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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2018

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 St., Lawrence, MA
 
01843
(Address of Principal Executive Offices)
 
(Zip Code)
(978) 687-4700
(Registrant's Telephone Number, Including Area Code)
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. þ Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  
þ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
Emerging growth company ¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
¨ Yes þ No
     There were 66,684,692 shares of the registrant's common stock outstanding as of the close of business on November 1, 2018.
 

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NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2018
TABLE OF CONTENTS
 
 
Page
 
 
 
Condensed Consolidated Balance Sheets at September 30, 2018 and December 31, 2017
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2018 and 2017
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017
 
 
 
 
 


















Note Regarding Nomenclature
For convenience, in this Quarterly Report “NxStage,” “we,” “us,” and “the Company” refer to NxStage Medical, Inc. and our consolidated subsidiaries, taken as a whole.
Note Regarding Trademarks
NxStage® is a registered trademark of NxStage Medical, Inc. PureFlowTM and System OneTM are trademarks of NxStage Medical, Inc.

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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements

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NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,

December 31,
 
2018

2017
 
(In thousands, except share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
81,944

 
$
64,928

Accounts receivable, net
66,127

 
31,625

Inventory
53,353

 
49,212

Prepaid expenses and other current assets
9,819

 
7,609

Total current assets
211,243

 
153,374

Property and equipment, net
55,106

 
60,262

Field equipment, net
22,925

 
24,264

Deferred cost of revenues
33,012

 
31,410

Intangible assets, net
6,131

 
7,660

Goodwill
42,748

 
42,748

Other assets
6,284

 
5,911

Total assets
$
377,449

 
$
325,629

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
19,811

 
$
14,785

Accrued expenses
34,854

 
27,985

Current portion of long-term debt
101

 
101

Other current liabilities
3,989

 
4,559

Total current liabilities
58,755

 
47,430

Deferred revenues
75,568

 
46,874

Long-term debt
444

 
520

Other long-term liabilities
17,069

 
17,824

Total liabilities
151,836

 
112,648

Commitments and contingencies (Note 10)

 

Noncontrolling interests subject to put provisions
(291
)
 
(165
)
Stockholders’ equity:
 
 
 
Undesignated preferred stock: par value $0.001 per share, 5,000,000 shares authorized; no shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively

 

Common stock: par value $0.001 per share, 100,000,000 shares authorized; 67,756,628 and 67,341,819 shares issued as of September 30, 2018 and December 31, 2017, respectively
68

 
67

Additional paid-in capital
667,620

 
657,640

Accumulated deficit
(418,799
)
 
(421,593
)
Accumulated other comprehensive loss
(3,527
)
 
(3,673
)
Treasury stock, at cost: 1,083,013 and 1,046,870 shares as of September 30, 2018 and December 31, 2017, respectively
(20,170
)
 
(19,283
)
Total NxStage Medical, Inc. stockholders' equity
225,192

 
213,158

Noncontrolling interests not subject to put provisions
712

 
(12
)
Total stockholders' equity
225,904

 
213,146

Total liabilities and stockholders’ equity
$
377,449

 
$
325,629

See accompanying notes to these condensed consolidated financial statements.

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NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018

2017
 
2018

2017
 
(In thousands, except per share data)
Revenues
$
108,122

 
$
97,295

 
$
322,390

 
$
290,340

Cost of revenues
61,589

 
56,688

 
183,745

 
167,377

Gross profit
46,533

 
40,607

 
138,645

 
122,963

Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
17,549

 
16,984

 
53,735

 
50,595

Research and development
9,698

 
11,222

 
29,729

 
29,757

Distribution
8,636

 
8,065

 
26,539

 
23,394

General and administrative
9,388

 
12,619

 
29,599

 
31,237

Total operating expenses
45,271

 
48,890

 
139,602

 
134,983

Income (loss) from operations
1,262

 
(8,283
)
 
(957
)
 
(12,020
)
Other income (expense):
 
 
 
 
 
 
 
Interest expense, net
(69
)
 
(168
)
 
(266
)
 
(595
)
Other income (expense), net
109

 
26

 
(858
)
 
(565
)
 
40

 
(142
)
 
(1,124
)
 
(1,160
)
Net income (loss) before income taxes
1,302

 
(8,425
)
 
(2,081
)
 
(13,180
)
Provision for (benefit from) income taxes
512

 
469

 
1,148

 
(166
)
Net income (loss)
790

 
(8,894
)
 
(3,229
)
 
(13,014
)
Less: Net loss attributable to noncontrolling interests
(91
)
 
(449
)
 
(62
)
 
(1,291
)
Net income (loss) attributable to NxStage Medical, Inc.
$
881

 
$
(8,445
)
 
$
(3,167
)
 
$
(11,723
)
Add: Accretion to redemption value of noncontrolling interests
(68
)
 
(481
)
 
(68
)
 
(481
)
Net income (loss) attributable to common stockholders
$
813

 
$
(8,926
)
 
$
(3,235
)
 
$
(12,204
)
 
 
 
 
 
 
 
 
Net income (loss) per common share:
 
 
 
 
 
 
 
    Basic
$
0.01

 
$
(0.14
)
 
$
(0.05
)
 
$
(0.19
)
    Diluted
$
0.01

 
$
(0.14
)
 
$
(0.05
)
 
$
(0.19
)
Weighted-average shares outstanding:
 
 
 
 
 
 
 
    Basic
66,660

 
66,082

 
66,522

 
65,723

    Diluted
68,009

 
66,082

 
66,522

 
65,723

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized income (loss) on derivative instruments, net of income taxes
538

 
(661
)
 
177

 
2,376

Other income (loss)
513

 
268

 
(31
)
 
1,830

Total other comprehensive income (loss)
1,051


(393
)
 
146

 
4,206

Total comprehensive income (loss)
1,841

 
(9,287
)
 
(3,083
)
 
(8,808
)
Less: Comprehensive loss attributable to noncontrolling interests
(91
)
 
(449
)
 
(62
)
 
(1,291
)
Total comprehensive income (loss) attributable to NxStage Medical, Inc.
$
1,932

 
$
(8,838
)
 
$
(3,021
)
 
$
(7,517
)

See accompanying notes to these condensed consolidated financial statements.

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NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
Nine Months Ended September 30,
 
2018
 
2017
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net loss
$
(3,229
)
 
$
(13,014
)
Adjustments to reconcile net loss to net cash flow from operating activities:
 
 
 
Depreciation and amortization
25,630

 
25,321

Stock-based compensation
7,061

 
8,684

Other
1,636

 
1,183

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(30,212
)
 
2,443

Inventory
(20,726
)
 
(18,154
)
Prepaid expenses and other assets
(198
)
 
604

Accounts payable
5,150

 
(1,886
)
Accrued expenses and other liabilities
7,081

 
(1,286
)
Deferred revenues
28,514

 
(1,906
)
Net cash provided by operating activities
20,707

 
1,989

Cash flows from investing activities:
 
 
 
Cash paid for acquisitions, net of cash acquired

 
(100
)
Purchase of cost method investment

 
(2,500
)
Purchases of property and equipment
(4,364
)
 
(7,550
)
Net cash used in investing activities
(4,364
)
 
(10,150
)
Cash flows from financing activities:
 
 
 
Issuance of shares under stock incentive plans, net of payroll taxes paid
2,067

 
11,019

Proceeds from loans, lines of credit and capital lease obligations

 
452

Repayments on loans and lines of credit
(64
)
 
(126
)
Repayments on capital leases
(1,191
)
 
(981
)
Net cash provided by financing activities
812

 
10,364

Foreign exchange effect on cash and cash equivalents
(139
)
 
1,144

Increase in cash and cash equivalents
17,016

 
3,347

Cash and cash equivalents, beginning of period
64,928

 
59,632

Cash and cash equivalents, end of period
$
81,944

 
$
62,979


See accompanying notes to these condensed consolidated financial statements.

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NXSTAGE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.
Nature of Operations, Proposed Merger, Basis of Presentation and Principles of Consolidation
Nature of Operations
We are a medical technology company that develops, manufactures, markets and provides innovative products and services for patients suffering from chronic or acute kidney failure. Our primary product, the System One, was designed to satisfy an unmet clinical need for a system capable of delivering the therapeutic flexibility and clinical benefits of 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 and home-like settings, including skilled nursing facilities, 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 that are more practical to deliver in the home setting, including more frequent hemodialysis and nocturnal hemodialysis. Clinical literature suggests such therapies provide patients better clinical outcomes and improved quality of life. In addition to the System One, we provide patients with our PureFlow SL accessory which prepares on-site premixed dialysate fluid in the patient's home using ordinary tap water and dialysate concentrate.
We also operate a small number of NxStage Kidney Care dialysis centers, independently and in some instances as joint ventures, that treat end-stage renal disease (ESRD) patients directly. These centers provide us with the opportunity to innovate and foster new care delivery models to advance the standard of renal care across other markets. At these centers, we offer a range of treatment options, including home hemodialysis, peritoneal dialysis and flexible in-center hemodialysis.
We are headquartered in Lawrence, Massachusetts, with manufacturing facilities in Mexico, Germany and Italy. Through our international network of affiliates and distribution partners, patients in over 21 countries have been treated with our products.
Proposed Merger
On August 7, 2017, we entered into an Agreement and Plan of Merger (as amended, the Merger Agreement) with Fresenius Medical Care Holdings, Inc. (Fresenius), pursuant to which we will merge with a wholly-owned subsidiary of Fresenius (Merger), subject to certain conditions. At the closing of the Merger, all outstanding shares of our common stock (except those held by us, Fresenius or its wholly-owned subsidiaries or any stockholders properly exercising their appraisal rights under the General Corporation Law of the State of Delaware) would be converted into the right to receive $30.00 per share in cash, subject to any applicable tax withholdings.
Fresenius' obligation to close the Merger is conditioned on (1) receipt of regulatory approval from the U.S. Federal Trade Commission (FTC) and the expiration of applicable waiting periods, or extensions thereof, under the Hart-Scott-Rodino Act of 1976, as amended (HSR Act), (2) the absence of any governmental law or order preventing the consummation of the transaction and (3) NxStage's compliance, in all material respects, with our covenants under the Merger Agreement. Pursuant to the HSR Act, we and Fresenius each submitted pre-merger notification filings to the FTC and Department of Justice, Antitrust Division. On October 18, 2017, we and Fresenius each received a Request for Additional Information and Documentary Material (also known as a Second Request) from the FTC. The effect of the Second Request is to extend the waiting period imposed by the HSR Act until 30 days after Fresenius and we have substantially complied with the Second Request, unless that period is terminated sooner by the FTC. By agreement with the FTC, the parties may voluntarily extend the time for closing beyond the expiration of the HSR Act waiting period. The parties continue to work to obtain FTC approval of the proposed transaction. On October 27, 2017, the stockholders of NxStage Medical, Inc. voted to approve the Merger Agreement. In addition, the Merger has cleared antitrust review in Germany. See “Risk Factors” in Part I Item 1A of our 2017 Annual Report (as defined below) for additional information. In an effort to advance the process of obtaining FTC clearance of the proposed Merger under the HSR Act, on July 10, 2018 we entered into an agreement to sell our bloodlines business operated under the Medisystems name to B. Braun Medical Inc. Consummation of that transaction is subject to (1) FTC approval of that transaction, (2) the closing of the Merger, (3) and other customary conditions.  The original end date for our Merger Agreement with Fresenius (End Date) was August 7, 2018. We have agreed with Fresenius to extend the End Date to February 5, 2019 to obtain required antitrust clearances. The Merger Agreement may be terminated by us or Fresenius if the Merger is not closed by February 5, 2019. The Merger Agreement generally requires each party to use its reasonable best efforts to obtain all consents and clearances required under any antitrust law, except that Fresenius is not required (i) to litigate against a governmental entity or (ii) to divest or to take any other actions with respect to any assets or business of Fresenius, its subsidiaries or the Company, other than, if necessary to obtain antitrust clearances, with respect to certain Company assets.
Fresenius is required to pay us a termination fee of $100 million (the Reverse Termination Fee) if the Merger Agreement is terminated by us or Fresenius (i) if the End Date has passed or (ii) if a court or other governmental entity issues a final,

