NxStage Medical, Inc.
NxStage Medical, Inc. (Form: 10-Q, Received: 11/08/2017 16:19:36)
Table of Contents


 
 

 
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, 2017

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  
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

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Table of Contents

     There were 66,232,226 shares of the registrant's common stock outstanding as of the close of business on November 2, 2017 .
 

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NXSTAGE MEDICAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2017
TABLE OF CONTENTS
 
 
Page
 
 
 
Condensed Consolidated Balance Sheets at September 30, 2017 and December 31, 2016
 
Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2017 and 2016
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016
 
 
 
 


















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. PureFlow TM and System One TM are trademarks of NxStage Medical, Inc.

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Table of Contents

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements

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Table of Contents

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

December 31,
 
2017

2016
 
(In thousands, except share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
62,979

 
$
59,632

Accounts receivable, net
30,245

 
32,286

Inventory
50,668

 
46,845

Prepaid expenses and other current assets
8,039

 
6,136

Total current assets
151,931

 
144,899

Property and equipment, net
62,212

 
61,561

Field equipment, net
23,793

 
22,309

Deferred cost of revenues
31,125

 
33,165

Intangible assets, net
8,169

 
9,688

Goodwill
42,748

 
42,648

Other assets
5,376

 
2,937

Total assets
$
325,354

 
$
317,207

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,871

 
$
14,177

Accrued expenses
28,625

 
30,985

Current portion of long-term debt
99

 
328

Other current liabilities
4,602

 
3,770

Total current liabilities
46,197

 
49,260

Deferred revenues
47,422

 
49,001

Long-term debt
551

 
1,305

Other long-term liabilities
17,994

 
15,568

Total liabilities
112,164

 
115,134

Commitments and contingencies (Notes 1 and 10)

 

Noncontrolling interests subject to put provisions
650

 
50

Stockholders’ equity:
 
 
 
Undesignated preferred stock: par value $0.001, 5,000,000 shares authorized; no shares issued and outstanding as of September 30, 2017 and December 31, 2016

 

Common stock: par value $0.001, 100,000,000 shares authorized; 67,231,121 and 65,883,026 shares issued as of September 30, 2017 and December 31, 2016, respectively
67

 
65

Additional paid-in capital
653,431

 
631,219

Accumulated deficit
(419,324
)
 
(407,601
)
Accumulated other comprehensive loss
(1,895
)
 
(6,101
)
Treasury stock, at cost: 1,034,188 and 936,360 shares as of September 30, 2017 and December 31, 2016, respectively
(18,955
)
 
(16,184
)
Total NxStage Medical, Inc. stockholders' equity
213,324

 
201,398

Noncontrolling interests not subject to put provisions
(784
)
 
625

Total stockholders' equity
212,540

 
202,023

Total liabilities and stockholders’ equity
$
325,354

 
$
317,207

See accompanying notes to these condensed consolidated financial statements.

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Table of Contents

NXSTAGE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017

2016
 
2017

2016
 
(In thousands, except per share data)
Revenues
$
97,295

 
$
91,951

 
$
290,340

 
$
273,365

Cost of revenues
56,688

 
52,770

 
167,377

 
159,244

Gross profit
40,607

 
39,181

 
122,963

 
114,121

Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
16,984

 
16,024

 
50,595

 
47,394

Research and development
11,222

 
8,278

 
29,757

 
23,393

Distribution
8,065

 
7,063

 
23,394

 
21,131

General and administrative
12,619

 
7,792

 
31,237

 
24,334

Total operating expenses
48,890

 
39,157

 
134,983

 
116,252

(Loss) income from operations
(8,283
)
 
24

 
(12,020
)
 
(2,131
)
Other expense:
 
 
 
 
 
 
 
Interest expense, net
(168
)
 
(244
)
 
(595
)
 
(773
)
Other income (expense), net
26

 
(346
)
 
(565
)
 
(987
)
 
(142
)
 
(590
)
 
(1,160
)
 
(1,760
)
Net loss before income taxes
(8,425
)
 
(566
)
 
(13,180
)
 
(3,891
)
Provision for (benefit fro m) income taxes
469

 
324

 
(166
)
 
1,007

Net loss
(8,894
)
 
(890
)
 
(13,014
)
 
(4,898
)
Less: Net loss attributable to noncontrolling interests
(449
)
 
(724
)
 
(1,291
)
 
(1,724
)
Net loss attributable to NxStage Medical, Inc.
$
(8,445
)
 
$
(166
)
 
$
(11,723
)
 
$
(3,174
)
Add: Accretion to redemption value of noncontrolling interests
(481
)
 

 
(481
)
 

Net loss attributable to common stockholders
$
(8,926
)
 
$
(166
)
 
$
(12,204
)
 
$
(3,174
)
 
 
 
 
 
 
 
 
Net loss per share, basic and diluted
$
(0.14
)
 
$
(0.00
)
 
$
(0.19
)
 
$
(0.05
)
Weighted-average shares outstanding, basic and diluted
66,082

 
64,638

 
65,723

 
64,414

 
 
 
 
 
 
 
 
Other comprehensive (loss) income:
 
 
 
 
 
 
 
Unrealized (loss) income on derivative instruments, net of income taxes
(661
)
 
(5
)
 
2,376

 
92

Other income (loss)
268

 
(73
)
 
1,830

 
(389
)
Total other comprehensive (loss) income
(393
)

(78
)
 
4,206

 
(297
)
Total comprehensive loss
(9,287
)
 
(968
)
 
(8,808
)
 
(5,195
)
Less: Comprehensive loss attributable to noncontrolling interests
(449
)
 
(724
)
 
(1,291
)
 
(1,724
)
Total comprehensive loss attributable to NxStage Medical, Inc.
$
(8,838
)
 
$
(244
)
 
$
(7,517
)
 
$
(3,471
)

See accompanying notes to these condensed consolidated financial statements.

