NxStage Medical Inc., Q4 2007 Earnings Call Transcript

Feb.12.08 | About: NxStage Medical, (NXTM)

NxStage Medical, Inc. (NASDAQ:NXTM)

Q4 2007 Earnings Call

February 12, 2008 9:00 am ET

Executives

Robert Brown - SVP, CFO and Treasurer

Jeff Burbank - President and CEO

Analysts

Taylor Harris - JP Morgan

Ben Andrew - William Blair

Bill Plovanic - Canaccord Adams

Robert Faulkner - Thomas Weisel Partners

Anthony Ostrea - JMP Securities

David Beard - Morgens Waterfall

Vivian Wohl - Federated Kaufman Funds

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter and full year 2007 NxStage Medical Incorporated earnings conference call. (Operator Instructions)

I would now like to turn the presentation over to Mr. Robert Brown, Chief Financial Officer. Please proceed, sir.

Robert Brown

Good morning. Hopefully by now, you have seen our fourth quarter and yearend press release. For your convenience, a replay of this call will be available, beginning tomorrow, for one week. In addition, the press release for the fourth quarter and yearend results, and a recording of this call, will be archived on our website under the Investor information section.

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 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 of our operations, growth of the home and more frequent hemodialysis market in general, market adoption and demand for our product, the rollout of the PureFlow SL, anticipated benefits of the Medisystems acquisition, anticipated improvement 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 discussed in our SEC filings, including our quarterly report on Form 10-Q for the period ended September 30, 2007.

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 would like to turn the call over to Jeff Burbank, our CEO.

Jeff Burbank

Thanks Robert, and thank you all for joining us. When I look back on 2007, I'm really pleased with the remarkable transformation of NxStage in just one year. When we spoke last year at this time, we were targeting two dialysis markets, and still striving to convert a sliver of the market to home hemodialysis.

Today, NxStage is taking its place as the dialysis industry leader in three markets; critical care, in-center and home hemodialysis. Our biggest growth opportunity of home hemodialysis has seen a lot of validation from partners, patients, and clinical data, and even our competitors. As I look forward to 2008, I'm excited about the opportunities to continue growing NxStage as an innovator and a value leader in this market.

I'd like to organize my thought in four categories that I consider the most important aspects of our business. They are product quality, market development, clinical evidence that support the adoption of our products, and finally, our economic performance. So I'm going to organize my remarks today around these four areas.

So let's start with product quality. I'm pleased to say there are no new or emerging issues to report. The way for NxStage to be a leader in this industry is to deliver superior quality in all that we do. We experienced what's it worth and quality can do during the third quarter of 2007 with the cartridge leaks. I'm proud that our quality systems were responsive, and minimized our customer's inconvenience.

However, the quality issues had a big impact on our Q3 financial performance. We learned a lot from that experience, and have improved a number of our processes and procedures as a result. We're in a stronger position now, to deliver our quality commitment, than ever before. We have a product design that's stable, we benefited from our recent vertical integration, and we're just planning to have more mature systems.

Let me say a few words about Medisystems quality. Medisystems branded product have long enjoyed the reputation of being the best quality, which is one of the reasons that we were attracted to them as a partner, and ultimately as an acquisition. Through the acquisition transition, we've retained most of the people that created this success, so we feel really good about carrying this tradition of excellence forward. We believe our new blood tubing set, Streamline, presents an opportunity to establish an even higher standard of quality and value.

Turning to NxStage branded products, we made significant progress in a number of areas during 2007, though we did also have a few disappointments, particularly related to the Q3 cartridge leaks. First, looking at PureFlow SL, overall, we are extremely pleased with the success of this product line. We did start 2007 with quality challenge associated with the PureFlow's rapid launch and scale up, but we ended the year with a maturing product that has achieved wide option and support from our patients.

At the end of 2007, 70% of our patients were using PureFlow SL. And according to a survey of over 300 users, 95% of them would recommend it to other patients. We continue to work with some centers in certain states to ensure that PureFlow is implemented consistently with their regulatory guidelines. We continue to see progress in performance and adoption moving forward.

The System One cycler, which going into 2007, had already earned a reputation as a reliable device, saw a 25% improvement in its reliability across the year. We expect to achieve another 10% in reliability improvements in 2008. We introduced an entirely new filter design for System One during the first quarter of 2007. You haven't heard me talk about it much, simply because it went so well. During the majority of 2007, our customers have been using this new filter, which improved performance and reduced its cost. This is how we'd like all of our product enhancements to go.

As you know, our System One cartridge had a dip in reliability this year associated with product leaks. We recalled certain affected lots of the cartridges in Q3, in a sense to improve the robustness of our cartridge design, as well as mature our quality processes to further booster reliability. I like the progress we've made in this area, and the commitment our organization has to continue to improve all the aspects of quality and reliability.

From the high quality standards of Medisystems business, we know what's possible to accomplish. We have ways to go to achieve our internal goals, but we've made significant progress in 2007, and we think the market is really noticing the improvements.

Now, let me take a few minutes on our three markets, and discuss how they are developing. First, critical care. We estimate that there are between 1,800 and 2,200 critical care systems used in the US. Assuming about a seven to eight year useful life in a hospital before replacement, there is an annual machine market of about 300 machines.

We believe that this market has been a little smaller than that in the last two years, due to Gambro's absence delaying some purchases, but will be closer to that 300, or even more, with them back in the market. After just a few short years in the market, we believe we are now 20% to 25% of the installed base, and clearly lead in the share of new placements. This success continues to drive revenue growth, actually 77% improvement this fourth quarter over a year ago.

