<PAGE>
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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                   FORM 10-K

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       [x] Annual Report pursuant to Section 13 or 15 (d) of the Securities
           Exchange Act of 1934 for the fiscal year ended December 31, 1998 or
                                                          -----------------

       [ ] Transition Report pursuant to Section 13 or 15 (d) of the Securities
           Exchange Act of 1934 for the transition period from _______ to ______

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                         Commission file number 0-28290
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                                  AKSYS, LTD.
             (Exact name of registrant as specified in its charter)
       =========================================================================

                 Delaware                                    36-3890205
         (State or other jurisdiction of                    (I.R.S. Employer
          incorporation or organization)                   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

   Securities registered pursuant to Section 12(b) of the Act: Not applicable

          Securities registered 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) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.      Yes __x__  No_____

       Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

       The aggregated market value of voting stock held by non-affiliates of the
registrant as of March 19, 1999 at a closing sale price of $5.438 as reported by
the Nasdaq National Market was approximately $52,419,000.

       As of March 19, 1999 the registrant had 14,812,585 shares of Common Stock
issued and outstanding.

                      Documents Incorporated by Reference

       Portions of the Registrant's Proxy Statement to be used in connection
with the solicitation of proxies for the Annual Meeting to be held on April 22,
1999 (the "Proxy Statement") are incorporated by reference in Part III and
portions of the Registrant's 1998 Annual Report to Stockholders are incorporated
by reference in Part II and Part IV.

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                                  AKSYS, LTD.

                      INDEX TO ANNUAL REPORT ON FORM 10-K

<TABLE> 
<CAPTION> 
                                        
                                                                                        Page No.
                                                                                        --------
 
<S>                                                                                       <C>
PART I...................................................................................   1
 
Item 1.          Business................................................................   1
Item 2.          Properties..............................................................  17
Item 3.          Legal Proceedings.......................................................  17
Item 4.          Submission of Matters to a Vote of Security-Holders.....................  17
 
PART II.................................................................................   17
 
Item 5.          Market for the Registrant's Common Stock and Related
                 Stockholder Matters.....................................................  17
Item 6.          Selected Financial Data.................................................  17
Item 7.          Management's Discussion and Analysis of Financial Condition and
                 Results of Operations...................................................  19
Item 7A.         Quantitative and Qualitative Disclosures About Market Risk..............  22
Item 8.          Financial Statements and Supplementary Data.............................  23
Item 9.          Changes in and Disagreements with Accountants on Accounting
                 and Financial Disclosure................................................  23
 
PART III.................................................................................  23
 
Item 10.         Directors and Executive Officers of the Registrant......................  23
Item 11.         Executive Compensation..................................................  23
Item 12.         Security Ownership of Certain Beneficial Owners and Management..........  23
Item 13.         Certain Relationships and Related Transactions..........................  23
 
PART IV..................................................................................  24
 
Item 14.         Exhibits, Financial Statement Schedules and Reports on Form 8-K.........  24
 
SIGNATURES...............................................................................  25
 
EXHIBIT INDEX............................................................................  26
           
</TABLE>
<PAGE>
 
PART I

Item 1.  Business

                                   Background
                                        
     Aksys, Ltd. (the "Company") was founded in 1991 to provide hemodialysis
products and services for patients suffering from end-stage renal disease
("ESRD"), commonly known as chronic kidney failure. The Company has developed an
automated personal hemodialysis system, known as the Aksys PHD Personal
Hemodialysis System (the "PHD System"), which is designed to enable patients to
perform daily hemodialysis at alternate sites, such as the patient's home, and
to thereby improve clinical outcomes, reduce total ESRD treatment costs and
enhance the patients' quality of life. All these characteristics have been
associated with daily hemodialysis.

     The Company is currently working toward satisfying the regulatory
requirements for Food and Drug Administration ("FDA") clearance of the PHD
System in the United States. On March 30, 1999, the Company filed an
Investigational Device Exemption ("IDE") with the FDA. After approval of the
IDE, the Company will begin a clinical evaluation of the PHD System. The Company
expects the clinical evaluation will be approximately six months in
length. Following completion of the clinical evaluation, the data compiled will
be submitted along with other requested data in a 510(k) pre-market
notification, which the Company expects to file in early 2000. 510(k) clearance
by the FDA is required prior to the U.S. commercialization of the PHD System.

     In parallel with its U.S. regulatory efforts, the Company will seek to
obtain ISO 9001 certification in 1999, and also intends to submit final
production systems for CE mark approval (the European equivalent to 510(k)
clearance) during this same time frame. The Company hopes to receive CE mark
approval in late 1999 or early 2000, followed by a product launch in select
European countries.

     Japan is also a significant market where Aksys plans to seek regulatory
approval, although the regulatory approval cycle in Japan is much longer than in
the U.S. On January 7, 1998, the Company entered into a strategic alliance with
Teijin Limited of Osaka Japan (see "Foreign Operations" for a description of the
agreements that represent the strategic alliance). The Company is currently
working with Teijin to jointly develop and eventually commercialize the PHD
System in Japan.

     There can be no assurance that the Company will be able to obtain any of
the above-mentioned regulatory clearances or approvals in a timely manner or at
all.

                                The Marketplace
                                        
     The target market of the Company is the ESRD treatment market. A healthy
human kidney continuously removes waste products and excess water from the
blood. ESRD is a slow, progressive loss of kidney function caused by inherited
disorders, prolonged medical conditions such as diabetes and hypertension, or
the long-term use of certain medications. ESRD is irreversible and lethal if
untreated. Life can be sustained only through either transplantation or
dialysis. Transplantation is severely limited due to the shortage of suitable
donors, the incidence of organ transplant rejection and the age and health of
many ESRD patients. The vast majority (over 90%) of patients, therefore, must
rely on dialysis for the remainder of their lives.

