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Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

(Mark One)

  þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2014

OR

 

  ¨ 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)

 

Delaware   04-3454702
(State or Other Jurisdiction of Incorporation or
Organization)
  (I.R.S. Employer Identification No.)
350 Merrimack Street, Lawrence, MA   01843
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code:

(978) 687-4700

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.001 par value   Nasdaq Global Select Market

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ      No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨      No  þ

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ      No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ      No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer  þ         Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨      No  þ

The aggregate market value of common stock held by non-affiliates of the registrant was approximately $870 million, as of June 30, 2014, based on the last reported sale price of the registrant’s common stock on the NASDAQ Global Select Market on June 30, 2014.

There were 62,707,290 shares of the registrant’s common stock outstanding as of the close of business on February 17, 2015.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for its 2015 Annual Meeting of Stockholders are incorporated by reference in response to Part III of this report.

 

 

 


Table of Contents

NXSTAGE MEDICAL, INC.

2014 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

              Page  

PART I

     
  Item 1.    Business      5   
  Item 1A.    Risk Factors      33   
  Item 1B.    Unresolved Staff Comments      54   
  Item 2.    Properties      54   
  Item 3.    Legal Proceedings      55   
  Item 4.    Mine Safety Disclosures      55   

PART II

     
  Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      56   
  Item 6.    Selected Financial Data      58   
  Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      59   
  Item 7A.    Quantitative and Qualitative Disclosures about Market Risk      75   
  Item 8.    Financial Statements and Supplementary Data      76   
  Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      107   
  Item 9A.    Controls and Procedures      107   
  Item 9B.    Other Information      110   

PART III

     
  Item 10.    Directors, Executive Officers and Corporate Governance      110   
  Item 11.    Executive Compensation      110   
  Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      110   
  Item 13.    Certain Relationships and Related Transactions, and Director Independence      110   
  Item 14.    Principal Accounting Fees and Services      110   

PART IV

     
  Item 15.    Exhibits, Financial Statement Schedules      111   

SIGNATURES

     112   

Exhibit Index

     113   

 

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CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This report and certain information incorporated by reference herein contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 concerning our business, operations and financial condition, including statements with respect to:

 

   

our market opportunity and the market adoption of our products in the U.S. and internationally;

 

   

the growth of the home and critical care markets;

 

   

access to home and more frequent hemodialysis;

 

   

plans to continue expanding internationally;

 

   

the development and commercialization of new products and improvements to existing products;

 

   

regulatory submissions and approvals;

 

   

sales to our key customers, including DaVita HealthCare Partners Inc. and Fresenius Medical Care;

 

   

the adequacy of our funding;

 

   

expectations with respect to future demand for our products and revenue growth and the components of such revenue growth;

 

   

the timing, scope and success of our initiatives to improve our gross profit as a percentage of revenues;

 

   

improvements in certain segment cash flows and profitability and other operational and financial metrics;

 

   

our manufacturing operations and supply chain;

 

   

availability of suitable facilities;

 

   

our plans to open and operate NxStage Kidney Care dialysis centers;

 

   

planned investments in marketing and research and development;

 

   

expectations with respect to our expenses and working capital levels and requirements;

 

   

changes in deferred revenue;

 

   

changes with respect to our expenses as a percentage of revenues;

 

   

achieving our business plan;

 

   

global economic conditions;

 

   

product recalls;

 

   

expectations with respect to achieving positive operating margins, positive cash flows and profitable operations;

 

   

volatility of our stock price;

 

   

retention of earnings;

 

   

product cost reduction plans;

 

   

expectations with respect to product reliability;

 

   

manufacturing dialyzers for sale to Asahi Kasei Kuraray Medical Co.;

 

   

our ability to withstand supply chain disruptions;

 

   

the scope of patent protection with respect to our products;

 

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the availability of, and changes in, reimbursement for home and more frequent hemodialysis, including home nocturnal hemodialysis; and

 

   

the financial, commercial and operational impact of any of the above.

All statements other than statements of historical facts included in this Annual Report regarding our strategies, prospects, financial condition, costs, plans and objectives are forward-looking statements. When used in this report, the words “expect”, “anticipate”, “intend”, “plan”, “believe”, “seek”, “estimate”, “potential”, “continue”, “predict”, “may”, “will” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Because these forward-looking statements involve risks and uncertainties, actual results could differ materially from those expressed or implied by these forward-looking statements.

Readers should carefully review the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in this report, as these sections describe important factors that could cause actual results to differ materially from those indicated by our forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statement.

NOTE REGARDING TRADEMARKS

NxStage®, Streamline®, ButtonHole®, MasterGuard® and Fingershield® are registered trademarks of NxStage Medical, Inc. PureFlow SLTM and System OneTM are trademarks of NxStage Medical, Inc.

 

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Table of Contents

PART I

For convenience, in this Annual Report, “NxStage,” “we,” “us,” and “the Company” refer to NxStage Medical, Inc. and our consolidated subsidiaries, taken as a whole.

 

Item 1. Business

Overview

We are a medical device company that develops, manufactures and markets innovative products for the treatment of kidney failure, fluid overload and related blood treatments and procedures. Our primary product, the System One, was designed to satisfy an unmet clinical need for a system that can deliver the therapeutic flexibility and clinical benefits associated with traditional dialysis machines in a smaller, portable, easy-to-use form that can be used by healthcare professionals and trained lay users alike in a variety of settings, including patient homes, as well as more traditional care settings such as hospitals and dialysis centers. Given its design, the System One is particularly well-suited for home hemodialysis and a range of dialysis therapies including more frequent dialysis and nocturnal dialysis, which clinical literature suggests provides patients better clinical outcomes and improved quality of life. The System One is cleared or approved for commercial sale in the U.S., Canada and certain other markets, and is CE marked in the EU, for the treatment of acute and chronic kidney failure and fluid overload. The System One is cleared specifically by the U.S. Food and Drug Administration (FDA) for home hemodialysis and home nocturnal hemodialysis, as well as therapeutic plasma exchange in a clinical environment. The System One is also CE marked in the EU for home nocturnal hemodialysis. In February 2013, we received CE Mark approval and in April 2013 we received clearance from the FDA for the new high flow capabilities with the System One. We began selling the System One with this feature to both U.S. customers and international distributors in 2014. We also sell, through our Medisystems subsidiary, blood tubing sets and needles primarily to dialysis centers for the treatment of end-stage renal disease (ESRD). These products are cleared or approved for commercial sale in the U.S., Canada and certain other markets and are CE marked in the EU. We believe our largest market opportunity is for the System One used in the home dialysis market for the treatment of ESRD. We operate a small number of NxStage Kidney Care dialysis centers focused on supporting home therapy and providing flexible in-center options with NxStage technology as part of our market development activities to increase home therapy access. We continue to make significant investments in marketing, research and development, and these dialysis centers, all of which are intended to help us to further penetrate and expand the market for our products.

ESRD, which affects over 630,000 people in the U.S. and 2 million people worldwide, is an irreversible, life-threatening loss of kidney function that is treated predominantly with dialysis. Dialysis is a kidney replacement therapy that removes toxins and excess fluids from the bloodstream and, unless the patient receives a kidney transplant, is required for the remainder of the patient’s life. Approximately 70% of ESRD patients in the U.S. rely on life-sustaining dialysis treatment. Hemodialysis, the most widely prescribed type of dialysis, typically consists of treatments in a dialysis clinic three times per week, with each session lasting three to five hours. Approximately 11% of U.S. ESRD dialysis patients receive dialysis treatment at home, mostly through self-treatment with peritoneal dialysis, although surveys of physicians and healthcare professionals suggest that a larger proportion of patients could take responsibility for their own care. We believe that approximately 10-15% of the over 440,000 U.S. ESRD patients currently receiving dialysis treatment would be appropriate candidates for home hemodialysis with the NxStage System One. Clinical data also suggests that hemodialysis therapy administered five or six times per week, commonly referred to as more frequent therapy, including more frequent nocturnal therapy, better mimics the natural functioning of the human kidney and can lead to improved clinical outcomes, including lower mortality, significant improvements in left ventricular mass, reductions in antihypertensive medications, reduced fluid overload, reduced depression and improvements in health-related quality of life. We believe there is an unmet need for a hemodialysis system that allows more frequent, nocturnal and easily administered therapy at home, as well as in other settings, and we have designed our system to address this and other kidney replacement markets. Given the clinical and quality of life benefits associated with more frequent hemodialysis therapy, nearly all of our System One patients in the home market receive treatment five or six times a week.

 

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Measuring a little over a foot tall, the System One is the smallest and only portable commercially available hemodialysis system. It consists of a compact, portable and easy-to-use cycler, disposable drop-in cartridge and high purity premixed fluid. The System One has a self-contained design and simple user interface making it easy to operate by a trained patient and trained care partner in any setting prescribed by the patient’s physician, including while the patient is sleeping. Unlike traditional dialysis systems, our System One does not require any special disinfection and its operation does not require specialized electrical or plumbing infrastructure or modifications to the home. Patients can bring the System One home, plug it into a conventional electrical outlet and operate it, thereby eliminating what can be expensive plumbing and electrical household modifications required by other traditional dialysis systems. Because of its portability, patients also have the freedom to travel with the System One. We market the System One to dialysis clinics for chronic home hemodialysis treatment. The clinics in turn provide the System One to ESRD patients.

We also market the System One to hospitals for treatment of acute kidney failure and fluid overload. It is estimated that there are over 200,000 cases of acute kidney failure in the U.S. each year. The clinical flexibility of our System One, coupled with its ease-of-use and portability, make our system well suited for hospital critical care environments.

In addition to the System One, we sell a line of extracorporeal disposable products that are primarily used for in-center dialysis treatments for patients with ESRD. These products include hemodialysis blood tubing sets, arteriovenous (AV) fistula needles and apheresis needles. Our main blood tubing set product line is Streamline which is designed to provide certain clinical and operational benefits. Our needle products line includes AV fistula needles, which incorporate safety features including MasterGuard technology, and ButtonHole needles.

For the year ended December 31, 2014, our revenues were $301.5 million and we incurred a net loss of $24.3 million. As of December 31, 2014, we had cash and cash equivalents of $52.9 million, total assets of $309.7 million and total stockholders’ equity of $191.6 million. We have operated at a loss since our inception in 1998. At December 31, 2014, we had an accumulated deficit of approximately $387.5 million.

We have continued to make improvements in our gross margins for our products; however, we cannot provide assurance that our gross margins will continue to improve or, if they do improve, the rate at which they will improve. Continued improvements in gross margins for our System One and In-Center segments are dependent on many factors, including growing revenues, reducing costs of revenues by lowering manufacturing costs, implementing design and process improvements, obtaining better purchasing terms and prices, and increasing reliability of our products. Additionally, we expect our operating expenses to continue to increase as we continue to invest in selling and marketing, research and development and NxStage Kidney Care, our Services segment. We expect that the combined profitability of the System One and In-Center segments will improve as we continue to leverage our existing operating infrastructure; however, our continued investment in NxStage Kidney Care will offset these improvements and negatively impact our near-term profitability.

We expect to make continued improvements in the combined cash flows associated with our System One and In-Center segments. In addition, we have spent and expect to continue to spend cash to establish NxStage Kidney Care dialysis centers. We believe, based on current projections and the current nature of our business, that we have the required resources to fund our ongoing operating requirements, which include selling and marketing activities to increase public awareness in the System One, our research and development activities to develop new products and enhance our existing products, and our planned investments in NxStage Kidney Care. If we determine that additional investments in these or any other initiatives would be beneficial, we may choose to access the credit or capital markets to provide additional liquidity.

We were incorporated in Delaware in 1998 under the name QB Medical, Inc., and later changed our name to NxStage Medical, Inc. Our principal executive offices are located at 350 Merrimack Street, Lawrence, Massachusetts 01843.

 

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Additional financial information regarding our business segments and geographic data about our assets is contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7, and in our Notes to Consolidated Financial Statements included in Item 8, of this Annual Report.

Our Products

The System One

Our primary product, the System One, is a small, portable, easy-to-use hemodialysis system. Sales of the System One and related products accounted for approximately 71%, 67% and 67% of our total sales for the years ended December 31, 2014, 2013 and 2012, respectively.

The System One uses the following components:

 

   

The NxStage Cycler.    A compact portable electromechanical device containing pumps, control mechanisms, safety sensors and remote data capture functionality.

 

   

The NxStage Cartridge.    A single-use, disposable, integrated treatment cartridge that loads simply and easily into the cycler. The cartridge incorporates a proprietary volumetric fluid management system and includes a pre-attached dialyzer.

 

   

Premixed Dialysate.    The System One uses high-purity premixed dialysate for hemodialysis applications. The volume of fluids used varies with treatment options, prescription, and setting. We supply our premixed dialysate in sterile five liter bags or through the use of our PureFlow SL accessory. The PureFlow SL module prepares dialysate fluid in the patient’s home using ordinary tap water and dialysate concentrate thereby reducing the need for bagged fluids for in-home treatments.

Streamline Blood Tubing Sets

Streamline blood tubing sets feature an efficient and airless design intended to enable providers to reduce treatment time and optimize dose delivery. Streamline also includes our patented LockSite needleless access sites, eliminating the need for sharp needles or costlier guarded needles to be used with the tubing set in connection with dialysis therapy. LockSite is intended to facilitate healthcare facility compliance with Occupational Safety and Health Administration bloodborne pathogens requirements to implement use of medical devices with engineered sharps-injury protection and needleless systems. Sales of our Streamline product accounted for approximately 17%, 20% and 19% of our total sales for the years ended December 31, 2014, 2013 and 2012, respectively.

AV Fistula and Apheresis Needles

Our AV fistula and apheresis needles have been designed to achieve a smooth blood flow throughout the treatment, intended to result in less clotting, lower pressure drops, and less stress on the patient’s blood. A significant amount of our needles sold are branded MasterGuard, and include our Fingershield anchor designed to protect the operator from inadvertent needle stick injury. We also offer ButtonHole needles for hemodialysis therapies as an alternative to our AV fistula needles with MasterGuard. ButtonHole needles are used by patients that employ “the constant-site technique”, whereby a fistula needle is inserted in the same place each treatment. Published clinical experience suggests that the incidence of pain, hematoma, and infiltrations at the needle insertion site can be reduced by utilizing the constant-site technique. Our ButtonHole AV fistula needle has an anti-stick, dull bevel design well-suited for the constant-site technique, while also being designed to reduce the risk of accidental needle sticks. Sales of needles accounted for approximately 8%, 10% and 11% of our total sales for the years ended December 31, 2014, 2013 and 2012, respectively.

Our Business by Segment

We have three reportable business segments: System One, In-Center and Services. We distribute our products in three markets: home, critical care and in-center.

 

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Our System One segment includes revenues from the sale and rental of the System One and PureFlow SL dialysate preparation equipment and the sale of disposable products in the home and critical care markets. The home market is devoted to the treatment of ESRD patients in the home or a home-like setting, while the critical care market is devoted to the treatment of hospital-based patients with acute kidney failure or fluid overload. Some of our largest customers in the home market provide outsourced renal dialysis services to some of our customers in the critical care market. Sales of product to both markets are made primarily through dedicated sales forces and distributed directly to the customer, or the patient, with certain products sold through distributors. The results of our international business are included in the System One segment.

Our In-Center segment includes revenues from the sale of blood tubing sets and needles for hemodialysis primarily for the treatment of ESRD patients at dialysis centers and needles for apheresis. Nearly all In-Center products are sold through national distributors.

Our Services segment includes revenues from dialysis services provided to patients at our recently opened NxStage Kidney Care dialysis centers.

The remainder of our operations and financial information, included within the Other category, relates to the manufacturing of dialyzers for sale to Asahi Kasei Kuraray Medical Co. (Asahi) and research and development and general and administrative expenses that are excluded from the segment operating performance measures.

System One

We began marketing the System One to perform hemodialysis for ESRD patients in September 2004, and we began marketing our System One specifically for home use in July 2005, after the System One was cleared by the FDA for home hemodialysis. We market the System One to independent dialysis clinics as well as dialysis clinics that are part of national or regional chains, providing clinics with improved access to the developing home dialysis market. As Medicare regulations require that all chronic ESRD patients be under the care of a dialysis clinic, whether they are treated at home or in clinic, we do not sell the System One directly to patients. In February 2013, we received CE Mark approval and in April 2013 we received clearance from the FDA for the new high flow capabilities with the NxStage System One. We began selling the System One with this feature to both U.S. customers and international distributors in 2014.

For each month that a patient is treated with the System One, we bill the clinic for the purchase of the related disposable cartridges and treatment fluids necessary to perform treatment. A significant majority of System One equipment in the home market is purchased, rather than rented, by our customers including our two largest customers in the home market, DaVita HealthCare Partners (DaVita) and Fresenius Medical Care (Fresenius). Purchased equipment pricing includes service for an initial contractual period after which the customer pays a standard service fee for continued access to the service depot and the replacement service swap pool of equipment. After selling or renting a System One to a clinic, our clinical educators train the clinic’s nurses and dialysis technicians on the proper use of the System One using our proprietary training materials. We then rely on our customers’ trained technicians and nurses to train home patients, their care partners and other technicians and nurses using the System One. We are not responsible for and do not provide patient training except for NxStage Kidney Care patients.

Patient training takes place at the clinic primarily during the patient’s prescribed treatment sessions. Training typically takes three to four weeks and includes basic instruction on ESRD, the operation of the System One and the insertion by the patient or their care partner of needles into the patient’s vascular access site. Training sessions are reimbursed at a fixed rate by Medicare and private insurance.

The System One cycler sold to hospitals in the critical care market is based on the same technology platform used in the home market but has additional features that offer a wider range of therapies, including therapeutic plasma exchange, and includes an additional display module, called OneView, which is designed to facilitate easier medical record charting and troubleshooting. We also sell related disposable cartridges and treatment fluids necessary to perform dialysis treatment in the critical care market. Most of our customers in the critical

 

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care market use our System One to perform prolonged or continuous renal replacement therapy for their acute kidney failure or fluid overload patients. We are specifically focusing our sales efforts in the critical care market on those large institutions that we believe are most dedicated to prolonged or continuous renal replacement therapy for patients with acute kidney failure and believe in ultrafiltration as an earlier-stage treatment option for fluid overload.

After selling or renting a System One to a hospital, our clinical educators generally train the hospital’s intensive care unit and acute dialysis nurses on the proper use of the System One using our proprietary training materials. We then rely on the trained nurses to train other nurses. By adopting this “train the trainer” approach, our sales nurses do not need to return to the hospital each time a new nurse requires training. We also sell one- and two-year service contracts following the expiration of our standard one-year warranty period for System One hardware. We sell a bio-medical training program, whereby we train bio-medical engineers on how to service and repair certain aspects of the System One in the critical care setting.

Our customers in the System One segment are highly consolidated. DaVita and Fresenius own and operate the two largest chains of dialysis clinics in the U.S. and collectively provide treatment to more than two-thirds of U.S. dialysis patients. DaVita and Fresenius are our two largest customers in the System One segment.

During 2014, 2013 and 2012, direct sales to DaVita represented 30%, 32% and 31% of our System One segment revenues, respectively, and direct sales to Fresenius represented 22%, 20% and 17% of our System One segment revenues, respectively. Furthermore, DaVita and Fresenius are our largest customers in the home market, with approximately 40% and 30%, respectively, of our home hemodialysis patients. Increased sales to DaVita and Fresenius have driven a large portion of our historical revenue growth and will be important to future growth. If the purchasing patterns of either of these customers adversely change, including in response to our initiative to establish NxStage Kidney Care dialysis centers, our business could be negatively affected.

Our agreement with DaVita for the U.S. home hemodialysis market extends through December 31, 2015, and thereafter automatically extends on a monthly basis unless terminated by us or DaVita. Our agreement with Fresenius for the U.S. home hemodialysis market extends through December 31, 2016, with monthly renewals thereafter unless terminated by us or Fresenius.

In-Center

We sell primarily blood tubing sets and needles to customers in the in-center market. In this market, our customers are independent dialysis clinics as well as dialysis clinics that are part of national or regional chains. Although in many instances we have direct contractual relationships with our customers, nearly all of our sales in this market are made through national distributors in order to leverage national networks, shipping efficiencies and existing customer relationships. We plan our manufacturing and distribution activities based on distributor purchase orders. Finished goods are shipped directly to distributor warehouses. We support distributor selling and marketing efforts with brand marketing support and a team of clinical educators who assist with clinical in-service activities.

Our In-Center segment revenues are highly concentrated in several significant purchasers. Our two largest distributors are Gambro AB and Henry Schein, Inc. Revenues from Gambro represented 36%, 37% and 36% of our In-Center segment revenues during 2014, 2013 and 2012, respectively. Revenues from Henry Schein represented 30%, 32% and 34% of our In-Center segment revenues during 2014, 2013 and 2012, respectively. Our distribution agreement with Gambro extends through December 31, 2015, with annual renewals thereafter unless terminated by us or Gambro. Our distribution agreement with Henry Schein expires on April 25, 2015, and we are negotiating the terms of a new distribution agreement with Henry Schein.

DaVita has been a significant customer in the In-Center segment. Sales of our products through distributors to DaVita accounted for approximately half of In-Center segment revenues during 2014, 2013 and 2012. In-Center segment sales are expected to decrease as a result of DaVita’s needle purchase agreement expiring in

 

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December 2014. DaVita continues to have purchase commitments for our blood tubing sets pursuant to an agreement with Gambro. Currently, DaVita’s product supply agreement with Gambro requires DaVita to purchase a significant majority of its blood tubing set requirements from Gambro, and our distribution agreement with Gambro requires Gambro to exclusively supply our blood tubing sets to DaVita.

Services

We operate a small number of NxStage Kidney Care dialysis centers focused on supporting home therapy and providing flexible in-center options with NxStage technology as part of our market development activities to increase home therapy access.

International

We sell the System One and certain other products internationally, through a combination of direct sales to hospitals and dialysis centers and sales through distributors. Products sold to distributors are shipped directly to distributor warehouses and the distributors sell or rent our products to dialysis providers or hospitals and are responsible for marketing, clinic training and equipment servicing and repair. To date, our international sales have been limited, and we are still very early in our international commercialization efforts.

Marketing, Customer Support

We have a sales force that calls on dialysis clinics, nephrologists and hospitals. In addition to specialized sales representatives, we also employ nurses in our sales force as clinical educators to support our sales efforts. We have a staff of customer support specialists to assist patients, clinics and hospitals with product orders and deliveries. We also provide technical support 24 hours a day, seven days a week through a dedicated staff of technical support representatives, to respond to questions raised by patients, clinics and hospitals concerning the System One. Our marketing activities also include utilizing direct mail and internet campaigns to provide product literature and clinically relevant information, advertising in trade publications, sponsoring educational programs for dialysis patients and clinicians, and participating in nephrology conferences. Our direct sales efforts focus almost exclusively on the home and critical care markets as we rely heavily on distributors to sell our products in the in-center market.

In the home market we use a depot service model for equipment servicing and repair while we generally service equipment sold to customers in the critical care market in the field. For our home market customers, if a device requires repair, we arrange for a replacement device to be shipped to the site of care, whether it is a patient’s home or a clinic, and for pick up and return to us of the system requiring service. This shipment is done by common carrier, and, as there are no special installation requirements, the patient or clinic can quickly and easily set up the new machine. The nature of the hospital critical care settings, coupled with the practices of other intensive care unit dialysis equipment suppliers, necessitates an option for on-site support for our systems installed in this environment, or for the use of a trained bio-medical engineer.

Competition

The dialysis therapy market is mature, consolidated and competitive. Our business faces a high degree of competition from larger, more established companies with greater financial and human resources.

Products

Our System One in the critical care market competes against products from Gambro, a subsidiary of Baxter International, Inc., Fresenius, B. Braun Medical, Inc. and others. Our product lines in the in-center market compete directly against products produced by Fresenius, Nipro Medical Corporation, B. Braun, Baxter together with its subsidiary Gambro, JMS Co. Ltd. and others. Our competitors in each of these markets sell one or more FDA-cleared medical devices for the treatment of acute or chronic kidney failure. Each of these competitors offer

 

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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, including Fresenius which operates a chain of dialysis centers. The product lines of most of these companies are broader than ours, enabling them to offer a broader bundle of products, and have established sales forces and distribution channels that may afford them a significant competitive advantage.

We believe the competition in the market for kidney dialysis equipment and supplies is based primarily on:

 

   

product quality;

 

   

ease-of-use;

 

   

cost effectiveness;

 

   

sales force coverage; and

 

   

clinical flexibility and performance.

Our System One is currently the only portable system specifically indicated for home hemodialysis and home nocturnal hemodialysis in the U.S. Presently, no other product has an indication for home nocturnal hemodialysis in the U.S. There is a non-portable product on the market with a home clearance in the U.S., and a number of other products that are under development and may be released in the next several years, that are, or will be, competitive to our System One in the home market.

In 2011, Fresenius, our second largest customer in the System One segment, with nearly all of those sales in the home market, obtained clearance for its 2008K@home hemodialysis system for use in home chronic therapy. Fresenius has indicated that it is seeking clearance for its sorbent technology within the critical care setting. Fresenius has also suggested that it would seek clearance for its Portable Artificial Kidney to market in the U.S. for in-center use.

