ITEM 1. BUSINESS
BACKGROUND
Aksys, Ltd. (the "Company") was founded in 1991 to provide hemodialysis products and services for patients suffering from end-stage renal disease ("ESRD"), commonly known as chronic kidney failure. The Company has developed an automated personal hemodialysis system, known as the Aksys PHD(TM) Personal Hemodialysis System (the "PHD System"), which is designed to enable patients to perform frequent hemodialysis at alternate sites, such as the patient's home, and to thereby improve clinical outcomes, reduce total ESRD treatment costs and enhance the patients' quality of life. All these characteristics have been associated with frequent hemodialysis.
On March 27, 2002, the Company announced that it received the Food and Drug Administration's ("FDA") clearance to market the PHD System in the United States. The FDA clearance had no restrictions and included authorization to use the product in the home. The Company had been working toward satisfying the regulatory requirements of the FDA since submitting a 510(k) pre-market notification for clearance to market the PHD System in January 2001. 510(k) clearance by the FDA was required prior to the commercialization of the PHD System in the United States.
Japan is also a significant market where the Company plans to seek regulatory approval, although the regulatory approval cycle in Japan is much longer than in the U.S. On June 21, 1999, the Company entered into a co-development and licensing agreement with Teijin Limited of Osaka Japan (see "Foreign Operations" for a description of the agreement). The Company is currently working with Teijin to jointly develop and eventually commercialize the PHD System in Japan.
There can be no assurance that the Company will be able to obtain regulatory clearances or approvals in Japan or other foreign jurisdictions in a timely manner or at all.
THE MARKETPLACE
The target market of the Company is the ESRD treatment market. A healthy human kidney continuously removes waste products and excess water from the blood. ESRD is a slow, progressive loss of kidney function caused by inherited disorders, prolonged medical conditions such as diabetes and hypertension, or the long-term use of certain medications. ESRD is irreversible and lethal if untreated. Life can be sustained only through either transplantation or dialysis. Transplantation is severely limited due to the shortage of suitable donors, the incidence of organ transplant rejection and the age and health of many ESRD patients. The vast majority (over 90%) of patients, therefore, must rely on dialysis for the remainder of their lives.
The Company estimates that over $16 billion was spent in the U.S. during 2000 for the treatment of patients suffering from ESRD, of which more than $5 billion was directly related to dialysis treatment. Based upon information published by The Centers for Medicare and Medical Services ("CMS"), the approximate number of ESRD patients in the United States requiring dialysis treatments has grown from 66,000 at the end of 1982 to an estimated 260,000 at the end of 2000. The current estimated annual growth rate of ESRD patients in the U.S. is approximately 6%. In addition, it is estimated that there were approximately 450,000 dialysis patients in Europe and Japan at the end of 1999. The Company believes that the sustained growth in the ESRD population, especially in the United States, has been caused by (i) the aging of the population (the median age of newly diagnosed ESRD patients in the United States is 62), (ii) the longer average life expectancy of patients with diabetes and hypertension (two patient groups at high risk for ESRD), (iii) the relatively more rapid growth in the general population of certain ethnic subsets that have a higher incidence of ESRD, (iv) competing risk - with the decline in vascular diseases of the
heart, there is a rise in vascular diseases of the kidney and (v) a possible increase in the use of medications that damage the kidneys.
Given the expense of kidney dialysis treatments and the lack of effective alternative therapies, in 1972 Congress enacted legislation providing for Medicare funding for all eligible patients with ESRD regardless of age or financial circumstances.
Under this program, after the first 30 months of treatment Medicare is responsible for payment of 80% of the rate set by CMS for reimbursement of outpatient dialysis. Although this program made dialysis available to virtually all patients in need of treatment, the cost of funding the program grew rapidly, quickly exceeding original expectations. In an effort to hold down these costs, Congress, in 1983, capped the Medicare reimbursement rate for outpatient dialysis at approximately $20,000 per patient per year. The costs of operating dialysis centers, however, such as capital, labor and facility overhead, have continued to rise. These circumstances have forced dialysis providers to seek ways to reduce dialysis treatment costs. For example, certain dialysis providers may be shortening dialysis treatments, reusing medical equipment and supplies intended for a single use and shifting the responsibilities of doctors and nurses to employees with less training.
REIMBURSEMENT
Demand for the Company's products and services will be influenced by governmental and other third-party reimbursement programs because providers of ESRD treatment are reimbursed by Medicare, Medicaid and private insurers.
Medicare Reimbursement
Medicare generally provides health insurance coverage for persons who are age 65 or older and for persons who are completely disabled. Medicare also provides coverage for other eligible patients, regardless of age, who have been medically determined to have ESRD. For patients eligible for Medicare based solely on ESRD (generally patients under age 65), Medicare eligibility begins three months after the month in which the patient begins dialysis treatments. During this three-month waiting period, either Medicaid, private insurance or the patient is responsible for payment for dialysis services. This waiting period is waived for individuals who participate in a self-care dialysis training program, or are hospitalized for a kidney transplant and the surgery occurs within a specified time period.
For ESRD patients under age 65 who have any employer group health insurance coverage (regardless of the size of the employer or the individual's employment status), Medicare coverage is generally secondary to the employer coverage during a 30-month coordination period that follows the establishment of Medicare eligibility or entitlement based on ESRD. During the coordination period, an employer group health plan is responsible for paying primary benefits at the rate specified in the plan, which may be a negotiated rate or the healthcare provider's usual and customary rate. As the secondary payer during this coordination period, Medicare will make payments up to the applicable composite rate for dialysis services to supplement any primary payments by the employer group health plan if the plan covers the services but pays only a portion of the charge for the services.
Medicare generally is the primary payer for ESRD patients after the 30-month coordination period. Under current rules, Medicare is also the primary payer for ESRD patients during the 30-month coordination period if, before becoming eligible for Medicare on the basis of ESRD, the patient was already age 65 or over (or eligible for Medicare based on disability) unless covered by an employer group health plan (other than a "small" employer plan) because of current employment. This rule eliminates for many dual-eligible beneficiaries the 30-month coordination period during which the employer plan would serve as primary payer and reimburse health care providers at a rate that the Company believes may be higher than the Medicare composite rate. The rules regarding entitlement to primary Medicare coverage when the patient is eligible for Medicare on the basis of both age (or disability) and ESRD have been the subject of frequent legislative and regulatory changes in recent years and there can be no assurance that such rules will not be unfavorably changed in the future.
When Medicare is the primary payer, it reimburses 80% of the composite rate set by the Medicare prospective reimbursement system for each dialysis treatment. The beneficiary is responsible for the remaining 20%, as well as any unmet Medicare deductible amount, although an approved Medicare supplement insurance policy, other private health insurance or Medicaid may pay on the beneficiary's behalf. Reimbursement rates are subject to periodic adjustment based on certain factors, including budget and other legislation and costs incurred in rendering the services if tied to certain criteria. The composite reimbursement rate was unchanged from commencement of the program in 1972 until 1983. From 1983 through December 1990, numerous Congressional actions resulted in net reductions of the average composite reimbursement rate from a fixed fee of $138 per treatment in 1983 to approximately $125 per treatment in December 1990. Effective January 1, 1991, Congress increased the ESRD composite reimbursement rate, resulting in an average rate of $126 per treatment. The Balanced Budget Refinement Act of 1999 raised the composite rate by 1.2% in 2000 and an additional 1.2% in 2001.
Reimbursement for home dialysis can be made in two ways. A beneficiary may choose to receive home dialysis equipment, supplies and support services directly from a facility or to make independent arrangements for equipment and supplies. If the beneficiary chooses to use a facility, the facility receives the composite rate for each treatment the patient performs at home. If the beneficiary chooses to make independent arrangements, the supplier bills Medicare on an assignment basis and payment is made at a rate not greater than the composite rate, with the exception of continuous cycling peritoneal dialysis ("CCPD"). There is a monthly payment cap of $2,080 for CCPD and approximately $1,600 for all other methods of home dialysis.
The Medicare ESRD composite reimbursement rate has been the subject of a number of reports and studies. Actions to change such rate usually occur in the context of federal budget negotiations.
The Company is unable to predict what, if any, future changes may occur in the Medicare composite reimbursement rate or in any other reimbursement program. Any reductions in the Medicare composite reimbursement rate or in any other reimbursement program could have a material adverse effect on the Company's prospects, revenues and earnings. In addition, there have been various legislative proposals for the reform of numerous aspects of Medicare, the occurrence and effect of which are uncertain. See "--Potential Health Care Legislation."