     The Company estimates that $15 billion was spent in the U.S. during 1998
for the treatment of patients suffering from ESRD, of which nearly $5 billion
was directly related to dialysis treatment. Based upon information published by
the Health Care Financing Administration ("HCFA"), the approximate number of
ESRD patients in the United States requiring dialysis treatments has grown from
66,000 at the end of 1982 to approximately 250,000 at the end of 1998,
representing a compound annual growth rate of approximately 8%. In addition, it
is estimated that there were approximately 330,000 dialysis patients in Europe
and Japan in 1997. The Company believes that the sustained growth in the ESRD
population, especially in the United States, has been caused by (i) the aging of
the
                                       1
<PAGE>
 
population (the median age of newly diagnosed ESRD patients in the United
States is 62), (ii) the longer average life expectancy of patients with diabetes
and hypertension (two patient groups at high risk for ESRD), (iii) the
relatively more rapid growth in the general population of certain ethnic subsets
that have a higher incidence of ESRD, (iv) competing risk - with the decline in
vascular diseases of the heart, there is a rise in vascular diseases of the
kidney and (v) a possible increase in the use of medications that damage the
kidneys.

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

Under this program, after the first 30 months of treatment Medicare is
responsible for payment of 80% of the rate set by HCFA for reimbursement of
outpatient dialysis.  Although this program made dialysis available to virtually
all patients in need of treatment, the cost of funding the program grew rapidly,
quickly exceeding original expectations.  In an effort to hold down these costs,
Congress,  in 1983,  capped the Medicare reimbursement rate for outpatient
dialysis at approximately $20,000 per patient per year.  The costs of operating
dialysis centers, however, such as capital, labor and facility overhead, have
continued to rise.  These circumstances have forced dialysis providers to seek
ways to reduce dialysis treatment costs.  For example, certain dialysis
providers may be shortening dialysis treatments, reusing medical equipment and
supplies intended for a single use and shifting the responsibilities of doctors
and nurses to employees with less training.

                                 Reimbursement
                                        
Demand for the Company's products and services will be influenced by
governmental and other third-party reimbursement programs because providers of
ESRD treatment are often reimbursed by Medicare, Medicaid and private insurers.

Medicare Reimbursement

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

For ESRD patients under age 65 who have any employer group health insurance
coverage (regardless of the size of the employer or the individual's employment
status), Medicare coverage is generally secondary to the employer coverage
during a 30-month coordination period that follows the establishment of Medicare
eligibility or entitlement based on ESRD.  During the coordination period, an
employer group health plan is responsible for paying primary benefits at the
rate specified in the plan, which may be a negotiated rate or the healthcare
provider's usual and customary rate.  As the secondary payer during this
coordination period, Medicare will make payments up to the applicable composite
rate for dialysis services to supplement any primary payments by the employer
group health plan if the plan covers the services but pays only a portion of the
charge for the services.

Medicare generally is the primary payer for ESRD patients after the 30-month
coordination period.  Under current rules, Medicare is also the primary payer
for ESRD patients during the 30-month coordination period if, before becoming
eligible for Medicare on the basis of ESRD, the patient was already age 65 or
over (or eligible for Medicare based on disability) unless covered by an
employer group health plan (other than a "small" employer plan) because of
current employment.  This rule eliminates for many dual-eligible beneficiaries
the 30-month coordination period during which the employer plan would serve as
primary payer and reimburse health care

                                       2
<PAGE>
 
providers at a rate that the Company believes may be higher than the Medicare
composite rate. The rules regarding entitlement to primary Medicare coverage
when the patient is eligible for Medicare on the basis of both age (or
disability) and ESRD have been the subject of frequent legislative and
regulatory change in recent years and there can be no assurance that such rules
will not be unfavorably changed in the future.

When Medicare is the primary payer, it reimburses 80% of the composite rate set
by the Medicare prospective reimbursement system for each dialysis treatment.
The beneficiary is responsible for the remaining 20%, as well as any unmet
Medicare deductible amount, although an approved Medicare supplement insurance
policy, other private health insurance or Medicaid may pay on the beneficiary's
behalf.  The Medicare base composite rates for outpatient dialysis services
currently are $126 per treatment for hospitals and $122 for independent
facilities (equivalent to approximately $20,000 per year) and are adjusted
depending on regional wage differences.  Reimbursement rates are subject to
periodic adjustment based on certain factors, including budget and other
legislation and costs incurred in rendering the services if tied to certain
criteria.  The composite reimbursement rate was unchanged from commencement of
the program in 1972 until 1983.  From 1983 through December 1990, numerous
Congressional actions resulted in net reductions of the average composite
reimbursement rate from a fixed fee of $138 per treatment in 1983 to
approximately $125 per treatment in December 1990.  Effective January 1, 1991,
Congress increased the ESRD composite reimbursement rate, resulting in the
current average rate of $126 per treatment.

Reimbursement for home dialysis can be made in two ways.  A beneficiary may
choose to receive home dialysis equipment, supplies and support services
directly from a facility or to make independent arrangements for equipment,
supplies and support services.  If the beneficiary chooses to use a facility,
the facility receives the composite rate for each treatment the patient performs
at home.  If the beneficiary chooses to make independent arrangements, the
supplier bills Medicare on an assignment basis and payment is made at a rate not
greater than the composite rate, with the exception of CCPD (as defined below).
There is a monthly payment cap of $2,080 for CCPD and approximately $1,600 for
all other methods of home dialysis.

The Medicare ESRD composite reimbursement rate has been the subject of a number
of reports and studies.  Actions to change such rate usually occur in the
context of federal budget negotiations each year.

In its March 1, 1996 report, ProPAC recommended that HCFA should encourage the
availability of managed care alternatives for ESRD patients.  Previously, in
1993, Congress directed HCFA to include the integration of chronic and acute
ESRD care management through expanded community care services.  In January 1996,
HCFA announced the availability of funding for ESRD Managed Care Demonstrations
based on approval of grant applications and proposals.  During October 1996,
HCFA announced the selection of four dialysis treatment centers where government
funding will be provided to conduct the ESRD Managed Care Demonstration Project.
In addition to the HCFA ESRD Managed Care Demonstration Project, private
companies have recently initiated disease management programs for the treatment
of ESRD patients.

