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NxStage Medical, Inc. (NASDAQ:NXTM)

Q3 2013 Earnings Conference Call

November 7, 2013 9:00 AM ET

Executives

Kristen K. Sheppard – Vice President-Investor Relations

Jeffrey H. Burbank – Chief Executive Officer

Matthew W. Towse – Chief Financial Officer

Analysts

Kimberly Gailun – JPMorgan

Bill J. Plovanic – Canaccord Genuity, Inc.

Kevin Ellich – Piper Jaffray

Danielle Antalffy – Leerink Swann

Margaret Kaczor – William Blair

Chris Cooley – Stephens Inc.

Raj Denhoy – Jefferies & Co.

Ryan Halsted – Wells Fargo Securities LLC

Operator

Good day ladies and gentlemen and welcome to the NxStage Medical’s Third Quarter Fiscal 2013 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I’d now like to hand the conference over to Ms. Kristen Sheppard. Ma’am you may begin.

Kristen K. Sheppard

Good morning and welcome to NxStage Medical’s third quarter 2013 financial results conference call. My name is Kristen Sheppard and with me here today are Jeff Burbank, NxStage’s CEO, and Matt Towse, our CFO. For your convenience, a replay of this call will be available shortly after its conclusion. In addition, the press release for the third quarter and a recording of this call will be archived on our website under the Investor Relations section.

Before starting I would like to remind you that statements we may make on this call which are not purely historical regarding the company’s or our intentions, beliefs, expectations and strategies for the future are forward-looking statements for the purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. These forward-looking statements may include topics such as the results of our operations, growth of the Home and more frequent hemodialysis market in general, market adoption and demand for our products both domestically and internationally, our expectations regarding relationships with key customers, continued supplies from key vendors, our plans with respect to regulatory filings, our plans with respect to future developments including Centers of Excellence, beliefs as to the expected impact of current economic, reimbursement or regulatory conditions on the business, anticipated improvements in the operating efficiencies, gross margins, and product quality and financial guidance for the future.

Because such statements deal with future events, they are subject to various risks and uncertainties and actual results may differ materially from these forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in our SEC filings, including our quarterly report on Form 10-Q for the quarter ended June 30, 2013. In addition any forward-looking statements made on this call represent the company’s views only as of today and should not be relied upon as representing our views as of subsequent dates. Future events and developments may cause these expectations to change and while we may elect to update forward-looking statements at some point in the future, the company disclaims any obligation to do so; and therefore you should not rely on these forward-looking statements as representing our views on any date subsequent to today.

Now, I’d like to hand the call over to our CEO, Jeff Burbank.

Jeffrey H. Burbank

Thanks, Kristen. Good morning everyone and thanks for joining us. Revenue for the third quarter of 2013 was within guidance at $66.9 million, that’s a 9.4% increase over the prior year period. Growth came from continued execution across each of our businesses. Home revenue increased to $33.7 million. These results are a little different than our prior outlook. We’ve seen good performance form the domestic patient marketing programs, however, international hasn’t expanded as expected. More specifically, our domestic home revenues increased 8.1% over the prior year period, which drove all of homes annual and sequential growth.

As many of you know, we’re in the early stages of market development in international, so providing guidance around the small but growing base of business is challenging. We’ve learned from the domestic experience that going deep to understand the local issues and bringing comprehensive support tools is very important. By being direct in the UK and building deeper executional relationships with our distributors, we hope to improve our performance.

Continued execution in the launch of new product later this year should also help. We’re seeing patient growth in international, but it’s not reflected in the revenue number due to slower than expected patient adds, ordering patterns and the change in accounting for direct to operations in the UK. Therefore, we’re adjusting our 2013 year end guidance for total home revenue growth to 6.5% to 7.5%, down from 8%. We still have more work to do, but the U.S. remains solidly on track. We continue to drive growth and believe our direct to patient marketing initiatives are effective in areas where we focused these efforts with dedicated partners. Our data suggests that we’re not only reaching more patients, but making it easier for patients to experience our therapy.

We continue to improve and expand these programs and see repeated success. We’re on track to expand two additional regions in the U.S. by year end, with a goal of building on this momentum. In addition to our marketing programs, our innovative product pipeline looks to be significant and improving our patient experience, driving increased adoption. We’ve established some nice momentum executing against our pipeline with 2013 shaping up to be a landmark year for NxStage.

We’ve gained 5 noteworthy product clearances year-to-date and expect more in 2014. All our latest innovations are aligned with our stated focus. It’s been our target patient population by reducing burden and improving efficiency for the provider, the doctor and most importantly the patients. Given the increasing challenge of gaining FDA clearances, I’m very proud of the execution that’s occurred to get these innovations, developed, cleared and launching into the market.