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Table of Contents

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

 
Nine Months Ended September 30,
 
2017
 
2016
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net loss
$
(13,014
)
 
$
(4,898
)
Adjustments to reconcile net loss to net cash flow from operating activities:
 
 
 
Depreciation and amortization
25,321

 
23,974

Stock-based compensation
8,684

 
7,688

Other
1,183

 
(886
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
2,443

 
(5,501
)
Inventory
(18,154
)
 
(22,026
)
Prepaid expenses and other assets
604

 
621

Accounts payable
(1,886
)
 
3,930

Accrued expenses and other liabilities
(1,286
)
 
3,015

Deferred revenues
(1,906
)
 
(924
)
Net cash provided  by operating activities
1,989

 
4,993

Cash flows from investing activities:
 
 
 
Cash paid for acquisitions, net of cash acquired
(100
)
 
(513
)
Purchase of cost method investment
(2,500
)
 

Purchases of property and equipment
(7,550
)
 
(6,796
)
Net cash used  in investing activities
(10,150
)
 
(7,309
)
Cash flows from financing activities:
 
 
 
Issuance of shares under stock incentive plans, net of payroll taxes paid
11,019

 
3,677

Investment by noncontrolling interest holder

 
1,210

Proceeds from loans, lines of credit and capital lease obligations
452

 

Repayments on loans and lines of credit
(126
)
 
(225
)
Repayments on capital leases
(981
)
 
(1,153
)
Net cash provided  by financing activities
10,364

 
3,509

Foreign exchange effect on cash and cash equivalents
1,144

 
559

Increase in cash and cash equivalents
3,347

 
1,752

Cash and cash equivalents, beginning of period
59,632

 
59,065

Cash and cash equivalents, end of period
$
62,979

 
$
60,817


See accompanying notes to these condensed consolidated financial statements.

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Table of Contents

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 and markets 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 valuable experience to better meet and anticipate the needs of both our customers and patients, while optimizing our product technology. In addition, 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. More specifically, at NxStage Kidney Care we offer a range of treatment options, including home hemodialysis, peritoneal dialysis and flexible in-center hemodialysis. These centers also help us to devise best practices for successful home dialysis programs and provide sites for future clinical trials of our products.
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 (the “Merger Agreement”) with Fresenius Medical Care Holdings, Inc. (“Fresenius”), pursuant to which we will merge with a wholly-owned subsidiary of Fresenius, 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.
The closing of the merger is conditioned, among other things, on receipt of regulatory approval under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act") or the expiration or termination of the applicable waiting periods (and any extension thereof) under the HSR Act and other customary closing conditions.
Immediately prior to, and contingent upon, closing, each outstanding Company stock option, restricted stock unit, restricted share and performance share (collectively, the “Company Equity Awards”) will vest in full (with applicable performance conditions deemed satisfied at maximum levels). Such fully vested Company Equity Awards will be canceled and converted into cash at $30.00 per share for each share of our common stock underlying such Company Equity Awards (net of any applicable exercise price and subject to any applicable withholding tax).
The Merger Agreement may be terminated by us or Fresenius if it is not closed by August 7, 2018 (the “End Date”), although Fresenius may extend the End Date for up to 180 days under certain circumstances in order to obtain required antitrust clearances. 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 and any applicable extension has passed or (ii) if a court or other governmental entity issues a final, 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).

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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 representation or warranty, (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 of the Company and Fresenius. 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.
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 II Item 1A of this Quarterly Report for additional information.
Basis of Presentation
The accompanying condensed consolidated financial statements as of September 30, 2017 and December 31, 2016 and for the three and nine months ended September 30, 2017 and 2016 , 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, 2016 ( 2016 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, 2016 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 2016 Annual Report.
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
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. No customer represented more than 10% of accounts receivable at September 30, 2017 . Two customers represented 12% and 10% of accounts receivable at December 31, 2016 .
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 loss. The following is a rollforward of our warranty accrual (in thousands):

9


Balance at December 31, 2016
$
280

Provision
317

Usage
(328
)
Balance at September 30, 2017
$
269

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.
In 2017, 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, 2017, our expected non-discounted future cash flows for the majority of our centers indicated such carrying amounts were expected to be recovered. No impairment charge was recognized during the third quarter of 2017. We recorded an impairment charge during the second quarter of 2017 of $0.3 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. We had $15.0 million of long-lived assets at our Services segment at September 30, 2017. 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 2016 and 2015 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 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.
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 carry value. Our Services reporting unit, with a goodwill of $1.1 million at September 30, 2017 , has been identified as having a higher risk for impairment. Future events that could have a negative impact on the levels of excess fair value over carrying value of our Services reporting unit include, but are not limited to, changes in discount rates, slower than expected patient ramp, lower than expected reimbursement rates or operating income, increases in capital expenditures or unfavorable changes in working capital. Negative changes in one or more of these factors, among others, could results in a goodwill impairment charge of up to $1.1 million in the future.
Recent Accounting Pronouncements
Recently Implemented Accounting Pronouncements