The Company is unable to predict what, if any, future changes may occur in the
Medicare composite reimbursement rate or in any other reimbursement program.
Any reductions in the Medicare composite reimbursement rate or in any other
reimbursement program could have a material adverse effect on the Company's
prospects, revenues and earnings.  In addition, there have been various
legislative proposals for the reform of numerous aspects of Medicare, including
expanded enrollment of Medicare beneficiaries in managed care programs, the
occurrence and effect of which are uncertain.  See "--Potential Health Care
Legislation."

Medicaid Reimbursement

Medicaid programs are state-administered programs partially funded by the
federal government.  These programs are intended to provide coverage for
patients whose income and assets fall below state defined levels and who are
otherwise uninsured.  The programs also serve as supplemental insurance programs
for the Medicare co-insurance portion and provide certain coverage (e.g., oral
medications) that are not covered by Medicare.  State regulations 

                                       3
<PAGE>
 
generally follow Medicare reimbursement levels and coverage without any co-
insurance amounts. Certain states, however, require beneficiaries to pay a
monthly share of the cost based upon levels of income or assets.


Private Reimbursement

Some ESRD patients have private insurance that covers dialysis services.  As
discussed above, health care providers receive reimbursement for ESRD treatments
from the patient or private insurance during a "waiting period" up to three
months before the patient becomes eligible for Medicare.  In addition, if the
private payer is an employer group health plan, it is generally required to
continue to make primary payments for dialysis services during the 30-month
period following eligibility or entitlement to Medicare.  In general, employers
may not reduce coverage or otherwise discriminate against ESRD patients by
taking into account the patient's eligibility or entitlement to Medicare
benefits.

The Company believes that before Medicare primary coverage is established,
private payers may reimburse dialysis expenses at rates higher than the per-
treatment composite rate set by Medicare.  When Medicare becomes a patient's
primary payer, private insurance often covers the per-treatment 20% coinsurance
that Medicare does not pay.

Potential Health Care Legislation

Because the Medicare program represents a substantial portion of the federal
budget, Congress takes action in almost every legislative session to modify the
Medicare program for the purpose of reducing the amounts otherwise payable by
the program to health care providers in order to achieve deficit reduction
targets or meet other political goals.  Legislation and/or regulations may be
enacted in the future that may significantly modify the Medicare ESRD program or
substantially affect reimbursement for dialysis services.

                          Prevailing Treatment Methods
                                        
Hemodialysis and peritoneal dialysis are the two prevailing methods of dialysis.

Hemodialysis

HCFA estimates that as of December 31, 1997, approximately 87% (200,000) of the
ESRD dialysis patients in the United States were receiving hemodialysis.
Approximately 1% of these patients performed treatment in their homes, and all
others received treatment at outpatient facilities.  Outpatient hemodialysis
requires that a patient travel to a dialysis clinic three times per week for
dialysis sessions lasting three to four hours.  In each session, the patient's
blood is cleansed by circulation through an artificial kidney controlled by a
dialysis machine.

Home hemodialysis was common practice prior to Medicare funding, with
approximately 42% of the 11,000 United States dialysis patients on home
hemodialysis in 1973.  Although the initial motivation for performing home
treatment for many patients reflected the lack of availability of dialysis
clinics and the desire to reduce the cost of hospital-based dialysis, clinicians
report that many of these patients found significant advantages in quality of
life when treating themselves at home.  As Medicare funding became available,
however, the vast majority of patients began receiving treatment in outpatient
facilities, and hemodialysis machines became more complex and sophisticated as
they evolved for use in clinics.  The dialysis machines currently used in these
centers are predominantly operated by trained personnel and require significant
manual preparation and cleaning in connection with each treatment session.

Peritoneal Dialysis

HCFA estimates that as of December 31, 1997, approximately 13% (30,000) of the
ESRD dialysis patients in the United States were receiving peritoneal dialysis,
with over 99% performing such treatment in their homes.  There 

                                       4
<PAGE>
 
are two principal forms of peritoneal dialysis, and all forms use the patient's
peritoneum, a large membrane rich in blood vessels that surrounds many of the
body's internal organs, as a filter to eliminate toxins and excess fluids from
the patient's blood. Dialysate, a blood-cleansing electrolyte solution, is
infused through a catheter into the patient's peritoneal cavity. Once this fluid
absorbs the toxins and excess water that are filtered from the blood through the
peritoneum, it is drained from the peritoneal cavity through a catheter. In the
most common form of peritoneal dialysis, Continuous Ambulatory Peritoneal
Dialysis ("CAPD"), the process of exchanging dialysate into and out of the
patient's peritoneal cavity occurs four times daily, seven days per week. The
other form, Continuous Cycling Peritoneal Dialysis ("CCPD"), uses an instrument
to automatically perform exchanges of solution through the peritoneal cavity
overnight, while the patient sleeps. Both forms require strict aseptic
technique.

Limitations of Prevailing Treatment Methods

Hemodialysis.  Patients receiving outpatient hemodialysis often experience a
number of chronic and acute health problems.  The chronic problems include
hypertension, anemia (low red blood cell count), malnutrition, fluid and
electrolyte imbalance, calcium deficiency, insomnia, sexual impotency, decreased
mental acuity and lower energy levels.  The acute problems include headaches,
nausea, hypotension and asthenia (a general lack of strength and vitality),
which are associated with thrice weekly dialysis sessions.  In addition, a
general feeling of ill health tends to increase between dialysis treatments as a
result of toxins, sodium and water building up in the patient's blood.  These
side effects have a significant impact on (i) clinical outcomes, with the
leading cause of death among ESRD patients being cardiovascular disease, which
many clinicians believe is caused in large part by oscillations in toxins,
sodium and body fluid levels, (ii) total patient costs, resulting from the
frequent need to hospitalize ESRD patients as well as the need to treat anemia
and hypertension with medication and (iii) patient quality of life, with
patients having to not only suffer through these chronic and acute health
problems and related "hangover" frequently following each treatment, but also to
essentially devote three days per week to the treatment regimen.