We started to rollout the System One S. You may know this by another name High Flow. It’s a valuable expansion of System One’s performance. This can provide the ability to reduce burden of therapy with higher dialysate flow rates or provide expanded therapy options with more comparable treatment times. To help adoption of these new capabilities, we have developed and launch the NxStage System One dosing calculator. This online tool helps physicians to develop prescriptions tailored to patient’s clinical and lifestyle objectives.

We believe the dosing calculator can reduce the time and provide a complete picture of the 100s of possible prescription options to achieve that goal. This is another example of our cloud based tool set. As many of you know, I’ve been excited about our connected health initiative. As expected, we would see clearance for this significant innovation last month. We selected the commercial name Nx2me or Nx2me Connected Health. This tool really looks to be a path to reducing burden, this web-based solution automates the significant part of flow sheet administrative paperwork and provides additional new features that are important to home dialysis patients and nurses, we are excited to be discussing and demonstrating these products and capabilities at ASN, the industries largest conference which occurs this week. With other launches planned for this year and early next, we expect these technologies will be a significant contributor to helping us achieve our growth objectives.

We continue to make progress on our next generation hemodialysis products, new therapies for Critical Care and our Peritoneal Dialysis product. We are on track with all of these initiatives. In addition we just completed Phase I of the DARPA project on time and on budget. These programs provide the pathway to longer term growth opportunities. So I believe our fundamentals are strong and we’re executing well in support of our goal of 15% annual home revenue growth in 2014 and beyond.

Another key aspect of driving growth is to innovate the dialysis care model with our centers of excellence strategy. Under NxStage Kidney Care, these centers are intended to support and encourage patient centered care by providing enhanced access to the life changing benefits of home therapy as well as flexible and center options. A few months ago we opened our first NxStage Kidney Care center in St. Louis. So far like what I see, the build out of the center went well as is our engagement with medical directors, staff and patients. We’re all really proud of the way that facility came up. I had the opportunity to visit the center recently and meet with both our center staff and a few of our patients.

It was really nice to see their enthusiasm and this has to be exciting for NxStage but to see and hear patients talk so passionately about our therapy and how we’re helping them take control of their dialysis was really amazing.

We hope to have one to two more centers opened by the end of this year and two to three more opened in the first quarter of 2014. We will be watching the progress of our COE as closely as we build our experience and manage our plans going forward. We were hoping we could have some clarity around the CMS final rule by now, but it now seems it will be made public around the end of the month and we need to review and reflect on this one as made available. Matt will share more details of the other two segments, Critical Care and In-Center. So I will turn the call over to him now. Matt?

Matthew W. Towse

Thank you, Jeff and good morning everyone. I will review revenue for the third quarter of 2013 including details of our reportable segments, discuss the company’s financial performance, and then finish with the discussion regarding our outlook for the fourth quarter. Total revenue for the third quarter was within guidance of $66.9 this represents 9.4% increase over the third quarter of 2012. Now taking a closer look at our revenues by segment, during the third quarter of 2013, our System One segment increased 8% over the prior year with strong performances across domestic Home and Critical Care. Home increased to $33.7 million for the third quarter of 2013 compared with $31.9 million for the third quarter of 2012.

As Jeff indicated growth in our domestic business drove all of the sequential and year-over-year increase in Home. In total Home grew 5.5% in the third quarter versus last year, but note that Domestic Home grew 8.1% compared to Q3 of 2012 which made up for lower international Home revenues.

And for the nine months ended September, while total Home growth was 6.1% excluding international, Home domestic growth was also up 8.1%. This performance reflects early, but good momentum with our strategic growth initiatives, primarily our direct to patient marketing programs.

Regarding international we continue to see choppiness in the revenue numbers as we get traction in those markets. And while the expansion is not moving as rapidly as we expected, we continue to drive good growth in patient count. So given that international home revenues are coming in below our expectations, we are reducing our 2013 year-end guidance for total home revenue growth to 6.5% to 7.5%, down from 8%.

Critical Care also increased to $10.7 million in the third quarter of 2013, representing an increase of 17% over the third quarter of 2012. We continue to extend our leadership position in the CRRT market with a strong installed base of leading hospitals. In addition, we continue to experience healthy new customer adoption in the high win rate.

Our third quarter of 2013 results, however, includes the impact of both lower disposable sales and general trends toward lower hospital utilization. We are reflecting these factors in our 2013 year-end guidance for Critical Care, which we now expect to be approximately 10% versus our previous estimates of10% to 15% growth through 2013.