Baxter obtained CE marking for a new home hemodialysis system in the EU in December 2013 and has discussed its plans for a near-term European launch. Baxter has also discussed plans to complete additional clinical studies and file for regulatory approval for a home nocturnal hemodialysis indication in the U.S.

Other small companies are also working to develop products for this market. We are unable to predict when, if ever, any of these products may attain regulatory clearance and appear in the market, or how successful they may be should they be introduced, but the introduction of additional viable products to the home market could adversely affect our sales and growth.

For the critical care market, we believe we compete favorably in terms of product quality and ease of use due to our System One design, portability, drop-in cartridge and use of premixed fluids. We believe we also compete favorably on the basis of clinical flexibility, given the System One’s ability to perform hemofiltration, hemodialysis and ultrafiltration. We believe we compete favorably in terms of cost-effectiveness for hospitals that perform continuous renal replacement therapies. In the fluid overload market, which is a very small component of our critical care market, drug therapy is currently the most common and preferred treatment. To date, ultrafiltration has not been broadly adopted and, if the medical community does not accept ultrafiltration as clinically useful, cost-effective and safe, we will not be able to successfully compete against existing pharmaceutical therapies and other device-based technologies in the treatment of fluid overload.

For the in-center market, where we sell blood tubing sets and needles, we believe that we compete favorably in terms of product quality, ease-of-use, cost effectiveness, clinical flexibility and performance. We also compete favorably in terms of branding, as our subsidiary Medisystems has been selling products to dialysis centers for the treatment of ESRD since 1981. We compete unfavorably in terms of sales force coverage, as we rely nearly exclusively on distributors rather than our own direct sales force.

 

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Our primary competitors are large, well-established businesses with significantly more financial and human resources and greater commercial infrastructures than ours. We believe our ability to compete successfully will depend largely on our ability to:

 

   

continuously improve our products and develop and obtain clearance for new products;

 

   

establish the infrastructures necessary to support a growing home, critical care and in-center dialysis products business;

 

   

maintain and improve product quality;

 

   

continue to develop sales and marketing capabilities; and

 

   

achieve cost reductions.

Our ability to successfully market our products for the treatment of kidney failure could also be adversely affected by pharmacological and technological advances in preventing the progression of chronic ESRD and/or in the treatment of acute kidney failure, technological developments by others in the area of dialysis, the development of new medications designed to reduce the incidence of kidney transplant rejection and progress in using kidneys harvested from genetically-engineered animals as a source of transplants. These pharmacological or technological advancements and competitive pressures in general may adversely affect our business.

Services

The U.S. dialysis services industry is highly competitive, with providers of varying sizes vying for patients, medical directors and employees. We believe the ability of our NxStage Kidney Care dialysis centers to be successful and attract patients in local markets will depend on our ability to effectively educate the local patient and physician community on the benefits of the therapies offered at these dialysis centers while continuing to deliver a high level of quality care at cost-effective rates.

Clinical Experience and Results

Significant clinical literature strongly supports that daily or more frequent hemodialysis therapy can lead to improved clinical outcomes, including lower mortality, reduced cardiovascular hospitalizations, reduction in left ventricular mass, reduction in hypertension and use of antihypertensive medications, improved nutritional status, and overall improvement in quality of life, including improvements related to overall physical and mental health, depressive symptoms, sleep, restless legs syndrome and post-dialysis recovery time.

In early 2006, we enrolled the first patient in our post-market FREEDOM (Following Rehabilitation, Economics, and Everyday Dialysis Outcome Measurements) study, which is designed to quantify the clinical and economic benefits of daily home therapy administered to Medicare patients with the System One versus conventional thrice-weekly dialysis. The FREEDOM study is a prospective, multi-center, observational study of 501 Medicare patients in over 41 clinical centers. The study compares Medicare patients using the System One with a matched cohort of patients from the U.S. Renal Data System, or USRDS, a database of patients treated with traditional in-center thrice weekly dialysis, to help define differences in the cost of care and patient outcomes between the daily home setting and the dialysis clinic setting. Comparing the study group of patients using the System One to a USRDS database group matched in terms of demographics, co-morbidities, geography, number of years on dialysis and other key factors should allow a valuable comparison to be made without the time and cost challenges of a crossover study, in which patients would be followed for a given time on each type of therapy.

Interim four and twelve month results from our ongoing FREEDOM study show daily home hemodialysis treatment made possible by the System One therapy significantly improves select measures of patient quality-of-life as compared to conventional, thrice-weekly in-center treatment. Specific improvements identified to date include a reduction in post-dialysis recovery time (the average time to resume normal activity), returning significant quality time to patients each week. Other benefits include a reduction in depressive symptoms,

 

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improvements in select physical and mental health quality of life factors, a reduction in antihypertensive medications, improvements in sleep and restless legs syndrome and improvements in overall quality of life and physical intimacy. These results have been published in major peer review journals including the Journal of the American Society of Nephrology, the American Journal of Kidney Disease, and Kidney International.

In a NxStage-funded study of Medicare patients starting NxStage home hemodialysis therapy from 2005-2007 compared to traditional in-center dialysis patients during the same period, risk of death was found to be significantly lower, and three-year survival significantly higher, in the NxStage population versus the matched in-center hemodialysis cohort. This study was published in the Journal of the American Society of Nephrology in early 2012.

In another NxStage-funded study of Medicare patients starting NxStage home hemodialysis therapy from 2007 to mid-2010 compared to peritoneal dialysis patients during the same period, risks of death, hospitalization, and therapy attrition were found to be significantly lower in the NxStage population versus the matched peritoneal dialysis cohort. This was the first matched cohort study of its kind comparing home dialysis modalities.

The Frequent Hemodialysis Network (FHN) Trial Group (2010) conducted a randomized clinical trial to determine whether increasing hemodialysis frequency would result in beneficial changes in left ventricular mass, self-reported physical health, and other intermediate outcomes among patients undergoing maintenance hemodialysis. Patients were randomly assigned to undergo hemodialysis six times per week (frequent hemodialysis, 125 patients) or three times per week (conventional hemodialysis, 120 patients) for 12 months. The investigators concluded that frequent hemodialysis, as compared with conventional hemodialysis, was associated with favorable results with respect to the composite outcomes of death or change in left ventricular mass and death or change in a physical-health composite score, but prompted more frequent interventions related to vascular access.

During 2014, we completed an approved Investigational Device Exemption, or IDE, clinical study intended to support a home nocturnal indication for the System One, and in December 2014, the FDA cleared the System One to perform home nocturnal hemodialysis. Presently, no other product is cleared to perform home nocturnal hemodialysis in the U.S.

In addition to the FREEDOM and nocturnal studies, we have completed two significant clinical trials with the System One for ESRD therapy: a post-market study of chronic daily hemofiltration and a study under an FDA-approved IDE. We have also completed a study of ultrafiltration with the System One for fluid overload associated with congestive heart failure.

In the IDE study, we compared center-based and home-based daily dialysis with the System One. That study was a prospective, multi-center, two-treatment, two-period, open-label, cross-over study. The first phase of the study consisted of 48 treatments, six per week, in an eight-week period performed in-center, while the second phase consisted of the same number of treatments performed in an in-home setting. Between the two phases, there was a two-week transition period conducted primarily in the patient’s home. Prior to study initiation, enrolled patients were to have been on at least two weeks of daily hemodialysis with the System One in an in-center environment. The objective of the study was to evaluate equivalence on a per-treatment basis between the delivery of hemodialysis with our system in-center and at home. The result of the investigation showed that the safety and effectiveness of hemodialysis with our system was equivalent in each setting.

Research and Development

Our research and development organization has focused on developing innovative technical approaches that address the limitations of current dialysis systems and disposable products. Our development team has skills across the range of technologies required to develop and maintain dialysis systems and products. These areas include filters, tubing sets, mechanical systems, fluids, software and electronics. In response to physician and

 

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patient feedback and our own assessments, we are continually working on enhancements to our product designs to improve ease-of-use, functionality, reliability and safety and to reduce product cost. In addition, we are engaged in development activities focused around our next generation systems, including a system for peritoneal dialysis. We also seek to develop new products that supplement our existing product offerings and intend to continue to actively pursue research and development opportunities for complementary products.

In June 2013, we entered into a research and development program sponsored by the Defense Advanced Research Projects Agency (DARPA) to develop an innovative new device to treat sepsis. This program aligns well with our technology and supports our next generation product development.

For the years ended December 31, 2014, 2013 and 2012, we incurred research and development expenses of $22.6 million, $18.9 million and $17.1 million, respectively.

Intellectual Property

We seek to protect our investment in the research, development, manufacturing and marketing of our products through the use of patent, trademark, copyright and trade secret law. We own rights to a number of patents, trademarks, copyrights, trade secrets and other intellectual property directly related and important to our business both in the U.S. and abroad. We also have domestic and foreign pending patent applications.

Patents for individual products extend for varying periods of time according to the date a patent application is filed or a patent is granted and the term of the patent protection available in the jurisdiction granting the patent. The scope of protection provided by a patent can vary significantly from country to country.

The following table lists all of our issued U.S. and international patents as of December 31, 2014.

 

Patent No.

   Regime   

Title

  

  Expiration Date

 

5643190

   US    Flow-Through Treatment Device      1/17/2015   

5704924

   US    Easy Use Needle Protector Sheath      1/11/2016   

5772624

   US    Reusable Blood Lines      7/20/2015   

5772638

   US    Protector For Needle      9/17/2016   

5817043

   US    Flow-Through Treatment Device      1/17/2015   

5895368

   US    Blood Set Priming Method And Apparatus      9/23/2016   

5951870

   US    Automatic Priming Of Blood Sets      10/21/2017   

5980741

   US    Bubble Trap With Flat Side Having Multipurpose Supplemental Ports      8/1/2017   

5983947

   US    Docking Ports For Medical Fluid Sets      3/3/2017   

6042570

   US    Needle Point Protection Sheath      2/11/2019   

6051134

   US    Bubble Trap Having Common Inlet/Outlet Tube      3/28/2017   

6089527

   US    Squeeze Clamp For Flexible Tubing      10/3/2017   

6113062

   US    Squeeze Clamp      1/28/2019   

6117342

   US    Bubble Trap With Directed Horizontal Flow And Method Of Using      11/26/2016   

6165149

   US    Reusable Blood Lines      7/20/2015   

6177049

   US    Reversing Flow Blood Processing System      6/10/2018   

6187198

   US    Automatic Priming Of Blood Sets      10/21/2017   

6193694

   US    Needle Point Protection Sheath      2/11/2019   

6196519

   US    Squeeze Clamp For Flexible Tubing      10/3/2017   

6206954

   US    Blood Set And Chamber      5/13/2018   

6299589

   US    Flow-Through Treatment Method      1/17/2015   

6440095

   US    Pump Segment Having Connected, Parallel Branch Line      12/31/2015   

6290665

   US    Blood Set Priming Method And Apparatus      9/23/2016   

 

14


Table of Contents

Patent No.

   Regime   

Title

  

  Expiration Date

 

6319465

   US    Reversing Flow Blood Processing System Having Reduced Clotting Potential      6/3/2019   

6344139

   US    Arterial and Venous Blood Tubing Set      10/21/2017   

6387069

   US    Blood Set Priming Method And Apparatus      9/23/2016   

6464878

   US    Automatic Priming Of Blood Sets      10/21/2017   

6517508

   US    Set For Blood Processing      11/3/2019   

6517522

   US    Tubular Intravenous Set      4/3/2020   

6554789

   US    Layered Fluid Circuit Assemblies And Methods For Making Them      2/14/2017   

6572576

   US    Method And Apparatus For Leak Detection In A Fluid Line      7/7/2021   

6579253

   US    Fluid Processing Systems And Methods Using Extracorporeal Fluid Flow Panels Oriented Within A Cartridge      2/14/2017   

6582385

   US    Hemofiltration System Including Ultrafiltrate Purification And Re-Infusion System      2/19/2018   

6589482

   US    Extracorporeal Circuits For Performing Hemofiltration Employing Pressure Sensing Without An Air Interface      2/14/2017   

6595943

   US    Systems And Methods For Controlling Blood Flow And Waste Fluid Removal During Hemofiltration      2/14/2017   

6595965

   US    Needle Protector Sheath      7/15/2017   

6596234

   US    Reversing Flow Blood Processing System      3/14/2019   

6616635

   US    Tubular Intravenous Set      4/3/2020   

6620119

   US    Reusable Blood Lines      11/12/2015   

6638478

   US    Synchronized Volumetric Fluid Balancing Systems And Methods      2/14/2017   

6649063

   US    Devices for Sterile-Filtering Fluid and Methods of Use      10/7/2021   

6666839

   US    Reusable Blood Lines      7/20/2015   

6673314

   US    Interactive Systems And Methods For Supporting Hemofiltration Therapies      2/14/2017   

6685680

   US    Tapered Intravenous Cannula      4/20/2019   

6695807

   US    Blood Flow Reversing System      1/18/2022   

6743193

   US    Hermetic Flow Selector Valve      7/17/2021   

6755801

   US    Dialysis Pressure Monitoring With Clot Suppression      11/8/2019   

6830553

   US    Blood Treatment Systems And Methods That Maintain Sterile Extracorporeal Processing Conditions      2/14/2017   

6852090

   US    Fluid Processing Systems And Methods Using Extracorporeal Fluid Flow Panels Oriented Within A Cartridge      12/10/2017   

6955655

   US    Hemofiltration System      10/7/2017   

6979309

   US    Systems And Methods For Performing Blood Processing And/Or Fluid Exchange Procedures      6/19/2017   

7004924

   US    Methods, Systems, And Kits For The Extracorporeal Processing Of Blood      10/19/2018   

7025744

   US    Injection Site For Male Luer Or Other Tubular Connector      8/12/2023   

7025750

   US    Set For Blood Processing      11/3/2019   

7040142

   US    Method And Apparatus For Leak Detection In Blood Circuits Combining External Fluid Detection And Air Infiltration Detection      2/9/2022   

7056308

   US    Medical Device With Elastomeric Penetrable Wall And Inner Seal      11/1/2022   

7087033

   US    Method And Apparatus For Leak Detection In A Fluid Line      8/23/2022   

7112273

   US    Volumetric Fluid Balance Control For Extracorporeal Blood Treatment      10/2/2024   

7147613

   US    Measurement Of Fluid Pressure In A Blood Treatment Device      8/29/2020   

7166084

   US    Blood Set Priming Method And Apparatus      7/22/2017   

7214312

   US    Fluid Circuits, Systems, And Processes For Extracorporeal Blood Processing      7/8/2022   

 

15


Table of Contents

Patent No.

   Regime   

Title

  

  Expiration Date

 

7226538

   US    Fluid Processing Apparatus      1/21/2022   

7267658

   US    Renal Replacement Therapy Device For Controlling Fluid Balance Of Treated Patient      3/6/2021   

7300413

   US    Blood Processing Machine And System Using Fluid Circuit Cartridge      5/4/2021   

7337674

   US    Pressure Detector For Fluid Circuits      12/13/2025   

7338460

   US    Blood Processing Machine Fluid Circuit Cartridge      6/19/2021   

7347849

   US    Modular Medical Treatment Replaceable Component      10/7/2022   

7419597

   US    Fluid, Circuits, Systems, And Processes For Extracorporeal Blood Processing      7/12/2021   

7470265

   US    Dual Access Spike For Infusate Bags      1/11/2024   

7473238

   US    Hemofiltration Systems And Methods That Maintain Sterile Extracorporeal Processing Conditions      8/11/2020   

7544300

   US    Batch Filtration System For Preparation Of Sterile Fluid For Renal Replacement Therapy      1/7/2024   

7569047

   US    Medical Device With Elastomeric Penetrable Wall      11/11/2024   

7588684

   US    Systems And Methods For Handling Air And/or Flushing Fluids In A Fluid Circuit      7/13/2021   

7591804

   US    Short-Winged Needle And Guard      12/20/2026   

7686778

   US    Waste Balancing For Extracorporeal Blood Treatment Systems      7/7/2026   

7749393

   US    Batch Filtration System For Preparation Of Sterile Fluid For Renal Replacement Therapy      1/7/2024   

7758082

   US    Fluid Line Connector Safety Device      5/5/2028   

7771379

   US    Functional Isolation Of Upgradeable Components To Reduce Risk In Medical Treatment Devices      7/16/2025   

7776001

   US    Registration Of Fluid Circuit Components In A Blood Treatment Device      10/28/2023   

7776219

   US    Methods, Devices, And Systems For Hemodilution      8/11/2021   

7780619

   US    Blood Treatment Apparatus      11/29/2019   

7790043

   US    Systems And Methods For Handling Air And/Or Flushing Fluids In A Fluid Circuit      7/13/2021   

7892208

   US    Medical Tubing Set Sheath      6/12/2028   

7901579

   US    Blood Treatment Dialyzer/Filter For Permitting Gas Removal      3/1/2026   

7976711

   US    Batch Filtration System For Preparation Of Sterile Fluid For Renal Replacement Therapy      1/7/2024   

8002727

   US    Methods And Apparatus For Leak Detection In Blood Processing Systems      9/24/2026   

8042838

   US    Fluid Line Connector Safety Device      12/5/2027   

8092414

   US    Diaphragm Pressure Pod For Medical Fluids      12/12/2029   

8190651

   US    System And Method For Identifying And Pairing Devices      12/4/2029   

8192387

   US    Last-Chance Quality Check And/Or Air/Pathogen Filter For Infusion Systems      10/29/2024   

8202420

   US    Batch Filtration System For Preparation Of Sterile Fluid For Renal Replacement Therapy      1/7/2024   

8210049

   US    Pressure Measurement Device      5/4/2031   

8235931

   US    Waste Balancing For Extracorporeal Blood Treatment Systems      2/10/2025   

8251973

   US    Medical Devices And Methods For Assisting In Sub-Scab Access      2/20/2029   

8377039

   US    Injection Site For Male Luer Or Other Tubular Connector      9/9/2028   

8460228

   US    Methods, Devices, And Systems For Parallel Control Of Infusion Device      1/9/2031   

8460558

   US    Batch Filtration System For Preparation Of Sterile Fluid For Renal Replacement Therapy      1/7/2024   

8469331

   US    Filtration System For Preparation Of Fluids For Medical Applications      5/21/2030   

 

16


Table of Contents

Patent No.

   Regime   

Title

  

  Expiration Date

 

8480608

   US    Methods And Apparatus For Leak Detection In Blood Processing Systems      1/16/2025   

8491518

   US    Diaphragm Pressure Pod For Medical Fluids      1/9/2026   

8496625

   US    Safe Needle Methods, Apparatus, And Systems      10/20/2031   

8506536

   US    Medical Devices And Methods For Assisting In Sub-Scab Access      12/12/2030   

8545428

   US    Filtration System For Preparation Of Fluids For Medical Applications      1/7/2024   

8585096

   US    Fluid Line Safety Device      10/26/2030   

8608658

   US    Method And Apparatus For Machine Error Detection By Combining Multiple Sensor Inputs      1/4/2022   

8641615

   US    Method And Apparatus For Machine Error Detection By Combining Multiple Sensor Inputs      1/4/2022   

8647312

   US    Injection Site For Male Luer Or Other Tubular Connector      10/4/2022   

8641684

   US    Closure For Tubular Access Port      5/15/2029   

8679348

   US    Filtration System For Preparation Of Fluids For Medical Applications      11/28/2024   

8876777

   US    Safe Needle Methods, Apparatus, And Systems      5/26/2031   

8909613

   US    System And Method For Identifying And Pairing Devices      3/10/2031   

3809563

   JP    Easy Use Needle Protector Sheath      12/20/2016   

4118233

   JP    Method And Apparatus For Leak Detection In A Fluid Line      7/8/2022   

3843414

   JP    Needle Protector Sheath      4/12/2025   

4416368

   JP    Fluid Processing Systems And Methods Using Extracorporeal Fluid Flow Panels Oriented Within A Cartridge      11/29/2020   

4117505

   JP    Flow-Through Treatment Device      1/16/2016   

4387631

   JP    Layered Fluid Circuit Assemblies And Methods For Making Them      11/29/2020   

4416797

   JP    Improved Methods And Apparatus For Leak Detection In Blood Processing Systems      11/5/2024   

4734343

   JP    Filtration System For Preparation Of Fluids For Medical Applications      1/9/2026   

4739019

   JP    Injection Site For Male Luer Or Other Tubular Connector      10/2/2023   

5378203

   JP    Filtration System For Preparation Of Fluids For Medical Applications      4/9/2027   

1425063

   IT    Method And Apparatus For Leak Detection In A Fluid Line      7/8/2022   

1691882

   IT    Apparatus For Leak Detection In Blood Processing System      11/5/2024   

1838356

   IT    Filtration System For Preparation Of Fluids For Medical Applications      1/9/2026   

2012906

   IT    Tubing Clamp For Medical Applications      4/9/2027   

1235614

   GB    Interactive Systems And Methods For Supporting Hemofiltration Therapies      1/19/2015   

1414543

   GB    Systems And Methods For Handling Air And/Or Flushing Fluids In A Fluid Circuit      7/8/2022   

1425063

   GB    Method And Apparatus For Leak Detection In A Fluid Line      7/8/2022   

1531894

   GB    Blood Treatment Machine Comprising An Air/Pyrogen Filter      6/5/2023   

1592494

   GB    Preparing Replacement Fluid      1/7/2024   

1691882

   GB    Apparatus For Leak Detection In Blood Processing System      11/5/2024   

1838356

   GB    Filtration System For Preparation Of Fluids For Medical Applications      1/9/2026   

2012906

   GB    Tubing Clamp For Medical Applications      4/9/2027   

2505363

   GB    Fluid Heating Apparatuses, Systems, And Methods      5/14/2032   

1235614

   FR    Interactive Systems And Methods For Supporting Hemofiltration Therapies      11/29/2020   

1425063

   FR    Method And Apparatus For Leak Detection In A Fluid Line      7/8/2022   

1691882

   FR    Apparatus For Leak Detection In Blood Processing System      11/5/2024   

1838356

   FR    Filtration System For Preparation Of Fluids For Medical Applications      1/9/2026   

2012906

   FR    Tubing Clamp For Medical Applications      4/9/2027   

 

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Table of Contents

Patent No.

   Regime   

Title

  

  Expiration Date

 

60045621.8

   DE    Fluid Processing Systems And Methods Using Extracorporeal Fluid Flow Panels Oriented Within A Cartridge      11/29/2020   

60047429.1

   DE    Interactive Systems And Methods For Supporting Hemofiltration Therapies      11/29/2020   

602004021672.0

   DE    Preparing Replacement Fluid      1/7/2024   

60245474.3

   DE    Systems And Methods For Handling Air And/Or Flushing Fluids In A Fluid Circuit      7/8/2022   

60341758.2

   DE    Blood Treatment Machine Comprising An Air/Pyrogen Filter      6/5/2023   

602004029077.7

   DE    Apparatus For Leak Detection In Blood Processing System      11/5/2024   

602006017654.6

   DE    Filtration System For Preparation Of Fluids For Medical Applications      1/9/2026   

60043710.8-08

   DE    Synchronized Volumetric Fluid Balancing Systems And Methods      11/29/2020   

602007008395.8

   DE    Tubing Clamp For Medical Applications      4/9/2027   

60237621.1

   DE    Methods And Apparatus For Leak Detection In A Fluid Line      7/8/2022   

2153091

   CA    Needle Protector Sheath      6/30/2015   

2530440

   CA    Medical Device With Elastomeric Penetrable Wall And Inner Seal      6/28/2024   

2593580

   CA    Filtration System For Preparation Of Fluids For Medical Applications      1/9/2026   

000023148-0001

   EU    Blood Treatment Machine And Parts Thereof      4/1/2028   

1235614

   EP    Interactive Systems And Methods For Supporting Hemofiltration Therapies      11/29/2020   

1425063

   EP    System For Leak Detection In A Fluid Line      7/8/2022   

1531894

   EP    Blood Treatment Machine Comprising An Air/Pyrogen Filter      6/5/2023   

In addition to the issued patents and pending patent applications owned by us, in the U.S. and select non-U.S. markets, we possess trade secrets and proprietary know-how relating to our products. Any of our trade secrets, know-how or other technology not protected by a patent could be misappropriated, or independently developed by, a competitor and could, under some circumstances, be used to prevent us from further use of such information, know-how or technology.

Our strategy is to develop patent portfolios for our research and development projects. We monitor the activities of our competitors and other third parties with respect to their use of intellectual property. We intend to aggressively defend the patents we hold, and we intend to vigorously contest claims other patent holders may bring against us.

The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. While we attempt to ensure that our products and methods do not infringe other parties’ patents and proprietary rights, our competitors may assert that our products, or the methods that we employ, are covered by patents held by them. In addition, our competitors may assert that future products and methods we may market infringe their patents.

We require our employees, consultants and advisors to execute confidentiality agreements with us. We also require our employees to agree to disclose and assign to us all inventions conceived by them during their employment with us. Similar obligations are imposed upon consultants and advisors performing work for us relating to the design or manufacture of our products. Despite efforts to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary.

Manufacturing

The manufacture of our products is accomplished through a complementary combination of outsourcing and internal production. We have manufacturing facilities in Mexico, Germany and Italy. At our facility in Tijuana,

 

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Table of Contents

Mexico, we manufacture System One equipment and disposables and In-Center bloodlines, and we service System One equipment. We manufacture our dialyzer filters at a facility in Germany owned by Asahi and operated by us, and we perform molding activities at our facility in Italy. We outsource the manufacture of premixed dialysate, needles and some components.