Medicaid Reimbursement
Medicaid programs are state-administered programs partially funded by the federal government. These programs are intended to provide coverage for patients whose income and assets fall below state defined levels and who are otherwise uninsured. The programs also serve as supplemental insurance programs for the Medicare co-insurance portion and provide certain coverage (e.g., oral medications) that are not covered by Medicare. State regulations generally follow Medicare reimbursement levels and coverage without any co-insurance amounts. Certain states, however, require beneficiaries to pay a monthly share of the cost based upon levels of income or assets.
Private Reimbursement
Some ESRD patients have private insurance that covers dialysis services. As discussed above, health care providers receive reimbursement for ESRD treatments from the patient or private insurance during a "waiting period" up to three months before the patient becomes eligible for Medicare. In addition, if the private payer is an employer group health plan, it is generally required to continue to make primary payments for dialysis services during the 30-month period following eligibility or entitlement to Medicare. In general, employers may not reduce coverage or otherwise discriminate against ESRD patients by taking into account the patient's eligibility or entitlement to Medicare benefits.
The Company believes that before Medicare primary coverage is established, private payers may reimburse dialysis expenses at rates higher than the per-treatment composite rate set by Medicare. When Medicare becomes a patient's primary payer, private insurance often covers the per-treatment 20% coinsurance that Medicare does not pay.
Potential Health Care Legislation
Because the Medicare program represents a substantial portion of the federal budget, Congress takes action in almost every legislative session to modify the Medicare program for the purpose of reducing the amounts otherwise payable by the program to health care providers in order to achieve deficit reduction targets or meet other political goals. Legislation and/or regulations may be enacted in the future that may significantly modify the Medicare or Medicaid ESRD programs or substantially affect reimbursement for dialysis services.
PREVAILING TREATMENT METHODS
Hemodialysis and peritoneal dialysis are the two prevailing methods of dialysis.
Hemodialysis
CMS estimates that as of December 31, 2000, approximately 90% (234,000) of the ESRD dialysis patients in the United States were receiving hemodialysis. Fewer than 1% of these patients performed treatment in their homes, and all others received treatment at outpatient facilities. Outpatient hemodialysis requires that a patient travel to a dialysis clinic three times per week for dialysis sessions lasting three to four hours. In each session, the patient's blood is cleansed by circulation through an artificial kidney controlled by a dialysis machine.
Home hemodialysis was common practice prior to Medicare funding, with approximately 42% of the 11,000 United States dialysis patients on home hemodialysis in 1973. Although the initial motivation for performing home treatment for many patients reflected the lack of availability of dialysis clinics and the desire to reduce the cost of hospital-based dialysis, clinicians report that many of these patients found significant advantages in quality of life when treating themselves at home. As Medicare funding became available, however, the vast majority of patients began receiving treatment in outpatient facilities, and hemodialysis machines became more complex and sophisticated as they evolved for use in clinics. The dialysis machines currently used in these centers are predominantly operated by trained personnel and require significant manual preparation and cleaning in connection with each treatment session.
Peritoneal Dialysis
CMS estimates that as of December 31, 2000, approximately 10% (26,000) of the ESRD dialysis patients in the United States were receiving peritoneal dialysis, with over 99% performing such treatment in their homes. There are two principal forms of peritoneal dialysis, and all forms use the patient's peritoneum, a large membrane rich in blood vessels that surrounds many of the body's internal organs, as a filter to eliminate toxins and excess fluids from the patient's blood. Dialysate, a blood-cleansing electrolyte solution, is infused through a catheter into the patient's peritoneal cavity. Once this fluid absorbs the toxins and excess water that are filtered from the blood through the peritoneum, it is drained from the peritoneal cavity through a catheter. In the most common form of peritoneal dialysis, Continuous Ambulatory Peritoneal Dialysis ("CAPD"), the process of exchanging dialysate into and out of
the patient's peritoneal cavity occurs four times daily, seven days per week. The other form, Continuous Cycling Peritoneal Dialysis ("CCPD"), uses an instrument to automatically perform exchanges of solution through the peritoneal cavity overnight, while the patient sleeps. Both forms of treatment require strict aseptic technique.
Limitations of Prevailing Treatment Methods
Hemodialysis. Patients receiving outpatient hemodialysis often experience a number of chronic and acute health problems. The chronic problems include hypertension, anemia (low red blood cell count), malnutrition, fluid and electrolyte imbalance, calcium deficiency, insomnia, sexual impotency, decreased mental acuity and lower energy levels. The acute problems include headaches, nausea, hypotension and asthenia (a general lack of strength and vitality), which are associated with thrice weekly dialysis sessions. In addition, a general feeling of ill health tends to increase between dialysis treatments as a result of toxins, sodium and water building up in the patient's blood. These side effects have a significant impact on (i) clinical outcomes, with the leading cause of death among ESRD patients being cardiovascular disease, which many clinicians believe is caused in large part by oscillations in toxins, sodium and body fluid levels, (ii) total patient costs, resulting from the frequent need to hospitalize ESRD patients as well as the need to treat anemia and hypertension with medication and (iii) patient quality of life, with patients having to not only suffer through these chronic and acute health problems and related "hangover" frequently following each treatment, but also to essentially devote three days per week to the treatment regimen.
The Company believes that these health problems are caused in part by inadequate doses and frequency of dialysis. The amount of toxins removed from the blood during dialysis is widely accepted to be determined by a formula indicating that hemodialysis is most efficient in the earlier stages of therapy. Thus, simply increasing the duration of a treatment session is not the most efficient way to improve the dose of hemodialysis. Rather, the efficiency of hemodialysis and the delivered dose can be improved with more frequent dialysis sessions of shorter duration. More frequent sessions also decrease the severe oscillations in toxin and hydration levels associated with the prevailing three times per week dialysis regimen and should result in fewer side effects.
The clinical outcomes of conventional dialysis have contributed to the significant patient treatment cost. According to CMS, total treatment costs per dialysis patient have risen from $33,400 in 1988 to $68,000 in 1999. The cost of hospitalization on a fee for service basis represents the most significant component of this increase. While reimbursement for outpatient hemodialysis treatment (the "composite rate") has been capped since 1983, reimbursement for the associated cost of care due to chronic and acute health problems and other complications continues to be reimbursed on a fee for service basis. Under this reimbursement scheme, providers have an incentive to reduce the cost of outpatient dialysis rather than the total cost of treating dialysis patients.
Peritoneal Dialysis. Although peritoneal dialysis accounted for 10% (or 26,000) of the dialysis patient population in 2000 according to CMS, approximately 22% (or 6,000) of the patients in the United States switched to outpatient in-center hemodialysis. The Company believes that most of these patients switched from peritoneal dialysis to outpatient hemodialysis because of the following limitations presented by CAPD, the most common form of peritoneal dialysis: (i) due to the limited efficiency of using the peritoneal membrane as a filter for toxin removal, patients must have a relatively low body weight or have some residual kidney function to achieve adequate levels of dialysis (once residual kidney function is lost, which is eventually the case in most patients, CAPD is no longer a viable treatment for a majority of the population); (ii) CAPD demands considerable responsibility and time to perform the required four exchanges of solution each day, which often causes patient "burnout" and non-compliance with the prescribed regimen; (iii) peritoneal dialysis demands that patients follow strict aseptic techniques when changing dialysate bags because the failure to do so often leads to peritonitis, an infection of the peritoneum; and (iv) the supplies used in peritoneal dialysis require considerable storage space given the quantity of dialysate (up to 30 large boxes per month) used in this treatment.
The Company believes that most new peritoneal dialysis patients choose CCPD, in part, in an attempt to improve clinical outcomes. Although CCPD addresses some of the limitations imposed by CAPD, it continues to present a risk of infection of the peritoneum and in many cases requires some residual kidney function to achieve adequate levels of dialysis. Moreover, because CCPD must often be supplemented with peritoneal dialysis performed by the patients during the day using the CAPD method, patient "burnout" also occurs.
