**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 
|   | **ý** | **Annual  Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of  1934**                                                                                              |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       | **for the fiscal year ended December  31, 2002 or**                                                                                                                                      |
|   |       |                                                                                                                                                                                     |
|   | **o**      | **Transition  Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of  1934**                                                                                          |
|   |       | **for the transition period from                to            ** |

 

**Commissionfile number 0-28290**

 

| **AKSYS,  LTD.**                                        |
|---------------------------------------------------------|
| (Exact name of  registrant as specified in its charter) |

 

| **Delaware**                                                                 |   | **36-3890205**                        |
|------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction  of  incorporation or organization)             |   | (I.R.S. Employer  Identification No.) |
|                                                                         |   |                                  |
| **Two  Marriott Drive, Lincolnshire, IL**                                    |   | **60069**                             |
| (Address of Principal  executive offices)                                    |   | (Zip Code)                            |
|                                                                         |   |                                  |
| Registrant’s telephone  number, including area code: **(847) 229-2020** |

 

Securitiesregistered pursuant to Section 12(b) of the Act: **Not applicable**

 

Securitiesregistered pursuant to Section 12(g) of the Act:

 

| **Common  Stock, par value $.01 per share, and related preferred stock purchase rights** |
|------------------------------------------------------------------------------------------|
| (Title of Class)                                                                         |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   Yes   ý      No   o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. ý

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12b-2).  Yes   ý               No   o

 

The aggregate market value of the voting stock held bynon-affiliates of the registrant was approximately $184,672,000 as of March 27,2003, based on the closing sale price of $7.03 as reported by the Nasdaq NationalMarket.

 

As of March 27, 2003 the registrant had 26,324,480shares of Common Stock issued and outstanding.

 

**DocumentsIncorporated by Reference**

 

Portions of the Registrant’s Proxy Statement to beused in connection with the solicitation of proxies for the Annual Meeting ofStockholders to be held on May 15, 2003 (the “Proxy Statement”) areincorporated by reference into Part III and portions of the Registrant’s 2002Annual Report to Stockholders filed herewith as Exhibit 13 are incorporated byreference into Part II and Part IV.

** **

 

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**AKSYS, LTD.**

 

**INDEX TO ANNUAL REPORT ON FORM 10-K**

 
| **PART I**         |
|--------------------|
|               |   |
| Item 1.            | Business |
| Item 2.            | Properties |
| Item 3.            | Legal Proceedings |
| Item  4.           | Submission  of Matters to a Vote of Security-Holders |
|               |   |
| **PART II**        |
|               |   |
| Item  5.           | Market  for the Registrant’s Common Stock and Related Stockholder Matters |
| Item 6.            | Selected Financial  Data |
| Item  7.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item  7A.          | Quantitative  and Qualitative Disclosures About Market Risk |
| Item  8.           | Financial  Statements and Supplementary Data |
| Item  9.           | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure |
|               |   |
| **PART III**       |
|               |   |
| Item  10.          | Directors  and Executive Officers of the Registrant |
| Item 11.           | Executive  Compensation |
| Item  12.          | Security  Ownership of Certain Beneficial Owners and Management |
| Item  13.          | Certain  Relationships and Related Transactions |
| Item 14.           | Controls and Procedures |
|               |   |
| **PART IV**        |
|               |   |
| Item 15.           | Exhibits, Financial Statement  Schedules and Reports on Form 8-K |
|               |   |
| **SIGNATURES**     |
|               |
| **CERTIFICATIONS** |
|               |
| **EXHIBIT INDEX**  |

 

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**PART I**

 

**Item1.  Business**

 

**Background**

 

Aksys, Ltd. (the “Company”) was founded in 1991 to provide hemodialysisproducts and services for patients suffering from end-stage renal disease(“ESRD”), commonly known as chronic kidney failure.  The Company has developed an automated personal hemodialysissystem, known as the Aksys Personal Hemodialysis (PHDä)System (the “PHD System”), which is designed to enable patients to performfrequent hemodialysis at alternate sites (such as their own homes) and tothereby improve clinical outcomes, reduce total ESRD treatment costs andenhance the quality of life of patients.

 

On March 27, 2002, the Company announced that it received Food and DrugAdministration (“FDA”) clearance to market the PHD System in the UnitedStates.  The FDA clearance had norestrictions and included authorization to use the product in the home.  510(k) clearance by the FDA was required priorto the commercialization of the PHD System in the United States.

 

During the quarter ended September 30, 2002, the Company commencedcommercial activities and is no longer considered to be in the developmentstage.

 

On October 7, 2002, the Company announced the receipt of ECCertification for CE Mark approval pursuant to the Medical Device Directive ofthe European Economic Area.  Thecertification approved the PHD System for home use. Such approval was requiredprior to the commercialization of the PHD System in the European Economic Area.

 

**TheMarketplace**

 

The target market of the Company is the ESRD treatment market.  A healthy human kidney continuously removeswaste products and excess water from the blood.  ESRD is a slow, progressive loss of kidney function caused byinherited disorders, prolonged medical conditions such as diabetes andhypertension, or the long-term use of certain medications.  ESRD is irreversible and lethal ifuntreated.  Life can be sustained onlythrough either transplantation or dialysis. Transplantation is severely limited due to the shortage of suitabledonors, the incidence of organ transplant rejection and the age and health ofmany ESRD patients.  The vast majority(over 90%) of patients, therefore, must rely on dialysis for the remainder oftheir lives.

 

The Company estimates that over $17 billion was spent in the U.S.during 2001 for the treatment of patients suffering from ESRD, of which morethan $7 billion was directly related to dialysis treatment.  Based upon information published by TheCenters for Medicare and Medical Services (“CMS”), the approximate number ofESRD patients in the United States requiring dialysis treatments has grown from66,000 at the end of 1982 to an estimated 286,000 at the end of 2001.  The current estimated annual growth rate ofESRD patients in the U.S. is approximately 5%. In addition, it is estimated that there were approximately 486,000dialysis patients in Europe and Japan at the end of 2001.  The Company believes that the sustained growthin the ESRD population, especially in the United States, has been caused by (i)the aging of the population (the median age of newly diagnosed ESRD patients inthe United States is 62), (ii) the longer average life expectancy of patientswith diabetes and hypertension (two patient groups at high risk for ESRD),(iii) the relatively more rapid growth in the general population of certainethnic subsets that have a higher incidence of ESRD, (iv) competing risk –(i.e., with the decline in vascular diseases of the heart, there is a rise invascular diseases of the kidney), and (v) a possible increase in the use ofmedications that damage the kidneys.

 

Given the expense of kidney dialysis treatments and the lack ofeffective alternative therapies, in 1972 Congress enacted legislation providingfor Medicare funding for all eligible patients with ESRD regardless of age orfinancial circumstances.

 

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Under this program, after the first 30 months of treatment Medicare isresponsible for payment of 80% of the rate set by CMS for reimbursement ofoutpatient dialysis.  Although thisprogram made dialysis available to virtually all patients in need of treatment,the cost of funding the program grew rapidly, quickly exceeding originalexpectations.  In an effort to hold downthese costs, Congress,  in 1983,  capped the Medicare reimbursement rate foroutpatient dialysis at approximately $21,000 per patient per year.  The costs of operating dialysis centers,however, such as capital, labor and facility overhead, have continued torise.  These circumstances have forceddialysis providers to seek ways to reduce dialysis treatment costs.

 

**Reimbursement**

 

Demand for the Company’s products and services will be influenced bygovernmental and other third-party reimbursement programs because providers ofESRD treatment are reimbursed by Medicare, Medicaid and private insurers.

 

***Medicare Reimbursement***

 

Medicare generally provides health insurance coverage for persons whoare age 65 or older and for persons who are completely disabled.  Medicare also provides coverage for othereligible patients, regardless of age, who have been medically determined tohave ESRD.  For patients eligible forMedicare based solely on ESRD (generally patients under age 65), Medicareeligibility begins three months after the month in which the patient beginsdialysis treatments.  During thisthree-month waiting period, either Medicaid, private insurance or the patientis responsible for payment for dialysis services.  This waiting period is waived for individuals who participate ina self-care dialysis training program, or are hospitalized for a kidneytransplant and the surgery occurs within a specified time period.

 

For ESRD patients under age 65 who have any employer group healthinsurance coverage (regardless of the size of the employer or the individual’semployment status), Medicare coverage is generally secondary to the employercoverage during a 30-month coordination period that follows the establishmentof Medicare eligibility or entitlement based on ESRD.  During the coordination period, an employer group health plan isresponsible for paying primary benefits at the rate specified in the plan,which may be a negotiated rate or the healthcare provider’s usual and customaryrate.  As the secondary payer duringthis coordination period, Medicare will make payments up to the applicablecomposite rate for dialysis services to supplement any primary payments by theemployer group health plan if the plan covers the services but pays only aportion of the charge for the services.

 

Medicare generally is the primary payer for ESRD patients after the30-month coordination period.  Undercurrent rules, Medicare is also the primary payer for ESRD patients during the30-month coordination period if, before becoming eligible for Medicare on thebasis of ESRD, the patient was already age 65 or over (or eligible for Medicarebased on disability) unless covered by an employer group health plan (otherthan a “small” employer plan) because of current employment.  This rule eliminates for many dual-eligiblebeneficiaries the 30-month coordination period during which the employer planwould serve as primary payer and reimburse health care providers at a rate thatthe Company believes may be higher than the Medicare composite rate.  The rules regarding entitlement to primaryMedicare coverage when the patient is eligible for Medicare on the basis ofboth age (or disability) and ESRD have been the subject of frequent legislativeand regulatory changes in recent years and there can be no assurance that suchrules will not be unfavorably changed in the future.

 

When Medicare is the primary payer, it reimburses 80% of the compositerate set by the Medicare prospective reimbursement system for each dialysistreatment.  The beneficiary isresponsible for the remaining 20%, as well as any unmet Medicare deductibleamount, although an approved Medicare supplement insurance policy, otherprivate health insurance or Medicaid may pay on the beneficiary’s behalf.  Reimbursement rates are subject to periodicadjustment based on certain factors, including budget and other legislation andcosts incurred in rendering the services if tied to certain criteria.  The composite reimbursement rate was unchangedfrom commencement of the program in 1972 until 1983.  From 1983 through December 1990, numerous Congressional actionsresulted in net reductions of the average composite reimbursement rate from afixed fee of $138 per treatment in 1983 to

 

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approximately $125 per treatment in December 1990.  Effective January 1, 1991, Congressincreased the ESRD composite reimbursement rate, resulting in an average rateof $126 per treatment.  The BalancedBudget Refinement Act of 1999 raised the composite rate by 1.2% in 2000 and anadditional 1.2% in 2001.

 

Reimbursement for home dialysis can be made in two ways.  A beneficiary may choose to receive homedialysis equipment, supplies and support services directly from a facility orto make independent arrangements for equipment and supplies.  If the beneficiary chooses to use afacility, the facility receives the composite rate for each treatment thepatient performs at home.  If thebeneficiary chooses to make independent arrangements, the supplier billsMedicare on an assignment basis and payment is made at a rate not greater thanthe composite rate, with the exception of continuous cycling peritonealdialysis (“CCPD”).  There is a monthlypayment cap of $1,975 for CCPD and approximately $1,500 for all other methodsof home dialysis.

 

The Medicare ESRD composite reimbursement rate has been the subject ofa number of reports and studies. Actions to change such rate usually occur in the context of federalbudget negotiations.

 

The Company is unable to predict what, if any, future changes may occurin the Medicare composite reimbursement rate or in any other reimbursementprogram.  Any reductions in the Medicarecomposite reimbursement rate or in any other reimbursement program could have amaterial adverse effect on the Company’s prospects, revenues and earnings.  In addition, there have been variouslegislative proposals for the reform of numerous aspects of Medicare,  the occurrence and effect of which areuncertain.  See “—Potential Health CareLegislation.”

 

***Medicaid Reimbursemen****t*

 

Medicaid programs are state-administered programs partially funded bythe federal government.  These programsare intended to provide coverage for patients whose income and assets fall belowstate defined levels and who are otherwise uninsured.  The programs also serve as supplemental insurance programs forthe Medicare co-insurance portion and provide certain coverage (*e.g.*,oral medications) that are not covered by Medicare.  State regulations generally follow Medicare reimbursement levelsand coverage without any co-insurance amounts. Certain states, however, require beneficiaries to pay a monthly share ofthe cost based upon levels of income or assets.

 

***Private Reimbursemen****t*

 

Some ESRD patients have private insurance that covers dialysisservices.  As discussed above, healthcare providers receive reimbursement for ESRD treatments from the patient orprivate insurance during a “waiting period” up to three months before thepatient becomes eligible for Medicare. In addition, if the private payer is an employer group health plan, itis generally required to continue to make primary payments for dialysisservices during the 30-month period following eligibility or entitlement toMedicare.  In general, employers may notreduce coverage or otherwise discriminate against ESRD patients by taking intoaccount the patient’s eligibility or entitlement to Medicare benefits.

 

The Company believes that before Medicare primary coverage isestablished, private payers may reimburse dialysis expenses at rates higherthan the per-treatment composite rate set by Medicare.  When Medicare becomes a patient’s primarypayer, private insurance often covers the per-treatment 20% coinsurance thatMedicare does not pay.

 

***Potential Health Care Legislation***

 

Because the Medicare program represents a substantial portion of thefederal budget, Congress takes action in almost every legislative session tomodify the Medicare program for the purpose of reducing the amounts otherwisepayable by the program to health care providers in order to achieve deficitreduction targets or meet other political goals.  Legislation and/or regulations may be enacted in the future thatmay significantly modify the Medicare or Medicaid ESRD programs orsubstantially affect reimbursement for dialysis services.

 

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**PrevailingTreatment Methods**

 

Hemodialysis and peritoneal dialysis are the two prevailing methods ofdialysis.

 

***Hemodialysis***

 

CMS estimates that as of December 31, 2001, approximately 90% (259,000)of the ESRD dialysis patients in the United States were receivinghemodialysis.  Fewer than 1% of thesepatients performed treatment in their homes, and all others received treatmentat outpatient facilities.  Outpatienthemodialysis requires that a patient travel to a dialysis clinic three timesper week for dialysis sessions lasting three to four hours.  In each session, the patient’s blood iscleansed by circulation through an artificial kidney controlled by a dialysismachine.

 

Home hemodialysis was common practice prior to Medicare funding, withapproximately 42% of the 11,000 United States dialysis patients on homehemodialysis in 1973.  Although theinitial motivation for performing home treatment for many patients reflectedthe lack of availability of dialysis clinics and the desire to reduce the costof hospital-based dialysis, clinicians report that many of these patients foundsignificant advantages in quality of life when treating themselves athome.  As Medicare funding becameavailable, however, the vast majority of patients began receiving treatment inoutpatient facilities, and hemodialysis machines became more complex andsophisticated as they evolved for use in clinics.  The dialysis machines currently used in these centers arepredominantly operated by trained personnel and require significant manualpreparation and cleaning in connection with each treatment session.

 

***Peritoneal Dialysis***

 

CMS estimates that as of December 31, 2001, approximately 10% (27,000)of the ESRD dialysis patients in the United States were receiving peritonealdialysis, with over 99% performing such treatment in their homes.  There are two principal forms of peritonealdialysis, and all forms use the patient’s peritoneum, a large membrane rich inblood vessels that surrounds many of the body’s internal organs, as a filter toeliminate toxins and excess fluids from the patient’s blood.  Dialysate, a blood-cleansing electrolytesolution, is infused through a catheter into the patient’s peritonealcavity.  Once this fluid absorbs thetoxins and excess water that are filtered from the blood through theperitoneum, it is drained from the peritoneal cavity through a catheter.  In the most common form of peritonealdialysis, Continuous Ambulatory Peritoneal Dialysis (“CAPD”), the process ofexchanging dialysate into and out of the patient’s peritoneal cavity occursfour times daily, seven days per week. The other form, Continuous Cycling Peritoneal Dialysis (“CCPD”), uses aninstrument to automatically perform exchanges of solution through theperitoneal cavity overnight, while the patient sleeps.  Both forms of treatment require strictaseptic technique.