Now, looking at the rest of our business, revenue for In-Center increased to $21.3 million in the third quarter of 2013 and 8% increase over the prior year. And finally in other revenue, we reported $1.3 million reflecting the company’s dialyzer sales to Asahi for the third quarter of 2013. This increased sequentially from the second quarter sales of $700,000 as we ramped our capacity at the new dialyzer plant.

Gross margins for the third quarter came in at 38% for total company compared to 39% last year. While we continue to execute on our overall gross margin improvement programs, margins are impacted by higher than anticipated start-up costs in our new German dialyzer plant. Additionally, the mix of revenues impacted our margins unfavorably by about 1 percentage point compared to our expectations for the third quarter.

By segments, System One gross margin was 45% for the third quarter of 2013, compared with 46% in 2012, which reflected the start-up costs I just mentioned. In-Center gross margin increased to 29% for the third quarter compared with 25% in 2012. Taking a step back, we successfully executed against a number of strategic gross margin improvement initiatives over the last two years, most notably the in-sourcing of our blood tubing manufacturing to our Mexican plant.

To-date many of these improvements have enabled us to hold gross margin relatively stable while continuing to move forward with other key projects, including the build-out of our new dialyzer plant in Germany. For the near-term, this project will be a bit of a drag on our gross margin, but we continue to expect that it will deliver gross margin benefit to the System One segment over the long-term.

And looking at the bottom line NxStage had a loss of $5 million for the third quarter of 2013, compared with a net loss of $2.6 million for the third quarter of last year. The unfavorable product mix that I mentioned earlier drove a higher net loss than expected during the third quarter of 2013.

We ended the quarter with $83 million in cash. Cash burn for the third quarter was $11 million and included $5 million of capital expenditures associated with our manufacturing operations and our centers of excellence and approximately $2 million associated with the acquisition of our home business in the UK.

Now, turning to our guidance, given our expectation for lower international and Critical Care disposal sales, we expect fourth quarter of 2013 revenue to be between $67 million to $68.5 million. To reflect this revenue range and continued investments in our strategic growth initiatives, including centers of excellence, we expect a net loss in the range of $6 million to $5 million, or a negative $0.10 to $0.08 per share for the fourth quarter of fiscal 2013.

This translates to full-year 2013 revenue to be within a range of $261 million to $262.5 million and a net loss in the range of $19.5 million to $18.5 million, or negative $0.32 to $0.31 per share compared with our previous guidance for full-year 2013 revenue, which was in a range of $265 million to $270 million and a net loss in the range of $17 million to $13 million, or $0.28 to $0.22 per share.

So let me recap the components of our guidance. We expect to Home to come in at 6% to 7.5%, Critical Care at approximately 10%, and In-Center at 6% to 7% annual growth for 2013. Our guidance of $4 million in sales to Asahi remains unchanged.

So to sum up the net change to our year-end revenue guidance reflects a longer ramp of international revenue growth and lower growth in Critical Care disposable sales compared with our earlier projections. And we do remain committed to the investments that we believe will drive growth in 2014 and beyond.

So with that, I would like to open the call to questions. Operator, we are ready for the first question.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Kim Gailun from JPMorgan.

Kimberly Gailun – JPMorgan

Good morning. Thanks for taking the questions. So first question for me is just on that 2014 outlook, you’ve kind of reiterated your goal to get towards the 15% growth in Home starting in 2014. Can you bridge to that for us just given that essentially a doubling off of what you’re forecasting for this year and kind of talk through the different components of what get you to 15% next year?

Jeffrey H. Burbank

Sure, Kim, thanks. So our confidence is based on continued execution of the breadth of programs. The direct to patient marketing, we’d now done that in about 37 regions and we’ve got 17 more plan for fourth quarter, and we’ve seen the results there that really support the kind of growth rate we want to see and it’s been consistent and repeatable. So that feels really good to us. It’s awfully hard to - from a distance predict the execution on innovation all the way through clearances and product launch, we are now further and long in that process than we were at the beginning of the year. We just received our clearance on the next to me connected health program. We’re launching and have shipped the first Hyflow System 1S machines.

So we’re feeling really good about our execution there, which I think is a pretty extraordinary given how challenging the regulatory environment is and this technology is. So we feel good about that and on track there. We’ve had a couple of contract negotiations this year. So we’ve gotten pricing stability that that kind of disability that we wanted. We’ve got one more to go there, but we feel like we’ll get that done in time and really appropriate with that, but we will come back to you when we get that done.

And we’ve got some services that we’re adding into those, so we’ve got some visibility to the new products. So all of these things along with our mid-term and the long-term objectives with centers of excellence, feel really good to us. And we’re seeing the results of them and we’re seeing that we can keep them on time and execute them well, so that’s what’s leading to our enthusiasm.

Kimberly Gailun – JPMorgan

Okay. And so as you look at 2014, how do you think about that that ramp in the growth rate even just kind of first half versus second half?