Gambro appears to have resolved their import hold in the fourth quarter of 2007, and they recently received their 510(k) clearance for Prismaflex, which is their critical care system. They are now back in the market, and we're absolutely confident in the benefits of NxStage System One and in our field team, which has been preparing for Gambro's reentry.

With respect to the in-center market where we sell Medisystems branded products lead strong sales in the fourth quarter of $15.7 million. We believe this is approximately a million higher than end customer demand, as our distributors adjust their inventory up to normal levels.

The market continues to see the value of our high quality products, which improved clinical performance and save cost. Last month, we were pleased to announce the five-year agreement for MasterGuard needle sales to DaVita. We're expanding our Streamline airless blood tubing system past the first few centers and are replicating success.

Streamline sales will not be a significant percentage of our sales this year, but our activity this year will lay the groundwork for 2009 and beyond. We see the growth of our sales in this segment matching the market growth due to our large market share. As we get further along with Streamline and launch other products, we should have an opportunity to grow a bit faster than the market.

In the home market, we've seen nice growth throughout 2007. We grew centers by 28 in the fourth quarter, and 160 for the whole year. Patients grew by 266 in the fourth quarter, and by 1,201 for the entire year of 2007. At the end of the year, we had 2,223 patients changing their lives by using NxStage System One at home. We're very excited about the therapy, and how the market is developing, which is reflected in our guidance for 2008. Once again, we'll significantly draw the number of patients going home with NxStage.

As we think about how to continue to develop this market, we believe the three key drivers are providing clinical evidence, reimbursement and momentum through penetrating local markets. These will be the leverage we're prioritizing in 2008. I'd like to give you a little bit more insight into our plans for that last driver, building momentum to penetrate local markets.

We're spending a lot of time ensuring we're developing this market as effectively as possible. Based on our experience, we are adjusting our tactics a little bit in 2008 for longer terms growth. We think there is benefit in focusing even more on developing large deep partner centers. We like what we see when programs go up, grow larger, and we think this deserves more emphasis.

By focusing on patient density, we believe we can make a geographic area more robust as centers respond with more training resources while gaining in sales efficiency. We want our sales team to turn their focus from to creating local demand, because we think that we have reached the point where patient access really isn't the limitation by center availability.

Therefore, we decided that we'll target adding approximately 20 or 30 centers per quarter, rather than approximately 40 per quarter that we were adding during 2007. This will allow our commercial team more time with existing accounts, and with prescribing physicians. We want to see the impact of this focus with our existing experienced sales team before we expand our sales team further.

Based on our experience, we think this approach will optimize the development of the market. But we're adjusting as we go, and we'll remain nimble as the market develops, particularly if there are significant changes in reimbursement, or clinical evidence that could impact demand.

We're aware that we won't be the only home dialysis product in the market forever. We know the market better than anyone else, and believe this is the best way to exploit our leadership position today to commence growth and economic efficiency. Reimbursement is clearly a key driver for this business and we are actively working to achieve favorable outcomes there.

Commercial insurers, and in particular Kaiser Permanente, have demonstrated strong support for daily home, and these payors have been the primary enablers of growth of the therapy today. We're confident that Medicare reimbursement will be modernized, so that these beneficiaries may also have equal access to these life changing therapies. But we obviously can't count on this or predict when these changes may happen.

Turning to another driver I mentioned, supporting clinical evidence of our products, we believe doing good clinical work and sharing these results is crucial to support a broad market adoption. Daily home dialysis continues to be a much discussed topic at clinician meetings as one of the great potential alternatives to dramatically improve patient outcomes.

We were again pleased with the number and outcomes of the work presented at American Society of Nephrology in November on home and more frequent dialysis. A few highlights include an Australian study of 72 patients on nocturnal home dialysis, which showed a reduction of mortality by 58% when compared to a match cohort of patients in the US RDS database.

In another study in the US, 8 patients reported a recovery time of 4 to 12 hours on traditional 3-time a week in-center therapy. This dropped to less than 15 minutes when they were converted to short daily hemodialysis with the NxStage System One. In our own clinical work, enrollment continues on the Freedom trial. As of this call, we have 157 patients enrolled. We look forward to sharing the first data on this, this year.

In addition, we've been monitoring mortality rates in our patients since the commercialization of our product. We thought it was the obligation of a responsible company to do this, so we've been reviewing it frequently with our Medical Advisory Board. It seems similar to what has been reported by others, such as the study at Northwest Kidney Center, which shows 30% to 40% improvement in mortality for patients on daily home hemodialysis. We're very encouraged by what we see in our own data, and we'll be looking for the right vehicle to share it more broadly.

I'm also very pleased to provide an update on our nocturnal trial, news that I think many of you have been waiting for. We've received unconditional approval from the FDA to conduct our nocturnal IDE trial, which should lead to an expansion of our indication statement to include nocturnal use. We're initiating a study over to the next few weeks.

I'm very pleased to be on a path that will add a nocturnal indication to our product. We think this is another application where the market wants a clear device to give them confidence. The trial design is very similar to the one required for the home indication, which took us about 18 months to conduct and gain FDA clearance.

Moving to clinical development in the in-center business, on Streamline, we continue to just demonstrate the clinical and economic advantage of this product with trials and customer evaluations. As we continue to grow from the initial centers, we've been able to replicate our success. Synergies in Streamline have been able to increase their patient dialysis dose delivery, increasing the number of patients achieving a very lofty goal of Kt/V of 1.4 from 75% of patient to 90% and to achieve a minimum Kt/V of 1.2 preferentially all other patients.

These increases were achieved while reducing dialysis usage by 25%, which significantly impacts both cost and the environmental responsibility of centers. Their additional advantage is a Streamline, but this one is really causing people to rethink the role of tubing sets in delivering better therapy to patients at improved economics.