We depend upon a number of single-source suppliers for certain of our raw materials, components and finished goods, including the fiber used in our System One filters, our needles, premixed dialysate and sterile bags, as well as sterilization services. Finding alternative sources for these raw materials, components, finished goods and sterilization services would be difficult and in many cases entail a significant amount of time, disruption and cost. Where obtaining a second source is more difficult, we have tried to establish supply agreements that better protect our continuity of supply, although we do not have supply agreements with all of our single-source suppliers. Where we have no agreements in place, we work, to the extent economically feasible, to maintain enough inventory of the single-sourced component to allow us to, if needed, satisfy our requirements for the component while we secure an alternative source of supply. Some of our most critical single-source supply relationships are with Membrana and Laboratorios PiSA S.A. de C.V.

Membrana is our only supplier of the fiber used in our filters for System One products under an agreement that expires in December 2023, and contractually we cannot obtain an alternative source of fiber for our System One products. While our relationship with Asahi could afford us back-up supply in the event of supply disruptions at Membrana, we do not have the regulatory approvals necessary to use Asahi fiber in our System One cartridge in the U.S. and the performance of Asahi fiber in our System One has not yet been validated.

Laboratorios PiSA is our only supplier of premixed dialysate. Our supply agreement with Laboratorios PiSA extends through December 2019. We have committed to purchase from Laboratorios PiSA a minimum quantity of premixed dialysate over the term of the agreement. While we can purchase premixed dialysate from other qualified suppliers, any significant disruption in Laboratorios PiSA’s ability to supply premixed dialysate to us would impair our business, at least in the near-term.

Government Regulation

We are subject to government regulation in the countries in which we conduct business. In the U.S., numerous laws and regulations govern all the processes by which medical devices are brought to market and, for our NxStage Kidney Care dialysis centers, the manner in which we administer and submit claims for patient care. In the foreign countries in which we market and sell our products, we are subject to local regulations affecting, among other things, design and product standards, packaging and labeling and promotion requirements.

Food and Drug Administration

In the U.S., our products are subject to regulation by the FDA, which regulates our products as medical devices. The FDA regulates the design, development, clinical testing, manufacture, labeling, distribution, import and export, sale and promotion of medical devices. Noncompliance with applicable FDA requirements can result in, among other things:

 

   

fines;

 

   

injunctions;

 

   

civil penalties;

 

   

recall or seizure of products;

 

   

total or partial suspension of production;

 

   

failure of the government to grant pre-market clearance or pre-market approval for devices;

 

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withdrawal of marketing clearances or approvals; and

 

   

criminal prosecution.

Unless an exemption applies, all medical devices must receive either 510(k) clearance or pre-market approval (PMA) from the FDA before they may be commercially distributed in the U.S.

The FDA classifies medical devices into one of three classes:

 

   

Class I devices, which are subject to only general controls (e.g., labeling, medical device reporting, and prohibitions against adulteration and misbranding) and, in some cases, to the 510(k) pre-market clearance requirements;

 

   

Class II devices, generally requiring 510(k) pre-market clearance before they may be commercially marketed in the U.S.; and

 

   

Class III devices, consisting of devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a predicate device, generally requiring submission of a PMA supported by clinical trial data.

In addition, the FDA can impose restrictions on the sale, distribution or use of devices at the time of their clearance or approval, or subsequent to marketing.

FDA Regulatory Clearance Status

We currently have all of the regulatory clearances required to market the System One in the U.S. in both the home and critical care markets. The FDA has cleared the System One for the treatment, under a physician’s prescription, of renal failure or fluid overload using hemofiltration, hemodialysis and/or ultrafiltration. The FDA has also specifically cleared the System One for both home hemodialysis and home nocturnal hemodialysis use under a physician’s prescription.

We received our first clearance from the FDA for a predecessor model to the System One in January 2001 for hemofiltration and ultrafiltration. In July 2003, we received expanded clearance from the FDA for the System One for hemodialysis, hemofiltration and ultrafiltration. In June 2005, we received FDA clearance specifically allowing us to promote home hemodialysis using the System One. In October 2010, we received FDA clearance for our therapeutic plasma exchange cartridge for use with the NxStage System One in a clinical environment. In February 2013, we received CE Mark approval and in April 2013 we received clearance from the FDA for the new high flow capabilities with the NxStage System One. We began selling the System One with this feature to both U.S. customers and international distributors in 2014. To date we have received 37 product clearances from the FDA since our inception in December 1998 for our System One and related products. We continue to seek opportunities for product improvements and feature enhancements, which will, from time to time, require FDA clearance before market launch.

We have received a total of 27 product clearances to market Medisystems products that support the in-center market. These clearances, the first of which was received in 1981, cover blood tubing sets used for hemodialysis, needle sets used in hemodialysis and apheresis, and other components such as intravenous administration sites, medics and transducer protectors, used primarily for hemodialysis.

FDA Clearance Procedures

510(k) Clearance Pathway.    When we are required to obtain a 510(k) clearance for a device that we wish to market, we must submit a pre-market notification to the FDA demonstrating that the device is substantially equivalent to (1) a device that was legally marketed prior to May 28, 1976 and for which the FDA has not yet required pre-market approval; (2) a device which has been reclassified from Class III to Class II or I; or (3) a

 

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novel device classified into Class I or II through de novo classification. If the FDA agrees that the device is substantially equivalent to the predicate, it will subject the device to the same classification and degree of regulation as the predicate device, thus effectively granting clearance to market it. The FDA attempts to respond to a 510(k) pre-market notification within 90 days of submission of the notification (or in some instances 30 days under what is referred to as a “special” 510(k) submission), but the response may be a request for additional information or data, sometimes including clinical data. As a practical matter, pre-market clearance can take significantly longer, including up to one year or more.

After a device receives 510(k) clearance for a specific intended use, any modification that could significantly affect its safety or effectiveness, or that constitutes a major change in its intended use, would require a new 510(k) clearance or could require pre-market approval. In the first instance, the manufacturer may determine that a change does not require a new 510(k) clearance. The FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination that a new clearance or approval is not required for a particular modification, the FDA can require the manufacturer to cease marketing and recall the modified device until 510(k) clearance or pre-market approval is obtained.

Pre-market Approval Pathway.    A pre-market approval application must be submitted if the device cannot be cleared through the 510(k) process. The pre-market approval process is much more demanding than the 510(k) pre-market notification process. A pre-market approval application must be supported by extensive information including, but not limited to, technical data, preclinical and clinical trials, manufacturing details and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device. After the FDA determines that a pre-market approval application is complete, the FDA accepts the application and begins an in-depth review of the submitted information. The FDA, by statute and regulation, has 180 days to review an accepted pre-market approval application, although the review generally occurs over a significantly longer period of time, and can take up to several years. During this review period, the FDA may request additional information or clarification of information already provided. Also during the review period, an advisory panel of experts from outside the FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a pre-approval inspection of the manufacturing facility to ensure compliance with the Quality System Regulations. New pre-market approval applications or supplemental pre-market approval applications are required for modifications that affect the safety or effectiveness of the device. These types of changes include changes to the manufacturing process, labeling, use and design of the approved device. PMA supplements often require submission of the same type of information as a pre-market approval application, except that the supplement is limited to information needed to support any changes from the device covered by the original pre-market approval application, and may not require as extensive clinical data or the convening of an advisory panel.

Clinical Trials.    A clinical trial is almost always required to support a pre-market approval application and is sometimes required for a 510(k) pre-market notification. Clinical trials for devices that involve significant risk, referred to as significant risk devices, require submission of an application for an IDE to the FDA. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. Clinical trials for a significant risk device may begin once the IDE application is approved by the FDA and the institutional review board, or IRB, overseeing the clinical trial. If the FDA fails to respond to an IDE application within 30 days of receipt, the application is deemed approved, but IRB approval would still be required before a study could begin. Products that are not significant risk devices are deemed to be “non-significant risk devices” under FDA regulations, and are subject to abbreviated IDE requirements, including informed consent, IRB approval of the proposed clinical trial and submission of certain reports to the IRB. Clinical trials are subject to extensive recordkeeping and reporting requirements. Our clinical trials must be conducted under the oversight of an IRB at each clinical study site and in accordance with applicable regulations and policies including, but not limited to, the FDA’s good clinical practice requirements.

 

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Continuing FDA Regulation

After a device is placed on the market, numerous regulatory requirements apply. These include, among others:

 

   

product listing and establishment registration, which helps facilitate FDA inspections and other regulatory action;

 

   

Quality System Regulations, which require manufacturers to have a quality system for the design, manufacture, packaging, labeling, storage, installation, and servicing of finished medical devices;

 

   

labeling regulations, which govern product labels and labeling, prohibit the promotion of products for unapproved, or off-label, uses and impose other restrictions on labeling and promotional activities;

 

   

clearance of product modifications that could significantly affect safety or efficacy or that would constitute a major change in intended use of one of our cleared devices;

 

   

medical device reporting, or MDR, regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur;

 

   

the FDA’s recall authority, whereby it can ask, or under certain conditions order, device manufacturers to recall from the market a product that is in violation of governing laws and regulations;

 

   

regulations pertaining to voluntary recalls; and

 

   

notices of corrections or removals.

MDR Regulations.    The MDR regulations require that we report to the FDA any incident in which our product may have caused or contributed to a death or serious injury, or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to a death or serious injury. To date, a majority of our MDR reports had been submitted to comply with the FDA’s blood loss policy for routine dialysis treatments. This policy, which is no longer in effect, required manufacturers to file MDR reports related to routine dialysis treatments if the patient experienced blood loss greater than 20cc.

FDA Inspections.    We have registered with the FDA as a medical device manufacturer. The FDA seeks to ensure compliance with regulatory requirements through periodic, unannounced facility inspections and these inspections may include the manufacturing facilities of our subcontractors. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following:

 

   

warning letters or untitled letters;

 

   

fines, injunctions, and civil penalties;

 

   

administrative detention, which is the detention by the FDA of medical devices believed to be adulterated or misbranded;

 

   

voluntary or mandatory recall or seizure of our products;

 

   

customer notification, or orders for repair, replacement or refund;

 

   

operating restrictions, partial suspension or total shutdown of production;

 

   

refusal to review pre-market notification or pre-market approval submissions;

 

   

rescission of a substantial equivalence order or suspension or withdrawal of a pre-market approval; and

 

   

criminal prosecution.

The FDA has inspected our Lawrence, Massachusetts facility and quality system multiple times. In our first inspection, one observation was made, but was rectified during the inspection, requiring no further response from

 

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us. Our subsequent inspections, including our most recent inspection in January 2013, resulted in no inspectional observations. Medisystems has been inspected by the FDA on multiple occasions, and all inspections resulted in no action indicated. We cannot provide assurance that we can maintain a comparable level of regulatory compliance in the future at our facilities.

Foreign Regulation of Medical Devices

We are also subject to regulations in the foreign countries in which we market and sell our products. We currently have limited sales outside of the U.S. Foreign regulations, which may vary substantially from country to country, relate to, among other things, product standards, packaging, labeling and promotion requirements, import restrictions, tariff regulations, duties and tax requirements.

Clearance or approval of our products by regulatory authorities comparable to the FDA, or in the case of the EU the affixing of the CE mark, may be necessary in foreign countries prior to marketing the product in those countries, whether or not FDA clearance has been obtained. The regulatory requirements for medical devices vary significantly from country to country. They can involve requirements for additional testing and may be time consuming and expensive. We cannot provide assurance that we will be able to obtain regulatory approvals in any other markets or be able to affix the CE mark to new products in the EU.

In the specific case of the EU, manufacturers of medical devices are required to conduct an assessment of the conformity of the devices with the Essential Requirements found in Annex I to Council Directive 93/42/EEC of 14 June 1993 concerning medical devices, commonly known as the Medical Devices Directive, and to affix a CE Mark to these devices prior to marketing these within the EU. The Essential Requirements govern the quality, safety and performance of the medical devices. The classification of individual medical devices will determine whether the participation by a notified body in the conformity assessment process will be necessary. Notified bodies are private organizations that are licensed by the competent authorities of individual EU Member States to conduct conformity assessment procedures and to verify the conformity of manufacturers and their medical devices with the Essential Requirements.

If, where the participation by a notified body is necessary, the outcome of the conformity assessment procedure is positive the notified body will issue a related CE Certificate of Conformity. The manufacturer of the device will then complete the technical file for the medical device and, after having prepared and signed a related Declaration of Conformity, affix the CE mark to the product.

Demonstration of conformity of medical devices and their manufacturers with the Essential Requirements laid down in Annex I of the Medical Devices Directive must be based, among other things, on the evaluation of clinical data supporting the safety and performance of the products during normal conditions of use. Where necessary, this will include evaluation of clinical data generated in clinical investigations conducted with the medical devices. Conduct of clinical investigations in the EU is governed by detailed regulatory obligations. These include the requirement of prior authorization of the investigation by the competent authorities of the EU Member States in which the investigation takes place and the requirement to obtain a positive opinion concerning the investigation protocol from a competent Ethics Committee. The conduct of clinical investigations in the EU can be expensive and challenging and the outcome of such investigations is uncertain. There are no guarantees that the data generated in the clinical investigation would be sufficient to support CE marking of the medical device. Moreover, the clinical investigation may be suspended or discontinued by the competent authorities of the EU Member States or on the advice of the Ethics Committee.

The Medical Devices Directive requires manufacturers to maintain a Technical File related to their products. Manufacturers must also comply with quality system requirements set forth in the Annexes to the Medical Devices Directive. Such compliance can be facilitated by, among other things, a certificate of compliance with ISO 13485:2003. Through compliance with the ISO 13485:2003 standard, manufacturers benefit from a presumption of conformity with the relevant quality system requirements laid down in the Annexes to Medical Devices Directive.

 

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CE Certificates of Conformity have been issued in relation to all of our products that require such certificates and we have affixed a CE mark to these products. However, if we introduce any substantial change to any of our CE marked medical devices in the EU this may require an additional conformity assessment process in relation to the substantial changes and modification or preparation of new CE Certificates of Conformity and Declarations of Conformity. “Substantial changes” include the introduction of a new intended purpose for the medical device, a change in its design or a change in the device quality management system. There is little guidance concerning modifications that should be considered a substantial change. As the manufacturer of the medical device we would have sole responsibility for determining whether any modification constitutes a substantial change. There is a risk that the competent authorities of the EU Member States or our notified body may disagree with our assessment of the changes introduced to our products. The competent authorities of the EU Member States or our notified body may also come to a different conclusion than the FDA concerning any change made to our products.

In the EU we must comply with a number of regulatory requirements for products that have been CE marked and placed on the market relating to:

 

   

registration of medical devices;

 

   

pricing and reimbursement of medical devices;

 

   

establishment of post-marketing surveillance and adverse event reporting procedures;

 

   

field safety corrective actions, including product recalls and withdrawals;

 

   

marketing and promotion of medical devices; and

 

   

interactions with physicians.

Failure to comply with these requirements may result in enforcement measures being taken by the competent authorities of the EU Member States. These can include fines, administrative penalties, compulsory product withdrawals, injunctions and criminal prosecution. Such enforcement measures would have an adverse effect on the marketing of our products in the EU and, consequently, on our business and financial position.

The System One cycler and related cartridges are regulated as medical devices in Canada under the Canadian Medical Device Regulations and in the EU under the Medical Device Directive. We have received four product licenses from Canada. We have conducted a conformity assessment and affixed the CE mark in the EU to our System One and associated ancillaries.

Our blood tubing sets, AV fistula needles, apheresis needles, and other ancillary products are regulated as medical devices in Canada under the Canadian Medical Device Regulations and in the EU under the Medical Device Directive. We maintain six Medical Device Licenses in Canada under the Medisystems brand name for these products. We have conducted a conformity assessment and affixed the CE mark in the EU for AV fistula needles, apheresis needles, and other ancillary products.

Fraud and Abuse Laws

U.S. federal healthcare laws apply when our customers and NxStage Kidney Care dialysis centers submit claims for items or services that are reimbursed under Medicare, Medicaid, or other federally-funded healthcare programs. The principal federal fraud and abuse laws include: (1) the Anti-Kickback Statute, which prohibits the offer or payment of any remuneration for the purpose of inducing or rewarding referrals of items or services reimbursable by a federal healthcare program; (2) the False Claims Act, which prohibits the submission of false or otherwise improper claims for payment to a federally-funded healthcare program; and (3) criminal healthcare fraud statutes that prohibit false statements and improper claims to any third-party payors. There are often similar state anti-kickback and false claims laws that apply to state-funded Medicaid and other healthcare programs, as well as to private third-party payors. In addition, the U.S. Foreign Corrupt Practices Act can be used to prosecute companies in the U.S. for arrangements with physicians or other parties outside the U.S. if the physician or party is a government official of another country and the arrangement violates the laws of that country.

 

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Similar laws are increasingly being introduced in the individual EU Member States. The provision of benefits or advantages to physicians to induce or encourage the prescription, recommendation, endorsement, purchase, supply, order or use of medical devices is prohibited. The provision of benefits or advantages to physicians is also governed by the national anti-bribery laws of the EU Member States. One such example is the UK Bribery Act. Payments made to physicians in certain EU Member States must also be publicly disclosed. Moreover, agreements with physicians must often be the subject of prior notification and approval by the physician’s employer or competent professional organization or the competent authorities of the individual EU Member States. These requirements are provided in the national laws, industry codes or professional codes of conduct applicable in the EU Member States. Failure to comply with these requirements could result in reputational harm, public reprimands, administrative penalties, fines or imprisonment.

Anti-Kickback Statutes

The federal healthcare program Anti-Kickback Statute, and similar state laws, prohibit payments and other forms of remuneration that are intended to induce health care professionals or others either to refer patients or to purchase, lease, order or arrange for or recommend the purchase, lease or order of healthcare products or services. Other laws prohibit remuneration intended to induce patients to select a particular provider of services, including for dialysis. A number of states have enacted laws that require pharmaceutical and medical device companies to monitor and report payments, gifts and other remuneration made to physicians and other health care professionals and health care organizations. In addition, some state statutes, most notably laws in Massachusetts and Vermont, impose outright bans on certain manufacturer gifts to physicians. Some of these laws, referred to as “aggregate spend” or “gift” laws, carry substantial fines if they are violated. The federal Physician Payments Sunshine Act was enacted by Congress in 2010 as part of the comprehensive health care reform legislation, and the implementing regulations, released in February 2013, require us to collect and report certain data on payments and other transfers of value to physicians and teaching hospitals annually to the Centers for Medicare and Medicaid Services (CMS) for public reporting. It is widely anticipated that public reporting under the Sunshine Act will result in increased scrutiny of the financial relationships between industry, physicians and teaching hospitals.

The Anti-Kickback Statute is broad and potentially prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements, the Office of Inspector General of the Department of Health and Human Services, or OIG, issued a series of regulations, known as the safe harbors, beginning in July 1991. These safe harbors set forth provisions that, if all the applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within a safe harbor does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy an applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the OIG. If scrutinized, arrangements that implicate the Anti-Kickback Statute, and that do not fall within a safe harbor, are analyzed by the OIG and other enforcement authorities on a case-by-case basis.

Government officials have focused recent enforcement efforts on, among other things, the sales and marketing activities of medical device manufacturers and other healthcare companies, and recently have brought cases against individuals or entities with personnel who allegedly offered unlawful inducements to potential or existing customers in an attempt to procure their business. Judgments and settlements of these cases by healthcare companies have involved significant fines and, in some instances, criminal pleas and convictions.

In addition to the federal Anti-Kickback Statute, many states have their own anti-kickback laws. Often, these laws closely follow the language of the federal law, although they do not always have the same exceptions or safe harbors. In some states, these anti-kickback laws apply with respect to all payors, including commercial health insurance companies.

The national legislation of many foreign countries includes provisions equivalent in content and consequences to the federal Anti-Kickback Statute and the Sunshine Act.

 

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False Claims Laws

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government or knowingly making, or causing to be made, a false statement to get a false claim paid. Our NxStage Kidney Care dialysis centers are directly subject to these laws with respect to the reimbursement claims they file with government payors. In addition, medical device manufacturers can be held liable under false claims laws, even if they do not submit claims to the government, if they are found to have caused the submission of false claims, including through arrangements that violate the Anti-Kickback Statute. The federal False Claims Act also includes whistleblower provisions that allow private citizens to bring suit against an entity or individual on behalf of the U.S. and to recover a portion of any monetary recovery. Many of the recent highly publicized settlements in the healthcare industry related to the sales and marketing practices of pharmaceutical and medical device manufacturers have been cases brought under the False Claims Act. Violations of The Ethics in Patient Referrals Act, commonly known as the Stark Act, can also form the basis for False Claims Act liability. The Stark Act generally prohibits a physician from referring a patient to an entity for certain designated health services payable by Medicare or Medicaid when the physician has a financial relationship with the entity, such as an investment interest or a medical directorship. While outpatient dialysis services and most drugs furnished by our NxStage Kidney Care dialysis centers are excluded from the Stark Act’s prohibitions on self-referrals, certain outpatient prescription drugs may be subject to the Stark Act.

The majority of states also have statutes or regulations similar to the federal false claims laws, which apply to items and services reimbursed under Medicaid and other state programs. Several states have false claims laws that apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines and imprisonment.

The national legislation of many foreign countries includes provisions equivalent in content and consequences to the federal false claims laws.

Compliance Program

The healthcare laws and fraud and abuse laws applicable to our business are complex and subject to variable interpretations. We maintain certain compliance review, education and training and other programs to further our commitment to high standards of ethical and legal conduct and to minimize the likelihood that we would engage in conduct or enter into arrangements in violation of applicable authorities. For example, we have (1) established a compliance team consisting of representatives from our Legal, Finance, Human Resources, Regulatory Affairs/Quality Assurance and Commercial departments that meets regularly; (2) established a compliance hotline that permits our employees to report anonymously any compliance issues that may arise; and (3) instituted other safeguards intended to help prevent any violations of the applicable fraud and abuse laws and healthcare laws, and to remediate any situations that could give rise to violations. We also review our transactions and agreements, both past and present, with qualified legal counsel to help ensure they are compliant.

Through our compliance efforts, we constantly strive to structure our business operations and relationships with our customers to comply with all applicable legal requirements. However, many of the laws and regulations applicable to us are broad in scope and may be interpreted or applied by prosecutorial, regulatory or judicial authorities in ways that we cannot predict. Thus, it is possible that governmental entities or other third parties could interpret these laws differently or assert non-compliance with respect to one or more of our business operations and relationships. Moreover, the standards of business conduct expected of healthcare companies under these laws and regulations have become more stringent in recent years, even in instances where there has been no change in statutory or regulatory language. If a claim were asserted against us for alleged non-compliance with fraud and abuse laws or other healthcare laws, and we were not to prevail, possible penalties and sanctions could have a material effect on our financial condition and ability to conduct our operations.

 

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Privacy and Security

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 and related products to home hemodialysis patients. We may learn patient names and be exposed to confidential patient health information when we provide training on our products to our customers’ staff. Our home hemodialysis patients may also call our customer service representatives directly and, during the call, disclose confidential patient health information. We also receive and maintain confidential patient health information in connection with the operation of our NxStage Kidney Care centers. 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, as amended under the Health Information Technology for Economic and Clinical Health Act, or HIPAA. HIPAA and the rules promulgated thereunder require certain entities to comply with established standards, including standards regarding the privacy and security of protected health information known as the HIPAA Privacy and Security Rules and to provide notification following a data breach involving protected health information. We are subject to HIPAA with regard to certain aspects of our business. In addition, many other state and federal laws regulate the use and disclosure of health information, including state medical privacy laws, state breach notification laws, and federal and state consumer protection laws. In many cases, these laws are not necessarily preempted by HIPAA, particularly if they afford greater protection to the individual than does HIPAA. These various laws may be subject to varying interpretations by courts and government agencies creating potentially complex compliance issues for our business.

We are also subject to laws and regulations in foreign countries covering the privacy and other regulation of health and employee information that may be more onerous than corresponding U.S. laws. These regulations may require that we obtain individual consent before we collect or process any personal data, restrict our use or transfer of personal data, impose technical and organizational measures to ensure the security of personal data, and require that we notify regulatory agencies, individuals or the public about any data securities breaches. As we expand our international operations, we may be required to expend significant time and resources to put in place additional mechanisms to ensure compliance with multiple data privacy laws. Failure to comply with these laws may result in significant fines and other administrative penalties and harm our business.

Reimbursement

Home and In-Center Markets

Medicare regulations require that all chronic ESRD patients be under the care of a dialysis clinic, whether they are treated at home or in-clinic. We sell or rent our System One and sell our needles and blood tubing sets to dialysis clinics. These clinics, in turn, are reimbursed by Medicare, Medicaid and private insurers. According to the 2014 USRDS Annual Data Report, Medicare or Medicaid is the primary payor for approximately 83% of prevalent dialysis patients using hemodialysis and peritoneal dialysis. The report also indicates that approximately 6% of patients are covered by commercial insurance with Medicare as the secondary payor, with the remaining 11% of patients classified by the USRDS as “other” or “unknown.” Certain centers have indicated that more frequent home hemodialysis therapy with the System One attracts a higher percentage of commercial insurance patients than other forms of dialysis.