Jeffrey H. Burbank

We’ve got the specific on that and we’re going through our year-end process planning. We’ll come back to you with our guidance, which I will layout a little bit more visibility that. At this point we feel good for the overall goal, but we’ll break that out a little bit better for you when we come back on the next fall.

Kimberly Gailun – JPMorgan

Okay. And how do you think in terms of the centers of excellence, you’ve got one up and running and you’re planning to kind of ramp from here. How do you think that the centers of excellence would plan to your 2014 guidance just in terms of time it takes to get those up and running and actually kind of producing anything meaningful to the top line?

Unidentified Company Representative

Yeah, so we are focused on the first two. We’ve got to make sure they are successful primarily from a clinical perspective, make sure we can deliver the quality of care we set out to do. Our early indication is we are doing well there, but its one center. So we’ve got a number of discussions. I think we’ve been gratified as you think about how the market is evolving, it seems that clinicians are coming to the realization that one side doesn’t fit all patients that there is an interest in having more therapeutic flexibility that some patients can benefit from that. So doing three times a weekend is better, maybe not be best for everybody. We are really excited about building an option that efficiently effectively delivers all that flexibility. So that’s what we are really setting out to do there. We need to make sure we get that right. It’s why we are doing – focused on firsthand.

So we should get one to two more open by the end of this year; maybe, two to three in the first quarter; we’re going to watch those carefully. We’ve got a lot of activities that we can poll from depending on how we do in there, but specifics to how that’s going to lay off, a little too early for us to talk as we are watching it really careful and managing our pace based on success there.

Kimberly Gailun – JPMorgan

Okay. And just one follow-up, so fair to say that you don’t have much in your 15% growth thinking associated with the centers of excellence?

Unidentified Company Representative

So let me be clear about that, we didn’t include service revenue from centers of excellence in that, that is product revenue. So relative to the way we are thinking about our growth, that’s product growth not including the service revenue from COEs.

Kimberly Gailun – JPMorgan

Okay, great. Thank you.

Operator

Thank you. And our next question comes from Bill Plovanic from Canaccord.

Bill J. Plovanic – Canaccord Genuity, Inc.

Thanks. I was just wondering if we could talk about the cash burn with all of the programs you’ve had, I think for a while, you had kept your cash pretty stable and then I think year-to-date you’ve burned about $22 million. I’m just trying to get a feel for as you move forward, are we through the investment stage or would you expect continued need cash usage going forward. And what’s the inflexion point or what kind of changes it back to being either cash neutral or cash flow positive?

Matthew W. Towse

Bill, this Matt. Yes, so when you look at the products business, you are right, we’ve burned about $5 million to $6 million in the quarter in the first half. We did burn about $11 million in the third quarter, there was some COE cost and there was some additional CapEx. In the fourth quarter, we expect to burn a bit less than that, as we make some adjustments. I think as far as investments, as Jeff said, we are in the planning process for next year and we’ll come back with guidance on OpEx and investments. We think where at good levels right now, we want to do, but we’ll get back to you on what is for next year. I think, overall, on the product side, the goal is continually improve the parts of business both top line and on how we can allocate resources and spend R&D and sales and marketing.

Bill J. Plovanic – Canaccord Genuity, Inc.

Okay. And then in critical care, I was wondering if you could provide us more details in your commentary regarding utilization coming down and I believe I don’t know if you mentioned pricing, but just anything there would be helpful because it seems like that’s a bit of a change in the trajectory for that business?

Unidentified Company Representative

Yes, we continue to feel really good and actually this year has been a very strong year for equipment sales and our market share looks really good there. Sometimes equipment can be seasonal. We didn’t see anything different on that this year. What we saw is a little bit less on consumables in the third quarter. We don’t know if that’s something long-term or short-term. It looks like a macro thing. We’re not seeing any loss in market share. Pricing is not moving significantly to explain that. So it’s not a pricing thing. It seems to be an overall utilization and we don’t know if that’s a quarter event or a multi-quarter event. So we are watching it closely. But I want to be clear, we have a very solid product offering. Our market share continues to be stable and successful there. We’re not seeing any competitive dynamics that’s leading to this. It’s really a global thing that we’re watching carefully.

Bill J. Plovanic – Canaccord Genuity, Inc.

And if I could ask a simple P&L question. Matt, what was the medtech tax in the quarter? What did that cost you? And that’s it. Thank you.

Matthew W. Towse

Okay. That’s a simple question. Let me just take a look. We’re running about a $3 million annual run rate. So that’s been pretty steady for quarter-by-quarter for the year.

Bill J. Plovanic – Canaccord Genuity, Inc.

Great. Thank you.