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In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): "Simplifying the Measurement of Inventory." The update requires that an entity should measure in scope inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments were effective for us beginning January 1, 2017. The adoption of this update did not have a material impact on our financial statements.
In March 2016, the FASB issued ASU No. 2016-09: “Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new guidance was effective for us beginning January 1, 2017. We have elected to continue to estimate forfeiture rates. This new standard impacts our income tax footnote disclosures. We have tax effected federal net operating losses of $18.0 million and state net operating losses of $1.6 million that are attributable to excess tax deductions related to stock-based compensation from prior years. Upon adoption the cumulative excess tax deductions related to stock-based compensation that were previously unrecognized are being recognized as a deferred tax asset and are fully offset by a valuation allowance. Other than this change in our income tax footnote disclosures, the adoption does not have a material impact on our financial statements.
In January 2017, the FASB issued ASU No. 2017-04: "Intangibles - Goodwill and Other Topics (Topic 350): Simplifying the Test for Goodwill Impairment". The purpose of this update is to reduce the cost and complexity of evaluating goodwill for impairment. It eliminates the need for entities to calculate the impaired fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. Under this update, an entity will perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge is recognized for the amount by which the carrying value exceeds the reporting unit's fair value. We elected to early adopt this update on a prospective basis for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this update did not have a material impact on our financial statements.
In May 2017, the FASB issued ASU No. 2017-09: "Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting". The purpose of this update is to reduce the diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications. It will allow companies to make non-substantive changes to their share-based payment awards, without accounting for them as modifications. It does not change the accounting for modifications. Under this update, an entity will apply the modification accounting guidance only if the value (or calculated value or intrinsic value, if those measurement methods are used), vesting conditions or classification of the award as an equity or liability instrument changes. This update also clarifies that a modification to an award could be significant and therefore require disclosure, even if modification accounting is not required. The new guidance will be applied prospectively to awards modified on or after the adoption date. We elected to early adopt this update in the second quarter of 2017. The adoption of this update did not have a material impact on our financial statements.
Recent Accounting Pronouncements Not Yet Adopted
In May 2014, the FASB issued ASU No. 2014-9: “Revenue from Contracts with Customers.” 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 is effective for us beginning January 1, 2018. The new guidance allows for full retrospective adoption applied to all periods presented or a modified retrospective adoption with the cumulative effect of initially applying the new guidance recognized at the date of initial application. In 2016, we commenced our evaluation of the impact of the standard, by establishing a cross functional team and evaluating the anticipated impact on significant contracts from each of our business segments. We intend to use the modified retrospective adoption methodology. We are evaluating the potential impact of the standard on the 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 and to assess the internal control structure in order to adopt the standard on January 1, 2018. We believe that the standard will impact the timing of revenue recognition for our Services segment as the standard eliminates cash basis revenue recognition and instead requires revenues to be estimated and recognized upon transfer of the promised goods and services. The adoption of the standard is not expected to have a material impact on our other segments. We have periodically briefed our Audit Committee on our progress made towards adoption. Based on our evaluation to date, we anticipate being able to estimate the quantitative impacts of adopting the ASU in connection with the filing of our 2017 Form 10-K.
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 and

11


requires application of 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 intend to adopt this standard as of January 1, 2019. We are currently evaluating the potential impact this standard will have on our financial statements.
In January 2017, the FASB issued ASU No. 2017-01: "Business Combinations (Topic 805): Clarifying the Definition of a Business" which changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. The update is effective for us beginning January 1, 2018. Early adoption is permitted, including for interim or annual periods in which the financial statements have not been issued or made available for issuance. The adoption of this update is not expected to have a material impact on our financial statements.
3.
Inventory
Inventory includes material, labor and overhead, and is stated at lower of cost (first-in, first-out) or market. The components of inventory are as follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Purchased components
$
14,861

 
$
14,967

Work in process
14,891

 
13,939

Finished goods
20,916

 
17,939

Total
$
50,668

 
$
46,845

4.
Property and Equipment, and Field Equipment
Accumulated depreciation on property and equipment was $57.3 million and $47.2 million at September 30, 2017 and December 31, 2016 , respectively. Accumulated depreciation on field equipment was $52.5 million and $48.4 million at September 30, 2017 and December 31, 2016 , respectively.
5.
Intangible Assets
Accumulated amortization of intangible assets was $26.5 million and $25.0 million at September 30, 2017 and December 31, 2016 , respectively.
6.
Net Loss per Share
Basic net 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 loss per share is similar to basic 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 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,
 
2017
 
2016
 
2017
 
2016
Options to purchase common stock
1,069

 
1,096

 
1,126

 
682

Unvested restricted stock
327

 
382

 
238

 
359

     Total
1,396

 
1,478

 
1,364

 
1,041

7. Accrued Expenses, Other Current Liabilities and Other Long-Term Liabilities

12


The components of accrued expenses are as follows (in thousands):
 
September 30,
2017

December 31,
2016
Payroll, compensation and related benefits
$
12,637

 
$
14,086

Distribution expenses
5,132

 
4,804

General and administrative expenses
1,830

 
4,415

Audit, legal and consulting fees
3,469

 
1,373

Other manufacturing costs
1,481

 
1,891

Other
4,076

 
4,416

     Total
$
28,625

 
$
30,985

The components of other current liabilities are as follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Capital lease obligations
$
2,154

 
$
1,840

Deferred revenue, current portion
1,526

 
1,035

Other
922

 
895

Total
$
4,602

 
$
3,770

The components of other long-term liabilities are as follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Capital lease obligations
$
11,595

 
$
9,991

Lease incentive obligations
2,842

 
3,059

Benefit plan obligations
2,020

 
1,678

Other
1,537

 
840

     Total
$
17,994

 
$
15,568

8. Debt and Capital Lease Obligations
Other Loan
In May 2017, we extinguished a loan with a balance of $0.9 million and simultaneously entered into a capital lease of certain property and equipment for the same amount. The capital lease obligation is payable over five years . This debt extinguishment and capital lease financing represent a noncash investing and financing activity.

13


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 of the System One and PureFlow SL dialysate preparation equipment and sales 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 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 2016 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):

14


 
System One
 
In-Center
 
Other
 
Services
 
Intersegment Elimination
 
Total
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

Three Months Ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
70,011

 
$
14,493

 
$
3,601

 
$
3,846

 
$

 
$
91,951

Intersegment revenues
1,930

 

 

 

 
(1,930
)
 

Revenues
71,941

 
14,493

 
$
3,601

 
3,846

 
(1,930
)
 
91,951

Segment profit (loss)
19,828

 
2,463

 
(15,676
)
 
(6,384
)
 
(207
)
 
24

Depreciation and amortization
6,015

 
500

 
1,134

 
1,232

 
(556
)
 
8,325

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

Nine Months Ended September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
205,538

 
$
47,990

 
$
9,190

 
$
10,647

 
$

 
$
273,365

Intersegment revenues
5,553

 

 

 

 
(5,553
)
 

Revenues
211,091

 
47,990

 
$
9,190

 
10,647

 
(5,553
)
 
273,365

Segment profit (loss)
55,997

 
8,155

 
(46,332
)
 
(19,354
)
 
(597
)
 
(2,131
)
Depreciation and amortization
17,362

 
1,489

 
3,361

 
3,441

 
(1,679
)
 
23,974

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:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
DaVita
20
%
 