Medicare.    Medicare generally provides health insurance coverage for persons who are age 65 or older and for persons who are completely disabled. For ESRD patients, however, Medicare coverage is not dependent on age or disability. Patients are eligible for Medicare based solely on ESRD. Coverage for patients eligible for Medicare based solely on ESRD begins on the first day of the fourth month after the patient begins dialysis treatments. During the three-month waiting period either Medicaid, private insurance or the patient is responsible for payment for dialysis services. Medicare waives this waiting period for individuals who participate in a home dialysis training program, or are hospitalized for a kidney transplant and the surgery occurs within a specified time period.

 

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For ESRD patients under age 65 who have any employer group health insurance coverage, regardless of the size of the employer or the individual’s employment status, Medicare coverage is generally secondary to the employer coverage during the 30-month period that follows the establishment of Medicare eligibility or entitlement based on ESRD. During this period, the patient’s existing insurer is responsible for paying primary benefits at the rate specified in the plan, which may be a negotiated rate or the healthcare provider’s usual and customary rate. As the secondary payor during this period, Medicare will make payments up to the applicable Medicare payment rate for dialysis services to supplement any primary payments by the employer group health plan if the plan covers the services but pays only a portion of the charge for the services.

Medicare generally is the primary payor for ESRD patients after the 30-month coordination period. Under current rules, Medicare is also the primary payor for ESRD patients during the 30-month period under certain circumstances. Medicare remains the primary payor when an individual becomes eligible for Medicare on the basis of ESRD if (1) the individual was already age 65 or over or was eligible for Medicare based on disability and (2) the individual’s private insurance coverage is not by reason of current employment or, if it is, the employer has fewer than 20 employees (in the case of eligibility by reason of age) or fewer than 100 employees (in the case of eligibility by reason of disability). The rules regarding entitlement to primary Medicare coverage when the patient is eligible for Medicare on the basis of both ESRD and age, or disability, have been the subject of frequent legislative and regulatory changes and there can be no assurance that these rules will not be unfavorably changed in the future.

When Medicare is the primary payor for services furnished by dialysis clinics, it reimburses dialysis clinics for 80% of the allowable rate, leaving the secondary insurance or the patient responsible for the remaining 20%.

As a result of legislation passed by the U.S. Congress more than 30 years ago, Medicare provides broad and well established reimbursement in the U.S. for ESRD. Effective January 1, 2011, CMS implemented a new prospective payment system for dialysis treatment. Under the new ESRD prospective payment system, CMS makes a single bundled payment to the dialysis facility for each dialysis treatment that covers all renal dialysis services and home dialysis and includes certain drugs (including erythropoiesis stimulating agents, iron and Vitamin D). The prospective payment system replaced the former system, which paid facilities a composite rate for a defined set of items and services, while paying separately for dugs, laboratory tests, and other services that were not included in the composite rate. With a vast majority of U.S. ESRD patients covered by Medicare, the Medicare reimbursement rate is an important factor in a potential customer’s decision to use the System One or our other products and limits the fees for which we can sell or rent our products. Additionally, current CMS rules limit the number of hemodialysis treatments paid for by Medicare to three times a week, unless there is medical justification provided by the dialysis facility based on information from the patient’s physician for additional treatments. Most patients using the System One in the home treat themselves, with the help of a care partner, up to six times per week. To the extent that Medicare contractors elect not to pay for additional treatments, adoption of the System One would likely be impaired and revenues from our Kidney Care dialysis centers likely would be reduced.

Medicare has been consolidating the Medicare contractors that process and pay Medicare claims. Accordingly, there have been and may continue to be changes in the contractors that determine medical justification for dialysis treatments. This change in the reviewing entity for Medicare claims could lead to a change in whether a customer receives Medicare reimbursement for additional treatments. If an adverse change to historical payment practices occurs, adoption of our System One in the home market may be impaired and revenues from our Kidney Care dialysis centers likely would be reduced.

Based on an analysis of historical Medicare payment files by the University of Michigan Kidney Epidemeology and cost Center, those delivering more frequent dialysis at home receive reimbursement, on average, for 1.5 times the number of treatments per month versus conventional dialysis, although this amount varies by jurisdiction. This variance arises from Medicare contractor policies, as well as from varying center billing practices. Currently, only three of the Medicare contractor jurisdictions have formal Local Coverage Determinations (LCDs); the majority have not issued a LCD and thus make coverage determinations on a case-

 

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by-case basis. As there is no consistent national standard for obtaining medical justification, a clinic’s decision as to how much it is willing to spend on home dialysis equipment and services will be at least partly dependent on the level of confidence the center has in the predictability of receiving reimbursement from Medicare for additional treatments per week based on submitted claims for medical justification.

Although access to home and more frequent hemodialysis continues to grow, we believe that current Medicare reimbursement policies lead to adoption rates lower than rates commensurate with the percentage of patients experts believe can perform and medically benefit from this therapy. We believe more predictable Medicare reimbursement for more frequent dialysis with less administrative burden, including further improving Medicare reimbursement for home hemodialysis training, would allow adoption of home hemodialysis at rates more consistent with what is deemed to be appropriate by the medical community. These beneficial changes, however, may never materialize.

A stated goal of the ESRD prospective payment system was to encourage home dialysis. To date, it has not had a positive impact on the adoption of home or more frequent hemodialysis or the price for which we can sell our products. However, the prospective payment system has had a significant positive impact on the adoption of peritoneal dialysis as evidenced by the significantly increased training rates for peritoneal dialysis. We believe this increased focus on peritoneal dialysis growth and peritoneal dialysis training has been to the detriment of home hemodialysis training rates, as home training resources, including home training nurses in particular, have been more devoted to peritoneal dialysis training, leaving less time for home hemodialysis training. CMS increased the payment rate for home dialysis training by 50% effective January 1, 2014. We do not know yet what effect this increase will have on use of home hemodialysis.

As part of the American Taxpayer Relief Act of 2012, Congress instructed the Centers for Medicare and Medicaid Services to recalculate the base payment rate under the prospective payment system for services furnished in 2014 and thereafter to account for changes in utilization of renal dialysis drugs since the prospective payment system was implemented. In response, the Centers for Medicare and Medicaid Services enacted a 12% reduction to the base payment rate to be implemented over a three- to four-year transition period, with overall payments for 2014 remaining unchanged. However, the Protecting Access to Medicare Act of 2014 replaced this phased-in reduction with reductions to the annual inflation adjustment to the base rate (known as the “market basket adjustment”) in 2015–2018. As a result, there is no reduction to the market basket adjustment in 2015, and the reduction is 1.25 percentage points in 2016 and 2017, and 1 percentage point in 2018. The effect of this change on the adoption of home and more frequent hemodialysis is not yet known.

Since April 1, 2013, Medicare payments to providers and suppliers for dialysis and related services have been reduced by 2% due to the automatic spending cuts (known as “sequestration”) required by U.S. federal legislation. These cuts adversely impact Medicare payment for all dialysis treatments and could affect adoption of home and more frequent hemodialysis.

Medicaid.    Medicaid programs are state-administered programs partially funded by the federal government. These programs are intended to provide coverage for certain categories of patients whose income and assets fall below state defined levels and who are otherwise uninsured. For those who are eligible, the programs serve as supplemental insurance programs for the Medicare co-insurance portion and provide certain coverage, such as self-administered outpatient prescription medications, that is not covered by Medicare. For ESRD treatment, state regulations generally follow Medicare reimbursement levels and coverage without any co-insurance amounts, which is pertinent mostly for the three-month waiting period for Medicare coverage. Certain states, however, require beneficiaries to pay a monthly share of the cost based upon levels of income or assets.

Private Insurers.    Some ESRD patients have private insurance that covers dialysis services. Healthcare providers receive reimbursement for ESRD treatments from the patient or private insurance during a waiting period of up to three months before the patient becomes eligible for Medicare. In addition, if the private payor is an employer group health plan, it is generally required to continue to make primary payments for dialysis

 

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services during the 30-month period following eligibility or entitlement to Medicare. In general, employers may not reduce coverage or otherwise discriminate against ESRD patients by taking into account the patient’s eligibility or entitlement to Medicare benefits. It is generally believed that private insurance pays significantly more for dialysis services than Medicare and these patients with private insurance are generally viewed as more profitable to dialysis service providers. In 2012, both United Healthcare and Aetna established formal policies covering home hemodialysis for its beneficiaries.

Critical Care Market

For Medicare patients, both acute kidney failure and fluid overload therapies provided in an in-patient hospital setting are reimbursed under a traditional Medicare severity diagnosis related group system. Under this system, reimbursement is determined based on a patient’s primary diagnosis and is intended to cover all of the hospital’s costs of treating the patient. The presence of acute kidney failure or fluid overload increases the severity of the primary diagnosis and, accordingly, could increase the amount reimbursed. Longer hospitalization stays and higher labor needs, which are typical for patients with acute kidney failure and fluid overload, must be managed for care of these patients to be cost-effective. We believe that there is a significant incentive for hospitals to find a more cost-efficient way to treat these patients in order to improve hospital economics for these therapies.

Reimbursement Outside of the U.S.

The use of our products outside the U.S. is similarly affected by reimbursement policies adopted by foreign regulatory agencies, government managed health care systems and private insurance. Reimbursement for the treatment of patients using medical devices in the EU Member States is governed by complex mechanisms established on a national level in each country. These mechanisms vary widely among the EU Member States. Moreover, these mechanisms evolve constantly, reflecting the efforts of these countries to reduce public spending on healthcare. As a result, obtaining reimbursement for the treatment of patients using medical devices has become more and more challenging. We cannot, therefore, guarantee that the treatment of patients with our products would be reimbursed in any EU Member State.

The rules on the coverage and reimbursement of medical devices outside the U.S. and EU vary widely from country to country and often from hospital to hospital. In addition, healthcare reform proposals and medical cost containment measures in many foreign countries could, among other things, limit the use of our products and treatments in those countries and further reduce reimbursement available for such use or eliminate coverage altogether. These reforms or cost containment measures, including the uncertainty in the medical community regarding their nature and effect, could have an adverse effect on our customers’ purchasing decisions regarding our products and treatments within these regions.

Our Employees

As of December 31, 2014, we had approximately 3,400 employees, including full-time, part-time and temporary employees. From time to time we also employ independent contractors to support our engineering, marketing, sales, clinical and administrative organizations. Most of our employees are involved in the manufacture of our products and are employed outside of the U.S., with the significant majority employed in Mexico.

Executive Officers

Our executive officers as of February 26, 2015 were as follows:

Jeffrey H. Burbank, 52, is our Chief Executive Officer and a member of our Board of Directors and has served in these positions since he founded the company in December 1998. Mr. Burbank has over 25 years of in-depth management experience with companies developing, marketing and manufacturing products for ESRD

 

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patients. He has led NxStage since its inception, guiding it through all of its developmental phases to the successful initiation and rapid growth of commercial activities, its initial public offering, and the acquisition of Medisystems Corporation. Prior to founding NxStage, Mr. Burbank co-founded Vasca, Inc., a company providing innovative implantable access devices, where he was the President and Chief Executive Officer, as well as Chairman of the Board. He gained significant renal industry experience during his nine years in the Renal Division at Gambro, Inc., a medical technology company, with his last position as Director of Marketing and Advanced Technologies. During his career he has been an inventor on over 50 U.S. patents for medical devices. Mr. Burbank received his BS in Industrial Engineering from Lehigh University.

Robert S. Brown, 56, is the President of NxStage Kidney Care and has served in this position since June 2013. Before that, he served as our Senior Vice President, Chief Financial Officer and Treasurer since 2006. Mr. Brown has more than 20 years of financial experience. Prior to joining NxStage, Mr. Brown held several leadership positions in the financial group of Boston Scientific Corporation, a medical device company, including Vice President, Corporate Analysis & Control, where he and his team were responsible for the company’s financial, compliance, and operational audits and reported directly to the audit committee of the board of directors. Mr. Brown also served as Vice President, International at Boston Scientific where he was responsible for the financial functions of the company’s $2.5 billion international division in over 40 countries. Previous experience also includes financial reporting and special projects at United Technologies, a high technology manufacturer, and public accounting and consulting at Deloitte & Touche, an auditing firm. Mr. Brown received his BBA from The University of Toledo and his MBA from The University of Michigan. He is also a Certified Public Accountant.

Winifred L. Swan, 50, is our Senior Vice President and General Counsel and has served in these positions since January 2005. Before that, she served as our Vice President and General Counsel since November 2000. Ms. Swan has over 20 years of legal expertise in medical devices. Prior to joining NxStage, Ms. Swan was Senior Corporate Counsel at Boston Scientific Corporation, a medical device company, where she focused on mergers and acquisitions and business development transactions. Before that, she was an associate at Goodwin Procter LLP, a law firm, specializing in corporate and securities law. Prior to law school, Ms. Swan served as a financial analyst in the Capital Markets Group of Merrill Lynch, a financial management and advisory company. Ms. Swan received a BA in Economics and Public Policy from Duke University and her JD from the University of Pennsylvania.

Matthew W. Towse, 52, is our Senior Vice President, Chief Financial Officer and Treasurer and has served in these positions since July 2013. He has also served as our Chief Accounting Officer since January 2015. Mr. Towse has over 25 years of experience in global financial management with both public and private companies across multiple industries. Prior to joining NxStage, he served as Vice President and Chief Financial Officer of Vette Corp., a venture-capital backed global design, engineering and manufacturing technology company from 2006 until its acquisition by a strategic buyer in April 2012. From 2003 to 2005, he served as Senior Vice President and Chief Financial Officer of Fairchild Semiconductor International, Inc. Previously, Mr. Towse served as Fairchild’s Vice President and Corporate Treasurer from 1997 to 2003, and held various financial positions with National Semiconductor from 1991 to 1997 before becoming part of the team that spunoff Fairchild from National. Earlier in his career, Mr. Towse was an audit manager with Ernst & Young LLP, an auditing firm, and most recently, he served as an Interim Chief Financial Officer with Tatum, LLC, an executive services firm. Mr. Towse is a Certified Public Accountant and received his BBA from the University of Notre Dame.

Joseph E. Turk, Jr., 47, is our President and has served in this position since November 2013. Before that, Mr. Turk served as our President of North American Operations from December 2010 to November 2013, Senior Vice President, Commercial Operations from January 2005 to December 2010 and Vice President, Sales and Marketing from May 2000 to January 2005. Mr. Turk brings a strong strategy and market development background to NxStage. Prior to joining NxStage, he served as Director of New Business Development at Boston Scientific Corporation, a medical device company. Before that, he was one of the leaders of the Midwest Health

 

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Care and Biotechnology Practice of McKinsey & Company, a management consulting firm, as a Senior Engagement Manager in the firm’s Chicago office. Mr. Turk received an AB in Economics from Wabash College and his MBA in Marketing and Finance from Northwestern University’s J.L. Kellogg School.

Where To Find More Information

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website (www.nxstage.com) under the “Investor Relations” subsection of the “Our Company” section of the site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or SEC. In addition, we intend to disclose on our website any amendments to, or waivers from, our code of business conduct and ethics that are required to be disclosed pursuant to the rules of the SEC. We are not including the information contained on our website as part of, or incorporating it by reference into, this report.

 

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Item 1A. Risk Factors

In addition to the factors discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report, the following are some of the important factors that could materially and adversely affect our business, financial condition, results of operations and common stock price and cause our actual results to differ materially from those projected in any forward-looking statements.

Risks Related to our Business

We expect to derive most of our future revenues from the System One and related products.

We expect to derive most of our future revenues from the sale or rental of the System One and the related products used with the System One, with the remainder of our revenues largely coming from the sale of a few key disposable products, including blood tubing sets and needles. To the extent that any of our primary products are not commercially successful or are withdrawn from the market for any reason, our revenues and business prospects will be adversely impacted.

The home dialysis market may be smaller than we expect and may be slow to develop.

We believe our largest product market opportunity is the home dialysis market. However, this market is presently very small and adoption of home hemodialysis therapies has been limited. Only 11% of U.S. chronic dialysis patients receive dialysis treatment at home, with most of such patients receiving peritoneal dialysis rather than home hemodialysis. Most dialysis centers presently do not have the infrastructure to support a significant home hemodialysis patient population. Our growth depends on a significant shift in patients’ and the medical community’s understanding and view of home hemodialysis, and will require a substantial increase in the number of patients who adopt home hemodialysis, physicians who are willing to prescribe home hemodialysis, and dialysis centers that are willing to support home hemodialysis. We operate a small number of dialysis centers focused on supporting home therapy with NxStage technology as part of our market development activities to increase home therapy access. We will need to continue to devote significant resources to expanding the market for our products, but these efforts ultimately may not be successful.

Because nearly all of our home hemodialysis patients are also receiving dialysis more frequently than the traditional thrice weekly treatment, market adoption of the System One for home hemodialysis is also dependent upon the penetration and market acceptance of more frequent hemodialysis. Given the increased provider costs associated with providing more frequent dialysis, market acceptance will be impacted, especially for U.S. Medicare patients, by whether dialysis centers obtain adequate reimbursement for additional dialysis treatments provided in excess of three times a week, which is discussed in the immediately following risk factor. New regulations particularly impacting home hemodialysis technologies may impede further market expansion of the System One for home hemodialysis. We saw the impact of such regulations in 2008, when the Centers for Medicare and Medicaid Services released new Conditions for Coverage that imposed water testing requirements on patients using our PureFlow SL product. These water testing requirements increased the burden of our therapy for patients and may have impaired market adoption, especially for our PureFlow SL product. To the extent additional regulations are introduced that are unique to the home environment, market adoption of the System One could be further impaired.

Current Medicare reimbursement rates, at three times per week, limit the price at which we can market our home hemodialysis products, and adverse changes to reimbursement would likely impede the adoption or continued sale of our home products.

Medicare provides broad and well-established reimbursement in the U.S. for treating end-stage renal disease patients with hemodialysis three times a week. Most patients using the System One in the home, however, treat themselves, with the help of a care partner, up to six times per week. Reimbursement for more frequent hemodialysis requires medical justification provided by the dialysis facility based on information from the

 

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patient’s physician. The total number of paid treatments may vary due to differing policies of Medicare contractors, as well as from varying center billing practices. Currently, only three of the Medicare contractor jurisdictions have formal local coverage determinations; the majority have not issued a local coverage determination and thus make coverage determinations on a case by case basis. One Medicare contractor without such a local coverage determination, Noridian Healthcare Solutions, recently issued a Medicare coverage article discussing considerations for hemodialysis frequency. Certain language in the coverage article is unclear or inconsistent with long-standing Medicare policy, including that reiterated in the 2015 Medicare payment rules, but it may suggest a limitation to coverage of more frequent hemodialysis, even with medical justification. In partnership with other provider, patient, and professional organizations, we have actively engaged Noridian on this question. It remains unclear how the article will be implemented. Some customers may not receive or pursue additional reimbursement in all cases, and providing the required medical justification for treatments beyond three times per week increases administrative burden. Although access to home and more frequent hemodialysis continues to grow, we believe that current Medicare reimbursement policies lead to adoption rates lower than rates commensurate with the percentage of patients experts believe can competently perform and medically benefit from this therapy. We believe that more predictable Medicare reimbursement for more frequent dialysis with less administrative burden, including further improving Medicare reimbursement for home hemodialysis training, would allow adoption of more frequent home hemodialysis at rates more consistent with what are deemed to be appropriate by the medical community. These beneficial changes, however, may never materialize. Conversely, any reduction in reimbursement rates or adverse changes in the reimbursement criteria for home or more frequent hemodialysis could materially reduce our revenues, earnings and cash flows.

In 2011, the Centers for Medicare and Medicaid Services implemented a new prospective payment system for dialysis treatment. Under the new prospective payment system, the Centers for Medicare and Medicaid Services makes a single bundled payment to the dialysis facility for each dialysis treatment that covers all renal dialysis services, inclusive of home dialysis and most drugs frequently administered to dialysis patients. This payment system replaced the former system which paid facilities a composite rate for a defined set of items and services, while paying separately for drugs, laboratory tests, and other services that were not included in the composite rate. With a vast majority of U.S. patients with end-stage renal disease covered by Medicare, the Medicare reimbursement rate is an important factor in a potential customer’s decision to use the System One or our other products and limits the prices we may charge for our products. It is also an important factor in the revenues received by our Kidney Care dialysis centers. A stated goal of the new prospective payment system was to encourage home dialysis. To date, it has not had a positive impact on the adoption of home or more frequent hemodialysis or the price of our products. However, the prospective payment system has had a significant positive impact on the adoption of peritoneal dialysis as evidenced by the significantly increased training rates for peritoneal dialysis. We believe this increased focus on peritoneal dialysis growth and peritoneal dialysis training has been to the detriment of home hemodialysis training rates, as home training resources, including home training nurses in particular, have been more devoted to peritoneal dialysis training, leaving less time for home hemodialysis training.

As part of the American Taxpayer Relief Act of 2012, Congress instructed the Centers for Medicare and Medicaid Services to recalculate the base payment rate under the prospective payment system for services furnished in 2014 and thereafter to account for changes in utilization of renal dialysis drugs since the prospective payment system was implemented. In response, the Centers for Medicare and Medicaid Services enacted a 12% reduction to the base payment rate to be implemented over a three- to four-year transition period, with overall payments for 2014 remaining unchanged. However, the Protecting Access to Medicare Act of 2014 replaced this phased-in reduction with reductions to the annual inflation adjustment to the base rate (known as the “market basket adjustment”) in 2015–2018. As a result, there is no reduction to the market basket adjustment in 2015, and the reduction is 1.25 percentage points in 2016 and 2017, and 1 percentage point in 2018. The effect of this change on the adoption of home and more frequent hemodialysis is not yet known.

 

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We have a history of net losses and a significant accumulated deficit, and we may be unable to become profitable or to sustain any profitability.

Since inception, we have incurred negative operating margins and losses every quarter. At December 31, 2014, we had an accumulated deficit of approximately $387.5 million. We expect our operating expenses to continue to increase as we grow and expand our business. While we have achieved positive gross profit for our products since the fourth quarter of 2007, we cannot provide assurance that our gross profit as a percentage of revenues will improve or, if it does improve, the rate at which it will improve. Achieving gross profit improvements will depend upon our ability to introduce additional process improvements and product design changes, further rationalize our manufacturing operations and supply chain, realize additional economies of scale, and continue to improve product reliability. We may not be successful at these and other cost reduction initiatives, and cannot provide assurance about achieving profitability, or the timing, extent or sustainability of such profitability.

Our customers in the System One and In-Center segments are highly consolidated and have concentrated buying power.

DaVita and Fresenius own and operate the two largest chains of dialysis centers in the United States. Collectively, these entities provide treatment to over two-thirds of U.S. dialysis patients, and this percentage may continue to grow with further market consolidation. These large dialysis providers have significant purchasing power and we may be required to grant them favorable pricing and other terms for our products that reduce our gross margins and have an adverse effect on our operating results.

The partial or complete loss of sales to DaVita or Fresenius would materially impair our financial results.

DaVita and Fresenius are our two largest customers, with sales to them representing approximately half of our total revenues during 2014. Our home market agreements with DaVita and Fresenius are intended to support the continued expansion of patient access to home hemodialysis with the System One, but like all our agreements with home market customers, these agreements are not requirements contracts and they contain no minimum purchase volumes. Our home market agreement with DaVita expires at the end of 2015 and our home market agreement with Fresenius expires at the end of 2016, and there can be no assurance that we will renew or extend these agreements on similar terms, if at all, before their expiration. We have no assurance that our sales to DaVita or Fresenius will continue to grow. Given the significance of DaVita and Fresenius as customers in the home market, any adverse change in either customer’s ordering or clinical practices, as might be the case in periodic contract negotiations or in response to the establishment of our NxStage Kidney Care dialysis centers, would have a significant adverse impact on our revenues.

We face additional risks from the acquisition or development of new lines of business, including in connection with establishing our NxStage Kidney Care dialysis centers.

In the course of evaluating growth opportunities, we may acquire or develop a new line of business or products. For example, we recently began establishing a small number of NxStage Kidney Care dialysis centers, which are dialysis centers focused on the provision of home therapy and flexible in-center options. There are substantial risks and uncertainties associated with any change in business lines or strategy, particularly in instances where our customers may perceive the new activity or business line to be in direct competition with their business, which could, in turn, lead them to stop or reduce their purchases of products from us. In addition to the external risks such new businesses or strategies may represent, we may face internal risks relating to developing knowledge of and experience in the new business and recruiting professionals, as well as business execution risks. New strategies and businesses may also require significant investment and involvement of our senior management, which will take away from the time they ordinarily spend on the remainder of our business.

If we make any strategic businesses acquisitions, we may encounter substantial integration risks that may prevent us from realizing the anticipated benefits of our acquisitions. These risks include:

 

   

difficulty in transitioning and integrating the operations and personnel of the acquired businesses, including with respect to differing and complex accounting and financial reporting systems;

 

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disruption of our ongoing business and distraction of management;

 

   

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;

 

   

difficulty in incorporating acquired technology and rights into our product and service offerings;

 

   

unanticipated expenses and delays in completing acquired development projects and technology integration;

 

   

difficulty in managing geographically remote units both in the United States and internationally;

 

   

impairment of relationships with partners and customers;

 

   

customers delaying purchases of our products pending resolution of product integration between our existing and our newly acquired products;

 

   

entering markets or types of businesses in which we have limited experience;

 

   

loss of key employees of the acquired company; and

 

   

inaccurate assumptions of the acquired company’s product or service quality.

