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Nxstage Medical, Inc. (NASDAQ:NXTM)

Q3 2010 Earnings Call

November 03, 2010 09:00 am ET

Executives

Kristen Sheppard - VP, IR

Jeff Burbank - President, CEO

Robert Brown - CFO, SVP

Analysts

Kim Gailun - JP Morgan

Bill Plovanic - Canaccord

Matthew O'Brien - William Blair

Danielle Antalffy - Leerink Swann

Jeff Hornman - Salto and Company

Suraj Kalia – Rodman & Renshaw

Darren Lehrich - Deutsche Bank

Kevin Ellich - RBC Capital Markets

Operator

Good day, ladies and gentlemen, and welcome to the NxStage Medical third quarter financial results call. My name is Michele and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host, Mrs. Kristen Sheppard with NxStage. Please go ahead.

Kristen Sheppard

Thank you, and good morning. Welcome to NxStage Medical’s third quarter 2010 conference call. My name is Kristen Sheppard and with me here today are Jeff Burbank, our CEO and Robert Brown, our CFO.

For your convenience a replay of this call will be available shortly after the conclusion of two weeks. In addition, the press release for the third quarter and recording of this call will also be archived on our website under the Investor Information section.

Before starting, I’d like to remind you that statements we 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 purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

These forward-looking statements may include topics such as the results for operations, growth of the home and more frequent hemodialysis market in general, market adoption and demand for our product. Our expectations regarding cash, cash flow and relationship with key customers as well as our expectations regarding a nocturnal indication but reassess to the expected impact of current economic, reimbursement or regulatory conditions on our business, anticipated improvements in the operating efficiencies, gross margins, 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 disclosed in our SEC filings, including our quarterly report on Form 10-Q for the quarter ended June 30, 2010. 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 obligations 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 Jeff Burbank.

Jeff Burbank

Thanks Christine and good morning everyone. Q3 was another solid quarter for NxStage. We continue to build good momentum across our business and set new record in a number of financial metrics. We achieved record revenues of 45 million, that’s up 18% over the prior September’s quarter’s results. In the home market revenues were 37% year-over-year and now represent 50% of our total revenues. We increased gross margins to 33% up to 200 basis point improvement from Q2. For the first time in our history we achieved our goal of positive adjusted EBITDA with $0.5 million for the quarter. We also had our second straight quarter of positive cash flow with 1.9 million.

Overall, our third quarter reflects systematic execution, solid operational performance and good financial discipline. We feel good about our ability to deliver continued improvement and meaningful growth over the long term. Regarding our fourth quarter revenue in a range of 45 to 47 million, which will bring us in around the high end of our annual revenue guidance of 170 to 175.

In addition, to these financial milestones I’d like to touch on some other accomplishments during the quarter. On the home side, revenue was 37% year-over-year and up 1.5 million sequentially at the top end of our guidance range. Key drivers of our momentum include our progress and reimbursement, clinical data, our go deep strategy and continued product improvements.

Medicare reimbursement is critical to the growth of patient access to daily home hemodialysis. Since our last call the bundle’s final role has been released. It goes into effect this January. We think that this is has stepped in the right direction in payment for a therapy. The new bundle will pay by treatment and the IV drugs are now included in this payment. We are moving disincentive to home therapy that exists under today’s payment system.

CMS also reiterated the process of documentation of medical necessity for payment of more than 3 treatments per week, allowing our customers to seek appropriate payment for the therapy they delivered.

Finally, the new payment system retains and slightly increases payment for hemodialysis training, which is positive. CMS’s intent to incur its hemodialysis therapy is good, however there is still work to be done. Daily home hemodialysis still won’t enjoy this simple, predictable and appropriate reimbursement that other dialysis therapies such as PD and In-Center receive.

Over the long run, addressing this complexity be a key factor in our ability to accelerate growth and improve patient access to this important therapy. We believe this is CMSs ultimate objective. This is why we continue to invest in our freedom study which is a single (inaudible) perspective clinical trial ever conducted of daily home hemodialysis. Results to-date make a highly compelling clinical phase for the therapy including a 30% reduction in depressive symptoms is measured by the Beck Depression Inventory, greater than 85% reduction in recovery time.

Giving our patient’s back about one waking day per week or over seven weeks a year, 6 to 17% improvement in a range of quality of life measures, reduced any hypertensive medications, including a doubling of the number of patients that don’t need any therapy. Significant improvement in overall sleep quality as measured by a validated sleep index. Our marked improvement in restless leg syndrome. And a 40% reduction in mortality. It’s clear that FREEDOM and other data are increasingly swaying Nephrologist to prescribe and embrace home hemodialysis.