Operator

Thank you. And our next question comes from Kevin Ellich from Piper Jaffray.

Kevin Ellich – Piper Jaffray

Good morning. Just a couple of questions. Going back to centers of excellence, Jeff, could you give us some details, now that St. Louis has been open for a little bit. How many patients, how many times they are going to be dialyzing a week? And are all these new dialysis patients or are they transferred from some other clinic?

Jeffrey H. Burbank

Yes. So it’s a little bit of both on new and transferred. We tend to be the center that is trying to accommodate prescriptions that a little bit different that are more focused on the patient versus trying to fit it into the center. So we have a few PD patients, a few in-center more frequent patients, some home patients. So we have a mix of a lot of different things. I think that will change over time. It’s still very easy. But what we’re finding is clinicians are taking advantage of the ability to have a provider that’s flexible in delivery of therapy. So we’re probably going to see more different therapies if you will because that’s what we’re – that’s that.

Kevin Ellich – Piper Jaffray

Got it. And then, is that center full yet? I know it’s only been open for a little while.

Jeffrey H. Burbank

No. It’s in the starting blocks pulling out and doing well, but it’s still early.

Kevin Ellich – Piper Jaffray

And then, Matt, how should we think about the CapEx on spend in Q4 and into Q1 with another center opening and maybe two to three in Q1?

Matthew W. Towse

Well, I think on the center side, I mean the numbers we disclosed earlier about $1 million of CapEx per center, it is the right number to think about as you look at the center. So as Jeff said, we got another one, two opening up in this quarter and a couple – two to three next quarter, probably amount of something like that in for the COE. As far as the CapEx, the product is pretty much on the same run rate we’re experiencing year-to-date.

Kevin Ellich – Piper Jaffray

Okay. That’s helpful. And then Jeff, going back to your comments on the competitive landscape, we saw, I don’t know, a few weeks ago Medtronic made a comment about I think expanding into India in the home dialysis market. Just wondering what your thoughts are on that front, and do you expect any of the other big medtech companies to get involved?

Jeffrey H. Burbank

I think it’s a very interesting time in dialysis. This is a huge product segment, multi-billion $13 billion, $14 billion of product revenue. There aren’t many market as big as this and I think it’s becoming obvious to people that the fundamental delivery on a change that it ought to be more patient focused, more flexible. We have been leading that and really bringing great technology to achieve that. So I think we are going to have some others that will attempt to copy that and clearly there are others doing that there is always a list of a few, it’s hard, it takes long time but I think copying is the best form of flattery I think that’s a great validation that other people are seeing the market opportunity the way we are. So I wouldn’t be surprised if we hear more but I think we have just a huge advantage in understanding an execution and technology that will service well moving into the future.

Unidentified Analyst

Got it, that’s all I have, thank you.

Operator

Thank you, and our next question comes from Danielle Antalffy from Leerink Swann.

Danielle Antalffy – Leerink Swann

Good morning, guys, thanks so much for taking the question. Just on in-center and critical care Gambro is a big customer for in-center and also a competitor in critical care how does the dynamics with Gambro change now that company is part of Baxter and does that have anything to do with your lower critical care guidance or am I reading too much into that?

Unidentified Company Representative

It has nothing to do with our lower critical care guidance we’re still doing very well in competitive environment there continue to maintain and grow our market share in critical care. So nothing to do with that, we make great products in in-center they have very high value that’s what at the end of the day provides us with the opportunities for that business.

So we continue to have a solid leadership position in those products. So we think that’s a great value proposition, it’s not uncommon for companies to be collaborative on one side and a little competitive on the other that’s pretty common in this industry.

So everybody should be able to manage that especially for the benefit of having great products, high quality, high value products.

Danielle Antalffy – Leerink Swann

Okay, great and then if I could follow up on the St. Louis Clinical Center of Excellence can you give us any color on how you’ve seen DaVita and Fresenius react in that region as that center is starting to come online have those centers been growing their home businesses over the last few months in that region in reaction to that, have you seen anything there?

Unidentified Company Representative

So that’s an interesting question now probably a little early to tell, we’re really excited about the opportunity with that center to make the investment beyond the technology and develop the business model to help DaVita Fresenius and all providers to be able to deliver this more flexible care and home care.

So it’s a pretty exciting opportunity for us that we think will be a great investment to growing the total market opportunity, it’s too early to tell whether we’re having that impact or not, we’re very transparent about our objectives there, we’ve shared it with them and you and everyone else what our intentions are. So there is a no real surprises there but I think there is a lot of people talking about it because we’re doing something different and that’s exciting and folks are watching it real closely but I don’t think I could reflect any specifics on that, it is little too early.

Danielle Antalffy – Leerink Swann

Okay, thank you so much.

