| AKSYS LTD Item 1A Risk Factors |
| You should carefully consider the risks and uncertainties described below before investing |
| If any of the following risks actually occur, our business, financial condition, or results of operations would likely suffer |
| In that case, the market price of the common stock could fall, and you may lose all or part of the money you paid to buy such common stock |
| Also consider carefully the statements under the heading “Note on Forward-Looking Information” below |
| You should be prepared to accept the occurrence of any and all of the risks associated with purchasing our commons stock, including a loss of all of your investment |
| Risks Related to Our Business As a result of our transaction with the Durus fund and the Durus fund’s current ownership position in our common and preferred stock, persons other than the Durus fund who own our common stock will own a minority of our common stock and will not be able to exercise voting control over most matters put to a vote of stockholders |
| On March 31, 2006 we executed definitive agreements for a financing transaction with the Durus fund |
| These documents included an amendment to our existing settlement agreement with the Durus fund and Artal Long Biotech Portfolio LLC (the “Artal fund”) to release the Durus fund and the Artal fund from standstill and other restrictive covenants, including elimination of the requirement for the Durus fund to reduce its ownership in our common stock to 15prca by May 2006 and the requirement that, on matters requiring the vote of the Company’s stockholders, the Durus fund and the Artal fund vote their shares of the Company’s common stock in proportion to the votes cast by all other holders of the Company’s common stock |
| By releasing the Durus fund from these restrictions, the Durus fund is no longer prohibited from acquiring our securities or making any solicitation of proxies to vote our shares |
| In addition, we took actions to amend our shareholder rights agreement so that it will not be applicable to the Durus fund or the transactions with the Durus fund and to eliminate our shareholder rights outstanding under our rights agreement |
| Stockholders other than the Durus fund own a minority of our outstanding shares of common stock |
| After giving effect to the financing transaction, the Durus fund’s ownership position and representation on the board of directors will entitle the Durus fund to exercise control over most matters put to a vote of our board of directors and our stockholders |
| The Durus fund will be in a position to control the election of our directors, determine our corporate and management policies and to determine, without the consent of our other stockholders, the outcome of any corporate transaction or other matter submitted to our stockholders for approval, including exercising its voting control to prevent a sale or merger transaction in which stockholders could receive a premium for their shares |
| In addition, the Durus fund also has sufficient voting power to amend our organizational documents |
| The Durus fund’s interests may not coincide with the interests of other holders of our common stock |
| The Durus fund is in the business of making investments in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us |
| The Durus fund may pursue, for its own account, acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us |
| Such concentration of ownership could also have the effect of delaying, deterring or preventing a change in control of the Company that might otherwise be beneficial to minority stockholders and may also discourage acquisition bids for the Company and limit the amount certain investors may be willing to pay for shares of our common stock |
| 22 ______________________________________________________________________ We require additional capital to operate our business which, if not available to us, may prevent our ability to continue operations and which, if raised, will dilute stockholder ownership interest in us or otherwise reduce the value of our common stock |
| Our capital requirements have been and will continue to be significant |
| To date, we have raised approximately dlra152 million from equity offerings and have received approximately dlra53dtta7 million in payments and financings from the Durus fund, approximately dlra48dtta7 million as part of the original settlement in 2004 and dlra5dtta0 million on March 31, 2006 in the form of a short term loan |
| Our capital requirements will depend on many factors, including without limitation: · the cost of servicing and supporting PHD Systems in use; · manufacturing and associated costs; · costs associated with marketing, distribution, patient training and technical and patient support networks; · continued progress in research and development; and · the costs involved with protecting our proprietary rights |
| During 2006, we expect to use approximately dlra16 to dlra18 million in our operations including service and support of the PHD Systems being used by patients today |
| Resources will also be directed toward using the PHD System’s platform technology to develop our next generation product |
| We believe our cash and liquid investments (including the receivable for the settlement of the sale of long-term investment securities) at December 31, 2005, combined with expected proceeds from the Durus fund financing, are only sufficient to finance our operations into 2007 |
| In 2006, we will seek to raise the additional capital required to fund commercial activities in 2007 |
| We received a letter dated as of March 31, 2006, in which the Durus fund stated its intention, and confirmed its ability, to provide financing necessary to fund our operations at least through January 1, 2007 |
| However, this letter does not represent a legally binding commitment of the Durus fund to provide the Company with any financing, and the letter further provides that there are no third party beneficiaries to the letter |
| Any additional capital that we are able to raise through additional issuances of our equity securities may result in substantial dilution to our then existing stockholders, and any debt financing we may be able to obtain could result in the imposition of significant financial and operational restrictions on us |
| Should the financing we require to sustain our working capital needs be unavailable or prohibitively expensive when we require it, our business, operating results, financial condition and prospects could be materially and adversely effected |
| Customers, suppliers and other third parties may not do business with us, may terminate business relationships with us or may not extend business relationships |
| Due to our capital constraints, vendors and other third parties may decide not to conduct business with us, or may conduct business with us only on a cash basis and on other terms that are less favorable than those customarily extended by them |
| In that event, our costs may increase |
| In addition, our capital constraints may make it difficult for us to market the PHD System and related services to current and prospective customers |