21
%
 
20
%
 
20
%
Fresenius
20
%
 
18
%
 
19
%
 
18
%
Sales to DaVita HealthCare Partners Inc. (DaVita) and Fresenius Medical Care (Fresenius) are in the System One segment.
10. Commitments and Contingencies
Significant commitments and contingencies at September 30, 2017 are consistent with those discussed in Note 10 to the consolidated financial statements in our 2016 Annual Report.
11. Income Taxes
We recognized a provision for income taxes during both the three and nine months ended September 30, 2017 and 2016 related to the profitable operations of certain foreign subsidiaries. However, the provision recognized during 2017 includes the impact of an allocation of U.S. tax expense between continuing operations and total other comprehensive (loss) income. Such allocation resulted in an increase to the provision for income taxes of $0.1 million during the three months ended September 30, 2017 and a decrease to the provision for income taxes of $1.1 million during the nine months ended September 30, 2017. This allocation has no impact on total comprehensive loss or total stockholders' equity for 2017. However, it did result in a net tax benefit from income taxes in continuing operations of $0.2 million during the nine months ended September 30, 2017.

15


As of September 30, 2017 , we had a liability for unrecognized tax benefits included in the balance sheet of approximately $0.8 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, 2017 .
12. Stock-Based Compensation
Stock-based Compensation Expense
The following table presents stock-based compensation expense included in our condensed consolidated statements of comprehensive loss (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Cost of revenues
$
335

 
$
314

 
$
902

 
$
1,056

Selling and marketing
1,054

 
781

 
3,047

 
2,562

Research and development
437

 
344

 
1,154

 
1,148

General and administrative
1,534

 
855

 
3,581

 
2,922

Total
$
3,360

 
$
2,294

 
$
8,684

 
$
7,688

Stock Options and Restricted Stock Units
The Company granted options to purchase 7,480 and 20,351 shares of common stock during the three months ended September 30, 2017 and 2016 , respectively, and options to purchase 675,358 and 1,334,351 shares of common stock during the nine months ended September 30, 2017 and 2016 , respectively, 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 and 2016 was $9.92 and $5.89 per option, respectively.
The Company awarded 20,970 and 23,380 restricted stock units during the three months ended September 30, 2017 and 2016 , respectively, and 175,895 and 219,846 restricted stock units during the nine months ended September 30, 2017 and 2016 , respectively, 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 and 2016 was $27.23 and $17.34 per unit, respectively.
In March 2017 , the Compensation Committee of our Board of Directors approved the grant of up to 231,384 restricted stock units subject to the achievement of certain Company financial performance metrics for the year ending December 31, 2017 . In August 2017, in connection with the Board of Director's approval of the Merger Agreement, the Compensation Committee determined that all Company financial performance metric criteria shall be deemed fully satisfied. The restricted stock units vest over a requisite service period of three years and have a modified grant date fair value of $23.14 per unit.
13. Stockholders' Equity
We received 97,828 and 100,571 shares of common stock that were surrendered in payment for the exercise of stock options during the nine months ended September 30, 2017 and 2016 , respectively.
14. Noncontrolling Interest
As of September 30, 2017 , we have 5 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, and provide operating and capital funding as necessary for the entities to accomplish their operational and strategic objectives which transfer substantial power over and economic responsibility for the entities to us.
The analysis upon which these consolidation determinations rest are complex, involve uncertainties, and require significant judgment on various matters. At September 30, 2017 and December 31, 2016 , total assets of our VIEs were $5.8 million and $8.0 million , and total liabilities and noncontrolling interests of our VIEs were $5.9 million and $7.2 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, 2017 the Company's noncontrolling interests subject to put provisions were $0.7 million and none of the rights were exercisable.

16


The following table sets forth the changes in noncontrolling interest not subject to put provisions for the three and nine months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Balance at beginning of period
$
(145
)
 
$
1,722

 
$
625

 
$
1,694

Capital contributions by noncontrolling interest

 
231

 

 
531

Sales of noncontrolling interests

 

 

 
679

Accretion to redemption value of noncontrolling interests
481

 

 
481

 

Reclassification of noncontrolling interest subject to put provision
(744
)
 

 
(744
)
 

Net loss attributable to noncontrolling interest in consolidated subsidiary
(376
)
 
(672
)
 
(1,146
)
 
(1,623
)
Balance at end of period
$
(784
)
 
$
1,281

 
$
(784
)
 
$
1,281

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, 2017 and December 31, 2016 , the notional amount of our outstanding contracts that are designated as cash flow hedges was $22.4 million and $18.6 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 $1.9 million at September 30, 2017 and a net liability of $1.8 million at December 31, 2016 , respectively. 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, 2017 and 2016 . 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.
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 Loss
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
Three Months Ended September 30, 2016
 
 
 
 
 
 
Foreign exchange forward contracts
 
$
(386
)
 
$
(381
)
 
Cost of revenues
Nine Months Ended September 30, 2016
 
 
 
 
 
 
Foreign exchange forward contracts
 
$
(1,338
)
 
$
(1,430
)
 
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):

17


 
 
Unrealized gain on derivative instruments
 
Other (2)
 
Total
Balance, net of tax, as of December 31, 2016
 
$
(2,285
)
 
$
(3,816
)
 
$
(6,101
)
Other comprehensive income before reclassifications, net of $1,581 tax during 2017
 
2,630

 
1,830

 
4,460

Gain reclassified to earnings (1)
 
(254
)
 

 
(254
)
Total other comprehensive income, net of tax
 
2,376

 
1,830

 
4,206

Balance, net of tax, as of September 30, 2017
 
$
91

 
$
(1,986
)
 
$
(1,895
)
(1) Reclassifications of gains/ losses on derivative instruments are included in cost of revenues on the condensed consolidated statement of comprehensive 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, 2017 .
The following tables present assets and liabilities measured at fair value on a recurring basis and their level within the value hierarchy (in thousands):
September 30, 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)

$
34,945


$


$


$
34,945

Foreign exchange forward contracts (2)



2,096




2,096

Liabilities








Foreign exchange forward contracts (2)

$


$
203


$


$
203

December 31, 2016
 
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)
 
$
34,804

 
$

 
$

 
$
34,804

Liabilities
 
 
 
 
 
 
 
 
Foreign exchange forward contracts (2)
 
$

 
$
1,771

 
$

 
$
1,771

(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.