Operator

Thank you. (Operator Instructions) And our next question comes from Margaret Kaczor from William Blair.

Margaret Kaczor – William Blair

Hi guys, thanks for taking the questions, I guess the first question is actually a follow-up on – questions at the beginning making more specific to international, how much does international [indiscernible] should reach your guidance sort of both next quarter and then 2014 and then also on the rebates how much was that did you concentrating on your guidance for next year?

Unidentified Company Representative

Yeah I appreciate that because that is probably an area that we wanted to try to be really clear on. That is why we gave the domestic growth which we are very pleased about year-over-year at 8.1%. There are a lot of things going on in international. On the one side, we are growing international patients, but that’s really not reflected in the revenue, which actually year-over-year is down. So domestic had to overcome some drag on that and that’s due to a couple of things. One is clearly the difference in accounting due to going direct and some of the effect there. It’s a bit slower to ramp than w expected and there are some timing issues in there around that revenue. So we’re watching that carefully. We’ve got a lot of work to do, but it’s been a drag on that overall performance and we’re working hard to turn that around.

Margaret Kaczor – William Blair

Okay, but no specifics as you look into Q4? Is it kind of the same, flat sequentially that we should think about and the rest in U.S. or more of a drag?

Unidentified Company Representative

Yeah, we’re being a little conservative there. So we are on the range of flat, and our range is around flat to slightly down to maybe a little better that on our international, but we are biasing towards flat to down.

Margaret Kaczor – William Blair

Okay. And then in terms of some of the new product launches, have those been more broadly launched at this point, did we see an impact this quarter on patient adds due to that? And then when can we see the impact on sales? Because the way you guys defer revenues, I assume you guys can see more of the funnel of patients before we see it hit the P&L?

Unidentified Company Representative

Yeah, we do have a little bit of an advanced view of that. We have not significantly launched those products, we are rolling them amount. We are very methodical about how we do that process. So I don’t think you are seeing the benefit of that yet at all. I think we’ll start to see that more in first quarter and beyond, but a little – very small amount in fourth quarter, because we are just launching the System One S right now as we speak, and Connected Health will be more impacted in Q1. So there’s stuff going on, but not reflected in the P&L yet.

Margaret Kaczor – William Blair

Okay. And then, on the insurance exchange, is there kind of any visibility into what kind of an impact you might expect there? Is there any reason to believe that how many won’t be reimbursed up to four to five times per week?

Unidentified Company Representative

So very hard to predict the future right now with private pays and even with CMS with appropriate medical justification. That payment has worked pretty well for our appropriate patients. So we feel good about that today, but who knows in the future that there is no reason to expect the change in that, but you can never get too far ahead of yourself on that.

Margaret Kaczor – William Blair

Okay. And then last question for me. Any update on the Fresenius contract? Have you seen kind of any of the typical negotiation patterns and how those may be impacting patient average right now? Thanks.

Unidentified Company Representative

Obviously, we are working hard to get that done in a way that works well for both organizations, so we’ll come back to you when we get it done. The current contract goes through the end of this year. So you can imagine we are in discussions to try to finish that up, but we’ll get it finished for you and come back with more details when that happens.

Margaret Kaczor – William Blair

Thank you.

Operator

Thank you. And our next question comes from Chris Cooley from Stephens.

Chris Cooley – Stephens Inc.

Appreciate you taking the questions. Could we start with just the rollout of HighFlow? Could you just walk us through the mechanics of that transition for your existing users as well as expectations to kind of just get that more broadly available for new patients? And then I have a couple of follow-ups. Thanks.

Unidentified Company Representative

So the way we rollout products is we do them conservatively and expand as we feel comfortable that everything is working fine, which we expected will be. We haven’t had any problems with launches. In the past, we’ve got a very rigorous process about it. So it will go to a handful of centers which is it is now and that it will expand beyond that. Not every patient will want or need that. So it will be a focus towards the patients that can benefit most and new patients that could take advantage of that and then come out of the therapy. So that will be the large focus on high flow.

Chris Cooley – Stephens Inc.

So – but just to be clear if I’m an existing patient and I would benefit in more high flow and I already have obviously a System 1, I’m getting a new unit. so help me think about the economics to me to change that?

Unidentified Company Representative

It is not the right path. so either on your next service events or if it’s really important to you, we can switch on your cycler and give you that capability, that software onto your flow.

Chris Cooley – Stephens Inc.

Okay. And then let me also just kind of – just some clarification on the centers of excellence, I think in your prepared remarks, you mentioned, do you hope to have two centers possibly up in running in this quarter, another two to three in the March quarter. Sounds like you may be doing, maybe one center or more than the original goal or just five max. am I doing the math wrong or is that a function of just the timing of whether you – when you may or may not have centers open here during the current quarter? I just want to make sure I understand kind of conceptually where you may or may not be going with the COE effort?