| If we are unable to maintain relationships with existing clinics and/or develop relationships with new clinics, our future revenues will likely decrease |
| 23 ______________________________________________________________________ We currently rely on a few key customers for a significant portion of our sales |
| We currently derive, and expect to continue to derive, a substantial percentage of our net sales from fewer than ten customers |
| A loss of one or more of those customers could cause a significant decrease in our net revenue |
| Our largest customers, DaVita, the Dialysis Centers of Lincoln and Northwest Kidney Center accounted for 16prca, 11prca and 8prca, respectively, of our revenues (by dollar volume) for fiscal year 2005 |
| For fiscal year 2004, our largest customers, Northwest Kidney Center, the Dialysis Centers of Lincoln and Berkshire Medical Center accounted for 24prca, 10prca and 9prca, respectively, of its total revenue |
| The amount of revenue we derive from a specific customer is likely to vary from period to period, and a major customer in one period may not produce significant additional revenue in a subsequent period |
| We anticipate that our operating results will continue to depend on sales to a small number of key customers in the foreseeable future |
| Loss of a significant amount of business from any of our large customers could have a material adverse effect on our results of operations and financial condition if such business were not substantially replaced by additional business from existing or new customers |
| Additionally, our results of operations and financial condition could be materially adversely affected if any of our large customers experience financial difficulties that cause them to delay, or fail to make, payments for goods sold or leased to them |
| If our current manufacturing agreement with Delphi Medical Systems Corporation (“Delphi”) is terminated and we are required to establish new manufacturing or parts sourcing relationships, we may experience increased costs, disruptions in the manufacture and shipment of PHD Systems and a loss of revenue |
| The PHD System is manufactured by Delphi |
| On October 8, 2005, Delphi and its parent corporation filed a voluntary petition for business reorganization under Chapter 11 of the US Bankruptcy Code |
| The ultimate effect of the bankruptcy on our relationship with Delphi is unclear |
| We have a Uniform Commercial Code financing statement on file with the Colorado Secretary of State with respect to certain component inventory located at Delphi’s warehouses |
| In addition, as of December 31, 2005, we had a cash deposit in the amount of dlra1cmam432cmam000 with Delphi as security for certain of our purchase obligations |
| We have recorded a reserve to reflect the uncertainty associated with the bankruptcy filing; however, we are pursuing the full value of the deposit |
| We have had ongoing discussions with Delphi regarding our accounts payable balance, our deposit and certain parts inventory located at Delphi’s warehouses |
| In the first quarter of 2006, we received correspondence from Delphi advising us of their decision to stop further shipments of PHD Systems and parts until these items have been resolved |
| We plan to continue our discussions with Delphi and believe that we have a sufficient inventory of parts and machines on hand to enable us to continue operations pending resolution of this matter |
| If Delphi rejects our manufacturing agreement in connection with its bankruptcy proceeding or we are unable to settle open issues with Delphi on a timely basis, we would be forced to establish new manufacturing and/or direct parts sourcing relationships which could expose us to a number of risks and uncertainties |
| These risks and uncertainties could include whether the new manufacturer(s) and parts suppliers will agree to do business with us on satisfactory terms as well as whether such manufactures(s) and parts suppliers will perform to our expectations and produce the PHD System and supply parts in a timely, cost-efficient manner on a consistent basis and in accordance with all regulatory requirements including QSRs |
| Any of these risks could make it difficult for us to produce the PHD System on satisfactory commercial terms, if at all |
| We have a history of operating losses and a significant accumulated deficit, and we may not achieve or maintain profitability in the future |
| We have not been profitable since our inception in January 1991 |
| As of December 31, 2005, we had an accumulated deficit of approximately dlra190dtta8 million |
| We expect to continue to incur additional losses for the foreseeable future as a result of a high level of operating expenses, significant up-front expenditures, production and marketing activities and very limited revenue from our core business |
| We may never realize 24 ______________________________________________________________________ significant revenues from our core business or be profitable |
| Factors that will influence the timing and amount of our profitability include: · the success of the product development efforts under the DEKA Agreement; · our ability to obtain sufficient financing to operate our business; · market acceptance of the PHD System; · our success in commercializing the PHD System; · our ability to effectively and efficiently manufacture, market and distribute the PHD System; and · our ability to sell or lease the PHD System and related services at a price that covers our per unit costs, which result may be difficult to achieve, in part because of the significant restrictions on the reimbursement of dialysis treatment by the Medicare program, as discussed below, and the high cost of manufacturing the PHD System |
| We face significant challenges in shifting from the development stage to the commercialization stage for the PHD System |
| Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered in such a transition, and there can be no assurance that we will have any significant revenues or that we will ever achieve profitable operations |
| Our cost to produce the PHD System and deliver related services and supplies currently exceeds the market price of the PHD System and related services and supplies |
| The pricing of the PHD System and related services and supplies is constrained by limitations on governmental and third party reimbursement programs |
| Although we are working to reduce the cost of servicing the machine and we are attempting to reduce manufacturing costs by identifying alternative materials and suppliers, there can be no assurance that these efforts will enable us to achieve profitable operations |
| In addition, the cost of services and supplies for the PHD System currently exceeds the market price as a result of the need to have a local presence of field service and clinical service personnel in each geographical area that PHD Systems are sold |
| Furthermore, the PHD System is comprised of new, complex, highly automated technologies, which operate in a rigorous process |
