the chronic care 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:
|
|
|
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; |
|
|
|
|
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; |
|
|
|
|
the ownership and operation of some dialysis providers by companies that also
manufacture and sell competitive dialysis products; |
|
|
|
|
the introduction of competing products or treatments that may be more effective,
safer, easier to use or less expensive than ours; |
|
|
|
|
the number of patients willing and able to perform therapy independently, outside
of a traditional dialysis clinic, may be smaller than we estimate; and |
|
|
|
|
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. Changes in Medicare reimbursement rates could negatively affect
demand for our products and the prices we charge for them.
31
As we continue to commercialize the System One and related 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.
If we are unable to improve on the product reliability performance typically experienced in
the early stages of a products life cycle, our ability to grow our business and achieve
profitability could be impaired.
Our System One is still early in its product launch, and our PureFlow SL module was only
introduced during the third quarter of 2006. We
continue to experience product reliability issues that are higher than we expect long-term, which
lead us to incur increased service and distribution costs, as well as increase the size of our
field equipment base. This, in turn, negatively impacts our gross margins and increases our working
capital requirements. Additionally, product reliability issues can also lead to decreases in
customer satisfaction and our ability to grow or maintain our revenues. We continue to work to
improve product reliability, and have achieved some improvements to date. If we are unable to
continue to improve product reliability, our ability to achieve our growth objectives as well as
profitability could be significantly impaired.
Most recently, in the second quarter of 2007, we started to experience an increased incidence
of reported dialysate leaks associated with our System One cartridges. The reported incidence of leaks is higher than we have historically
observed. When the System One is used in accordance with its instructions, these leaks present no
risk to patient health. System One device labeling anticipates the potential for leaks to occur
and specifically warns against leaks and alerts users of the need to observe treatments in order to
detect leaks. Four patients with reported leaks, that were unobserved by these patients or their
partners until after their treatments were terminated, reported hypotension, or low blood
pressure, resolved by a fluid bolus, with no lasting clinical effect. In early August 2007, we
sent a letter to our patients and customers informing them of the increased incidence in leaks and
reminding them of existing System One labeling alerting users of the potential for leaks and
instructing them to observe treatments in order to detect any leaks. We have characterized this
notification as a voluntary recall. In response to the reported increase in incidence of leaks, we
are also currently developing a test to better evaluate the susceptibility of our cartridges to leaks prior to release, with the goal of reducing the chance for pinhole-sized leaks in our cartridges.
These cartridge leaks have resulted in dissatisfaction with our System One for certain of our
customers and could impair our future growth and patient retention.
The incremental leaks have also been associated with increased cycler
service costs, which have imposed additional service pool
requirements, and could impair our ability to meet future demand. If the incidence of leaks
persists or increases or if patient satisfaction declines, we may incur additional costs,
however we deem any loss to the approximately $2.5 million of
affected inventory to be improbable at this time, therefore no amount
has been accrued to date. Additionally, costs related to the return or replacement of cartridges, and costs incurred to rework inventory on-hand
and/or returned by customers may also be incurred and could be
material. We have not
incurred any material costs to date in connection with this matter. We are working to address the
product leaks quickly, but they still remain an issue with our customer base.
We have a significant amount of field equipment, and our ability to effectively manage this asset
could negatively impact our working capital requirements and future profitability.
Because the majority of our chronic care business continues to rely upon an equipment
rental model, our ability to manage System One equipment is important to minimizing our working
capital requirements. In addition, our gross margins may be negatively impacted if we have excess
equipment deployed, and unused, in the field. If we are unable to successfully track, service and
redeploy equipment, we could (1) incur increased costs, (2) realize increased cash requirements
and/or (3) have material write-offs of equipment.
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Our agreement with DaVita confers certain geographic market rights to DaVita and limits our ability
to sell the System One to Fresenius, both of which may present a barrier to adoption of the System
One.
Fresenius and DaVita own and operate the two largest chains of dialysis clinics in the
United States. Fresenius controls approximately 33% of the U.S. dialysis clinics and is the largest
worldwide manufacturer of dialysis systems. DaVita controls approximately 27% of the U.S. dialysis
clinics, and has entered into a preferred supplier agreement with Gambro pursuant to which Gambro
will provide a significant majority of DaVitas dialysis equipment and supplies for a period of at
least 10 years. Each of Fresenius and DaVita may choose to offer their dialysis patients only the
dialysis equipment manufactured by them or their affiliates, to offer the equipment they
contractually agreed to offer or to otherwise limit access to the equipment manufactured by
competitors.