Unidentified Company Representative

Yes, you’re sizing a little bit there. We’re really focusing on the first ones. We’ve got some activities in our pipeline, because there’s still a lot more interest in this model than we originally anticipated. So there’s an activity in the pipeline, we’re not sure if or when we’ll execute on those. But we’re just trying to balance gaining experience and doing it well against getting ahead of ourselves. So we’re pacing ourselves through this, very pleased with St. Louis, believe we can do a good job of bringing one to two or more up by the end of this year. so we’ll be two to three by the end of the year in total and then maybe two or three in the first quarter.

So I don’t know if one or two of those will slip the quarter. We can’t be that precise at this point. You are trying to be a little bit more precise, but I think we have the ability to be realistically. But in that range, that’s what we are pretty confident in for the next few quarters. Is that helpful or?

Chris Cooley – Stephens Inc.

No, no that clarifies it. Thank you. And then I guess just one more and I’ll get back in queue. And I know it’s premature at this point to establish kind of formal guidance for the 2014 outlook, but clearly, a number of potential scenarios being contemplated from the bundle’s perspective going forward. Is there a scenario which you think would most impair your ability to ramp closer than 15% next year. I guess I’m just trying to get a feel for how confident you feel, you can get up from obviously, a little bit lower baseline here in 2013 now, regardless of the variability and what CNS does or doesn’t do on November 29? Thanks.

Unidentified Company Representative

Sure. Good question, because that’s some unanswered question for the industry in general around the bundle. But I think, let me focus on where our confidence is coming from, because it’s really coming from the direct to patient efforts. I think we’ve provided some numbers on this call to give you a sense of how quickly those are expanding and how successful they are.

We’ve done 37 regions and we’ll add actually 17 more in the fourth quarter. So we’re really operationalizing those activities well, getting the benefits from those. That plus the products and being able now to have the launches in our timelines versus question of regulatory, really de-risk some of those activities. Centers of excellence are moving well. So the things that are within our control, we’re executing quite well on and that brings a lot of confidence.

Now you’re bringing something that’s little out of our control, which is what else CMS asking to do around the final rule. Our focus has been around training. We continue to be in aggressive [indiscernible] to try to get appropriate training reimbursement in place, have no idea, have no idea what that outcome could be. But we continue to press that issue and hope that our cries are heard.

And in terms of the general bundle, I have really no idea. We’ll watch that and as we get the results from that we’ll see how impactful they are and how the markets responding to those and come back with that time. But I don’t want to get ahead of that one because, we’ve always said you can almost never predict where CMS will come out. We need to be honest about that for you guys.

Chris Cooley – Stephens Inc.

Understood; thank you.

Operator

Thank you. And our next question comes from Raj Denhoy from Jefferies.

Raj Denhoy – Jefferies & Co.

Hi, good morning. I wonder if could ask you Jeff, following the companies for a while and I think the thing that strikes in this quarter is that U.S. home growth, it’s just 8% and I know you seem to be comfortable with that number, but if you look back over the last several years, I don’t think you’ve ever grown the U.S. business less than double digits. And I realized against the increase in large base, but that’s still cosmetically headed in the wrong directions still.

I hear your confidence that we’re going to see better results as we move in to 2014, but you’ve been confident in the past that things would improve and I guess I’m asking what’s different now and what’s given you perhaps the renewed sense of confidence that at 8% number is the bottom in terms of growth here in the U.S. and we’ll start to see better results as we move forward.

Unidentified Company Representative

That’s probably a fair question. And again I got to back to the things that we’re in our control. So I think we had a visibility to do kinds of things that will draw a line of sight to that growth. So I feel good about that. I’m disappointed in international. It’s growing in patient numbers, it isn’t growing as fast as we like. So that’s being more of a drag, but despite that, we believe we have a visibility to that growth rate for the domestic market.

Raj Denhoy – Jefferies & Co.

Is there one or two things that win that domestic market? Is it the centers of excellence? Is it high flow? It is there something in particular that you can point to in 2014 that’s what’s going to start to take our numbers up?

Unidentified Company Representative

So we’re almost doubling in one quarter, the number of regions where we’re deploying direct to patient marketing. We are now able to scale that even better. So I feel really good about that. Those are very effective programs. We’re seeing growth where we implement those and seeing a change in market dynamics and we are focusing in larger and larger markets to deploy those. So the benefit of them is improving in time as we refine those.