HOME HEMODIALYSIS AS AN ALTERNATIVE
The Company believes that increasing the frequency of hemodialysis treatments while decreasing the length of each treatment session can significantly improve clinical outcomes and patient quality of life while reducing the total cost of managing ESRD patients. The Company completed a clinical trial of the PHD System in November 2000, whereby a total of 23 patients converted from three times per week dialysis at home to a treatment regimen of more frequent dialysis on the PHD System. Over 4,000 dialysis treatments have been performed by patients on the PHD System, including over 3,500 times at home. Patients showed better clinical outcomes and improved quality of life on more frequent dialysis.
Several other studies over the past 32 years indicate that increasing the number of dialysis treatments per week leads to dramatic improvements in patients. Several study centers report that most of the ESRD patients who performed hemodialysis on a daily basis reported that daily hemodialysis gave them a more positive attitude toward treatment and a higher quality of life. Neither the Company nor the PHD System was involved in the treatments received by patients in these other studies and the Company did not fund these studies. Moreover, patient selection for these studies was not randomized; the Company gathered the data on a retrospective basis from providers that it knew were treating patients with a daily hemodialysis regimen. Consequently there can be no assurance that the patient populations in these studies are representative of the general ESRD patient population. As a result, these studies should not be deemed to have established the impact of daily hemodialysis on clinical outcomes.
In addition to the aforementioned retrospective studies, daily hemodialysis is gaining popularity. There are initiatives in the U.S. and worldwide to study the benefits of daily hemodialysis. The Company estimates that in early 2001, there are 40 centers worldwide, 20 of which are in North America, treating over 400 patients with daily hemodialysis.
Despite the potential benefits of frequent hemodialysis, several barriers have prevented it from becoming a viable treatment regimen. The most significant is the economic implication of administering more frequent hemodialysis to patients from the traditional three times per week dialysis. Under the current capped Medicare reimbursement level, dialysis providers cannot afford the additional costs that would be incurred in providing more frequent treatments in outpatient facilities. Requiring more frequent visits to a dialysis treatment facility would also place additional burdens on a patient's lifestyle.
There is also a perception that vascular access complications arising from inserting the needles into the patient's blood access site may increase with daily treatment sessions. These complications are common in the clinical setting already and account for a significant portion of the cost of treating patients. The Company believes that vascular access complications should not increase with more frequent hemodialysis sessions in a home or self-care setting and such complications may in fact decrease. That belief is based on data collected from patients using a native fistula. The Company has collected little data from patients using artificial blood vessel grafts or central venous catheters, and there is no assurance that such grafts or catheters will withstand daily treatment. There are a number of approaches to vascular access that may enhance more frequent treatments, including (i) the use of "single needle" vascular access devices which reduce the number of punctures by half, (ii) the use of central venous catheters which eliminate the need to use needles at all, (iii) novel graft materials, (iv) new, totally implanted central venous catheters with titanium ports and (v) the practice of inserting needles in the same site each day, which has been demonstrated to have several benefits according to publications by Dr. Zbylut J. Twardowski, a leading dialysis researcher.
The Company believes that most barriers to a more frequent hemodialysis regimen could be overcome if it were available in the patient's home, but to date no hemodialysis device has become sufficiently available to establish home hemodialysis as a feasible alternative therapy for the general dialysis patient population.
PRODUCT DEVELOPMENT
THE AKSYS PHD SYSTEM
By addressing the many drawbacks of conventional hemodialysis systems, which have prevented the widespread use of daily home hemodialysis, the Company believes its products and services can be instrumental in improving clinical outcomes, decreasing the total treatment costs and improving quality of life for dialysis patients. The following chart describes how the PHD System addresses the drawbacks presented when ESRD patients and helpers use conventional systems for home hemodialysis:
Although the most common form of peritoneal dialysis, CAPD, does not require a dialysis machine, as discussed above, peritoneal dialysis has inherent limitations. The Company believes that the PHD System addresses the primary drawbacks of both forms of peritoneal dialysis by delivering a substantially greater dose of dialysis in significantly less time. Furthermore, by enabling the use of frequent home hemodialysis, the PHD System overcomes other limitations of peritoneal dialysis such as the risk of peritonitis and patient non-compliance to the prescribed regimen.
The Company believes that the PHD System offers patients simplification and control. The new technology of the PHD System integrates three systems into one: water purification, delivery of dialysis and dialyzer reprocessing. The PHD System is a fully automated personal dialysis instrument designed to enable operators to perform hemodialysis in a self-care setting, such as the patient's home, on a frequent or daily basis. The PHD System is designed to reduce the patient's time and effort involved in performing each hemodialysis treatment with minimal assistance. Through a touch sensitive display screen with instructions available on a graphic video display, the PHD System is designed to be less intimidating and easier to use than current hemodialysis systems.
The PHD System is designed to evaluate the performance of the artificial kidney in removing toxins from the patient's blood prior to each treatment to ensure that the prescribed dose of hemodialysis is achieved during the treatment. The PHD System also automatically evaluates the water treatment filters and indicates whether a replacement is required and verifies that all critical safety systems, sensors and alarms are operating correctly.
To begin a treatment session on the PHD System, the operator connects the blood tubing to the vascular access device. A user-friendly, touch-sensitive monitor prompts the patient through the treatment and displays procedure and patient-specific information for review. The PHD System is designed to monitor during the treatment a variety of vital statistics, including the patient's blood flow rate, the amount of water removed from the patient, the length of the treatment session and other key parameters. The treatment can be suspended at any time by the patient. If the patient's blood pressure drops below normal levels during the treatment, the system prompts the patient to take appropriate action. Data from a hemodialysis treatment is displayed for viewing by the patient.
At the end of a treatment session, the operator reconnects the blood tubing to the system and inserts two small bottles of dialysate in the system to replace those consumed for the previous treatment. The PHD System then automatically
flushes and disinfects all fluid pathways, performs a self-diagnostic test to determine whether the disinfection was adequate and readies itself without further patient involvement for the next treatment session.
SERVICES SUPPORTING THE PHD SYSTEM
To fully service hemodialysis patients, the Company intends to develop a service network to provide support for patients and dialysis providers in all aspects relating to the use and maintenance of the PHD System. The Company expects this service network will provide: (i) delivery and installation of the PHD System (including arranging for any minor changes to plumbing and electrical circuits in the patient's home, or other self-care setting, that will be necessary for operation of the PHD System), (ii) technical service through a 24 hour call center and through field representatives who will maintain and repair all components of the PHD System, (iii) delivery of consumables used in dialysis such as the artificial kidney and arterial and venous blood tubing (which are replaced periodically), water purification components and dialysate concentrate, (iv) delivery of ancillary supplies such as dressings, tape, antiseptics, drugs and syringes and (v) customer service representatives who will interface with the dialysis provider to address the status of, and any necessary changes in, the patient's treatment made by the dialysis provider. The Company believes that by providing all of the products and services necessary to perform hemodialysis at home as well as in other self-care settings and nursing homes, the Company can establish and maintain loyalty with patients and dialysis providers.
The PHD System is intended to reduce total treatment costs for ESRD patients, including hospitalization costs. There is no reliable way at this time, however, to quantify the potential savings in total treatment cost. The Company expects that the PHD System will be priced at a level to fit within current reimbursement guidelines. Thus, the Company expects there will be little or no reduction in dialysis cost (as opposed to total treatment costs) associated with the PHD System.
Although the Company believes that the PHD System provides a solution to many of the problems presented by conventional dialysis modalities, there are a number of risks that must be overcome for the PHD System to succeed, including achieving market acceptance and development and the uncertainty of obtaining regulatory clearance or approval in foreign jurisdictions.
OTHER PRODUCT DEVELOPMENT
During 2002, the Company expects that substantially all of its resources, including available cash and short-term investments, will be devoted to the regulatory approval process and commercialization activities of the PHD System. Now that the FDA clearance has been obtained and the Company plans to move into commercial production, resources will be devoted to additional features, service and support of the PHD System. Resources will also be directed toward using the platform technology incorporated in the PHD System to develop follow-on products.
BUSINESS AND MARKETING STRATEGY
In October 1997, the National Kidney Foundation released the results of the first comprehensive effort to standardize practices at U.S. dialysis centers (the Dialysis Outcomes Quality Initiative, or DOQI guidelines). The recommendations called for minimum doses of dialysis; however, approximately 32% of all current U.S. patients are under that recommended minimum dosage. These recommendations support the Company's belief that patients who receive that higher dose through daily dialysis would benefit through improved clinical outcomes. The Company believes that the PHD System offers the potential for better clinical outcomes, lower total treatment costs and improved quality of life for dialysis patients. The relatively poor patient outcomes resulting from current dialysis treatment methods and the increasing total cost of treating ESRD patients have created significant demand for improved dialysis systems. Through the PHD System, the Company intends to capitalize on this demand by pursuing the following strategies.