 

***Limitations of Prevailing Treatment Methods***

 

*Hemodialysis.* Patients receiving outpatienthemodialysis often experience a number of chronic and acute healthproblems.  The chronic problems includehypertension, anemia (low red blood cell count), malnutrition, fluid andelectrolyte imbalance, calcium deficiency, insomnia, sexual impotency,decreased mental acuity and lower energy levels.  The acute problems include headaches, nausea, hypotension andasthenia (a general lack of strength and vitality), which are associated withthrice weekly dialysis sessions.  In addition,a general feeling of ill health tends to increase between dialysis treatmentsas a result of toxins, sodium and water building up in the patient’sblood.  These side effects have asignificant impact on (i) clinical outcomes, with the leading cause of deathamong ESRD patients being cardiovascular disease, which many clinicians believeis caused in large part by oscillations in toxins, sodium and body fluidlevels, (ii) total patient costs, resulting from the frequent need tohospitalize ESRD patients as well as the need to treat anemia and hypertensionwith medication and (iii) patient quality of life, with patients having to notonly suffer through these chronic and acute health problems and related“hangover” frequently following each treatment, but also to essentially devotethree days per week to the treatment regimen.

 

The Company believes that these health problems are caused in part byinadequate doses and frequency of dialysis. The amount of toxins removed from the blood during dialysis is widelyaccepted to be determined by a formula indicating that hemodialysis is mostefficient in the earlier stages of therapy. Thus, simply increasing the duration of 

 

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a treatment session is not the most efficient way to improve the doseof hemodialysis.  Rather, the efficiencyof hemodialysis and the delivered dose can be improved with more frequentdialysis sessions of shorter duration. More frequent sessions also decrease the severe oscillations in toxinand hydration levels associated with the prevailing three times per weekdialysis regimen and should result in fewer side effects.

 

The clinical outcomes of conventional dialysis have contributed to thesignificant patient treatment cost. According to CMS, total treatment costs per dialysis patient have risenfrom $33,400 in 1988 to $70,200 in 2000. The cost of hospitalization on a fee for service basis represents themost significant component of this increase. While reimbursement for outpatienthemodialysis treatment (the “composite rate”) has been capped since 1983,reimbursement for the associated cost of care due to chronic and acute healthproblems and other complications continues to be reimbursed on a fee forservice basis.  Under this reimbursementscheme, providers have an incentive to reduce the cost of outpatient dialysisrather than the total cost of treating dialysis patients.

 

*PeritonealDialysis.*  Althoughperitoneal dialysis accounted for 10% (or 27,000) of the dialysis patientpopulation in 2001 according to CMS, approximately 22% (or 6,000) of thepatients in the United States switched to outpatient in-centerhemodialysis.  The Company believes thatmost of these patients switched from peritoneal dialysis to outpatienthemodialysis because of the following limitations presented by CAPD, the mostcommon form of peritoneal dialysis: (i) due to the limited efficiency of usingthe peritoneal membrane as a filter for toxin removal, patients must have arelatively low body weight or have some residual kidney function to achieveadequate levels of dialysis (once residual kidney function is lost, which iseventually the case in most patients, CAPD is no longer a viable treatment fora majority of the population); (ii) CAPD demands considerable responsibilityand time to perform the required four exchanges of solution each day, whichoften causes patient “burnout” and non-compliance with the prescribed regimen;(iii) peritoneal dialysis demands that patients follow strict aseptictechniques when changing dialysate bags because the failure to do so oftenleads to peritonitis, an infection of the peritoneum; and (iv) the suppliesused in peritoneal dialysis require considerable storage space given thequantity of dialysate (up to 30 large boxes per month) used in this treatment.

 

The Company believes that most new peritoneal dialysis patients chooseCCPD, in part, in an attempt to improve clinical outcomes.  Although CCPD addresses some of thelimitations imposed by CAPD, it continues to present a risk of infection of theperitoneum and in many cases requires some residual kidney function to achieveadequate levels of dialysis. Moreover, because CCPD must often be supplementedwith peritoneal dialysis performed by the patients during the day using the CAPDmethod, patient “burnout” also occurs.

 

**Home Hemodialysis as an Alternative**

 

The Company believes that increasing the frequency of hemodialysistreatments while decreasing the length of each treatment session cansignificantly improve clinical outcomes and patient quality of life whilereducing the total cost of managing ESRD patients.  The Company completed a clinical trial of the PHD System inNovember 2000, whereby a total of 23 patients converted from three times perweek dialysis at home to a treatment regimen of more frequent dialysis on thePHD System.  Over 5,000 dialysistreatments have been performed by patients on the PHD System, including over4,000 times at home.  Patients showedbetter clinical outcomes and improved quality of life on more frequentdialysis.

 

Several other studies over the past 33 years indicate that increasingthe number of dialysis treatments per week leads to dramatic improvements inpatients.  Several study centers reportthat most of the ESRD patients who performed hemodialysis on a daily basisreported that daily hemodialysis gave them a more positive attitude towardtreatment and a higher quality of life. Neither the Company nor the PHD System was involved in the treatmentsreceived by patients in these other studies and the Company did not fund thesestudies.  Moreover, patient selectionfor these studies was not randomized; the Company gathered the data on aretrospective basis from providers that it knew were treating patients with adaily hemodialysis regimen.  Consequentlythere can be no assurance that the patient populations in these studies arerepresentative of the general ESRD patient population.  As a result, these studies should not bedeemed to have established the impact of daily hemodialysis on clinical outcomes.

 

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In addition to the aforementioned retrospective studies, dailyhemodialysis is gaining popularity. There are initiatives in the U.S. and worldwide to study the benefits ofdaily hemodialysis.  The Companyestimates that in  2002, there were over40 centers worldwide, approximately 25 of which are in North America, treatingover 400 patients with daily hemodialysis.

 

Despite the potential benefits of frequent hemodialysis, severalbarriers have prevented it from becoming a viable treatment regimen.  The most significant is the economicimplication of administering more frequent hemodialysis to patients from thetraditional three times per week dialysis. Under the current capped Medicare reimbursement level, dialysisproviders cannot afford the additional costs that would be incurred inproviding more frequent treatments in outpatient facilities.  Requiring more frequent visits to a dialysistreatment facility would also place additional burdens on a patient’slifestyle.

 

There is also a perception that vascular access complications arisingfrom inserting the needles into the patient’s blood access site may increasewith daily treatment sessions.  Thesecomplications are common in the clinical setting already and account for asignificant portion of the cost of treating patients.  The Company believes that vascular access complications shouldnot increase with more frequent hemodialysis sessions in a home or self-caresetting and such complications may in fact decrease.  That belief is based on data collected from patients using anative fistula.  The Company hascollected little data from patients using artificial blood vessel grafts orcentral venous catheters, and there is no assurance that such grafts orcatheters will withstand daily treatment. There are a number of approaches to vascular access that may enhancemore frequent treatments, including (i) the use of “single needle” vascularaccess devices which reduce the number of punctures by half, (ii) the use ofcentral venous catheters which eliminate the need to use needles at all, (iii)novel graft materials, (iv) new, totally implanted central venous catheterswith titanium ports and (v) the practice of inserting needles in the same siteeach day, which has been demonstrated to have several benefits according topublications by Dr. Zbylut J. Twardowski, a leading dialysis researcher.

 

The Company believes that most barriers to a more frequent hemodialysisregimen could be overcome if it were available in the patient’s home, but todate no hemodialysis device has become sufficiently available to establish homehemodialysis as a feasible alternative therapy for the general dialysis patientpopulation.

 

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**ProductDevelopment**

 

**The Aksys PHD System**

 

By addressing the many drawbacks of conventional hemodialysis systems,which have prevented the widespread use of daily home hemodialysis, the Companybelieves its products and services can be instrumental in improving clinicaloutcomes, decreasing the total treatment costs and improving quality of lifefor dialysis patients.  The followingchart describes how the PHD System addresses the drawbacks presented when ESRDpatients and helpers use conventional systems for home hemodialysis:

 
| **Drawback**         |   | **Conventional Home Systems**                                           |   | **Aksys PHD System**                                                                                    |
|----------------------|--------|-------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|
|                 |   |                                                                    |   |                                                                                                    |
| Complexity           |   | Complicated equipment designed foroperation only by  trained personnel. |   | Designed for ease of operation at home, including  computerized, user-friendly interface.               |
|                 |   |                                                                    |   |                                                                                                    |
| Time and Effort      |   | Difficult and time consuming to setup,operate, clean  and maintain.     |   | Fully automated, reducing operator involvement.                                                         |
|                 |   |                                                                    |   |                                                                                                    |
| Cost of Consumables  |   | Requires frequent replacement ofbloodcircuit.                           |   | Integrated automatic disinfection system designed to  enable safe and effective reuse of blood circuit. |
|                 |   |                                                                    |   |                                                                                                    |
| Storage Requirements |   | Large volume of consumables anddialysate consumed  each month.          |   | Substantially fewer and smaller items consumed with  each treatment.                                    |

 

The Company believes that the PHD System offers patients simplificationand control.  The new technology of thePHD System integrates four systems into one: water purification, delivery of dialysis, dialyzer reprocessing andonline manufacturing of infusion-quality solution.   The PHD System is a fully automated personal dialysis instrumentdesigned to enable operators to perform hemodialysis in a self-care setting,such as the patient’s home, on a frequent or daily basis.  The PHD System is designed to reduce thepatient’s time and effort involved in performing each hemodialysis treatmentwith minimal assistance.  Through atouch sensitive display screen with instructions available on a graphic videodisplay, the PHD System is designed to be less intimidating and easier to usethan current hemodialysis systems.

 

The PHD System is designed to evaluate the performance of theartificial kidney in removing toxins from the patient’s blood prior to eachtreatment to ensure that the prescribed dose of hemodialysis is achieved duringthe treatment.  The PHD System alsoautomatically evaluates the water treatment filters and indicates whether areplacement is required and verifies that all critical safety systems, sensorsand alarms are operating correctly.

 

To begin a treatment session on the PHD System, the operator connectsthe blood tubing to the vascular access device.  A user-friendly, touch-sensitive monitor prompts the patientthrough the treatment and displays procedure and patient-specific informationfor review.  The PHD System is designedto monitor during the treatment a variety of vital statistics, including thepatient’s blood flow rate, the amount of water removed from the patient, thelength of the treatment session and other key parameters.  The treatment can be suspended at any timeby the patient.  If the patient’s bloodpressure drops below normal levels during the treatment, the system prompts thepatient to take appropriate action. Data from a hemodialysis treatment is displayed for viewing by thepatient.

 

At the end of a treatment session, the operator reconnects the bloodtubing to the system and inserts two small bottles of dialysate in the systemto replace those consumed for the previous treatment.  The PHD System then automatically flushes and disinfects allfluid pathways, performs a self-diagnostic test to determine whether thedisinfection was adequate and readies itself without further patientinvolvement for the next treatment session.

 

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**Services Supporting the PHD System**

 

To fully service hemodialysis patients, the Company is developing aservice network to provide support for patients and dialysis providers in allaspects relating to the use and maintenance of the PHD System.  The Company’s service network provides thefollowing: (i) delivery and installation of the PHD System, (ii) technicalservice through a 24 hour call center and through field representatives whowill maintain and repair all components of the PHD System, (iii) delivery ofconsumables used in dialysis such as the artificial kidney and arterial andvenous blood tubing (which are replaced periodically), water purificationcomponents and dialysate concentrate and (iv) customer service representativeswho will interface with the dialysis provider to address the status of, and anynecessary changes in, the patient’s treatment as ordered by the patient’sphysician.  The Company believes that byproviding all of the products and services necessary to perform hemodialysis athome as well as in other self-care settings and nursing homes, the Company canestablish and maintain loyalty with patients and dialysis providers.

 

The PHD System is intended to reduce total treatment costs for ESRDpatients, including hospitalization costs. There is no reliable way at this time, however, to quantify thepotential savings in total treatment cost. The Company has priced the PHD System at a level to fit within currentreimbursement guidelines.  Thus, theCompany expects there will be little or no reduction in dialysis cost (asopposed to total treatment costs) associated with the PHD System.

 

Although the Company believes that the PHD System provides a solutionto many of the problems presented by conventional dialysis modalities, thereare a number of risks that must be overcome for the PHD System to succeed,including, among others, achieving market acceptance and the uncertainty ofobtaining regulatory clearance or approval in jurisdictions other than theUnited States and the European Economic Area.

 

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**2003 Activities**

 

During 2003, the Company expects that substantially all of itsresources, including available cash and short-term investments, will be devotedto commercialization of the PHD System, including sales and marketingactivities, and service and support of the PHD System.  Resources will also be directed toward usingthe platform technology incorporated in the PHD System to develop follow-onproducts.

 

**Businessand Marketing Strategy**

 

In October 1997, the National Kidney Foundation released the results ofthe first comprehensive effort to standardize practices at U.S. dialysiscenters (the Dialysis Outcomes Quality Initiative, or DOQI guidelines).  The recommendations called for minimum dosesof dialysis; however, approximately 32% of all current U.S. patients are underthat recommended minimum dosage.  Theserecommendations support the Company’s belief that patients who receive thathigher dose through daily dialysis would benefit through improved clinicaloutcomes.  The Company believes that thePHD System offers the potential for better clinical outcomes, lower totaltreatment costs and improved quality of life for dialysis patients.  The relatively poor patient outcomesresulting from current dialysis treatment methods and the increasing total costof treating ESRD patients have created significant demand for improved dialysissystems.  Through the PHD System, theCompany intends to capitalize on this demand by pursuing the followingstrategies.

 

*TargetSpecific Market Segments. *TheCompany currently markets its products and services directly to those providersof dialysis services most focused on patient outcomes and total cost ofcare.  This strategy is designed toachieve access to the key patient segments which the Company believes will beespecially receptive to frequent home hemodialysis using the PHD System,including: (i) dialysis patients currently receiving conventional homehemodialysis, (ii) dialysis patients who drop out of home peritoneal dialysisand (iii) ESRD patients who are just beginning dialysis treatment.  In the United States, these segmentsaccounted for approximately 1,600, 6,000 and 91,000 dialysis patients,respectively, in 2001 according to industry data.  Although the PHD System has been designed primarily for home use,the Company believes it will also be an attractive alternative dialysis devicefor self-care clinics and nursing homes.

 

*Providea Broad Range of Dialysis Products and Services.*  The Company provides a broad range ofproducts and services for hemodialysis patients and providers.  In addition to the delivery, installationand maintenance of the PHD System, the Company provides training, technicalsupport and delivery of all required consumables.  The Company sells or rents the machines to customers (or sellsthe machines to a third party lease company), and enters into contracts withits customers to provide all consumables and services for a single monthlyprice.

 

*Captureand Provide Outcome Data.* The PHD System has a built-in computer capable of recording specificmedical data regarding dialysis treatment and patient health andcompliance.  Future versions of the PHDSystem may allow outcome data to be furnished on-line to the healthcareprovider responsible for treating the patient and will aid the provider inassessing the effectiveness of the patient’s dialysis treatment prescription aswell as promote the potential clinical and cost benefits of frequent homehemodialysis.  Outcome data shouldbecome increasingly important if, as the Company believes, CMS moves towards areimbursement system that capitates total ESRD patient cost.