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nonappealable order or takes any other actions that permanently prohibits the Merger or makes closing the Merger illegal (in each case because approval under applicable antitrust laws remains the only unsatisfied closing condition).
We would be required to pay Fresenius a termination fee of $60 million (the Termination Fee) if all of the following conditions were applicable: (i) the Merger Agreement is terminated because the End Date has passed or we have breached a covenant, (ii) an alternative acquisition proposal has been publicly made and not publicly withdrawn at least ten days prior to the termination, and (iii) within 12 months following such termination, we enter into an alternative acquisition agreement or an alternative acquisition is consummated. Nonetheless, we will not be required to pay the Termination Fee if the Merger Agreement is terminated due to failure to obtain required antitrust approvals by the End Date and Fresenius is required to pay the Reverse Termination Fee.
The Merger Agreement includes customary representations, warranties and covenants. Pursuant to the Merger Agreement, we agreed to use commercially reasonable efforts to operate our business in all material respects in the ordinary course until closing.
Basis of Presentation
The accompanying condensed consolidated financial statements as of September 30, 2018 and December 31, 2017 and for the three and nine months ended September 30, 2018 and 2017, and related notes, are unaudited but, in the opinion of our management, include all adjustments, consisting of normal recurring adjustments, that are necessary for fair statement of the interim periods presented. Our unaudited condensed consolidated financial statements have been prepared following the requirements of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under these rules, we have condensed or omitted certain footnotes and other financial information that are normally required by U.S. generally accepted accounting principles (GAAP). Our accounting policies are described in the notes to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2017 (2017 Annual Report) and updated, as necessary, in this Quarterly Report on Form 10-Q (Quarterly Report). Operating results for any interim period are not necessarily indicative of results for the entire year or future periods. The December 31, 2017 condensed consolidated balance sheet contained herein was derived from audited financial statements, but does not include all disclosures that would be required for audited financial statements under GAAP. For further information, refer to the consolidated financial statements and footnotes thereto included in our 2017 Annual Report.
We adopted Accounting Standards Update (ASU) No. 2014-9: “Revenue from Contracts with Customers” (ASC 606) with a date of initial application of January 1, 2018. We applied ASC 606 using the cumulative effect method, i.e., by recognizing the cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of equity at January 1, 2018. Therefore, the comparative information has not been adjusted and continues to be reported under ASC 605. The details of the significant changes and quantitative impact of the changes are outlined in Note 2.
The preparation of our condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Such financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of the results of the periods presented. All such adjustments are of a normal recurring nature.
Principles of Consolidation
Our condensed consolidated financial statements include the accounts of NxStage Medical, Inc. and our wholly-owned subsidiaries and other entities in which we maintain a majority voting interests or for which we maintain effective control, including variable interest entities ("VIEs") for which we are deemed the primary beneficiary. All significant intercompany balances and transactions have been eliminated. Noncontrolling interests represent the proportionate equity interests in the consolidated entities that are not wholly owned by us. Noncontrolling interests of acquired entities are recognized at their initial fair value.
2. Summary of Significant Accounting Policies
Revenue Recognition
We recognize revenue from product sales and services when earned through fulfillment of our performance obligations. The amount of revenue recognized is based on the total consideration that we ultimately expect to collect relative to the good or service provided.
We estimate the standalone selling price for an individual performance obligation based on consideration of both industry and Company-specific factors, including the 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.

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Any tax assessed by a governmental authority that is incurred as a result of a revenue transaction (e.g. sales tax) is excluded from revenues and reported on a net basis. In general, we do not have any significant extended payment terms as payment is received at or shortly after the point of sale. The expected costs associated with our standard product warranties continue to be recognized as expense when the products are sold. When shipping and handling activities are performed after the transfer of control to the customer (e.g., when control transfers prior to delivery), they are considered as fulfillment activities, and accordingly, the costs are accrued for when the related revenue is recognized.
System One Segment
We derive revenue in the home market primarily from sales of the System One hardware and sales of disposable products.
We enter into arrangements with customers that may include multiple elements including equipment lease or licensing transactions pursuant to the depot service model described below or equipment sales with no post-delivery obligations other than standard warranty obligations, disposable product sales and services. The transaction price is allocated to the elements including allocation to the lease and non-lease elements of the arrangement, where applicable, based on their relative standalone selling price and recognized pursuant to the applicable guidance.
System One hardware sales to dialysis clinic customers in the home market are made under the depot service model whereby equipment requiring service is picked up and a replacement device is shipped to the site of care. Accordingly, we recognize upfront fees received from equipment transactions as revenue on a straight-line basis over the term of our remaining service obligation, which generally range between 5 and 7 years, and direct costs relating to the delivered equipment are classified in deferred cost of revenues and amortized over the same expected period as the related revenue. Beginning in the third quarter of 2018, we entered into a long-term licensing arrangement with one of our customers. Under this new arrangement, a number of this customer’s previously purchased units were converted to a license arrangement in order to extend access to the service pool under the service depot model for a period beyond the initial contractual period. The customer agreed to pay up-front the fees related to this multiyear license. This amount is reflected as an increase in accounts receivable and deferred revenue as of the end of the period, and the amount in deferred revenue will be amortized on a straight line basis over the term. Disposable products sales are recognized in accordance with the contract terms.
We also offer a month-to-month System One hardware rental arrangements. Under these arrangements, revenue is recognized on a monthly basis in accordance with agreed upon arrangements with the customers.
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.
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 equipment service to our customers. We recognize training and technical support revenue when the related services are performed and our performance obligations are satisfied. In the case of equipment service contracts entered into after the initial standard warranty period, the service contract revenue is recognized ratably over the service period.
Some of our contracts with customers in the System One segment contain contractually determined volume discounts offered to similar classes of customers. In addition, in many agreements we offer rebates and discounts for early payment which result in the ultimate payment being variable. The variable consideration paid by the customer is estimated and recognized when we satisfy our performance obligation (generally upon delivery) to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized to date will not occur. We are able to reliably estimate the amount of rebates and discounts and record them as a reduction to revenue and accounts receivable at the time of sale.
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 rebates and discounts for early payment which results in the ultimate payment being variable. The variable fee paid by the distributor is estimated and recognized when we satisfy our performance obligation (generally upon delivery to the distributor) to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized to date will not occur. We are able to reliably estimate the amount of rebates/discounts and record them as a reduction to revenue and trade accounts receivable at the time of sale.
Services Segment

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Revenues in our Services segment are derived from dialysis care services provided to patients at our NxStage Kidney Care dialysis centers.
Revenues are recognized in the period in which services are provided. For revenues associated with Medicare, Medicaid or commercial insurers with which we have formal agreements, revenue is recognized based on contractual rates or rates established by statute or regulation in the case of Medicare and Medicaid. For certain classes of payors, for example non-contracted commercial health insurance payors and amounts due from patients (including co-pay and deductible amounts), revenue is recognized based on our estimate of the consideration that will be ultimately received from the payor which results in the ultimate payment being variable. The variable fee is estimated using historical collections experience with similar classes of payors and recognized when we satisfy our performance obligation (when services are provided) to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized to date will not occur. Overall, these estimates reflect the Company’s best estimates of the amount of consideration to which it is entitled from these customers. The amount of variable consideration which is included in the transaction price may be constrained, and is included in the sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. Actual amounts of consideration ultimately received may differ from our estimates. If actual results in the future vary from our estimates, we adjust these estimates, which would affect revenues and earnings in the period such variances become known. Such changes, if material, will be disclosed in the period such variances become known.
Other
Other revenues relate to the manufacturing of dialyzers for sale to Asahi Kasei Kuraray Medical Co. (Asahi). Sales to Asahi are structured as direct product sales and we have no significant post-delivery obligations. Revenue from direct product sales is recognized upon delivery in accordance with contract terms.
Costs to Obtain or Fulfill a Contract
We capitalize commission fees as costs of obtaining a contract, when they are incremental and if they are expected to be recovered, and amortize them consistently with the pattern of transfer of the good to which the asset relates. If the expected amortization period is one year or less, the commission fee is expensed when incurred.
Direct costs related to the delivered equipment within the System One home market are capitalized as deferred cost of revenues and amortized over the same expected period as the related revenue.
Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable is primarily limited to certain customers to whom we make substantial sales. One customer represented 40% of accounts receivable at September 30, 2018. Payment has been received against the majority of these receivables and as of October 15, 2018, the outstanding amount for this customer represented less than 10% of accounts receivable. No customer represented more than 10% of accounts receivable at December 31, 2017.
Warranty Costs
We accrue estimated costs that we may incur under our product warranty programs at the time the product revenue is recognized, based on contractual rights and historical experience. Warranty expense is included in cost of revenues in the condensed consolidated statements of comprehensive income (loss). The following is a rollforward of our warranty accrual (in thousands):
Balance at December 31, 2017
$
293

Provision
588

Usage
(336
)
Balance at September 30, 2018
$
545

Intangibles and Other Long-Lived Assets
Intangible assets are carried at cost less accumulated amortization. For assets with determinable useful lives, amortization is recognized using the straight-line method over the estimated economic lives of the respective intangible assets.  Long-lived assets, including intangible assets, are evaluated for recoverability whenever events or circumstances indicate that their carrying value may not be recoverable. Recoverability of long-lived assets is assessed at the lowest level for which discrete cash flows are available and is measured by comparing the asset group’s carrying value to its expected non-discounted future cash flows. If the sum of the expected non-discounted future cash flows is less than the carrying amount of the long-lived assets, an impairment loss is recognized for excess of the carrying amount of the asset group over its fair value.