| While we continue to realize improvements in the PHD System’s reliability as a result of the acquisition and development of new parts and subsystems, there can be no assurance that we will be successful in reaching industry norms for reliability |
| If we are unable to improve the reliability of the PHD System, our operating costs will be adversely impacted and we may never achieve profitability as a result |
| If a PHD System is unavailable for treatments for more than a few days, the patient assigned to the machine must go back to his dialysis clinic for in-center treatment until his PHD System is repaired |
| Although we have experienced infrequent incidents of patients on the PHD System needing to go back in center for treatments to date, we cannot assure you, based on our limited experience that such incidents will not occur more frequently in the future |
| Our business will fail if we cannot successfully commercialize the PHD System; because we have only recently begun this commercialization process, our success cannot be predicted and is uncertain |
| Our success is dependent on many variables entirely outside of our control |
| Acceptance of the PHD System in the marketplace by both potential users and purchasers (two separate groups with at times conflicting interests) is uncertain, and failure to achieve sufficient market acceptance will significantly limit our ability to generate revenue and become profitable |
| The success of the PHD System is dependent on many variables, including its safety, price, reliability, effectiveness and 25 ______________________________________________________________________ cost-effectiveness as an alternative dialysis modality |
| The failure to conclusively demonstrate each of these factors could significantly hinder market acceptance of our PHD System, and the failure of our PHD System to achieve sustained commercial viability or market acceptance would have a material adverse effect on us and your investment in us |
| Moreover, successful commercialization will depend upon, among other things, market acceptance of the efficacy of daily hemodialysis |
| This will require substantial marketing efforts and the expenditure of significant funds by us to inform nephrologists, dialysis clinics, other healthcare providers and dialysis patients of the benefits of daily hemodialysis, and thus the benefits of the PHD System |
| In marketing the PHD System, we may encounter significant clinical and market resistance to: · using the PHD System; · home hemodialysis, which is currently employed by only a small percentage of patients suffering from end-stage renal disease; and · daily hemodialysis, which to our knowledge has never been a widely implemented dialysis alternative |
| There can be no assurance that our efforts will be successful or that the PHD System will ever achieve market acceptance |
| In addition, the PHD System is a personal system, designed for use by a single patient, and requires several hours after a dialysis treatment to prepare itself for the next treatment session |
| As such, it is very unlikely to be used in the prevailing method of outpatient hemodialysis, which generally involves treating patients three times per week for treatment sessions lasting between three and four hours |
| In this prevailing method of hemodialysis, patients receiving treatment on a given day are treated in shifts, with patients on succeeding shifts using dialysis machines employed during prior shifts |
| A number of other factors will affect the future success and sales of our product |
| These factors include: · the amount of government and private reimbursement for dialysis treatment; · whether the system will be safe or effective or whether it will be cost-effective relative to other dialysis treatment alternatives; · whether daily hemodialysis will be shown to be more clinically effective than alternative dialysis modalities; · whether patients will be reluctant to administer and monitor the PHD System with limited or no supervision; and · whether there are unexpected side effects, complications or other safety issues associated with daily hemodialysis (or the PHD System) that may adversely affect the market for our products and services |
| We are entirely dependent on the PHD System, our sole product |
| Since our inception, we have devoted substantially all of our efforts to the development of the PHD System |
| We expect to be entirely dependent for the foreseeable future on sales of, and services relating to, the PHD System for revenues |
| Our dependence on a single product creates significant risk for our company and stockholders |
| 26 ______________________________________________________________________ Our strategy to develop a new generation of our product under the DEKA Agreement involves a number of risks and uncertainties |
| Our strategy for development of a new generation of our product depends upon the success of the DEKA Agreement |
| The ultimate success of the development efforts under the DEKA Agreement is subject to a number of cost, timing and other risks and uncertainties, many of which are outside of our control |
| We cannot be certain that the DEKA Agreement will be successful or that any product will ultimately be developed under this agreement |
| Uncertainty and amount of third-party reimbursement could affect our profitability |
| Although most private insurance policies cover a substantial portion of the cost of dialysis treatment in the United States, most patients receiving dialysis treatment in the United States are insured by Medicare or Medicaid |
| Medicare and Medicaid provide reimbursement for dialysis treatment at set composite rates, which have not increased significantly since 1983 |
| There can be no assurance that the current limitations or requirements on Medicare and Medicaid reimbursement for dialysis will not have a materially adverse effect on the market for the PHD System, that health administration authorities outside of the United States will provide reimbursement at acceptable levels or at all or that current or future reimbursement rates will be sufficient to enable us to maintain prices at levels sufficient to become profitable |
| Competitors and technological advances could cause us to lose current and future business opportunities and materially harm our results of operations and ability to grow |
| The dialysis industry is characterized by competition for financing, executive talent, intellectual property, and, ultimately, product sales |
| Our primary competitors in supplying dialysis equipment, disposables, and services are Fresenius Medical Care AG, Baxter International, Inc, and Gambro AB These competitors have more financial, scientific, and technical resources than do we, as well as more experience with respect to manufacturing, product development, and marketing in the dialysis market |
| We also compete with NxStage Medical, Inc |
| If our competitors succeed in developing products that are more effective and/or less costly than the PHD System for performing more frequent home hemodialysis, both our sales and our prospects for achieving profitability may be adversely impacted |