Our recent agreement with DaVita confers certain market rights for the System One and
related supplies for home hemodialysis therapy. DaVita is granted exclusive rights in a small
percentage of geographies, which geographies collectively represent less than 10% of the U.S. ESRD
patient population, and limited exclusivity in the majority of all other U.S. geographies, subject
to DaVitas meeting certain requirements, including patient volume commitments and new patient
training rates. Under the agreement, we can continue to sell to other clinics in the majority of
geographies. If certain minimum patient numbers or training rates are not achieved, DaVita can lose
all or part of its preferred geographic rights. The agreement further limits, but does not
prohibit, the sale by NxStage of the System One for chronic home patient hemodialysis therapy to
any provider that is under common control or management of a parent entity that collectively
provides dialysis services to more than 25% of U.S. chronic dialysis patients and that also
supplies dialysis products. Therefore, our ability to sell the System One for chronic home patient
hemodialysis therapy to Fresenius is presently limited.
It is not yet clear what impact this agreement may have on the market acceptance for our
product. It is also not yet clear to what extent DaVita will purchase the System One from us. For
the three months ended June 30, 2007, sales to DaVita represented 30% of our total revenues.
Although we expect that DaVita will continue to be a significant customer of ours, the agreement
imposes no purchase obligations upon DaVita and we cannot be certain whether DaVita will continue
to purchase and/or rent the System One from us in the future. We believe that any future decision
by DaVita to stop or limit the use of the System One would adversely affect our business, at least
in the near term.
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 2004 approximately 17,000 patients received
kidney transplants in the United States. The development of new medications designed to reduce the
incidence of kidney transplant rejection, progress in using kidneys harvested from genetically
engineered animals as a source of transplants or any other advances in kidney transplantation could
limit the market for our 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.
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.
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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 three 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 cartridges. Although System One device labeling anticipates
the potential for leaks to occur, and therefore specifically warns against leaks and alerts users
of the need to check for leaks while performing treatments, the incidence of leaks was higher than
we had historically experienced. 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. Our third voluntary recall occurred in the United
Sates in August 2007 and also related to pinhole-sized leaks in our cartridges. Four patients with
reported leaks, that were unobserved by these patients or their partners until the end of their
treatments, reported hypotension, or low blood pressure, resolved by a fluid bolus, with
no lasting clinical effect. No other patient injuries were reported in connection with this
recall. In response to this increased incidence in leaks, we are developing a test to better
evaluate the susceptibility of cartridges to leaks prior to release, with the goal of reducing 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 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 sought to address many
potential sources of operator error with product design changes to simplify the operator process.
In addition, we have made improvements in our training materials and product labeling. However,
instances of operator error cannot be eliminated and 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 maintain insurance at levels deemed adequate by management, however, future claims could exceed
our applicable insurance coverage.
We maintain insurance for property and general liability, directors and officers
liability, workers compensation, and other coverage in amounts and on terms deemed adequate by
management based on our expectations for future claims. Future claims could, however, exceed our
applicable insurance coverage, or our coverage could not cover the applicable claims.
We 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.
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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 June 30, 2007,
we had 107 employees in our sales, marketing and distribution organization, including 31 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 retain or 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 manufacturing facilities
in Rosdorf, Germany and Fresnillo, Mexico 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.
Risks Related to the Proposed Acquisition of the Medisystems Entities and Other Possible Business
Combinations
We may not complete the acquisition of the Medisystems entities and, the failure to do so,
could harm our common stock price and future business and operations.
On June 4, 2007, we entered into a stock purchase agreement with David S. Utterberg to
purchase his issued and outstanding shares of Medisystems Services Corporation, a Nevada
corporation, Medisystems Corporation, a Washington corporation, Medisystems Europe S.p.A., a
company organized under the laws of Italy, and Medimexico s. de R.L. de C.V., a company organized
under the laws of Mexico, which we refer to collectively as the Medisystems entities. The proposed
acquisition of the Medisystems entities is subject to a number of closing conditions, including
approval of our stockholders, and may not be completed. If the acquisition is not completed, we
may be subject to the following risks:
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the price of our common stock may decline; |
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we will not realize our expected benefits of the acquisition; |
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under certain circumstances we will be required to pay Mr. Utterberg a
termination fee of up to $600,000 in reasonable documented expenses
incurred by him in connection with the acquisition; and |
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the costs incurred by us related to the acquisition, such as legal,
accounting and certain financial advisory fees, must be paid even if
the acquisition is not completed. |
The market price of our common stock may decline as a result of the acquisition.