 

*ImplementPrograms to Demonstrate Clinical Benefits and Cost-Effectiveness.*  The Company intends to complement itsmarketing by conducting clinical studies and implementing other measuresdesigned to document the clinical and cost benefits it believes will resultfrom frequent home hemodialysis using the PHD System.  In 1998, the Company sponsored a study at six centers to measurethe early improvements in nutrition and well-being of patients converting fromthe standard thrice-weekly hemodialysis regimen to a daily hemodialysisregimen.  Results of the study indicateddramatic improvements in the patients’ feeling of well-being after convertingto a regimen of daily hemodialysis.  Incollaboration with members of the Company’s Scientific Advisory Board and otherleading nephrologists, the Company intends to promote the benefits of the PHDSystem through publication in clinical journals and presentations at scientificconferences of the results of these studies.

 

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*PhasedDomestic and International Market Launch.*  The Company believes that there is worldwidedemand for a cost effective, more clinically effective approach todialysis.  In addition to pursuingmarket launch in the United States, the Company is establishing marketing andregulatory resources in Europe, Japan and elsewhere.  As of December 31, 2001, the Company estimates that there wereapproximately 286,000 dialysis patients in Europe and 200,000 dialysis patientsin Japan.

 

**Sales and Marketing**

 

The Company operates with a relatively small direct sales force tomarket its products and services, primarily to healthcare providers such ashospitals, dialysis clinics, managed care organizations and nephrologyphysician groups.  The Companydistributes and provides technical support for the PHD System through acombination of in-house resources and contracted third parties.

 

**Manufacturingand Suppliers**

 

The Company does not currently manufacture any component of the PHDSystem or related consumables.  Withrespect to the PHD System, the Company has contracted with Peak Industries,Inc. (‘‘Peak’’), a contract manufacturer of medical devices, to assemble andproduce the dialysis machine.  TheCompany has entered into an agreement with Peak that remains in effect throughFebruary 28, 2005, subject to earlier termination under specifiedcircumstances.  Peak specializes in thecustom manufacturing of medical instrumentation and is certified to ISOrequirements for manufacture of such products. ISO Certification is an internationally recognized standard of qualitymanufacturing.  The Company may identifyadditional manufacturing locations in the future, whether or not owned by Peak,to avoid having to rely on a single location. There can be no assurances that the Company will be able to do so onterms acceptable to it.  Themanufacturing of the Company’s products is subject to quality system regulations(“QSR”) and other requirements prescribed by regulatory agencies.  There can be no assurance that Peak or anyother manufacturer of the Company’s products will continue to comply withapplicable regulatory requirements or that Peak or any other manufacturer willbe able to supply the Company with products in sufficient quantity or at all.

 

Certain key components of the PHD System, such as the dialyzer, areavailable from other manufacturers.  Theblood tubing set, however, is custom made to the Company’s specifications by asingle supplier.  Similarly, thedialysate chemicals supplied to patients using the PHD System will be custommade and packaged to the Company’s specifications.  The Company is currently working with a leading manufacturer of dialysisproducts to provide the Company’s needed dialysate chemicals.  There can be no assurances that any of thekey components of the Company’s products, including dialyzers produced by othermanufacturers, will be available on terms acceptable to the Company or at all.

 

**Researchand Development**

 

As of December 31, 2002, the Company employed a research anddevelopment staff of 37 full time employees, most of whom are engineers andtechnicians.  In addition, the Companyused contractors on an as needed basis to assist in its developmentprocess.   The research and developmentstaff is composed of specialists in the fields of mechanical engineering,electrical engineering, software engineering, biomedical and systems engineering,chemistry and microbiology.  For theyears ended December 31, 2002, 2001 and 2000, the Company incurred totalresearch and development expenditures of approximately $5,792,000, $10,883,000,and $14,542,000, respectively.

 

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**Competition**

 

The Company competes in the kidney dialysis market with suppliers ofhemodialysis and peritoneal dialysis devices, supplies and services.  The Company does not compete with providersof dialysis services such as the national dialysis providers or managed carecompanies.  Rather, it is marketing itsproducts and services to these providers and is working with them to make homehemodialysis a viable alternative to currently available treatment methods.

 

The Company’s primary competitors in supplying dialysis equipment,supplies and services are Baxter International Inc., Fresenius Medical Care AGand Gambro AB.  These companies and mostof the Company’s other potential competitors have substantially greaterfinancial, scientific and technical resources, research and developmentcapabilities, marketing and manufacturing resources and experience than theCompany, and greater experience in developing products, providing services andobtaining regulatory approvals.

 

The Company’s ability to successfully market its products and servicescould be adversely affected by pharmacological and technological advances inpreventing the progression of ESRD in high-risk patients (such as those withdiabetes and hypertension), technological developments by others in the area ofdialysis, the development of new medications designed to reduce the incidenceof kidney transplant rejection and progress in using kidneys harvested fromgenetically-engineered animals as a source of transplants.  There can be no assurance that competitivepressure or pharmacological or technological advancements will not have amaterial adverse effect on the Company.

 

The Company believes that competition in the market for kidney dialysisequipment, supplies and services is based primarily on clinical outcomes,price, product performance, cost-effectiveness, reliability and technologicalinnovation and that such competition in the home hemodialysis market will bebased on such factors as well as on products being relatively easy to use,transport and maintain.  Certain kidneydialysis equipment manufacturers and service providers currently own andoperate, or may in the future acquire, dialysis treatment facilities and otherproviders.  As a result, the Company’sability to sell its products and services to such providers may be adverselyaffected.

 

**GovernmentRegulation**

 

**Food and Drug Administration**

 

The PHD System is regulated as a medical device by the FDA under theFederal Food, Drug and Cosmetic Act (the “FDC Act”).   Pursuant to the FDC Act, the FDA regulates the manufacture anddistribution of medical devices in the United States.  Noncompliance with applicable requirements can result in, amongother things, fines, injunctions and civil penalties; recall or seizure ofproducts; total or partial suspension of production; denial or withdrawal ofpre-market clearance or approval of devices; recommendations by the FDA thatthe Company not be allowed to enter into government contracts; and criminalprosecution.  The FDA also has authorityto require repair, replacement or refund of the cost of any device illegallymanufactured or distributed by the Company.

 

In the United States, medical devices are classified into one of threeclasses (Class I, II or III) on the basis of the controls deemed necessary by theFDA to reasonably ensure their safety and effectiveness.  Class I devices are subject to generalcontrols (*e.g.*,labeling and adherence to some of the QSRs). Class II devices are subject to general and special controls (*e.g.*,performance standards, post-market surveillance and patient registries).  Class III devices are those which mustreceive pre-market approval by the FDA to ensure their safety and effectiveness(*e.g.*,life-sustaining, life-supporting and implantable devices or new devices whichhave been found not to be substantially equivalent to legally marketeddevices).

 

The PHD System is classified as a Class II device.  On March 30, 1999, the Company filed anInvestigational Device Exemption (“IDE”) with the FDA, a prerequisite forconducting a clinical evaluation of the PHD System.  The Company received full IDE approval in July 1999, and inSeptember 1999 began the clinical trial of the PHD System.  Twenty-five patients participated in thetrial at three centers.  The protocolfor the study called for patients to dialyze at home on existing hemodialysisequipment for 10 weeks, followed by one month in the center on the 

 

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PHD System and two months at home on the PHD System.  The clinical trial was completed in  November 2000, with 23 patients receivingdialysis on the PHD System.  Over  5,000 dialysis treatments have been performedby patients on the PHD System, including over 4,000 in the home.

 

On March 27, 2002, the Company announced that it received the FDA’sclearance to market the PHD System in the United States.  The FDA clearance had no restrictions andincluded authorization to use the product in the home.  The Company had been working towardsatisfying the regulatory requirements of the FDA since submitting a 510(k)pre-market notification for clearance to market the PHD System in January2001.  510(k) clearance by the FDA wasrequired prior to the commercialization of the PHD System in the United States.

 

The FDC Act requires that medical devices be manufactured in accordancewith the FDA’s current QSRs.  Theseregulations require, among other things, that (i) the manufacturing processmust be regulated and controlled by the use of written procedures and (ii) theability to produce devices which meet the manufacturer’s specifications bevalidated by extensive and detailed testing of every aspect of theprocess.  They also requireinvestigation of any deficiencies in the manufacturing process or in theproducts produced and detailed record keeping. Manufacturing facilities are therefore subject to FDA inspection on aperiodic basis to monitor compliance with QSR requirements.  If violations of the applicable regulationsare noted during FDA inspections of the Company’s manufacturing facilities orthe manufacturing facilities of its contract manufacturers, there may be amaterial adverse effect on the continued marketing of the Company’s products.

 

Even though the FDA has cleared the PHD System, the FDA mayperiodically inspect the manufacturing facilities and processes for compliancewith QSRs.  In addition, in the eventthat additional manufacturing sites are added or manufacturing processes arechanged, such new facilities and processes are also subject to FDA inspectionfor compliance with QSRs.

 

**Foreign Government Regulation**

 

On October 7, 2002, the Company announced the receipt of ECCertification for CE Mark approval pursuant to the Medical Device Directive ofthe European Economic Area.  Thecertification approved the PHD System for home use. Such approval was requiredprior to the commercialization of the PHD System in the European Economic Area.

 

The Company plans to market the PHD System in several foreign markets,including Europe and Japan. Requirements pertaining to the PHD System vary widely from country tocountry, ranging from no health regulations to detailed submissions such asthose required by the FDA.  The Companybelieves the extent and complexity of regulations of medical devices such asthe PHD System is increasing worldwide. The Company anticipates that this trend will continue and that the costand time required to obtain approval to market in any given country willincrease, with no assurance that such approval will be obtained.  The ability to export into other countriesmay require compliance with EN46001 or ISO13485, which is analogous tocompliance with the FDA’s QSR requirements.

 

**IntellectualProperty**

 

As of March 1, 2003, the Company either owns or has exclusive rights to46 U.S. patents and 24 foreign patents for technologies that are important todeveloping a safe, convenient, self-contained hemodialysis system.   The U.S. Patent and Trademark Office hasalso allowed claims on 10 additional patents. The Company has filed a number of additional patent applicationsdirected to a number of different features of the PHD System in the UnitedStates, and in several other countries that have significant hemodialysismarkets.  The Company has also filed aPatent Cooperation Treaty (“PCT”) patent application that permits it to filepatent applications in additional PCT-member countries for a limited period oftime.  The Company expects to fileadditional patent applications in the United States directed to the PHD Systemas new technology is developed.

 

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*TwardowskiLicense.*  On April 1,1993, the Company entered into a License Agreement (the “Twardowski License”)with Dr. Zbylut Twardowski, a member of the Company’s Scientific AdvisoryBoard, granting to the Company a worldwide exclusive license which relates tothe patent issued on August 9, 1994 entitled “Artificial Kidney for Frequent(Daily) Hemodialysis” which expires August 9, 2011 (the “TwardowskiPatent”).  The Twardowski Patent relatesto an artificial kidney intended to provide frequent (daily) homehemodialysis.  The Twardowski Licensehas a duration for as long as the Twardowski Patent remains in effect.  The Twardowski License provides forroyalties based on the revenue received by the Company from the sale or leaseof the licensed product. The Twardowski License requires certain minimumsemiannual royalty payments.  If theCompany fails to make any such minimum royalty payment, Twardowski has theoption to convert the Twardowski License to a non-exclusive license.  There can be no assurance that theTwardowski Patent will provide the Company significant exclusivity or benefitin its markets.  Furthermore,competitors may develop alternative technology that achieves the sameadvantages as the Twardowski Patent.

 

*BoagLicense.*  On April 1,1993, the Company also entered into a License Agreement (the “Boag License”)with Cynthia P. Walters for the use of a patent entitled “Dialyzer ReuseSystem” issued on September 22, 1987, which expires September 22, 2004 (the“Boag Patent”).  The Boag License isexclusive, subject to the rights of Servall Corp. to market its HR3000 product,a device for facilitating reuse of consumables with conventional hemodialysismachines.  The Boag Patent relates to adialysis reuse system for cleaning, sterilizing and testing a hemodialysismachine and its associated dialyzer and blood tubing set.  The Boag License has a duration for as longas the Boag Patent remains in effect. The Boag License provides for royalties based on the revenue received bythe Company from the sale or lease of the licensed product with a minimumsemiannual royalty payment.  Commencingwith the third semiannual period after the first licensed product is sold, ifthe Company pays no more than the minimum semiannual royalty payment for twoconsecutive semiannual periods, the licensor has the right to convert the BoagLicense to a non-exclusive license. Also, commencing with the first semiannual period occurring five years afterthe first licensed product is sold, if the Company pays no more than theminimum semiannual royalty payment for two consecutive semiannual periods, thelicensor has the right to terminate the Boag License.  In the event of infringement of the patent by third parties, theCompany’s right to enforce the patent is subject to the licensor’s superiorright to bring suit on its own and to recover all damages without accounting tothe Company.  There can be no assurancethat the Boag Patent will provide the Company significant exclusivity orbenefit in its markets.  Furthermore,competitors may develop alternative technology that achieves the sameadvantages as the Boag Patent.

 

*AllerganLicense.*   On March11, 1996, the Company entered into a License Agreement (the “Allergan License”)with Allergan, Inc. for the use of a U.S. patent entitled “Pressure TransducerMagnetically-Coupled Interface Complementing Minimal Diaphragm Movement DuringOperation” issued on February 28, 1995, and its foreign counterparts (the“Allergan Patent”).   The Company has exclusiveworldwide rights to the patented technology, limited to the field of use ofkidney dialysis machines and methods. The Allergan License has a duration for as long as the Allergan Patentremains in effect and provides for royalty payments to Allergan based onmanufacturing of the PHD System, which incorporates the patentedtechnology.   Royalty payments are to bemade quarterly, with minimum annual royalty payments beginning in 1998.  If the Company fails to pay the full minimumannual royalties, the License Agreement will terminate.  If the Company pays at least half of theminimum annual royalties but does not pay such royalties in full, the LicenseAgreement shall be converted to a non-exclusive license.   There can be no assurance that the AllerganPatent will provide the Company significant exclusivity or benefits in itsmarkets.   Furthermore, competitors maydevelop alternative technology that achieves the same advantages as theAllergan Patent.

 

There can be no assurance that any of the Company’s pending patentapplications will be approved by the patent offices in the various countries inwhich they were filed.  In addition,there can be no assurance that the Company will develop additional proprietaryproducts or processes that are patentable or that any patents that may beissued to or be licensed by the Company will provide the Company withcompetitive advantages.  There can be noassurance that the Company’s patent applications or patents that may be issuedto or be licensed by the Company will not be challenged by any third parties orthat the patents of others will not prevent the commercialization of productsincorporating the Company’s technologies. Furthermore, there can be no assurance that others will not or have notindependently developed similar products, duplicated and designed any of theCompany’s products or design around the patents

 

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that may be issued to or be licensed by the Company.  Any of the foregoing results could have amaterial adverse effect on the Company.

 

The commercial success of the Company will depend, in part, on itsability to avoid infringing patents issued to others.  The field of dialysis includes a significant number of patentsthat have been issued to third parties. The Company may receive from third parties, including potential oractual competitors, notices claiming that it is infringing third party patentsor other proprietary rights.  If it wasdetermined that the Company was infringing any third-party patent, the Companycould be required to pay substantial damages, alter its products or processes,obtain licenses or cease certain activities. In addition, if patents are issued to others which contain claims thatcompete or conflict with the licensed patents or patent applications of theCompany and such competing or conflicting claims are ultimately determined tobe valid, the Company may be required to pay damages, to obtain licenses tothese patents, to develop or obtain alternative technology or to cease usingsuch technology.  If the Company isrequired to obtain any licenses, there can be no assurance that the Companywill be able to do so on commercially favorable terms, if at all.  The Company’s failure to obtain a license toany technology that it may require to commercialize its products could have amaterial adverse impact on the Company’s business, operating results andfinancial condition.