Target Specific Market Segments. The Company intends to market its products and services directly to those providers of dialysis services most focused on patient outcomes and total cost of care. This strategy is designed to achieve access to the key patient segments which the Company believes will be especially receptive to frequent home hemodialysis using the PHD System, including: (i) dialysis patients currently receiving conventional home hemodialysis, (ii) dialysis patients who drop out of home peritoneal dialysis and (iii) ESRD patients who are just beginning dialysis treatment. In the United States, these segments accounted for approximately 1,600, 9,000 and 91,000 dialysis patients, respectively, in 2000 according to industry data. Although the PHD System has been designed primarily for home use, the Company believes it will also be an attractive alternative dialysis device for self-care clinics and nursing homes.
Provide a Broad Range of Dialysis Products and Services. The Company intends to provide a broad range of products and services for hemodialysis patients and providers. In addition to the delivery, installation and maintenance of the PHD System, the Company intends to provide training, technical support and delivery of all required consumables. The Company intends to sell the instruments to customers or to a third party lease company, and enter into contracts with its customers to provide all consumables and services for a single monthly price.
Capture and Provide Outcome Data. The PHD System has a built-in computer capable of recording specific medical data regarding dialysis treatment and patient health and compliance. Future versions of the PHD System may allow outcome data to be furnished on-line to the healthcare provider responsible for treating the patient and will aid the provider in assessing the effectiveness of the patient's dialysis treatment prescription as well as promote the potential clinical and cost benefits of frequent home hemodialysis. Outcome data should become increasingly important if, as the Company believes, CMS moves towards a reimbursement system that capitates total ESRD patient cost.
Implement Programs to Demonstrate Clinical Benefits and Cost-Effectiveness. The Company intends to complement its marketing by conducting clinical studies and implementing other measures designed to document the clinical and cost benefits it believes will result from frequent home hemodialysis using the PHD System. In 1998, the Company sponsored a study at six centers to measure the early improvements in nutrition and well-being of patients converting from the standard thrice-weekly hemodialysis regimen to a daily hemodialysis regimen. Results of the study indicated dramatic improvements in the patients' feeling of well-being after converting to a regimen of daily hemodialysis. In collaboration with members of the Company's Scientific Advisory Board and other leading nephrologists, the Company intends to promote the benefits of the PHD System through publication in clinical journals and presentations at scientific conferences of the results of these studies.
Phased Domestic and International Market Launch. The Company believes that there is worldwide demand for a cost effective, more clinically effective approach to dialysis. In addition to pursuing market launch in the United States, the Company is establishing marketing and regulatory resources in Europe, Japan and elsewhere. As of December 31, 2000, the Company estimates that there were approximately 260,000 dialysis patients in Europe and 190,000 dialysis patients in Japan.
SALES AND MARKETING
The Company initially intends to operate with a relatively small direct sales force to market its products and services, primarily to healthcare providers such as hospitals, dialysis clinics, managed care organizations and nephrology physician groups. The Company intends to distribute and provide technical support for the PHD System through a combination of in-house resources and contracted third parties.
MANUFACTURING AND SUPPLIERS
The Company does not intend to initially manufacture any component of the PHD System or related consumables. With respect to the PHD System, the Company has contracted with Peak Industries, Inc. ("Peak"), a contract manufacturer of medical devices, to assemble and produce the dialysis machine. The Company has entered into an agreement with Peak that remains in effect through February 28, 2003, subject to earlier termination under specified circumstances. Peak specializes in the custom manufacturing of medical instrumentation and is certified to ISO requirements for manufacture of such products. ISO Certification is an internationally recognized standard of quality manufacturing. The Company intends to identify additional manufacturing locations in the future, whether or not owned by Peak, to avoid having to rely on a single location. There can be no assurances that the Company will be able to do so on terms acceptable to it. The manufacturing of the Company's products is subject to quality system regulations ("QSR") and other requirements prescribed by regulatory agencies. There can be no assurance that Peak or any other manufacturer of the Company's products will continue to comply with applicable regulatory requirements or that Peak or any such manufacturer will be able to supply the Company with such products in sufficient quantity or at all.
Certain key components of the PHD System, such as the dialyzer, are available from other manufacturers. The blood tubing set, however, is custom made to the Company's specifications by a single supplier. Similarly, the dialysate chemicals supplied to patients using the PHD System will be custom made and packaged to the Company's specifications. The Company is currently working with a leading manufacturer of dialysis products to provide the Company's needed dialysate chemicals. There can be no assurances, however, that any of the key components of the Company's products, including dialyzers produced by other manufacturers, will be available on terms acceptable to the Company or at all.
RESEARCH AND DEVELOPMENT
As of December 31, 2001, the Company employed a research and development staff of 30 full time employees, most of whom are engineers and technicians. In addition, the Company used contractors on an as needed basis to assist in its development process. The research and development staff is composed of specialists in the fields of mechanical engineering, electrical engineering, software engineering, biomedical and systems engineering, chemistry and microbiology. For the years ended December 31, 2001, 2000 and 1999, the Company incurred total research and development expenditures of approximately $10,883,000, $14,542,000, and $15,910,000, respectively.
COMPETITION
The Company expects to compete in the kidney dialysis market with suppliers of hemodialysis and peritoneal dialysis devices, supplies and services. The Company does not intend to compete with providers of dialysis services such as the national dialysis providers or managed care companies. Rather, it intends to market its products and services to these providers and to work with them to make home hemodialysis a viable alternative to currently available treatment methods.
The Company's primary competitors in supplying dialysis equipment, supplies and services are expected to be Baxter International Inc., Fresenius Medical Care AG and CGH Medical, Inc. (Cobe, Gambro, Hospal). These companies and most of the Company's other potential competitors have substantially greater financial, scientific and technical resources, research and development capabilities, marketing and manufacturing resources and experience than the Company and greater experience in developing products, providing services and obtaining regulatory approvals.
The Company's ability to successfully market its products and services could be adversely affected by pharmacological and technological advances in preventing the progression of ESRD in high-risk patients (such as those with diabetes and hypertension), technological developments by others in the area of dialysis, the development of new medications designed to reduce the incidence of kidney transplant rejection and progress in using kidneys harvested from genetically-engineered animals as a source of transplants. There can be no assurance that competitive pressure or pharmacological or technological advancements will not have a material adverse effect on the Company.
The Company believes that competition in the market for kidney dialysis equipment, supplies and services is based primarily on clinical outcomes, price, product performance, cost-effectiveness, reliability and technological innovation and that such competition in the home hemodialysis market will be based on such factors as well as on products being relatively easy to use, transport and maintain. Certain kidney dialysis equipment manufacturers and service providers currently own and operate, or may in the future acquire, dialysis treatment facilities and other providers. As a result, the Company's ability to sell its products and services to such providers may be adversely affected.
GOVERNMENT REGULATION
FOOD AND DRUG ADMINISTRATION
The PHD System is regulated as a medical device by the FDA under the Federal Food, Drug and Cosmetic Act (the "FDC Act"). Pursuant to the FDC Act, the FDA regulates the manufacture and distribution of medical devices in the United States. Noncompliance with applicable requirements can result, among other things, in fines, injunctions and civil penalties; recall or seizure of products; total or partial suspension of production; denial or withdrawal of pre-market clearance or approval of devices; recommendations by the FDA that the Company not be allowed to enter into government contracts; and criminal prosecution. The FDA also has authority to require repair, replacement or refund of the cost of any device illegally manufactured or distributed by the Company.
In the United States, medical devices are classified into one of three classes (Class I, II or III) on the basis of the controls deemed necessary by the FDA to reasonably ensure their safety and effectiveness. Class I devices are subject to general controls (e.g., labeling and adherence to some of the QSRs). Class II devices are subject to general and special controls (e.g., performance standards, post-market surveillance and patient registries). Class III devices are those which must receive pre-market approval by the FDA to ensure their safety and effectiveness (e.g., life-sustaining, life-supporting and implantable devices or new devices which have been found not to be substantially equivalent to legally marketed devices).