The market price of our common stock may decline as a result of the acquisition for a number
of reasons including if:
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we do not achieve the perceived benefits of the acquisition as rapidly or to the extent
anticipated by financial or industry analysts; |
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the effect of the acquisition on our business and prospects is not consistent with the
expectations of financial or industry analysts; or |
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investors react negatively to the effect on our business and prospects from the acquisition. |
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Our stockholders may not realize a benefit from the acquisition commensurate with the ownership
dilution they will experience in connection with the acquisition.
As consideration for the acquisition of the Medisystems entities, we expect to issue 6,500,000
shares of our common stock, or approximately 21.7% of our outstanding common stock as of June 29,
2007. If we are unable to realize the strategic and financial benefits currently anticipated from
the acquisition, our stockholders will have experienced substantial dilution of their ownership
interest without receiving commensurate benefit.
We may face challenges in integrating Medisystems business with NxStages and, as a result, may
not realize the expected benefits of the proposed acquisition.
Even though NxStages and Medisystems businesses are relatively distinct, integrating the
operations and personnel of Medisystems and NxStage will require a significant investment of
managements time and effort as well as the investment of capital, particularly with respect to
information systems. The successful integration of Medisystems and NxStage will require, among
other things, coordination of certain manufacturing operations and sales and marketing operations
and the integration of Medisystems operations into the NxStage organization. The diversion of the
attention of NxStages and Medisystems senior management and any difficulties encountered in the
process of combining the companies could cause the disruption of, or a loss of momentum in, the
activities of the combined businesses.
The inability to successfully integrate the operations and personnel of Medisystems and NxStage, or
any significant delay in achieving integration, could have a material adverse effect on the
combined businesses after the completion of the acquisition, and, as a result, on the market price
of NxStages common stock.
We may grow through additional acquisitions, which could dilute our existing shareholders and could
involve substantial integration risks.
As part of our business strategy, we may acquire, in addition to our proposed acquisition
of Medisystems, other businesses and technologies in the future. We may issue equity securities as
consideration for future acquisitions that would dilute our existing stockholders, perhaps
significantly depending on the terms of the acquisition. We may also incur additional debt in
connection with future acquisitions, which, if available at all, may place additional restrictions
on our ability to operate our business. Acquisitions may involve a number of risks, including:
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difficulty in transitioning and integrating the operations and personnel of the
acquired businesses, including different and complex accounting and financial
reporting systems; |
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potential disruption of our ongoing business and distraction of management; |
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potential difficulty in successfully implementing, upgrading and deploying in a
timely and effective manner new operational information systems and upgrades of our
finance, accounting and product distribution systems; |
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difficulty in incorporating acquired technology and rights into our products and
technology; |
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unanticipated expenses and delays in completing acquired development projects and
technology integration; |
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management of geographically remote units both in the United States and internationally; |
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impairment of relationships with partners and customers; |
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customers delaying purchases of our products pending resolution of product
integration between our existing and our newly acquired products; |
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entering markets or types of businesses in which we have limited experience; and |
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potential loss of key employees of the acquired company; |
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Inaccurate assumptions of acquired companys product quality and/or product reliability. |
As a result of these and other risks, we may not realize anticipated benefits from our
acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired
businesses and technologies could seriously harm our business.
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Purchase accounting treatment of acquisitions could decrease our net income in the foreseeable
future, which could have a material and adverse effect on the market value of our common stock.
Under accounting principles generally accepted in the United States of America, we would
account for acquisitions using the purchase method of accounting. Under purchase accounting, we
would record the consideration issued in connection with the acquisition and the amount of direct
transaction costs as the cost of acquiring the company or business. We would allocate that cost to
the individual assets acquired and liabilities assumed, including various identifiable intangible
assets such as acquired technology, acquired trade names and acquired customer relationships based
on their respective fair values. Intangible assets generally will be amortized over a three to
fifteen year period. Goodwill and certain intangible assets with indefinite lives are not subject
to amortization but are subject to at least an annual impairment analysis, which may result in an
impairment charge if the carrying value exceeds their implied fair value. These potential future
amortization and impairment charges may significantly reduce net income, if any, and therefore may
adversely affect the market value of our common stock.