Failure to manage the risks associated with the development and implementation of new businesses or strategies could materially and adversely affect our business, results of operations and financial condition.

Our NxStage Kidney Care dialysis centers introduce significant new risks to our business.

In addition to implicating some of the same business and regulatory risks as are applicable to our medical products business (including in particular risks related to reimbursement), establishing our NxStage Kidney Care dialysis centers requires that we comply with complex regulatory requirements applicable to this new business. As health care providers and participants in federal health care programs, our NxStage Kidney Care dialysis centers are subject to extensive government regulations, including:

 

   

Medicare and Medicaid payment rules, including coverage rules that limit the clinical circumstances under which payment will be made for more frequent dialysis treatments;

 

   

anti-kickback and related laws prohibiting payments and other remuneration intended to influence the referral of health care business or selection of a provider;

 

   

antitrust laws;

 

   

prohibitions on submitting false claims for government reimbursement;

 

   

laws regulating the use and disclosure of patient health information; and

 

   

laws regulating the storage and administration of pharmaceuticals and medical devices.

Violations of such laws and regulations may be punishable by criminal and civil sanctions against us, including fines and civil monetary penalties and exclusion from participation in government programs, including Medicare and Medicaid, as well as against executives overseeing our business. In addition to penalties for violation of laws and regulations, we could be required to repay amounts we received from government payors, or pay additional damages and interest, if we are found to have submitted improper claims for reimbursement to the government. Whether or not we have complied with the law, an investigation into alleged unlawful conduct could increase our expenses, damage our reputation, divert management time and attention and adversely affect our business.

We compete against other dialysis equipment manufacturers with much greater financial resources and established products and customer relationships, which may make it difficult for us to penetrate the market and achieve significant sales of our products.

Fresenius, our second largest customer, markets its own home hemodialysis system. Fresenius may at any time reduce its promotion of our dialysis products to its dialysis patients in favor of its own dialysis products.

 

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Fresenius has also indicated that it is seeking clearance for its sorbent technology within the critical care setting, and has suggested that it would seek clearance for its Portable Artificial Kidney to market in the United States for in-center use. Baxter obtained CE marking for a new home hemodialysis system in the European Union in December 2013 and has discussed its plans for a near-term European launch. Baxter has also discussed plans to complete additional clinical studies and file for regulatory approval for a home nocturnal hemodialysis indication in the United States. Other small companies are also working to develop products for this market. We are unable to predict when, if ever, any of these products may attain regulatory clearance and appear in the market, or how successful they may be should they be introduced, but the introduction of additional viable products to the home market could adversely affect our sales and growth.

The System One in the critical care market competes against products from Gambro, a subsidiary of Baxter, Fresenius, B. Braun Medical, Inc. and others. Our product lines in the in-center market compete directly against products produced by Fresenius, Nipro Medical Corporation, B. Braun, Baxter together with its subsidiary Gambro, JMS Co. Ltd. and others. Our competitors in each of these markets sell one or more FDA-cleared medical devices for the treatment of acute or chronic kidney failure. Each of these competitors offers products that have been in use for longer than the 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, including Fresenius which owns and operates a chain of dialysis centers. The product lines of most of these companies are broader than ours, enabling them to offer a broader bundle of products and have established sales forces and distribution channels that may afford them a significant competitive advantage. Further consolidation within the highly competitive dialysis industry, demonstrated most recently by Baxter’s acquisition of Gambro, may exacerbate these risks.

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 centers by large dialysis chains. If we are successful, our competitors are likely to develop products that offer features and functionality similar to our products, including the System One. Improvements in existing competitive products or the introduction of new competitive products may make it more difficult for us to compete for sales, particularly if those competitive products demonstrate better reliability, convenience or effectiveness or are offered at lower prices.

Our ability to successfully market our products could also be adversely affected by pharmacological and technological advances in preventing the progression of end-stage renal disease or in the treatment of acute kidney failure or fluid overload. If we are unable to effectively respond to and compete against competitors, alternative treatments and pharmacological and technological advances, it will be difficult for us to expand the market for, and achieve significant sales of, our products.

Our continued growth is dependent on our development and successful commercialization of new and improved products.

Our future success will depend in part on our timely development and introduction of new and improved products that address changing market requirements. To the extent that we fail to introduce new and innovative products, including without limitation the next generation System One, or incremental product improvements, we may lose revenues or market share to our competitors, which may be difficult to regain. Our inability, for technological, regulatory, operational or other reasons, to successfully develop and introduce new or improved products could reduce our growth rate or otherwise damage our business. Our developments may not keep pace with the marketplace and our new or improved products may not adequately meet the requirements of the marketplace.

The success and growth of our business will depend upon our ability to achieve expanded market acceptance of the System One.

In the home market, we have to convince five distinct constituencies involved in the choice of dialysis therapy, namely operators of dialysis centers, nephrologists, dialysis nurses, patients and payors (private payors

 

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and Medicare), that the System One provides an effective alternative to other existing dialysis equipment. In the in-center market, we have to convince most of the same constituencies that our blood tubing sets and needles provide an effective alternative to other dialysis disposables. In the critical care market, we have to convince hospital purchasing groups, hospitals, nephrologists, dialysis nurses and critical care nurses that our system provides an effective alternative to other existing dialysis equipment. Each of these constituencies use different considerations in reaching their decision. Lack of acceptance by any of these constituencies will make it difficult for us to grow our business.

We may have difficulty gaining widespread or rapid acceptance of any of our products, including the System One, for a number of reasons including:

 

   

our failure to demonstrate that our products are equivalent or superior to existing therapy options;

 

   

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 hospitals or dialysis centers;

 

   

our failure to continue to improve product reliability and the ease of use of our products;

 

   

limitations on the existing infrastructure in place to support home hemodialysis, including without limitation, home hemodialysis training nurses, and the willingness, costs associated with, and ability of dialysis centers to build that infrastructure;

 

   

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, easier to use or less expensive than ours;

 

   

regulations that impose additional burden on patients, such as the Medicare conditions for coverage which impose additional water testing requirements in connection with the use of our PureFlow SL;

 

   

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 availability of satisfactory reimbursement from healthcare payors.

If we are unable to convince additional hospitals and healthcare providers of the benefits of our products for the treatment of acute kidney failure and fluid overload, we will not be successful in increasing our market share in the critical care market.

We sell the System One in the critical care market for use in the treatment of kidney failure and fluid overload. Physicians currently treat most acute kidney failure patients using conventional hemodialysis systems or dialysis systems designed specifically for use in the intensive care unit. We will need to convince hospitals and healthcare providers that using the System One is as effective as using conventional or intensive care hemodialysis systems for treating acute kidney failure or fluid overload and that it provides advantages over conventional or intensive care systems because of its significantly smaller size, ease of operation and clinical flexibility. In addition, the impact of tightened credit markets on hospitals could impair the manner in which we sell products in the critical care market. Hospitals facing pressure to reduce capital spending may choose to delay capital equipment purchases or seek alternative financing options.

Our business and results of operations may be negatively impacted by general economic and financial market conditions and such conditions may increase other risks that affect our business.

Global macro-economic conditions and the world’s financial markets remain susceptible to significant stresses, resulting in reductions in available credit, foreign currency fluctuations and volatility in the valuations of securities generally. In general, we believe demand for our products in the home and in-center markets will not

 

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be substantially affected by overall economic conditions as regular dialysis is a life-sustaining, non-elective therapy. However, hospitals or clinics facing pressure to reduce capital spending may choose to rent equipment rather than purchase it outright, or to enter into other less-capital intensive purchase structures with us, which may, in turn, have a negative impact on our cash flows. Hospitals or clinics may address budget constraints by reducing staff, resulting in fewer personnel available to train new patients for home hemodialysis. Uncertainty in the general economic environment and governmental spending on public health programs may also lead to a reduction in hospital days (particularly those due to elective procedures) and delays in capital purchases, both of which could negatively impact our critical care business. Our ability to sell products internationally is particularly vulnerable to adverse impacts from global macro economic conditions. Government funded hospitals in various international markets may seek to defer capital purchases or tenders or reduce staff in response to economic pressures. Distributors with reduced access to capital may be less willing to purchase our equipment outright, impairing our ability to sell our products. Furthermore, unfavorable changes in foreign exchange rates versus the U.S. dollar would increase our product costs which would negatively impact our gross profit and gross profit as a percentage of revenues.

Healthcare reform legislation could adversely affect our revenue and financial condition.

In recent years, there have been numerous initiatives on the federal and state levels, and in foreign countries, for comprehensive reforms affecting the availability of and reimbursement for healthcare services. These initiatives have ranged from fundamental changes to federal and state healthcare reimbursement programs, such as providing comprehensive healthcare coverage to the public under governmental funded programs, to minor modifications to existing programs.

In 2010, comprehensive health care reform legislation was passed that, among other things, imposes a 2.3% excise tax on domestic sales of certain medical devices. Our profitability has been negatively impacted due to the medical device excise tax assessed on nearly all of our products sold in the United States since the beginning of 2013. Subsequent legislation required an adjustment to the Medicare payment rates starting in 2016. These changes could affect the adoption of home and more frequent hemodialysis in the future, particularly if NxStage customers are distracted in efforts to address any revenue shortfalls, or choose to redirect home training resources toward other center activities. Additional healthcare reforms in the United States may have a material adverse effect on our financial condition and results of operations.

The governments of foreign countries are actively pursuing similar actions intended to reduce costs related to provision of healthcare. The results of these actions may also have a material adverse effect on our financial condition and results of operations.

As our business continues to grow, we may have difficulty managing our growth and expanding our operations successfully.

As our business continues to grow, we will need to expand our manufacturing, sales and marketing and on-going development capabilities or contract with other organizations to provide these capabilities for us. As our operations expand, we expect that we will need to manage additional relationships with various partners, suppliers, manufacturers and other organizations. Our ability to manage our operations and growth requires us to continue to improve our information technology infrastructure, operational, financial and management controls and reporting systems and procedures. Such growth could place a strain on our administrative and operational infrastructure. We may not be able to make improvements to our information management and control systems in an efficient or timely manner and may discover deficiencies in existing systems and controls. Also, if demand for our products continues to grow we may not be able to increase our manufacturing capacity fast enough to meet customer demand.

If we are unable to maintain strong product reliability for our products, we may be unable to grow our business and achieve profitability.

Product reliability issues associated with any of our product lines could lead to decreases in customer satisfaction and our ability to grow or maintain our revenues and could negatively impact our reputation. Further,

 

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any unfavorable changes in product reliability would result in increased service and distribution costs which negatively impacts our gross profit and operating profit and increases our working capital requirements. We continue to work to maintain strong product reliability for all products. If we are unable to maintain strong product reliability for our existing products, our ability to achieve our growth objectives as well as profitability could be significantly impaired.

We also need to establish strong product reliability for all new products we offer. With new products, we are more exposed to risks relating to product quality and reliability until the manufacturing processes for these new products mature. We also choose from time to time to transition the manufacturing and supply of products and components to different suppliers or locations. As we make these changes, we are more exposed to risks relating to product quality and reliability until the manufacturing processes mature. Like all transitions of this nature, they could also lead us to incur additional costs in the near-term, which would negatively impact our gross profits in the near-term.

We have a significant amount of System One field equipment, and our inability to effectively manage this asset could negatively impact our working capital requirements and future profitability.

Because our home market relies upon an equipment service swap model and, for some of our customers, an equipment rental model, our ability to manage System One equipment is important to minimizing our working capital requirements. Both approaches require that we maintain a significant level of field equipment of the System One and PureFlow SL hardware. While a majority of our home market customers have committed to purchase, rather than rent, the significant majority of their future System One equipment requirements, there can be no assurance that we will be able to continue to expand or sustain this level of equipment placements that are purchased rather than rented. Any excess rental or service swap equipment would increase our ongoing cash requirements to fund working capital. 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 incur increased costs, realize increased cash requirements and have material write-offs of equipment. This would negatively impact our working capital requirements and future profitability.

We may be subject to litigation claims from time to time.

From time to time, we are threatened with individual actions involving our business, including without limitation products liability, employment, intellectual property, commercial and tort claims. The manufacture and marketing of medical devices, in particular, has an attendant risk of product liability claims. If any of our employees or products is found to have caused or contributed to injuries or deaths, we could be held liable for substantial damages. Any claims made against us could adversely affect our reputation, which could damage our position in the market. Claims can also 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.

While we maintain insurance at levels deemed adequate by management, future claims could exceed our insurance coverage.

We maintain insurance for property and general liability, directors’ and officers’ liability, product liability, malpractice related to NxStage Kidney Care dialysis centers, workers compensation, and other coverage in amounts and on terms deemed to be adequate by management based on our expectations for future claims. Future claims, however, may be brought against us that result in court judgments or settlements that exceed the limits of our insurance coverage. In addition, our insurance policies have various exclusions, and we may be subject to a claim for which we have no coverage. As a result, we may 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 any insurance, which may have a material adverse effect on our financial condition and results of operations.

 

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We face risks associated with having international operations, and if we are unable to manage these risks effectively, our business could suffer.

We operate manufacturing facilities in Germany, Italy and Mexico. We also purchase components, products and supplies from foreign vendors. We are subject to a number of risks and challenges that specifically relate to these international operations, and we may not be successful if we are unable to meet and overcome these challenges. Significant risks relate to foreign currency, in particular the euro and peso. To mitigate our foreign currency exposure we engage in hedging transactions on peso denominated expenses. To the extent we fail to control our exchange rate risk, our gross profit as a percentage of revenues and profitability could suffer and our ability to maintain mutually beneficial and profitable relationships with foreign vendors could be impaired. In addition to these risks, through our international operations we are exposed to costs and challenges associated with sourcing and shipping goods internationally and importing and exporting goods, difficulty managing operations in multiple locations, local regulations that may restrict or impair our ability to conduct our operations and increase compliance costs, health issues, such as pandemic disease risk, and natural disasters, such as flooding, hurricanes and earthquakes, which could disrupt our manufacturing and logistical and import activities. Risks associated with our international operations may increase where we sell our products and services directly rather than through distributors, such as in the United Kingdom. Furthermore, in certain locations, such as Mexico, we are also exposed to risks associated with local instability, including threats of violence, which could lead to disruptions in supply at our manufacturing facilities or key vendors.

Our In-Center segment relies heavily upon third-party distributors.

Substantially all of our products for the in-center market are sold through distributors. Relying on third-party distributors exposes us to many risks, including competitive pressure, compliance risks, credit risk and concentration. Distributors may sell products that compete with our products, and we may be unsuccessful in motivating our distributors to focus their efforts on selling our products. Any failure on the part of our distributors to comply with applicable laws in the sale and marketing of our products or to fulfill any responsibilities they may have to protect the intellectual property rights underlying our products could have an adverse effect on our revenues and involve us in legal proceedings. Distributors may face financial difficulties, including bankruptcy, which could harm our collection of accounts receivable and financial results. In addition, Gambro (a subsidiary of Baxter) and Henry Schein are our most significant distributors for the in-center market, and the loss of Gambro or Henry Schein as our distributors for any reason could materially adversely affect our business, at least in the near term. Our distribution agreement with Henry Schein expires on April 25, 2015, and we are negotiating the terms of a new distribution agreement with Henry Schein. If we are unsuccessful in renewing our distribution relationship with Henry Schein on mutually agreeable terms, transitioning this business to another distributor would adversely affect our business, at least in the near-term.

Unless we can demonstrate sufficient product differentiation in our In-Center segment products, we will continue to be susceptible to further pressures to reduce product pricing and more vulnerable to the loss of our blood tubing set or needle business to competitors in the dialysis industry.

Our blood tubing set and needle businesses have historically been commodities businesses. Our products continue to compete favorably in the dialysis blood tubing set and needle business, but are increasingly subject to pricing pressures, especially given recent market consolidation in the U.S. dialysis services industry, with Fresenius and DaVita collectively controlling over two-thirds of the U.S. dialysis services business. Unless we can successfully demonstrate to customers the differentiating features of our Streamline blood tubing set, MasterGuard needle, ButtonHole needle or products that we introduce in the future, we may continue to be susceptible to pressures to reduce our product pricing and more vulnerable to the loss of our blood tubing set and needle business to competitors in the dialysis industry.

 

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The success of our business depends on the services of each of our senior executives as well as certain key engineering, scientific, manufacturing, clinical and marketing personnel, the loss of whom could negatively affect our business.

Our success depends upon the skills, experience and efforts of our senior executives and other key personnel, including our research and development and manufacturing executives and managers. Much of our expertise is concentrated in relatively few employees, the loss of whom for any reason could negatively affect our business. Competition for our highly skilled employees is intense and we cannot prevent the future resignation of any employee. We maintain key person insurance for only our Chief Executive Officer.

If kidney transplantation becomes a viable treatment option for more patients with end-stage renal disease, or if medical or other solutions for renal replacement become viable, the market for our products may be limited.

While kidney transplantation is the treatment of choice for most patients with end-stage renal disease, 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 patients. The development of new medications designed to reduce the incidence of kidney transplant rejection, progress in using kidneys harvested from genetically engineered animals as a source of transplants or any other advances in kidney transplantation could limit the market for our products and services. The development of viable medical, pharmaceutical, or other solutions for renal replacement or prolonging kidney life may also limit the market for our products and services.

Risks Related to the Regulatory Environment

We cannot market or commercially distribute our products without obtaining and maintaining necessary regulatory clearances or approvals.

Our products are medical devices subject to extensive regulation in the United States. 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 clearance 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. We may be required to obtain 510(k) clearances or pre-market approvals for additional products, product modifications, or for new indications of our products. Regulatory pathways for such clearances may be difficult to define and could change. 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.

The FDA’s policies may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approval of our future products. Although the 510(k) regulation has not been formally changed, the FDA has announced that it is intending to implement modifications to the 510(k) process. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may lose any marketing approval that we may have obtained, which would adversely affect our business, prospects and the ability to sell and promote our products.

Our products are also subject to extensive regulation in foreign markets in which we are currently present or which we may wish to enter. The regulatory approval process outside the United States exposes us to many of the same risks associated with obtaining FDA clearance. Accordingly, we may be unable to obtain foreign regulatory approvals on a timely basis, if at all, which would limit our market expansion goals, and any existing foreign regulatory approvals may be curtailed, suspended or withdrawn, which would adversely affect our business. In addition, the regulatory approval procedure in foreign markets varies from country to country and requires that we comply with numerous regulatory requirements that differ from the FDA clearance process and are not

 

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superseded by obtaining clearance or approval from the FDA or another country’s regulatory authority. As these regulatory requirements become increasingly more stringent, it may become more difficult and costly for us to expand into new markets. In certain foreign markets, some of our products are classified as drugs rather than medical devices, which require us to demonstrate compliance with separate regulations applicable to drug manufacturers and distributors. These complex regulations may impose additional approval, manufacturing, surveillance and reporting requirements. Compliance with these additional requirements may increase our costs of doing business in new foreign markets and delay our entry into such markets.

New regulations affecting our business are periodically adopted in the United States and in other countries. These regulations may require us to change our existing product technologies, operating procedures or marketing practices in order to continue selling our products. This may expose us to increased costs, as well as risks that we may be unable to satisfy the new regulatory requirements. For example, extensive revisions to current EU medical device legislation, which is currently being discussed by the Council of the European Union, will impose significant additional obligations. If we are unable to comply with the new obligations imposed by the regulation, we may need to suspend, curtail or otherwise modify our selling and marketing efforts in the European Union. Any additional regulatory developments in the European Union or elsewhere may adversely affect our ability to market our existing products or introduce new products in a timely manner, which would have a negative impact on our business.

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.

In the United States, 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, require 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 and require such a submission. If the FDA requires us to submit a 510(k) for any modification to a previously cleared device, 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, and may be subject to fines or other sanctions for failing to obtain such clearance in advance. In the future, we intend to introduce new products and enhancements and improvements to existing products, which may not be cleared by the FDA in a timely manner, if at all. In addition, the FDA may characterize any new products or significantly modified marketed products in a class that requires submission of a more costly and lengthy pre-market approval application before commercial distribution would be permissible. Compared to 510(k) submissions, pre-market approval applications require substantially more data and their review by the FDA typically takes significantly longer. Also, products subject to pre-market approval applications require approval supplements for any change that affects safety and effectiveness before the modified device may be marketed. Delays in our receipt of regulatory clearance or approval will cause delays in our ability to sell our products, which will have a negative effect on the growth of our revenues.

Outside the United States, modifications to approved devices expose us to many of the same risks associated with modifications to 510(k) cleared devices. For example, in the European Union any substantial changes to a CE marked device may require a new conformity assessment and a new CE Certificate of Conformity from our notified body before the proposed change is implemented. There is limited guidance, however, on whether a change to a device should be considered substantial. Therefore, there is a risk that the competent authorities in the European Union or our notified body disagree with our assessment of the changes introduced to our products, and may come to a different conclusion than the FDA concerning such changes. Delays in conduct of any regulatory assessments in the European Union or elsewhere will cause delays in our ability to sell our products in those markets and will have a negative effect on our revenue growth.

 

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Even if we obtain the necessary regulatory 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.

Numerous regulatory requirements apply to our products following clearance or approval in the United States, European Union, and other markets, including regulations governing:

 

   

registration of medical devices;

 

   

pricing and reimbursement of medical devices;

 

   

establishment of post-marketing surveillance;

 

   

field safety corrective actions, including product recalls and withdrawals;

 

   

filing reports of device corrections and removals;

 

   

marketing and promotion of medical devices; and

 

   

interactions with physicians.

In addition, we are subject to the Medical Device Reporting 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 death or serious injury. Similar obligations are imposed in foreign countries.

Our failure to comply with these or other applicable regulatory requirements may result in enforcement measures being taken by regulatory authorities, which may include:

 

   

untitled letters, warning letters, fines, injunctions and civil penalties;

 

   

detention of medical devices believed to be adulterated or misbranded;

 

   

customer notification, or orders for repair, replacement or refund;

 

   

voluntary or mandatory recall, withdrawal or seizure of our products;

 

   

operating restrictions, partial suspension or total shutdown of production;

 

   

refusal to review or delay in issuing pre-market notification or pre-market approval submissions;

 

   

rescission of a regulatory clearance or approval that has already been granted;

 

   

refusal to issue export documentation or approval for our products;

 

   

suspension, withdrawal or variations of CE Certificates of Conformity or delay in obtaining new CE Certificates of Conformity;

 

   

refusal of entry for imported products, materials and components; and

 

   

criminal prosecution.

Such enforcement measures would require unanticipated expenditures to address or defend such actions and would have an adverse effect on the marketing of our products and, consequently, on our business and financial position.

Any market withdrawals or recalls of our products could expose us to product liability claims and harm our reputation and financial results.

Medical devices can experience performance problems in the field that require review and possible corrective action. The occurrence of component failures, manufacturing errors, design defects or labeling inadequacies affecting a medical device could lead to a government-mandated or voluntary recall by the device

 

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manufacturer, in particular when such deficiencies may endanger health. From time to time we have chosen to voluntarily recall certain products that we believed were mislabeled or otherwise defective. Although we do not believe that any of our recent recalls have had any long-term negative effect on our business, future recalls may materially divert management attention and financial resources, expose us to product liability or other claims, and harm our reputation with customers.

If we or our contract manufacturers fail to comply with the FDA’s Quality System Regulations and other quality system requirements, 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, must comply with the FDA’s Quality System Regulations which cover the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our devices. Foreign regulatory authorities impose similar obligations. The FDA enforces these regulations through periodic unannounced inspections of manufacturing facilities. We and our contract manufacturers have been subject to such inspections on multiple occasions and we anticipate additional inspections in the future. While our previous inspections have resulted in no significant observations, we cannot provide assurance that we can maintain a comparable level of regulatory compliance in the future at our facilities, or that 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 quality system inspection, the FDA, the notified body, or the competent authorities in the European Economic Area could take enforcement action, including:

 

   

issuing a public warning letter;

 

   

shutting down part or all of our manufacturing operations;

 

   

suspending or withdrawing our existing CE Certificates of Conformity;

 

   

embargoing the import of certain components;

 

   

ordering the recall or detention of our products;

 

   

refusing to approve new marketing applications or to issue new CE Certificates of Conformity;

 

   

instituting legal proceedings to detain, seize or enjoin the manufacture or distribution of our products; and

 

   

imposing administrative, civil or criminal penalties or other sanctions.

Any of these actions could harm our business, reputation and operating results.

We have obligations to protect the privacy and security of patient health information. Failure or perceived failure to comply with applicable federal and state requirements could subject us to criminal or civil penalties, and contractual liability.