Now let me turn to my final category of comments, which is how we improve our economic performance moving forward. Pricing has held in all three of our market, and we think it will continue to be relatively steady in 2008. So I'll focus more on the key cost area.

Let's first talk about cost of goods, and more specifically, that of the NxStage products. We continue to make progress on projects that will deliver the cost performance we need to become profitable, as well as achieve our ultimate goal of 50% gross margin. As we have implemented these cost reduction projects, we have consistently achieved the benefits we intended.

Some examples in 2007 were the transition of PureFlow disposables to Mexico, the switch to our new filter and equipment manufacturing in Mexico, just to name a few. Although we've delivered the cost reduction, it has taken us longer than we anticipated for this to impact the P&L. As a result, we've been more conservative in our guidance to reflect slower impact of cost reduction projects in 2008.

Turning to distribution, as I mentioned in the past, we beefed up our distribution team. They're just starting to be able to impact their cost, so we expect to reduce distribution cost for home and critical care from 28% of revenues in the fourth quarter to approximately 20% by the end of 2008. Ultimately, we think distribution should be about 10% of sales, which will require more scale in the systems and network that come as a result over the next few years.

In R&D and clinical areas, we have a nice pipeline of products and programs. Real world experience continues to point us to worthy opportunities that we believe will keep us the leader in value, ease of use, safety, quality, and functionality. Therefore, we are increasing our spending in this category by about 25% over what NxStage did in 2007. This reflects continued investment in both NxStage and Medisystems.

As we build our models looking at the next few years, these revised assumptions, and timing of cost reductions, and increased R&D spending, led us to believe we will need additional capital to fully fund our business model. We expect it to be in the range of $20 million to $40 million, and we'll be evaluating the best way to raise this capital. We'll update you on our plans as they develop.

In conclusion, we're very optimistic about the growth opportunities before us in each of our three markets in 2008 and beyond. We'll continue to focus on product quality and cost improvements in the coming year. And we have our eye on a number of potentially significant clinical developments on the horizon. We've put a lot of pieces in place in 2007, and now are poised to execute on many exciting opportunities in 2008.

Thank you. And I will now turn the call over to Robert.

Robert Brown

Thank you, Jeff.

Revenues for the fourth quarter of 2007 were $29.9 million, compared to $7.4 million in the fourth quarter of 2006 and $11.6 million in the third quarter of 2007. This represents a 307% year-over-year increase, and a 157% sequential increase compared to the third quarter of 2007.

Revenues for the fourth quarter of 2007 include revenues from the acquisition of Medisystems Corporation beginning as of October 1, 2007. Excluding the impact of the acquisition of Medisystems, revenues increased 93% year-over-year and 22% sequentially.

Revenues in the chronic home dialysis market were $9.3 million for the fourth quarter of 2007, compared to $4.6 million in the fourth quarter of 2006, and $8.3 million in the third quarter of 2007. This represents a 103% year-over-year increase, and a 12% sequential increase compared to the third quarter of 2007.

Revenues in the critical care market for the fourth quarter of 2007 were $4.9 million compared to $2.7 million in the fourth quarter of 2006, and $3.3 million in the third quarter of 2007. This represents a 77% year-over-year increase, and a 48% sequential increase compared to the third quarter of 2007.

Revenues in the in-center market from the company's Medisystems business were $15.7 million in the fourth quarter of 2007. Full year 2007 revenues were $60 million, including revenues from the Medisystems acquisition in the fourth quarter, a 188% increase compared to $20.8 million for the full year 2006.

Full year 2007 revenues in the chronic home dialysis market totaled 29.8%, a 134% increase compared to $12.7 million for the full year of 2006. For the full year of 2007, critical care revenues were $14.4 million a 78% increase compared to $8.1 million for the full year of 2006.

We added 266 patients during the fourth quarter, and at the end of December, the number of patients on the System One in the chronic care market totaled 2,223. We added 28 centers in the fourth quarter reaching at total 334 at the end of the year.

Gross margin in the fourth quarter of 2007 was 2% compared to a 30% debt in the third quarter of 2007. We had expected gross margins in Q4 to be 12% to 13%. The miss is attributable of $2.5 million of cost or 8 margin points, primarily related to the acquisition of Medisystems that are not expected to recur, foreign exchange for 1 margin point and cost improvement projects which were delayed for 1 to 2 margin points. Excluding the $2.5 million of cost not expected to recur, gross margins would have been 10% in the quarter.

Operating expenses for the fourth quarter were $17.8 million, compared to $9.9 million in the fourth quarter of 2006. The increase in operating expenses reflects increased sales and marketing expenses as we expand our sales force and increase our marketing activities and distribution expenses for a growing number of patients.

The increase in general and administrative expense reflects $1 million of operating expenses, $800.000 of amortized intangibles and $500,000 of acquisition cost related to the Medisystems acquisition. Non-cash stock-based compensations totaled $1.2 million in the quarter.

We reported a net loss of $17.4 million or $0.47 per share for the fourth quarter of 2007 compared with a net loss of $10.4 million, or $0.37 per share for the fourth quarter of 2006, reflecting improved gross margins offset by increased spending in sales and marketing in support of the ongoing launch of the System One, and increased distribution expenses in the chronic home hemodialysis market.

Fourth quarter 2007 net loss includes $3.2 million in charges primarily related to the acquisition of Medisystems that are not expected to recur. For the full year 2007, we reported a net loss of $58.4 million or $1.86 per share, compared to a net loss of $39.6 million, or $1.60 per share in 2006, reflecting improved gross margins offset by increased spending in operating expenses as the company continues to build its infrastructure to support the business.