For example, as of Q3, we had a 29% increase in the number of nephrologists that have prescribed therapy on the NxStage System One over the prior year period. Through a recent independent survey of nephrologists over 85% of respond has reported the highest degree of satisfaction with our patient’s clinical outcomes, on NxStage therapy. That’s versus 52% for PD and only 24% for incentive therapy. What we are seeing in the FREEDOM trial continues to be validated by growing patients support and increasing awareness of our therapy.

Just recently a group of over 100 people, including 40 patients concluded the first independent NxStage user’s conference in Las Vegas, with a goal of advancing home hemodialysis and patient center care. The energy around this meeting was inspiring.

In addition, there seems to be an increasing amount of media attention focused on home dialysis or home hemodialysis as well as dialysis in general. An example of this was last month’s featured health care story in the Wall Street Journal, which highlighted the experiences of the few of our patients.

A very important end point of the FREEDOM study is hospitalization rate, which correlates highly with the total cost to care. We believe this clinical efficacy in research will play a significant role in decisions of patients, clinicians, payers and policy makers in the future. Given the importance of this end point, it’s critical that the study is appropriately powered for this analysis. Consistent with the protocol, we decided to hold off on doing the interim analysis of the data that becomes available this year to ensure that it is appropriately powered

In the end term, we expect to release and publish other important data from the FREEDOM study. We are also making good progress developing deeper relationships at the center level to increase patient adoption. Centers with great than 10 patients grew 8% quarter-over-quarter and 37% year-over-year. Centers with greater than 20 patients grew 5% quarter-over-quarter and 26% year-over-year and geographies with greater than 5% penetration increased 20% sequentially and 26% year-over-year.

These positive trends demonstrate our success in bringing center’s home hemodialysis program to scale and in replicating this across the provider base. As science tend to aggregate patients, our performance within the geography shows our progress towards our target goal of 10 to 15% of the overall market. Importantly, we continue to advance these metrics with little to no additions in our dedicated home sales team.

Turning to an update on our efforts to expand our indication to include nocturnal treatments, meaning treatments done overnight while the patient sleeps. As you know we completed the trial and submitted our 510(k) earlier this year. We continue to work through the approval process to gain this clearance from the FDA. We’ve responded to the agency’s questions and they are now reviewing the information we provided them.

With respect to our international opportunities, we are still in the early stages of developing a presence within our five international regions. While we are making progress with our local partners, international continues to be a small contributor to our total home revenue this quarter. Home continues to systematically improve and we’ll grow at our expectations. We are working hard to continue this positive momentum with the expectation of driving adoption higher.

We see significant growth opportunities moving forward and we anticipate that due to the effect of fourth quarter holidays on training capacity sequential growth rate in home, be at the lower end of our 1.2 to 1.6 million sequential revenue growth range.

Moving on to Critical Care. Critical care had another solid quarter, increasing 20% over the prior year period. Higher revenues were driven by better than expected machine sales and a steady increase in our disposables revenue. Despite the fact that Q3 is seasonally low quarter for machine sales, we believe that we continue to outpace the competition and place new machines at a rate estimated to be nearly twice our installed market share.

We are winning on the strength of our product offering and [peace of use]. Also pleased to announce that the System One is now providing continuous renal replacement therapy within eight of the top 10 US hospitals and most recently to our US troops in Afghanistan. Seeing the benefits of our technology being recognized more broadly is great achievement one that all of us at NxStage are very proud of.

Looking ahead, we feel good about our prospects for critical care. We continue to build a healthy pipeline of opportunities and grow our large installed base. Although we are projecting sequential revenue growth in critical care for Q4, we are remaining somewhat cautious on the timing of machine sales during the quarter.

Finally In-Center, we had good end customer demand in Q3, due to distributor and inventory fluctuations revenue decline just slightly versus last year. Revenues were down sequentially, primarily as a result of some shipment sifting into the fourth quarter. One of the two factors we continue to highlight as having the ability to effect revenues on a quarterly basis.

As a result, we expect fourth quarter In-Center revenues to include these shipments and be higher than Q3 more in line with end customer demand. In addition to driving customer demand, we are executing against conversion opportunities with streamline, our next generation blood tubing set. Customs and clinical performance of both streamline and the buttonhole was terrific is grapping nicely. As we move deeper into these conversions.

Also last night we announced an expansion of the Medisystems In-Center product portfolio with automated vascular access surveillance. This strategic partnership with Vascular is timely as providers are tasked with implementing recent CMS requirements for access surveillance. On the side about the role vascular will play in establishing Medisystems is a leader and access surveillance.

In closing, Q3 was a solid quarter for Nxstage. The consistent growth in revenue improving gross margin, positive adjusted EBITDA and positive cash flow are strong validation of our business model. We continue to build good momentum across our business, we see significant opportunities in each of our markets to advance our long term growth strategy and remain confident in our ability to deliver continued improvement and meaningful growth.