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 510(k) pre-market notification to address the change. Although in the first instance we may
determine that a change does not rise to a level of significance that would require us to make a
pre-market notification submission, the FDA may disagree with us and can require us to submit a
510(k) for a significant change in the labeling, technology, performance specifications or
materials or major change or modification in intended use, despite a documented rationale for not
submitting a pre-market notification. We have modified various aspects of 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 510(k) decision of substantial equivalence. Also, PMA products require approval
supplements for any change that affects safety and
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effectiveness before the modified device may be
marketed. Delays in our receipt of regulatory clearance or approval will cause delays in our
ability to sell our products, which will have a negative effect on our revenues growth.
Even if we obtain the necessary FDA clearances or approvals, if we or our suppliers fail to comply
with ongoing regulatory requirements our products could be subject to restrictions or withdrawal
from the market.
We are subject to the 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 could 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. Recalls, involving the System One, depending upon the nature and scope of the recall, may be
particularly harmful to our business and financial results, because the System One is our primary product.
Our August 2007 voluntary recall relating to the increased incidence of reported cartridge leaks has not,
as of the date of this report, caused us to incur material costs. If the incidence of leaks persists or increases
or if patient satisfaction declines, this may change.
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.
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manufacturing facility has
previously had three FDA QSR inspections. The first resulted in one observation, which was
rectified during the inspection and required no further response from us. Our last two inspections,
including our most recent inspection in March 2006, resulted in no observations. We cannot provide
assurance that any future inspections would have the same result. If one of our manufacturing
facilities or those of any of our contract manufacturers fails to take satisfactory corrective
action in response to an adverse QSR inspection, FDA could take enforcement action, including
issuing a public warning letter, shutting down our manufacturing operations, embargoing the import
of components from outside of the United States, recalling our products, refusing to approve new
marketing applications, instituting legal proceedings to detain or seize products or imposing civil
or criminal penalties or other sanctions, any of which could cause our business and operating
results to suffer.
Changes in reimbursement for 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 coordination 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. The CMS
provides the composite rate for dialysis services, which is subject to regional variation and
varies depending upon whether the facility is hospital-based or an independent clinic. The
composite rate 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. 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 DRG system.
Under this system, reimbursement is determined based on a patients primary diagnosis and is
intended to cover all costs of treating the patient. The presence of acute kidney failure or fluid
overload increases the severity of the primary diagnosis and, accordingly, may increase the amount
reimbursed. For care of these patients to be cost-effective, hospitals must manage the longer
hospitalization stays and significantly more nursing time typically necessary for patients with
acute kidney failure and fluid overload. If we are unable to convince hospitals that our System One
provides a cost-effective treatment alternative under this diagnosis related group reimbursement
system, they may not purchase our product. In addition, changes in Medicare reimbursement rates for
hospitals could negatively affect demand for our products and the prices we charge for them.
Legislative or regulatory reform of the healthcare system may affect our ability to sell our
products profitably.
In both the United States and foreign countries, there have been legislative and regulatory
proposals to change the healthcare system in ways that could affect our ability to sell our
products profitably. The federal government and some states have enacted healthcare reform
legislation, and further federal and state proposals are likely. We cannot predict the exact form
this legislation may take, the probability of passage, or the ultimate effect on us. Our business
could be adversely affected by future healthcare reforms or changes in Medicare.
Failure to obtain regulatory approval in foreign jurisdictions would prevent us from marketing our
products outside the United States.
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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 and hospitals to protect
the privacy of patient health information.
In the course of performing our business we obtain, from time to time, confidential patient
health information. For example, we learn patient names and addresses when we ship our System One
supplies to home hemodialysis patients. We may learn patient names and be exposed to confidential
patient health information when we provide training on 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 the Health Insurance Portability and Accountability Act of 1996, or HIPAA. At
this time, we are not a HIPAA covered entity and consequently are not directly subject to HIPAA.