The PHD System is classified as a Class II device. On March 30, 1999, the Company filed an Investigational Device Exemption ("IDE") with the FDA, a prerequisite for conducting a clinical evaluation of the PHD System. The Company received full IDE approval in July 1999, and in September 1999 began the clinical trial of the PHD System. 25 patients participated in the trial at three centers. The protocol for the study called for patients to dialyze at home on existing hemodialysis equipment for 10 weeks, followed by one month in the center on the PHD System and two months at home on the PHD System. The clinical trial was completed in November 2000, with 23 patients receiving dialysis on the PHD System. Over 4,000 dialysis treatments have been performed by patients on the PHD System, including over 3,500 in the home.
On March 27, 2002, the Company announced that it received the FDA's clearance to market the PHD System in the United States. The FDA clearance had no restrictions and included authorization to use the product in the home. The Company had been working toward satisfying the regulatory requirements of the FDA since submitting a 510(k) pre-market notification for clearance to market the PHD System in January 2001. 510(k) clearance by the FDA was required prior to the commercialization of the PHD System in the United States.
The FDC Act requires that medical devices be manufactured in accordance with the FDA's current QSRs. These regulations require, among other things, that (i) the manufacturing process must be regulated and controlled by the use of written procedures and (ii) the ability to produce devices which meet the manufacturer's specifications be validated by extensive and detailed testing of every aspect of the process. They also require investigation of any deficiencies in the manufacturing process or in the products produced and detailed record keeping. Manufacturing facilities are therefore subject to FDA inspection on a periodic basis to monitor compliance with QSR requirements. If violations of the applicable regulations are noted during FDA inspections of the Company's manufacturing facilities or the manufacturing facilities of its contract manufacturers, there may be a material adverse effect on the continued marketing of the Company's products.
Even though the FDA has cleared the PHD System, the FDA may periodically inspect the manufacturing facilities and processes for compliance with QSRs. In addition, in the event that additional manufacturing sites are added or manufacturing processes are changed, such new facilities and processes are also subject to FDA inspection for compliance with QSRs. The processes that will be used to manufacture the Company's products have not yet been inspected by the FDA for compliance with QSRs. There is no assurance that the facilities and processes utilized by the Company will comply with QSRs and there is a risk that clearance or approval will, therefore, be delayed by the FDA until such compliance is achieved.
FOREIGN GOVERNMENT REGULATION
The Company plans to market the PHD System in several foreign markets, including Europe and Japan. Requirements pertaining to the PHD System vary widely from country to country, ranging from no health regulations to detailed submissions such as those required by the FDA. The Company believes the extent and complexity of regulations of medical devices such as the PHD System is increasing worldwide. The Company anticipates that this trend will continue and that the cost and time required to obtain approval to market in any given country will increase, with no assurance that such approval will be obtained. The ability to export into other countries may require compliance with EN46001 or ISO13485, which is analogous to compliance with the FDA's QSR requirements. The Company has not obtained any regulatory approvals to market the PHD System outside of the United States.
INTELLECTUAL PROPERTY
As of March 1, 2002, the Company either owns or has exclusive rights to 45 U.S. patents and 21 foreign patents for technologies that are important to developing a safe, convenient, self-contained hemodialysis system. The U.S. Patent and Trademark Office has also allowed claims on 10 additional patents. The Company has filed a number of additional patent applications directed to a number of different features of the PHD System in the United States, and in several other countries that have significant hemodialysis markets. The Company has also filed a Patent Cooperation Treaty ("PCT") patent application that permits it to file patent applications in additional PCT-member countries for a limited period of time. The Company expects to file additional patent applications in the United States directed to the PHD System as new technology is developed.
Twardowski License. On April 1, 1993, the Company entered into a License Agreement (the "Twardowski License") with Dr. Zbylut Twardowski, a member of the Company's Scientific Advisory Board, granting to the Company a worldwide exclusive license which relates to the patent issued on August 9, 1994 entitled "Artificial Kidney for Frequent (Daily) Hemodialysis" which expires August 9, 2011 (the "Twardowski Patent"). The Twardowski Patent relates to an artificial kidney intended to provide frequent (daily) home hemodialysis. The Twardowski License has a duration for as long as the Twardowski Patent remains in effect. The Twardowski License provides for royalties based on the revenue received by the Company from the sale or lease of the licensed product. The Twardowski License requires certain minimum semiannual royalty payments. If the Company fails to make any such minimum royalty payment, Twardowski has the option to convert the Twardowski License to a non-exclusive license. There can be no assurance that the Twardowski Patent will provide the Company significant exclusivity or benefit in its markets. Furthermore, competitors may develop alternative technology that achieves the same advantages as the Twardowski Patent.
Boag License. On April 1, 1993, the Company also entered into a License Agreement (the "Boag License") with Cynthia P. Walters for the use of a patent entitled "Dialyzer Reuse System" issued on September 22, 1987, which expires September 22, 2004 (the "Boag Patent"). The Boag License is exclusive subject to the rights of Servall Corp. to market its HR3000 product, a device for facilitating reuse of consumables with conventional hemodialysis machines. The Boag Patent relates to a dialysis reuse system for cleaning, sterilizing and testing a hemodialysis machine and its associated dialyzer and blood tubing set. The Boag License has a duration for as long as the Boag Patent remains in effect. The Boag License provides for royalties based on the revenue received by the Company from the sale or lease of the licensed product with a minimum semiannual royalty payment. Commencing with the third semiannual period after the first licensed product is sold, if the Company pays no more than the minimum semiannual royalty payment for two consecutive semiannual periods, the licensor has the right to convert the Boag License to a non-exclusive license. Also, commencing with the first semiannual period occurring five years after the first licensed product is sold, if the Company pays no more than the minimum semiannual royalty payment for two consecutive semiannual periods, the licensor has the right to terminate the Boag License. In the event of infringement of the patent by third parties, the Company's right to enforce the patent is subject to the licensor's superior right to bring suit on its own and to recover all damages without accounting to the Company. There can be no assurance that the Boag Patent will provide the Company significant exclusivity or benefit in its markets. Furthermore, competitors may develop alternative technology that achieves the same advantages as the Boag Patent.
Allergan License. On March 11, 1996, the Company entered into a License Agreement (the "Allergan License") with Allergan, Inc. for the use of a U.S. patent entitled "Pressure Transducer Magnetically-Coupled Interface Complementing Minimal Diaphragm Movement During Operation" issued on February 28, 1995, and its foreign counterparts (the "Allergan Patent"). The Company has exclusive worldwide rights to the patented technology, limited to the field of use of kidney dialysis machines and methods. The Allergan License has a duration for as long as the Allergan Patent remains in effect and provides for royalty payments to Allergan based on manufacturing of the PHD System, which incorporates the patented technology. Royalty payments are to be made quarterly, with minimum annual royalty payments beginning in 1998. If the Company fails to pay the full minimum annual royalties, the License Agreement will terminate. If the Company pays at least half of the minimum annual royalties
but does not pay such royalties in full, the License Agreement shall be converted to a non-exclusive license. There can be no assurance that the Allergan Patent will provide the Company significant exclusivity or benefits in its markets. Furthermore, competitors may develop alternative technology that achieves the same advantages as the Allergan Patent.
There can be no assurance that any of the Company's pending patent applications will be approved by the patent offices in the various countries in which they were filed. In addition, there can be no assurance that the Company will develop additional proprietary products or processes that are patentable or that any patents that may issue to or be licensed by the Company will provide the Company with competitive advantages. There can be no assurance that the Company's patent applications or patents that may issue to or be licensed by the Company will not be challenged by any third parties or that the patents of others will not prevent the commercialization of products incorporating the Company's technologies. Furthermore, there can be no assurance that others will not or have not independently developed similar products, duplicated and designed any of the Company's products or design around the patents that may issue to or be licensed by the Company. Any of the foregoing results could have a material adverse effect on the Company.
The commercial success of the Company will depend, in part, on its ability to avoid infringing patents issued to others. The field of dialysis includes a significant number of patents that have been issued to third parties. The Company may receive from third parties, including potential or actual competitors, notices claiming that it is infringing third party patents or other proprietary rights. If it was determined that the Company was infringing any third-party patent, the Company could be required to pay substantial damages, alter its products or processes, obtain licenses or cease certain activities. In addition, if patents are issued to others which contain claims that compete or conflict with the licensed patents or patent applications of the Company and such competing or conflicting claims are ultimately determined to be valid, the Company may be required to pay damages, to obtain licenses to these patents, to develop or obtain alternative technology or to cease using such technology. If the Company is required to obtain any licenses, there can be no assurance that the Company will be able to do so on commercially favorable terms, if at all. The Company's failure to obtain a license to any technology that it may require to commercialize its products could have a material adverse impact on the Company's business, operating results and financial condition.