We ended the year with $34.3 million in cash, cash equivalent and short-term investments compared to $61.8 million at the end of 2006.

Turning to guidance, for the first quarter of 2008 we expect revenue to be in the range of $29 million to $31 million. We expect a net loss in the range of $14 million to $15 million, or $0.38 to $0.41 per share, including estimated non-cash stock-based stock compensation charges of $1.4 million to $1.5 million. We expect to add 300 to 375 additional net patients, in 20 to 30 new centers, offering therapy with the NxStage System One during the first quarter.

For the full year 2008, we expect revenue to be in the range of $130 million to $140 million. We expect the net loss in the range of $52 million to $56 million, or $1.41 to $1.52 per share for the full year of 2008, including estimated non-cash stock-based stock compensation charges to $6 million to $7 million, and amortization of acquisition intangible of $3 million. We expect to end the year with 3,700 to 4,100 patients at approximately 420 to 450 centers offering therapy with the NxStage System One.

We expect a 12 to 14 point gross margin improvement by the end of the year. The majority of the improvement will come in the home business as we continue to in-source and improve the reliability of our equipment and cross reduce our PureFlow disposables.

Operator, that concludes our prepared remark. Please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

And your first question comes from the line of Taylor Harris with JP Morgan. Please proceed.

Taylor Harris - JP Morgan

Thanks a lot. Jeff, just want to start on the gross margin issue and the cost reduction program, some of which you talked about. You mentioned having success in some programs, but those taking longer to hit the P&L than you had expected. Can you just elaborate on that and tell us why that's occurring?

Jeff Burbank

Yeah. I think there are multiple reasons, Taylor. It's specific to each project. For instance, in some of the disposable areas, the fact that we had the quality issue in the third quarter distracted some of the resources that were working on cost reduction. So that's one example. Another example is we were just a little too optimistic like the transition of our equipment into the Mexico facility. It's just taking a little bit longer than we had modeled. So we wanted to do a better job tightening up on that based on our experience.

In all cases, we achieved the cost reductions that we set out to achieve. So we have very tight model on that. And looking forward, we've identified the projects that will take us to the kind of economic performance that we want to achieve. Specifically, we're pretty comfortable that we've identified everything that needs to be done to, over the next two years, get us to 50% gross margins. But you can't do it all today. So we've modeled out what we think is more realistic relative to that project timing.

Taylor Harris - JP Morgan

Okay. And to clarify the '08 guidance for the 12 to 14 points of improvement through the year is that off of the reported base that you had in the fourth quarter or an adjusted figure to exclude some of those non-recurring costs?

Robert Brown

Yeah. It's the adjusted figure of 10%.

Taylor Harris - JP Morgan

Okay. So in the year close to 25%?

Jeff Burbank

22%, 24%, I think.

Robert Brown

22%, 24% by the end of the year.

Taylor Harris - JP Morgan

Okay. As we think about the leverage that you have for the subsequent years, is that the scale of improvement that we should see year-over-year for the next three or four years that gets you to that 50, or can it start happening more quickly than that?

Robert Brown

Not quite sure I totally understand your question.

Jeff Burbank

Is it linear or --

Taylor Harris - JP Morgan

What's the progression to 50% gross margin, how many years do you think that takes, or ultimately, how many patients do you think you need on therapy to be there?

Jeff Burbank

I'll let Robert answer that too, a lot of moving parts on doing that. In general, it tends to be a little bit more front loaded, but this one, it's pretty linear.

Robert Brown

Yeah. I think it's pretty linear. It's less patient-dependent than it has been in the past because we're starting to actually get some mass over our fix infrastructure base. So there will be less coming from leverage of our infrastructure base and more just cost reductions in the products themselves.

Taylor Harris - JP Morgan

Okay, great. And then one final question. Jeff, on the strategy for going deeper into existing centers, have you tested that in certain markets? And what are you seeing underneath the reported numbers that we see, which would show patient per centers staying relatively flat, but probably because you've added so many centers over the past year, what are you seeing in local market areas as you try to implement that strategy?

Jeff Burbank

Yeah, that's a good question and I want to be clear about. It's not a change in direction. It's really a refinement in the focus based off of what we learn. So let me share what we've learned. The centers have grown at the rate that we wanted and expected. But when you take a center and see the effect of it after growing longer and getting bigger. You see some benefits both economically for us because you have a density of patients and it's more efficient for us to manage in distribution cost and all things like that, also more efficient with the referring clinician.

So, we like that model and we're pairing down that versus some centers that we probably were driving always to go deep, but maybe go deep in some more rural areas or some areas that take a little longer to get to those kinds of things. So, we're just tuning that a bit and seeing if we can redeploy those resources to drive those larger centers and those deeper centers even a little faster than what our previous model had predicted. Was I clear on that, Taylor?

Taylor Harris - JP Morgan

Yeah, it was. Thanks a lot.

Operator

Your next question will come from the line of Ben Andrew with William Blair. Please proceed.

Ben Andrew - William Blair

Good morning, Jeff.

Jeff Burbank

Morning.

Ben Andrew - William Blair

Just a couple of questions. If you think about the patient acquisition cost, if you try to calculate that for '07 versus kind of where you're guiding for '08, do you see that changing materially or do you guys even look at it that way?

Jeff Burbank

Well, in a sense yes, we do look at it that way. Maybe everybody does their math different. Some just say what's the percentage of sales that you're investing, some try to break it down to centers or patients. So that is what is fundamentally driving us to make sure that we're not -- let me back up a little bit, Ben.