| We also expect that the number of our competitors will increase, and there can be no assurance that we will be able to compete successfully against any competitor |
| Our ability to successfully market our products and services could be adversely impacted by pharmacological and technological advances in preventing the progression of ESRD in patients (such as those with diabetes and hypertension), technological developments by others, 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 |
| Furthermore, although home hemodialysis treatment options are available, adoption has been limited |
| The most widely adopted form of dialysis therapy used in a setting other than a dialysis clinic is peritoneal dialysis |
| Because the adoption of home hemodialysis has been limited to date, the number of patients who desire to, and are capable of, administering their own hemodialysis treatment is unknown and there is limited data upon which to make estimates |
| Our long-term growth will depend on the number of patients who adopt home-based hemodialysis and how quickly they adopt it |
| We cannot be certain that this market will develop, how quickly it will develop or how large it will be |
| Our future sales could be adversely affected due to our limited marketing experience |
| We currently market our products and services primarily through our own sales force |
| There can be no assurance that we will be able to staff an adequate marketing staff or sales force or that the cost of such 27 ______________________________________________________________________ will not be prohibitive, or that our direct sales and marketing efforts will be successful |
| The choice of dialysis therapy involves the successful marketing to dialysis clinic operators and nurses, nephrologists and patients, each of which may have different factors that they consider in making their decision |
| Ineffective marketing to any one of these decision makers may adversely affect acceptance of the PHD System |
| We may have difficulty in gaining acceptance of the PHD System for a number of factors including: · the failure by us to demonstrate to patients, operators of dialysis clinics, nephrologists, dialysis nurses and others that our product is equivalent or superior to existing therapy options, or that the cost or risk associated with use of our product is not greater than available alternatives; · competition from products sold by companies with longer operating histories and greater financial resources, more recognizable brand names and better established distribution networks and relationships with dialysis clinics; · the ownership and operation of some dialysis providers by companies that also manufacture and sell competitive dialysis products; · the introduction of competing products or treatments that may be more effective, safer, easier to use or less expensive than ours; · the number of patients willing and able to perform therapy independently, outside of a traditional dialysis clinic, may be smaller than we estimate; and · the continued availability of satisfactory reimbursement from healthcare payers, including Medicare |
| We are subject to extensive government regulation, which can be costly, time consuming and subject us to unanticipated interruptions or delays in our commercial operations |
| The PHD System, our sole product, is subject to stringent government regulation in the United States and other countries |
| In the United States, the PHD System is regulated as a medical device by the FDA In March 2002, we announced receipt of clearance from the FDA 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; however, FDA clearance under 510(k) is subject to continual review and later discovery of previously unknown problems may result in restrictions on product marketing or withdrawal of the product from the market |
| In the European Economic Area, the PHD System is regulated as a medical device under the Medical Device Directive |
| In October 2002, we announced receipt of EC Certification for CE Mark approval pursuant to the Medical Device Directive |
| The certification approved the PHD System for home use |
| Such approval was required prior to the commercialization of the PHD System in the European Economic Area |
| Additional government regulations may be established or imposed in the United States or the European Economic Area, or the interpretation or enforcement of such regulations may change, which could materially impact the regulatory clearances we have received for the PHD System and its continued commercialization |
| In addition, various statutes and regulations also govern the testing, labeling, storage, record keeping, distribution, sale, marketing, advertising and promotion of our products, which present significant compliance burdens for our company |
| Failure to comply with applicable requirements can result in fines, recalls or seizures of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution |
| The manufacture of the PHD System must also comply or ensure compliance with current QSR regulations promulgated by the FDA We may be required to expend time, resources and effort in product 28 ______________________________________________________________________ manufacturing and quality control to ensure compliance even though our PHD System is manufactured currently by an independent contractor |
| If violations of the applicable regulations are noted during FDA inspections of manufacturing facilities, it may have a material adverse effect on the continued marketing of our products |
| You should also be aware that proper regulatory approvals have not been completed in any jurisdictions other than the United States and the European Economic Area |
| There can be no assurance or guarantee that any of these approvals will be obtained in a timely manner or at all |
| We rely on independent contract manufacturers for the manufacture of our PHD System |
| Our inability to manufacture the PHD System, and our dependence on independent contractors, may delay or impair our ability to generate revenues, or adversely affect our profitability |
| To be successful, our PHD System must be manufactured in commercial quantities and at acceptable cost |
| Production of this product, especially in commercial quantities, will create technical as well as financial challenges for us |
| We may encounter unexpected delays or costs in the scale-up of manufacturing operations |
| Further, manufacturing or quality control problems may arise (and among other things increase our costs) as we increase production of the PHD System or as additional manufacturing capacity is required in the future |
| We currently rely on single contract manufacturers to manufacture each of the major components of the PHD System |
| Such contractors are not employed or otherwise controlled by us and are generally free to conduct their business at their own discretion |
| Although certain of our contract manufacturers have entered into contracts with us to manufacture components of the PHD System, such contracts can be terminated at any time under certain circumstances by us or by the contractors, and can be breached at any time |