18


The carrying amount of our long-term debt approximates fair value at September 30, 2017 and December 31, 2016 . 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.
In September 2017, we acquired a 2.5% equity ownership of a privately held dialysis services company in exchange for $2.5 million in cash. This investment is accounted for using the cost method as we are unable to exercise any significant influence over the company. The investment has been recorded at historical cost, classified within other assets on our condensed consolidated balance sheet, and is reviewed for events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. There have been no changes in circumstances or identified events that may have a significant adverse effect on the fair value.
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,
 
2017
 
2016
Noncash Investing and Financing Activities:
 
 
 
Transfers from inventory to field equipment
$
13,709

 
$
14,629

Transfers from field equipment to deferred cost of revenues
7,570

 
10,396

Market value of shares received in payment for exercise of stock options
2,771

 
1,963

Redemption of noncontrolling interest
481

 

PP&E financed by construction liability
109

 
187

Property and equipment acquired under capital lease

 
127

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, 2016 , included in our 2016 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;
the ability of our product pipeline and other initiatives to help us expand existing markets and enter new ones;
achieving greater operating leverage and improved financial results in the future;
expectations about the profitability of our products business and company as a whole;
financial performance of our NxStage Kidney Care dialysis centers and our continued investments in them;
estimates of the number of end-stage renal disease (ESRD) patients that could be treated at home and with the System One;
our strategic initiatives to grow home hemodialysis adoption, expand globally, enhance our product offerings, expand into high growth adjacencies and enter the peritoneal dialysis market and their ability to unlock market opportunity;
access to home and more frequent hemodialysis;
the market opportunity within and outside the U.S.;
the development and commercialization of new products and improvements to existing products;
sales to our key customers, including DaVita HealthCare Partners Inc. and Fresenius Medical Care;
the adequacy of our funding;

19

Table of Contents

expectations with respect to future demand for our products and revenue growth and the components of such revenue growth;
expansion to new markets where our current and future technology has the ability to deliver value for our patients and customers;
future financial results for our System One, In-Center and Services segments and total company;
expectation of sustaining gross profit as a percentage of revenue in our System One segment above 50%;
future selling and marketing, research and development, distribution, and general and administrative expenses;
our manufacturing operations and supply chain;
expectations with respect to our working capital levels and requirements;
global economic conditions;
the timing and cost of our remediation efforts concerning a software anomaly affecting certain System One cyclers;
expectations with respect to achieving positive operating margins and positive cash flows;
volatility of our stock price;
expectations with respect to product reliability;
anticipated benefits of manufacturing dialyzers for sale to Asahi Kasei Kuraray Medical Co. (Asahi) and future sales to Asahi;
expected impact of changes to accounting standards and policies;
the availability of, and impact of changes in, reimbursement for home and more frequent hemodialysis, including home nocturnal hemodialysis;
the anticipated timing and likelihood of completion of the proposed merger of us with a subsidiary of Fresenius;
the operation of our business during the pendency of the proposed merger;
expectations for the business in the event the proposed merger is completed;
the possibility that various closing conditions to the proposed merger may not be satisfied or waived in a timely manner or at all;
the possibility that a material adverse effect occurs with respect to our business;
risks related to disruption of management time from ongoing business operations due to the proposed merger;
limitations placed on our ability to operate the business by the Merger Agreement;
the risk that the proposed merger and its announcement could have an adverse effect on our ability to retain and hire key employees and maintain relationships with our suppliers and customers; 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 and markets 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 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 to 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 NxStage Kidney Care are included

20

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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 a definitive 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 $4.1 million and $4.3 million of incremental costs for the three and nine months then ended September 30, 2017 , respectively, for professional service fees and certain other costs related to the proposed merger. The majority of these expenses have been recorded as general and administrative costs in our condensed consolidated statement of comprehensive loss.
Segment and Market Highlights
Our customers in the System One segment are highly concentrated. DaVita and Fresenius own and operate the two largest chains of dialysis centers in the U.S. Collectively, they provide treatment to more than approximately 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 any future growth. Our home market agreements with DaVita and Fresenius are intended to support the continued expansion of patient access to home hemodialysis with the System One, but like all our agreements with home market customers, these agreements are not requirements contracts and 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 23% and 33% of our In-Center segment revenues for the three months ended September 30, 2017 and 2016 , respectively, and 22% and 27% for the nine months ended September 30, 2017 and 2016 , respectively. Gambro AB (a subsidiary of Baxter International, Inc.) accounted for 17% and 19% of our In-Center segment revenues for the three months ended September 30, 2017 and 2016 , respectively, and 21% and 22% for the nine months ended September 30, 2017 and 2016 , respectively, with all of Gambro's sales of our product 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, 2017 , we had $2.7 million reserved against trade accounts receivable for future distributor rebates and recorded $3.7 million and $2.9 million during the three months ended September 30, 2017 and 2016 , respectively, and $11.5 million and $10.1 million during the nine months ended September 30, 2017 and 2016 , respectively, as a reduction of revenues in connection with distributor rebates. For the In-Center segment, as of September 30, 2017 , we had $2.5 million reserved against trade accounts receivable for future estimated distributor rebates and recorded $2.0 million and $1.8 million during the three months ended September 30, 2017 and 2016 , respectively, and $5.0 million and $5.2 million during the nine months ended September 30, 2017 and 2016 , 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. We currently 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.
Financial Performance
The following table summarizes our consolidated results (in thousands, except percentages):

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Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Products Business (System One Segment, In-Center Segment & Other)
 
 
 
 
 
 
 
Revenues
$
93,533

 
90,035

 
$
279,319

 
$
268,271

Gross profit
$
44,333

 
$
43,455

 
$
133,988

 
$
126,888

Gross margin percentage
47
%
 
48
%
 
48
%
 
47
%
(Loss) income from operations
$
(2,672
)
 
$
6,615

 
$
5,728

 
$
17,820

Services Segment
 
 
 
 
 
 
 
Revenues
$
4,959

 
$
3,846

 
$
14,866

 
$
10,647

Gross profit
$
(3,741
)
 