The Company believes that these health problems are caused in part by inadequate
doses and frequency of dialysis.  The amount of toxins removed from the blood
during dialysis is widely accepted to be determined by a formula indicating that
hemodialysis is most efficient in the earlier stages of therapy.  Thus, simply
increasing the duration of a treatment session is not the most efficient way to
improve the dose of hemodialysis.  Rather, the efficiency of hemodialysis and
the delivered dose can be improved with more frequent dialysis sessions of
shorter duration.  More frequent sessions also decrease the severe oscillations
in toxin and hydration levels associated with the prevailing thrice weekly
dialysis regimen and should result in fewer side effects.

The clinical outcomes of conventional dialysis have contributed to the
significant patient treatment cost.  According to HCFA, total treatment costs
per dialysis patient have risen from $33,400 in 1988 to $63,000 in 1997.  The
cost of hospitalization on a fee for service basis represents the most
significant component of this increase. While reimbursement for outpatient
hemodialysis treatment (the "composite rate") has been capped since 1983,
reimbursement for the associated cost of care due to chronic and acute health
problems and other complications continues to be reimbursed on a fee for service
basis.  Under this reimbursement scheme, providers have an incentive to reduce
the cost of outpatient dialysis rather than the total cost of treating dialysis
patients.

The Company expects that Medicare will eventually change its reimbursement with
respect to ESRD patients to a managed care system in which all costs of treating
ESRD patients are subject to a cap.  This would encourage providers to focus on
clinical outcomes in order to reduce the total cost of care.  Congress has
mandated a demonstration project to evaluate the benefits of an ESRD managed
care approach, in which providers would be paid a capitated rate covering both
in-patient and outpatient care.  This project began in 1998 and will run for
three years.

Peritoneal Dialysis.  Although peritoneal dialysis accounted for 13% (or 30,000)
of the dialysis patient population in 1997 according to HCFA, approximately 23%
(or 7,000) of the patients in the United States switched to outpatient in-center
hemodialysis.  The Company believes that most of these patients switched from
peritoneal dialysis to outpatient hemodialysis because of the following
limitations presented by CAPD, the most common form of peritoneal dialysis: (i)
due to the limited efficiency of using the peritoneal membrane as a filter for
toxin removal, 

                                       5
<PAGE>
 
patients must have a relatively low body weight or have some residual kidney
function to achieve adequate levels of dialysis (once residual kidney function
is lost, which is eventually the case in most patients, CAPD is no longer a
viable treatment for a majority of the population); (ii) CAPD demands
considerable responsibility and time to perform the required four exchanges of
solution each day, which often causes patient "burnout" and non-compliance with
the prescribed regimen; (iii) peritoneal dialysis demands that patients follow
strict aseptic techniques when changing dialysate bags because the failure to do
so often leads to peritonitis, an infection of the peritoneum; and (iv) the
supplies used in peritoneal dialysis require considerable storage space given
the quantity of dialysate (up to 30 large boxes per month) used in this
treatment.

     The Company believes that most new peritoneal dialysis patients choose
CCPD, in part, in an attempt to improve clinical outcomes. Although CCPD
addresses some of the limitations imposed by CAPD, it continues to present a
risk of infection of the peritoneum and in many cases requires some residual
kidney function to achieve adequate levels of dialysis. Moreover, because CCPD
must often be supplemented with peritoneal dialysis performed by the patients
during the day using the CAPD method, patient "burnout" also occurs.

Home Hemodialysis as an Alternative

     The Company believes that increasing the frequency of hemodialysis
treatments while decreasing the length of each treatment session can
significantly improve clinical outcomes and patient quality of life while
reducing the total cost of managing ESRD patients. Several studies over the past
32 years indicate that increasing the number of dialysis treatments per week
leads to dramatic improvements in patients. The Company has compiled data on 72
patients (including approximately 24 patients from nine centers in Europe and
the U.S. treated with daily hemodialysis for up to 14 years) dialyzing six or
seven times per week. The data obtained from these retrospective studies
indicates that the patients involved, when dialyzing six or seven times per
week, experienced normalization of blood pressure, decreased incidence of
anemia, improved appetite and decreased mortality. Several study centers report
that most of the ESRD patients who performed hemodialysis on a daily basis
reported that daily hemodialysis gave them a more positive attitude toward
treatment and a higher quality of life. Neither the Company nor the PHD System
was involved in the treatments received by patients in these studies and the
Company did not fund these studies. Moreover, patient selection for these
studies was not randomized; the Company gathered the data on a retrospective
basis from providers that it knew were treating patients with a daily
hemodialysis regimen. Consequently there can be no assurance that the patient
populations in these studies are representative of the general ESRD patient
population. As a result, these studies should not be deemed to have established
the impact of daily hemodialysis on clinical outcomes.

     In addition to the aforementioned retrospective studies, daily hemodialysis
is gaining popularity. There are initiatives in the U.S. and worldwide to study
the benefits of daily hemodialysis. The Company estimates that in early 1999,
there are 21 centers world, 10 of which are in North America, treating over 140
patients with daily hemodialysis.

     Despite the potential benefits of frequent hemodialysis, several barriers
have prevented it from becoming a viable treatment regimen. The most significant
is the economic implication of administering more frequent hemodialysis to
patients from the traditional three times per week dialysis. Under the current
capped Medicare reimbursement level, dialysis providers cannot afford the
additional costs that would be incurred in providing more frequent treatments in
outpatient facilities. Requiring more frequent visits to a dialysis treatment
facility would also place additional burdens on a patient's lifestyle.