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In the third quarter 2018, events and circumstances have indicated that certain long-lived tangible assets in the Services segment may not be recoverable. Therefore, a recoverability test was performed at the center level by comparing the carrying value of each center to its estimated future undiscounted cash flows, within the initial lease term (which is the equivalent to the depreciable life of the centers' most significant asset, its leasehold improvements). As of September 30, 2018, our expected non-discounted future cash flows for the majority of our centers indicated such carrying amounts were expected to be recovered. We recorded an impairment charge during the second quarter of 2018 of $0.1 million in cost of revenue to write-down certain center level assets within our Services segment.
Our expected non-discounted future cash flows used in our impairment testing are based upon cash flow projections and, if appropriate, include assumed proceeds upon sale of the asset group at the end of the cash flow period. We believe our procedures for developing cash flow projections, including the estimated sales proceeds, are reasonable and consistent with current market conditions for each of the dates when impairment testing has been performed.
Developing cash flow projections requires significant estimates and judgment.  Among other things, slower than expected patient ramp or lower than expected reimbursement rates would negatively impact our cash flow projections in the near term. Fair value of the asset group was estimated using a discounted cash flow approach. Estimating fair value requires significant judgment in the selection of the valuation technique and assumptions used in developing cash flow projections, growth rates and discount rates. Our assumptions are based on our best estimates, using appropriate and customary market participant assumptions. Any adverse changes in certain valuation assumptions could result in the need to record additional impairment to write down all or a portion the centers’ remaining asset carrying value.
We had $11.3 million of long-lived assets at our Services segment at September 30, 2018. It is reasonably possible that our cash flow projections may change in the near term resulting in the need to record an impairment charge for at least some portion of these assets.
Goodwill
We test goodwill for impairment during the fourth quarter, or more frequently when events or changes in circumstances indicate that the goodwill might be impaired. 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. Our System One, In-center and Services reporting units contain goodwill of $41.1 million, $0.5 million and $1.1 million, respectively. 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 or other fair value measurement.
During 2017 and 2016 we utilized the qualitative assessment to assess the fair value of our System One and In-center reporting units and concluded that it was more likely than not that the fair value of our reporting units was greater than their carrying value. During 2017, we also utilized the qualitative assessment to assess the fair value of our Services reporting unit and concluded that it was more likely than not that the fair value of the reporting unit was greater than its carrying value. During 2016, for our Services reporting unit, we utilized the quantitative assessment noting that the fair value of the reporting unit exceeds its carrying value, indicating that goodwill was not impaired. We estimated the fair value of our Services reporting unit using a discounted cash flow approach. Estimating the fair value of our Services reporting unit requires significant judgment in the selection of the valuation technique and assumptions used in cash flow projections, growth rates and discount rates. Our assumptions are based on our best estimates, using appropriate and customary market participant assumptions.
There have been no events or changes in circumstances since the date of our last goodwill impairment tests that would indicate it is more likely than not that the fair value of our reporting units is less than their carrying value. Developing cash flow projections involves significant judgment with respect to patient additions and reimbursement rates, operating income, capital expenditures and changes in working capital. Reductions in our cash flow projections due to slower than expected patient ramp or lower than expected reimbursement rates, among other things, or adverse changes in certain valuation assumptions or changes in the reporting units net assets could result in a goodwill impairment charge of up to $1.1 million in our Services reporting unit in the future.
Recent Accounting Pronouncements
Recently Implemented Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued ASU No. 2014-9: “Revenue from Contracts with Customers” (ASC 606). The standard provides that revenue should be recognized when an entity transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing and uncertainty of revenues and cash flow arising from contracts with customers. The FASB has issued several amendments and updates to the new revenue standard, including how an entity should identify performance obligations. As amended, the new guidance was effective for us

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beginning January 1, 2018. We adopted ASC 606 using the modified retrospective method approach as of January 1, 2018. This approach was applied to all contracts not completed as of January 1, 2018.
We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. See above in Note 2 for discussion of our updated Revenue Recognition policy.
We do not expect the adoption of the new revenue standard to have a material impact to our net income on an ongoing basis. The adoption of ASC 606 impacted the timing of revenue recognition for our Services segment and resulted in enhanced footnote disclosures related to customer contracts as included in Note 3 to these condensed consolidated financial statements. It also modified the accounting for commissions fees as it requires such incremental and recoverable costs to be capitalized and amortized over the estimated life of the asset. Previously, these costs were expensed as incurred.
The cumulative effect of the changes made to our condensed consolidated balance sheet for the adoption of ASC 606 was as follows (in thousands):
 
As Reported
Adjustment due to ASC 606
 
 
December 31, 2017
January 1, 2018
ASSETS
 
 
 
Accounts receivable, net
$
31,625

$
4,419

$
36,044

Prepaid expenses and other current assets
7,609

1,895

9,504

Deferred cost of revenues
31,410

(139
)
31,271

Other assets
5,911

379

6,290

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Noncontrolling interests subject to put provisions
(165
)
49

(116
)
Accumulated deficit
(421,593
)
5,961

(415,632
)
Noncontrolling interests not subject to put provisions
(12
)
544

532

In accordance with the new revenue standard requirements, the disclosure of the impact of adoption on our condensed consolidated statement of comprehensive income (loss) for the three and nine months ended September 30, 2018 was as follows (in thousands):
 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
 
As Reported
Balance without adoption of ASC 606
Effect of Change
 
As Reported
Balance without adoption of ASC 606
Effect of Change
Revenues
$
108,122

$
108,259

$
(137
)
 
$
322,390

$
323,986

$
(1,596
)
Cost of revenues
61,589

61,630

(41
)
 
183,745

183,892

(147
)
Selling and marketing
17,549

17,619

(70
)
 
53,735

53,970

(235
)
In accordance with the new revenue standard requirements, the disclosure of the impact of adoption on our condensed consolidated balance sheet at September 30, 2018 was as follows (in thousands):

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September 30, 2018
ASSETS
As Reported
Balance without adoption of ASC 606
Effect of Change
Accounts receivable, net
$
66,127

$
63,027

$
3,100

Prepaid expenses and other current assets
9,819

7,708

2,111

Deferred cost of revenues
33,012

33,003

9

Other assets
6,284

5,886

398

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Noncontrolling interests subject to put provisions
$
(291
)
$
(295
)
$
4

Accumulated deficit
(418,799
)
(424,386
)
5,587

Noncontrolling interests not subject to put provisions
712

688

24

Accumulated other comprehensive loss
(3,527
)
(3,530
)
3

The impacts noted above are primarily attributable to the change in the timing of revenue recognition for our Services segment as the standard requires revenues to be estimated and recognized upon transfer of the promised goods and services and accounting for capitalization of certain commissions.
In January 2016, the FASB issued ASU No. 2016-01: “Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” which impacts the recognition, measurement, presentation and disclosure of financial assets and financial liabilities. Among other things, the standard generally requires all equity investments (except those accounted for under the equity method and those that result in consolidation of the investee) be measured at fair value through earnings. For those equity instruments that do not have readily determinable fair values, the standard permits the application of a measurement alternative using the cost of the investment, less any impairments, plus or minus changes resulting from observable price changes for an identical or similar investment of the same issuer with such changes recognized in net income. The new guidance was effective for us beginning January 1, 2018. We have made this measurement alternative policy election for our equity investments without readily determinable fair values. The adoption of this standard did not have an impact on our financial position or results of operation.
Recent Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU No. 2016-02: "Accounting for Leases" which amends the existing accounting standards for leases. The new standard requires lessees to record a right-of-use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than twelve months. For lessees, leases will continue to be classified as either operating or financing in the income statement. This ASU is required to be applied with a modified retrospective approach which gives the option of applying the new lease requirements as of the effective date with enhanced disclosure requirements for comparative periods presented under the current guidance or applying the new standard at the beginning of the earliest comparative period presented. The new guidance is effective for us beginning January 1, 2019 and early adoption is permitted. We are evaluating the method of adoption and the potential impact of the standard on our consolidated financial statements and related disclosures and are comparing our current policies and practices to the requirements of the standard. We have developed a project plan to develop processes and tools in order to adopt the standard on January 1, 2019. We have periodically briefed our Audit Committee on our progress made towards adoption.
In August 2017, the FASB issued ASU 2017-12: "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities" which amends the hedge accounting recognition and presentation requirements. The update is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting and increase transparency as to the scope and results of hedge programs. The update is effective for us beginning January 1, 2019, with early adoption permitted. We are currently evaluating the potential impact this update will have on our financial statements.
3. Revenues
The following table disaggregates our revenues by market (in thousands):

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Three Months Ended September 30,
Nine Months Ended September 30,
 
2018
2018
System One segment
 
 
 
Home
$
62,387

 
$
182,821

Critical Care
22,958

 
69,491

Total System One segment
85,345

 
252,312

In-Center segment
15,943

 
49,689

Other
2,503

 
7,845

Products subtotal
103,791

 
309,846

Services segment
5,453

 
16,056

Elimination of intersegment revenues
(1,122
)
 