$
(4,067
)
 
$
(11,001
)
 
$
(12,170
)
Gross margin percentage
n/a

 
n/a

 
n/a

 
n/a

Loss from operations
$
(5,626
)
 
$
(6,384
)
 
$
(17,724
)
 
$
(19,354
)
Eliminations
 
 
 
 
 
 
 
Elimination of intersegment revenues
$
(1,197
)
 
$
(1,930
)
 
$
(3,845
)
 
$
(5,553
)
Elimination of intersegment gross profit
$
15

 
$
(207
)
 
$
(24
)
 
$
(597
)
Total Company
 
 
 
 
 
 
 
Revenues
$
97,295

 
$
91,951

 
$
290,340

 
$
273,365

Gross profit
$
40,607

 
$
39,181

 
$
122,963

 
$
114,121

Gross margin percentage
42
%
 
43
%
 
42
%
 
42
%
(Loss) income from operations
$
(8,283
)
 
$
24

 
$
(12,020
)
 
$
(2,131
)
For several years, we have focused on operating and financial improvements. During the three and nine months ended September 30, 2017 these efforts resulted in revenues increasing by 6% to $97.3 million and by 6% to $290.3 million , respectively, versus the prior year comparable periods with sales in the home and critical care markets principally driving the growth. Driving continued improvements will remain an area of focus in 2017 and beyond within our products business. At the same time, we expect operating losses in our Services segment to improve in the long term, but continue to have a negative impact on our total operating performance in the near term.
Comparison of the Three and Nine Months Ended September 30, 2017 and 2016

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Revenues
Our revenues for the three and nine months ended September 30, 2017 and 2016 were as follows (in thousands, except as percentages of revenues):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
System One segment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home
$
55,852

 
57
 %
 
$
53,759

 
58
 %
 
$
165,949

 
57
 %
 
$
154,397

 
56
 %
Critical Care
18,824

 
20
 %
 
18,182

 
20
 %
 
58,846

 
20
 %
 
56,694

 
21
 %
Total System One segment
74,676

 
77
 %
 
71,941

 
78
 %
 
224,795

 
77
 %
 
211,091

 
77
 %
In-Center segment
15,465

 
16
 %
 
14,493

 
16
 %
 
45,397

 
16
 %
 
47,990

 
18
 %
Other
3,392

 
3
 %
 
3,601

 
4
 %
 
9,127

 
3
 %
 
9,190

 
3
 %
Products subtotal
93,533

 
96
 %
 
90,035

 
98
 %
 
279,319

 
96
 %
 
268,271

 
98
 %
Services segment
4,959

 
5
 %
 
3,846

 
4
 %
 
14,866

 
5
 %
 
10,647

 
4
 %
Elimination of intersegment revenues
(1,197
)
 
(1
)%
 
(1,930
)
 
(2
)%
 
(3,845
)
 
(1
)%
 
(5,553
)
 
(2
)%
     Total
$
97,295

 
100
 %
 
$
91,951

 
100
 %
 
$
290,340

 
100
 %
 
$
273,365

 
100
 %
Home product revenues increased $2.1 million , or 4% and $11.6 million , or 7% for the three and nine months ended September 30, 2017 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 along with contractual price improvements. These improvements were offset by lower equipment sales to NxStage Kidney Care as a result of completing the build out of our existing centers. 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 $0.6 million , or 4% and $2.2 million , or 4% during the three and nine months ended September 30, 2017 versus the prior year comparable period , respectively. 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 $1.0 million , or 7% and decreased $2.6 million , or 5% for the three and nine months ended September 30, 2017 , versus the prior year comparable period, respectively. The changes are due to timing of sales of our blood tubing sets. Both periods benefited from increased needle sales, and were impacted by variations in inventory management policies at both our distributors and end users. Similarly, we expect In-Center segment revenues will continue to fluctuate as a result of these factors.
Other revenues for the three and nine months ended September 30, 2017 and 2016 relate to dialyzers sold to Asahi. The fluctuation in revenues was due to changes in volume. Sales to Asahi may fluctuate due to timing of sales, inventory management policies at Asahi and changes in currency exchange rates.
Service segment revenues for the three and nine months ended September 30, 2017 and 2016 relate to dialysis services provided to patients at our NxStage Kidney Care dialysis centers. We expect future revenues to increase modestly, but may fluctuate in the near term based on payor mix, and the timing of certain payments.
Gross Profit (Loss)
Our gross profit (loss) for the three and nine months ended September 30, 2017 and 2016 were as follows (in thousands, except as percentages of revenues):

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Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
System One segment
$
39,671

 
53
%
 
$
38,680

 
54
%
 
$
120,618

 
54
%
 
$
111,427

 
53
%
In-Center segment
4,423

 
29
%
 
4,381

 
30
%
 
12,821

 
28
%
 
14,066

 
29
%
Subtotal
44,094

 
49
%
 
43,061

 
50
%
 
133,439

 
49
%
 
125,493

 
48
%
Other
239

 
7
%
 
394

 
11
%
 
549

 
6
%
 
1,395

 
15
%
Products subtotal
$
44,333

 
47
%
 
$
43,455

 
48
%
 
133,988

 
48
%
 
126,888

 
47
%
Services segment
(3,741
)
 
n/a

 
(4,067
)
 
n/a

 
(11,001
)
 
n/a

 
(12,170
)
 
n/a

Elimination of intersegment gross profit
15

 
n/a

 
(207
)
 
n/a

 
$
(24
)
 
n/a

 
$
(597
)
 