Regarding fourth quarter revenue in the range of $45 million to $47 million which brings us to the high end of our annual revenue guidance of 170 - 175.

Now, I’ll turn the call over to Robert for his financial review. Robert?

Robert Brown

Thank you, Jeff. I will review revenue for the third quarter 2010 including details of our two reporting segments to discuss the company’s operating performance, balance sheet and cash flow results, and then finish with a discussion regarding our outlook for the fourth quarter. I will discuss the numbers on both the GAAP and non-GAAP basis. Please refer to the reconciliation table in our press release for further information in this regard.

We are very pleased with both, our operating and financial performance for the third quarter of 2010. NxStage had a record revenue of 45 million, which represent an 18% increase over the third quarter of 2009. This performance was at the top end of our guidance for the third quarter revenue to be in the range of 43 million to 45 million. Home and critical care grow the year-over-year growth, home had the strongest growth as revenue of 22.3 million, which represent a 37% increase over the third quarter 2009. With this performance home now represents 50% of total NxStage revenue.

Critical care delivered revenue of 6.8 million, representing a 20% increase over the third quarter 2009. As Jeff mentioned, solid machine sales and strong reoccurring revenues accounted for the year-over-year growth. In-Center revenue was 15.9 million, compared with 16 million in the third quarter of 2009. In-Center sequential decline from Q2 of 2010 was primarily resulted timing of shipment for the end of the quarter. Consistent with what we discussed in prior calls In-Center revenue will continue to be susceptible to the timing of shipments and variability in customer ordering patterns.

Gross margin improved to 33% in the third quarter of 2010, up 200 basis points for the second quarter and compares same duly with gross margin of 25% in the third quarter of 2009. The sequential improvement is consistent with our goal of making between one or three percentage point improvement quarter-on-quarter. The improvement from the third quarter of 2009 came from three primary areas within System One segment.

First, our cost base initiative, we continue to achieve lower manufacturing cost primarily as a result of certain cost saving initiative and improvement in product design and reliability. Next, product mix, in Q3 we had increased sales of higher margin products. And lastly, FX, in Q3 we had favorable foreign exchange rate. We reported a net loss of 8.2 million for the third quarter of 2010, compared with a net loss of 10 million for the third quarter of 2009. This improvement was the result of higher revenue and improved gross margin. Our net loss includes the impact of 7 million in non-cash items, primarily related to the amortization of deferred revenue, depreciation in amortization and stock based compensation.

Third quarter operating expenses increased 3.2 million over third quarter of 2009 and stock based compensation accounted for nearly one half of the year-over-year increase in operating expenses. The increase in stock based compensation is a result of the valuation stock based awards due to the upward movement at our stock price as compared to prior period, as well as achievement against the company’s 2010 performance metrics.

On a non-GAAP basis, we achieved positive adjusted EBITDA, adjusted for stock based compensation, deferred revenue recognized and other non-cash, non-recurring expenses with a profit of 5,000, compared with an adjusted EBITDA loss of 2.4 million in the third quarter of 2009.

NxStage also generated 1.9 million of positive cash flow for a three months ended September 30, 2010, which included strong home machine sales and 3.4 million in employee option exercises in the quarter. For the next couple of quarters, cash flow should range between plus or minus 2 million, based on the level of machine sales and inventory needed to support machine build plans and cash received from the exercise of employee stock option.

For the year, we expect cash usage to be between a positive 2 million and a negative 2 million. We ended the third quarter with 22 million in cash and cash equivalent.

Now let’s turn to our guidance. For the fourth quarter of 2010, we expect revenues to be in the range of 45 to 47 million, a net loss in the range of 6.5 to 7.5 million or $0.13 to $0.16 per share. And an adjusted EBITDA profit of 500,000 to 1.5 million. We expect to achieve a consolidated gross margins of between 33% to 35% in the fourth quarter of 2010 and remain committed to achieving our gross margin target of 50% over the longer term.

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Kim Gailun of JP Morgan, please go ahead.

Kim Gailun - JP Morgan

The first question I had was just a question about what you are seeing in the broader environment in front of the bundle coming in January. We have heard some commentary more on the PD side that there has been some behavior amongst the providers starting to kind of make a movement toward the home ahead of the bundle. So, curious if you are seeing any of that in your business?

Jeff Burbank

We are very enthusiastic about where the future is going to bring us in terms of more attention on home therapies. We are seeing that as well. I think that’s reflected even in some of the media that we’ve seen like the Wall Street Journal article and things like that, so there is definitely more focus and attention there. We think in general more attention on home is good for all home therapies including NxStage. It’s also a time of great change for the industry.