(3,512
)
     Total
$
108,122

 
$
322,390

For the three and nine months ended September 30, 2018, revenue recognized from performance obligations related to prior periods, including changes to variable consideration estimates, was not material.
Capitalized commission fees are amortized consistently with the pattern of transfer of the good to which the asset relates which is approximately 21 months. Capitalized commission fees were $2.3 million and $2.0 million as of September 30, 2018 and January 1, 2018, respectively, and are included in prepaid expenses and other current assets and other assets on our condensed consolidated balance sheet. During the nine months ended September 30, 2018, we recorded $1.8 million of amortization expense related to capitalized commissions, which is included in sales and marketing expense, and there was no impairment loss in relation to the costs capitalized.
Long-term deferred revenues primary relate to sales of System One hardware to dialysis clinic customers in the home market made under the depot service model which is deemed to be a lease element of the respective home transactions and, to a lesser extent, deferred revenue related to our Dialyzer Production Agreement with Asahi which is recognized in revenues on a straight-line basis over the expected term of the agreement. Other revenue expected to be recognized in future years related to remaining performance obligations, excluding revenue pertaining to contracts that have an original expected duration of one year or less and contracts where revenue is recognized as invoiced, is immaterial.
4. Inventory
Inventory includes material, labor and overhead, and is stated at lower of cost (first-in, first-out) or market (net realizable value). The components of inventory are as follows (in thousands):
 
September 30,
2018
 
December 31,
2017
Purchased components
$
14,695

 
$
14,947

Work in process
14,530

 
13,433

Finished goods
24,128

 
20,832

Total
$
53,353

 
$
49,212

5. Property and Equipment, Field Equipment and Deferred Cost of Revenues
Accumulated depreciation on property and equipment was $65.7 million and $56.8 million at September 30, 2018 and December 31, 2017, respectively. Accumulated depreciation on field equipment was $76.8 million and $51.6 million at September 30, 2018 and December 31, 2017, respectively. Accumulated amortization on deferred costs of revenues was $93.8 million and $106.3 million at September 30, 2018 and December 31, 2017, respectively.
6. Intangible Assets
Accumulated amortization of intangible assets was $28.5 million and $27.0 million at September 30, 2018 and December 31, 2017, respectively.
7. Net Income (Loss) per Share

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Basic net income (loss) per share is computed by dividing loss attributable to NxStage Medical, Inc. common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) for the period. The computation of diluted income (loss) per share is similar to basic income (loss) per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.
The following potential common stock equivalents, as calculated using the treasury stock method, were not included in the computation of diluted net loss per share for the three months ended September 30, 2017 and the nine months ended September 30, 2018 and 2017 as their effect would have been anti-dilutive due to the net loss incurred (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Options to purchase common stock
1,165

 
1,069

 
1,074

 
1,126

Unvested restricted stock
184

 
327

 
202

 
238

     Total
1,349

 
1,396

 
1,276

 
1,364

8. Accrued Expenses, Other Current Liabilities and Other Long-Term Liabilities
The components of accrued expenses are as follows (in thousands):
 
September 30,
2018

December 31,
2017
Payroll, compensation and related benefits
$
17,502

 
$
13,195

Distribution expenses
5,217

 
4,914

Other
12,135

 
9,876

     Total
$
34,854

 
$
27,985

The components of other current liabilities are as follows (in thousands):
 
September 30,
2018
 
December 31,
2017
Capital lease obligations
$
1,996

 
$
2,131

Deferred revenue, current portion
1,146

 
1,473

Other
847

 
955

Total
$
3,989

 
$
4,559

The components of other long-term liabilities are as follows (in thousands):
 
September 30,
2018
 
December 31,
2017
Capital lease obligations
$
10,765

 
$
11,589

Lease incentive obligations
2,432

 
2,652

Benefit plan obligations
2,129

 
2,060

Other
1,743

 
1,523

     Total
$
17,069

 
$
17,824

9. Segment Disclosures
We have three reportable business segments: System One, In-Center and Services. The operating results of NxStage Kidney Care are included in our Services segment. We refer to our System One segment, In-Center segment and Other category as our products business.
Our System One segment includes revenues from sales and rentals of the System One and PureFlow SL dialysate preparation equipment and the sale of disposable products to customers in the home market, including through our NxStage Kidney Care dialysis centers, and critical care market. The home market is devoted to the treatment of ESRD patients in the home or a home-like setting, including skilled nursing facilities, 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

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made primarily through dedicated sales forces and distributed directly to the customer, or the patient, with certain products sold through distributors.
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.
The remainder of our products business, which is included within the Other category, relates to the manufacturing of dialyzers for sale to Asahi Kasei Kuraray Medical Co., Ltd. (Asahi) and research and development and general and administrative expenses that are excluded from the segment operating performance measures.
Our Services segment includes revenues from dialysis services provided to patients at our NxStage Kidney Care dialysis centers. Sales of the System One and related products to our NxStage Kidney Care dialysis centers are included in System One segment revenues, which are then eliminated upon consolidation.
The accounting policies of our reportable segments are described in Note 2 to the consolidated financial statements included in our 2017 Annual Report and updated, as necessary, in Note 2 to the condensed consolidated financial statements included in this Quarterly Report. Our chief operating decision maker allocates resources to our business segments and assesses segment performance based on segment profit (loss), which consists of revenues less cost of revenues, selling and marketing and distribution expenses.
The following summarizes the operating performance of our reportable segments (in thousands):
 
System One
 
In-Center
 
Other
 
Services
 
Intersegment Elimination
 
Total
Three Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
84,223

 
$
15,943

 
$
2,503

 
$
5,453

 
$

 
$
108,122

Intersegment revenues
1,122

 

 

 

 
(1,122
)
 

Revenues
85,345

 
15,943

 
2,503

 
5,453

 
(1,122
)
 
108,122

Segment profit (loss)
23,526

 
2,036

 
(19,065
)
 
(5,270
)
 
35

 
1,262

Depreciation and amortization
5,904

 
454

 
1,069

 
1,303

 
(46
)
 
8,684

Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
73,479

 
$
15,465

 
$
3,392

 
$
4,959

 
$

 
$
97,295

Intersegment revenues
1,197

 

 

 

 
(1,197
)
 

Revenues
74,676

 
15,465

 
3,392

 
4,959

 
(1,197
)
 
97,295

Segment profit (loss)
18,799

 
2,131

 
(23,602
)
 
(5,626
)
 
15

 
(8,283
)
Depreciation and amortization
5,539

 
564

 
1,088

 
1,318

 
(26
)
 
8,483

Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
248,800

 
$
49,689

 
$
7,845

 
$
16,056

 
$

 
$
322,390

Intersegment revenues
3,512

 

 

 

 
(3,512
)
 

Revenues
252,312

 
49,689

 
7,845

 
16,056

 
(3,512
)
 
322,390

Segment profit (loss)
68,011

 
6,771

 
(59,148
)
 
(16,696
)
 
105

 
(957
)
Depreciation and amortization
17,168

 
1,405

 
3,230

 
3,965

 
(138
)
 
25,630

Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
220,950

 
$
45,397

 
$
9,127

 
$
14,866

 
$

 
$
290,340

Intersegment revenues
3,845

 

 

 

 
(3,845
)
 

Revenues
224,795

 
45,397

 
9,127

 
14,866

 
(3,845
)
 
290,340

Segment profit (loss)
60,021

 
6,152

 
(60,445
)
 
(17,724
)
 
(24
)
 
(12,020
)
Depreciation and amortization
16,601

 
1,633

 
3,252

 
3,888

 
(53
)
 
25,321

Substantially all of our revenues are derived from the sale of the System One and related products, which cannot be used with any other dialysis system, and from needles and blood tubing sets in the U.S..
The following table summarizes the number of customers who individually make up greater than ten percent of total revenues:

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Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
DaVita
19
%
 
20
%
 
19
%
 
20
%
Fresenius
21
%
 
20
%
 
20
%
 
19
%
Sales to DaVita HealthCare Partners Inc. (DaVita) and Fresenius are in the System One segment.
10. Commitments and Contingencies
Significant commitments and contingencies at September 30, 2018 are consistent with those discussed in Note 10 to the consolidated financial statements in our 2017 Annual Report.
11. Income Taxes
We recognized a provision for income taxes during the three and nine months ended September 30, 2018 and 2017 related to the profitable operations of certain foreign subsidiaries. In addition, the provision recognized during both periods includes the impact of an allocation of U.S. tax expense between continuing operations and total other comprehensive income (loss) of $0.1 million for both the three months ended September 30, 2018 and 2017 and $1.1 million for the nine months ended September 30, 2017. This allocation has no impact on total comprehensive income (loss) or total stockholders' equity for 2018. However, it did result in a net tax benefit from income taxes in continuing operations of less than $0.1 million and $0.2 million during the three and nine months ended September 30, 2017, respectively.
In accordance with Staff Accounting Bulletin 118, we recognized provisional tax impacts related to the Tax Cuts and Jobs Act of 2017 (Tax Reform) for the year ended December 31, 2017. Specifically, we remeasured our tax assets at December 31, 2017 based on the new Federal income tax rate of 21%. No additional adjustments were recorded in the current quarter.  We are still in the process of completing our evaluation of the impact of the Tax Reform on our financial statements. We will continue to make and refine our calculations as additional analysis is completed and gain a more thorough understanding of the Tax Reform.
As of September 30, 2018, we had a liability for unrecognized tax benefits included in the balance sheet of approximately $1.0 million, including a nominal accrual for interest and penalties of less than $0.1 million. There have been no significant changes to these amounts during the three and nine months ended September 30, 2018.
12. Stock-Based Compensation
Stock-based Compensation Expense
The following table presents stock-based compensation expense included in our condensed consolidated statements of comprehensive income (loss) (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Cost of revenues
$
214