     There is also a perception that vascular access complications arising from
inserting the needles into the patient's blood access site may increase with
daily treatment sessions. These complications are common in the clinical setting
already and account for a significant portion of the cost of treating patients.
Although the Company believes that vascular access complications should not
increase with more frequent hemodialysis sessions in a home or self-care setting
and such complications may in fact decrease, that belief is based on data
collected from patients using a native fistula. The Company has collected little
data from patients using artificial blood vessel grafts or central

                                       6
<PAGE>
 
venous catheters, and there is no assurance that such grafts or catheters will
withstand daily treatment. There are a number of approaches to vascular access
that may enhance more frequent treatments, including (i) the use of "single
needle" vascular access devices which reduce the number of punctures by half,
(ii) the use of central venous catheters which eliminate the need to use needles
at all, (iii) novel graft materials, (iv) new, totally implanted central venous
catheters with titanium ports and (v) the practice of inserting needles in the
same site each day, which has been demonstrated to have several benefits
according to publications by Dr. Zbylut J. Twardowski, a leading dialysis
researcher and member of the Company's Scientific Advisory Board.

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

                              Product Development

The Aksys PHD System

The Company is in the final stages of developing the PHD System.  By addressing
the many drawbacks of conventional hemodialysis systems, which have prevented
the widespread use of daily home hemodialysis, the Company believes its products
and services can be instrumental in improving clinical outcomes, decreasing the
total treatment costs and improving quality of life for dialysis patients.  The
following chart describes how the PHD System addresses the drawbacks presented
when ESRD patients use conventional systems for home hemodialysis:

<TABLE>
<CAPTION>
 
        Drawback                  Conventional Home Systems                        Aksys PHD System
<S>                       <C>                                         <C> 
Complexity                Complicated equipment designed for          Designed for ease of operation by patients
                          operation only by trained personnel.        at home, including computerized, user-
                                                                      friendly interface.
 
Time and Effort           Difficult and time consuming to setup,      Fully automated, reducing patient
                          operate, clean and maintain.                involvement.
 
Cost of Consumables       Requires frequent replacement of blood      Integrated automatic disinfection system
                          circuit.                                    designed to enable safe and effective
                                                                      reuse of blood circuit.
                                                                                  
Clinical Monitoring       Patient treatment compliance monitoring     Patient monitored by, and able to
                          and patient ability to consult with         communicate with, clinic by fax or modem
                          clinic   not available unless treatment     (and eventually through real time on-line
                          received in   an outpatient facility.       monitoring system.)
 
Storage Requirements      Large volume of consumables and             Substantially fewer and smaller items
                          dialysate consumed each month.              consumed with each treatment.
 
</TABLE>

Although the most common form of peritoneal dialysis, CAPD, does not require a
dialysis machine, as discussed above, peritoneal dialysis has inherent
limitations.  The Company believes that the PHD System addresses the primary
drawbacks of both forms of peritoneal dialysis by delivering a substantially
greater dose of dialysis in significantly less time.  Furthermore, by enabling
the use of frequent home hemodialysis, the PHD System overcomes other
limitations of peritoneal dialysis such as the risk of peritonitis and patient
non-compliance to the prescribed regimen.

The Company believes that the PHD System offers patients simplification and
control.  The new technology of the PHD System integrates three systems into
one:  water treatment, delivery of dialysis and dialyzer reprocessing.   The 

                                       7
<PAGE>
 
PHD System is a fully automated personal dialysis instrument designed to enable
patients 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 the
patient's time and effort involved in performing each hemodialysis treatment and
to be operated by the patient with minimal or no assistance. Through a touch
sensitive display screen with instructions available on a graphic video display,
the PHD System is designed to be less intimidating and easier to use than
current hemodialysis systems. The system can be separated into three modules to
facilitate transportability.

The PHD System is designed to help evaluate the performance of the artificial
kidney in removing toxins from the patient's blood prior to each treatment to
ensure that the prescribed dose of hemodialysis is achieved during the
treatment.  The PHD System also automatically evaluates the water treatment
filters and indicates whether a replacement is required and verifies that all
critical safety systems, sensors and alarms are operating correctly.

To begin a treatment session on the PHD System, the patient would connect the
blood tubing to the vascular access device and attach an integrated blood
pressure cuff.  A user-friendly, touch-sensitive monitor prompts the patient
through the treatment and displays procedure and patient-specific information
for review.  The PHD System is designed to monitor during the treatment a
variety of vital statistics, including the patient's blood pressure and blood
flow rate, the amount of water removed from the patient, the length of the
treatment session and other key parameters.  The treatment can be suspended at
any time by the patient.  If the patient's blood pressure drops below normal
levels during the treatment, the system prompts the patient to take appropriate
action.  Data from a hemodialysis treatment is displayed for viewing by the
patient and can be communicated by modem or fax to the dialysis provider or
other healthcare personnel at pre-determined intervals.

At the end of a treatment session, the patient reconnects the blood tubing to
the system and inserts two small bottles of dialysate in the system to replace
those consumed during the treatment.  The PHD System then automatically flushes
and disinfects all fluid pathways, performs a self-diagnostic test to determine
whether the disinfection was adequate and readies itself without further patient
involvement for the next treatment session.

Services Supporting the PHD System

To fully service hemodialysis patients, the Company intends to develop a service
network to provide support for patients and dialysis providers in all aspects
relating to the use and maintenance of the PHD System.  The Company expects this
service network will provide: (i) delivery and installation of the PHD System
(including arranging for any minor changes to plumbing and electrical circuits
in the patient's home, or other self-care setting, that will be necessary for
operation of the PHD System), (ii) technical service through a 24 hour call
center and through field representatives who will maintain and repair all
components of the PHD System, (iii) delivery of consumables used in dialysis
such as the artificial kidney and arterial and venous blood tubing (which are
replaced periodically), water purification components and dialysate concentrate,
(iv) delivery of ancillary supplies such as dressings, tape, antiseptics, drugs
and syringes and (v) customer service representatives who will interface with
the dialysis provider to address the status of, and any necessary changes in,
the patient's treatment made by the dialysis provider.  The Company believes
that by providing all of the products and services necessary to perform
hemodialysis at home as well as in other self-care settings and nursing homes,
the Company can establish and maintain loyalty with patients and dialysis
providers.