However, we have entered into several business associate agreements with covered entities that
contain commitments to protect the privacy and security of patients health information and, in
some instances, require that we indemnify the covered entity for any claim, liability, damage, cost
or expense arising out of or in connection with a breach of the agreement by us. If we were to
violate one of these agreements, we could lose customers and be exposed to liability and/or our
reputation and business could be harmed. In addition, conduct by a person that is not a covered
entity could potentially be prosecuted under aiding and abetting or conspiracy laws if there is an
improper disclosure or misuse of patient information.
Many state laws apply to the use and disclosure of health information, which could affect the
manner in which we conduct our business. Such laws are not necessarily preempted by HIPAA, in
particular those laws that afford greater protection to the individual than does HIPAA. Such state
laws typically have their own penalty provisions, which could be applied in the event of an
unlawful action affecting health information.
We are subject to federal and state laws prohibiting kickbacks and false and fraudulent claims
which, if violated, could subject us to substantial penalties. Additionally, any challenges to or
investigation into our practices under these laws could cause adverse publicity and be costly to
respond to, and thus could harm our business.
The Medicare/ Medicaid anti-kickback laws, and several similar state laws, prohibit payments
that are intended to induce physicians or others either to refer patients or to acquire or arrange
for or recommend the acquisition of healthcare products or services. These laws affect our sales,
marketing and other promotional activities by limiting the kinds of financial arrangements,
including sales programs, we may have with hospitals, physicians or other potential purchasers or
users of medical devices. In particular, these laws influence, among other things, how we structure
our sales and rental offerings, including discount practices, customer support, education and
training programs and physician consulting and other service arrangements. Although we seek to
structure such arrangements in compliance with applicable requirements, these laws are broadly
written, and it is often difficult to determine precisely how these laws will be applied in
specific circumstances. If one of our sales representatives were to offer an inappropriate
inducement to purchase our 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,
40
or for items or services that were not provided as
claimed. Although we do not submit claims directly to payors, manufacturers can be held liable
under these laws if they are deemed to cause the submission of false or fraudulent claims by
providing inaccurate billing or coding information to customers, or through certain other
activities. In providing billing and coding information to customers, we make every effort to
ensure that the billing and coding information furnished is accurate and that treating physicians
understand that they are responsible for all billing and prescribing decisions, including the
decision as to whether to order dialysis services more frequently than three times per week.
Nevertheless, we cannot provide assurance that the government will regard any billing errors that
may be made as inadvertent or that the government will not examine our role in providing
information to our customers concerning the benefits of daily therapy. Anti-kickback and false
claims laws prescribe civil, criminal and administrative penalties for noncompliance, which can be
substantial. Moreover, an unsuccessful challenge or investigation into our practices could cause
adverse publicity, and be costly to respond to, and thus could harm our business and results of
operations.
Foreign governments tend to impose strict price controls, which may adversely affect our future
profitability.
Although we have not initiated any marketing efforts in jurisdictions outside of the United
States and Canada, we intend in the future to market our products in other markets. 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, our manufacturing 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. Virtually all of our
employees have agreements which impose obligations 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.
41
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,
although we are considering a plan to develop alternative manufacturing capabilities for this
product; 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
our primary supplier of lactate-based dialysate; and Medisystems Corporation is the only supplier
of our disposable cartridge and several cartridge components. 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, at June 30, 2007, held approximately 6.7% of our common
stock. We also obtain certain other components included in the System One from other single source
suppliers or a limited group of suppliers. Our dependence on single source suppliers of components,
subassemblies and finished goods exposes us to several risks, including disruptions in supply,
price increases, late deliveries, and an inability to meet customer demand. This could lead to
customer dissatisfaction, damage to our reputation, or customers switching to competitive products.
Any interruption in supply could be particularly damaging to our customers using the System One to
treat chronic ESRD and who need access to the System One and related disposables.
Finding alternative sources for these components and subassemblies would be difficult in many
cases and may entail a significant amount of time and disruption. In the case of B. Braun, for
bicarbonate, and Membrana, for fiber, we are contractually prevented from obtaining an alternative
source of supply, except in certain limited instances. In the case of Medisystems, we are
contractually prevented from obtaining an alternative source of supply for more than 10% of our
North American requirements, except in certain limited instances. In the case of other suppliers,
we would need to change the components or subassemblies if we sourced them from an alternative
supplier. This, in turn, could require a redesign of our System One and, potentially, further FDA
clearance or approval of any modification, thereby causing further costs and delays.