 
$
335

 
$
685

 
$
902

Selling and marketing
738

 
1,054

 
2,314

 
3,047

Research and development
311

 
437

 
1,004

 
1,154

General and administrative
821

 
1,534

 
3,058

 
3,581

Total
$
2,084

 
$
3,360

 
$
7,061

 
$
8,684

Stock Options and Restricted Stock Units
The Company granted no new options during the three and nine months ended September 30, 2018. The Company granted options to purchase 7,480 and 675,358 shares of common stock during the three and nine months ended September 30, 2017, which vest based on continued employment over a period of one to four years. The weighted-average fair value of options granted during the nine months ended September 30, 2017 was $9.92 per option.
The Company awarded no new restricted stock units during the three and nine months ended September 30, 2018. The Company awarded 20,970 and 175,895 restricted stock units during the three and nine months ended September 30, 2017,

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which vest based on continued employment over a period of three to four years. The weighted-average fair value of these restricted stock units awarded during the nine months ended September 30, 2017 was $27.23 per unit.
13. Stockholders' Equity
We received 36,143 and 97,828 shares of common stock that were surrendered in payment for the exercise of stock options during the nine months ended September 30, 2018 and 2017, respectively.
14. Noncontrolling Interest
As of September 30, 2018, we have 4 VIEs included in our consolidated financial statements, all of which are NxStage Kidney Care dialysis centers. We are the managing member or we have a majority seat on the entity’s board of managers, manage these entities through a management services agreement.
The analysis upon which these consolidation determinations rest are complex, involve uncertainties and require significant judgment on various matters. At September 30, 2018 and December 31, 2017, total assets of our VIEs were $6.2 million and $5.6 million, respectively, and total liabilities and noncontrolling interests of our VIEs were $5.8 million and $5.8 million, respectively.
We have potential obligations to purchase the noncontrolling interests held by third parties in certain of our consolidated subsidiaries. These obligations are in the form of put provisions and are contingently exercisable at the third-party owners' discretion given specific facts and circumstances as outlined in each specific put provision. If these put provisions were exercised, we would be required to purchase all the third-party owners' noncontrolling interests at a fair value at the time of exercise pursuant to the terms of the agreement. At September 30, 2018 the Company's noncontrolling interests subject to put provisions were $(0.3) million and none of the rights were exercisable.
The following table sets forth the changes in noncontrolling interest not subject to put provisions for the three and nine months ended September 30, 2018 and 2017 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Balance at beginning of period
$
641

 
$
(145
)
 
$
(12
)
 
$
625

Adjustment due to adoption of ASC 606

 

 
542

 

Accretion to redemption value of noncontrolling interests
68

 
481

 
68

 
481

Reclassification of noncontrolling interest subject to put provision

 
(744
)
 

 
(744
)
Net loss attributable to noncontrolling interest in consolidated subsidiary
3

 
(376
)
 
114

 
(1,146
)
Balance at end of period
$
712

 
$
(784
)
 
$
712

 
$
(784
)
15. Derivative Instruments and Hedging
We operate manufacturing and service facilities in Mexico, Germany and Italy, and we purchase materials and pay our employees at those facilities in pesos and euros, and as such, we are potentially exposed to adverse as well as beneficial movements in currency exchange rates. We enter into foreign exchange forward contracts to minimize the impact of currency exchange rate fluctuations on these peso and euro denominated expenses. These contracts have durations of up to twelve months and are designated as cash flow hedges. The counterparties to these foreign exchange forward contracts are creditworthy financial institutions; therefore, we do not consider the risk of counterparty nonperformance to be material. As of September 30, 2018 and December 31, 2017, the notional amount of our outstanding contracts that are designated as cash flow hedges was $21.9 million and $24.1 million, respectively. The fair value of these contracts is recorded on the balance sheet within prepaid expenses and other current assets or accrued expenses depending on the gain (loss) position. The fair value of these contracts was a net asset of $0.3 million at September 30, 2018 and a net asset of less than $0.1 million at December 31, 2017. The cash flows related to our currency exchange contracts are classified as operating cash flows, which is consistent with the cash flow treatment of the underlying items being hedged.
Gains or losses related to hedge ineffectiveness recognized in earnings were not material during the nine months ended September 30, 2018 and 2017. Given the short-term nature of our contracts, any gains or losses recorded within accumulated other comprehensive income (loss) will be recognized in earnings within the next twelve months.

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The following table presents the effect of these contracts designated as cash flow hedges on our condensed consolidated financial statements (in thousands):
 
 
Gain (Loss) Recognized in OCI
(Effective Portion)
 
Gain (Loss) Reclassified from OCI into Income
(Effective Portion)
 
Classification within the Condensed Consolidated Statement of Comprehensive Income (Loss)
Three Months Ended September 30, 2018
 
 
 
 
 
 
Foreign exchange forward contracts
 
$
84

 
$
(240
)
 
Cost of revenues
Nine Months Ended September 30, 2018
 
 
 
 
 
 
Foreign exchange forward contracts
 
$
903

 
$
735

 
Cost of revenues
Three Months Ended September 30, 2017
 
 
 
 
 
 
Foreign exchange forward contracts
 
$
116

 
$
733

 
Cost of revenues
Nine Months Ended September 30, 2017
 
 
 
 
 
 
Foreign exchange forward contracts
 
$
4,211

 
$
254

 
Cost of revenues
16. Accumulated Other Comprehensive (Loss) Income
The following additional information is provided with respect to the accumulated other comprehensive (loss) income as presented on the condensed consolidated balance sheets (in thousands):
 
 
Unrealized gain (loss) on derivative instruments
 
Other (2)
 
Total
Balance, net of tax, as of December 31, 2017
 
$
(1,284
)
 
$
(2,389
)
 
$
(3,673
)
Other comprehensive income (loss) before reclassifications, net of tax
 
903

 
(22
)
 
881

Gain reclassified to earnings (1)
 
(735
)
 

 
(735
)
Total other comprehensive income (loss), net of tax
 
168

 
(22
)
 
146

Balance, net of tax, as of September 30, 2018
 
$
(1,116
)
 
$
(2,411
)
 
$
(3,527
)
(1) Reclassifications of gains (losses) on derivative instruments are included in cost of revenues on the condensed consolidated statement of comprehensive income (loss). See Note 15, Derivative Instruments and Hedging for further information.
(2) Other includes cumulative translation adjustments and, to a lesser extent, pension benefits.
17. Fair Value Measurements
We have certain financial assets and liabilities measured at fair value on a recurring and non-recurring basis recorded in our condensed consolidated balance sheets. The fair value measurements used are based on quoted prices, when available, or through the use of alternative approaches. The inputs used to determine fair value have been classified as Level 1, 2 or 3. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves for similar instruments and model-derived valuations whose inputs are observable. Fair values determined by Level 3 inputs utilize unobservable data points for the asset or liability.
We measure the fair value of our foreign exchange forward contracts classified as derivative instruments using an income approach, based on prevailing market forward rates less the contract rate multiplied by the notional amount. The product of this calculation is then adjusted for counterparty risk.
We did not have any transfers between Level 1 and Level 2 and Level 3 during the nine months ended September 30, 2018.
The following tables present assets and liabilities measured at fair value on a recurring basis and their level within the value hierarchy (in thousands):

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September 30, 2018
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total Fair Value
Assets








Money market funds (1)

$
35,397


$


$


$
35,397

Foreign exchange forward contracts (2)



732




732

Liabilities








Foreign exchange forward contracts (2)

$


$
407


$


$
407

December 31, 2017
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total Fair Value
Assets
 
 
 
 
 
 
 
 
Money market funds (1)
 
$
35,020

 
$

 
$

 
$
35,020

Foreign exchange forward contracts (2)
 

 
690

 

 
690

Liabilities
 
 
 
 
 
 
 
 
Foreign exchange forward contracts (2)
 
$

 
$
661

 
$

 
$
661

(1)
Money market funds are included within cash and cash equivalents.
(2)
Foreign exchange forward contracts are included within prepaid expenses and other current assets or accrued expenses depending on the gain (loss) position.
The carrying amount of our long-term debt approximates fair value at September 30, 2018 and December 31, 2017. The fair value of our long-term debt was estimated using inputs derived principally from market observable data, including current rates offered to us for debt of the same or similar remaining maturities. Within the hierarchy of fair value measurements, these are Level 2 inputs.
The carrying amounts reflected in the condensed consolidated balance sheets for cash and cash equivalents (including money market funds), accounts receivable, prepaid expenses and other current and non-current assets, accounts payable and accrued expenses approximate fair value due to their short-term nature.
At September 30, 2018 and December 31, 2017, we had an equity instrument without readily determinable fair values of $2.5 million for which we have elected the measurement alternative. We have evaluated this investment for any impairment, as well as any observable price changes for an identical or similar equity instrument of the same issuer, and determined that no material adjustment in the carrying value was required for the nine months ended September 30, 2018.
18. Supplemental Cash Flow Information
The following additional information is provided with respect to the condensed consolidated statements of cash flows (in thousands):
 
Nine Months Ended September 30,
 
2018
 
2017
Noncash Investing and Financing Activities:
 
 
 