The PHD System is intended to reduce total treatment costs for ESRD patients,
including hospitalization costs.  There is no reliable way at this time,
however, to quantify the potential savings in total treatment cost.  The Company
expects that the PHD System will be priced at a level close to the cost of
competing dialysis treatment modalities.  Thus, the Company expects there will
be little or no reduction in dialysis cost (as opposed to total treatment costs)
associated with the PHD System.

Although the Company believes that the PHD System provides a solution to many of
the problems presented by conventional dialysis modalities, there are a number
of risks that must be overcome for the PHD System to succeed, including the
uncertainty of obtaining regulatory clearance or approval and of achieving
market acceptance and development.

                                       8
<PAGE>
 
Other Product Development

     During 1999, virtually all of the Company's resources will be devoted to
the development and regulatory approval process of the PHD System. As the
Company nears the stage of commercial production, resources will continue to be
devoted to additional features, service and support of the PHD System. At that
time, resources will also be directed toward using the platform technology
incorporated in the PHD System to develop follow-on products.


                        Business and Marketing Strategy

     In October 1997, the National Kidney Foundation released the results of the
first comprehensive effort to standardize practices at U.S. dialysis centers
(the Dialysis Outcomes Quality Initiative, or DOQI guidelines). The
recommendations called for minimum doses of dialysis; however, approximately 32%
of all current U.S. patients are under that recommended minimum dosage. These
recommendations support the Company's belief that patients who receive that
higher dose through daily dialysis would benefit through improved clinical
outcomes. The Company believes that the PHD System offers the potential for
better clinical outcomes, lower total treatment costs and improved quality of
life for dialysis patients. The relatively poor patient outcomes resulting from
current dialysis treatment methods and the increasing total cost of treating
ESRD patients have created significant demand for improved dialysis systems.
Through the PHD System, the Company intends to capitalize on this demand by
pursuing the following strategies.

     Target Specific Market Segments. The Company intends to market its products
and services directly to those providers of dialysis services most focused on
patient outcomes and total cost of care. This strategy is designed to achieve
access to the key patient segments which the Company believes will be especially
receptive to frequent home hemodialysis using the PHD System, including: (i)
dialysis patients currently receiving conventional home hemodialysis, (ii)
dialysis patients who drop out of home peritoneal dialysis, (iii) ESRD patients
currently enrolled in a managed care program, such as a health maintenance
organization and (iv) ESRD patients who are just beginning dialysis treatment.
In the United States, these segments accounted for approximately 2,000, 7,000,
12,000 and 80,000 dialysis patients, respectively, in 1997 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 device for
self-care clinics, nursing homes and hospitals in an acute care setting.

     Provide a Broad Range of Dialysis Products and Services. The Company
intends to provide a broad range of products and services for hemodialysis
patients and providers. In addition to the delivery, installation and
maintenance of the PHD System, the Company intends to provide training,
technical support and delivery of all required consumables. The Company intends
to sell the instruments to the customers or to a third party lease company, and
enter into contracts with its customers to provide all consumables and
services for a single monthly price.

     Capture and Provide Outcome Data. The PHD System has a built-in computer
capable of recording specific medical data regarding dialysis treatment and
patient health and compliance. Future versions of the PHD System will allow
outcome data to be furnished on-line to the healthcare provider responsible for
treating the patient and will aid the provider in assessing the effectiveness of
the patient's dialysis treatment prescription as well as promote the potential
clinical and cost benefits of frequent home hemodialysis. Outcome data should
become increasingly important if, as the Company believes, HCFA moves towards a
reimbursement system that capitates total ESRD patient cost.

     Implement Programs to Demonstrate Clinical Benefits and Cost-Effectiveness.
The Company intends to complement its marketing by conducting clinical studies
and implementing other measures designed to document the clinical and cost
benefits it believes will result from frequent home hemodialysis using the PHD
System. In 1998, the Company sponsored a study at six centers to measure the
early improvements in nutrition and well-being of patients converting from the
standard thrice-weekly hemodialysis regimen to a daily hemodialysis regimen.

                                       9
<PAGE>
 
Results of the study indicated dramatic improvements in the patients' feeling of
well-being after converting to a regimen of daily hemodialysis. In addition, the
Company is sponsoring a long-term study, lasting at least two years, to measure
the long-term clinical benefits of daily hemodialysis. In collaboration with
members of the Company's Scientific Advisory Board and other leading
nephrologists, the Company intends to promote the benefits of the PHD System
through publication in clinical journals and presentations at scientific
conferences of the results of these studies.

Phased Domestic and International Market Launch. The Company believes that there
is worldwide demand for a cost effective, more clinically effective approach to
dialysis. In addition to pursuing market launch in the United States, the
Company is establishing marketing and regulatory resources in Europe, Japan and
elsewhere. According to international patient registries compiled by the USRDS,
there were approximately 160,000 dialysis patients in Europe and 170,000
dialysis patients in Japan, both as of December 31, 1997.

Sales and Marketing

The Company initially intends to operate with a relatively small direct sales
force to market its products and services, primarily to healthcare providers
such as hospitals, dialysis clinics, managed care organizations and nephrology
physician groups. The Company intends to distribute and provide technical
support for the PHD System through third parties.



                          Manufacturing and Suppliers
                                        
The Company does not intend to initially manufacture any component of the PHD
System or related consumables. With respect to the PHD System, the Company has
contracted with SeaMED Corporation (''SeaMED''), a contract manufacturer of
medical devices, to assemble and produce the dialysis machine. The Company has
entered into an agreement with SeaMED that remains in effect for three years
after delivery of the first production model of the PHD System, subject to
earlier termination under specified circumstances. SeaMED has specialized in the
custom manufacturing of medical instrumentation for more than 15 years and is
certified to ISO requirements for manufacture of such products. ISO
Certification is an internationally recognized standard of quality
manufacturing. The Company intends to identify additional manufacturing
locations in the future, whether or not owned by SeaMED, to avoid having to rely
on a single location. There can be no assurances that the Company will be able
to do so on terms acceptable to it. The manufacturing of the Company's products
is subject to GMP and other requirements prescribed by regulatory agencies.
There can be no assurance that SeaMED or any other manufacturer of the Company's
products will continue to comply with applicable regulatory requirements or that
SeaMED or any such manufacturer will be able to supply the Company with such
products in sufficient quantity or at all.