The bundle is probably the biggest reimbursement change that we’ve seen in decades. So I think there is a lot of adjustments’ being made and focus and we’ll see how that results as we move forward. So, little too early to kind of specifically say, but its pretty obvious that PD is more profitable that means there’ll be more investment there and we think the bundle helps our prospects as well and we’ll grow significantly over the next years.

Kim Gailun - JP Morgan

And a quick question on the nocturnal indication that you guys are waiting on. It sounds like you guys have had constructive back and forth with FDA, maybe over the last couple of months, do you have this sense from the agency are you waiting on another side of questions, or do you think that their next event is likely word on approval or I guess potential non-approval.

Jeff Burbank

The process still is very typical to us at this point, it’s very hard to predict, you go through the rounds, it would be very reasonable for us to have another round of questions as we now are down and communicate on those specifics. But I feel like it’s a very normal process and we are in the process just a little tough to predict the specifics on that and the timing on that. In general the FDA is trying to move the standard a little bit on medical devices, so I think it’ll take a little longer than it used to take, but the process feels pretty normal at this point.

Operator

Your next comes from Bill Plovanic of Canaccord. Please go ahead.

Bill Plovanic - Canaccord

Just as we think about the potential impact for bundling, I think a lot of people get very excited as what this can do for you, but I was wondering if you can walk us through what the mechanics are for the bottlenecks in bringing new patients on and even if there is kind of this flood of scripts that comes through. Can the system actually handle it? Now I'm not saying that there is a flood, but just to let you talk a little about the bottlenecks that you might face?

Jeff Burbank

I think that’s an important aspect of our business model to understand, and there is a good and may be not as good side of that, it cuts a little both ways. The great side of this business is it’s primarily an annuity based business model and it tends to be pretty predictable. With that said its very difficult to make immediate significant changes in the patient population because you have to go through the process of training patients which relates to the amount of training capacity that’s available. So there is a bit of a range that’s possible and it’s not like may be some other types of technology where you can just switch from one to the other. So, what we expect is over time that capacity the trend will expand, but it does takes some time to do it, so its not as immediate as we like, but on the other side its very predictable and very stable.

Bill Plovanic - Canaccord

Okay. And then at this point I think the way it's set up typically the center, they'll have a separate training room in the back or what have you that they can do X number of patients. As you look at all the facilities that you currently kind of have programs with, is that a case? Is that how it's done and if so, are they typically do they have is it one chair, two chair, four chairs? How would you characterize that?

Jeff Burbank

Sure, let me make sure because we may have some new people on the call, obviously we don’t train patients. So we provide the product to dialysis providers who then provide the training to the patients and that can take between two and four weeks depending on the patient. Its typically one on one so a center will have a dedicated area for home training and even maybe more specifically they’ll have an area that’s PD training and an area that’s home hemodialysis training, and they’ll go through a process of not only training the patient, how to use our device, but also how to care for themselves at home, how to recognize signs and symptoms and things like that. So it’s a pretty broad set of training that they do, and after that period, and the patient goes home and most centers will visit one or two of the treatments just to make sure the patient settled into the environmental okay and the machine is setup and its in a place its safe and those types of things. So that is a process that occurs and it takes in the range of 2 to 4 weeks depending on the patient and the trainer and such.

We worked very hard improving the efficiency of that with best practices and showing better tools to enable them to do that, that’s the role we can play to try to improve that efficiency and it does in time as we develop better and better techniques and approaches to training to help them be more efficient in fact.

Bill Plovanic - Canaccord

Okay, and then just you went through some metrics for us. You talked about the number of centers 10 or greater, 20 or greater and then you had a third comment in there and I just kind of missed that one relative to…

Jeff Burbank

Geographies?

Bill Plovanic - Canaccord

Yes.

Jeff Burbank

Yes, so we get those three metrics and they mean kind of different things, the first two are the penetration or scale of programs, because we believe, larger scale programs are more efficient, they get better at it. So we get a 10 and 20 centers that have grown past 10 or 20 patients. The next metric is how penetrated are we in the geography because dialysis centers they may have three or five dialysis centers in a geography, but they’ll typically pick one of those locations to do their home training. So we don’t want to know what the penetration was in the center, we want to know what’s in the penetration within that geography to see. Are we really penetrating the opportunity? So we share the number of geographies that are over 5% or the growth of that. That was up 20% sequentially and 26% year-over-year.

There is one more metrics that we give, that is another important one to us which is the increase in the number of nephrologists that are prescribed NxStage System One and that’s a measure of how well we are detailing the nephrology community, are they comfortable with writing prescriptions on therapy, and that was up pretty significantly to, it was 29%. Thank you, Kristen.