Transfers from inventory to field equipment
$
15,649

 
$
13,709

Transfers from field equipment to deferred cost of revenues
11,875

 
7,570

Market value of shares received in payment for exercise of stock options
887

 
2,771

PP&E financed by construction liability
95

 
109

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Regarding Forward Looking Statements
The following discussion should be read with our unaudited condensed consolidated financial statements and notes included in Part I, Item 1 of this Quarterly Report, as well as the audited financial statements and notes and “Management's
Discussion and Analysis of Financial Condition and Results of Operations” for the year ended December 31, 2017, included in our 2017 Annual Report.
This Quarterly Report and certain information incorporated by reference herein contain forward-looking statements concerning our business, operations and financial condition, including statements with respect to:
the growth of our business and the drivers of such growth;
the ability of enhancements to our product portfolio to help us expand existing markets and enter new ones;
achieving greater operating leverage and improved financial results in the future;
estimates of the number of end-stage renal disease (ESRD) patients that could be treated at home with the System One;
patients' access to home and more frequent hemodialysis;
sales to our key customers, including DaVita HealthCare Partners Inc. (DaVita) and Fresenius;
the adequacy of our funding;
expectations with respect to future demand for our products and revenue growth, with components of such revenue growth including sales of disposable products;
future financial results for our System One, In-Center and Services segments, Other revenues and total company;
expectation of sustaining gross profit as a percentage of revenue in our System One segment above 50% and the underlying elements of such objective;
future selling and marketing, research and development, distribution, and general and administrative expenses and the drivers for such expenses;
our manufacturing operations and supply chain;
the scope, timing and impact of our research and development efforts;
expectations with respect to our working capital levels and requirements;
availability of credit under our revolving credit facility;
global economic conditions;
impact of the adoption of new accounting standards and the Tax Cuts and Jobs Act of 2017 (Tax Reform);
the availability of, and impact of changes in, reimbursement for home and more frequent hemodialysis, and the expected impact of draft local coverage determinations on reimbursement for more frequent hemodialysis in the United States;
the anticipated timing and likelihood of completion of our proposed merger of us with a subsidiary of Fresenius (Merger);
disruptions to our business operations due to the pendency of the proposed Merger;
anticipated benefits of manufacturing dialyzers for sale to Asahi Kasei Kuraray Medical Co. (Asahi) and future sales to Asahi;
our ability to withstand supply chain disruptions;
the scope and adequacy of patent protection with respect to our products; and
the financial, commercial and operational impact of any of the above.
All statements other than statements of historical facts included in this Quarterly Report regarding our strategies, prospects, financial condition, costs, plans and objectives are forward-looking statements. When used in this Quarterly 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 Quarterly Report, as these sections describe important factors that could cause actual results to differ materially from those indicated by our forward-looking statements. We caution investors not to view forward-looking statements as guarantees of future outcomes. We undertake no obligation to revise or update publicly any forward-looking statement.
Introduction    
We are a medical technology company that develops, manufactures, markets and provides innovative products and services for patients suffering from chronic or acute kidney failure. Since our initial public offering in 2005, we have built a strong business that we believe serves as a solid foundation for future growth. As a leader in home hemodialysis, we remain

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committed to not only growing this and our other existing markets, but also expanding to new markets, including skilled nursing facilities, where we believe our current and future technology has the ability to deliver value for both patients and our customers.
We report our operating results through three segments: System One, In-Center and Services. We sell our products in and provide our services in three markets: home, critical care and in-center. Our other business activities excluded from segment operating performance measures are reported in an Other category. The operating results of our dialysis centers business, which
we refer to as NxStage Kidney Care, are included in our Services segment. Sales of our System One and related products to
our NxStage Kidney Care dialysis centers are included in System One segment home market revenues, which are then
eliminated upon consolidation. For convenience, we use the term “products business” to refer collectively to our System One segment, In-Center segment, and Other category.
On August 7, 2017, we entered into the Merger Agreement, pursuant to which we will merge with a wholly-owned subsidiary of Fresenius, subject to the conditions set forth therein. See “Risk Factors” in Part II Item 1A of this Quarterly Report and Note 1, “Nature of Operations, Proposed Merger, Basis of Presentation and Principles of Consolidation” to the unaudited condensed consolidated financial statements contained herein for additional information. We have incurred $0.6 million and $2.6 million of incremental costs for the three and nine months ended September 30, 2018, respectively, and $4.1 million and $4.3 million during the three and nine months ended September 30, 2017, respectively, for professional service fees and costs related to the performance based restricted stock unit awards being deemed earned pursuant to the terms of the Merger Agreement. The majority of these expenses have been recorded as general and administrative costs in our condensed consolidated statement of comprehensive income (loss).
Segment and Market Highlights
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 are our two largest customers for products used in the home. Collectively, they provide treatment to more than two-thirds of U.S. dialysis patients and a similar portion of our home patients, and account for the majority of our System One segment revenues. Increased sales to DaVita and Fresenius have driven a large portion of our historical revenue growth and will be important to future growth. Our home market customer 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 contain no minimum purchase volumes. Our home agreement with DaVita extends through December 31, 2018, with monthly renewals thereafter unless terminated by either party with 30 days' prior notice. Our home agreement with Fresenius continues to renew on a monthly basis unless we and Fresenius choose to modify the terms with an amendment or new agreement.
Our In-Center segment revenues are highly concentrated in several significant purchasers. Henry Schein, Inc., accounted for 20% and 23% of our In-Center segment revenues for the three months ended September 30, 2018 and 2017, respectively, and 21% and 22% for the nine months ended September 30, 2018 and 2017, respectively. B. Braun Medical, Inc. accounted for 22% and 22% of our In-Center segment revenues for the three months ended September 30, 2018 and 2017, respectively, and 24% and 22% for the nine months ended September 30, 2018 and 2017, respectively. Gambro AB (a subsidiary of Baxter International, Inc.) accounted for 22% and 17% of our In-Center segment revenues for the three months ended September 30, 2018 and 2017, respectively, and 21% and 21% for the nine months ended September 30, 2018 and 2017 respectively, with all of Gambro's sales of our products being to DaVita.
We offer certain distributors rebates based on sales to specific end users. Our revenues are presented net of these rebates. For our System One segment, as of September 30, 2018, we had $3.0 million reserved against trade accounts receivable for future distributor rebates and recorded $4.7 million and $3.7 million during the three months ended September 30, 2018 and 2017, respectively, and $14.3 million and $11.5 million during the nine months ended September 30, 2018 and 2017, respectively, as a reduction of revenues in connection with distributor rebates. For the In-Center segment, as of September 30, 2018, we had $2.5 million reserved against trade accounts receivable for future estimated distributor rebates and recorded $2.0 million and $2.0 million during the three months ended September 30, 2018 and 2017, respectively, and $6.1 million and $5.0 million during the nine months ended September 30, 2018 and 2017 respectively, as a reduction of revenues in connection with distributor rebates.
Our Services segment includes revenues from dialysis services provided to patients at our NxStage Kidney Care dialysis centers. As of September 30, 2018 we have 20 centers operating in 13 states. At these centers, we provide patients with a range of therapy options to address their clinical and lifestyle needs. For appropriate patients, such therapies may include home hemodialysis, flexible in-center hemodialysis and peritoneal dialysis.
We adopted ASC 606 with a date of initial application of January 1, 2018. As a result, we changed our accounting policy for revenue recognition as detailed in Note 2. We applied ASC 606 using the cumulative effect method, i.e., by recognizing the cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of equity at January 1, 2018.

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Therefore, the comparative information has not been adjusted and continues to be reported under ASC 605. The details of the significant changes and quantitative impact of the changes are outlined in Note 2.
Financial Performance
The following table summarizes our consolidated results (in thousands, except percentages):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Products Business (System One Segment, In-Center Segment & Other)
 
 
 
 
 
 
 
Revenues
$
103,791

 
$
93,533

 
$
309,846

 
$
279,319

Gross profit
$
49,827

 
$
44,333

 
$
149,082

 
$
133,988

Gross margin percentage
48
%
 
47
%
 
48
%
 
48
%
Income (loss) from operations
$
6,497

 
$
(2,672
)
 
$
15,634

 
$
5,728

Services Segment
 
 
 
 
 
 
 
Revenues
$
5,453

 
$
4,959

 
$
16,056

 
$
14,866

Gross profit
$
(3,329
)
 
$
(3,741
)
 
$
(10,542
)
 
$
(11,001
)
Gross margin percentage
n/a

 
n/a

 
n/a

 
n/a

Loss from operations
$
(5,270
)
 
$
(5,626
)
 
$
(16,696
)
 
$
(17,724
)
Eliminations
 
 
 
 
 
 
 
Elimination of intersegment revenues
$
(1,122
)
 
$
(1,197
)
 
$
(3,512
)
 
$
(3,845
)
Elimination of intersegment gross profit
$
35

 
$
15

 
$
105

 
$
(24
)
Total Company
 
 
 
 
 
 
 
Revenues
$
108,122

 
$
97,295

 
$
322,390

 
$
290,340

Gross profit
$
46,533

 
$
40,607

 
$
138,645

 
$
122,963

Gross margin percentage
43
%
 
42
%
 
43
%
 
42
%
Income (loss) from operations
$
1,262

 
$
(8,283
)
 
$
(957
)
 
$
(12,020
)
For several years, we have focused on operating and financial improvements. During the three and nine months ended September 30, 2018, these efforts resulted in revenues for both periods increasing by 11% to $108.1 million and $322.4 million, respectively, versus the prior year comparable periods with sales in the home and critical care markets principally driving the growth. Our financial results for the third quarter 2018 also represent the first quarter of profitable operations since inception. Driving continued improvements will remain an area of focus in 2018 and beyond within our products business. At the same time, we expect operating losses in our Services segment to have a negative impact, along with costs related to the proposed Merger, on our total operating performance in the near term.
Comparison of the Three and Nine Months Ended September 30, 2018 and 2017

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Revenues
Our revenues for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands, except as percentages of revenues):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
System One segment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home
$
62,387

 
58
 %
 
$
55,852

 
57
 %
 
$
182,821

 
57
 %
 
$
165,949

 
57
 %
Critical Care
22,958

 
21
 %
 
18,824

 
20
 %
 
69,491

 
22
 %
 
58,846

 
20
 %
Total System One segment
85,345

 
79
 %
 
74,676

 
77
 %
 
252,312

 
79
 %
 
224,795

 
77
 %
In-Center segment
15,943

 
15
 %
 
15,465

 
16
 %
 
49,689

 
15
 %
 
45,397

 
16
 %
Other
2,503

 
2
 %
 
3,392

 
3
 %
 
7,845

 
2
 %
 
9,127

 
3
 %
Products subtotal
103,791

 
96
 %
 
93,533

 
96
 %
 
309,846

 
96
 %
 
279,319

 
96
 %
Services segment
5,453

 
5
 %
 
4,959

 
5
 %
 
16,056

 
5
 %
 
14,866

 
5
 %
Elimination of intersegment revenues
(1,122
)
 
(1
)%
 
(1,197
)
 
(1
)%
 
(3,512
)
 
(1
)%
 
(3,845
)
 