Certain of our products are recently developed or are transitioning to other locations and we, and
certain of our third party manufacturers, have limited manufacturing experience with these
products.
We continue to develop new products and make improvements to existing products. We are
also expanding our manufacturing capacity which requires us to relocate our manufacturing
operations to other locations. As such, we and certain of our third party manufacturers, have
limited manufacturing experience with certain of our products, including key products such as the
PureFlow SL and related disposables. We are, therefore, more exposed to risks relating to product
quality and reliability until the manufacturing processes for these new products mature.
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 could lead to disruptions in product
supply, which could permanently impair our customer base and reputation.
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:
42
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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 June 30, 2007, we had 48 pending patent applications, including foreign, international
and U.S. applications, and 27 U.S. and international issued patents. We cannot specify which of
these patents individually or as a group will permit us to gain or maintain a competitive
advantage. We cannot provide assurance that any pending or future patent applications we hold will
result in an issued patent or that if patents are issued to us, that such patents will provide
meaningful protection against competitors or against competitive technologies. The issuance of a
patent is not conclusive as to its validity or enforceability. The United States federal courts or
equivalent national courts or patent offices elsewhere may invalidate our patents or find them
unenforceable. Competitors may also be able to design around our patents. Our patents and patent
applications cover particular aspects of our products. Other parties may develop and obtain patent
protection for more effective technologies, designs or methods for treating kidney failure. If
these developments were to occur, it would likely have an adverse effect on our sales.
The laws of foreign countries may not protect our intellectual property rights effectively or
to the same extent as the laws of the United States. If our intellectual property rights are not
adequately protected, we may not be able to commercialize our technologies, products or services
and our competitors could commercialize similar technologies, which could result in a decrease in
our revenues and market share.
Our products could infringe the intellectual property rights of others, which may lead to
litigation that could itself be costly, could result in the payment of substantial damages or
royalties, and/or prevent us from using technology that is essential to our products.
The medical device industry in general has been characterized by extensive litigation and
administrative proceedings regarding patent infringement and intellectual property rights. Products
to provide kidney replacement therapy have been available in the market for more than 30 years and
our competitors hold a significant number of patents relating to kidney replacement devices,
therapies, products and supplies. Although no third party has threatened or alleged that our
products or methods infringe their patents or other intellectual property rights, we cannot provide
assurance that our products or methods do not infringe the patents or other intellectual property
rights of third parties. If our business is successful, the possibility may increase that others
will assert infringement claims against us.
Infringement and other intellectual property claims and proceedings brought against us,
whether successful or not, could result in substantial costs and harm to our reputation. Such
claims and proceedings can also distract and divert management and key personnel from other tasks
important to the success of the business. In addition, intellectual property litigation or claims
could force us to do one or more of the following:
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cease selling or using any of our products that incorporate the asserted
intellectual property, which would adversely affect our revenues; |
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pay substantial damages for past use of the asserted intellectual property; |
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obtain a license from the holder of the asserted intellectual property, which
license may not be available on reasonable terms, if at all and which could reduce
profitability; and |
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redesign or rename, in the case of trademark claims, our products to avoid
infringing the intellectual property rights of third parties, which may not be possible
and could be costly and time-consuming if it is possible to do so. |
43
Confidentiality agreements with employees and others may not adequately prevent disclosure of trade
secrets and other proprietary information.
In order to protect our proprietary technology and processes, we also rely in part on
confidentiality agreements with our corporate partners, employees, consultants, outside scientific
collaborators and sponsored researchers, advisors and others. These agreements may not effectively
prevent disclosure of confidential information and trade secrets and may not provide an adequate
remedy in the event of unauthorized disclosure of confidential information. In addition, others may
independently discover or reverse engineer trade secrets and proprietary information, and in such
cases we could not assert any trade secret rights against such party. Costly and time consuming
litigation could be necessary to enforce and determine the scope of our proprietary rights, and
failure to obtain or maintain trade secret protection could adversely affect our competitive
position.
We may be subject to damages resulting from claims that our employees or we have wrongfully used or
disclosed alleged trade secrets of other companies.