 

In addition to patent licenses and applications for patents, theCompany possesses trade secrets, copyrights, proprietary know-how andunpatented technological advances.  TheCompany seeks to protect these assets, in part, by confidentiality agreementswith its business partners, consultants and vendors and non-competitionagreements with its officers and employees. There can be no assurance that these agreements will not be breached,that the Company will have adequate remedies for any breach or that theCompany’s trade secrets and proprietary know-how will not otherwise becomeknown or be independently developed by others.

 

**Employees**

 

As of December 31, 2002, the Company had 80 full-time employees, 37 ofwhom were employed in research and development capacities, 12 employed in thetechnical and clinical services area and 11 in the Company’s sales and marketinggroups.  The Company considers itsemployee relations to be good.

 

**ExecutiveOfficers**

 

The information under this Item is furnished pursuant to Instruction 3to Item 401(b) of Regulation S-K. Executive Officers of the Company are elected by and serve at thediscretion of the Board of Directors.

 

**William C. Dow** was appointed President and Chief ExecutiveOfficer and a director of the Company in September 1999.  From August 1997 until joining the Companyin September 1999, he served as President and Chief Executive Officer of PLCSystems Inc., a manufacturer of lasers used in cardiac surgery.  From 1993 to 1997, he served as Presidentand Chief Executive Officer of Deknatel Snowden Pencer Worldwide, Inc., a $100million medical device manufacturer that became a manufacturing and marketingsubsidiary of Genzyme Corporation in 1996. Mr. Dow has over 25 years of experience in the medical device andservice industry having held various positions in sales, marketing,distribution and general management with Griffith Micro Science, Kendall,Terumo and American Hospital Supply. Mr. Dow is a graduate of the United States Naval Academy with a Bachelorof Science in Engineering and served as both a pilot and a Supply Corps officerin the U.S. Navy.

 

**Richard P. Goldhaber**,Senior Vice President and Chief Technical Officer, joined the Company in July2000.  Prior to joining the Company,from 1993 to 2000, he was Vice President of Research and Development atMinntech Corporation, a company that develops, manufactures and distributesdialysis related products.  Prior toMinntech, from 1965 to 1993, he held positions of increasing responsibility inproduct development with Baxter International Inc., including 20 yearsdeveloping dialysis products.

 

**Lawrence D. Damron**,Senior Vice President and Chief Financial Officer, joined the company in May2002. Mr. Damron has over 20 years of experience in the healthcare sector. FromJune 1999 to December 2000, he served as the Chief Financial Officer forEverest Healthcare Services Corporation, a provider of dialysis and other blood

 

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treatment services. From July 1997 until June 1999, he was Senior VicePresident, Finance and Treasurer at Evanston Northwestern Healthcare. Additionalexperience was with Baxter International since 1985 in a number of keymanagement positions including Corporate Treasurer from 1992 until 1997. From1980 until 1985, Mr. Damron was with American Hospital Supply in a variety offinancial positions. Mr. Damron received his Bachelor of Arts degree ineconomics from the University of Cincinnati in 1968 and his Masters of Artsdegree in international relations from the University of Southern California in1973. He received his Masters of Business Administration from HarvardUniversity in 1975 and is also a Certified Public Accountant. Mr. Damron was aLieutenant in the U.S. Navy.

 

**Thomas F. Scully**,Senior Vice President of Manufacturing and Operations since January 2002.  Mr. Scully first joined the Company inJanuary 1996 as Vice President of Operations. From 1971 to 1995, Mr. Scully worked at Baxter International Inc. invarious operational roles, including responsibilities as Vice President, Salesand Operations of the Renal Division. In that role, Mr. Scully was involved principally in the design,development and management of the Renal Division’s home care operationsnetwork.

 

**ProductLiability Exposure**

 

The Company’s business exposes it to potential product liability risksrelating to the production, marketing and sale of dialysis products.  There can be no assurance that the Companywill be able to avoid significant product liability exposure.  Upon commencement of the first human use ofthe PHD System in January 2000, the Company initiated product liability insurance coverage, with a limit of$10 million.  There can be no assurancethat such insurance coverage is sufficient, or that additional coverage will beavailable on acceptable terms, or at all, or that any insurance policy ifobtained will provide adequate protection against potential claims.  Furthermore, the Company’s agreements withcontract manufacturers require the Company to obtain product liabilityinsurance, and the failure to obtain adequate insurance coverage couldmaterially and adversely affect the Company’s ability to produce the PHDSystem.  A successful claim broughtagainst the Company in excess of any insurance coverage maintained by theCompany could have a material adverse effect upon the Company.  In addition, the Company has agreed toindemnify certain of its contract manufacturers against certain liabilitiesresulting from the sale of the PHD System.

 

**ForeignOperations**

 

In April 1996, the Company established Aksys Japan, K.K. (“AJKK”), awholly-owned Japanese subsidiary.   AJKKhad no employees as of December 31, 2002.  The Company has engaged the services of a business consultant to act onbehalf of AJKK in pursuing business opportunities in Japan.  The primary purpose of AJKK is to establisha presence for regulatory, business development and eventual technical andcustomer support as the Company progresses through the stages of clinicalstudies, regulatory approval and market launch.   All efforts and decisions are directed from the Company’sheadquarters in Lincolnshire, Illinois.

 

On June 21, 1999, the Company entered into a co-development and licenseagreement (the “Agreement”) with Teijin Limited of Osaka, Japan. Under theterms of the Agreement, Teijin paid the Company a $7.0 million co-developmentfee relating to the PHD System.  Use ofthe proceeds from the co-development fee was restricted to development costsincurred on the PHD System and could not be used for other general corporatepurposes.  Amounts paid under theco-development arrangement were recognized as revenue as development costs onthe PHD System were incurred.  Duringthe year ended December 31, 2000, the Company recognized revenue of $3.4million related to co-development of the PHD System.  During 2000, the Agreement was amended.  The final revenue related to the co-development of the PHD Systemunder the Agreement was recognized in 2000. The remaining unspent co-development funds of approximately $660,000under the Agreement were recorded in other liabilities at December 31, 2000 andwere subsequently spent exclusively on development activities by Teijin’sresearch employees.

 

Teijin is a leading Japanese manufacturer of synthetic fibers,chemicals and plastics, with annual sales in excess of $5 billion, of whichover $700 million is derived from pharmaceuticals and medical products.  Teijin pioneered and today is a leader inthe home oxygen therapy business in Japan.

 

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**RiskFactors**

 

*Investingin the Company’s common stock involves a high degree of risk. You shouldcarefully consider the risks and uncertainties described below beforeinvesting.  If any of the followingrisks actually occur, the Company’s business, financial condition or results ofoperations would likely suffer.  In thatcase, the market price of the common stock could fall, and you may lose all orpart of the money you paid to buy such common stock.  Also consider carefully the statements under the heading ‘‘Noteon Forward-Looking Information’’ below. You should be prepared to accept the occurrence of any and all of therisks associated with purchasing the securities, including a loss of all ofyour investment.*

** **

**Risks Related to the Company’sBusiness**

* *

*TheCompany has a history of operating losses and a significant accumulated deficit,and may not achieve or maintain profitability in the future.*

 

The Company has not been profitable since itsinception in January 1991.  As ofDecember 31, 2002, the Company had an accumulated deficit of approximately $107million.  The Company expects tocontinue to incur additional losses for the foreseeable future as a result of ahigh level of operating expenses, significant up-front expenditures, productionand marketing activities and very limited revenue from its core business.  The Company may never realize significantrevenues from its core business or be profitable.  Factors that will influence the timing and amount of theCompany’s profitability include:

 

**•**market acceptance of the PHD System;

 

**•**the Company’s success in commercializing the PHD System, which will bedifficult to achieve;

 

**•**the Company’s ability to effectively and efficiently manufacture, market anddistribute the PHD System; and

 

**•**the Company’s ability to sell or lease the PHD System and related services at aprice that covers per unit costs, which result may be difficult to achieve, inpart because of the significant restrictions on the reimbursement of dialysistreatment by the Medicare program, as discussed below, and the high cost ofmanufacturing the PHD System.

 

The Company faces significant challenges in shiftingfrom the development stage to the commercialization stage for the PHDSystem.  Its prospects must beconsidered in light of the risks, expenses and difficulties frequently encounteredin such a transition, and there can be no assurance that the Company will haveany significant revenues or that it will ever achieve profitable operations.

* *

*Thecost to produce the PHD System and deliver related services and suppliescurrently exceeds the market price of the PHD System and related services andsupplies.*

 

The pricing of the PHD System and related services andsupplies is constrained by limitations on governmental and third-partyreimbursement programs. Although a team of engineering personnel is currentlyimplementing plans to reduce costs through redesign of PHD subsystems and theCompany is attempting to source alternative materials and suppliers, there canbe no assurance that the Company will be successful in these efforts.

 

In addition, the cost of services and supplies for thePHD System currently exceeds the market price as a result of the need to have alocal presence of field service and clinical service personnel in eachgeographical area that PHD Systems are sold. Although the Company anticipates that as more PHD units are placed inthese geographical areas the per unit cost of services and supplies willdecrease, there can be no assurance that the Company will be successful inplacing a sufficient number of PHD units in the field to achieve these per unitcost reductions.

* *

*Thebusiness will fail if the Company cannot successfully commercialize the PHDSystem; because it is only now commencing this commercialization process, theCompany’s success cannot be predicted and is uncertain.  The Company’s success is dependent on manyvariables entirely outside of its control.*

 

Acceptance of the PHD System in the marketplace byboth potential users and purchasers (two separate groups with at timesconflicting interests) is uncertain, and failure to achieve sufficient marketacceptance will

 

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significantly limit the Company’s ability to generate revenue andbecome profitable.  The success of thePHD System is dependent on many variables, including its safety, effectivenessand cost effectiveness as an alternative dialysis modality.  The failure to conclusively demonstrate eachof these factors could significantly hinder market acceptance of the PHDSystem, and the failure of the PHD System to achieve sustained commercial viabilityor market acceptance would have a material adverse effect on the Company andyour investment.  Moreover, successfulcommercialization will depend upon, among other things, market acceptance ofthe efficacy of daily hemodialysis. This will require substantial marketing efforts and the expenditure ofsignificant funds by the Company to inform nephrologists, dialysis clinics,other healthcare providers and dialysis patients of the benefits of dailyhemodialysis and thus the benefits of the PHD System.

 

In marketing the PHD System, the Company may encounter significantclinical and market resistance to:

 

**•**using the PHD System;

 

**•**home hemodialysis, which is currently employed by only a small percentage ofpatients suffering from end-stage renal disease; and

 

**•**daily hemodialysis, which to the Company’s knowledge has never been a widelyaccepted dialysis alternative.

 

There can be no assurance that the Company’s effortswill be successful or that the PHD System will ever achieve marketacceptance.  In addition, the PHD Systemis a personal system, designed for use by a single patient, and requiresseveral hours after a dialysis treatment to prepare itself for the nexttreatment session.  As such, it is veryunlikely to be used in the prevailing method of outpatient hemodialysis, whichgenerally involves treating patients three times per week for treatmentsessions lasting between three and four hours. In this prevailing method of hemodialysis, patients receiving treatmenton a given day are treated in shifts, with patients on succeeding shifts usingdialysis machines employed during prior shifts.

 

A number of other factors will affect the future success and sales ofthe PHD System.  These factors include:

 

**•**the amount of government and private reimbursement for dialysis treatment;

 

**•**whether the system will be safe or effective or that it will be cost-effectiverelative to other dialysis treatment alternatives;

 

**•**whether daily hemodialysis will be shown to be more clinically effective thanalternative dialysis modalities;

 

**•**whether patients will be reluctant to administer and monitor the PHD Systemwith limited or no supervision; and

 

**•**whether there are unexpected side effects, complications or other safety issuesassociated with daily hemodialysis (or the PHD System) that may adverselyaffect the market for the Company’s products and services.

* *

*TheCompany is entirely dependent on the PHD System, its sole product.*

 

Since inception, the Company has devoted substantiallyall of its efforts to the development of the PHD System.  The Company expects to be entirely dependentfor the foreseeable future on sales of, and services relating to, the PHDSystem for revenues.  This dependence ona single product creates significant risk for the Company and its stockholders.

* *

*Uncertaintyand amount of third-party reimbursement could affect the Company’sprofitability.*

 

Although most private insurance policies cover asubstantial portion of the cost of dialysis treatment in the United States,most patients receiving dialysis treatment in the United States are insured byMedicare or Medicaid.  Medicare andMedicaid provide reimbursement for dialysis treatment at set composite rates,which are typically lower than the reimbursement rates provided by privateinsurers.  Treatment with the PHD Systemis eligible for reimbursement by Medicare and Medicaid and most privateinsurance policies.  The reimbursementrates for outpatient hemodialysis (including the PHD System) by Medicare and Medicaid,however, are at set composite rates and have not increased significantly since1983.  There can be no assurance thatthe current limitations or requirements on Medicare and Medicaid reimbursementfor dialysis will not materially adversely affect the market for the PHDSystem, that health administration authorities outside of the United Stateswill provide reimbursement at

 

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acceptable levels or at all or that any such reimbursement will becontinued at rates sufficient to enable the Company to maintain prices atlevels sufficient to realize profitability.

* *

*Competitorsand technological advances could cause the Company to lose current and futurebusiness opportunities and materially harm the Company’s results of operationsand ability to grow.*

 

The dialysis industry is characterized by competitionfor financing, executive talent, intellectual property and product sales.  Most of the Company’s competitors havesubstantially greater financial, scientific and technical resources, researchand development capabilities, manufacturing and marketing resources, technicaland service networks and experience than the Company, and greater experience indeveloping products, providing services and obtaining regulatory approvals.  The Company’s competitors may succeed indeveloping products that are more effective and/or less costly than any thatmay be developed by the Company.  TheCompany also expects that the number of competitors and potential competitorswill increase.  There can be noassurance that the Company will be able to compete successfully against anyexisting or potential competitors.

 

In order to compete effectively, the Company will needto, among other things, demonstrate the clinical and cost effectiveness ofdaily home hemodialysis using the PHD System. The ability to successfully market the Company’s products and servicescould be adversely impacted by pharmacological and technological advances inpreventing the progression of ESRD in patients (such as those with diabetes andhypertension), technological developments by others, development of newmedications designed to reduce the incidence of kidney transplant rejection andprogress in using kidneys harvested from genetically engineered animals as asource of transplants.

* *

*If theCompany cannot develop adequate distribution, customer service and technicalsupport networks, it may not be able to market and distribute the PHD Systemeffectively.*

 

The Company’s strategy involves contracting with dialysis providers tohave the Company supply to dialysis patients the PHD System, dialysate andother consumables, patient training, customer service and maintenance and othertechnical service.  To provide theseservices, the Company will be required to develop networks of employees orindependent contractors in each of the areas in which it intends tooperate.  There can be no assurance thatthe Company will be able to organize these networks on a cost-effective basis,or at all.  The failure to establishthese networks would have a material adverse effect on the Company.

* *

*TheCompany’s future sales could be adversely affected due to limited marketingexperience.*

 

The Company markets its products and servicesprimarily through its own sales force, and has limited experience in sales,marketing and distribution.  There canbe no assurance that it will be able to build an adequate marketing staff orsales force or that the cost of such will not be prohibitive, or that theCompany’s direct sales and marketing efforts will be successful.