(1
)%
     Total
$
108,122

 
100
 %
 
$
97,295

 
100
 %
 
$
322,390

 
100
 %
 
$
290,340

 
100
 %
Home product revenues increased $6.5 million, or 12%, and $16.9 million, or 10%, for the three and nine months ended September 30, 2018 versus the prior year comparable period, respectively, 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. We further expect that our System One segment revenues will be susceptible to fluctuations in equipment sales, changes in purchasing patterns and subsequent inventory levels at our international distributors and changes in currency exchange rates.
Critical Care product revenues increased $4.1 million, or 22%, and $10.6 million, or 18%, during the three and nine months ended September 30, 2018 versus the prior year comparable period, respectively, driven by higher sales of System One consumables. 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 critical care may fluctuate due to timing of sales and the overall capital spending environment of our customers.
In-Center segment revenues increased $0.5 million, or 3%, and $4.3 million, or 9%, for the three and nine months ended September 30, 2018, versus the prior year comparable period, respectively. The overall increase is attributable to increased sales of our blood tubing sets. We expect In-Center segment revenues will increase modestly but may fluctuate due to inventory management policies at both our distributors and end users.
Other revenues for the three and nine months ended September 30, 2018 and 2017 relate to dialyzers sold to Asahi. The fluctuation in revenues was due to changes in volume. Sales to Asahi are expected to decline in 2018 due to lower volume.
Service segment revenues for the three and nine months ended September 30, 2018 and 2017 relate to dialysis services provided to patients at our NxStage Kidney Care dialysis centers. We expect Service segment revenues to increase modestly, but may fluctuate in the near term based on payor mix. Effective January 1, 2018, we adopted the new revenue recognition guidance under ASC 606. This resulted in a change to the timing of revenue recognition for our Services segment as the standard requires revenues to be estimated and recognized upon transfer of the promised goods and services. Please refer to Note 2 to the accompanying financial statements for further discussion of the impact of our adoption of ASC 606.
Gross Profit (Loss)
Our gross profit (loss) for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands, except as percentages of revenues):

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Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
System One segment
$
45,674

 
54
%
 
$
39,671

 
53
%
 
$
135,830

 
54
%
 
$
120,618

 
54
%
In-Center segment
4,132

 
26
%
 
4,423

 
29
%
 
13,072

 
26
%
 
12,821

 
28
%
Subtotal
49,806

 
49
%
 
44,094

 
49
%
 
148,902

 
49
%
 
133,439

 
49
%
Other
21

 
n/a

 
239

 
7
%
 
180

 
n/a

 
549

 
6
%
Products subtotal
$
49,827

 
48
%
 
$
44,333

 
47
%
 
$
149,082

 
48
%
 
$
133,988

 
48
%
Services segment
(3,329
)
 
n/a

 
(3,741
)
 
n/a

 
(10,542
)
 
n/a

 
(11,001
)
 
n/a

Elimination of intersegment gross profit
35

 
n/a

 
15

 
n/a

 
105

 
n/a

 
(24
)
 
n/a

Gross profit
$
46,533

 
43
%
 
$
40,607

 
42
%
 
$
138,645

 
43
%
 
$
122,963

 
42
%
Gross profit as a percentage of revenues for the System One segment increased for the three months ended September 30, 2018 versus the prior year comparable period, primarily driven by product mix, offset in part by unfavorable exchange rates. Gross profit as a percentage of revenues for the System One segment remained consistent for the nine months ended September 30, 2018. We expect to sustain gross profit as a percentage of revenues in our System One segment above 50% as we continue to work to lower costs through process improvements, increase volume and improve our manufacturing operations in order to offset potential increases in material costs and labor rates.
Gross profit as a percentage of revenues for the In-Center segment decreased for the three months ended September 30, 2018 versus the prior year comparable period, primarily driven by unfavorable exchange rates, product mix and increased product costs. Gross profit as a percentage of revenues for the In-Center segment decreased for the nine months ended September 30, 2018 versus the prior year comparable period, driven primarily by changes in product mix and exchange rates. We expect gross profit as a percentage of revenues will fluctuate as a result of competitive pricing pressures and changes in product mix.
The Other category relates to costs associated with the manufacturing of dialyzers for sale to Asahi, which have provided us with long term cost efficiencies through increased dialyzer production volumes.
The negative gross profit as a percentage of revenues incurred by our Services segment was driven by costs associated with continued support of our NxStage Kidney Care dialysis centers, many of which are not at scale. We expect the Services segment gross margin will continue to be negative in 2018.
In aggregate, we expect total company gross profit as a percentage of revenues will continue to be negatively impacted by projected losses from our Services segment in 2018.
Selling and Marketing
Our selling and marketing expenses and selling and marketing expenses as a percentage of revenues for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands, except as percentages of revenues):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
System One segment
$
13,984

 
16
%
 
$
13,191

 
18
%
 
$
42,694

 
17
%
 
$
38,303

 
17
%
In-Center segment
1,624

 
10
%
 
1,908

 
12
%
 
4,887

 
10
%
 
5,569

 
12
%
Products subtotal
15,608

 
15
%
 
15,099

 
16
%
 
47,581

 
15
%
 
43,872

 
16
%
Services segment
1,941

 
36
%
 
1,885

 
n/a

 
6,154

 
38
%
 
6,723

 
n/a

     Total Selling and marketing
$
17,549

 
16
%
 
$
16,984

 
17
%
 
$
53,735

 
17
%
 
$
50,595

 
17
%
Selling and marketing expenses increased $0.6 million, or 3%, and $3.1 million, or 6%, for the three and nine months ended September 30, 2018 versus the prior year comparable period, respectively, but remained relatively consistent as a percentage of revenues.
Selling and marketing expenses for the System One segment increased due to increased personnel and personnel-related costs. Selling and marketing for the In-Center segment decreased due to decreased personnel and personnel-related costs.
Selling and marketing expenses for our Services segment increased $0.1 million, or 3%, and decreased $0.6 million, or 8%, for the three and nine months ended September 30, 2018, versus the prior year comparable period, respectively. The decrease for the nine months ended September 30, 2018 was driven by decreased personnel and personnel-related costs from

24

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the prior year which had included the recognition of severance and other post termination costs of $0.8 million during the nine months ended September 30, 2017. Selling and marketing expenses include the personnel and other costs associated with our market development activities to establish, develop and operate our NxStage Kidney Care dialysis centers, including administrative support functions directly related to the support of this initiative.
In aggregate, we anticipate that selling and marketing expenses will continue to increase but remain relatively consistent as a percentage of revenues in the near term.
Research and Development
Our research and development expenses for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands, except as percentages of revenues):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Research and development
$
9,698

 
9
%
 
$
11,222

 
12
%
 
$
29,729

 
9
%
 
$
29,757

 
10
%
Research and development expenses decreased by $1.5 million, or 14%, for the three months ended September 30, 2018 and remained relatively consistent for the nine months ended September 30, 2018 versus the prior year comparable period, respectively. The decrease was primarily due to timing of project related spending.
For the near term, we expect research and development expenses will increase as we seek to further develop and enhance the System One and invest in our next-generation critical care and peritoneal dialysis systems to expand our product portfolio.
Distribution
Our distribution expenses for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands, except as percentages of revenues):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
System One segment
$
8,164

 
10
%
 
$
7,681

 
10
%
 
$
25,125

 
10
%
 
$
22,294

 
10
%
In-Center segment
472

 
3
%
 
384

 
2
%
 
1,414

 
3
%
 
1,100

 
2
%
     Total Distribution
$
8,636

 
8
%
 
$
8,065

 
8
%
 
$
26,539

 
8
%
 
$
23,394

 
8
%
Distribution expenses increased $0.6 million, or 7%, and $3.1 million, or 13%, for the three and nine months ended September 30, 2018, respectively, versus the prior year comparable period, driven primary by higher shipment volumes in the System One segment. Distribution expenses for the nine months ended September 30, 2018 included costs associated with a consumable product quality issue and related expedited shipments. 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 for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands, except as percentages of revenues):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
General and administrative
$
9,388

 
9
%
 
$
12,619

 
13
%
 
$
29,599

 
9
%
 
$
31,237

 
11
%
General and administrative expenses decreased by $3.2 million, or 26%, and $1.6 million, or 5%, for the three and nine months ended September 30, 2018, respectively, versus the prior year comparable period, respectively. The decrease was primarily due to lower professional service fees and other costs incurred in connection with the proposed merger. We recognized $0.4 million and $2.0 million of expenses incurred in connection with the proposed merger during the three and nine months ended September 30, 2018, respectively, and $3.6 million and $3.9 million during the three and nine months ended September 30, 2017, respectively. We expect general and administrative expenses as a percentage of revenues will decrease versus prior periods reflecting costs associated with the proposed merger.



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Other Expense
Interest expense, net includes interest income and interest costs and other fees related to our debt obligations, including capital leases.
Other expense, net includes foreign currency gains and losses.
Provision for Income Taxes
We recognized a provision for income taxes during the three and nine months ended September 30, 2018 and 2017 related to the profitable operations of certain foreign subsidiaries. In addition, the provision recognized during both periods includes the impact of an allocation of U.S. tax expense between continuing operations and total other comprehensive income (loss) of $0.1 million for both the three months ended September 30, 2018 and 2017 and $1.1 million for the nine months ended September 30, 2017. This allocation has no impact on total comprehensive income (loss) or total stockholders' equity for 2018. However, it did result in a net tax benefit from income taxes in continuing operations of less than $0.1 million and $0.2 million during the three and nine months ended September 30, 2017, respectively.
Liquidity and Capital Resources
Before attaining profitability in the third quarter of 2018, we had operated at a loss since our inception in 1998. As of September 30, 2018, our accumulated deficit was $418.8 million and we had cash and cash equivalents of $81.9 million, with substantially all of that cash located in the U.S., and working capital of $152.5 million.
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 support of our existing NxStage Kidney Care dialysis centers, which have continued to experience operating losses, in aggregate.
Our ongoing cash requirements include funding normal working capital needs including inventory and field equipment assets as well as funding the losses from our NxStage Kidney Care dialysis centers. Field equipment assets include System One equipment rented to customers under our month-to-month rental program and our "service pool" of equipment, which is equipment owned and maintained by us that is swapped for equipment at our home market customers, including patient homes, that needs repair or maintenance. While a majority of System One equipment sold in the home market is paid for upfront by our customers versus on a monthly basis, any excess rental or service swap equipment would increase our working capital requirements.
We have a revolving credit facility with Capital One Financial Corporation and Silicon Valley Bank that allows for borrowing up to $35 million and 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 that we comply with certain covenants while borrowings are outstanding, contains events of default customary for an agreement of this type and is secured by substantially all of our assets. As of September 30, 2018, 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 and any restrictions pursuant to the Merger Agreement, we had approximately $35 million of credit commitment available for borrowing.
We maintain post-employment 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 $2.1 million at September 30, 2018 for costs associated with these plans. The expense recorded in connection with these plans was not significant during the nine months ended September 30, 2018 or 2017.
The following table sets forth the components of our cash flows for the periods indicated (in thousands):
 