The challenge in developing the market is always finding the right balance between not pushing hard enough so that the market's not developing as fast as you'd like and you're leaving an opportunity and pushing too fast and being inefficient in your spend. And what we're trying to do is tune a little bit off of what we learn to try to strike that balance. So, we're constantly looking at are we getting over our ski, so to speak, or are we back too far.

And that's what this is about. And it is based on the analysis that you let into the question with, which is, are we getting the level of efficiency we want? And we believe that once you learn how to get that efficiency, it's easier to replicate it, and we're just turning a little bit, tuning a little bit to make sure that we've got that level of efficiency going.

Ben Andrew - William Blair

So basically by reducing the number of clinic openings, you can improve that efficiency of patient additions and keep those costs a little bit better under control?

Jeff Burbank

We believe so. We believe it's a more economical way to grow the business moving forward, right.

Ben Andrew - William Blair

Okay.

Jeff Burbank

As contrasted to the strategy that says, you go out and you really push for every patient you can put on the system.

Ben Andrew - William Blair

Right. No, of course, because we talked about last year, towards the middle of the year, sort of setting the sales force loose versus holding them back, and it sound like maybe we're going back towards that restraint model a little bit just to make sure we go deeper and do it more efficiently than opening --

Jeff Burbank

Yeah. It's hard to get. It's maybe a 20% change, it's not a 50% change. It's a slight modulation. It's dealing with the outliers and making sure that we're spending more time on what we think statistically represent better opportunities.

Ben Andrew - William Blair

Sure. And if you think about the distribution costs, those have consistently been running ahead of plan. I know some of that was because of the recall and whatnot, but talk about why beyond the recalling the extra shipping of components for PureFlow and what not that that's been running higher, and why is it going drop so quickly even over the course of '08 as a percent of revenues? I assume you're talking as a percent of revenue just the home and over the critical care piece?

Jeff Burbank

You want to take that one, Rob.

Robert Brown

Yeah, that's true, Ben. It is just as a percent of home and the critical care piece. We saw a 2 point improvement in those distribution costs between Q3 and Q4. The teams have been in place now for three to six months now. They are gathering information they are getting, a lot of good data for us look at.

A couple of things that we see are going to help us as we go forward through 2008. The first is basically we've renegotiated our rates with some of our carriers. So we'll start to see benefits of that in Q1 and that will carry through for the rest of the year. The other item is that we're going through our processes and streamlining our processes and streamlining our shipping lane to take full advantage of not expediting and also taking full advantage of full truckloads on certain lanes. And we see that benefiting us as those process improvements go in throughout the year.

Jeff Burbank

I'll be the summary guy here. There are really two things. We now have a capability from the team, and we're also at a different scale level than we've been. And we can take advantage of those two things and really believe there's good opportunity there.

Ben Andrew - William Blair

Okay. And last question on the cash side. I mean if I do the math you took down 25 on the debt before. Has that changed? And you just add that through your cash on hand with what's left on the line that gives you about $60 million. If you're going to burn EPS of 52 or 56 and your CapEx is pretty minimal, there's some D&A in there, of course, aren't you going to be down to say $10 million-ish or so by the end of the year? And how does $20 million or $30 million more get you to profitability and leave you some cushion obviously?

Jeff Burbank

Yeah. You're not far off from our modeling. We haven't been specific on that, but that's why we believe $20 million or $40 million. And if you take the cost reductions and the way the P&L evolves over that period of time, an additional $20 million to $40 million does give us a kind of a cushion that we're looking for.

Ben Andrew - William Blair

So you feel like coming out of Q4, the net income burn rate is coming down pretty hard. And then if you think about profitability is it still sort of Q3 '09-ish or has that moved as a result of some of the cost changes that you've talked about.

Jeff Burbank

Again, lots of moving parts haven’t been specific. But your model is not that far off of what looks feasible to us right now.

Ben Andrew - William Blair

Okay. I'll hop off. Thank you.

Jeff Burbank

Thanks.

Operator

Your next question will come from the line of Bill Plovanic with Canaccord Adams. Please proceed.

Bill Plovanic - Canaccord Adams

Great. Thank you. Good morning.

Jeff Burbank

Hi, Bill. Good morning.

Robert Brown

Good morning.

Bill Plovanic - Canaccord Adams

Just a couple of questions. Actually, if you go back to the one-time charges, I was wondering you said $2.5 million of that was in the cogs line and the other 700,000 where was that in the P&L?

Robert Brown

It was in general and administrative charges.

Bill Plovanic - Canaccord Adams

And then, did I hear you correctly in terms of the Medisystems that about $1 million of that was in excess of actual demand or stocking?

Jeff Burbank

Yeah. In terms of the revenue, it was 15.7. It was, we think, about $1 million higher than end customer demand and that was to reflect our distributor getting back to inventory levels that are their standard levels. So we wanted to share that with you so that you didn't model off of higher revenue than is a steady state.

Bill Plovanic - Canaccord Adams

Okay. Would there be any more inventory write-up or one-time cost associated with the Medisystems acquisition as we roll through first quarter 2008?

Robert Brown

Nothing material. There's a slight amount for some lower running codes, but it really won't impact the Q1 financial numbers.

Bill Plovanic - Canaccord Adams

Okay. And then in term of the Freedom trial you gave us the number of patients. What's the number of centers enrolling? Do you expect that to change? And then, just some commentary regarding, what you previously expected some preliminary data in the first quarter of '08, which is in the next month or so, now you're saying later in '08. What type of data are you expecting, what type of venue, just give us a little color there?

Jeff Burbank

Yeah. In terms of centers, we are continuing to add centers. We're about half filled on centers. So we'll keep looking for good partners there. In term of venue, we haven't really picked that, so that's why the variability in the timing. Could be as soon as second quarter, could be as late as third or fourth.