 

*TheCompany is subject to extensive government regulation which can be costly, timeconsuming and subject it to unanticipated delays.*

 

The PHD System is subject to stringent governmentregulation in the United States and other countries.  In the United States, the PHD System is regulated as a medicaldevice by the FDA.  On March 27, 2002,the Company announced that it had received clearance from the FDA to market thePHD System in the United States.  TheFDA clearance had no restrictions and included authorization to use the productin the home; however, FDA clearance under 510(k) is subject to continual reviewand later discovery of previously unknown problems may result in restrictionson product marketing or withdrawal of the product from the market.

 

In the European Economic Area, the PHD System isregulated as a medical device under the Medical Device Directive.  On October 7, 2002, the Company announcedthe receipt of EC Certification for CE Mark approval pursuant to the MedicalDevice Directive.  The certification approvedthe PHD System for home use.  Suchapproval was required prior to the commercialization of the PHD System in theEuropean Economic Area.

 

Additional government regulations may be establishedor imposed in the United States or the European Economic Area, or theinterpretation or enforcement of such regulations may change, which couldmaterially impact the continued commercialization of the PHD System and theregulatory clearances received for the PHD System.

 

18

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In addition, various statutes and regulations alsogovern the testing, labeling, storage, record keeping, distribution, sale,marketing, advertising and promotion of the Company’s products, which presentsignificant compliance burdens.  Failureto comply with applicable requirements can result in fines, recalls or seizuresof products, total or partial suspension of production, withdrawal of existingproduct approvals or clearances, refusal to approve or clear new applicationsor notices and criminal prosecution.

 

The manufacture of the PHD System must also comply orensure compliance with current Quality System Requirements (QSR) regulationspromulgated by the United States Food and Drug Administration (FDA).  The Company may be required to expend time,resources and effort in product manufacturing and quality control to ensurecompliance even if the PHD System is manufactured by an independentcontractor.  If violations of theapplicable regulations are noted during FDA inspections of manufacturingfacilities, the continued marketing of the Company’s products may be materiallyadversely affected.

 

You should also be aware that proper regulatoryapprovals have not been completed in any jurisdictions other than the UnitedStates and the European Economic Area. There can be no assurance or guarantee that any other such approvalswill be obtained in a timely manner or at all.

* *

*TheCompany relies on independent contract manufacturers for the manufacture of thePHD System.  The Company’s inability tomanufacture the PHD System, and its dependence on independent contractors, maydelay or impair its ability to generate revenues, or adversely affectprofitability.*

 

To be successful, the PHD System must be manufacturedin commercial quantities and at acceptable cost.  Production of this product, especially in commercial quantities,will create technical as well as financial challenges for the Company.  The Company may encounter unexpected delaysor costs in the scale-up of manufacturing operations.  Further, no assurance can be given that manufacturing or qualitycontrol problems will not arise (and among other things increase costs) as theCompany increases production of this product or as additional manufacturingcapacity is required in the future.

 

The Company relies currently on a single contractmanufacturer to manufacture each of the major components of the PHDSystem.  As with any independentcontractors, such contractors are not employed or otherwise controlled by theCompany and are generally free to conduct their business at their owndiscretion.  Although certain of theCompany’s contract manufacturers have entered into contracts with the Companyto manufacture components of the PHD System, such contracts can be terminatedat any time under certain circumstances by the Company or the contractors andcan be breached at any time.  Further,work stoppages and the slowing of production at a single independent contractorwould have a material adverse effect on the Company.

 

There are also other risks inherent in using singlesources of supply.  The Company has notmade alternative arrangements for the manufacture of the major components ofthe PHD System and there can be no assurance that acceptable alternative arrangementscould be made on a timely basis, or at all. It is likely that a significant interruption in supply would result ifthe Company utilized or were required to utilize a different manufacturingcontractor for any of the major components of the PHD System.  The loss of the services of any of contractmanufacturers would have a material adverse effect on the Company.  In addition, no assurance can be given thatthe Company or its manufacturers will be able to obtain on a timely basiscomponents or other supplies necessary to manufacture or use the PHD System.

* *

*TheCompany will need additional capital which, if not available, may alter theCompany’s business plans or limit its ability to achieve growth and which, ifraised, will dilute your ownership interest in the Company.*

 

The Company’s capital requirements have been and willcontinue to be significant.  To date,the Company has been dependent primarily on the net proceeds of public andprivate sales of equity securities, aggregating approximately $125 million.  Other than the Company’s equity line ofcredit arrangement with Kingsbridge Capital Limited, it currently has nocommitted sources of, or other arrangements with respect to, additionalfinancing.  There can be no assurancethat the Company’s existing capital resources, including the equity linearrangement, together with future operating cash flows, will be sufficient tofund future operations.  The Company’scapital requirements will depend on many factors, including without limitation:

 

**•**manufacturing scale-up and associated costs;

 

19

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**•**costs associated with establishing marketing, distribution, patient trainingand technical and patient support networks;

 

**•**continued progress in research and development; and

 

**•**the costs involved in protecting proprietary rights.

 

In the event that the Company’s plans change, itsassumptions change or prove inaccurate or it is unable to obtain productionfinancing on commercially reasonable terms, it could be required to seekadditional financing sooner than currently anticipated and on less favorableterms than anticipated.  Any necessaryadditional equity financing may involve substantial dilution to then existingstockholders and debt financing could result in the imposition of significantfinancial and operational restrictions on the Company.

 

Generally, U.S. customers will lease or purchase PHDSystems and enter into contracts whereby the Company provides all products andservices related to the PHD Systems for a single monthly price, which wouldinclude all consumables, service and product support.  If U.S. customers enter into lease agreements, the single monthlypayment would increase to include the lease payment for the PHD System.

 

Financing production of the PHD System in quantitiesnecessary for commercialization will require a significant investment inworking capital.  This need for workingcapital is likely to increase to the extent that demand for the PHD Systemincreases.  The Company would,therefore, have to rely on sources of capital beyond cash generated fromoperations to finance production of the PHD System even if it is successful inmarketing products and services.  TheCompany currently intends to finance the working capital requirements associatedwith these arrangements through equipment and receivable financing with acommercial lender.  If it is unable toobtain such equipment financing, or to obtain it on commercially reasonableterms, it would need to seek other forms of financing, through the sale ofequity securities or otherwise, to achieve its business objectives.

 

The Company has not yet obtained a commitment for suchequipment financing, and there can be no assurance that it will be able toobtain equipment financing or alternative financing on acceptable terms or atall.

 

*TheCompany may not be able to protect its intellectual property rights and, as aresult, could lose competitive advantages that could adversely affect operatingresults.*

 

The Company’s success depends, in part, on its abilityand the ability of its licensors to obtain, assert and defend patent rights,protect trade secrets and operate without infringing the proprietary rights ofothers.  The Company currently owns orhas rights to 46 U.S. patents and 24 foreign patents.  There can be no assurance, however, that:

 

**•**the Company will be able to obtain additional licenses to patents of others orthat it will be able to develop additional patentable technology of its own;

 

**•**any patents issued to the Company will provide it with competitive advantagesor that the patents or proprietary rights of others will not have an adverseeffect on its ability to do business;

 

**•**others will not independently develop similar products;

 

**•**others will not design around or infringe such patents or proprietary rightsowned by or licensed to the Company; and

 

**•**any patent obtained or licensed by the Company will be held to be valid andenforceable if challenged by another party.

 

The Company is aware that numerous patents have beenissued relating to methods of dialysis. Although the Company endeavors to protect its patent rights frominfringement, it is possible that by virtue of the numerous patents that havebeen, or potentially will be, issued relating to hemodialysis methods, theCompany may not be aware, or become aware, of patents issued to its competitorsor others that conflict with its own or those of its licensors.  Such conflicts could result in a rejectionof important patent applications or the invalidation of important patents,which could have a material adverse effect on the Company’s competitiveposition.  In the event of suchconflicts, or in the event the Company believes that competitive productsinfringe patents to which it holds rights, it may pursue patent infringementlitigation or interference proceedings against, or may be required to defendagainst

 

20

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such litigation or proceedings involving, holders of such conflictingpatents or competing products.  Suchlitigation or proceedings may materially adversely affect the Company’scompetitive position, and there can be no assurance that it will be successfulin any such litigation or proceeding. Litigation and other proceedings relating to patent matters, whetherinitiated by the Company or a third party, can be expensive and time consuming,regardless of whether the outcome is favorable to the Company, and can resultin the diversion of substantial financial, managerial and other resources.  An adverse outcome could subject the Companyto significant liabilities to third parties or require it to cease any relateddevelopment or commercialization activities. In addition, if patents that contain dominating or conflicting claimshave been or are subsequently issued to others and such claims are ultimatelydetermined to be valid, the Company may be required to obtain licenses underpatents or other proprietary rights of others. No assurance can be given that any licenses required under any suchpatents or proprietary rights would be made available on terms acceptable tothe Company, if at all.  If the Companydoes not obtain such licenses, it could encounter delays or could find that thedevelopment, manufacture or sale of products requiring such licenses isforeclosed.

 

The Company relies on proprietary know-how andconfidential information and employs various methods, such as entering intoconfidentiality and noncompete agreements with its current employees and withcertain third parties to whom it has divulged proprietary information, toprotect the processes, concepts, ideas and documentation associated with itstechnologies.  Such methods may notafford significant protection to the Company, and there can be no assurancethat it will be able to protect adequately trade secrets or that othercompanies will not acquire information that the Company considers proprietary.

* *

*If theCompany becomes subject to product liability claims, they may reduce demand forthe PHD System or result in damages that exceed its insurance limitation.*

 

The Company’s business exposes it to potential productliability risks that are inherent in the production, marketing and sale ofdialysis products.  There can be noassurance that the Company will be able to avoid significant product liabilityexposure.  The Company currentlymaintains product liability insurance with a coverage limit of $10million.  There can be no assurance thatthe insurance policy will provide adequate protection against potential claims.Furthermore, the Company’s agreements with contract manufacturers require it tomaintain product liability insurance, and the failure to obtain such insurancecould materially and adversely affect the Company’s ability to produce the PHDSystem.  A successful claim broughtagainst the Company in excess of any insurance coverage could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.  In addition, the Companyhas agreed to indemnify certain of its contract manufacturers against certainliabilities resulting from the use of the PHD System.

* *

*TheCompany’s business is likely to be hurt if it is unable to keep its seniorexecutive officers and key scientific personnel.*

 

The Company is dependent upon the services of itssenior executives, such as William C. Dow, its President and Chief ExecutiveOfficer, and key scientific personnel. The Company does not maintain key-man life insurance on seniorexecutives.  In addition, it does nothave employment agreements, other than certain severance, confidentiality andnon-competition agreements, with any of its personnel.  The loss of the services of Mr. Dow or anyother senior executive or key employee could have a material adverse impact onthe Company.  Also, the Company’sability to transition from development stage to commercial operations willdepend upon, among other things, the successful recruiting and retention ofhighly skilled managerial and marketing personnel with experience in businessactivities such as those contemplated by the Company.  Competition for the type of highly skilled individuals sought bythe Company is intense.  There can be noassurance that the Company will be able to retain existing employees or that itwill be able to find, attract and retain skilled personnel on acceptable terms.

 

**Risks Related to the Company’s Stock**

 

*TheCompany’s stock price is highly volatile, and you may not be able to resellyour shares at or above the price you initially paid for the shares.*

 

Since its initial public offering on May 16, 1996, theCompany’s common stock has traded between $3.50 and $23.50 and has generallyexperienced relatively low daily trading volumes in relation to the aggregatenumber of shares outstanding.

 

21

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Factors that may have a significant impact on themarket price or the liquidity of the common stock include:

 

**•**reports by official or unofficial health or medical authorities, the generalmedia or the FDA regarding the potential benefits or detriments of the PHDSystem or of similar products distributed by other companies, or of daily orhome dialysis;

 

**•**announcements of technological innovations or new products by the Company orits competitors;

 

**•**events or announcements relating to the Company’s relationships with others,including third party manufacturers;

 

**•**developments or disputes concerning patents or proprietary rights;

 

**•**regulatory developments in the United States and foreign countries;

 

**•**economic and other factors, as well as period-to-period fluctuations in theCompany’s financial results; and

 

**•**market conditions for the dialysis industry generally.

 

External factors may also adversely affect the marketprice for the common stock.  The commonstock currently trades on The Nasdaq National Market System.  The price and liquidity of the common stockmay be significantly affected by the overall trading activity and marketfactors on The Nasdaq National Market System.

 

Future sales of substantial amounts of common stock inthe public market and the existence of a substantial number of authorized butunissued shares of common stock could adversely affect market prices of thecommon stock, and also could impair the Company’s ability to raise additionalcapital through the sale of equity securities.

* *

*TheCompany may issue additional shares of common stock and dilute your ownershippercentage.*

 

Certain events over which you have no control couldresult in the issuance of additional shares of common stock, which would diluteyour ownership percentage in the Company. As of March 27, 2003, there were 26,324,480 shares of common stockissued and outstanding and there were 2,120,843 shares of common stock reservedfor issuance under equity incentive and stock purchase plans.  In addition, as of March 27, 2003, therewere outstanding options, warrants and other rights to acquire up toapproximately 2,363,124 shares of common stock. There are also 3,500,000 sharesof common stock which are reserved for issuance under the equity linearrangement with Kingsbridge Capital Limited. The Company may also issue additional shares of common stock orpreferred stock:

 

**•**to raise additional funds for working capital, commercialization, productionand marketing activities;

 

**•**upon the exercise or conversion of outstanding options and warrants; and

 

**•**in lieu of cash payment of dividends.

 

The issuance or even potential issuance of sharesunder the equity line arrangement with Kingsbridge, in connection with otheradditional financings, and upon exercise of warrants, options or other rightsmay have a negative effect on the market price of the common stock.  In addition, if the Company elects to drawdown the equity line, it will issue shares to Kingsbridge at a discount to thedaily volume weighted average prices of the common stock during a specifiedperiod of trading days after initiation of each respective draw down.  This will further dilute the interests ofother stockholders.

 

If the Company draws down the equity line when theshare price is decreasing, it will need to issue more shares than otherwiserequired.  Such issuance will have adilutive effect and may further decrease the stock price.

 

To the extent that Kingsbridge sells shares of commonstock issued under the equity line to third parties, the stock price maydecrease due to the additional selling pressure in the market. The perceivedrisk of dilution from sales of stock to or by Kingsbridge may cause holders ofthe Company’s common stock to sell their shares, or it may encourage shortsales.  This could contribute to adecline in the stock price.

* *

*TheCompany’s charter documents, rights agreement and Section 203 of the DGCL couldmake it more difficult for a third party to acquire the Company.*

 

The Company’s Restated Certificate of Incorporation(‘‘Charter’’) and Amended and Restated Bylaws (‘‘Bylaws’’) contain certain provisionsthat are intended to enhance the likelihood of continuity and stability in thecomposition of its board of directors, and which may have the effect ofdelaying, deferring or preventing a future

 

22

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takeover or change in control of the Company unless the takeover orchange of control is approved by the Company’s board of directors.  Such provisions may also render the removalof the current board of directors and of management more difficult.  These provisions provide for, among otherthings:

 

**•**a classified board of directors;

 

**•**a ‘‘fair price’’ provision, which requires that the Company’s stockholdersreceive equivalent consideration at both stages of a two-step acquisition (suchas a tender offer followed by a merger);

 

**•**a prohibition on stockholder action through written consents;

 

**•**a requirement that special meetings of stockholders be called only by the boardof directors or the chief executive officer;

 

**•**advance notice requirements for stockholder proposals and nominations;

 

**•**limitations on the ability of stockholders to amend, alter or repeal theCharter or Bylaws; and

 

**•**the authority of the board of directors to issue, without stockholder approval,preferred stock with such terms as the board of directors may determine.