In addition to patent licenses and applications for patents, the Company possesses trade secrets, copyrights, proprietary know-how and unpatented technological advances. The Company seeks to protect these assets, in part, by confidentiality agreements with its business partners, consultants and vendors and non-competition agreements with its officers and employees. There can be no assurance that these agreements will not be breached, that the Company will have adequate remedies for any breach or that the Company's trade secrets and proprietary know-how will not otherwise become known or be independently developed by others.
EMPLOYEES
As of December 31, 2001, the Company had 62 full-time employees, 30 of whom were employed in research and development capacities. The Company considers its employee relations to be good.
EXECUTIVE OFFICERS
The information under this Item is furnished pursuant to Instruction 3 to Item 401(b) of Regulation S-K. Executive Officers of the Company are elected by and serve at the discretion of the Board of Directors.
William C. Dow was appointed President and Chief Executive Officer and a director of the Company in September 1999. From August 1997 until joining the Company in September 1999, he served as President and Chief Executive Officer of PLC Systems Inc., a manufacturer of lasers used in cardiac surgery. From 1993 to 1997, he served as President and Chief Executive Officer of Deknatel Snowden Pencer Worldwide, Inc., a $100 million medical device manufacturer that became a manufacturing and marketing subsidiary of Genzyme Corporation in 1996. Mr. Dow has over 25 years of experience in the medical device and service industry having held various positions in sales, marketing, distribution and general management with Griffith Micro Science, Kendall, Terumo and American
Hospital Supply. Mr. Dow is a graduate of the United States Naval Academy with a Bachelor of Science in Engineering and served as both a pilot and a Supply Corps officer in the U.S. Navy.
Richard P. Goldhaber, Senior Vice President and Chief Technical Officer, joined the Company in July 2000. Prior to joining the Company, from 1993 to 2000, he was Vice President of Research and Development at Minntech Corporation, a company that develops, manufactures and distributes dialysis related products. Prior to Minntech, from 1965 to 1993, he held positions of increasing responsibility in product development with Baxter International Inc., including 20 years developing dialysis products.
David L. Bellitt, Senior Vice President of Sales and Marketing, joined the Company in November 2000 with over 25 years of experience in the medical devices, diagnostics and home healthcare markets. From June 1997 to November 1999, he served as Senior Vice President at Organon Teknika Corporation, a $100 million division of Akzo Nobel dealing in medical diagnostic instrumentation systems. Prior to Organon, from 1995 to 1997, he was Senior Vice President of Bell+Howell Mail Processing Systems, with responsibilities for worldwide marketing, sales and service for the $370 million division operating in 48 countries.
Thomas F. Scully, Senior Vice President of Manufacturing and Operations, joined the Company in January 1996. From 1971 to 1995, Mr. Scully worked at Baxter International Inc. in various operational roles, including responsibilities as Vice President, Sales and Operations of the Renal Division. In that role, Mr. Scully was involved principally in the design, development and management of the Renal Division's home care operations network.
PRODUCT LIABILITY EXPOSURE
The Company's business exposes it to potential product liability risks that are inherent in the production, marketing and sale of dialysis products. There can be no assurance that the Company will be able to avoid significant product liability exposure. Upon commencement of the first human use of the PHD System in January 2000, the Company initiated product liability insurance coverage, with a limit of $10 million. There can be no assurance that such insurance coverage is sufficient, or that additional coverage will be available on acceptable terms or at all or that any insurance policy if obtained will provide adequate protection against potential claims. Furthermore, the Company's agreements with contract manufacturers require the Company to obtain product liability insurance, and the failure to obtain adequate insurance coverage could materially and adversely affect the Company's ability to produce the PHD System. A successful claim brought against the Company in excess of any insurance coverage maintained by the Company could have a material adverse effect upon the Company. In addition, the Company has agreed to indemnify certain of its contract manufacturers against certain liabilities resulting from the sale of the PHD System.
FOREIGN OPERATIONS
In April 1996, the Company established Aksys Japan, K.K. ("AJKK"), a wholly-owned Japanese subsidiary. AJKK had no employees as of December 31, 2001. The Company has engaged the services of a business consultant to act on behalf of AJKK in pursuing business opportunities in Japan. The primary purpose of AJKK is to establish a presence for regulatory, business development and eventual technical and customer support as the Company progresses through the stages of clinical studies, regulatory approval and market launch. All efforts and decisions are directed from the Company's headquarters in Lincolnshire, Illinois.
On June 21, 1999, the Company entered into a co-development and license agreement (the "Agreement") with Teijin Limited of Osaka, Japan. Under the terms of the Agreement, Teijin paid $7.0 million to the Company for the right to manufacture and sell the PHD System in Japan. The Company is also entitled to future royalty payments from future product sales in Japan. The $7.0 million has been recognized as revenue. Teijin also paid the Company a $7.0 million co-development fee relating to the PHD System. Use of the proceeds from the co-development fee was restricted to development costs incurred on the PHD System and could not be used for other general corporate purposes. Amounts paid under the co-development arrangement were recognized as revenue as development costs on the PHD System are incurred. During the years ended December 31, 2000 and 1999, the Company recognized
revenue of $3.4 million and $2.6 million, respectively, related to co-development of the PHD System. During 2000, the Agreement was amended. The final revenue related to the co-development of the PHD System was recognized during 2000, and the remaining unspent co-development funds under the Agreement were recorded in other liabilities Amounts due to Teijin were $0 and $658,423 at December 31, 2001 and 2000, respectively.
On January 7, 1998, the Company established a strategic alliance with Teijin as a result of mutually initiated negotiations. The alliance is represented by a Stock Purchase Agreement and a Joint Development Agreement. Under the terms of the Stock Purchase Agreement, Teijin purchased 493,097 newly issued common shares of the Company at a price of $10.14 per share and received certain registration rights with respect to such shares. The Joint Development Agreement provided that, conditional on the achievement of certain milestones, Teijin would make additional cash payments to the Company. The first of those milestones, for agreeing to the regulatory strategy in Japan, resulted in a payment to the Company of $1,000,000 during 1998. The Joint Development Agreement was superceded by the Agreement entered into with Teijin in June 1999.
Teijin is a leading Japanese manufacturer of synthetic fibers, chemicals and plastics, with annual sales in excess of $5 billion, of which over $600 million is derived from pharmaceuticals and medical products. Teijin pioneered and today is a leader in the home oxygen therapy business in Japan, and is also one of the principal suppliers to the dialysis industry of the resins and fibers used to produce dialyzers.
ITEM 2.
ITEM 2. PROPERTIES.
The Company leases approximately 41,500 square feet of office space in Lincolnshire, Illinois to conduct its research, development and administrative functions. The Company believes that its present facilities are adequate for its operations. The Company presently expects all manufacturing will be contracted out to third party subcontractors.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any material pending legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
There were no matters submitted for a vote of the Company's stockholders during the fourth quarter ended December 31, 2001.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
On December 14, 2001, the Company completed a private placement to several institutional investors of 3,195,230 shares of its common stock. The gross proceeds of the offering were approximately $10.39 million. The investors were also issued stock purchase warrants for the right to acquire an aggregate of 584,728 shares of common stock at an exercise price of $3.25 per share. The shares were sold with the assistance of U.S. Bancorp Piper Jaffray ("Piper Jaffray"). As the placement agent, Piper Jaffray received fees of approximately $0.6 million and stock purchase warrants to acquire an aggregate of 159,762 shares of common stock at $4.90 per share. The securities were sold in reliance on the exemption from registration provided by section 4(2) of the Securities Act of 1933. The private placement was made without any general solicitation or advertising and each investor represented to the Company in writing that it was an accredited investor within the meaning of Rule 501(a) of Regulation D.
The Company's Common Stock trades on the Nasdaq National Market under the symbol AKSY. The following table lists the quarterly high and low prices of the Common Stock for the period from January 1, 2000 through December 31, 2001.