Bill Plovanic - Canaccord

And then last question, I’ll jump back into the queue. Just looking at the P&L we did see the G&A bump up a little. I think it’s bumped up couple of quarters in a row. The new level is just kind of since you’ve gotten to cash flow breakeven. You are kind of investing more in the infrastructure that was needed and is this level we should expect from here going forward? Thanks

Robert Brown

I think we are still being pretty consistent, we will invest in R&D, and sales and marketing when it makes sense. A lot of the bump up is actually related to stock base compensation, and two items in there. One is the value of the stock price is much higher this year when we granted our awards in last year. So that has caused stock based compensation to bump up, the other is that we are actually performing overall performance metrics right now, so that also cause it to go up. If you look at year-over-year cash spend on operating expenses, it’s only about half of the increase in operating expenses year-over-year. So, we continue to maintain pretty tight controls around that.

Operator

Your next question comes from the line of Matthew O'Brien of William Blair. Please go ahead.

Matthew O'Brien - William Blair

I just wanted to see if you are willing to provide the number of cyclers that were purchased in the quarter?

Jeff Burbank

No, that’s a level of detail we don’t think helps our business model. So as a percentage of the total it continues to increase.

Matthew O'Brien - William Blair

Okay. It looked like your deferred revenue increased pretty much early in the quarter, is that a function of existing customers that you've been with, potentially over a year or some newer customers that you've seen recently that has been driving that metric higher?

Jeff Burbank

I think in general we continue to increase the percentage of our customer partners that are buying versus renting, so that will relate to an increase in that number. But it’s not necessarily one specific customer; it’s more a broad base set of customers now.

Matthew O'Brien - William Blair

Okay, and then on the patient backlog side, have you seen that increase materially over the last several months, or has that been trending about where you've seen it over last few quarters?

Jeff Burbank

I think it's pretty similar.

Matthew O'Brien - William Blair

Okay and then one final one, kind of along Bill's question, but just do you have any sense for your training capacity in a quarter, be it 500 patients, not your training capacity but the centers where you work at, is it 500? Is it 1,000 patients in a quarter? I mean how many patients could legitimately get through if all the nurses were available to fully train?

Jeff Burbank

That’s a good question, we are really excited about how that capacity is expanded overtime, that’s a specific metrics that we are not going to share with you, we obviously know it and quite a bit of detail, but it has grown nicely for us overtime.

Matthew O'Brien - William Blair

Okay would you say it’s over or under 50% utilized on a quarterly basis?

Jeff Burbank

Not going to comment on that

Operator

Your next question comes from the line of Danielle Antalffy of Leerink Swann, please go ahead.

Danielle Antalffy - Leerink Swann

My first question is on gross margins for Q4. You guys had said in the past 1% to 3% sequential increase. It looks like now the 33% would actually be flat sequentially. What's going on there? Is there anything specific to the fourth quarter that we might not be appreciating that could be impacting that 1% to 3% sequential increase, and then just one more follow-up after that.

Robert Brown

No there is nothing specific, we still have a number of projects going through and we feel good about the points we are going to make in the fourth quarter. We are up 2 points in Q3 and we continue on that

Danielle Antalffy - Leerink Swann

Okay great and as far as the competitive landscape, some of your competitors have been increasingly more visible this quarter as far as timing goes can you talk a little bit about your thoughts there how that’s impacting your strategy and any update on next generation device from you guys, have you talked about that publicly or you are willing to? Thanks so much.

Jeff Burbank

So couple of things, I probably can add a lot to what they say about their plans. We are obviously very excited that others see the market opportunity the way we do, we have been planning our strategy around potential competitors in the future and feel like we are making good progress to be successful competitors and superior in the future and try to maintain our lead. So we feel good about that. I think in general, it’s a lot easier when you are not in the business to project what you can do than having the kind of experience that we have and understanding what it takes to be successful in this business. So my sense is that there are little bit more aggressive on their timelines publicly than we believe is achievable, but time will tell. But we feel like we are positioned well to compete anybody that wants to come into this market in the long term.

I’d like to go back maybe a bit to the gross margins as well. We made a really nice sequential progress Q2 to Q3 of 200 basis points and the guidance we gave predicts a similar kind of 1 to 3 point improvement next quarter. So we don’t see any, nothing strange is happening there.

Danielle Antalffy - Leerink Swann

And then can I just ask about the gross margin in another way, what would be factors that would drive you more towards that 33% range versus 35%? And also the impact of FX?

Robert Brown

I think the two factors that, lets step back a little bit. Generally over the last two to there years we have seen a lot of improvement in our cost of products and leverage on gross margin so we have made four years ago we were negative 18% gross margin, we are now 33% gross margin so we have moved on that path, we still see a lot of opportunity in that area.

As we get closer to the 50% goal, we see more of the impact of mix on our products, so higher mixed products versus lower mixed products. So that mix could now play into a quarter and actually have more get ability in a quarter going forward. The other thing we see FX, right now we are actually seeing the favorably euro going through because of our supply chain from earlier in the year. We still will see favorable FX in Q4 going through our P&L and the unfavorable movement in the euro will actually been seen in Q1. So we still feel pretty good about moving gross margins forward in Q4.