Bill Plovanic - Canaccord Adams

Okay. And then, lastly, in terms of PureFlow penetration it was 70%, it did improve sequentially from 65%. Just where would you expect that to go during the year, any kind of guidance on that you could give us?

Jeff Burbank

We haven't been specific on the year. We think ultimately it can be approaching 90%, and it will probably take us a couple of years to get there.

Bill Plovanic - Canaccord Adams

Okay, great. Typically in the Q, you give us DaVita as a percentage of revenues in the chronic piece of the business. Do you have that data available now?

Jeff Burbank

No, you'll see it in the Q.

Bill Plovanic - Canaccord Adams

Okay. Great. All right. Thanks a lot

Jeff Burbank

Thank you.

Operator

Your next question will come from the line of Robert Faulkner with Thomas Weisel Partners. Please proceed.

Robert Faulkner - Thomas Weisel Partners

Hi, thanks. A few items. When we look at the gross margins, you talked a little bit about the progression, is it fair to think of the fourth quarter '08 up to 35 percent-ish, if it's more or less linear?

Robert Brown

No. It is more 12 to 14 points on top of the 10 points that we have in Q4 '07, so more in the 22 to 24.

Robert Faulkner - Thomas Weisel Partners

By fourth quarter, but not for the year?

Robert Brown

Not for the year. That's by the end of the year.

Robert Faulkner - Thomas Weisel Partners

Okay. All right.

Jeff Burbank

And that's the total business. So there's a little bit of shift in language here that we used to talk about gross margins as an NxStage business, that's the entire business that includes Medisystems.

Robert Faulkner - Thomas Weisel Partners

That's about the Medisystems margin anyway, so it's neutral at that point.

Jeff Burbank

That's right.

Robert Faulkner - Thomas Weisel Partners

When we think about the expense estimate for this year, should we think of this as a kitchen sink estimate that you're tired of having expenses kind of come in higher than where you thought they'd be. So you are making really sure or is this kind of the best estimate now, could be higher, could be lower?

Jeff Burbank

We don't like missing guidance.

Robert Faulkner - Thomas Weisel Partners

So I should think of it as a kitchen sink.

Jeff Burbank

Those are your words. I don't know what a kitchen sink means.

Robert Faulkner - Thomas Weisel Partners

Everything, but the kitchen sink.

Jeff Burbank

Yeah. I've heard the phrase before. I don't know that we can put color on it. There were times in our past where we had struggled to get patient numbers. We've done a good job of that in the last few quarters here. We've done a good job on revenue. This is an area where we haven't achieved our targets and we didn't like that. So we want to make sure we have a realistic number that we are confident, is accurate and achievable, because we think that's what you guys need as well.

Robert Faulkner - Thomas Weisel Partners

Okay. Thanks. And when we think about the capital raise, you have a debt facility. Would that cover the capital that you see yourself needing?

Jeff Burbank

No.

Robert Brown

No. That's on top of our debt.

Robert Faulkner - Thomas Weisel Partners

That's on top. Okay.

Jeff Burbank

We're not in an emerging situation where we need to raise it. We'll be able to show progress before we're in that position. But we wanted to give you that update on our view because we have been communicating that. We thought that the debt would carry us through and fully fund the business, and our projections don't support that at this time.

Robert Faulkner - Thomas Weisel Partners

Right. Okay. Perfect. And then when it comes to shifting the emphasis, if you will, on making centers larger, and I know that there's been an evolving thought process and that some of the largest centers have grown faster than some of the small centers and like, so that they're actually -- it seems an easier way to grow the business.

Jeff Burbank

Your statement is actually not really correct. The growth rates are very similar. It's a disproportionate amount of cost. And when you stretch yourself over geographies, you don't spend as much time to do what we think is an opportunity, which is potentially achieve a faster growth rate in the larger centers than the smaller centers.

Robert Faulkner - Thomas Weisel Partners

Okay.

Jeff Burbank

So it's not because the smaller centers weren't growing. It's because we think it's more efficient to do it this way. And then, as market adoption changes, we think you get more efficient in other ways.

Robert Faulkner - Thomas Weisel Partners

Yeah. Okay.

Jeff Burbank

Sorry to stop there, Rob, just wanted to be clear about what it is.

Robert Faulkner - Thomas Weisel Partners

Yeah. No, that's helpful. Okay. So then that gets to the kind of the point of the question which was that sometimes investors perceive a shift like this as a topping out of some sort of demand or penetration or the like. How would you respond to that question?

Jeff Burbank

We don't see that. And I'll try to lay this out in a way that's trying to avoid giving that concern. We don't have that concern as we sit here. So we think it's a better way, more effective, economic way to grow the market, which we think is our responsibility to figure out. But I think we'd be sitting here telling you, if we saw that the key demand drivers were significantly changing, that's not why we're doing this.

Robert Faulkner - Thomas Weisel Partners

Yeah. Okay.

Jeff Burbank

As you know, all the disclosure that goes around that, things can change. But that's not why we are doing that today.

Robert Faulkner - Thomas Weisel Partners

Yeah. Okay. Thank you.

Jeff Burbank

Yeah.

Operator

(Operator Instructions)

And your next question will come from the line of Anthony Ostrea with JMP Securities. Please proceed.

Anthony Ostrea - JMP Securities

Hi. Good morning, guys. Can you hear me?

Jeff Burbank

Yes.

Anthony Ostrea - JMP Securities

A question on your guidance actually for '08. The revenue guidance of 130 or 140, is there a way you can break that out into its components; i.e., critical care, chronic and medi?