Many of our employees were previously employed at other medical device companies focused on
the development of dialysis products, including our competitors. Although no claims against us are
currently pending, we may be subject to claims that these employees or we have inadvertently or
otherwise used or disclosed trade secrets or other proprietary information of their former
employers. Litigation may be necessary to defend against these claims. If we fail in defending such
claims, in addition to paying monetary damages, we may lose valuable intellectual property rights.
Even if we are successful in defending against these claims, litigation could result in substantial
costs, damage to our reputation and be a distraction to management.
Risks Related to our Common Stock
Our stock price is likely to be volatile, and the market price of our common stock may drop.
The market price of our common stock could be subject to significant fluctuations. Market
prices for securities of early stage companies have historically been particularly volatile. As a
result of this volatility, you may not be able to sell your common stock at or above the price you
paid for the stock. Some of the factors that may cause the market price of our common stock to
fluctuate include:
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timing of market acceptance of our products; |
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timing of achieving profitability and positive cash flow from operations; |
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changes in estimates of our financial results or recommendations by securities
analysts or the failure to meet or exceed securities analysts expectations; |
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actual or anticipated variations in our quarterly operating results; |
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disruptions in product supply for any reason, including product recalls of the
failure of third party suppliers to needed products or components; |
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reports by officials or health or medical authorities, the general media or the
FDA regarding the potential benefits of the System One or of similar dialysis products
distributed by other companies or of daily or home dialysis; |
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announcements by the FDA of non-clearance or non-approval of our products, or
delays in the FDA or other foreign regulatory agency review process; |
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product recalls; |
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regulatory developments in the United States and foreign countries; |
44
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changes in third-party healthcare reimbursements, particularly a decline in the
level of Medicare reimbursement for dialysis treatments; |
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litigation involving our company or our general industry or both; |
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announcements of technical innovations or new products by us or our competitors; |
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developments or disputes concerning our patents or other proprietary rights; |
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our ability to manufacture and supply our products to commercial standards; |
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significant acquisitions, strategic partnerships, joint ventures or capital
commitments by us or our competitors; |
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departures of key personnel; and |
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investors general perception of our company, our products, the economy and
general market conditions. |
The stock markets in general have experienced substantial volatility that has often been
unrelated to the operating performance of individual companies. These broad market fluctuations may
adversely affect the trading price of our common stock.
In the past, following periods of volatility in the market price of a companys securities,
stockholders have often instituted class action securities litigation against those companies. Such
litigation, if instituted, could result in substantial costs and diversion of management attention
and resources, which could significantly harm our profitability and reputation.
Anti-takeover provisions in our restated certificate of incorporation and amended and restated
bylaws and under Delaware law could make an acquisition of us more difficult and may prevent
attempts by our stockholders to replace or remove our current management.
Provisions in our restated certificate of incorporation and our amended and restated bylaws
may delay or prevent an acquisition of us. In addition, these provisions may frustrate or prevent
attempts by our stockholders to replace or remove members of our board of directors. Because our
board of directors is responsible for appointing the members of our management team, these
provisions could in turn affect any attempt by our stockholders to replace current members of our
management team. These provisions include:
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a prohibition on actions by our stockholders by written consent; |
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the ability of our board of directors to issue preferred stock without
stockholder approval, which could be used to institute a poison pill that would work
to dilute the stock ownership of a potential hostile acquirer, effectively preventing
acquisitions that have not been approved by our board of directors; |
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advance notice requirements for nominations of directors or stockholder proposals; and |
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the requirement that board vacancies be filled by a majority of our directors then in office. |
In addition, because we are incorporated in Delaware, we are governed by the provisions of
Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of
15% of our outstanding voting stock from merging or combining with us for a period of three years
after the date of the transaction in which the person acquired in excess of 15% of our outstanding
voting stock, unless the merger or combination is approved in a prescribed manner. These provisions
would apply even if the offer may be considered beneficial by some stockholders.
If there are substantial sales of our common stock in the market by our existing stockholders, our
stock price could decline.
45
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 29,989,461 shares of common stock outstanding
as of June 30, 2007. 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 299,895 shares, or the average weekly trading volume of our common
stock during the four calendar weeks preceding the filing of a notice on Form 144 with respect to
the sale.