Operator

Your next question comes from the line of Jeff Hornman of Salto and Company. Please go ahead.

Jeff Hornman - Salto and Company

Just thinking about the In-Center business, timing issues impact this quarter, what’s your idea for your underlying growth in that business just if you looked at actual utilization rather than what distributors bought in any given quarter?

Jeff Burbank

That’s because of our significant market share in that business it grows very similar to the market growth rate which is in the 3 to 5% range.

Jeff Hornman - Salto and Company

Okay. And then I guess some of the other suppliers have talked about price pressure and customer trade-down ahead of the bundle in their In-Center supplies business, are you seeing anything similar?

Jeff Burbank

Can’t say that we have. No.

Jeff Hornman - Salto and Company

Okay. And then on the balance sheet it looked like inventory days were up sequentially, typically it's been down in the third quarter. Is that a result of the In-Center timing issues or is there anything else in there perhaps building demand on the home side?

Robert Brown

Actually most of that is in our supply chain on equipment components on the home side. We basically have up that a little bit, and had the opportunity to do that and we did it actually done it over the last three quarters.

Jeff Hornman - Salto and Company

And then do you have the gross margin for System One and In-Center broke out?

Robert Brown

Actually we do break that out in our Queue. Its actually System One is 38% and is 38% and the In-Center is 25% for the quarter. And that’s when we talk about mix, so the mix of system one, the In-Center right now there is more impact on that then we used to have, in the past it used to be the system one gross margins for closure the In-Center gross margin and so used to be big aggregate worked out mathematically very equal on two, now the system one is actually higher, so as we grow the system one faster, we actually move gross margins up, if In-Center is little bit in the stronger in the quarter, it actually tend to ramp back a little bit on the aggregate basis.

Jeff Hornman - Salto and Company

I know the visibility on a critical care side isn’t the greatest still? But is there a chance for kind of that budget flush quarter and fourth quarter similar to what we saw last year?

Jeff Burbank

There is two pieces of critical care business, first of all the disposables or consumables which is over 80% of the total revenue there, that's very predictable, it grows really nicely as we grow our installed base. So the variability comes in that 10% to 20% that relates to equipment sales. Those go through capital cycles, so Q3 is traditionally a lower capital sales quarter, Q4 tends to be higher, although we are little bit cautious on that because it tends to be back end loaded, so we don’t have as good a visibility on that going into this call, and so we tend to project that a little bit more conservatively, but fourth quarter is traditionally a higher equipment sales quarter for us.

Jeff Hornman - Salto and Company

You did 45 million this quarter, your guidance is 45 to 47 for fourth quarter. Home is still growing sequentially, even if its kind of low and that’s another 1.2 million, you got the potentially higher equipment sales in critical care revenues and probably not timing issues in fact timing issues effectively impacting positively the In-Center business so all that only adds $2 million at the high end.

Jeff Burbank

Yeah, when we apply our factoring on that, we have the systematic process that we go through every quarter, we compensate it the way we think is reasonable based on variance factors, so that’s where the number came up.

Operator

Your next question comes from the line of Suraj Kalia of Rodman & Renshaw. Please go ahead.

Suraj Kalia – Rodman & Renshaw

Just forgive me if I heard this wrong, you mentioned something about, by the way good quarter, on the interim analysis of FREEDOM, if I heard you correct you said the review of interim data is on the hold to make sure the study is appropriately powered may be forgive me I was driving and may be I heard it wrong. Can you expand on that and help us understand that?

Jeff Burbank

Sure, thanks for the opportunity to talk about it more. FREEDOM has a number of such studies in it and those have been very impactful with the practicing clinician population, all the things I listed in my talk relative to any hypertensive medications restlessly, sleep index, (inaudible) time to recovery and actually a 40% reduction mortality, so that clinical trial is delivering fantastic results that are driving our marketing. We have the opportunity to do one interim analysis and we looked at one the right timing for that was given that there is a lot data flowing from that and other sources as well. We think its best to take our shot at that interim not do it with the data we have today, but wait and look at it, so very pleased with the results we've seen, we just want to be really prudent because we've invested tremendous resources in that and we want to make sure it is as powered as it possibly can be on that interim analysis.

Suraj Kalia – Rodman & Renshaw

Okay and Jeff in terms of FREEDOM I don’t think so you’ll have indicated the level of enrolment. Would you care to shed some color in terms of what level or when do you expect or whatever you can share?

Jeff Burbank

Sure we are close to 75% enrolled on that trial.