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 System One supplies to home hemodialysis patients. We may learn patient names and be exposed to confidential patient health information when we provide training on our products to our customers’ staff. Our home hemodialysis patients may also call our customer service representatives directly and, during the call, disclose confidential patient health information. We also receive and maintain confidential patient health information in connection with the operation of our NxStage Kidney Care dialysis centers. 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 Health Insurance Portability and Accountability Act of 1996 and its implementing regulations, as amended under the Health Information Technology for Economic and Clinical

 

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Health Act, or HIPAA, governs the use and disclosure of confidential patient health information known as protected health information. HIPAA and the rules promulgated thereunder require certain entities to comply with established standards, including standards regarding the privacy and security of protected health information known as the HIPAA Privacy and Security Rules, and to provide notification following a data breach involving protected health information. We are subject to HIPAA with regard to certain aspects of our business. In addition, many other state and federal laws regulate the use and disclosure of health information, including state medical privacy laws, breach notification laws and federal and state consumer protection laws. In many cases, these laws are not necessarily preempted by HIPAA, particularly if they afford greater protection to the individual than does HIPAA.

Complying with these federal and state privacy and security requirements impose compliance related costs, subjects us to potential regulatory audits, and may restrict our business operations. These various laws may be subject to varying interpretations by courts and government agencies creating potentially complex compliance issues for our business. If we were to violate any of our legal obligations to safeguard any confidential patient health information or protected health information against improper use and disclosure, we could lose customers and be exposed to liability, including potential civil and criminal penalties under HIPAA and contractual liabilities, and our reputation and business could be harmed. Concerns or allegations about our practices with regard to the privacy or security of personal health information or other privacy-related matters, even if unfounded, could damage our reputation and harm our business.

We are also subject to laws and regulations in foreign countries covering data privacy and other protection of health and employee information that may be more onerous than corresponding U.S. laws. These regulations may require that we obtain individual consent before we collect or process any personal data, restrict our use or transfer of personal data, impose technical and organizational measures to ensure the security of personal data, and require that we notify regulatory agencies, individuals or the public about any data security breaches. As we expand our international operations, we may be required to expend significant time and resources to put in place additional mechanisms to ensure compliance with multiple data privacy laws. Failure to comply with these laws may result in significant fines and other administrative penalties and harm our business.

We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products in a manner not consistent with our products’ cleared indications for use or with other state or federal laws governing the promotion of our products.

Our promotional materials and other product labeling must comply with FDA rules and other applicable laws and regulations. If the FDA or other federal, state or foreign enforcement authorities determine that our promotional materials or other product labeling constitute promotion of an unapproved or uncleared use, it could request that we modify our materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine and criminal penalties. Promotional activities related to our NxStage Kidney Care dialysis centers also may be scrutinized. Other federal, state and foreign regulatory agencies, including the U.S. Federal Trade Commission, have issued guidelines and regulations that govern how we promote our products and services, including how we use endorsements and testimonials. If our promotional materials or activities are inconsistent with any of these guidelines or regulations, we could be subject to enforcement actions, which could result in significant fines, costs and penalties. Our reputation could also be damaged and the adoption of our products could be impaired.

Medical devices in the European Union may be promoted only for the intended purpose for which the devices have been CE marked. Failure to comply with this requirement could lead to the imposition of penalties by the competent authorities of the EU Member States. The penalties could include warnings, orders to discontinue the promotion of the medical device, seizure of the promotional materials and fines. Our promotional materials must also comply with various laws and codes of conduct developed by medical device industry bodies in the European Union governing promotional claims, comparative advertising, advertising of medical devices reimbursed by the national health insurance systems and advertising to the general public. If our promotional materials do not comply with these laws and industry codes we could be subject to penalties that could include significant fines. Our reputation could also be damaged and the adoption of our products could be impaired.

 

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We are subject to federal and state laws prohibiting “kickbacks” and false and fraudulent claims which, if violated, could subject us to substantial penalties.

The federal healthcare program Anti-Kickback Statute, and similar state laws, prohibit payments and other forms of remuneration that are intended to induce health care professionals or others either to refer patients or to purchase, lease, order or arrange for or recommend the purchase, lease or order of healthcare products or services. Other laws prohibit remuneration intended to induce patients to select a particular provider of services, including for dialysis. A number of states have enacted laws that require pharmaceutical and medical device companies to monitor and report payments, gifts and other remuneration made to physicians and other health care professionals and health care organizations. Some state statutes, most notably laws in Massachusetts and Vermont, impose outright bans on certain manufacturer gifts to physicians. Some of these laws, referred to as “aggregate spend” or “gift” laws, carry substantial fines if they are violated. In addition, under the federal Physician Payments Sunshine Act we must collect and report certain data on payments and other transfers of value to physicians and teaching hospitals, which became publicly available in 2014. It is widely anticipated that public reporting under the Sunshine Act will result in increased scrutiny of the financial relationships between industry, physicians and teaching hospitals.

These anti-kickback, public reporting and aggregate spend 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, including patients, of medical devices and services. They also impose additional administrative and compliance burdens on us. 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. For our NxStage Kidney Care dialysis centers, they also affect our arrangements with any joint venture partners in a position to refer patients, our medical directors and our patient billing and collection practices. Although we seek to structure such arrangements in compliance with all 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 we were to offer or pay inappropriate inducements to purchase, order or use our products or services, or to refer patients to our NxStage Kidney Care dialysis centers, we could be subject to a claim under the federal healthcare program Anti-Kickback Statute, the federal patient inducement prohibition or similar state laws. If we fail to comply with particular reporting requirements, we could be subject to penalties under applicable federal or state laws.

Other federal and state laws generally prohibit individuals or entities from knowingly presenting, or causing to be presented, claims for payments to Medicare, Medicaid or other third-party payors that are false or fraudulent, or for items or services that were not provided as claimed. Medical device 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, by providing improper financial inducements, 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 prescribing decisions, including the decision as to whether to order dialysis services more frequently than three times per week. In addition, our NxStage Kidney Care dialysis centers are directly subject to these laws with respect to the reimbursement claims they file with government payors. Potential false or fraudulent claim risk can arise from promoting and billing for services the government deems excessive or not medically necessary, as well as from other billing improprieties and from failure to timely return any identified overpayments. We are making every effort, including adhering strictly to guidelines in any local coverage determinations issued by Medicare contractors with jurisdiction over claims from any of our NxStage Kidney Care dialysis centers, to ensure that billing by our NxStage Kidney Care dialysis centers is proper and that physicians who order NxStage Kidney Care dialysis services fully document medical need for patients for whom more frequent than thrice weekly therapy is ordered. 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, physicians and patients concerning the benefits and potential coverage of more frequent therapy. Likewise, our financial relationships with customers, physicians,

 

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patients or others in a position to influence the purchase or use of our products may be subject to government scrutiny or be alleged or found to violate applicable fraud and abuse laws. False claims laws prescribe civil, criminal and administrative penalties for noncompliance, which can be substantial, and given the possibility of exclusion from participation in government health care programs, potentially crippling to the line of business involved. 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.

Increasingly, foreign countries are adopting laws similar in application and consequence to the anti-kickback, false claims and Sunshine Act laws in the United States. In the European Union, the provision of benefits or advantages to physicians to induce or encourage the prescription, recommendation, endorsement, purchase, supply, order or use of medical devices is prohibited. The provision of benefits or advantages to physicians is also governed by the national anti-bribery laws of the EU Member States. One such example is the UK Bribery Act. Increasingly, national laws or industry codes are imposing obligations of public disclosure of payments made to physicians in certain EU Member States. Moreover, agreements with physicians must often be the subject of prior notification and approval by the physician’s employer or competent professional organization or the competent authorities of the individual EU Member States. If we fail to comply with these laws we may face civil or criminal penalties. The negative consequences of any failure to comply with these laws may also harm our ability to operate in foreign countries and have a negative effect on our reputation that discourages third parties from doing business with us.

Foreign governments tend to impose strict price controls, which may adversely affect our future profitability.

We have begun to market the System One and certain of our other products internationally. 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 a device has been CE marked. To obtain reimbursement or pricing approval in some countries, we may be required to supply data that compares the cost-effectiveness of our products to other available therapies. If reimbursement of our products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, it may not be profitable to sell our products outside of the United States, which would negatively affect the long-term growth of our business. Furthermore, reimbursement provided for our products in other jurisdictions could change, positively or negatively. In the event reimbursements were to be negatively changed, such as in the United Kingdom where we sell our products directly, our ability to sell our products could be impaired.

If we violate import and export laws, or if laws governing our exemption from certain duties change, we could be subject to significant fines, liabilities or other adverse consequences.

We import into the United States disposable medical supplies from our manufacturing facilities and vendors located outside the United States. We have manufacturing facilities in Mexico, Germany and Italy and export various components and assemblies related to those operations. To a lesser but increasing degree, we also export finished goods from the United States to foreign countries. The import and export of these items are subject to extensive and complex laws and regulations. To the extent we fail to comply with these laws or regulations, or fail to interpret our obligations accurately, we may be subject to significant fines, liabilities, import holds and a disruption in our ability to deliver product, which could harm our business and operating results to suffer. To the extent there are modifications to the Generalized System of Preferences or cancellation of the Nairobi Protocol tariff classifications that apply to our products such that our products would be subject to duties, our profitability would also be negatively impacted.

Failure to comply with the U.S. Foreign Corrupt Practices Act, UK Anti-Bribery Act or similar anti-bribery laws in other countries could subject us to penalties and other adverse consequences.

We are subject to the U.S. Foreign Corrupt Practices Act which generally prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining

 

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business and requires companies to maintain accurate books and records and internal controls, including at foreign controlled subsidiaries. Through our international activities, we are also subject to the UK Anti-Bribery Act and other similar anti-bribery laws in other countries. While we have policies and procedures in place designed to promote compliance with such laws, our employees or other agents may nonetheless engage in prohibited conduct under these laws for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

If we violate environmental and occupational safety laws regulating the use of hazardous materials and medical waste, 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, and our NxStage Kidney Care dialysis centers produce medical waste in connection with providing dialysis services. Accordingly, we are subject to federal, state and local laws, as well as the laws of foreign countries, governing the use, handling and disposal of these materials. In the event of an accident or failure to comply with environmental or occupational safety laws, we could be held liable for resulting damages, and any such liability could exceed our insurance coverage.

Our business may be affected by U.S. government contracting risks.

We have agreements with Veterans Health Administration facilities and are one of the key subcontractors on a government contract to develop a portable medical device to treat sepsis. As a result, we must comply with and are affected by laws and regulations relating to the award, administration and performance of U.S. government contracts which, among other things, impose additional costs on our business. If we violate any of these laws or regulations, we may be liable for fines, penalties and any additional costs the government incurs in procuring replacement services, and we may be excluded from future U.S. government contracting.

Risks Related to Operations

We obtain some of our raw materials and production services from a single source or a limited group of suppliers, the loss of which may cause production delays and prevent us from delivering our products on a timely basis.

We depend upon a number of single-source suppliers for certain of our raw materials, components and finished goods, including the fiber used in our System One filters, our needles, premixed dialysate and sterile bags, as well as sterilization services. Some of our most critical single-source supply relationships are with Membrana and Laboratorios PiSA.

Membrana is our only supplier of the fiber used in our filters for System One products under an agreement that expires in December 2023, and contractually we cannot obtain an alternative source of fiber for our System One products. While our relationship with Asahi could afford us back-up supply in the event of supply disruptions at Membrana, we do not have the regulatory approvals necessary to use Asahi fiber in our System One cartridge in the United States and the performance of Asahi fiber in our System One has not yet been validated.

Laboratorios PiSA is our only supplier of premixed dialysate. Our supply agreement with Laboratorios PiSA extends through December 2019. We have committed to purchase from Laboratorios PiSA a minimum quantity of premixed dialysate over the term of the agreement. While we can purchase premixed dialysate from other qualified suppliers, any significant disruption in Laboratorios PiSA’s ability to supply premixed dialysate to us would impair our business, at least in the near term.

Our dependence upon these and other single-source suppliers of raw materials, components, finished goods and sterilization services 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

 

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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 end-stage renal disease and who need access to the System One and related disposables to continue their therapy.

Finding alternative sources for these raw materials, components, finished goods and sterilization services would be difficult and in many cases entail a significant amount of time, disruption and cost. Although we believe our supply chain has sufficient inventory of raw materials, components and finished goods to withstand a temporary disruption in supply from any single source supplier, any permanent or long-term disruption in supply from any single source supplier could lead to supply delays or interruptions which would damage our business and impair our reputation, at least in the near term.

Natural disasters, labor disputes and other adverse developments at our manufacturing facilities may cause production delays and prevent us from delivering our products on a timely basis.

We rely on our manufacturing facilities in Mexico, Italy and Germany for the production of our equipment and disposables. The loss of any of these facilities due to fire, natural disaster, war, power failure or other cause beyond our control could cause significant production delays, prevent us from meeting customer demand for our products, increase our product costs, impair our product quality or reliability, and result in substantially decreased revenues.

While we have labor agreements with our production employees in Mexico and Italy, we may experience strikes, work stoppages, work slowdowns, grievances, complaints, claims of unfair labor practices, other collective bargaining disputes, anti-union behavior, or other labor disputes at our manufacturing facilities. Some of our key single-source suppliers also have labor agreements in place, but nonetheless may be subject to similar risks related to labor disputes. Any such activity likely would cause production delays and prevent us from delivering our production commitments to customers, which could adversely affect our reputation and cause our business and operating results to suffer.

We do not have long-term supply contracts with many of our third-party suppliers.

We purchase raw materials and components from third-party suppliers, including some single-source suppliers, through purchase orders and do not have long-term supply contracts with many of our suppliers. Many of our suppliers are not obligated to perform services or supply products for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order. We do not maintain large volumes of inventory from most of our suppliers. If we inaccurately forecast demand for finished goods, we may be unable to meet customer demand which could harm our competitive position and reputation. In addition, if we fail to effectively manage our relationships with our suppliers, we may be required to change suppliers, which may be time consuming and lead to disruptions in our product supply. Although we believe our supply chain has sufficient inventory of raw materials, components and finished goods to withstand a temporary disruption in supply from any single-source supplier, any permanent or long-term disruption in supply from any single-source supplier could lead to supply delays or interruptions which would damage our business and impair our reputation, at least in the near term.

Increases in the price for resin, a key material in the manufacture of our products, could impair our ability to achieve profitability.

Resin is a key material in the manufacture of our products, including the System One cartridge. We currently source resin from a small number of suppliers. Periods of rising prices for crude oil, natural gas and other petrochemical intermediates from which resin is produced have resulted in significant price increases for this material, and similar periods of rising resin prices may occur in the future. Our contracts with customers restrict our ability to immediately pass on these price increases, and future pricing to customers may be insufficient to accommodate increasing resin costs. In addition, our overall cost reduction plans may not sufficiently offset the impact of increased resin costs, which could result in declining margins and operating results.

 

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Increasing fuel prices could impair our ability to achieve profitability.

We currently incur significant inbound and outbound distribution costs, which are dependent upon fuel prices. Increases in fuel prices could lead to increases in our distribution costs, which could impair our ability to achieve profitability.

Failure to protect our information technology infrastructure against cyber-based attacks, network security breaches, service interruptions, or data corruption could significantly disrupt our operations and adversely affect our business and operating results.

We rely on information technology and telephone networks and systems, including the Internet, to process and transmit sensitive electronic information and to manage or support a variety of business processes and activities, including sales, billing, customer service, procurement and supply chain, manufacturing, and distribution. We use enterprise information technology systems to record, process, and summarize financial information and results of operations for internal reporting purposes and to comply with regulatory, financial reporting, legal, and tax requirements. We are also in possession of confidential patient health information. Our information technology systems, some of which are managed by third-parties, may be susceptible to damage, disruptions or shutdowns due to computer viruses, attacks by computer hackers, failures during the process of upgrading or replacing software, databases or components thereof, power outages, hardware failures, telecommunication failures, user errors or catastrophic events. Despite the precautionary measures we have taken to prevent breakdowns in our information technology and telephone systems, if our systems suffer severe damage, disruption or shutdown and we are unable to effectively resolve the issues in a timely manner, we may be subject to material remediation expenses, reputational harm, and litigation, and our business and operating results may suffer significantly.

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:

 

   

prevent our competitors from duplicating our products;

 

   

prevent our competitors from gaining access to our proprietary information and technology; or

 

   

permit us to gain or maintain a competitive advantage.

These risks may increase in foreign countries whose laws do not protect intellectual property rights effectively or to the same extent as U.S. laws.

Any of our patents, including those we may license, may be challenged, invalidated, rendered unenforceable or circumvented. We may not prevail if our patents are challenged by competitors or other third parties. The U.S. federal courts or equivalent national courts or patent offices elsewhere may invalidate our patents, find them unenforceable, or narrow their scope. Furthermore, competitors may be able to design around our patents, or obtain patent protection for more effective technologies, designs or methods for treating kidney failure. If these developments were to occur, our products may become less competitive and sales of our products may decline.

We have filed numerous patent applications seeking protection of products and other inventions originating from our research and development. Our patent applications may not result in an issued patent, and any patents that are issued may not provide meaningful protection against competitors or competitive technologies.

 

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Our products could infringe the intellectual property rights of others, which may lead to costly litigation, result in substantial damages or royalty obligations, and prevent us from using technology that is essential to our products.

The medical device industry 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 for more than 30 years and our competitors hold a significant number of patents relating to kidney replacement devices, therapies, products and supplies. Competitors and other third parties may allege that our products or methods infringe their patents or other intellectual property rights, and the possibility of such infringement claims may increase as our business expands into new markets.

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 divert management and key personnel from other tasks important to the success of the business. In addition, intellectual property litigation or claims could require us to:

 

   

cease selling or using any of our products that incorporate the asserted intellectual property, which would adversely affect our revenues;

 

   

pay substantial damages for past use of the asserted intellectual property;

 

   

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

 

   

redesign or rename, in the case of trademark claims, our products to avoid infringing the intellectual property rights of third parties, which may not be possible and could be costly and time consuming if it is possible to do so.

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

In order to protect our proprietary technology and processes, we 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 may be unable to 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 have worked at other medical device companies focused on the development of dialysis products, including our competitors. 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 and harm to our reputation and be a distraction to management.

 

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Risks Related to our Common Stock

The market price of our common stock may fluctuate significantly.

There may be periods of volatility in the market price of our common stock that delay or prevent you from selling your common stock at or above the price you paid for it. Some of the factors that may cause the market price of our common stock to fluctuate include:

 

   

timing of market launch and market acceptance of our products;

 

   

timing of achieving profitability from operations;

 

   

changes in estimates of our financial results or recommendations by securities analysts or the failure to meet or exceed securities analysts’ expectations;

 

   

actual or anticipated variations in our quarterly operating results;

 

   

future debt or equity financings;

 

   

developments or disputes with key vendors or customers, or adverse changes to the purchasing patterns of key customers and distributors;

 

   

disruptions in product supply for any reason, including product recalls, our failure to appropriately forecast supply or demand, difficulties in moving products across international borders, or the failure of third party suppliers to produce needed products or components;

 

   

reports by officials or health or medical authorities, the general media or the FDA regarding the potential benefits of the System One, similar dialysis products distributed by other companies, or more frequent or home dialysis;

 

   

the FDA or foreign regulatory agencies and notified bodies declining to clear or approve our product candidates or to issue CE Certificates of Conformity, or delays in the FDA or other foreign regulatory agency and notified body review processes;

 

   

product recalls and withdrawals;

 

   

defaults under our material contracts, including without limitation our credit agreement;

 

   

regulatory developments in the United States and foreign countries;

 

   

changes in third-party healthcare reimbursements, particularly a decline in the level of Medicare reimbursement for dialysis treatments, or the willingness of Medicare contractors to pay for more than three treatments a week where medically justified;

 

   

litigation involving our company or our general industry;

 

   

announcements of technical innovations or new products by our competitors;

 

   

developments or disputes concerning our patents or other proprietary rights;

 

   

our ability to manufacture and supply our products to commercial standards;

 

   

significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors;

 

   

departures of key personnel;

 

   

investors’ general perception of our company, our products, the economy and general market conditions; and

 

   

the other risks and uncertainties described in these “Risk Factors.”

The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of individual companies. These broad market fluctuations may adversely affect the trading price of our common stock. In the past, following periods of volatility in the market price of a company’s

 

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securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm our profitability and reputation.

Provisions in our governing documents and under Delaware law may discourage potential acquisition proposals and changes in management that stockholders may favor.

Provisions in our charter and bylaws and under the corporation law of Delaware, where we are incorporated, may delay or prevent a takeover attempt that could be viewed as beneficial to stockholders who wish to receive a premium for their shares from a potential bidder. These provisions may also discourage stockholders from attempting to replace or remove members of our board of directors, which in turn may delay or prevent changes in our current management team that stockholders may favor. These provisions include:

 

   

a prohibition on stockholder actions by written consent;

 

   

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;

 

   

advance notice requirements for nominations of directors or stockholder proposals;

 

   

the requirement that board vacancies be filled by a majority of our directors then in office; and

 

   

the prohibition on 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.

If we obtain additional financing for acquisitions and other growth initiatives, it may reduce the market value of our common shares.

As part of our growth strategy, we may acquire other businesses and technologies and pursue additional business opportunities. To finance such activity, we may issue equity securities, which may dilute our existing stockholders, and incur debt, which may place restrictions on our business operations. Such financing activity may reduce the market value of our common shares and other securities, in particular if the initiatives being funded are not viewed favorably by our stockholders and are ultimately unsuccessful.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

Item 2. Properties

Our corporate headquarters are located at a facility in Lawrence, Massachusetts under a lease expiring in 2023 that will allow us to lease up to 141,000 square feet over a period of eight years. The facility is also used for research and development, general and administrative support functions, customer service and IT support services.

We have a manufacturing facility totaling 238,161 square feet in Tijuana, Mexico under leases that expire beginning in 2016 that supports both our System One and In-Center segments.

We have a 36,300 square foot manufacturing facility in Modena, Italy, a majority of which we own with the remainder subject to leases that expire beginning in 2018. This facility supports our System One and In-Center segments.

 

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We have a 12,369 square foot manufacturing and research and development facility in Rosdorf, Germany under a lease that expires in December 2015 and is subject to annual renewals. This facility principally supports our System One segment.

We operate a 50,110 square foot manufacturing facility owned by Asahi in Goettingen, Germany where we manufacturer products for our System One segment and for sale to Asahi.

We lease clinical and office space for all of our NxStage Kidney Care dialysis centers under leases that expire from 2018 to 2022. Our centers range in size from approximately 4,200 to 8,000 square feet, with an average size of approximately 6,300 square feet.

We believe that our existing facilities are adequate for our current needs and that suitable additional or alternative space will be available on commercially reasonable terms at such time as it becomes needed.

 

Item 3. Legal Proceedings

Not applicable.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is quoted on the NASDAQ Global Select Market under the symbol “NXTM”. The following table sets forth, for the periods indicated, the high and low sales prices of our common stock.

 

     High      Low  

2014

     

First Quarter

   $ 15.00       $ 9.92   

Second Quarter

   $ 14.85       $ 10.69   

Third Quarter

   $ 15.65       $ 11.50   

Fourth Quarter

   $ 18.98       $ 12.71   

2013

     

First Quarter

   $ 12.32       $ 10.35   

Second Quarter

   $ 14.64       $ 10.61   

Third Quarter

   $ 14.51       $ 12.28   

Fourth Quarter

   $ 14.08       $ 8.77   

Holders

As of February 17, 2015, there were approximately 53 holders of record of our common stock.

Dividends

We have never paid or declared any cash dividends on our common stock. We anticipate that we will retain our earnings for future growth and therefore do not anticipate paying cash dividends in the foreseeable future. Our revolving line of credit with General Electric Capital Corporation and Silicon Valley Bank restricts our ability to pay cash dividends while borrowings are outstanding. For more information about this revolving line of credit, please see Note 8, Debt and Capital Lease Obligations to our consolidated financial statements included in this Annual Report.

 

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Comparative Stock Performance Graph

The graph below compares the five-year cumulative total stockholder return on our common stock, the Total Return Index for the NASDAQ Stock Market (U.S. Companies), which we refer to as the NASDAQ Composite Index, and the NASDAQ Medical Equipment Index assuming the investment of $100.00 on December 31, 2009 with dividends being reinvested. Measurement points are the last trading days of each quarter during such five-year period.

 

LOGO

Issuer Purchases of Equity Securities

During November 2014, we repurchased 98,398 shares of our common stock at a price of $17.61 per share that were delivered in payment for the exercise of employee stock options. See Note 14 to our consolidated financial statements included in this Annual Report.

 

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Item 6. Selected Financial Data

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read together with the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes to those consolidated financial statements included elsewhere in this Annual Report. The selected statements of comprehensive loss data for the years ended December 31, 2014, 2013 and 2012 and balance sheet data as of December 31, 2014 and 2013 set forth below have been derived from our audited consolidated financial statements included elsewhere in this Annual Report. The selected statements of comprehensive loss data for the years ended December 31, 2011 and 2010 and balance sheet data as of December 31, 2012, 2011 and 2010 set forth below have been derived from the audited consolidated financial statements for such years included in prior Annual Reports on Form 10-K.