Jeff Burbank

Well, mathematically, we'll give you some highlights and it's pretty easy to do. I mean you know patient numbers, you know where we are and where we're going, and you know patient's revenue is about $18,000 per patient per year. That gets you on the chronic home. In the in-center, Medisystems was running about $58 million and we've said they grow at about market rate, which is something between 3% and 5%. So, you can calculate that, and the rest would be critical care.

Anthony Ostrea - JMP Securities

Got it. And then, just maybe back to your comments on your new strategy. First question is, is there a timing difference between the number of patients you would have gotten in had you continued with your old strategy versus what you expect for this year with a more focused strategy? And then, I guess the follow-up question there is if there is a timing difference, at what point do you think you actually catch up?

Jeff Burbank

Good question. The first part is pretty straightforward to answer. I think if we spend more sales on marketing dollars, we could have more patients. We just didn't feel that was the right return on investment. So, I guess to the first part, yes. There are more patients to be gotten if we were to spend more on that line. We don't think that's the right thing to do given this moment in time.

Do you catch up? I think as a market evolves, we all talk a lot about where's the hockey stick, when does it knee up? And I think when that occurs and if you do a good job of creating that that there never is a discussion of catching up. It's so obvious that it was the right strategy that those lines crossed pretty quickly. So the focus really needs to be in creating that knee and how you get there in the most cost-effective fashion and that's really what we're focused on.

So I think, absolutely, we're very confident that this is the right thing to do to create that situation, so you do not only catch up but exceed that. But it's a very esoteric math with a lot of assumptions. So I don't think I could tell you in terms of months or quarters or years what it takes. It's just philosophically the right way we believe to develop a market like this.

Anthony Ostrea - JMP Securities

That also doesn't mean that you are backing away from certain geographies or maybe smaller geographies, it just means that it's a focus on --

Jeff Burbank

We'll spend more time in certain areas, but not backing away, no.

Anthony Ostrea - JMP Securities

Okay.

Jeff Burbank

We take our obligation to our patients and customers very seriously.

Anthony Ostrea - JMP Securities

Okay. And then just maybe the potential impact, I guess, on future distribution costs in developing such a strategy, I know it's probably difficult to quantify that, but maybe just give us your thoughts on how that impacts the operating structure.

Jeff Burbank

Well, it is built into these revised models that we have, the multiyear models and the guidance in 2008. So our thoughts are reflected in that. But again, let me kind of share how we think about that. To the extent that you can aggregate patients in geographies, there is a pretty reasonably beneficial effect to that. I don't know that I could quantify it precisely, but there is probably a 20%, 30% differencing cost when you've aggregated patients versus them being reasonably distributed. I'm not talking about at the middle of Montana. I mean still smaller numbers in metropolitan areas.

So there is a lot of efficiency there. And we see it, again, as our obligation to find the most cost effective way to build this market. Overtime, you have enough volume that those differences don't really matter. But in getting from here to there, it's more efficient if you can aggregate them in the best manner possible. Does that help?

Anthony Ostrea - JMP Securities

Yeah. It does. And maybe just last question. You gave that the Q1 patient number and the full year patient number, should we think about the quarterly progression of patients throughout the year. Would that be kind of similar to what you saw in '07?

Jeff Burbank

They're not dissimilar. That's right. You can see we're quite bullish in the year and off to a reasonably good start in Q1. And we think Q1 reflects a little bit of just getting aligned, so we're maybe a little cautious and conservative in Q1 relative to modifying our approach a bit. But still feel really good about putting up the big numbers for the years.

Anthony Ostrea - JMP Securities

Great. Thank you very much.

Operator

Your next question will come from the line David Beard with Morgens Waterfall. Please proceed.

David Beard - Morgens Waterfall

Hi. Good morning.

Jeff Burbank

Good morning

David Beard - Morgens Waterfall

Can you just talk a little bit about your comment relative to advertising in the price elasticity of demand, why do you feel that if you advertise more, more people are going use your product?

Jeff Burbank

Though I'm struggling with the term advertising, that's not precisely what we do. We do try to stimulate local media coverage that's been successful for us and actually more successful in markets that have more patients because there is more patient stories. So that's been a benefit of deeper strategies. And our evidence shows that success begets success. So, that's why we think it is beneficial. We've seen it in our numbers.

David Beard - Morgens Waterfall

So if it works, why not continue?

Jeff Burbank

Which is precisely what we want to do. We want to replicate that model where it's been most successful. And we think those are in geographies that support this kind of market development. So we think we're doing the right thing. I'm not sure if I'm really answering the question precisely.

David Beard - Morgens Waterfall

It also relates to the second part, how much money or cash do you need to run the business?

Jeff Burbank

Yeah, I think we've been very clear. It's what we have and what we have available plus $20 million to $40 million to fully fund the business.

David Beard - Morgens Waterfall

And when do you think you'd raise that money?

Jeff Burbank

We don't have precise plans. We like to show progress in the business model to convince everybody that we are making the progress that needs to be made. So we'll do that, and then take the opportunity of that demonstration to see what our opportunities in capital are.

David Beard - Morgens Waterfall

Seems like you're caught a bit in that conundrum where, in order to grow the business, you have to spend money on marketing, but you don't have the cash. Is that a fair assumption?

Jeff Burbank

Only the case when you're building a market, you are forward investing until the market response and you build a business model. So it's in our view something that is very similar in these business models.

David Beard - Morgens Waterfall

One just last question then. If the product is so good why doesn't it sell itself, or the dogs do not want to eat the dog food?

Jeff Burbank

Dogs are eating lot of dog food. I think creating markets never sell themselves. I think people underestimate what it takes to change medical practice to get the word out so people know what's available. Where we've done that there has been very solid demand. So we're confident in doing it, and we think we're building a very successful company over the next few years here.