Fiscal Fiscal Year Quarter High Low ------- ---------- -------- ---------- 2001 1st $16.875 $4.750 2nd 12.000 3.625 3rd 10.670 3.000 4th 8.500 3.950
2000 1st $13.375 $4.875 2nd 11.375 6.563 3rd 14.00 7.813 4th 17.50 11.50
There were 255 stockholders of record of the Company's Common Stock as of March 22, 2002. In addition, the Company estimates that there were approximately 7,000 beneficial stockholders at March 22, 2002, who held shares in "street name." The Company has not paid cash dividends to date, and management anticipates that all future earnings will be retained for development of the Company's business.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The selected statements of operations and balance sheet data as of December 31, 2001 and 2000 set forth below have been derived from the audited financial statements of the Company included as Exhibit 13 to this Annual Report on Form 10-K. The selected statements of operations and balance sheet data as of December 31, 1999, 1998 and 1997 set forth below have been derived from the audited financial statements of the Company that have not been included in this Annual Report on Form 10-K. The historical financial data for the Company is not necessarily indicative of future results and should be read in conjunction with the financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.
/(1)/ Computed on the basis described in Note 1 of Notes to Consolidated Financial Statements. /(2)/ Consists primarily of deferred rent under operating lease for facilities.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
Since its inception in January 1991, the Company has been engaged in the development of hemodialysis products and services for patients suffering from ESRD. The Company has developed the PHD System, which is designed to enable patients to perform daily hemodialysis at alternate sites, such as the patient's home. The Company has never generated sales revenue and has incurred losses since its inception. At December 31, 2001, the Company had a deficit accumulated during the development stage of $90.9 million. The Company expects to incur additional losses in the foreseeable future at least until such time that it can sufficiently commercialize the PHD System, with
commercialization requiring necessary regulatory clearances or approvals from the FDA to market the PHD System in the United States and equivalent regulatory approvals to market the PHD System in countries other than the United States.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. The company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:
Accrued liabilities and contingencies
The Company is required to make certain estimates and assumptions that affect the amounts recorded as accrued liabilities and contingencies. The Company bases its estimates on historical experience and on various other factors that are believed to be reasonable to determine the amount of accrued liabilities and contingencies to be recorded. If actual results differ from these estimates, additional expenditures might be recorded.
Other receivable write down and realizability determinations
The Company maintains allowances for doubtful accounts for estimated losses resulting from the Company's review and assessment of its third-party vendor ability to make required payments. If the financial condition of the Company's third-party vendor were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required.
Net deferred tax assets valuation
The Company records its net deferred tax assets in the amount that it expects to realize based on projected future taxable income. In assessing the appropriateness of its valuation, assumptions and estimates are required such as the Company's ability to generate future taxable income. In the event that the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.
CONTRACTUAL OBLIGATIONS
The following table reflects a summary of the Company's contractual cash obligations as of December 31, 2001:
NOTE ON FORWARD-LOOKING INFORMATION
Certain statements in this Annual Report on Form 10-K and in future filings made by the Company with the Securities and Exchange Commission and in the Company's written and oral statements made by or with the approval of an officer of the Company constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and the Company intends that such forward-looking statements be subject to the safe harbors created thereby. The words "believes," "expects," "estimates," "anticipates," and "will be," and similar words or expressions, identify forward-looking statements made by or on behalf of the Company. These forward-looking statements reflect the Company's views as of the date they
are made with respect to future events and financial performance, but are subject to many uncertainties and factors which may cause the actual results of the Company to be materially different from any future results expressed or implied by such forward-looking statements. Factors that could cause such a difference include, but are not limited to, (i) risks related to the failure to meet development and manufacturing milestones for the PHD System on a timely basis, (ii) risks related to the regulatory approval process, (iii) market, regulatory and reimbursement conditions, including without limitation patient/clinic acceptance of the PHD System, (iv) additional capital requirements with respect to among other things the commercialization of the PHD System, (v) changing assumptions with respect to projected unit pricing, product cost, gross margin and operating profit targets as identified in the business plan, which are as yet untested, (vi) risks inherent in relying on a third party to manufacture products, (vii) the impact of products which may be developed, adapted or may otherwise compete with the PHD System, (viii) changes in QSR requirements and (ix) other factors discussed elsewhere in this Annual Report on Form 10-K. Regulatory approval risks include, without limitation, whether and when we will obtain clearances similar to the FDA's clearance from other countries in which we may attempt to distribute the PHD System. Additional clinical trials and/or other data may be needed in order to obtain such regulatory clearances. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results or events expressed or implied therein will not be realized.
RESULTS OF OPERATIONS
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net loss for the year ended December 31, 2001 was $17.2 million ($0.94 per share), compared with $15.7 million ($0.93 per share), for the year ended December 31, 2000. During the fiscal year 2000, the Company recognized revenue of $3.4 million related to co-development of the PHD(R) System with Teijin Limited of Osaka, Japan. There was no such related joint development income in the fiscal year 2001.
Joint development income. On June 21, 1999, the Company entered into a - ------------------------ co-development and license agreement with Teijin. Under the terms of the agreement, Teijin paid $7.0 million to the Company for the right to manufacture and sell the PHD System in Japan. The Company is also entitled to future royalty payments from future product sales in Japan. Teijin also paid the Company a $7.0 million co-development fee relating to the PHD System. Use of the proceeds from the co-development fee is restricted to development costs incurred on the PHD System and may not be used for other general corporate purposes. Amounts paid under the co-development arrangement are recognized as revenue as development costs on the PHD System are incurred. The Company has recognized $3.4 million in 2000. There was no such related joint development income in the fiscal year 2001. The agreement was amended in 2000, concluding the recognition of revenue under the co-development agreement during 2000.
Research and development expenses. For the year ended December 31, 2001, - --------------------------------- research and development expenses decreased to $10.9 million from $14.5 million for the year ended December 31, 2000. The decrease of $3.6 million in 2001 was attributable to labor costs decreasing by approximately $1.1 million and the completion of many activities associated with the development of the PHD System.
Business development expenses. During 2001, business development expenses - ----------------------------- increased $0.8 million, from $1.0 million in 2000 to $1.8 million in 2001. The increase is primarily attributable to an increase in head count in 2001 related to planning for commercialization of the PHD System.
General and administrative expenses. For the year ended December 31, 2001, - ----------------------------------- general and administrative expenses increased $0.4 million to $5.1 million. The increase is primarily a result of additions to the senior management team during the middle of 2000 and a staff addition in the beginning of 2001.
Interest income. For the year ended December 31, 2001, interest income was $0.5 - --------------- million, compared with $1.2 million for the year ended December 31, 2000, a decrease of $0.7 million. The decrease is primarily attributable to lower interest rates on investments and the Company's use of cash and cash equivalents to fund operations during 2001.
RESULTS OF OPERATIONS
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Net loss for the year ended December 31, 2000 was $15.7 million ($0.93 per share), compared with $11.3 million ($0.76 per share), for the year ended December 31, 1999. The increase in net loss is attributable to one-time income of $7.0 million in 1999 related to the license of manufacturing and marketing rights to the PHD System in Japan to the Company's partner, Teijin Limited of Osaka, Japan, as discussed below.
Joint development income. On June 21, 1999, the Company entered into a - ------------------------ co-development and license agreement with Teijin. Under the terms of the agreement, Teijin paid $7.0 million to the Company for the right to manufacture and sell the PHD System in Japan. The Company is also entitled to future royalty payments from future product sales in Japan. The $7.0 million has been recognized as revenue in 1999. Teijin also paid the Company a $7.0 million co-development fee relating to the PHD System. Use of the proceeds from the co-development fee is restricted to development costs incurred on the PHD System and may not be used for other general corporate purposes. Amounts paid under the co-development arrangement are recognized as revenue as development costs on the PHD System are incurred. The Company has recognized $3.4 million and $2.6 million of revenue related to co-development of the PHD System in 2000 and 1999, respectively. The agreement was amended in 2000, and final revenue under the co-development agreement was recognized during 2000.
Research and development expenses. For the year ended December 31, 2000, - --------------------------------- research and development expenses decreased to $14.5 million from $15.9 million for the year ended December 31, 1999. The decrease of $1.4 million was primarily attributable to a one-time charge in 1999 of approximately $1 million. During 1999, the Company determined that the PHD Systems built for clinical trials, plus additional components to be used for the future manufacture of PHD Systems, would differ from the version of the PHD System that will eventually be commercialized, resulting in the one-time charge of approximately $1 million to write those assets down to a carrying value of zero.