I also feel really good about the capabilities that come with the new technology, whether it’s the dosing calculator, high flow Connected Health, those are all very powerful tools that enhance the efficiency and expand the patient days. So we feel good about those. Centers of Excellence, it’s a great exciting thing that we’re doing. We’re really operationalizing this modern care or flexible care, but that’s going to take a little bit longer. We don’t see that as a key driver in 2014.

Raj Denhoy – Jefferies & Co.

Just lastly and sort of last question, we noted the direct to consumer marketing has the large impact and that’s on one hand I guess fairly an obvious observation, but why not expand it even faster if you’re seeing such a nice return from that in the markets in which we’re doing and I realized there is bounces in terms of your profitability and your cash front. But if that is we’ll really moves the needle for you, and why not to make heavy investments there?

Unidentified Management Representative

Yeah, let me try to remove some of the misunderstanding on that, it’s not something that’s as simple as just funding it and executing it. There is a number of pieces that have to be in place. You have to have a provider in those geographies that’s ready to train and expand their program because if you generate the demand and then it falls flat, then you don’t convert it, that’s really wasted investment. So it takes a little bit of time to get that infrastructure in place and get it worked out to a place where you can scale these in the new geographies. I am really proud of the ability to do that in 17 more geographies in the fourth quarter and I think we can continue to expand that as we gotten better and better and as you have success in those programs and you expand it to new geography, word gets out on that success. So success to get success on this one, but it’s not as easy as buying the program. If that were, please come back and say if it were a cash limitation, which it isn’t, we’d all be talking about that because it will be obvious thing. So it’s not that is operationalizing it and we are getting better and better at doing that.

Raj Denhoy – Jefferies & Co.

That’s perfectly fair. Thank you.

Operator

Thank you. And our next question comes from Gary Lieberman from Wells Fargo.

Ryan Halsted – Wells Fargo Securities LLC

Good morning. This is Ryan Halsted on for Gary. I guess just one question. I understand you’re not trying to predict I guess what may come out of CMS regarding the bundle, but given that the dialysis industry has been talking of some significant disruption to the market of the magnitude of, say, 35% of clinics could potentially be closed and patients moved around, I guess, I’m curious if you guys are having conversations with the providers, large and small, in anticipation of some of that significant disruption, and how you guys might sort of react or anticipate yourself.

Unidentified Management Representative

So that’s a good question. There is always concern when money is being taken out of this program. It’s a very delicate balance in providing quality care to these patients that requires appropriate funding. So I know the industry and CMS are working very hard to try to find an appropriate answer there. So that I think we are all trying to say guys there is a range of outcomes that you need to be aware of, it’s our kind of duty to disclose that to you. So I think you’re seeing that reflected in our statement. So it’s pretty wide range of what could be the outcome of what CMS proposed versus what the lend of that. So we are all watching that very closely.

We have another specific issue for NxStage, which is the training and we have worked very hard to try to point out to them that they are not paying for services that they’re requiring. They’re not paying appropriately for those. So we’ve worked very hard to try to bring that to their attention and hope that they will resolve that issue. Have no idea whether they will or they won’t. So we have that added thing that we’re paying a lot of attention to and very helpful about, but can’t predict any outcome there. So I think in general, there is a range. We’re all cautious, but we’re not any just – think there’s disadvantage or advantage on that. We think we’ve got a therapy that really is our high quality therapy that ultimately has benefit for a number of patients and we’re trying to evolve that and improve that overtime.

Ryan Halsted – Wells Fargo Securities LLC

Okay. I guess, as a follow-up, as far as your investments next year, I mean, in the case of I guess a worst-case scenario, I mean, could we expect you might shift your investments less in the COEs and maybe more on direct to patient marketing.

Unidentified Management Representative

Yes, I think we need to get through our process, but anything that creates this market and has the right return on investment for creating market is where we’re going to spend our money. A lot of that I don’t think requires additional spend. Centers of excellence, there are some discrete capital spend when we built some of those and develop that model. But we’re getting better and better at performing in the products business and having it self-fund. So I think we’ll see continued improvement in gross margin and revenue and the things that really create a great mid to long-term opportunity to that business.

If I ever – and I’ve already said this. If we ever saw the program, the opportunity to expand the market faster and thought it was a good return on investment and didn’t have the capital to do that, we’d come back and talk to about that, but right now we feel like we have the capital to do all the programs and all things that we are signed up to do.

Ryan Halsted – Wells Fargo Securities LLC

All right. Thanks.

Operator

Thank you. And I’m showing no further questions at this time. I would like to hand the conference back over to Mr. Jeff Burbank for any closing comments.

Jeffrey H. Burbank

We appreciate your attention. We look forward to finishing up the year and having a very exciting 2014 as well. Thank you very much and we’ll talk to you next quarter.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes our program for today. You may all disconnect and have a wonderful day.

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