 

     Years Ended December 31,  
     2014     2013     2012     2011     2010  
     (In thousands, except per share data)  

Statement of Comprehensive Loss Data:

          

Revenues

   $ 301,501      $ 263,429      $ 242,132      $ 217,256      $ 179,218   

Cost of revenues

     185,598        160,926        149,324        139,648        121,091   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     115,903        102,503        92,808        77,608        58,127   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

          

Selling and marketing

     55,385        47,842        40,485        37,550        34,166   

Research and development

     22,635        18,887        17,111        14,437        12,900   

Distribution

     26,001        21,246        18,888        17,916        14,751   

General and administrative

     34,069        32,326        27,530        23,206        22,774   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     138,090        120,301        104,014        93,109        84,591   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (22,187     (17,798     (11,206     (15,501     (26,464

Other expense, net

     (873     (1,008     (2,914     (5,002     (4,480
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss before income taxes

     (23,060     (18,806     (14,120     (20,503     (30,944

Provision for (benefit from) income taxes

     1,253        (245     1,033        899        768   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (24,313     (18,561     (15,153     (21,402     (31,712
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: Net loss attributable to noncontrolling interests

     (367                            
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to stockholders of NxStage Medical, Inc.

   $ (23,946     (18,561   $ (15,153   $ (21,402   $ (31,712
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share, basic and diluted

   $ (0.39   $ (0.31   $ (0.26   $ (0.39   $ (0.66
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding, basic and diluted

     61,700        60,261        57,890        54,217        48,188   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     December 31,  
     2014     2013     2012     2011     2010  
     (In thousands)  

Balance Sheet Data:

          

Cash and cash equivalents

   $ 52,884      $ 84,134      $ 106,439      $ 102,909      $ 104,339   

Working capital

     84,395        108,513        122,235        123,470        119,089   

Total assets

     309,726        306,962        311,949        291,708        286,094   

Long-term liabilities(1)

     73,415        74,594        75,126        109,723        97,574   

Accumulated deficit

     (387,488     (363,542     (344,981     (329,828     (308,426

Total stockholders’ equity(1)(2)

   $ 191,555      $ 194,761      $ 197,591      $ 151,186      $ 152,129   

 

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(1) In May 2012, we repaid in full all principal and interest in the aggregate amount of $45.2 million under our term loan and security agreement with Asahi through the issuance of 2.5 million shares of our common stock.

 

(2) In November 2010, we issued and sold 3.7 million shares of common stock pursuant to an underwriting agreement with Canaccord Genuity. Net proceeds from the sale were $73.4 million.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The results of our operations are included in three separately reportable business segments, System One, In-Center, and Services. Other business activities relate primarily to the manufacturing of dialyzers for sale to Asahi, and research and development and general and administrative expenses that are excluded from the segment operating performance measures. In the System One segment we derive our revenues from the sale and rental of the System One and PureFlow SL dialysate preparation equipment and the sale of disposable products in the home and critical care markets. The home market is devoted to the treatment of ESRD patients in the home or a home-like setting, while the critical care market is devoted to the treatment of hospital-based patients with acute kidney failure or fluid overload. In the In-Center segment, we derive our revenues from the sale of blood tubing sets and needles for hemodialysis primarily for the treatment of ESRD patients at dialysis centers, and needles for apheresis. Our Services segment includes revenues from dialysis services provided to patients at our recently opened NxStage Kidney Care dialysis centers.

Financial Performance

The following table summarizes our consolidated results (in thousands, except percentages).

 

     Twelve Months Ended December 31,  
     2014     2013     2012  

System One, In-Center and Other

      

Revenues

   $ 300,598      $ 263,077      $ 242,132   

Gross profit

   $ 123,011      $ 103,295      $ 92,808   

Gross margin percentage

     41     39     38

Loss from operations

   $ (7,261   $ (12,108   $ (9,988

Services

      

Revenues

   $ 1,749      $ 352      $   

Gross profit

   $ (7,108   $ (792   $   

Gross margin percentage

     n/a        n/a        n/a   

Loss from operations

   $ (14,926   $ (5,690   $ (1,218

Eliminations

      

Elimination of intersegment revenues

   $ (846   $      $   

Total Company

      

Revenues

   $ 301,501      $ 263,429      $ 242,132   

Gross profit

   $ 115,903      $ 102,503      $ 92,808   

Gross margin percentage

     38     39     38

Loss from operations

   $ (22,187   $ (17,798   $ (11,206

For several years, we have focused on operating and financial improvements. These efforts resulted in annual revenue growth of 14% during 2014 and 9% during 2013, with our home and critical care markets each driving growth. While driving continued improvements will remain an area of focus in 2015 and beyond within our System One and In-Center segments, at the same time, we expect to make significant investments in our

 

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Services segment. We expect that these investments will have a negative impact on our total operating performance in the near term and may offset performance improvements we expect in our System One and In-Center segments.

Statement of Comprehensive Loss Components

Revenues

In the System One segment we derive our revenues from the sale and rental of equipment and the sale of disposable products in the home and critical care markets. In the home market, customers purchase or rent the System One equipment, including cycler and PureFlow SL, and then purchase the related disposable products based on a specific patient prescription. In the critical care market, we sell or rent the System One and sell related disposables to hospital customers. In the In-Center segment, we derive our revenues from the sale of needles and blood tubing sets. Nearly all of our sales in the In-Center segment are through supply and distribution contracts with distributors. Our Services segment includes revenues from dialysis services provided to patients at our recently opened NxStage Kidney Care dialysis centers.

In the home market, the majority of our revenue is derived from recurring sales of disposable products. For customers that purchase the System One, we recognize revenue from the equipment sale ratably over the expected service obligation period. For customers that rent the System One, we recognize revenue on a monthly basis. We recognize revenues related to the disposable products upon delivery. Over time, as more home patients are treated with the System One and more systems are placed in patient homes, we expect to derive a growing recurring revenue stream from the sale of related disposables.

Our contracts with dialysis centers in the home market for ESRD home dialysis patients generally include terms providing for the sale of disposable products to accommodate up to the number of prescribed treatments per month per patient and the purchase or monthly rental of System One cyclers and, in most instances, our PureFlow SL equipment. These contracts typically have a term of one to seven years, and may be renewed on a month-to-month basis thereafter, subject to a 30-day termination notice. Under these contracts, if home hemodialysis is prescribed, supplies are shipped directly to patient homes and paid for by the treating dialysis center. We also include vacation delivery terms, providing for the shipment of products to a designated vacation destination for a specified number of vacation days. We derive a small amount of revenues from the sale of supplementary products and services such as equipment maintenance and service fees, ancillaries, reserve inventory and special deliveries.

In the critical care market we recognize revenues upon delivery in accordance with contract terms. Our contracts with hospitals generally include terms providing for the sale of our System One equipment and disposables, although we also provide an equipment rental option. These contracts typically have a term of one year. We derive a small amount of revenues from the sale of one- and two-year service contracts following the expiration of our standard one-year warranty period for System One equipment. To further support service in the critical care market, we have a bio-medical training program, whereby we train bio-medical engineers on how to service and repair certain aspects of the System One in the critical care setting. Bio-medical training is typically provided under a two-year contract following the expiration of our standard one-year warranty period for System One equipment. As more System One equipment is placed within hospitals, we expect to continue to derive a growing recurring revenue stream from the sale of disposable cartridges and fluids as well as, to a much lesser degree, from service and bio-medical training contracts.

In the In-Center segment nearly all sales to end users are structured through supply and distribution contracts with several significant distributors; however, in many instances we have direct contractual relationships with our end user customers. These contracts typically contain minimum volume commitments with negotiated pricing triggers at different volume tiers. Revenue is recognized upon delivery in accordance with contract terms.

 

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The majority of our revenues have been generated from sales to customers in the U.S. We sell our System One and certain of our other products internationally through direct sales in the UK and Canada and through distributors in other countries. We recognize revenues from equipment sales to our international distributors at the time of shipment or, if applicable, delivery in accordance with contract terms. Disposable product revenues are recognized upon delivery. We also manufacture and sell dialyzers to Asahi and recognize revenues at the time of shipment in accordance with contract terms.

Revenues in our Services segment are derived from dialysis care services provided to patients at our recently opened NxStage Kidney Care dialysis centers.

We offer certain customers rebates based on sales to specific end users and discounts for early payment. Our revenues are presented net of these rebates and discounts. For our System One segment, as of December 31, 2014, we had $2.0 million reserved against trade accounts receivable for future rebates and discounts and recorded $9.1 million, $6.8 million and $5.5 million during 2014, 2013 and 2012, respectively, as a reduction of revenues in connection with rebates and discounts. For our In-Center segment, as of December 31, 2014, we had $4.4 million reserved against trade accounts receivable for future rebates and discounts and recorded $8.7 million, $6.9 million, and $6.4 million during 2014, 2013 and 2012, respectively, as a reduction of revenues in connection with rebates and discounts.

Cost of Revenues

Cost of revenues consists primarily of direct product costs, material and labor required to manufacture our products, service of System One equipment that we sell or rent to customers and manufacturing overhead. It also includes the cost of servicing, repairing, and inspecting System One equipment prior to sale or during the warranty period, patient care costs at our NxStage Kidney Care dialysis centers and stock-based compensation for certain personnel. The cost of our products depends on several factors, including the efficiency of our manufacturing operations, the cost at which we can obtain labor and products from third-party suppliers, product reliability and related servicing costs and the design of our products.

Operating Expenses

Selling and Marketing.    Selling and marketing expenses consist primarily of salary, benefits and stock-based compensation for sales, marketing, and business development personnel, travel, promotional and marketing materials and other expenses associated with providing clinical training to our customers. Included in selling and marketing are the costs of clinical educators, usually nurses, we employ to teach our customers about our products and prepare our customers to instruct their patients and their partners in the operation of our products, customer service and technical support personnel. Also included in this category are the personnel and other costs associated with our market development activities to establish, develop and operate NxStage Kidney Care dialysis centers, including administrative support functions directly related to the startup and support of this initiative.

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.

Distribution.    Distribution expenses include the freight costs of delivering our products to our customers or our customers’ patients, depending on the market and the specific agreements with our customers, salary, benefits and stock-based compensation for distribution personnel and the cost of any equipment lost or damaged in the distribution process. We use common carriers and freight companies to deliver our products and do not operate our own delivery service. Also included in this category are the expenses of shipping products under warranty from customers back to our service center for repair and the related expense of shipping a replacement product to our customers or their patients.

 

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General and Administrative.    General and administrative expenses consist primarily of salary, benefits and stock-based compensation for our executive management, legal and finance and accounting staff, fees of outside legal counsel, fees for our annual audit and tax services, and general expenses to operate the business, including insurance and other corporate-related expenses. Also included in general and administrative expenses, beginning in 2013, are tax expenses incurred related to the medical device excise tax.

Comparison of Years Ended December 31, 2014 and 2013

Revenues

Our revenues for 2014 and 2013 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2014     2013  

System One segment

          

Home

   $ 157,822         52   $ 132,944         50

Critical Care

     55,609         19     43,812         17
  

 

 

    

 

 

   

 

 

    

 

 

 

Total System One segment

     213,431         71     176,756         67

In-Center segment

     78,885         26     81,852         31

Other

     8,282         3     4,469         2
  

 

 

    

 

 

   

 

 

    

 

 

 

Products subtotal

     300,598         100     263,077         100

Services segment

     1,749             352        

Elimination of intersegment revenues

     (846                 
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 301,501         100   $ 263,429         100
  

 

 

    

 

 

   

 

 

    

 

 

 

In the home market, revenues increased $24.9 million, or 19%, during 2014 compared to 2013. This increase was driven primarily by the increase in the number of patients prescribed to use the System One both in the U.S. and internationally. We expect future demand for our products and revenue growth in the home market to be strong as we further penetrate this market, both in the U.S. and internationally, and leverage the annuity nature of our business. As our international business grows, our System One revenue will be susceptible to fluctuations in equipment sales and changes in inventory levels at our international distributors.

Critical care market revenues increased $11.8 million, or 27%, during 2014 compared to 2013, driven by higher sales of disposables from our growing base of System One equipment placed with our customers coupled with increased sales of System One equipment. We expect future demand for our products and revenue growth to be strong as we seek to further penetrate this market and leverage the annuity nature of our business. However, sales of our System One equipment in the critical care market may fluctuate due to timing of sales and the overall capital spending environment of our customers.

In-Center segment revenues decreased $3.0 million, or 4%, during 2014 compared to 2013, driven by lower needle sales consistent with the wind down of the DaVita needle purchase agreement, contractual pricing and changes in inventory levels at our distributors. In-Center segment revenues are expected to decrease at least in the near term as a result of the expiration of DaVita’s needle purchase agreement in December 2014. Additionally, future revenues will fluctuate as a result of increased competition and variations in inventory management policies with both our distributors and end users.

Other revenues for 2014 and 2013 relate primarily to dialyzers sold to Asahi which have increased as we continue to ramp-up production capacity at the new manufacturing plant in Germany which commenced operations in late 2012. Sales to Asahi may fluctuate due to timing of sales, inventory management policies at Asahi and changes in currency rates.

 

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Service segment revenues for 2014 and 2013 relate to dialysis services provided to patients at our recently opened NxStage Kidney Care dialysis centers. We expect future revenues to increase modestly as we work towards attracting additional patients to our centers.

Gross Profit (Loss)

Our gross profit (loss) and gross profit (loss) as a percentage of revenues for 2014 and 2013 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2014     2013  

System One segment

   $ 102,420         48   $ 80,585         46

In-Center segment

     20,765         26     24,088         29
  

 

 

      

 

 

    

Subtotal

     123,185         42     104,673         40

Other

     (174      n/a        (1,378      n/a   
  

 

 

      

 

 

    

Products subtotal

     123,011         41     103,295         39

Services segment

     (7,108      n/a        (792      n/a   
  

 

 

      

 

 

    

Gross profit

   $ 115,903         38   $ 102,503         39
  

 

 

      

 

 

    

Gross profit as a percentage of revenues for the System One segment increased versus 2013 driven by favorable product mix, contractual price improvements, and manufacturing efficiencies, partially offset by higher product and service costs and unfavorable currency exchange rate changes versus the U.S. Dollar. We expect to continue to see improvements in gross profit as a percentage of revenue in our System One segment as we lower costs through process improvements and product design changes, increase volume, and rationalize our manufacturing operations.

Gross profit as a percentage of revenues for the In-Center segment decreased versus 2013 driven primarily by contractual pricing and lower volumes. We expect gross profit as a percentage of revenues to decline, at least in the near term, as a result of changes in product mix.

The Other category relates to costs associated with the manufacturing of dialyzers for sale to Asahi, which should provide us with long term cost efficiencies through increased dialyzer production volumes. These cost efficiencies may be offset in the short-term as we incur additional costs to expand capacity in this facility.

The negative gross profit as a percentage of revenues incurred by our Services segment was driven by costs associated with starting up our NxStage Kidney Care dialysis centers. We expect the Services segment gross margin will continue to be negatively impacted by costs associated with the development of our NxStage Kidney Care dialysis centers.

In aggregate, total company gross profit as a percentage of revenues will be negatively impacted, at least in the near-term, by costs associated with our continued investment in our Services segment and may be offset by other factors including increased freight costs and services costs and unfavorable product mix.

 

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Selling and Marketing

Our selling and marketing expenses and selling and marketing expenses as a percentage of revenues for 2014 and 2013 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2014     2013  

System One segment

   $ 41,763         20   $ 37,691         21

In-Center segment

     5,804         7     5,253         6
  

 

 

      

 

 

    

Products subtotal

     47,567         16     42,944         16

Services segment

     7,818         n/a        4,898         n/a   
  

 

 

      

 

 

    

Total Selling and marketing

   $ 55,385         18   $ 47,842         18
  

 

 

      

 

 

    

Selling and marketing expenses increased $7.5 million, or 16%, during 2014 compared to 2013 but remained consistent as a percentage of revenues.

Selling and marketing expenses for the System One and In-Center segments increased due to increased personnel and personnel-related costs and increased spending due to expanded marketing programs but remained consistent in total as a percentage of revenues during 2014 compared to 2013.

Selling and marketing expenses for our Services segment increased due to increased expenses for personnel and other costs associated with our market development activities to establish, develop and operate NxStage Kidney Care dialysis centers, including administrative support functions directly related to the startup and support of this initiative.

We anticipate that selling and marketing expenses will continue to increase but remain relatively consistent as a percentage of revenues as we broaden our marketing and market development initiatives, including with respect to NxStage Kidney Care, increase public awareness of the System One in the home market and support growth in international markets.

Research and Development

Our research and development expenses and research and development expenses as a percentage of revenues for 2014 and 2013 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2014     2013  

Research and development

   $ 22,635         8   $ 18,887         7
  

 

 

      

 

 

    

Research and development expenses increased $3.7 million, or 20%, during 2014 compared to 2013. The increase was primarily due to increased personnel and personnel-related costs and increased project related spending. Further, research and development costs for 2013 included a incremental benefit of $0.4 million related to the recognition of a tax incentive received from the Massachusetts Life Sciences Center.

For the near term, we expect research and development expenses will increase as we seek to further develop and enhance the System One, invest in our next generation hemodialysis system, invest in our peritoneal dialysis product development program and expand our product portfolio but will remain consistent as a percentage of revenues.

 

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Distribution

Our distribution expenses and distribution expenses as a percentage of revenues for 2014 and 2013 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2014     2013  

System One segment

   $ 23,855         11   $ 18,858         11

In-Center segment

     2,146         3     2,388         3
  

 

 

      

 

 

    

Total Distribution

   $ 26,001         9   $ 21,246         8
  

 

 

      

 

 

    

Distribution expenses increased $4.8 million, or 22%, during 2014 compared to 2013 driven mainly by increased shipment volumes; however, it has remained relatively consistent as a percentage of revenues during 2014 compared to 2013 in both segments. We expect that distribution expenses will remain consistent as a percentage of revenues at least in the near term.

General and Administrative

Our general and administrative expenses and general and administrative expenses as a percentage of revenues for 2014 and 2013 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2014     2013  

General and administrative

   $ 34,069         11   $ 32,326         12
  

 

 

      

 

 

    

General and administrative expenses increased $1.7 million, or 5%, during 2014 compared to 2013. The increase in general and administrative expenses was due to increased personnel and personnel-related costs and other related infrastructure costs and higher medical device excise tax expense driven by an increase in the amount of our products sold on which the tax is assessed, partially offset by lower professional service fees.

Other Expense

Interest expense increased $0.3 million during 2014 compared to 2013. Interest expense includes interest costs and other fees related to our debt obligations, including our capital lease obligations.

The change in other expense, net is derived primarily by foreign currency gains and losses.

Provision for Income Taxes

We recognized a provision for income taxes during 2014 and 2013 related to the profitable operations of certain foreign subsidiaries. However, the 2013 provision was offset by the recognition of a $1.2 million gain resulting from the favorable conclusion of a foreign income tax audit and a gain related to a foreign legislative change. Refer to Note 11, Income Taxes, to our consolidated financial statements included in this Annual Report for further discussion of our tax positions.

 

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Comparison of Years Ended December 31, 2013 and 2012

Revenues

Our revenues for 2013 and 2012 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2013     2012  

System One segment

          

Home

   $ 132,944         50   $ 123,589         51

Critical Care

     43,812         17     39,540         16
  

 

 

    

 

 

   

 

 

    

 

 

 

Total System One segment

     176,756         67     163,129         67

In-Center segment

     81,852         31     76,927         32

Other

     4,469         2     2,076         1
  

 

 

    

 

 

   

 

 

    

 

 

 

Products subtotal

     263,077         100     242,132         100

Services segment

     352                    

Elimination of intersegment revenues

                        
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 263,429         100   $ 242,132         100
  

 

 

    

 

 

   

 

 

    

 

 

 

In the home market, revenues increased $9.4 million, or 8%, during 2013 compared to 2012, driven by the increase in the number of patients prescribed to use, and centers offering, the System One, partially offset by lower deferred revenue recognized on previously sold System One equipment in the U.S. home market as a result of equipment reaching the end of its related revenue amortization period. These results also reflect a one-time reduction in revenue due to the transition of our UK business to a direct sales model from a distributor relationship in the first quarter of 2013. We have increased both the number of patients at existing centers and centers offering the System One, primarily through our existing relationships with service providers, including DaVita and Fresenius, and through our direct to patient marketing efforts. Critical care market revenues increased $4.3 million, or 11%, during 2013 compared to 2012, driven by higher sales of System One disposables and equipment. Sales of our System One equipment in the critical care market may fluctuate due to timing of sales and the overall capital spending environment.

In-Center segment revenues increased $4.9 million, or 6%, during 2013 compared to 2012, driven by increased end user demand and contractual price improvements.

Other revenues for 2013 and 2012 relate primarily to dialyzers sold to Asahi.

Service segment revenues relate to dialysis services provided to patients at our recently opened NxStage Kidney Care dialysis centers.

Gross Profit

Our gross profit (loss) and gross profit (loss) as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2013     2012  

System One segment

   $ 80,585         46   $ 74,402         46

In-Center segment

     24,088         29     19,153         25
  

 

 

      

 

 

    

Subtotal

     104,673         40     93,555         39

Other

     (1,378      n/a        (747      n/a   
  

 

 

      

 

 

    

Products subtotal

     103,295         39     92,808         38

Services segment

     (792      n/a                n/a   
  

 

 

      

 

 

    

Gross profit

   $ 102,503         39   $ 92,808         38
  

 

 

      

 

 

    

 

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Gross profit increased $9.7 million, or 10%, and increased as an overall percentage of revenue during 2013 compared to 2012.

Gross profit in the System One segment increased $6.2 million or 8% versus 2012 as a result of increased revenue. Gross profit as a percentage of revenue was negatively impacted by costs associated with the start-up of the new dialyzer plant in Germany. Gross profit for the In-Center segment increased $4.9 million, or 26%. In addition to the impact of increased revenues, the improvement of gross profits and gross profit as a percentage of revenues in the In-Center segment was attributable to contractual price improvements and lower manufacturing costs, including the non-recurrence of costs incurred during 2012 associated with the transition of certain blood tubing sets from a contract manufacturer to our own manufacturing plant.

The Other category relates to the manufacturing of dialyzers for sale to Asahi, which should provide us with long-term cost efficiencies through increased dialyzer production volumes.

The Services segment includes the costs associated with establishing and operating our NxStage Kidney Care dialysis centers.

Selling and Marketing

Our selling and marketing expenses and selling and marketing expenses as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2013     2012  

System One segment

   $ 37,691         21   $ 33,728         21

In-Center segment

     5,253         6     5,539         7
  

 

 

      

 

 

    

Products subtotal

     42,944         16     39,267         16

Services segment

     4,898         n/a        1,218         n/a   
  

 

 

      

 

 

    

Total Selling and marketing

   $ 47,842         18   $ 40,485         17
  

 

 

      

 

 

    

Selling and marketing expenses increased $7.4 million, or 18%, during 2013 compared to 2012.

Selling and marketing expenses for the System One and In-Center segments increased due to increased personnel and personnel-related costs and increased spending due to expanded marketing programs but remained relatively consistent as a percentage of revenues during 2013 compared to 2012 as we continued to leverage our infrastructure.

Selling and marketing expenses for our Services segment relates personnel and other costs associated with our market development activities to establish, develop and operate NxStage Kidney Care dialysis centers, including administrative support functions directly related to the startup and support of this initiative.

Research and Development

Our research and development expenses and research and development expenses as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2013     2012  

Research and development

   $ 18,887         7   $ 17,111         7
  

 

 

      

 

 

    

 

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Research and development expenses increased $1.8 million, or 10%, during 2013 compared to 2012 but remained consistent as a percentage of revenues. The increase was primarily due to increased personnel and personnel-related costs and increased project related spending partially offset by the recognition of $0.7 million during 2013 of a tax incentive received from the Massachusetts Life Sciences Center.

Distribution

Our distribution expenses and distribution expenses as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2013     2012  

System One segment

   $ 18,858         11   $ 16,325         10

In-Center segment

     2,388         3     2,563         3
  

 

 

      

 

 

    

Total Distribution

   $ 21,246         8   $ 18,888         8
  

 

 

      

 

 

    

Distribution expenses increased $2.4 million, or 13%, during 2013 compared to 2012 due to increased business volumes but remained relatively consistent as a percentage of revenues. Increased costs due to higher volumes and expanded delivery services in the System One segment were offset by distribution network efficiencies.

General and Administrative

Our general and administrative expenses and general and administrative expenses as a percentage of revenues for 2013 and 2012 were as follows (in thousands, except percentages):

 

     Years Ended December 31,  
     2013     2012  

General and administrative

   $ 32,326         12   $ 27,530         11
  

 

 

      

 

 

    

General and administrative expenses increased $4.8 million, or 17%, during 2013 compared to 2012. The increase in general and administrative expenses was primarily the result of the medical device excise tax assessed on nearly all of our products sold in the U.S. beginning in 2013 and increased professional service fees and other related infrastructure costs.

Other Income and Expense

Interest expense decreased $2.2 million during 2013 compared to 2012. In May 2012, we repaid our term loan with Asahi through the issuance of shares of our common stock.

The change in other expense, net is derived primarily by foreign currency gains and losses.

Provision for Foreign Income Taxes

We recognized a benefit from taxes of $(0.2) million in 2013 compared to a provision for income taxes of $1.0 million in 2012. We recorded income tax expense during both 2013 and 2012 for certain profitable foreign subsidiaries. The net benefit from income taxes recorded during 2013 includes the favorable conclusion of a foreign income tax audit during the second quarter, offset in part by additional reserves recorded for other uncertain tax positions.

 

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Liquidity and Capital Resources

We have operated at a loss since our inception in 1998. As of December 31, 2014, our accumulated deficit was $387.5 million and we had cash and cash equivalents of $52.9 million, with nearly all of that cash located in the U.S., and working capital of $84.4 million.