| Further, work stoppages and the slowing of production at a single independent contractor would have a material adverse effect on our results of operations |
| There are also other risks inherent in using a single source of supply |
| We have not made alternative arrangements for the manufacture of the major components of the PHD System and we may not be able to implement acceptable alternative arrangements on a timely basis, or at all |
| It is likely that a significant interruption in supply would result if we utilize or were required to utilize a different manufacturing contractor for any of the major components of PHD Systems |
| The loss of the services of any of our contract manufacturers would have a materially adverse effect on our results of operations |
| See “Risk Factors—If our current manufacturing agreement with Delphi is terminated and we are required to establish new manufacturing relationships, we may experience increased costs, disruptions in the manufacture and shipment of the PHD System and a loss of revenue |
| ” In addition, we or our manufacturers may not be able to obtain, on a timely basis, components or other supplies necessary to manufacture or use the PHD System |
| We may not be able to protect our intellectual property rights and, as a result, we could lose competitive advantages that could adversely affect our operating results |
| Our success depends, in part, on our ability and the ability of our licensors to obtain, assert and defend patent rights, protect trade secrets and operate without infringing the proprietary rights of others |
| We currently own or have rights in relevant fields to 47 US patents and 26 foreign patents |
| There can be no assurance, however, that: · we will be able to obtain additional licenses to patents of others or that we will be able to develop additional patentable technology of our own; · any patents issued to us will provide us with competitive advantages or that the patents or proprietary rights of others will not have an adverse effect on our ability to do business; 29 ______________________________________________________________________ · others will not independently develop similar products; · others will not design around or infringe such patents or proprietary rights owned by or licensed to us; and · any patent obtained or licensed by us will be held to be valid and enforceable if challenged by another party |
| We are aware that numerous patents have been issued relating to methods of dialysis |
| Although we endeavor to protect our patent rights from infringement, it is possible that by virtue of the numerous patents that have been, or potentially will be, issued relating to hemodialysis methods, we may not be aware, or become aware, of patents issued to our competitors or others that conflict with our own or those of our licensors |
| Such conflicts could result in a rejection of important patent applications or the invalidation of important patents, which could have a material adverse effect on our competitive position |
| In the event of such conflicts, or in the event we believe that competitive products infringe patents to which we hold rights, we may pursue patent infringement litigation or interference proceedings against, or may be required to defend against such litigation or proceedings involving, holders of such conflicting patents or competing products |
| Such litigation or proceedings may have a material adverse effect on our competitive position, and we may not be successful in any such litigation or proceeding |
| Litigation and other proceedings relating to patent matters, whether initiated by us or a third party, can be expensive and time consuming, regardless of whether the outcome is favorable to us, and can result in the diversion of substantial financial, managerial and other resources |
| An adverse outcome could subject us to significant liabilities to third parties or require us to cease any related development or commercialization activities |
| In addition, if patents that contain dominating or conflicting claims have been or are subsequently issued to others and such claims are ultimately determined to be valid, we may be required to obtain licenses under patents or other proprietary rights of others |
| The licenses required under any such patents or proprietary rights may not be made available on terms acceptable to us, if at all |
| If we do not obtain such licenses, we could encounter delays or could find that the development, manufacture or sale of products requiring such licenses is foreclosed which may adversely affect our results of operations |
| We rely on proprietary know-how and confidential information and employ various methods, such as entering into confidentiality and noncompete agreements with our current employees and with certain third parties to whom we have divulged proprietary information, to protect the processes, concepts, ideas and documentation associated with our technologies |
| Such methods may not afford significant protection to us, and we may not be able to protect adequately our trade secrets or our competitors or other companies may acquire information that we consider proprietary |
| Product liability claims may reduce demand for the PHD System or result in damages that exceed our insurance coverage |
| Our business exposes us to potential product liability risks that are inherent in the production, marketing and sale of dialysis products |
| We currently maintain product liability insurance with a coverage limit of dlra10 million |
| Our insurance policy may not provide adequate protection against potential claims |
| Furthermore, our agreements with contract manufacturers require us to maintain product liability insurance, and the failure to obtain such insurance could materially and adversely affect our ability to produce our PHD System |
| A successful claim brought against us in excess of any insurance coverage obtained by us could have a material adverse effect upon our business, financial condition and results of operations |
| In addition, we have agreed to indemnify certain of our contract manufacturers against certain liabilities resulting from the use of our PHD System |
| 30 ______________________________________________________________________ Our recent cost reduction initiatives may make it difficult for us to retain and hire critical personnel |
| We are dependent upon the services of our senior executives and key scientific personnel |
| We do not maintain key-man life insurance on our senior executives |
| In addition, we do not have employment agreements, other than certain severance, confidentiality and non-competition agreements, with any of our personnel |
| Our business would likely be interrupted if we lost the services of our senior executives or key employees, which could have a material adverse effect on operations |
| Also, our continued commercialization will depend upon, among other things, the successful recruiting and retention of highly skilled managerial and marketing personnel with experience in business activities such as those we contemplate |