 

Each outstanding share of the Company’s common stockincludes one preferred stock purchase right (individually a ‘‘Right’’ andcollectively the ‘‘Rights’’) as provided under the Rights Agreement between theCompany and First Chicago Trust Company of New York.  Each Right entitles the holder, until the earlier of October 28,2006 or the redemption of the Rights, to purchase one one-thousandth of a shareof Junior Participating Preferred Stock, Series A, par value $1.00 per share(the ‘‘Series A Preferred Stock’’), at a price of $85.00 per one one-thousandthof a share (as may be adjusted to reflect stock splits, stock dividends orcertain other dilutive events since the issuance of the Rights).  The Series A Preferred Stock is nonredeemableand will have 1,000 votes per share (subject to adjustment).  The Company has reserved 50,000 shares ofSeries A Preferred Stock for issuance upon exercise of such Rights.  In the event that any person becomes thebeneficial owner of 15% or more of the Company’s common stock, the Rights(other than Rights held by the acquiring stockholder) would become exercisablefor a number of shares of common stock having a market value of two times theexercise price of the Right. Furthermore, if after any person becomes the beneficial owner 15% ormore of common stock, the Company is acquired in a merger or other businesscombination or 50% or more of the Company’s assets or earnings power were sold,each Right (other than Rights held by the acquiring person) would becomeexercisable for that number of shares of common stock (or securities of thesurviving company in a business combination) having a market value of two timesthe exercise price of the Right. The Rights Agreement contains an exception forinadvertent acquisitions of more than 15% of the Company's common stock, solong as the holder reduces its ownership below the 15% threshold as soon aspracticable (as determined by the Company's board of directors).

 

The Rights have certain anti-takeover effects.  The Rights may cause substantial dilution toa person that attempts to acquire the Company on terms not approved by theboard of directors, except pursuant to an offer conditioned on a substantialnumber of Rights being acquired.  TheRights should not interfere with any merger or other business combinationapproved by the board of directors prior to the time a person has acquiredbeneficial ownership of 15% or more of the common stock, because until suchtime the Rights may generally be redeemed by the Company at one cent per Right.

 

The Company is subject to the ‘‘business combination’’statute of the General Corporation Law of the State of Delaware (the‘‘DGCL’’).  In general, Section 203 ofthe DGCL prohibits a publicly-held Delaware corporation from engaging in a‘‘business combination’’ with an ‘‘interested stockholder,’’ for a period ofthree years after the date of the transaction in which a person became an‘‘interested stockholder,’’ unless:

 

**•**prior to such date the board of directors of the corporation approved eitherthe ‘‘business combination’’ or the transaction which resulted in thestockholder becoming an ‘‘interested stockholder,’’

 

**•**upon consummation of the transaction which resulted in the stockholder becomingan ‘‘interested stockholder,’’ the ‘‘interested stockholder’’ owns at least 85%of the voting stock of the corporation outstanding at the time the transactioncommenced, excluding for purposes of determining the number of sharesoutstanding those shares owned

 

23

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(1) by persons who are directors and also officers and (2) employeestock plans in which employee participants do not have the right to determineconfidentially whether shares held subject to the plan will be tendered in atender or exchange offer, or

 

**•**on or subsequent to such date the ‘‘business combination’’ is approved by theboard of directors and authorized at an annual or special meeting ofstockholders by the affirmative vote of at least 66 2/3% of the outstandingvoting stock which is not owned by the ‘‘interested stockholder.’’

 

A ‘‘business combination’’ includes mergers, stock orasset sales and other transactions resulting in a financial benefit to the‘‘interested stockholders.’’  An‘‘interested stockholder’’ is a person who, together with affiliates andassociates, owns (or within three years, did own) 15% or more of the votingstock of the subject corporation. Although Section 203 permits the Company to elect not to be governed byits provisions, the Company has not made this election.  As a result of the application of Section203, potential acquirors of the Company may be discouraged from attempting toeffect an acquisition transaction with the Company, thereby possibly deprivingholders of the Company’s securities of certain opportunities to sell orotherwise dispose of such securities at above-market prices pursuant to suchtransactions.

 

The foregoing summaries do not purport to be completeand are subject to, and are qualified in their entirety by reference to, theCharter, the Bylaws and the Rights Agreement. A copy of each of these documents is filed as an exhibit to this report.

 

**AvailableInformation**

 

The Company files annual, quarterly and current reports, proxystatements and other information with the Securities and Exchange Commission(“SEC”).  You may read and copy anydocument the Company files at the SEC’s public reference room at Room 1024, 450Fifth Street, NW, Washington, D.C. 20549. Please call the SEC at

1-800-SEC-0330 for information on the public reference room.  The SEC maintains a web site (www.sec.gov)that contains annual, quarterly and current reports, proxy statements and otherinformation that issuers (including the Company) file electronically with theSEC.

 

The Company makes available free of charge, through a direct link fromits web site (www.aksys.com) to the Company's filings on the SEC’s website, itsannual reports on Form 10-K, quarterly reports on Form 10-Q, current reports onForm 8-K, Forms 3, 4 and 5 filed on behalf of directors and executive officers,and any amendments to those reports filed or furnished pursuant to theSecurities Exchange Act of 1934 as soon as reasonably practicable after suchmaterial is electronically filed with, or furnished to, the SEC.

 

**Item2.  Properties.**

 

The Company leases approximately 41,500 square feet of office space inLincolnshire, Illinois to conduct its research, development, marketing andadministrative functions.  The Companybelieves that its present facilities are adequate for its operations.  At present, all manufacturing has beencontracted out to third party subcontractors.

 

**Item3.  Legal Proceedings.**

 

The Company is not involved in any material pending legal proceedings.

 

**Item 4.  Submission of Matters to a Vote of Security-Holders.**

 

There were no matters submitted for a vote of the Company’sstockholders during the fourth quarter ended December 31, 2002.

 

24

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**PART II**

 

**Item 5.  Market for the Registrant’s Common Stock and Related StockholderMatters.**

 

The Company’s Common Stock trades on the Nasdaq National Market underthe symbol AKSY.  The following tablelists the quarterly high and low prices of the Common Stock for the period fromJanuary 1, 2001 through December 31, 2002.

 
| **Fiscal  Year** |   | **Fiscal  Quarter** |   | **High** |   | **Low** |   |
|------------------|--------|---------------------|--------|----------|--------|---------|--------|
| 2002             |   | 1st                 |   | $        | 8.990  |    | $      | 3.650 |   |
|             |   | 2nd                 |   | 10.400   |   | 4.560   |   |
|             |   | 3rd                 |   | 8.000    |   | 5.000   |   |
|             |   | 4th                 |   | 6.230    |   | 3.520   |   |
|             |   |                |   |     |   |    |   |
| 2001             |   | 1st                 |   | $        | 16.875 |    | $      | 4.750 |   |
|             |   | 2nd                 |   | 12.000   |   | 3.625   |   |
|             |   | 3rd                 |   | 10.670   |   | 3.000   |   |
|             |   | 4th                 |   | 8.500    |   | 3.950   |   |

 

There were 242 stockholders of record of the Company’s Common Stock asof March 21, 2003.  In addition, theCompany estimates that there were approximately 8,000 beneficial stockholdersat March 21, 2003, who held shares in “street name.”  The Company has not paid cash dividends to date, and managementanticipates that all future earnings will be retained for development of theCompany’s business.

 

**Item 6.  Selected Financial Data*****.***

 

The selected balance sheet data as of December 31, 2002 and 2001 andstatements of operations data for each of the years in the three-year periodended December 31, 2002, set forth below have been derived from the auditedfinancial statements of the Company included as Exhibit 13 to this AnnualReport on Form 10-K.  The selectedbalance sheet data as of December 31, 2000, 1999 and 1998 and statements ofoperations data for each of the years in the two-year period ended December31,1999, set forth below have been derived from the audited financialstatements of the Company that have not been included in this Annual Report onForm 10-K.  The historical financialdata for the Company is not necessarily indicative of future results and shouldbe read in conjunction with the financial statements and notes thereto and“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” included elsewhere in this Annual Report on Form 10-K. 

 

25

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|                                            |   | **Year Ended  December 31,** |        |
|-------------------------------------------------|--------|------------------------------|-------------|
|                                            |   | **2002**                     |        | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Consolidated  Statement of Operations Data**: |   |                         |        |   |   |   |   |   |   |   |   |
| Revenues:                                       |   |                         |        |   |   |   |   |   |   |   |   |
| Product                                         |   | $                            | 276,680     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Service and  supplies                           |   | 21,986                       |        | — |   | — |   | — |   | — |   |
| Joint  development income                       |   | —                       |        | — |   | 3,434,809 |   | 9,609,313 |   | 1,000,000 |   |
| Total Revenue                                   |   | 298,666                      |        | — |   | 3,434,809 |   | 9,609,313 |   | 1,000,000 |   |
|                                            |   |                         |        |   |   |   |   |   |   |   |   |
| Cost of Sales:                                  |   |                         |        |   |   |   |   |   |   |   |   |
| Product                                         |   | 1,685,562                    |        | — |   | — |   | — |   | — |   |
| Service and  supplies                           |   | 577,478                      |        | — |   | — |   | — |   | — |   |
| Total Cost of  Sales:                           |   | 2,263,040                    |        | — |   | — |   | — |   | — |   |
|                                            |   |                         |        |   |   |   |   |   |   |   |   |
| Operating costs  and expenses:                  |   |                         |        |   |   |   |   |   |   |   |   |
| Research and  development                       |   | 5,792,446                    |        | 10,882,796 |   | 14,541,873 |   | 15,909,993 |   | 15,342,533 |   |
| Sales and  marketing                            |   | 2,543,324                    |        | 1,753,499 |   | 1,025,315 |   | 1,737,069 |   | 1,185,254 |   |
| General and  administrative                     |   | 5,699,356                    |        | 5,121,223 |   | 4,738,737 |   | 4,258,162 |   | 3,304,747 |   |
| Total operating  expenses                       |   | 14,035,126                   |        | 17,757,518 |   | 20,305,925 |   | 21,905,224 |   | 19,832,534 |   |
|                                            |   |                         |        |   |   |   |   |   |   |   |   |
| Operating loss                                  |   | (15,999,500                  | )           | (17,757,518 | ) | (16,871,116 | ) | (12,295,911 | ) | (18,832,534 | ) |
| Other income,  net                              |   | 294,956                      |        | 515,892 |   | 1,159,961 |   | 997,642 |   | 1,677,807 |   |
|                                            |   |                         |        |   |   |   |   |   |   |   |   |
| Net loss                                        |   | $                            | (15,704,544 | ) | $ | (17,241,626 | ) | $ | (15,711,155 | ) | $ | (11,298,269 | ) | $ | (17,154,727 | ) |
|                                            |   |                         |        |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss per  share(1)                          |   | $                            | (0.65       | ) | $ | (0.94 | ) | $ | (0.93 | ) | $ | (0.76 | ) | $ | (1.17 | ) |
|                                            |   |                         |        |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted average  shares outstanding(1)         |   | 24,301,029                   |        | 18,418,410 |   | 16,934,532 |   | 14,885,449 |   | 14,653,953 |   |

 

 
|                                               |   | **December  31** |       |
|----------------------------------------------------|--------|------------------|------------|
|                                               |   | **2002**         |       | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Consolidated  Balance Sheet Data:**              |   |             |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments |   | $                | 11,509,757 |   | $ | 11,249,935 |   | $ | 19,121,697 |   | $ | 14,841,488 |   | $ | 20,260,268 |   |
| Working capital                                    |   | 11,872,340       |       | 10,548,397 |   | 16,636,100 |   | 9,191,004 |   | 18,009,636 |   |
| Total assets                                       |   | 16,509,492       |       | 14,454,503 |   | 22,188,020 |   | 18,811,434 |   | 25,941,835 |   |
| Long-term  liabilities(2)                          |   | 147,644          |       | 159,061 |   | 158,444 |   | 146,345 |   | 123,041 |   |
| Accumulated  deficit                               |   | (106,646,522     | )          | (90,941,978 | ) | (73,700,352 | ) | (57,989,197 | ) | (46,690,928 | ) |
| Total  stockholders’ equity                   |   | 13,647,629       |       | 12,603,629 |   | 19,349,018 |   | 12,623,381 |   | 23,301,944 |   |
|                                                    |        |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)           Computed on thebasis described in Note 1 of Notes to Consolidated Financial Statements.

(2)           Consists primarilyof deferred rent under operating lease for facilities.

 

26

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**Item 7.  Management’s Discussion and Analysis of Financial Condition andResults of Operations.**

 

**Overview**

 

Since its inception in January 1991, the Company has been engaged inthe development of hemodialysis products and services for patients sufferingfrom ESRD. The Company has developed an automated personal hemodialysis system,known as the Aksys PHDä PersonalHemodialysis System (the “PHD System”), which is designed to enable patients toperform frequent hemodialysis at alternate sites (such as their own homes) andto thereby improve clinical outcomes, reduce total ESRD treatment costs andenhance the quality of life of patients. During the quarter ended September 30,2002, the Company commenced commercial activities and is no longer considered tobe in the development stage. The Company expects to incur additional losses inthe foreseeable future.

 

On March 27, 2002, the Company announced that it received Food and DrugAdministration (“FDA”) clearance to market the PHD System in the United States. The FDA clearance had no restrictionsand included authorization to use the product in the home.  510(k) clearance by the FDA was requiredprior to the commercialization of the PHD System in the United States.

 

On October 7, 2002, the Company announced the receipt of ECCertification for CE Mark approval pursuant to the Medical Device Directive ofthe European Economic Area.  Thecertification approved the PHD System for home use. Such approval was requiredprior to the commercialization of the PHD System in the European Economic Area.

 

**Critical Accounting Policies**

 

The preparation of financial statements requires management to makeestimates and assumptions that affect amounts reported therein.  The Company believes the following criticalaccounting policies affect its more significant judgments and estimates used inthe preparation of its consolidated financial statements:

 

*Revenuerecognition*

 

The Company recognizes revenue in accordance with Staff AccountingBulletin (SAB) No. 101, *Revenue Recognition in Financial Statements*,and its related interpretations. Revenue is recognized when the following conditoins exist: (1) there ispersuasive evidence of an arrangement, (2) the product has been delivered andaccepted or services and supplies have been provided to the customer, (3) thesales price is fixed or determinable and (4) collectability is reasonablyassured.

 

The Company recognizes revenue from product sales at the time ofdelivery and acceptance by the customer of the PHD System.  Service and supplies revenue is recognizedwhen services are rendered and supplies are delivered.  The Company also leases the PHD System tocustomers on a short-term basis (12 months or less) and recognizes revenue onthese contracts on a straight-line basis over the lease term.  The Company has no contracts withdistributors and sells its product directly to its customers through its ownsales force.

 

*Accruedliabilities and contingencies*

 

The Company is required to make certain estimates and assumptions thataffect the amounts recorded as accrued liabilities and contingencies.  The Company bases its estimates onhistorical experience and on various other factors that are believed to bereasonable to determine the amount of accrued liabilities and contingencies tobe recorded.  If actual results differfrom these estimates, additional expenditures might be recorded.

 

27

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*Net deferred tax assets valuation*

 

The Company records its net deferred tax assets in the amount that itexpects to realize based on projected future taxable income.  In assessing the appropriateness of itsvaluation, assumptions and estimates are required such as the Company’s abilityto generate future taxable income.  Inthe event that the Company were to determine that it would be able to realizeits deferred tax assets in the future in excess of its net recorded amount, anadjustment to the deferred tax asset would increase income in the period suchdetermination was made.