Nine Months Ended September 30,
 
2018
 
2017
Net cash provided by operating activities
$
20,707

 
$
1,989

Net cash used in investing activities
(4,364
)
 
(10,150
)
Net cash provided by financing activities
812

 
10,364

Foreign exchange effect on cash and cash equivalents
(139
)
 
1,144

Net cash flow
$
17,016

 
$
3,347


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Net cash provided by operating activities. Net cash flows from operating activities increased by $18.7 million during the nine months ended September 30, 2018, versus the prior year comparable period. Improvements in net loss after adjustments for non-cash items such as depreciation, amortization and stock-based compensation during 2018 when compared to 2017 coupled with timing of accounts receivable collections and payments to our vendors were offset by other working capital changes. We expect working capital to fluctuate due to various factors including inventory requirements and the timing of certain payments from our customers and to our vendors.
Cash flow from deferred revenues improved by $30.4 million during the nine months ended September 30, 2018, versus the prior year comparable period. The increase in deferred revenues was primarily the result of a new multiyear licensing arrangement which was offset by a similar increase in accounts receivable and is discussed in Note 2 to the Condensed Consolidated Financial Statements. Amortization of deferred revenues into revenues relating to sales of home equipment was $13.8 million and $13.3 million during the nine months ended September 30, 2018 and 2017, respectively.
Net cash used in investing activities. For each of the periods above, net cash used in investing activities reflected purchases of property and equipment, related to expenditures for our manufacturing facilities as a result of our efforts to maintain and expand our manufacturing operations, coupled with the build-out of NxStage Kidney Care dialysis centers, along with purchases of information technology.
The decrease of $3.2 million in purchases of property and equipment was driven in part by decreased spending associated with our NxStage Kidney Care dialysis centers. Capital expenditures for our NxStage Kidney Care centers were $1.1 million and $1.9 million during the nine months ended September 30, 2018 and 2017, respectively.
Net cash provided by financing activities. During the nine months ended September 30, 2018 and 2017 we received $2.1 million and $11.0 million, respectively, of net cash flows from stock plan activities. Proceeds from stock incentive plans are subject to fluctuation based primarily on the number of options exercised and, to a lesser extent, the weighted-average exercise price. Cash provided by financing activities during both 2018 and 2017 was also reduced by cash used to pay our capital lease and debt obligations.
Summary of Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ substantially from our estimates.     
The significant accounting policies used in preparation of these condensed consolidated financial statements for the three and nine months ended September 30, 2018 are described in Note 2 to the consolidated financial statements included in our 2017 Annual Report and updated as necessary in Note 2 to the condensed consolidated financial statements included in this Quarterly Report. The critical accounting policies and the significant judgments and estimates used in the preparation of our condensed consolidated financial statements for the three and nine months ended September 30, 2018 are consistent with those described in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in our 2017 Annual Report, except for changes to revenue recognition from the adoption of ASC 606 (see Note 2).
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements is included in Note 2 to the consolidated financial statements included in our 2017 Annual Report and updated as necessary in Note 2 to the condensed consolidated financial statements included in this Quarterly Report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risks in the normal course of our business, including changes in interest rates and exchange rates. A discussion of market risk affecting us is included in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our 2017 Annual Report. There have been no material changes to our market risks or to our management of such risks during the three and nine months ended September 30, 2018.
Item 4. Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2018. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time

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periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2018, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective to achieve their stated purpose.
No change in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three and nine months ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
We implemented internal controls to ensure we adequately evaluated our contracts and properly assessed the impact of ASC 606 to facilitate its adoption on January 1, 2018. There were no significant changes to our internal control over financial reporting due to the adoption of this standard.
PART II - OTHER INFORMATION
Item 1A.  Risk Factors
We face a number of risks and uncertainties that are difficult to predict and many of which are outside of our control. In this section, we describe what we believe are the material risks to our business and future development. This is not an exhaustive list of risks affecting our business. There may be other risks that are not currently known to us or that we currently believe are immaterial but turn out to be material in the future. If any of these risks were to materialize, it could adversely affect our business, financial condition, results of operation, reputation and growth prospects, and cause actual results to differ materially from those projected in any of our forward-looking statements. In that case, the value of our common stock could decline substantially.
Investors should carefully consider the risk factors described below together with the other cautionary statements included in Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Quarterly Report.
Risks Related to our Business
The home hemodialysis market may not expand sufficiently to support our growth prospects.
While we believe our largest growth opportunity with our existing products is within the home hemodialysis market, home hemodialysis therapies have not been extensively adopted. With our current technology, we believe that approximately 10-15% of end-stage renal disease patients in the U.S. would be appropriate candidates for home hemodialysis. However, only 2% of U.S. chronic dialysis patients receive hemodialysis treatments at home.
Our growth requires that we continue to shift patients’ and the medical community’s understanding and view of home hemodialysis and will require further increases in the number of patients who adopt home hemodialysis from current levels, physicians who are willing to prescribe home hemodialysis, and dialysis centers that are willing to support home hemodialysis growth. Most dialysis centers presently do not have the infrastructure to support a significant home hemodialysis patient population, including the availability of home hemodialysis training nurses, and may not be motivated to invest in home hemodialysis programs due, in part, to certain Medicare reimbursement policies. We will need to continue to devote significant resources to expanding the home hemodialysis market, but these efforts ultimately may not be successful.
Medicare reimbursement policies may limit patient access to our home hemodialysis products.
Medicare regulations that, directly or indirectly, have a disproportionate impact on home hemodialysis therapy may limit patient access to our home hemodialysis products. In 2011, the Centers for Medicare and Medicaid Services implemented a prospective payment system for dialysis treatment. Under this prospective payment system, the Centers for Medicare and Medicaid Services generally makes a single bundled payment to the dialysis center 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 centers 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. A stated goal of the new prospective payment system was to encourage home dialysis. To date, this reimbursement structure 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 rates of training for peritoneal dialysis. We believe this increased focus on peritoneal dialysis growth and peritoneal dialysis

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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.
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, have been prescribed to dialyze more than three times per week to attain the clinical benefits of more frequent dialysis. Given the increased provider costs associated with providing more frequent dialysis, access to our home hemodialysis products will be impacted by whether dialysis centers receive or pursue adequate reimbursement for the additional dialysis treatments. Reimbursement for more frequent hemodialysis requires medical justification provided by the dialysis center based on information from the patient’s physician, which increases the center’s administrative burden. In addition, there is no national standard for what constitutes medical justification, thus reimbursement for more frequent hemodialysis varies due to differing Medicare contractor policies and center billing practices. Dialysis centers may be unwilling to support more frequent home hemodialysis in the absence of predictable Medicare reimbursement for additional treatments per week based on submitted claims for medical justification.
Currently, only four of the twelve Medicare contractor jurisdictions have issued formal local coverage determinations that describe medical justification for more frequent hemodialysis. In the remaining jurisdictions, medical justification is determined on a case-by-case basis. Recently, however, all Medicare contractors have issued proposed local coverage determinations setting forth a limited set of medical conditions that would constitute medical justification for more frequent hemodialysis in their respective jurisdictions. The proposed local coverage determinations are nearly identical across Medicare contractors and would cover all existing dialysis units. We believe the proposed local coverage determinations are inconsistent with long-standing Medicare policy, including that reiterated in recent Medicare payment rules, current clinical literature and locally accepted standards of care. In partnership with other provider, patient, and professional organizations, we have been actively engaged in the comment process for the proposed local coverage determinations. If the proposed local coverage determinations were adopted in their current form, they would adversely affect our business, financial condition and results of operation by significantly restricting patient access to home and more frequent hemodialysis.
Measures to reduce healthcare costs may hurt our business.
Our customers are healthcare providers who depend upon reimbursement by government and commercial insurance payors for dialysis treatments. 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 customer’s decision to use the System One or our other products and limits the prices we may charge for our products. The Centers for Medicare and Medicaid Services has issued the 2019 proposed rule for the end-stage renal disease prospective payment system, which proposes to increase the base reimbursement rate by only 1.5% over 2018 rates. Commercial insurance payors may also exert downward pressure on payment rates for dialysis services. A reduction in reimbursement rates for dialysis treatments may adversely affect our customers’ businesses and cause them to enact cost reduction measures that may include reducing the scope of their home hemodialysis programs.
In recent years, there have been numerous initiatives on the federal and state levels for comprehensive reforms affecting the availability of and reimbursement for healthcare services. For example, in 2010, comprehensive U.S. health care reform legislation was passed imposing a 2.3% excise tax on domestic sales of certain medical devices, including our products. This tax was suspended for 2016 and 2017, and, as part of the Tax Reform, the tax was again suspended for two years, beginning in January 2018. The tax will continue to have a negative impact when it is imposed again starting in 2020 unless permanently suspended or repealed. Rising healthcare costs have also led many European and other foreign countries to adopt healthcare reform proposals and medical cost containment measures, including government-imposed industry-wide price reductions, mandatory pricing systems, reference pricing systems, and payors limiting access to treatments based on cost-benefit analysis. Any of these 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, as well as limit the prices we may charge for our products.
We sell a limited number of products.
We derive most of our revenues from sales of the System One and the related products used with the System One, with the remainder of our revenues largely coming from sales of a few key disposable products, including blood tubing sets and needles. Although we are working on initiatives that should diversify our future revenues, our present business continues to be exposed to risks that are concentrated in a small number of products. As a result, any event that adversely affects these products or the markets for these products could adversely affect our business, financial condition and results of operation.
Our relationships with DaVita and Fresenius are important to our business.
DaVita and Fresenius collectively provide treatment to over two-thirds of U.S. dialysis patients and are our two largest customers. Sales to them have driven a large portion of our historical revenue growth. Any adverse change in either customer's ordering or clinical practices, including in response to the establishment of our NxStage Kidney Care dialysis centers or the pendency of our Merger with Fresenius, would have an adverse impact on our revenues. In addition, these large dialysis