Suraj Kalia – Rodman & Renshaw

Okay that is fair enough. And Jeff, Jim, what I heard on quality of life from FREEDOM maybe I goofed up the numbers I heard 6 to 17% improvement in quality of life. One, can you help us understand quality of life what are the metrics are being used and two is this commensurate to your expectations based on your experience in the industry.

Jeff Burbank

For that scenario we are really excited about and it requires kind of a familiarity with the measures of quality life. There is validated instruments that are used to look at typical and mental scores in quality of life, so we used the standard tools that are used in our industry to measure that. And I’d say its very difficult to show improvements in those scores as the disease progresses. So that’s what’s so stunning is that we can show quality of life improvement as the patient is progressing in their disease. There’ll be some more information on this coming out as a result of the FREEDOM trial. And I think we are really pleased with what we are seeing and how that’s developing, so its really hard to quantify if you are not intimately knowledgeable of those instruments, but those in the industry and actually the individual that works with us on this is well renowned in understanding quality of life and he is pretty impressed so impressed that he puts his name on the stuff for us so, we are real pleased with those results.

Suraj Kalia – Rodman & Renshaw

Okay, and finally, Jeff, in terms of the $1.5 million or so $1.2 million, $1.5 million sequential increase that we keep talking about, you'll have obviously looked at the training capacity and I agree with what you said look in terms of the training capacity and the floodgates won't open. And we see that in the field, but you're obviously looking at the $1.5 million sequential and you're looking at the reimbursement landscape change, it has become a little more level playing field for you compared to what the others were enjoying. At what point, would you care to say, is that three quarters, two quarters, six quarters, down the line will you say, you know what guys, we expect this trajectory to change because things are going to start coalescing based on this, this, this? What timeframe should we look at?

Jeff Burbank

Yeah I think our behavior in the past you will basically project our behavior in the future so you know going in to the year we were talking about a $1 million sequential improvement. We had some success across this year and it came from a number of initiatives everything from FREEDOM, data to clarification and reimbursement, better product and better skills in the centers. So we move that up to a new range of 1.2 to 1.6 I think as we move forward we’ll look at that number we’ll see what the behavior is around the bundle I think it’s a little too early to say is that a specific catalyst because we got a transition period here. So lets get past that see how providers are acting certainly there is a lot of enthusiasm, so we got to see if that translates into actual behavior and our tendency is to say we are going to call it when we know it, we are not going to talk in futures.

Operator

Your next question comes from the line of Darren Lehrich of Deutsche Bank, please go ahead.

Darren Lehrich - Deutsche Bank

I just wanted to ask one question about the penetration of your patient base maybe an update, what percent of your new patients are in the most recent period. We are receiving dialysis outside of the first 120 days. Is there any update you can provide is there any sort of change in terms one piece in serve coming on the service for you?

Jeff Burbank

I think I need a little more clarification, are you asking whether we are treating or moving incident patients into NxStage therapy or where our patients are coming from is that the question?

Darren Lehrich - Deutsche Bank

Yes that is the question.

Jeff Burbank

So the vast majority of our patients are not incident nor are they transplant barrier or PD failure. They typically are coming from In-Center dialysis and the reason is just the coordination of that, when you are making a therapy change you typically will stabilize and get in the queue for home training. So, it’s a little bit, there is some inaccuracies because we say statistically they are coming from In-Center.

When reality is and we just did a discussion about 50% or more of our patients have been PD but the issue the felt PD went back into the center to way to get trained. So we see a lot of patient flux, but there is a route by which they go. So a lot of our patients are PD failure. Very few are incident, but we do have some incident patients. And then some are long term dialysis patients that have been In-Center that are looking for better therapy

Darren Lehrich - Deutsche Bank

Okay. That's helpful. And then my other question just a little bit more of a high-level question around the reimbursement changes that are coming. It seems like a lot of your customers are clearly going to be impacted by the transition payment adjustment in 2011, and I guess we are starting to get some indications about the opt-in plans of the major chains. I guess the first question is do you have any indication at all from CMS as to how they may revisit their simulation model, around what's been learned from the November 1st opt-in decisions by providers, and whether you think that may stand a chance to change the transition payment adjustment in ‘11? And then, the second part of that question is just relative to the opt-in versus the transition, do you think behavioral changes among your provider customers may be any different?

Jeff Burbank

Okay so pretty broad question I think may be I can frame up the first part of it because it’s more of an industry question than it is NxStage specific question. I don’t think there is a direct consequence to NxStage if you will. So that’s in the process of implementing bundle, a provider can either transition in over four years to the new structure or they can opt in on 100% on January 1st. So data is starting to become available that says that most of the providers and it looks like potentially over 90% are going to opt in to transition as of January 1st. So what the providers are saying there is, there was an adjustment, I think about 3.1% that was taken out of payment to adjust for that transition and they are saying that was predicated on our far lower number of providers opting in. So, they are trying to get that number revisited so they don’t have to deal with that kind of reduction in payment during the transition period. I believe CMS doesn’t think they can have the authority to make a change due to the rule making process and the time that it would take, so I think this strategy is to try to get a legislative answer to that. So, the industry is working to try to solve that in equity if you will because more opted in than the calculation was based on.