 

Given the Company's historical losses and uncertainty with respect tothe Company's ability to generate taxable income, management has established avaluation allowance of $48,603,000 at December 31, 2002 and $43,477,000 atDecember 31, 2001 to reduce the net deferred tax assets to zero.

 

**ContractualObligations**

 

The following table reflects a summary of the Company’s contractualcash obligations as of December 31, 2002:

 
| **Contractual Cash Obligations**    |   | **Total** |      | **Less than  1 year** |   | **1-3 years** |   | **4-5 years** |      |
|-------------------------------------|--------|-----------|-----------|-----------------------|--------|---------------|--------|---------------|-----------|
|                                |   |      |      |                  |   |          |   |          |      |
| Operating Leases                    |   | $         | 1,601,070 |                  | $      | 419,980       |   | $             | 1,181,090 |   | $ | -0- |   |
|                                |   |      |      |                  |   |          |   |          |      |
| Royalties                           |   | $         | 1,468,750 |                  | $      | 215,000       |   | $             | 753,750   |   | $ | 500,000 |   |
|                                |   |      |      |                  |   |          |   |          |      |
| Purchase  Obligations               |   | $         | 3,750,000 |                  | $      | 3,750,000     |   | $             | -0-       |   | $ | -0- |   |
|                                |   |      |      |                  |   |          |   |          |      |
| Total  Contractual Cash Obligations |   | $         | 6,819,820 |                  | $      | 4,384,980     |   | $             | 1,934,840 |   | $ | 500,000 |   |

 

**Note onForward-Looking Information**

 

Certain statements in this Annual Report on Form 10-K and in futurefilings made by the Company with the Securities and Exchange Commission and inthe Company’s written and oral statements made by or with the approval of anofficer of the Company constitute “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934, and the Company intends that suchforward-looking statements be subject to the safe harbors created thereby.  The words “believes,” “expects,”“estimates,” “anticipates,” and “will be,” and similar words or expressions,identify forward-looking statements made by or on behalf of the Company.  These forward-looking statements reflect theCompany’s views as of the date they are made with respect to future events andfinancial performance, but are subject to many uncertainties and factors whichmay cause the actual results of the Company to be materially different from anyfuture results expressed or implied by such forward-looking statements. Factorsthat could cause such a difference include, but are not limited to, thefollowing: (i) uncertainty about the acceptance of the PHD System by bothpotential users and purchasers, including without limitation patients, clinicsand other health care providers; (ii) risks related to uncertain unit pricingand product cost, which may not be at levels that permit the Company to beprofitable; (iii) market, regulatory reimbursement and competitive conditions;(iv) risks related to the failure to meet additional development andmanufacturing milestones for the PHD System on a timely basis, (v) theCompany’s  ability to obtain sufficientcapital on acceptable terms to run its business; (vi) risks inherent in relyingon a third party to manufacture the PHD System; and (vii) changes in QSRrequirements.

 

**Resultsof Operations**

 

***Year Ended December31, 2002 Compared to Year Ended December 31, 2001***

 

Net loss for the year ended December 31, 2002 was $15.7 million ($0.65per share), compared with $17.2 million ($0.94 per share), for the year endedDecember 31, 2001.  The factorscontributing to the decrease in net loss are explained below.

 

Revenue.  For the year ended December 31, 2002, revenue was $0.3 millioncompared to no revenue for the year ended December 31, 2001.  Product revenue of $277,000 resultedprimarily from the sale of seven PHD Systems. Service and supplies revenue totaled $22,000 for fiscal 2002.

 

28

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The product sales recorded in fiscal 2002 were for PHD Systems sold inthe United States.  The sales recordedwere made pursuant to an agreement between the Company and a third partyleasing provider (4 units) and through direct sales to two customers (3 units).

 

The Company is not dependent upon reimbursement from insuranceproviders as a source of revenue. Rather, the Company generates revenue from dialysis centers, whichprovide dialysis services through the use of the PHD System.  The dialysis center is reimbursed on a pertreatment basis by the insurance provider. Accordingly, reimbursement rates may influence customers’ demand for theCompany’s product and the Company’s pricing of the PHD System and relatedsupplies and service.

 

Service and supplies sold during fiscal 2002 specifically relate to thePHD Systems placed during the year. Service and supply revenue is contracted under a separate agreement witha dialysis center at an established monthly amount.  Supplies, such as blood tubing sets, dialyzers and acid/bicarbsolutions, are required to perform dialysis treatments.  Service on the PHD System is for scheduledand unscheduled maintenance and repairs and is provided by the Company’s servicetechnicians on a 24 hour, 7 day a week basis.

 

Cost of sales.  Total cost of sales for fiscal 2002 was $2.3million compared to no cost of sales in fiscal 2001.  Product cost of sales for 2002 were $1.7 million and service andsupplies costs were $0.6 million. Included in product cost of sales is an inventory adjustment in theamount of $1.3 million, in order to value the PHD machines in inventory at thelower of cost or market.

 

The cost of producing the PHD System is currently in excess of itsmarket price and the Company cannot predict how long such deficit will continueor whether the Company will be able to eliminate such deficit.  The Company expects that it will have torely primarily on reductions in the production cost of the PHD System in orderto realize a positive gross margin on sales. The Company is implementing plans and continues to work diligently toachieve cost reductions on the PHD System. These efforts include, among others, the redesign of PHD subsystems andsourcing alternative materials and supplies. However, no assurance can be given that such cost reduction plans orefforts will be successful, or that the Company will be able to achieve apositive gross margin on sales of the PHD System in the future.

 

Service and supplies costs for the year ended December 31, 2002 were$0.6 million compared to no service and supplies costs for the year endedDecember 31, 2001.  The majority ofthese costs are for field service personnel to install and service the PHDmachines and for clinical support staff necessary to train the customers’nursing staff during the early phases of the product launch.  The cost of services and supplies iscurrently in excess of their market price as local presence of field serviceand clinical service personnel is required in each geographical area that PHDSystems are sold.  The Company expectsthat as more PHD units are placed in those geographical areas, the per unitcost of services and supplies will decrease.

 

Research and development expenses.   For the year ended December 31, 2002,research and development expenses decreased to $5.8 million from $10.9 millionfor the year ended December 31, 2001. The decrease of $5.1 million in 2002 wasattributable to reduced research and development activities due to the Companyreceiving FDA approval for its product in March 2002 and the Company’s relatedshift in focus from product development to commercialization and salesactivities.

 

Sales and marketing expenses.   During 2002, sales and marketing expensesincreased $0.7 million, from $1.8 million in 2001 to $2.5 million in 2002.  The increase is attributable to personneladditions in 2002 and costs associated with the scale up of the sales andmarketing efforts surrounding the early stages of commercialization of the PHDSystem.

 

Generaland administrative expenses.   Forthe year ended December 31, 2002, general and administrative expenses increased$0.6 million to $5.7 million.  Theincrease is primarily a result of personnel additions necessary to support thecommercialization efforts.

 

Interest income.  For the year ended December 31, 2002,interest income was $0.3 million, compared with $0.5 million for the year endedDecember 31, 2001, a decrease of $0.2 million. The decrease is primarilyattributable to lower interest rates on investments and the Company’s use ofcash and cash equivalents to fund operations during 2002.

 

29

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** **

**Resultsof Operations**

 

***Year Ended December31, 2001 Compared to Year Ended December 31, 2000***

 

Net loss for the year ended December 31, 2001 was $17.2 million ($0.94per share), compared with $15.7 million ($0.93 per share), for the year endedDecember 31, 2000.  During the fiscalyear 2000, the Company recognized revenue of $3.4 million related toco-development of the PHD System with Teijin Limited of Osaka, Japan.  There was no such related joint developmentincome in the fiscal year 2001.

 

Joint development income.  On June 21, 1999, the Company entered into aco-development and license agreement (the “Agreement”) with Teijin. Under theterms of the Agreement, Teijin paid the Company a $7.0 million co-developmentfee relating to the PHD System.  Use ofthe proceeds from the co-development fee was restricted to development costsincurred on the PHD System and could not be used for other general corporatepurposes.  Amounts paid under theco-development arrangement were recognized as revenue as development costs onthe PHD System were incurred.  Duringthe year ended December 31, 2000, the Company recognized revenue of $3.4million related to co-development of the PHD System.  During 2000, the Agreement was amended. The final revenue relatedto the co-development of the PHD System under the Agreement was recognized in2000 (and there was no joint development income in fiscal 2001).  The remaining unspent amount was recorded asan amount due to Teijin of approximately $660,000 at December 31, 2000(included in other liabilities) and was subsequently spent exclusively ondevelopment activities by Teijin’s research employees.

 

Research and development expenses.   For the year ended December 31, 2001,research and development expenses decreased to $10.9 million from $14.5 millionfor the year ended December 31, 2000. The decrease of $3.6 million in 2001 wasattributable to labor costs decreasing by approximately $1.1 million and thecompletion of many activities associated with the development of the PHD Systemduring 2000.

 

Sales and marketing expenses.   During 2001, sales and marketing expensesincreased $0.8 million, from $1.0 million in 2000 to $1.8 million in 2001.  The increase is primarily attributable to anincrease in personnel in 2001 related to planning for commercialization of thePHD System.

 

Generaland administrative expenses.   Forthe year ended December 31, 2001, general and administrative expenses increased$0.4 million to $5.1 million.  Theincrease is primarily a result of additions to the senior management teamduring the middle of 2000 and a staff addition in the beginning of 2001.

 

Interest income.  For the year ended December 31, 2001,interest income was $0.5 million, compared with $1.2 million for the year endedDecember 31, 2000, a decrease of $0.7 million. The decrease is primarilyattributable to lower interest rates on investments and the Company’s use ofcash and cash equivalents to fund operations during 2001.

 

**Liquidityand Capital Resources**

 

**CashFlows**

 

The Company has financed its operations to date primarily throughpublic and private sales of its equity securities.  At December 31, 2002, the Company had cash and cash equivalentsof $1.0 million, short-term investments of $10.6 million, working capital of$11.9 million and restricted long-term investments of $0.6 million.  The Company believes that inflationgenerally has not had a material impact on its operations or liquidity to date.

 

Net cash used in operating activities was $16.2 million in fiscal 2002compared to $18.3 million in fiscal 2001 and $17.5 million in fiscal 2000.  The decrease in 2002 compared to 2001 is primarilydue to reduced research and development costs, as the Company shifts its focusfrom product development to commercialization and sales

 

30

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activities.  The increase ininventory of $2.7 million in 2002 compared to 2001 is attributable to theproduction of commercial PHD machines during the last three-quarters of 2002and was partially offset by reduced deposits with vendors and high accountspayable balances in 2002.

 

Net cash used in investing activities was $9.8 million in fiscal 2002compared to $1.1 million in fiscal 2001. The increase in cash used in investing activities primarily related tothe purchase of investments.  Net cashprovided by investing activities was $10.4 million in fiscal 2000 primarilyrelating to maturing investments.

 

Net cash provided by financing activities was $16.7 million, $10.5million and $22.0 million in fiscal years 2002, 2001 and 2000,respectively.  Cash provided fromfinancing activities resulted from the issuance of common stock in connectionwith private placement transactions (see Note 5 to the consolidated financialstatements for a discussion of the specific private placement transactions).

 

**RecentFinancing Activities**

 

On January 22, 2003, the Company entered into a $15 million equity lineof credit arrangement with Kingsbridge Capital Limited (“Kingsbridge”).  This arrangement superceded a similararrangement entered into between the Company and Kingsbridge on October 15,2002.  Pursuant to the terms of the Amendedand Restated Common Stock Purchase Agreement between the Company andKingsbridge, the Company may sell common stock at its sole discretion over a24-month period on a “when and if needed” basis, and Kingsbridge is requiredunder the terms of the agreement to purchase this stock, subject to thesatisfaction of certain conditions contained in the agreement.  The Company has no obligation to draw downall or any portion of the commitment. As partial consideration for entering into the equity line arrangement,the Company issued warrants to Kingsbridge to purchase 200,000 shares of theCompany’s common stock at an exercise price of $5.75 per share.  These warrants had a fair value of  $881,000 using the Black Scholes pricingmodel.

 

The Company has filed a registration statement with the SEC coveringthe equity line arrangement that was declared effective by the SEC on February14, 2003.  Through March 27, 2003, theCompany issued 778,474 shares of common stock to Kingsbridge under the equityline arrangement and received $4.5 million.

 

On October 15, 2002, the Company filed a universal shelf registrationstatement on Form S-3 with the Securities and Exchange Commission (“SEC”).  The registration statement, which has notyet become effective, will cover up to $60 million of various types ofsecurities from time to time.

 

**FinancingNeeds**

 

The Company estimates that during fiscal 2003 it will spend between $20and $24 million for operations, including U.S. commercialization activities ofthe PHD System. The Company expects to incur increasingly substantial cashoutlays related to manufacturing scale-up and commercialization of the PHDSystem. The Company believes that cash and short-term investments as ofDecember 31, 2002 coupled with the $15 million equity line of creditarrangement with Kingsbridge are sufficient to finance the Company’s commercialand operating plans through December 31, 2003.

 

The Company plans to raise additional capital to fund operationsthrough public and/or private equity or debt financings in fiscal 2003 andsubsequent years.  The additionalcapital required for commercialization may not be available on terms agreeableto the Company or may not be available at all.

 

Generally, the Company expects U.S. customers to lease or purchase PHDSystems and enter into contracts whereby the Company will provide allconsumables, service and product support related to the PHD Systems for asingle monthly price. If the U.S. customers enter into lease agreements, thesingle monthly payment would increase to include the lease payment for the PHDSystem. The Company’s present commercialization plan for markets outside of theUnited States is to develop a partnership in those markets to distribute thePHD System and related consumables and services.

 

31

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Financing production of the PHD System in quantities necessary forcommercialization will require a significant investment in workingcapital.  This need for working capitalwill increase to the extent that demand for the PHD System increases.  In addition to any debt or equity financingtransactions, the Company may seek to finance the working capital requirementsassociated with these arrangements primarily through equipment and receivablefinancing with a commercial lender.  Ifthe Company is unable to obtain such equipment financing, or to obtain it oncommercially reasonable terms, it would need to seek other forms of financing,through the sale of equity securities or otherwise, to achieve its businessobjectives.  The Company has not yetobtained a commitment for such equipment financing, and there can be noassurance that the Company will be able to obtain equipment financing oralternative financing on acceptable terms or at all.

 

The Company’s funding needs will depend on many factors, including thetiming and costs associated with continued progress in research anddevelopment, manufacturing scale-up, increased sales and marketing activities,the cost involved in filing and enforcing patent claims and the status ofcompetitive products.  In the event thatthe Company’s plans change, its assumptions change or prove inaccurate or it isunable to obtain financing on commercially reasonable terms, the Company couldbe required to seek additional financing sooner than currently anticipated.

 

The Company has not generated taxable income to date.  At December 31, 2002, the net operatinglosses available to offset future taxable income were approximately $111.8million.  Because the Company hasexperienced ownership changes, future utilization of the carryforwards may belimited in any one fiscal year pursuant to Internal Revenue Coderegulations.  The carryforwards expireat various dates beginning in 2012.  Asa result of the annual limitation, a portion of these carryforwards may expirebefore ultimately becoming available to reduce federal income tax liabilities.