| Competition for the type of highly skilled individuals sought by us is intense, and we may not be able to retain existing employees or find, attract and retain other skilled personnel on acceptable terms |
| Our recent cost reduction initiatives may make it difficult to retain critical personnel or replace personnel who leave |
| In addition, due to the declines in the price of our common stock, the exercise price of outstanding employee stock options substantially exceeds the trading price of our common stock |
| These factors may affect our ability to retain critical employees, which could seriously harm our ability to generate revenue, manage day-to-day operations, and deliver our products and services |
| If we cannot develop adequate distribution, customer service and technical support networks, we may not be able to market and distribute our PHD System effectively |
| Our strategy involves contracting with dialysis providers to have us supply to dialysis patients the PHD System, dialysate and other consumables, patient training, customer service and maintenance and other technical service |
| There can be no assurance that we will be able to organize these networks on a cost-effective basis |
| The failure to establish these networks on a cost-effective basis would have a material adverse effect on our results of operations |
| We may not realize any of the anticipated benefits from our more focused resource allocation |
| On December 6, 2005, we announced a plan to realign our service network by designating geographic operating districts which have shown the highest adoption rates of the PHD System |
| The plan includes several operational changes designed to significantly reduce our cash burn rate and provide a more focused resource allocation |
| We are focusing our sales and servicing efforts on these target markets |
| While our decision to realign our operating model through the designation of PHD Operating Districts may strengthen our relationships with patients and clinics in designated areas, it may adversely affect our relationships outside of those areas |
| We cannot assure you that as a result of this reallocation our losses will decrease or we will achieve any particular patient count or revenue level |
| Our patient count and revenue level may decline in the near term due to attrition in areas outside of our PHD Operating Districts |
| Risks Related to Our Common Stock Our common stock has been delisted from the Nasdaq National Market and could be delisted from the Nasdaq Capital Market |
| On November 14, 2005, we received a letter from the Nasdaq noting that we had failed to comply with the minimum dlra10 million of stockholders’ equity required by Marketplace Rule 4450(a), Maintenance Standard 1 and the alternative listing requirements of Marketplace Rule 4450(b), Maintenance Standard 2 relating to market value of listed securities (and related assets and revenue tests) and market value of publicly held shares |
| On December 16, 2005, we were notified by the Nasdaq that for the last 30 consecutive business days the bid price of our common stock has closed below the minimum dlra1dtta00 per share required by Marketplace Rule 4450(a)(5) |
| On December 27, 2005, we received a letter from the 31 ______________________________________________________________________ Nasdaq denying our request for continued listing on the Nasdaq National Market |
| In response to this letter, on December 30, 2005, we requested a hearing before the Nasdaq Listing Qualifications Panel to review the Nasdaq staff’s determination |
| We subsequently received notification from the Nasdaq Listing Qualifications Panel that our common stock would be delisted from the Nasdaq National Market and would begin trading on the Nasdaq Capital Market on February 14, 2006 |
| The Nasdaq Capital Market has its own standards for continued listing, including Marketplace Rule 4310(c)(2)(B), which requires us to have a minimum of dlra2cmam500cmam000 in stockholders’ equity or dlra35cmam000cmam000 market value of listed securities or dlra500cmam000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently completed fiscal years |
| In addition, continued listing on the Nasdaq Capital Market requires satisfying the dlra1dtta00 minimum closing bid price imposed by Marketplace Rule 4450(a)(5) |
| There can be no assurance that we will sustain compliance with these standards |
| In particular, we do not currently have a minimum of dlra2cmam500cmam000 in stockholders’ equity and we did not have dlra500cmam000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently completed fiscal years, but the current market value of our listed securities does exceed dlra35cmam000cmam000 |
| In the event we cannot sustain compliance with the Nasdaq Capital Market’s listing standards, our common stock will be delisted from the Nasdaq Capital Market and we may be unable to list our common stock on another stock exchange or quotation service |
| Such a delisting may make it difficult or impossible for stockholders to sell their shares, for us to issue additional securities and for us to obtain additional financing in the future |
| A delisting may also result in a more limited amount of news and analyst coverage for our Company and could have a material adverse effect on the market price of our common stock |
| If our common stock becomes a “penny stock” you may find it difficult to resell shares |
| Generally, a “penny stock” is a common stock that is not listed on a securities exchange and trades for less than dlra5dtta00 a share |
| Prices often are not available to buyers and sellers and the market may be very limited |
| Penny stocks in start-up companies are among the riskiest equity investments |
| Broker-dealers who sell penny stocks must provide purchasers of these stocks with a standardized risk-disclosure document prepared by the Securities and Exchange Commission |
| The document provides information about penny stocks and the nature and level of risks involved in investing in the penny stock market |
| A broker must also give a purchaser, orally or in writing, bid and offer quotations and information regarding broker and salesperson compensation, make a written determination that the penny stock is a suitable investment for the purchaser, and obtain the purchaser’s written agreement to the purchase |
| Many brokers choose not to participate in penny stock transactions |
| If our common stock is delisted from the Nasdaq Capital Market and we are unable to satisfy certain other financial tests we will be classified as a “penny stock” as that term is defined under Rule 3a51-1 of the Securities Exchange Act of 1934 |
| Because of the penny stock rules, there is less trading activity in penny stock, and consequently you may have difficulty selling your shares |
| Our common stock is thinly traded, so you may be unable to sell at or near ask price or at all if you need to liquidate your shares |
| Our common shares have historically been sporadically or “thinly-traded” on the Nasdaq Capital Market and the Nasdaq National Market (prior to our delisting from the Nasdaq National Market), meaning that the number of persons interested in purchasing our common shares at or near ask prices at any given time may be relatively small or non-existent |