I don’t have any idea how to predict the success of that or not. It is one of those things [target per debt]. But whether that impacts us, I think generally for two reasons I like the fact that more opted in. one is we think bundle is the right direction for therapies that have clinical benefit and can potentially reduce medication use, I mean that was the whole reason or instance for this change was that good therapies that tend to reduce drug utilizations were reducing profitability centers which disincentive their adoption.

So, to the extent more go into the bundle, we think that’s a good thing. There other I think there is a lot of complexity in having a four year transition. So, we much rather get to the other side of this and get on with business both as an industry, but also NxStage so that we are not having an industry that’s distracted over years versus over maybe a few quarters.

Operator

You have a follow up question from the line of Bill Plovanic of Canaccord Genuity. Please go ahead.

Bill Plovanic - Canaccord Genuity

Just we are approaching ASN in a couple of weeks, so I was wondering, I don't think you'll have any data presented, but is there any key data that we should focus on while we're out there? That's all I had, thanks.

Jeff Burbank

So, there will be some posters, abstract those types of things around NxStage. So we actually do have some data continued either from our customers or other sources. So we don’t see some good stuff there around NxStage. In addition, and this is speculation I think at this point, but there has been a lot of discussion of whether some of the results from the IDDK home and more frequent and Nocturnal study will be presented there, that’s generally what people think there is going to be some insight to the results of those which would we assume kind of be pretty exciting because most of the trials have been positive. This is an independent trial, its not company sponsored it probably carries very good weight and in terms of educating clinicians on the results and hopefully the benefits of that therapy. So, we are pretty optimistic about what could become available at the ASN this year.

Bill Plovanic - Canaccord Genuity

And then the IDDK data, if it becomes available is there a certain day or time that we should be looking at?

Jeff Burbank

We can make that available. My assumption is its like breaking news because I don’t think they would have made the timeline for traditional. So that’s a specific session that you can look for in late breaking news.

Operator

Your next question comes from Kevin Ellich of RBC Capital Markets. Please go ahead.

Kevin Ellich - RBC Capital Markets

I just wanted to reconfirm did you say that your sources indicated 90% of the industry opted all in to bundling?

Jeff Burbank

That’s clearly an estimate, there was a survey by the (inaudible) group that was discussed in a press release. Their survey which wasn’t a 100% clinics at 98%, but then they did some factoring and other things and said it’s likely that over 90%. I think that’s roughly, but the net-net takeaway is the majority and I think presenting as they were on their call earlier in the week, DaVita I think has their call today. So, we should hear that and obviously that two-thirds of the market there depending on what DaVita does and then you can fill in the rest with the survey, but it looks like the vast majority will.

Kevin Ellich - RBC Capital Markets

And then just one other question. Just curious there has been a lot of discussion this morning about bundling the strategy of the company, but how do you think this will play out pre-NxStage, are you going to see increased competition? Are you going to see private penetration into the market? How are you setting things up?

Jeff Burbank

Let’s take each one. Competition, we don’t expect to see another company with a home indication of the product for two to three or four years. Two by their admission, longer because we think it may take longer to get the markets in that. So competition isn’t really in the near term. Long term, we have always expected competition and we position ourselves well for that inevitability. In terms of growth, I think that goes back to what I was saying earlier where we have been in the range of sequential growth, we feel pretty comfortable with that at this point. We haven’t seen specifics related to behaviors with the bundle, because I think everybody is kind of in the getting ready mode. We need to have a little bit more information on that to say is this a specific catalyst or not. We've heard a lot of discussion about PD and even potentially seeing some increase in PD and that’s a good thing. We think focus on home will expand home therapies in general, so we just need to have a little bit more experience, PD will grow its a mature therapy it will grow some percentage. Home hemodialysis is growing at a far greater percentage, we are just starting with a smaller base.

Kevin Ellich - RBC Capital Markets

Understood and then do you think you need to broaden your product offering outside of home hemo in the bundled environment?

Jeff Burbank

Well we do have a pretty broad product offering, we have good product position in the market leaders in our products and In-Center, we don’t have every single product category so there may be some opportunities with that over the long hall, but we have a pretty comprehensive relationship with our customers across all the products we are purchasing.

Operator

As there are no further questions, I would now like to turn the call back over to Jeff Burbank, CEO for closing remarks.

Jeff Burbank

Thank you everyone we appreciate your attention. Thanks for celebrating our first positive EBITDA quarter. And we look forward to talking to you after our next quarter.

Operator

Thank you for your participation on today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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