Business development expenses. During 2000, business development expenses - ----------------------------- decreased $0.7 million, from $1.7 million in 1999 to $1.0 million in 2000. The decrease is primarily attributable to 1999 costs related to execution of the co-development and licensing agreement with Teijin.
General and administrative expenses. For the year ended December 31, 2000, - ----------------------------------- general and administrative expenses increased $0.5 million to $4.7 million. The increase is primarily a result of additions to the senior management team during the middle of 2000.
Interest income. For the year ended December 31, 2000, interest income was $1.2 - --------------- million, compared with $1.0 million for the year ended December 31, 1999, an increase of $0.2 million. The increase is primarily attributable to interest earned on the net proceeds from the Company's private equity financings in 2000, totaling $20.6 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations to date primarily through public and private sales of its equity securities. Through December 31, 2001, the Company had received net offering proceeds from public and private sales of equity securities of approximately $102.7 million. Since its inception in 1991 through December 31, 2001, the
Company made $6.9 million of capital expenditures and used $83.6 million in cash to support its operations. At December 31, 2001, the Company had cash and cash equivalents of $10.2 million, short-term investments of $1 million, working capital of $10.5 million and restricted long-term investments of $0.8 million. The Company believes that inflation generally has not had a material impact on its operations or liquidity to date.
On March 27, 2002, the Company announced receipt of FDA clearance to market the PHD System in the United States. The FDA clearance had no restrictions and included authorization to use the product in the home. Additional capital will be required to fund operations for a full-scale commercialization launch. It is the Company's plan to raise the additional capital required to fund full-scale commercial operations through public or private equity or debt financings. The additional capital required for full-scale commercialization may not be available with terms agreeable to the Company. In the event the Company cannot raise sufficient capital for a full-scale commercial launch, the Company believes that cash and short-term investments as of December 31, 2001 are sufficient to finance the Company's operations through December 31, 2002, under a scaled back commercial launch.
Generally, the Company expects U.S. customers to purchase PHD Systems and enter into contracts whereby the Company will provide all products and services related to the PHD Systems for a single monthly price, which would include all consumables, service and product support. As an alternative, U.S. customers may enter into lease agreements for the PHD Systems, under which the single monthly price would also include a lease payment. The Company's present commercialization plan for markets outside of the United States is to develop a partnership in those markets to distribute the PHD System and related consumables and services. Financing production of the PHD System in quantities necessary for commercialization will require a significant investment in working capital. This need for working capital is likely to increase to the extent that demand for the PHD System increases. The Company would, therefore, have to rely on sources of capital beyond cash generated from operations to finance production of the PHD System even if the Company were successful in marketing its products and services.
The Company currently intends to finance the working capital requirements associated with these arrangements through the equity or debt financings to achieve its business objectives. The Company has not yet obtained a commitment for any such financings, and there can be no assurance that the Company will be able to obtain financing on acceptable terms or at all.
The Company's funding needs will depend on many factors, including the timing and costs associated with continued progress in research and development, the results of clinical studies, manufacturing scale-up, the cost involved in filing and enforcing patent claims and the status of competitive products. In the event that the Company's plans change, its assumptions change or prove inaccurate or it is unable to obtain production financing on commercially reasonable terms, the Company could be required to seek additional financing sooner than currently anticipated. In addition, in the future the Company will require substantial additional financing to fund full-scale production and marketing of the PHD System and related services. The Company has no current arrangements with respect to sources of additional financing.
The Company has not generated taxable income to date. At December 31, 2001, the net operating losses available to offset future taxable income were approximately $96.8 million. Because the Company has experienced ownership changes, future utilization of the carryforwards may be limited in any one fiscal year pursuant to Internal Revenue Code regulations. The carryforwards expire at various dates beginning in 2012. As a result of the annual limitation, a portion of these carryforwards may expire before ultimately becoming available to reduce federal income tax liabilities.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (FAS 141), Business Combinations, which supercedes Accounting Principles Board Opinion No. 16, Business Combinations, and Statement of Financial Accounting Standards No. 38, Accounting for Pre-acquisition Contingencies of Purchased Enterprises. This statement establishes financial accounting and reporting standards for
business combinations. The provisions of this statement are required to be applied to all business combinations initiated after June 30, 2001. Management does not expect there will be a material impact of adopting the provision of FAS 141.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 (FAS 142), Goodwill and Other Intangible Assets, which supercedes Accounting Principles Board Opinion No. 17, Intangible Assets, and establishes financial accounting and reporting standards for intangible assets acquired individually or with a group of other assets at acquisition. This Statement addresses financial accounting and reporting for goodwill and other intangible assets subsequent to their acquisition. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. Management does not expect there will be a material impact of adopting the provisions of FAS 142.
In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144 (FAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supercedes Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. Management does not expect there will be a material impact of adopting the provisions of FAS 144.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The investments of the Company have been made for investment (as opposed to trading) purposes. Interest rate risk with respect to the investments of the Company is not significant as substantially all of such investments are in U.S. dollar cash equivalents and short-term investments (with maturities of less than 12 months), which are by their nature less sensitive to interest rate movements. The investments of the Company are generally made in U.S. government and federal agency bonds and high-grade commercial paper and corporate bonds.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Balance Sheets as of December 31, 2001 and 2000, and the Consolidated Statements of Operations, Stockholders' Equity and Cash Flows for the years ended December 31, 2001, 2000 and 1999 and for the period from January 18, 1991 (inception) through December 31, 2001, the Notes to the Consolidated Financial Statements and the Independent Auditors' Report set forth on pages 7 through 20 of the 2001 Annual Report to Stockholders of the Company are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information with respect to the Directors of the Company is set forth in the Proxy Statement under the heading "Election of Directors," which information is incorporated herein by reference. Information regarding the executive officers is set forth above in Part I under "Business - Executive Officers ." Information required by Item 405 of
Regulation S-K is set forth in the Proxy Statement under the heading "Section 16 (a) Beneficial Ownership Reporting Compliance," which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information with respect to executive compensation is set forth in the Proxy Statement under the heading "Compensation of Executive Officers," which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information with respect to security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the heading "Beneficial Ownership of Common Stock," which information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements:
1. Financial Statements.
The Consolidated Balance Sheets as of December 31, 2001 and 2000, and the Consolidated Statements of Operations, Stockholders' Equity and Cash Flows for the years ended December 31, 2001, 2000 and 1999 and for the period from January 18, 1991 (inception) through December 31, 2001, the Notes to the Consolidated Financial Statements and the Independent Auditors' Report set forth on pages 7 through 20 of the 2001 Annual Report to Stockholders of the Company are incorporated herein by reference.
2. Financial Statement Schedules.
None.
(b) Reports on Form 8-K.
None.
(c ) Exhibits.
See "Exhibits Index" below.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 28th day of March, 2002.
AKSYS, LTD.
By /s/ William C. Dow ------------------------------------------------ William C. Dow President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on this 28th day of March, 2002.
Signature Capacity --------- --------
/s/ William C. Dow President, Chief Executive Officer and - --------------------------------- Director (Principal Executive Officer and William C. Dow Interim Principal Financial Officer)
/s/ Richard B. Egen Chairman of the Board of Directors - --------------------------------- Richard B. Egen
/s/ Peter H. McNerney Director - --------------------------------- Peter H. McNerney
/s/ W. Dekle Rountree, Jr. Director - --------------------------------- Dekle Rountree, Jr.
/s/ Bernard R. Tresnowski Director - --------------------------------- Berrnard R. Tresnowski
/s/ Alan R. Meyer Director - --------------------------------- Alan R. Meyer
AKSYS, LTD. EXHIBIT INDEX
/(1)/ Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration No.333-2492). /(2)/ Incorporated by reference to the Company's Current Report on Form 8-K, filed on April 19, 2000. /(3)/ Incorporated by reference to the Company's Current Report on Form 8-K, filed on August 21, 2000.
/(4)/ Incorporated by reference to the Company's Current Report on Form 8-K, filed on December 21, 2001. /(5)/ Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. /(6)/ Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1999. /(7)/ Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001. /(8)/ Incorporated by reference to the Company's Proxy Statement for its 2001 Annual Meeting of Stockholders. /(9)/ Filed herewith.