We expect to make continued improvements in cash flows driven by the improved combined performance of our System One and In-Center segments, as a result of revenue growth, operating leverage and improving profitability. Over the long term we expect to generate positive cash flow from the combined performance of these segments. We have made a significant investment of cash in our Services segment to open 11 NxStage Kidney Care dialysis centers in 2014. We currently do not expect any significant additional capital expenditures for our Services segment in 2015 beyond what is required to reach our target of 15 open centers. In the near term, these investments will offset the improvements we expect to achieve in our System One and In-Center segments. We believe, based on current projections and the current nature of our business, that we have the required resources to fund our ongoing operating requirements, which include selling and marketing activities to increase public awareness of the System One, our research and development activities to develop new products and enhance our existing products, and our planned investments in NxStage Kidney Care. If we determine that additional investment in these or any other initiatives would be beneficial, we may choose to access the credit or capital markets to provide additional liquidity. However, we can provide no guarantees that we would be successful in securing such additional financing.

Our ongoing cash requirements include funding normal working capital requirements including inventory and field equipment assets. Field equipment assets include System One equipment rented to customers in the home market and our “service pool” of equipment, which is equipment owned and maintained by us that is swapped for equipment owned or rented by our customers that needs repair or maintenance. While a majority of our home market customers have committed to purchase, rather than rent, the significant majority of their future System One equipment requirements, thereby reducing our working capital cash requirements, there can be no assurance that we will be able to continue to expand or sustain this level of equipment placements that are purchased rather than rented. Additionally, any excess rental or service swap equipment would increase our working capital requirements.

We have a revolving credit facility with General Electric Capital Corporation, or GECC, and SVB that allows for borrowing up to $35 million that expires in June 2019. Availability of credit is subject to a borrowing base that is calculated with reference to certain of our accounts receivable, inventory and equipment, and adjustments to such borrowing base are at the discretion of the lenders. The revolving credit facility requires us to comply with certain covenants while borrowings are outstanding, contains events of default customary for a transaction of this type and is secured by substantially all of our assets. As of December 31, 2014, there were no outstanding borrowings under the revolving credit facility, we were in compliance with all applicable covenants and, subject to the lenders’ adjustments described above, we had approximately $28 million of credit commitment available for borrowing.

We have two mortgages collateralized by a manufacturing facility in Italy that we acquired in May 2013 with interest rates of 6.0% and 2.0% payable over a 10-year period.

We maintain postemployment benefit plans for employees in certain foreign subsidiaries. The plans provide lump sum benefits, payable based on statutory regulations for voluntary or involuntary termination. Where required, we obtain an annual actuarial valuation of the benefit plans. We have recorded a liability of $1.7 million and $1.8 million at December 31, 2014 and 2013, respectively, for costs associated with these plans. The expense recorded in connection with these plans was not significant during 2014, 2013 or 2012.

 

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The following table sets forth the components of our cash flows for the periods indicated (in thousands):

 

     Years Ended December 31,  
     2014      2013  
     (In thousands)  

Net cash used in operating activities

   $ (20,273    $ (10,141

Net cash used in investing activities

     (20,097      (18,480

Net cash provided by financing activities

     9,461         5,755   

Foreign exchange effect on cash and cash equivalents

     (341      561   
  

 

 

    

 

 

 

Net cash flow

   $ (31,250    $ (22,305
  

 

 

    

 

 

 

Net cash used in operating activities.    Net cash used in operating activities increased by $10.1 million during 2014, versus 2013 driven by higher net loss and higher working capital requirements including increased inventory requirements to support our growth and new product offerings and higher outstanding accounts receivable from customers. We expect working capital to fluctuate due to various factors including inventory requirements and timing of payments from our customers and to our vendors.

Cash flow from deferred revenues improved by $3.9 million during 2014 as compared to 2013 as a result of increased System One equipment sales. Amortization of deferred revenues into revenues relating to sales of home equipment was $18.1 million during 2014 and $18.2 million during 2013.

Non-cash transfers from inventory to field equipment for the placement of units with our customers increased $11.5 million during 2014 compared to 2013. Non-cash transfers from field equipment to deferred costs of revenues increased $2.9 million during 2014 compared to 2013. The increase in field equipment was driven by an expansion of our service pool which we expect to normalize in the near term, increased rental activity, including that associated with our NxStage Kidney Care dialysis centers, and new product introductions.

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 the build-out of NxStage Kidney Care dialysis centers coupled with expenditures for our manufacturing facilities as a result of our efforts to rationalize and expand our manufacturing operations, along with purchases of equipment for research and development and information technology. The increase of $3.9 million in purchases of property and equipment was driven by spending related to the build-out of our NxStage Kidney Care dialysis centers. Capital expenditures for our Kidney Care centers were $13.5 million and $3.9 million during 2014 and 2013, respectively. Net cash used in investing activities during 2013 also includes $2.2 million of cash paid to Kimal in connection with our acquisition of substantially all of the System One assets of Kimal on April 2, 2013.

Net cash provided by financing activities.    During 2014 and 2013 we received $11.1 million and $5.5 million, respectively, of proceeds from stock option and stock purchase plans. Proceeds from stock option and purchase plans are subject to fluctuation based on the number of option exercised and, to a lesser extent, the weighted-average exercise price. We also received $0.9 million during 2014 and $0.5 million during 2013 of contributions from noncontrolling interest in connection with NxStage Kidney Care joint ventures. Cash provided by financing activity during 2013 included $1.1 million of proceeds from the issuance of debt in connection with financing the acquisition of a manufacturing facility in Italy. Cash provided by financing activities during both 2014 and 2013 was reduced by cash used to pay our capital lease obligations. Further, our cash provided by financing activities during 2014 was reduced by $1.1 million due to costs associated with obtaining our new revolving credit facility.

Off-Balance Sheet Arrangements

We do not have any significant off-balance sheet arrangements.

 

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Contractual Obligations

The following table summarizes our contractual commitments as of December 31, 2014 and the effect those commitments are expected to have on liquidity and cash flow in future periods (in thousands):

 

     Payments Due By Period  
     Total      Less Than
One Year
     1-3 Years      3-5 Years      More Than
5  Years
 

Capital lease obligations

   $ 17,985       $ 2,326       $ 4,237       $ 2,357       $ 9,065   

Operating leases

     29,473         4,412         8,634         7,904         8,523   

Debt

     1,099         129         259         259         452   

Purchase obligations

     87,684         42,482         27,263         17,939           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 136,241       $ 49,349       $ 40,393       $ 28,459       $ 18,040   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Our capital lease obligations include our capital lease obligation due to Asahi related to a manufacturing facility in Germany along with $6.6 million representing the estimated residual value of the manufacturing facility in Germany at the end of the estimated lease term which only becomes due and payable at Asahi’s option if we terminate our agreement with Asahi.

Our purchase obligations include purchase commitments for System One components, primarily for equipment and fluids along with needles for our In-Center segment pursuant to contractual agreements with several of our suppliers that are in the normal course of business. Certain of these commitments may be extended and/or canceled at our option.

The contractual commitments included in the table above do not include postemployment benefit obligations and unrecognized tax benefits. We maintain postemployment benefit plans for employees in certain foreign subsidiaries and may be required to make cash outlays related to the settlement of these obligations. However, the timing of such cash outlays is uncertain. Please see Note 12, Stock Plans and Stock-Based Compensation to our consolidated financial statements included in this Annual Report for further details. We may be required to make cash outlays related to our unrecognized tax benefits. However, we are unable to make reasonably reliable estimates of the period of cash settlement, if any, with the respective taxing authorities. Please see Note 11, Income Taxes to our consolidated financial statements included in this Annual Report for further details.

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 GAAP. Certain immaterial reclassifications have been made to prior periods’ financial statements to conform to the 2014 presentation. 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.

Note 2, Summary of Significant Accounting Policies to our consolidated financial statements included in this Annual Report describes the significant accounting policies used in the preparation of our consolidated financial statements. A summary of those accounting policies and estimates that we believe are most critical to fully understanding and evaluating our financial results is set forth below. This summary should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report.

 

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Revenue Recognition

We recognize revenue from product sales and services when earned. 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.

Certain agreements with distributors allow for product returns and credits. For shipment of product sold to distributors, revenue is recognized at the time of sale if a reasonable estimate of future returns or credit can be made. If a reasonable estimate of future returns or credit cannot be made, we recognize revenue using the “sell-through” method. Under the “sell-through” method, revenue and related costs of revenue is deferred until the final resale of such products to end customers.

In addition to contractually determined volume discounts, in many agreements we offer rebates based on sales to specific end customers and discounts for early payment. Rebates and discounts are recorded as a reduction of sales and trade accounts receivable, based on our best estimate of the amount of probable future rebate or discount on current sales.

We enter into multiple-element arrangements that may include a combination of equipment, related disposables and services. Revenue arrangements with multiple elements are divided into separate units of accounting if specified criteria are met, including whether the delivered element has stand-alone value to the customer, the consideration received is allocated among the separate units based on their respective selling price, and the applicable revenue recognition criteria are applied to each of the separate units.

We determine selling price using vendor specific objective evidence (“VSOE”), if it exists, otherwise third-party evidence of selling price is used. If neither VSOE nor third-party evidence of selling price exists for a unit of accounting, we use best estimated selling price (“BESP”). We generally expect that we will not be able to establish third-party evidence due to the nature of our products and the markets in which we compete, and, as such, we typically will determine selling price using VSOE or BESP.

We determine BESP for an individual element based on consideration of both market and Company-specific factors, including the selling price and profit margin for similar products, the cost to produce the deliverable and the anticipated margin on that deliverable and the characteristics of the varying markets in which the deliverable is sold.

System One Segment

We derive revenue in the home market from the sales of hemodialysis therapy to customers in which the customer either purchases or rents the System One and/or PureFlow SL hardware and purchases a specified number of disposable products and service.

For customers that purchase the System One and PureFlow SL hardware, in the U.S. home market, due to the depot service model whereby equipment requiring service is picked up and a replacement device is shipped to the site of care, we recognize fees received from equipment sale as revenue on a straight-line basis over the expected term of our remaining service obligation and direct costs relating to the delivered equipment are deferred and amortized over the same expected period as the related revenue. Disposable products revenue is recognized on a monthly basis upon delivery.

Under the rental arrangements revenue is recognized on a monthly basis in accordance with agreed upon contract terms and pursuant to binding customer purchase orders and fixed payment terms.

Our sales arrangements with our international distributors are structured as direct product sales and have no significant post delivery obligations with the exception of standard warranty obligations. Revenue from direct product sales is recognized upon delivery in accordance with contract terms.

 

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In the critical care market, we structure sales of the System One and disposable products as direct product sales and have no significant post delivery obligations with the exception of standard warranty obligations. Revenue from direct product sales is recognized upon delivery in accordance with contract terms. Certain of these arrangements provide for training, technical support and extended 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 service revenue is recognized ratably over the extended warranty period.

In-Center Segment

Our In-Center segment sales are structured as direct product sales primarily through distributors, and we have no significant post delivery obligations with the exception of standard warranty obligations. Revenue from direct product sales is recognized upon delivery in accordance with contract terms. Some of our distribution contracts for the In-Center segment contain minimum volume commitments with negotiated pricing discounts at different volume tiers. Each agreement may be canceled upon a material breach, subject to certain curing rights, and in many instances minimum volume commitments can be reduced or eliminated upon certain events.

Services Segment

Revenues in our Services segment are derived from dialysis care services provided to patients at our recently opened NxStage Kidney Care dialysis centers.

Revenues are recognized based on a customary fee schedule, net of estimated contractual allowances to reflect the estimated amounts to be received from the payor. Revenues are recognized in the period in which services are provided when we have the ability to reasonably estimate amounts ultimately collectible from the payor. In instances where we do not have the ability to reasonably estimate amounts ultimately collectible, as is often the case with non-contracted commercial health plans and amounts due from patients (including co-pay and deductible amounts), revenue is recognized in the period in which cash is received.

Inventory Valuation

Inventories are valued at the lower of cost or estimated market value. We regularly review our inventory quantities on hand and related cost and record a provision for excess or obsolete inventory primarily based on remaining shelf-life and estimated forecast of product demand. We also review our inventory value to determine if it reflects lower of cost or market, with market determined based on net realizable value. Appropriate consideration is given to inventory items sold at negative gross margins, purchase commitments and other factors in evaluating net realizable value. The medical device industry is characterized by rapid development and technological advances as well as regulatory and quality manufacturing guidelines that could result in obsolescence of inventory. Additionally, our estimates of future product demand may prove to be inaccurate.

Field Equipment

Field equipment consists of equipment being utilized under disposable-based rental agreements as well as “service pool” cyclers. Service pool cyclers are cyclers owned and maintained by us that are swapped for cyclers that need repairs or maintenance by us while being rented or owned by a patient. We continually monitor the number of cyclers in the service pool, as well as cyclers that are in-transit or otherwise not being used by a patient, and assess whether there are any indicators of impairment for such equipment. We also review field equipment carrying value for reasonableness. We consider factors such as actual equipment disposals and our ability to verify the equipment’s existence in the field to identify lost equipment. Charges for lost equipment are included in distribution expenses. Repairs and maintenance expenses are recorded in cost of revenues and expensed as incurred.

We capitalize field equipment at cost and depreciate field equipment through cost of revenues using the straight-line method over an estimated useful life. We review the estimated useful life of our field equipment

 

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periodically for reasonableness and make changes when appropriate. Factors considered in determining the reasonableness of the useful life include expected future design improvements, equipment age and actual equipment disposals.

Accounting for Stock-Based Awards

Stock-based compensation expense is estimated as of the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which generally equals the vesting period, based on the number of awards that are expected to vest. Estimating the fair value for stock options requires judgment, including the expected term of our stock options, volatility of our stock, expected dividends, risk-free interest rates over the expected term of the options and the expected forfeiture rate. In connection with our performance based programs, we make assumptions principally related to the number of awards that are expected to vest after assessing the probability that certain performance criteria will be met.

Valuation of Intangibles and Other Long-Lived Assets

For our long-lived assets including intangible assets, we assess the carrying value of these assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important include, but are not limited to, significant underperformance relative to historical or projected future results, significant negative industry factors and significant changes in strategy or operations that negatively affect the utilization of our long-lived assets. If an impairment review is triggered, we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the assets and compare that value to the carrying value of the assets. The amount of impairment, if any, is measured based on fair value, which is determined using projected discounted future operating cash flows. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the cash flow estimates or the significant operating assumptions upon which they are based change in the future, we may be required to record additional impairment charges.

Goodwill

We assess goodwill for impairment annually in the fourth quarter and whenever events or circumstances indicate impairment may exist. This test includes first a qualitative assessment and then, if necessary, a quantitative assessment to determine if the fair value of a reporting unit is less than its carrying amount. Factors considered in the qualitative assessment include, but are not limited to, both macroeconomic conditions and entity-specific conditions. For the quantitative assessment, the reporting unit’s fair value is estimated using a discounted cash flow approach. Our reporting units that contain goodwill are our System One and In-Center operating segments. Assessing the impairment of goodwill requires us to make assumptions and judgments including the identification of reporting units and determination of the fair value of the net assets of our reporting units based on estimates of future cash flows and the selection of discount rates. Changes in these estimates and assumptions could materially affect the estimated fair values of reporting units and could result in a goodwill impairment charge in a future period. However, our annual impairment testing indicated no impairment based upon various factors including reporting unit valuations prepared using discounted cash flows, the positive performance of our reporting units, and positive industry and economic trends.

Accounting for Income Taxes

We periodically assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. If our judgment as to the likely resolution of the position changes, if the matter is ultimately settled or if the statute of limitation expires, the effects of the change would be recognized in the period in which the change, resolution or expiration occurs.

 

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We conduct business globally and file income tax returns in the U.S. federal jurisdiction, various states and foreign jurisdictions. We evaluate the need for foreign income tax provisions or reserves based on our evaluation of inter-company transfer pricing. We evaluate the need for valuation allowances on our deferred tax assets based on positive and negative evidence about our ability to realize deferred tax attributes. We have accumulated significant losses since our inception in 1998 in the U.S. Utilization of the net operating losses may be subject to limitations and certain tax years in the respective tax jurisdictions remain open to examination.

Recent Accounting Pronouncements

A discussion of recent accounting pronouncements is included in Note 2 to the consolidated financial statements in this Annual Report.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

Our interest rate risk is currently limited to our investments. However, this risk is mitigated given our investment portfolio currently consists of treasury obligation money market funds. We manage our investment portfolio in accordance with our investment policy. The primary objectives of our investment policy are to preserve principal, maintain a high degree of liquidity to meet operating needs and obtain competitive returns subject to prevailing market conditions. Our investment policy specifies the credit quality standards for our investments and limits the amount of exposure from any single issue, issuer or type of investment.

Foreign Currency Exchange Risk

Our functional currency is the U.S. dollar and a majority of our revenues and expenses are denominated in U.S. dollars. However, we have manufacturing, service and distribution operations in foreign locations, namely Mexico, Germany, Italy and the United Kingdom. In addition, we purchase products for resale in the U.S. from foreign companies and have agreed to pay them in currencies other than the U.S. dollar, including the euro. Furthermore, certain revenues are denominated in other currencies, primarily the euro. As a result, we are potentially exposed to adverse as well as beneficial movements in foreign currency exchange rates. For example, a hypothetical 10% adverse change in exchange rates could have the net effect of reducing our operating profit by approximately $4.2 million.

We utilize natural hedges to minimize our transaction exposures. Also, certain of our long-term supply agreements include foreign exchange risk sharing at different exchange rate levels limiting our exposure to fluctuations in foreign exchange rates for our purchase commitment exposures. Finally, we enter into foreign exchange forward contracts on peso denominated expenses to further reduce our exposure to foreign currency exchange rate fluctuations from our foreign operations located in Mexico.

Our foreign exchange forward contracts are entered into with large financial institutions and have durations of up to twelve months. These contracts are designated as cash flow hedges and are carried on our balance sheet at fair value, with the effective portion of the contracts’ gains or losses included in cost of revenues in the same period as the related hedged item is recognized. As of December 31, 2014, the notional amount of our outstanding contracts that are designated as cash flow hedges was approximately $12.5 million. Based on our analysis, a hypothetical adverse foreign exchange rate movement of 10% against our contracts would have resulted in a net loss in fair value of these contracts of approximately $1.3 million.

 

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Item 8. Financial Statements and Supplementary Data

NXSTAGE MEDICAL, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm

     77   

Consolidated Balance Sheets

     78   

Consolidated Statements of Comprehensive Loss

     79   

Consolidated Statements of Changes in Stockholders’ Equity

     80   

Consolidated Statements of Cash Flows

     82   

Notes to Consolidated Financial Statements

     83   

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of NxStage Medical, Inc.

We have audited the accompanying consolidated balance sheets of NxStage Medical, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive loss, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of NxStage Medical, Inc. at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), NxStage Medical, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 26, 2015 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Boston, Massachusetts

February 26, 2015

 

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NXSTAGE MEDICAL, INC.

CONSOLIDATED BALANCE SHEETS

 

     December 31,  
     2014     2013  
     (In thousands, except
share data)
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 52,884      $ 84,134   

Accounts receivable, net

     24,099        20,158   

Inventory

     45,401        37,801   

Prepaid expenses and other current assets

     6,767        4,027   
  

 

 

   

 

 

 

Total current assets

     129,151        146,120   

Property and equipment, net

     66,574        52,478   

Field equipment, net

     21,118        13,041   

Deferred cost of revenues

     34,039        34,730   

Intangible assets, net

     14,370        17,194   

Goodwill

     41,817        41,817   

Other assets

     2,657        1,582   
  

 

 

   

 

 

 

Total assets

   $ 309,726      $ 306,962   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 13,845      $ 14,610   

Accrued expenses

     24,653        21,025   

Current portion of long-term debt

     93        102   

Other current liabilities

     6,165        1,870   
  

 

 

   

 

 

 

Total current liabilities

     44,756        37,607   

Deferred revenues

     52,943        53,277   

Long-term debt

     848        1,044   

Other long-term liabilities

     19,624        20,273   
  

 

 

   

 

 

 

Total liabilities

     118,171        112,201   

Commitments and contingencies (Note 10)

    

Stockholders’ equity:

    

Undesignated preferred stock: par value $0.001, 5,000,000 shares authorized; no shares issued and outstanding as of December 31, 2014 and 2013

              

Common stock: par value $0.001, 100,000,000 shares authorized; 63,429,005 and 61,666,048 shares issued as of December 31, 2014 and 2013, respectively

     63        61   

Additional paid-in capital

     593,073        567,468   

Accumulated deficit

     (387,488     (363,542

Accumulated other comprehensive (loss) income

     (2,192     212   

Treasury stock, at cost: 772,273 and 575,895 shares as of December 31, 2014 and 2013, respectively

     (12,989     (9,963
  

 

 

   

 

 

 

Total NxStage Medical, Inc. stockholders’ equity

     190,467        194,236   

Noncontrolling interest

     1,088        525   
  

 

 

   

 

 

 

Total stockholders’ equity

     191,555        194,761   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 309,726      $ 306,962   
  

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements.

 

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NXSTAGE MEDICAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

 

     Years Ended December 31,  
     2014     2013     2012  
     (In thousands, except per share data)  

Revenues

   $ 301,501      $ 263,429      $ 242,132   

Cost of revenues

     185,598        160,926        149,324   
  

 

 

   

 

 

   

 

 

 

Gross profit

     115,903        102,503        92,808   
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Selling and marketing

     55,385        47,842        40,485   

Research and development

     22,635        18,887        17,111   

Distribution

     26,001        21,246        18,888   

General and administrative

     34,069        32,326        27,530   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     138,090        120,301        104,014   
  

 

 

   

 

 

   

 

 

 

Loss from operations

     (22,187     (17,798     (11,206
  

 

 

   

 

 

   

 

 

 

Other expense:

      

Interest expense

     (863     (611     (2,766

Other expense, net

     (10     (397     (148
  

 

 

   

 

 

   

 

 

 
     (873 )      (1,008 )      (2,914 ) 
  

 

 

   

 

 

   

 

 

 

Net loss before income taxes

     (23,060     (18,806     (14,120

Provision for (benefit from) income taxes

     1,253        (245     1,033   
  

 

 

   

 

 

   

 

 

 

Net loss

     (24,313     (18,561     (15,153
  

 

 

   

 

 

   

 

 

 

Less: Net loss attributable to noncontrolling interests

     (367              
  

 

 

   

 

 

   

 

 

 

Net loss attributable to stockholders of NxStage Medical, Inc.

   $ (23,946   $ (18,561   $ (15,153
  

 

 

   

 

 

   

 

 

 

Net loss per share, basic and diluted

   $ (0.39   $ (0.31   $ (0.26
  

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding, basic and diluted

     61,700        60,261        57,890   

Other comprehensive (loss) income, net of tax

     (2,404     (258     538   
  

 

 

   

 

 

   

 

 

 

Total comprehensive loss

     (26,717     (18,819   $ (14,615
  

 

 

   

 

 

   

 

 

 

Less: Comprehensive loss attributable to noncontrolling interests

     (367              
  

 

 

   

 

 

   

 

 

 

Total comprehensive loss attributable to stockholders of NxStage Medical, Inc.

   $ (26,350   $ (18,819   $ (14,615
  

 

 

   

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements.

 

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NXSTAGE MEDICAL, INC

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

<
    

 

Common Stock

     Additional
Paid-In
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Income

(Loss)
    Treasury
Stock
    Total
NxStage
Medical, Inc.
Stockholders’
Equity
    Noncontrolling
Interest
     Total
Stockholders’
Equity
 
     Shares      Amount                  
     (In thousands, except share data)  

Balance at December 31, 2011

     56,167,090       $ 56       $ 489,542      $ (329,828   $ (68   $ (8,516   $ 151,186      $       $ 151,186   

Net loss

                            (15,153                   (15,153             (15,153

Adjustments to other comprehensive loss, net of tax

                                   538               538                538   

Issuance of common stock, net of issuance costs

     2,456,246         2         45,074                      (522     44,554                44,554   

Exercise of stock options

     913,066         1         6,344                      (513     5,832                5,832   

Shares issued under employee restricted stock plans

     200,587                 (1,173                          (1,173             (1,173

Shares issued under employee bonus plans

     47,533                 878                             878                878   

Shares issued under employee stock purchase plan

     56,691                 731                             731                731   

Shares issued to Directors in lieu of cash

     8,904                 138                             138                138   

Stock-based compensation expense

                     10,060                             10,060                10,060   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at December 31, 2012

     59,850,117         59         551,594        (344,981     470        (9,551     197,591                197,591   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net loss

                            (18,561                   (18,561             (18,561

Adjustments to other comprehensive loss, net of tax

                                   (258            (258             (258

Exercise of stock options

     662,767         1         4,666                      (412     4,255                4,255   

Exercise of warrants

     874,921         1         892                             893                893   

Shares issued under employee restricted stock plans

     105,573                 (424                          (424             (424

Shares issued under employee bonus plans

     93,778                 1,034                             1,034                1,034   

Shares issued under employee stock purchase plan

     75,301                 759                             759                759   

Shares issued to Directors in lieu of cash

     3,591