| As of December 31, 2005, our average trading volume per day for the past three months was approximately 57cmam932 shares a day with a high of 425cmam322 shares traded and a low of 1cmam775 shares traded |
| This situation is attributable to a number of factors, including the fact that we are a small company which is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume, and 32 ______________________________________________________________________ that even if we came to the attention of such persons, they tend to be risk-averse and would be reluctant to follow an unproven company such as ours or purchase or recommend the purchase of our shares until such time as we became more seasoned and viable |
| As a consequence, there may be periods of several days or more when trading activity in our shares is low, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price |
| We cannot give you any assurance that a broader or more active public trading market for our common shares will develop or be sustained, or that current trading levels will be sustained |
| The market price of our common stock may be subject to significant volatility |
| The price of our common stock may fluctuate widely depending upon many factors, including our perceived prospects and those of the dialysis market in general |
| Since our initial public offering in May 1996, our common stock price has traded between dlra0dtta52 and dlra23dtta50 per share and we have generally experienced relatively low trading volume in relation to the aggregate number of shares outstanding |
| Factors that may have a significant impact on the market price or liquidity of our common stock include: · reports by official or unofficial health or medical authorities, the general media or the FDA regarding the potential benefits or detriments of our PHD System or of similar products distributed by other companies, or of daily or home dialysis; · announcements of technological innovations or new products by us or our competitors; · events or announcements relating to our relationships with others, including our third party manufacturers; · developments or disputes concerning patents or proprietary rights; · regulatory developments in both the United States and foreign countries; · economic and other factors, as well as period-to-period fluctuations in our financial results; and · sales of our common stock by the Durus fund |
| External factors may also adversely affect the market price for the common stock |
| The common stock currently trades on the Nasdaq Capital Market |
| The price and liquidity of the common stock may be significantly affected by the overall trading activity and market factors on the Nasdaq Capital Market or the market, if any, on which we are then trading |
| Future sales of substantial amounts of our common stock in the public market could adversely affect the market price of the common stock, and also could impair our ability to raise additional capital through the sale of our equity securities |
| The resale by the Durus fund of a substantial number of shares of our common stock could adversely impact the market price of our common stock |
| Based on information contained in a Schedule 13D filed by the Durus fund with the Securities and Exchange Commission on March 13, 2006, we believe the Durus fund owns 21cmam498cmam118 shares of our common stock, representing approximately 66prca of our outstanding shares |
| We have filed a registration statement covering these shares and 498cmam100 shares held by the Artal fund |
| This registration statement was declared effective by the Securities and Exchange Commission on May 17, 2004, and enables the Durus fund and the Artal fund to resell their shares to the public at their discretion |
| Although we believe that the Durus fund and the Artal fund will effectuate the sale of their shares in an orderly manner and will seek to obtain the best prices available in connection with any sales, the timing, volume and manner of any sales is within their discretion |
| 33 ______________________________________________________________________ The Durus fund and the Artal fund’s sale of their shares may have a negative effect on the market price of our common stock due to, among other factors, the selling pressure such sales may cause |
| Moreover, the perception in the market that a significant portion of our outstanding shares may soon be sold may also have a negative effect on the market price of our common stock |
| These events may cause other holders of our common stock to sell their shares, or it may encourage short sales, all of which could contribute to a decline in the market price of our stock |
| In addition, these factors may have a material adverse effect on our ability to raise capital through the issuance of our equity securities |
| We do not intend to pay cash dividends on our common stock in the foreseeable future |
| We have never declared or paid any cash dividends on our common stock |
| For the foreseeable future, we intend to retain any earnings to finance the development of our business, and we do not anticipate paying any cash dividends on our common stock |
| Payment of any future dividends on our common stock will depend upon our earnings and capital requirements, the terms of any indebtedness we incur and other factors our board of directors considers appropriate |
| We will likely need to issue additional shares of our common stock and/or preferred stock in the future, which would dilute your voting and ownership percentage |
| Certain events over which you have no control could result in the issuance of additional shares of our common stock, which would dilute your voting and ownership interest in our Company |
| As of March 20, 2006, there were 32cmam177cmam574 shares of our common stock issued and outstanding and there were 717cmam677 shares of common stock reserved for issuance under our equity incentive and stock purchase plans |
| As of March 20, 2006, there were outstanding options, warrants and other rights to acquire up to approximately 3cmam338cmam602 shares of common stock |
| We may also issue additional shares of common stock or preferred stock: · to raise additional funds for working capital, research and development, commercialization, production and marketing activities; · upon the exercise or conversion of outstanding options and warrants; and · in lieu of payment of cash dividends |
| Furthermore upon closing of our securities purchase agreement with the Durus fund dated March 31, 2006 (the “Securities Purchase Agreement”) , the Durus fund will acquire newly issued shares of our Series B Preferred Stock, convertible into 5 million shares of our common stock at a conversion price of dlra1dtta00 per share and Warrants to purchase 5 million shares of our common stock at an exercise price of dlra1dtta10 per share |