n/a

Gross profit
$
40,607

 
42
%
 
$
39,181

 
43
%
 
$
122,963

 
42
%
 
$
114,121

 
42
%
Gross profit as a percentage of revenues for the System One segment decreased for the third quarter and improved for the year versus the same period last year. The quarterly decrease was primarily driven by increased product and service costs, offset in part by contractual price improvements. The year to date improvement was primarily driven by contractual price and product cost improvements, offset in part by increased service costs. 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.
Gross profit as a percentage of revenues for the In-Center segment decreased as a percentage of revenue for the three and nine months ended September 30, 2017 , versus the prior year comparable period, driven primarily by changes in pricing offset by favorable currency. We expect gross profit as a percentage of revenues will fluctuate as a result of changes in volume and changes product mix.
The Other category relates to costs associated with the manufacturing of dialyzers for sale to Asahi, which should provide us with long-term cost efficiencies through increased dialyzer production volumes. In the nine months ended September 30, 2016 , we received reimbursements from Asahi for $0.7 million related to additional startup costs incurred in 2015 with the build out of the manufacturing facility in Germany which was recorded as a reduction of cost of revenues. 
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; however, the margin percentage improved versus the prior year comparable periods due to continued revenue growth. We expect the Services segment gross margin will continue to be negatively impacted by costs associated with the operation of our NxStage Kidney Care dialysis centers, coupled with the impact of payor mix, and the timing of certain payments.
In aggregate, total company gross profit as a percentage of revenues will be negatively impacted by costs associated with our continued investment in our Services segment.
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, 2017 and 2016 were as follows (in thousands, except as percentages of revenues):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
System One segment
$
13,191

 
18
%
 
$
12,180

 
17
%
 
$
38,303

 
17
%
 
$
35,604

 
17
%
In-Center segment
1,908

 
12
%
 
1,527

 
11
%
 
5,569

 
12
%
 
4,606

 
10
%
Products subtotal
15,099

 
16
%
 
13,707

 
15
%
 
43,872

 
16
%
 
40,210

 
15
%
Services segment
1,885

 
n/a

 
2,317

 
n/a

 
6,723

 
n/a

 
7,184

 
n/a

     Total Selling and marketing
$
16,984

 
17
%
 
$
16,024

 
17
%
 
$
50,595

 
17
%
 
$
47,394

 
17
%
Selling and marketing expenses increased $1.0 million , or 6% and $3.2 million , or 7% for the three and nine months ended September 30, 2017 versus the prior year comparable period, respectively, but remained 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 increased due to increased personnel and personnel-related costs and increased further as a percentage of revenue for the nine month period primarily driven by lower revenues.
Selling and marketing expenses for our Services segment decreased $0.4 million , or 19% and $0.5 million , or 6% for the three and nine months ended September 30, 2017 , respectively, versus the prior year comparable period. The decrease included

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the recognition of severance and other post termination costs of $0.8 million during the nine months ended September 30, 2017 . These 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.
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, 2017 and 2016 were as follows (in thousands, except percentages):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Research and development
$
11,222

 
12
%
 
$
8,278

 
9
%
 
$
29,757

 
10
%
 
$
23,393

 
9
%
Research and development expenses increased for the three and nine months ended September 30, 2017 versus the prior year comparable period. The increase was primarily due to increased project related spending and increased personnel and personnel-related costs.
For the near term, we expect research and development expenses will increase for the year as we seek to further develop and enhance the System One and invest in our peritoneal dialysis and next-generation critical care systems to expand our product portfolio.
Distribution
Our distribution expenses for the three and nine months ended September 30, 2017 and 2016 were as follows (in thousands, except percentages):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
System One segment
$
7,681

 
10
%
 
$
6,672

 
9
%
 
$
22,294

 
10
%
 
$
19,826

 
9
%
In-Center segment
384

 
2
%
 
391

 
3
%
 
1,100

 
2
%
 
1,305

 
3
%
     Total Distribution
$
8,065

 
8
%
 
$
7,063

 
8
%
 
$
23,394

 
8
%
 
$
21,131

 
8
%
Distribution expenses increased $1.0 million , or 14% and $2.3 million , or 11% for the three and nine months ended September 30, 2017 versus the prior year comparable period, respectively, driven mainly by higher shipment volumes in the System One segment; however, it has remained relatively consistent as a percentage of revenues in both segments. We expect that distribution expenses will remain consistent as a percentage of revenues at least in the near term.
General and Administrative
Our general and administrative expenses for the three and nine months ended September 30, 2017 and 2016 were as follows (in thousands, except percentages):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
General and administrative
$
12,619

 
13
%
 
$
7,792

 
8
%
 
$
31,237

 
11
%
 
$
24,334

 
9
%
General and administrative expenses increased by $4.8 million , or 62% and $6.9 million , or 28% for the three and nine months ended September 30, 2017 versus the prior year comparable period , respectively. The increase was primarily due to professional service fees and other costs incurred in connection with the proposed merger. We recognized $3.6 million and $3.9 million of expenses incurred in connection with the proposed merger during the three and nine months ended September 30, 2017 , respectively. We expect general and administrative expenses as a percentage of revenues will increase compared to prior periods, driven by costs associated with the proposed merger.
Other Expense

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Interest expense, net remained relatively consistent for the three and nine months ended September 30, 2017 versus the prior year comparable period. 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 both the three and nine months ended September 30, 2017 and 2016 related to the profitable operations of certain foreign subsidiaries. However, the provision recognized during 2017 includes the impact of an allocation of U.S. tax expense between continuing operations and total other comprehensive (loss) income. Such allocation resulted in an increase to the provision for income taxes of $0.1 million during the three months ended September 30, 2017 and a decrease to the provision for income taxes of $1.1 million during the nine months ended September 30, 2017. This allocation has no impact on total comprehensive loss or total stockholders' equity for 2017. However, it did result in a net tax benefit from income taxes in continuing operations of $0.2 million during the nine months ended September 30, 2017.
Liquidity and Capital Resources
We have operated at a loss since our inception in 1998. As of September 30, 2017 , our accumulated deficit was $419.3 million and we had cash and cash equivalents of $63.0 million , with substantially all of that cash located in the U.S., and working capital of $105.7 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 continued investments in our existing NxStage Kidney Care dialysis centers.
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's 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, 2017 , there were no outstanding borrowings under the revolving credit facility, we were in compliance with all applicable covenants and, subject to the lenders’ adjustments described above, we had approximately $24 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 $2.0 million at September 30, 2017 for costs associated with these plans. The expense recorded in connection with these plans was not significant during the nine months ended September 30, 2017 or 2016 .
The following table sets forth the components of our cash flows for the periods indicated (in thousands):
 