Certain key components of the PHD System, such as the dialyzer, are available
from other manufacturers.  The blood circuit, however, is custom made to the
Company's specifications by a single supplier.  The Company has entered into a
contract with Texas Medical Products, Inc. to supply this product.  Similarly,
the dialysate chemicals supplied to patients using the PHD System will be custom
made and packaged to the Company's specifications.  The Company is currently
working with a leading manufacturer and packager of pharmaceutical products to
provide the Company's needed dialysate chemicals.  There can be no assurances,
however, that any of the key components of the Company's products, including
dialyzers produced by other manufacturers, will be available on terms acceptable
to the Company or at all.

                            Research and Development
                                        
As of December 31, 1998, the Company employed a research and development staff
of 64 full time employees, most of whom are engineers and technicians. In
addition, the Company used contractors on an as needed basis to assist in its
development process. The research and development staff is composed of
specialists in the fields of mechanical engineering, electrical engineering,
software engineering, biomedical and systems engineering,
                                       10
<PAGE>
 
chemistry and microbiology. For the years ended December 31, 1998, 1997 and
1996, the Company incurred total research and development expenditures of
approximately $15,343,000, $10,887,000 and $6,515,000, respectively.

                                  Competition
                                        
The Company expects to compete in the kidney dialysis market with suppliers of
hemodialysis and peritoneal dialysis devices, supplies and services. The Company
does not intend to compete with providers of dialysis services such as the
national dialysis providers or managed care companies. Rather, it intends to
market its products and services to these providers and to work with them to
make home hemodialysis a viable alternative to currently available treatment
methods.

The Company's primary competitors in supplying dialysis equipment, supplies and
services are expected to be Baxter International Inc., Fresenius Medical Care AG
and CGH Medical, Inc. (Cobe, Gambro, Hospal). These companies and most of the
Company's other potential competitors have substantially greater financial,
scientific and technical resources, research and development capabilities,
marketing and manufacturing resources and experience than the Company and
greater experience in developing products, providing services and obtaining
regulatory approvals. In addition, the Company is aware of at least one other
company that may be developing a machine that could be used for daily home
hemodialysis.

The Company's ability to successfully market its products and services could be
adversely affected by pharmacological and technological advances in preventing
the progression of ESRD in high-risk patients (such as those with diabetes and
hypertension), technological developments by others in the area of dialysis, the
development of new medications designed to reduce the incidence of kidney
transplant rejection and progress in using kidneys harvested from genetically-
engineered animals as a source of transplants. There can be no assurance that
competitive pressure or pharmacological or technological advancements will not
have a material adverse effect on the Company.

The Company believes that competition in the market for kidney dialysis
equipment, supplies and services is based primarily on clinical outcomes, price,
product performance, cost-effectiveness, reliability and technological
innovation and that such competition in the home hemodialysis market will be
based on such factors as well as on products being relatively easy to use,
transport and maintain. Certain kidney dialysis equipment manufacturers and
service providers currently own and operate, or may in the future acquire,
dialysis treatment facilities and other providers. As a result, the Company's
ability to sell its products and services to such providers may be adversely
affected.

                                       11
<PAGE>
 
                             Government Regulation
                                        
Food and Drug Administration

The PHD System is regulated as a medical device by the FDA under the Federal
Food, Drug and Cosmetic Act (the "FDC Act"). Pursuant to the FDC Act, the FDA
regulates the manufacture and distribution of medical devices in the United
States. Noncompliance with applicable requirements can result, among other
things, in fines, injunctions and civil penalties; recall or seizure of
products; total or partial suspension of production; denial or withdrawal 
of pre-market clearance or approval of devices; recommendations by the FDA that
the Company not be allowed to enter into government contracts; and criminal
prosecution. The FDA also has authority to require repair, replacement or refund
of the cost of any device illegally manufactured or distributed by the Company.

In the United States, medical devices are classified into one of three classes
(Class I, II or III) on the basis of the controls deemed necessary by the FDA to
reasonably ensure their safety and effectiveness. Class I devices are subject to
general controls (e.g., labeling and adherence to GMPs). 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
must receive pre-market approval by the FDA to ensure their safety and
effectiveness (e.g., life-sustaining, life-supporting and implantable devices or
new devices which have been found not to be substantially equivalent to legally
marketed devices).

The Company submitted a 510(k) pre-market notification for clearance of the PHD
System on March 5, 1996. The FDA notified the Company on July 17, 1996 of the
acceptance for formal review of the Company's 510(k) pre-market notification
submission. Subsequently, on September 18, 1996, the FDA notified the Company of
additional data required to be submitted with regard to the PHD System. The FDA
also notified the Company of the requirement for clinical data to be included in
the 510(k) pre-market notification submission. While the FDA withdrew the
Company's 510(k) filing due to the request for clinical data, the FDA also
notified the Company to resubmit the requested data, once available, in the form
of a new 510(k) pre-market notification.

On March 30, 1999, the Company filed an Investigational Device Exemption ("IDE")
with the FDA, a prerequisite for conducting a clinical evaluation of the PHD
System. After approval of the IDE, the Company will begin a clinical evaluation
of the PHD System. The Company expects the clinical evaluation will be
approximately six months in length. Upon completion of the clinical evaluation,
the data compiled will be submitted along with other requested data in a new
510(k) pre-market notification, which the Company expects to file in early 2000.
Although the FDA has notified the Company that it may submit a new 510(k) pre-
market notification subsequent to the completion of clinical trials, there is no
assurance that the FDA will not require the Company to file a PMA for approval
to market the PHD System rather than a 510(k) pre-market notification. Should
the FDA require a PMA filing, the regulatory approval timeline and commercial
launch date in the United States may be adversely affected.