At June 29, 2007, subject to certain conditions, holders of an aggregate of approximately
13,511,174 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 June 29, 2007, 3,203,202 shares of common stock are authorized for issuance under our
stock incentive plan, employee stock purchase plan and outstanding stock options. As of June 30,
2007, 3,153,724 shares were subject to outstanding options, of which 1,879,783 were exercisable and
which can be freely sold in the public market upon issuance, subject to the lock-up agreements
referred to above and the restrictions imposed on our affiliates under Rule 144.
Our costs have increased significantly as a result of operating as a public company, and our
management is required to devote substantial time to comply with public company regulations.
As a public company, we incur significant legal, accounting and other expenses that we did not
incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act,
as well as new rules subsequently implemented by the SEC and the NASDAQ Global Market, have imposed
various new requirements on public companies, including changes in corporate governance practices.
Our management and other personnel now need to devote a substantial amount of time to these new
requirements. Moreover, these rules and regulations increase our legal and financial compliance
costs and make some activities more time-consuming and costly.
In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain effective
internal controls for financial reporting and disclosure controls and procedures. In particular,
commencing in fiscal 2006, we must perform system and process evaluation and testing of our
internal controls over financial reporting to allow management and our independent registered
public accounting firm to report on the effectiveness of our internal controls over financial
reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our compliance with Section 404
will require that we incur substantial accounting expense and expend significant management
efforts. If we are not able to comply with the requirements of Section 404 in a timely manner, or
if we or our independent registered public accounting firm identify deficiencies in our internal
controls over financial reporting that are deemed to be material weaknesses, the market price of
our stock could decline and we could be subject to sanctions or investigations by the NASDAQ Global
Market, SEC or other regulatory authorities.
We do not anticipate paying cash dividends, and accordingly stockholders must rely on stock
appreciation for any return on their investment in us.
We anticipate that we will retain our earnings for future growth and therefore do not
anticipate paying cash dividends in the future. As a result, only appreciation of the price of our
common stock will provide a return to investors. Investors seeking cash dividends should not invest
in our common stock.
Our executive officers, directors and current and principal stockholders own a large percentage of
our voting common stock and could limit new stockholders influence on corporate decisions or could
delay or prevent a change in corporate control.
Our directors, executive officers and current holders of more than 5% of our outstanding
common stock, together with their affiliates and related persons, beneficially own, in the
aggregate, approximately 46% of our outstanding common stock. 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
46
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. |
Item 4. Submission of Matters to a Vote of Security Holders
We held our Annual Meeting of Stockholders on May 30, 2007 and our stockholders voted to:
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Elect the individuals named below to hold office until our 2008 Annual Meeting of
Stockholders: |
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Votes |
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Votes |
Nominees |
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For |
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Withheld |
Jeffrey H. Burbank |
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26,294,345 |
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121,944 |
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Philippe O. Chambon |
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26,285,597 |
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130,692 |
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Daniel A. Giannini |
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26,294,605 |
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121,684 |
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Craig W. Moore |
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26,292,005 |
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124,284 |
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Reid S. Perper |
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26,294,605 |
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121,684 |
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Peter P. Phildius |
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26,294,605 |
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121,684 |
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David S. Utterberg |
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25,714,360 |
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701,949 |
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(ii) |
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Ratify the appointment of Ernst & Young LLP as our independent auditors for the
fiscal year ending December 31, 2007, which matter was approved by a vote of 26,375,311
shares voting for, 37,525 shares voting against and 3,453 shares abstaining |
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(iii) |
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Approve the amendment of our 2005 Employee Stock Purchase Plan to increase the
number of shares of common stock which may be issued pursuant to the plan by an
additional 50,000, which matter was approved by a vote of 23,602,366 shares voting for,
130,177 shares voting against and 21,556 shares abstaining. |
Item 6. Exhibits
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Exhibit |
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Number |
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10.1
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Stock Purchase Agreement, dated June 4, 2007, by and between
the Registrant and David S. Utterberg. |
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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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Exhibit |
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Number |
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32.1
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Certification of Chief Executive Officer pursuant to
Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 2002. |
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32.2
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Certification of Chief Financial Officer pursuant to
Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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NXSTAGE MEDICAL, INC.
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By: |
/s/ Robert S. Brown
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Robert S. Brown |
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Chief Financial Officer
(Duly authorized officer and principal
financial and accounting officer)
August 9, 2007 |
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49