 

**RecentAccounting Pronouncements**

 

In November 2002, the FASB issued Interpretation No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness to Others*, *an interpretation of FASB StatementsNo. 5, 57 and 107 and a rescission of FASB Interpretation No. 34*.This Interpretation elaborates on the disclosures to be made by a guarantor inits interim and annual financial statements about its obligations underguarantees issued.  The Interpretationalso clarifies that a guarantor is required to recognize, at inception of aguarantee, a liability for the fair value of the obligation undertaken. Theinitial recognition and measurement provisions of the Interpretation areapplicable to guarantees issued or modified after December 31, 2002 and are notexpected to have a material effect on the Company’s financial statements.  The disclosure requirements are effectivefor financial statements of interim and annual periods ending after December15, 2002.

 

In December 2002, the FASB issued SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure, an amendment of FASBStatement No. 123*. This Statement amends FASB StatementNo. 123, *Accounting for Stock-Based Compensation,* to providealternative methods of transition for a voluntary change to the fair valuemethod of accounting for stock-based employee compensation. In addition, thisStatement amends the disclosure requirements of Statement No. 123 torequire prominent disclosures in both annual and interim financial statements.Certain of the disclosure modifications are required for fiscal years endingafter December 15, 2002 and are included in the notes to theseconsolidated financial statements.

 

32

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**Item7A.  Quantitative and QualitativeDisclosure About Market Risk.**

 

The investments of the Company have been made for investment (asopposed to trading) purposes.  Interestrate risk with respect to the investments of the Company is not significant assubstantially all of such investments are in U.S. dollar cash equivalents andshort-term investments (with maturities of less than 12 months), which are bytheir nature less sensitive to interest rate movements.  The investments of the Company are generallymade in U.S. government and federal agency bonds and high-grade commercialpaper and corporate bonds.

 

**Item 8.  Financial Statements and Supplementary Data.**

 

The Consolidated Balance Sheets as of December 31, 2002 and 2001, andthe Consolidated Statements of Operations, Stockholders’ Equity and Cash Flowsfor the years ended December 31, 2002, 2001 and 2000, the Notes to theConsolidated Financial Statements and the Independent Auditors’ Report setforth on pages 10 through 24 the 2002 Annual Report to Stockholders of theCompany are incorporated herein by reference.

 

**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure.**

 

Not applicable.

 

**PART III**

 

**Item10.  Directors and Executive Officers ofthe Registrant.**

 

Information with respect to the Directors of the Company is set forthin the Proxy Statement under the heading “Election of Directors,” whichinformation is incorporated herein by reference.  Information regarding the executive officers is set forth abovein Part I under “Business – Executive Officers .”  Information required by Item 405 of Regulation S-K is set forthin the Proxy Statement under the heading “Section 16 (a) Beneficial OwnershipReporting Compliance,” which information is incorporated herein by reference.

 

**Item11.  Executive Compensation**.

 

Information with respect to executive compensation is set forth in theProxy Statement under the heading “Compensation of Executive Officers,” whichinformation is incorporated herein by reference.

 

**Item12.  Security Ownership of CertainBeneficial Owners and Management.**

 

Information with respect to security ownership of certain beneficialowners and management is set forth in the Proxy Statement under the heading“Beneficial Ownership of Common Stock,” which information is incorporatedherein by reference.

 

**Item13.  Certain Relationships and RelatedTransactions.**

 

None.

 

**Item14.  Controls and Procedur****es.**

 

**(a)Evaluation of disclosure controls and procedures.**

The Company maintains disclosure controls and procedures that aredesigned to ensure that information required to be disclosed in its ExchangeAct reports is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such information isaccumulated and communicated to the Company’s management, including the chiefexecutive officer and the chief financial officer, to allow timely decisionsregarding required disclosure.

 

33

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The Company’s management, including its chief executive officer andchief financial officer, evaluated the effectiveness of the Company’sdisclosure controls and procedures as of a date within 90 days of the filing ofthis report. Based on this evaluation, the chief executive officer and chieffinancial officer concluded that the Company’s disclosure controls andprocedures were functioning properly as of the evaluation date.

 

**(b)Changes in internal controls.**

There have been no significant changes to the Company’s internalcontrols or in other factors that could significantly affect those controlssubsequent to the date of this evaluation, including any corrective actionswith regard to significant deficiencies and material weaknesses.

 

**PART IV**

 

**Item 15.  Exhibits****, Financial Statement Schedules andReports on Form 8-K.**

 

(a)       Financial Statements:

 

1.        F*inancial Statements.*

 

The ConsolidatedBalance Sheets as of December 31, 2002 and 2001, and the ConsolidatedStatements of Operations, Stockholders’ Equity and Cash Flows for the yearsended December 31, 2002, 2001 and 2000, the Notes to the Consolidated FinancialStatements and the Independent Auditors’ Report set forth on pages 10 through24 the 2002 Annual Report to Stockholders of the Company are incorporatedherein by reference.

 

2.        *Financial Statement Schedules.*

 

None.

 

(b)       Reportson Form 8-K.

 

On February 14,2003, the Company filed a current report on Form 8-K including in Item 5 a copyof its earnings release dated February 12, 2003, relating to fourth quarter andfiscal 2002 results.

 

(c )      Exhibits.

 

See “ExhibitsIndex” below.

 

34

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15 (d)of the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto duly authorizedon the 28th day of March, 2003.

 

** **
|   | **AKSYS, LTD.** |
|--------|-----------------|
|   |            |   |   |
| By     |            | /s/ William C. Dow |   |
|   |            | William C. Dow |   |
|   |            | President and Chief  Executive Officer |   |
|        |                 |  |  |  |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant in the capacities indicated on this 28thday of March, 2003.

 
| **Signature**               |   | **Capacity**                                      |
|-----------------------------|--------|---------------------------------------------------|
|                        |   |                                              |
| /s/ William C. Dow          |   | President, Chief Executive Officer and Director   |
| William C. Dow              |   | (Principal Executive Officer)                     |
|                        |   |                                              |
|                        |   |                                              |
| /s/ Lawrence D. Damron      |   | Senior Vice President and Chief Financial Officer |
| Lawrence D. Damron          |   |                                              |
|                        |   |                                              |
|                        |   |                                              |
| /s/ Richard B. Egen         |   | Chairman of the Board of Directors                |
| Richard B. Egen             |   |                                              |
|                        |   |                                              |
|                        |   |                                              |
| /s/ W. Dekle Rountree,  Jr. |   | Director                                          |
| W. Dekle Rountree, Jr.      |   |                                              |
|                        |   |                                              |
|                        |   |                                              |
| /s/ Bernard R.  Tresnowski  |   | Director                                          |
| Bernard R. Tresnowski       |   |                                              |
|                        |   |                                              |
|                        |   |                                              |
| /s/ Alan R. Meyer           |   | Director                                          |
| Alan R. Meyer               |   |                                              |

 

35

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**CERTIFICATION**

**Certificationof Principal Executive Officer**

 

I, William C. Dow, Chief Executive Officer and President, certify that:

 
| 1.     | I have reviewed this annual report on Form 10-K of  Aksys, Ltd.;                                                                                                                                                                                                                                                                                                                                 |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 2.     | Based on my knowledge, this annual report does not  contain any untrue statement of a material fact or omit to state a material  fact necessary to make the statements made, in light of the circumstances under  which such statements were made, not misleading with respect to the period  covered by this annual report;                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 3.     | Based on my knowledge, the financial statements, and  other financial information included in this annual report, fairly present in  all material respects the financial condition, results of operations and cash  flows of the registrant as of, and for, the periods presented in this annual  report;                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.     | The registrant’s other certifying officers and I are  responsible for establishing and maintaining disclosure controls and  procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the  registrant and we have:                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (a) | Designed such  disclosure controls and procedures to ensure that material information  relating to the registrant, including its consolidated subsidiaries, is made  known to us by others within those entities, particularly during the period  in which this annual report is being prepared; |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (b) | Evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this annual report (the  “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (c) | Presented in this  annual report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 5.     | The registrant’s other certifying officers and I  have disclosed, based on our most recent evaluation, to the registrant’s  auditors and the audit committee of the registrant’s board of directors (or  persons performing the equivalent function):                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (a) | All significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (b) | Any fraud, whether or not material, that involves management or other  employees who have a significant role in the registrant’s internal controls;  and |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 6.     | The registrant’s other certifying officers and I  have indicated in this annual report whether or not there were significant  changes in internal controls or in other factors that could significantly  affect internal controls subsequent to the date of our most recent  evaluation, including any corrective actions with regard to significant  deficiencies and material weaknesses. |

 

 
| Dated: March 28,  2003 |   |                                   |
|------------------------|--------|----------------------------------------|
|                   | By:    |  /s/ William C. Dow               |   |
|                   |   |                                   |   |
|                   |   | William C. Dow                         |
|                   |   | Chief Executive  Officer and President |

 

36

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**CERTIFICATION**

**Certificationof Principal Financial Officer**

 

I, Lawrence D.Damron, Senior Vice President and Chief Financial Officer, certify that:

 
| 1.     | I have reviewed this annual report on Form 10-K of  Aksys, Ltd.;                                                                                                                                                                                                                                                                                                                                 |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 2.     | Based on my knowledge, this annual report does not  contain any untrue statement of a material fact or omit to state a material  fact necessary to make the statements made, in light of the circumstances  under which such statements were made, not misleading with respect to the  period covered by this annual report;                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 3.     | Based on my knowledge, the financial statements, and  other financial information included in this annual report, fairly present in  all material respects the financial condition, results of operations and cash  flows of the registrant as of, and for, the periods presented in this annual  report;                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.     | The registrant’s other certifying officers and I are  responsible for establishing and maintaining disclosure controls and  procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the  registrant and we have:                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (a) | Designed such  disclosure controls and procedures to ensure that material information  relating to the registrant, including its consolidated subsidiaries, is made  known to us by others within those entities, particularly during the period  in which this annual report is being prepared; |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (b) | Evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this annual report (the  “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (c) | Presented in this  annual report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 5.     | The registrant’s other certifying officers and I have  disclosed, based on our most recent evaluation, to the registrant’s auditors  and the audit committee of the registrant’s board of directors (or persons  performing the equivalent function):                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (a) | All significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                             | (b) | Any fraud, whether or not material, that involves management or other  employees who have a significant role in the registrant’s internal controls;  and |
|   |                                                                                                                                                                                                                                                                                                                                                                                             |
| 6.     | The registrant’s other certifying officers and I  have indicated in this annual report whether or not there were significant  changes in internal controls or in other factors that could significantly  affect internal controls subsequent to the date of our most recent  evaluation, including any corrective actions with regard to significant  deficiencies and material weaknesses. |

 

 
| Dated: March 28,  2003 |   |                       |
|------------------------|--------|----------------------------|
|                   | By:    |                       | /s/ Lawrence D.  Damron |   |
|                   |   |                       |   |
|                   |   | Lawrence D.  Damron        |
|                   |   | Senior Vice  President and |
|                   |   | Chief Financial  Officer   |
|                        |        |                            |  |  |

 

37

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**AKSYS, LTD.**

**EXHIBITINDEX**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                 |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |   | Restated Certificate of  Incorporation of Aksys, Ltd. (1)                                                                                       |
| 3.2                 |   | Amended and Restated  By-Laws of Aksys, Ltd. (1)                                                                                                |
| 4.1                 |   | Form of certificate  representing shares of Common Stock, $.01 par value per share (1)                                                          |
| 4.2                 |   | Registration Agreement,  dated as of April 2, 1993, among the Company and certain stockholders of the  Company (1)                              |
| 4.3                 |   | Amendment No. 1 to  Registration Agreement, dated as of September 22, 1995, among the Company and  certain stockholders of the Company (1)      |
| 4.4                 |   | Registration  Rights Agreement, dated as of April 7, 2000, by and among the Company and the  investors named therein (2)                        |
| 4.5                 |   | Registration Rights  Agreement, dated as of August 14, 2000, by and among the Company and the  investors named therein (3)                      |
| 4.6                 |   | Registration  Rights Agreement, dated as of December 19, 2001, by and among the Company and  the investors named therein (4)                    |
| 4.7                 |   | Registration Rights  Agreement, dated as of December 19, 2001, by and among the Company and U.S.  Bancorp Piper Jaffray (4)                     |
| 4.8                 |   | Amended and Restated  Registration Rights Agreement, dated as of January 22, 2003, between the  Company and Kinsgbridge Capital Limited (10)    |
| 10.1                |   | Aksys, Ltd. 1993 Stock  Option Plan (1)                                                                                                         |
| 10.2                |   | Manufacturing  Agreement, dated as of January 23, 1996, between the Company and Texas  Medical Products, Inc. (1)                               |
| 10.3                |   | License Agreement,  dated as of April 1, 1993, between the Company and Zbylut J. Twardowski (1)                                                 |
| 10.4                |   | License Agreement,  dated as of April 1, 1993, between the Company and Cynthia P. Walters (1)                                                   |
| 10.5                |   | Form of Indemnification  Agreement(1)                                                                                                           |
| 10.6                |   | License Agreement,  dated as of March 11, 1996, between the Company and Allergan, Inc. (1)                                                      |
| 10.7                |   | Lease for Property at  Two Marriott Drive (5)                                                                                                   |
| 10.8                |   | Severance,  Confidentiality and Post-Employment Restrictions Agreement, dated as of  October 4, 1999 Between the Company and William C. Dow (6) |
| 10.9                |   | Manufacturing  Agreement, dated as of February 28, 2003, Between the Company and Peak  Industries, Inc. (9)                                     |
| 10.10               |   | Aksys, Ltd. 1996  Stock Awards Plan, as amended (8)                                                                                             |
| 10.11               |   | Aksys, Ltd. 2001  Employee Stock Purchase Plan (8)                                                                                              |
| 10.12               |   | Amended and  Restated Common Stock Purchase Agreement, dated as of January 22, 2003,  between the Company and Kingsbridge Capital Limited (10)  |
| 10.13               |   | Warrant, dated  as of October 15, 2002, issued to Kingsbridge Capital Limited(11)                                                               |
| 10.14               |   | Codevelopment  and Licensing Agreement, dated as of June 21,                                                                                    |

 

38

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|   |   | 1999, between  the Company and Teijin Limited(10)                                                                                                                                                   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15  |   | Stock Purchase  Agreement, dated as of January 7, 1998, between the Company and Teijin  Limited(10)                                                                                                 |
| 10.16  |   | Development and  Licensing Agreement, dated as of November 21, 2000, between the Company and  Teijin Limited(10)                                                                                    |
| 13     |   | Annual Report to  Stockholders.  Except as specifically  incorporated herein by reference, this document shall not be deemed “filed”  as part of this Annual Report on Form 10-K (9) |
| 21     |   | Subsidiaries of the  Company (1)                                                                                                                                                                    |
| 23     |   | Consent of KPMG LLP (9)                                                                                                                                                                             |
| 99.1   |   | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.(9)                                                                        |
| 99.2   |   | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.(9)                                                                        |

 

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(1)           Incorporated by reference to theCompany’s Registration Statement on Form S-1 (Registration No. 333-2492).

(2)           Incorporated by reference to theCompany’s Current Report on Form 8-K, filed on April 19, 2000.

(3)           Incorporated by reference to theCompany’s Current Report on Form 8-K, filed on August 21, 2000.

(4)           Incorporated by reference to theCompany’s Current Report on Form 8-K, filed on December 21, 2001.

(5)           Incorporated by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31, 1997.

(6)           Incorporated by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31, 1999.

(7)           Incorporated by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31, 2001.

(8)           Incorporated by reference to theCompany’s Proxy Statement for its 2001 Annual Meeting of Stockholders.

(9)           Filed herewith.

(10)         Incorporated by reference to theCompany’s Registration Statement on Form S-3 (Registration No. 102651).

(11)         Incorporated by reference to theCompany’s Current Report on Form 8-K filed on October 16, 2002.

 

39

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