David Beard - Morgens Waterfall

Okay. Good luck.

Jeff Burbank

Thank you.

Operator

Your next question will come from the line of Taylor Harris with JP Morgan. Please proceed.

Taylor Harris - JP Morgan

Thanks. Just a couple of follow-up questions. And the first is on in the current market revenue per patient, in the quarter look like it was down a bit from the first three quarters of the year. Is that the result of the contractual business that you have, and is the fourth quarter level, which was about, I think, 44, 50 a patient, is that where we should keep it for '08?

Jeff Burbank

You need to check your math a little bit, Taylor. We haven't really seen a drop in that. So you need to make sure that -- because the math can be somewhat difficult based on when the patients went on throughout the quarter, which is information you don't have. We don't think that the ASP in home has dropped, and certainly not as a result of the contract pricing. So, your 4,500 per quarter is about where it's been and where we expect it to stay.

Taylor Harris - JP Morgan

Okay. And you've given a couple of the cost line items broken down as part of the '08 guidance, but selling and marketing I don't think you talked about that. Can you give us range of expectations for the increase there?

Jeff Burbank

Not at this time, Taylor.

Taylor Harris - JP Morgan

Okay. And I guess, as I was adding it up, it seems like with distribution getting pretty good leverage down to the 10% level that in order to get -- I'm sorry, getting distribution down to 20% by the end of '08 I believe is what you said.

Jeff Burbank

Thank you, yes.

Taylor Harris - JP Morgan

Okay. It seemed like that would leave you a pretty good amount of room for increase in selling and marketing and still be within the loss range that you've talked about. And so that's why I was asking the question, especially since it sounds like you're not increasing the sales force.

Jeff Burbank

Yeah. You are right. That line item is going up from two effects. First of all, you're looking at a year of '07 and it grew across '07. So you're exiting at a higher rate than your average for '07. And secondly, we are making investments in that area. We're just not making as fast as we were thinking we would.

Taylor Harris - JP Morgan

Okay.

Robert Brown

And the other thing is that we now have three businesses. So we all put some investments around the in-center market to launch Streamline that weren't previously there in Medisystems.

Taylor Harris - JP Morgan

Okay. Great. And the acute care number was, obviously, really strong in the quarter. Can you just tell us a little bit about the business there? Was there a really big hospital conversion or a number of hospital customer wins, anything to explain the big jump there?

Jeff Burbank

Well, fourth quarter is always a solid quarter for us because of capital cycles and hospitals. So it's always the biggest quarter historically for us. No specific large accounts, but a number of larger size accounts that has been our focus in that market. To continue our mantra here, we focused on the biggest centers that you can go deep and they typically convert 100% and we did have some very nice hospital conversions in the fourth quarter. But it's consistent with where we are in the market being the majority of market share for new systems placed and continued growth there.

Taylor Harris - JP Morgan

Okay. Great. And then last question, have you seen anything, I guess, on a clinical basis in centers from competition whether it's Fresenius making use of the Renal Solutions products or Baxter testing product out in the field with centers. Have you see any pickup in activity there or is that all on the come?

Jeff Burbank

I can tell you what I know and there is a lot I can't know, but Renal Solutions before they were acquired by Fresenius was working on their home IDE trial to gain clearance for that indication. They had been doing that for, I think, about two and a half years with very limited success.

It would be my expectation that with a dialysis provider they would be, as long as the product works, which I think was part of the challenge on why it was taking them so long, but assuming the product works, they should be able to execute that much more effectively with Fresenius as a partner. We have not seen specific evidence of that, but it will probably be less visible to us because it will probably occur more in Fresenius centers.

So we haven't seen that progress, but we would expect that it would occur. And in past calls I have talked about that product and we feel pretty confident in our ability to compete with that technology and specifically with that product. We think that will change overtime in Fresenius's hands, but it takes time to make those kind of changes.

In terms of Baxter, we have not seen anything in the clinic. But again, we are prepared and expect that we could see them as early as a year and a half, two years, and as late as four or five years. So that's been our operating assumption when we think about them as a competitor, but haven't seen anything in the clinic yet.

Taylor Harris - JP Morgan

Okay. Thank you.

Operator

(Operator Instructions)

Your next question will come from the line of Vivian Wohl with Federated Kaufman Funds. Please proceed

Vivian Wohl - Federated Kaufman Funds

Good morning. I was just hoping you might give us a little more color on what the margins would look like in the home chronic business by the end of the year at the gross margin level, and then the distribution piece there. And I don't know if you have it down to the operating contribution.

Jeff Burbank

You want to take that one, Robert.

Robert Brown

Yeah. I think just a little bit more color on that is that most of the improvements we see in gross margin will actually be in the home segment and most of the improvement in distribution will actually be in the home segment too. Those are really the two areas that we see most of the improvement coming through that rollup to the consolidated P&L.

Jeff Burbank

Yes. So I guess pretty easy to back in because you know where we were.

Vivian Wohl - Federated Kaufman Funds

Yeah, I know. I just thought you might help us out there.

Jeff Burbank

Okay.

Vivian Wohl - Federated Kaufman Funds

It's a little early on the West coast.

Jeff Burbank

We appreciate your attendance.

Operator

At this time, there are no more questions in the queue. I will now like to turn the call back over to Jeff Burbank for any closing remarks.

Jeff Burbank

Thank you. I want to wrap-up by thanking our customers, our patients, our shareholders and the NxStage team for your support and hard work. We look forward to 2008 and are very excited about the opportunities to continue to grow NxStage as an innovator and a value leader in transforming renal care.

Thank you.

Operator

Ladies and gentlemen, this concludes your presentation. You may now disconnect and have a great day.

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