Nine Months Ended September 30,
 
2017
 
2016
Net cash provided  by operating activities
$
1,989

 
$
4,993

Net cash used  in investing activities
(10,150
)
 
(7,309
)
Net cash provided  by financing activities
10,364

 
3,509

Foreign exchange effect on cash and cash equivalents
1,144

 
559

Net cash flow
$
3,347

 
$
1,752

Net cash provided by operating activities . Net cash flows from operating activities decreased by $3.0 million during the nine months ended September 30, 2017 , versus the prior year comparable period, driven by changes in working capital

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requirements including timing of payments to our vendors and other accrued expenses, offset by in part by the timing of accounts receivable collections. 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 decreased by $1.0 million during the nine months ended September 30, 2017 , versus the prior year comparable period. Amortization of deferred revenues into revenues relating to sales of home equipment was $13.3 million and $13.4 million during the nine months ended September 30, 2017 and 2016 , 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 the build-out of NxStage Kidney Care dialysis centers, coupled with expenditures for our manufacturing facilities as a result of our efforts to maintain and expand our manufacturing operations, along with purchases of information technology. For the nine months ended September 30, 2017 , cash used in investing activities includes $2.5 million equity investment in a dialysis services company accounted for using the cost method. Cash used in investing activities include payments related to an acquisition of a dialysis center during each of the nine months ended September 30, 2017 and 2016 .
The increase of $0.8 million in purchases of property and equipment was driven primarily by spending associated with our manufacturing facilities. Capital expenditures for our NxStage Kidney Care centers were $1.9 million and $3.2 million during the nine months ended September 30, 2017 and 2016 , respectively.
Net cash provided by financing activities . During the nine months ended September 30, 2017 and 2016 we received $11.0 million and $3.7 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. During the nine months ended September 30, 2016 we received $1.2 million in investments by noncontrolling interest holders. Cash provided by financing activities during both 2017 and 2016 was also reduced by cash used to pay our debt and capital lease 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 US 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, 2017 are described in Note 2 to the consolidated financial statements included in our 2016 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, 2017 are consistent with those described in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in our 2016 Annual Report.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements is included in Note 2 to the consolidated financial statements included in our 2016 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 2016 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, 2017 other than those discussed below.
Foreign Currency Exchange Risk
We enter into foreign exchange forward contracts on peso and euro denominated expenses to reduce our exposure to foreign currency exchange rate fluctuations from our foreign manufacturing and service operations located in Mexico and Europe.
Our foreign exchange forward contracts are entered into with large financial institutions and have durations of up to twelve months. These contracts are designated as cash flow hedges intended to offset the effect of exchange rate fluctuations on

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forecasted manufacturing and service costs. The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in accumulated other comprehensive (loss) income and is subsequently reclassified into earnings in the period in which the hedged forecasted transaction affects earnings. As of September 30, 2017 , the notional amount of our outstanding contracts that are designated as cash flow hedges increased to approximately $22.4 million , as we accelerated our entry into certain planned foreign exchange forward contracts due to favorable exchange rates. Based on our analysis, a hypothetical adverse foreign exchange rate movement of 10% against our contracts would have resulted in a net loss in fair value of these contracts of approximately $2.7 million .
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, 2017 . 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 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, 2017 , 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, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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.

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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 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 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, seven 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 approximately 90% of 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 are actively engaged in the comment process for the proposed local coverage determinations. Comment letters are due on various dates during November and December 2017. If the proposed local coverage determinations were adopted in their current form, they would adversely affect our business by significantly restricting patient access to home and more frequent hemodialysis.
In October 2016, the Centers for Medicare & Medicaid Services issued its final rule to update the payment policies and rates under the end-stage renal disease prospective payment system for 2017. Among other things, the Centers for Medicare & Medicaid Services increased the home and self-dialysis training add-on payment and reiterated its policy of paying for appropriately medically justified hemodialysis treatments provided in excess of three treatments per week. The proposed rule issued for 2018 does not change either of these favorable payment policies.
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 issued the 2018 proposed rule for the end-stage renal disease prospective payment system, which proposes an increase to the base reimbursement rate of less than 1% over 2017 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 that had imposed a 2.3% excise tax on domestic sales of certain medical devices, including our products, which reduced our profitability. In December 2015, this tax was suspended for two years, but will continue to have a negative financial impact when it is imposed again starting in 2018, 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

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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. During 2017, we face uncertainty regarding potential federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all provisions of recent U.S. health care reforms. Such changes may negatively impact our prospects for revenue growth, increase our costs or benefit our competitors. Absent additional clarity on the terms of any such changes, the impact on our business is uncertain.
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, including a system for peritoneal dialysis, and our NxStage Kidney Care dialysis centers, 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 have a significant adverse impact on our business.
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 announcement of our merger agreement with Fresenius, would have an adverse impact on our revenues. In addition, these large dialysis providers have significant purchasing power, and we may be required to grant them favorable pricing and other terms for our products that reduce our gross margins and have an adverse effect on our operating results.
Our home market agreements with DaVita and Fresenius are intended to support the continued expansion of patient access to home hemodialysis with the System One, but like all our agreements with home customers, these agreements are not requirements contracts and they contain no minimum purchase volumes. Our home market agreement with DaVita extends through December 31, 2018, with monthly renewals thereafter unless terminated by either party with 30 days' prior notice. Our home market 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.
We may be unable to achieve or sustain profitable operations.
Since inception, we have incurred negative operating margins and losses every quarter. Currently, we have a significant accumulated deficit. We continue to invest in our operations, in particular with respect to our product pipeline and NxStage Kidney Care dialysis centers, to drive future growth. Accordingly, we cannot ensure the extent or sustainability of our future profitability.
Our NxStage Kidney Care dialysis centers introduce significant new risks to our business.
As health care providers and participants in federal health care programs, our NxStage Kidney Care dialysis centers must comply with complex regulations that are, in some instances, new to our business, including:
Medicare and Medicaid payment rules, including coverage rules that limit the clinical circumstances under which payment will be made for more frequent dialysis treatments;
anti-kickback and related laws prohibiting payments and other remuneration intended to influence the referral of health care business or selection of a provider;
prohibitions on submitting false claims for government or commercial insurance reimbursement;