| In addition, following the closing of the Securities Purchase Agreement, the Durus fund will have the option to invest, by itself or with other investors designated by the Durus fund, up to an additional dlra15 million in cash for additional shares of Series B Preferred Stock and Warrants having essentially the same terms as the Series B Preferred Stock and Warrants acquired by the Durus fund at the closing |
| If the Durus fund (by itself or with other investors) invests the maximum additional dlra15 million in cash for such additional shares of Series B Preferred Stock and Warrants, such additional shares of Series B Preferred Stock will be convertible into 15 million shares of common stock at a conversion price of dlra1dtta00 per Share and the additional Warrants will be exercisable to purchase 15 million shares of common stock at an exercise price of dlra1dtta10 per share |
| See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Recent Financing Activities |
| ” See also “Risks Related to Our Business—As a result of our transaction with the Durus fund and the Durus fund’s current ownership position in our common and preferred stock, persons other than the Durus fund who own our common stock will own a minority of our common stock and will not be able to exercise voting control over most matters put to a vote of stockholders |
| ” 34 ______________________________________________________________________ Our charter documents and Section 203 of the DGCL could make it more difficult for a third party to acquire us |
| Our Restated Certificate of Incorporation (“Charter”) and Amended and Restated Bylaws (“Bylaws”) contain certain provisions that are intended to enhance the likelihood of continuity and stability in the composition of our board of directors and which may have the effect of delaying, deferring or preventing a future takeover or change in control of the Company unless the takeover or change of control is approved by our board of directors |
| Such provisions may also render the removal of the current board of directors and of management more difficult |
| These provisions provide for, among other things: · a classified board of directors; · “fair price” provision, which requires that our stockholders receive equivalent consideration at both stages of a two-step acquisition (such as a tender offer followed by a merger); · a prohibition on stockholder action through written consents; · a requirement that special meetings of stockholders be called only by our board of directors or our chief executive officer; · advance notice requirements for stockholder proposals and nominations; · limitations on the ability of stockholders to amend, alter or repeal our Charter or our Bylaws; and · the authority of our board of directors to issue, without stockholder approval, preferred stock with such terms as the board of directors may determine |
| We are subject to the “business combination” statute of the General Corporation Law of the State of Delaware (the “DGCL”) |
| In general, Section 203 of the DGCL prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested stockholder,” for a period of three years after the date of the transaction in which a person became an “interested stockholder,” unless: · prior to such date the board of directors of the corporation approved either the “business combination” or the transaction which resulted in the stockholder becoming an “interested stockholder,” · upon consummation of the transaction which resulted in the stockholder becoming an “interested stockholder,” the “interested stockholder” owns at least 85prca of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned (1) by persons who are directors and also officers and (2) employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer, or · on or subsequent to such date the “business combination” is approved by the board of directors and authorized at an annual or special meeting of stockholders by the affirmative vote of at least 662¤3prca of the outstanding voting stock, which is not owned by the “interested stockholder |
| ” A “business combination” includes mergers, stock or asset sales and other transactions resulting in a financial benefit to the “interested stockholders |
| ” An “interested stockholder” is a person who, together with affiliates and associates, owns (or within three years, did own) 15prca or more of the voting stock of the subject corporation |
| Although Section 203 permits us to elect not to be governed by its provisions, we have not made this election |
| As a result of the application of Section 203, potential acquirers of our company may be discouraged from attempting to effect an acquisition transaction with us, thereby possibly depriving holders of our securities of certain opportunities to sell or otherwise dispose of such securities at above-market prices pursuant to such transactions |
| 35 ______________________________________________________________________ The foregoing summaries do not purport to be complete and are subject to, and are qualified in their entirety by reference to, our Charter and Bylaws, our Rights Agreement and the DGCL Copies of our Charter and Bylaws are filed as exhibits to this report and deemed to be incorporated herein in their entirety |
| If we sell common stock to Fusion Capital under our common stock purchase agreement with them you will likely experience significant dilution and the resale of shares of common stock acquired by Fusion Capital could cause the price of our common stock to decline |
| The sale of shares pursuant to our common stock purchase agreement with Fusion Capital or any other future equity financing transaction will have a dilutive impact on our stockholders |
| As a result, our net income or loss per share could decrease in future periods, and the market price of our common stock could decline |
| In addition, the lower our stock price is, the more shares of common stock we will have to issue under the common stock purchase agreement with Fusion Capital in order to draw down the full amount available to us on any trading day |
| If our stock price were lower, then our existing stockholders would experience greater dilution |
| We cannot predict the actual number of shares of common stock that will be issued pursuant to the agreement with Fusion Capital or any other future equity financing transaction, in part, because the purchase price of the shares will fluctuate based on prevailing market conditions and we do not know the exact amount of funds we will need |
| The purchase price for the common stock to be sold to Fusion Capital pursuant to the common stock purchase agreement will fluctuate based on the price of our common stock |
| Fusion Capital may sell none, some or all of the shares of common stock purchased from us at any time |
| Depending upon market liquidity at the time, a sale of shares by Fusion Capital at any given time could cause the trading price of our common stock to decline |
| The sale of a substantial number of shares of our common stock by Fusion Capital, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales |
| See also “Risks Related to Our Common Stock—we will likely need to issue additional shares of our common stock and/or preferred stock in the future, which would dilute your voting and ownership percentage |