The IDE approval and 510(k) clearance processes are lengthy and uncertain and
require substantial commitments of the Company's financial resources and
management's time and effort. Significant unforeseen delays in either process
could occur as a result of the FDA's failure to schedule advisory review panels,
changes in established review guidelines, regulations or administrative
interpretations or determinations by the FDA that clinical data collected is
insufficient to support the safety and effectiveness of one or more of the
devices for their intended uses or that the data warrants the continuation of
clinical studies. Delays in obtaining, or failure to obtain, requisite
regulatory approvals or clearances in the United States and other countries
would prevent the marketing of the PHD System and other devices and impair the
Company's ability to generate funds from operations, which in turn would have a
material adverse effect on the Company's business, financial condition, and
results of operations.

The FDC Act requires that medical devices be manufactured in accordance with the
FDA's current GMP regulations. These regulations require, among other things,
that (i) the manufacturing process must be regulated and controlled by the use
of written procedures and (ii) the ability to produce devices which meet the
manufacturer's specifications be validated by extensive and detailed testing of
every aspect of the process. They also require investigation of any deficiencies
in the manufacturing process or in the products produced and detailed record
keeping. Manufacturing facilities are therefore subject to FDA inspection on a
periodic basis to monitor compliance with GMP requirements. If violations of the
applicable regulations are noted during FDA inspections of the Company's
manufacturing facilities or the manufacturing facilities of its contract
manufacturers, there may be a material adverse effect on the continued marketing
of the Company's products.

                                       12
<PAGE>
 
Before the FDA approves a Section 510(k) submission, the FDA is likely to
inspect the utilized manufacturing facilities and processes for compliance with
GMP.  Even after the FDA has cleared a 510(k) submission, it will periodically
inspect the manufacturing facilities and processes for compliance with GMP.  In
addition, in the event that additional manufacturing sites are added or
manufacturing processes are changed, such new facilities and processes are also
subject to FDA inspection for compliance with GMP.  The manufacturing facilities
and processes that will be used to manufacture the Company's products have not
yet been inspected by the FDA for compliance with GMP.  There is no assurance
that the facilities and processes utilized by the Company will comply with GMP
and there is a risk that clearance or approval will, therefore, be delayed by
the FDA until such compliance is achieved.

Foreign Government Regulation

The Company plans to market the PHD System in several foreign markets.
Requirements pertaining to the PHD System vary widely from country to country,
ranging from no health regulations to detailed submissions such as those
required by the FDA.  The Company believes the extent and complexity of
regulations of medical devices such as the PHD System is increasing worldwide.
The Company anticipates that this trend will continue and that the cost and time
required to obtain approval to market in any given country will increase, with
no assurance that such approval will be obtained.  The ability to export into
other countries may require compliance with ISO 9000, which is analogous to
compliance with the FDA's GMP requirements.  The Company has not obtained any
regulatory approvals to market the PHD System outside of the United States.

In parallel with U.S. regulatory efforts, the Company expects to obtain ISO 9001
certification in 1999, and also to submit final production systems for CE mark
approval (the European equivalent to 510(k) clearance in the U.S.) during this
same time frame.  The Company is anticipating CE mark approval in late 1999 or
early 2000, followed by a controlled product launch in select European
countries.

                             Intellectual Property
                                        
As of January 29, 1999, the Company either owns or has exclusive rights to 31
U.S. patents and 14 foreign patents for technologies that are essential to
developing a safe, convenient, self-contained hemodialysis system.   The U.S.
Patent and Trademark Office has also allowed claims on three additional patents.
The Company has filed a number of additional patent applications directed to a
number of different features of the PHD System in the United States, and in
several other countries that have significant hemodialysis markets.  The Company
has also filed a Patent Cooperation Treaty ("PCT") patent application that
permits it to file patent applications in additional PCT-member countries for a
limited period of time.  The Company expects to file additional patent
applications in the United States directed to the PHD System as new technology
is developed.

Twardowski License.  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 Advisory Board, granting to the Company a worldwide
exclusive license which relates to the patent issued on August 9, 1994 entitled
"Artificial Kidney for Frequent (Daily) Hemodialysis" which expires August 9,
2011 (the "Twardowski Patent").  The Twardowski Patent relates to an artificial
kidney intended to provide frequent (daily) home hemodialysis.  The Twardowski
License has a duration for as long as the Twardowski Patent remains in effect.
The Twardowski License provides for royalties based on the revenue received by
the Company from the sale or lease of the licensed product. The Twardowski
License requires certain minimum semiannual royalty payments.  If the Company
fails to make any such minimum royalty payment, Twardowski has the option to
convert the Twardowski License to a non-exclusive license.  There can be no
assurance that the Twardowski Patent will provide the Company significant
exclusivity or benefit in its markets.  Furthermore, competitors may develop
alternative technology that achieves the same advantages as the Twardowski
Patent.

Boag License.  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 Reuse System" issued on September 22, 1987, which 

                                       13
<PAGE>
 
expires September 22, 2004 (the "Boag Patent"). The Boag License is exclusive
subject to the rights of Servall Corp. to market its HR3000 product, a device
for facilitating reuse of consumables with conventional hemodialysis machines.
The Boag Patent relates to a dialysis reuse system for cleaning, sterilizing and
testing a hemodialysis machine and its associated dialyzer and blood tubing set.
The Boag License has a duration for as long as the Boag Patent remains in
effect. The Boag License provides for royalties based on the revenue received by
the Company from the sale or lease of the licensed product with a minimum
semiannual royalty payment. Commencing with the third semiannual period after
the first licensed product is sold, if the Company pays no more than the minimum
semiannual royalty payment for two consecutive semiannual periods, the licensor
has the right to convert the Boag License to a non-exclusive license. Also,
commencing with the first semiannual period occurring five years after the first
licensed product is sold, if the Company pays no more than the minimum
semiannual royalty payment for two consecutive semiannual periods, the licensor
has the right to terminate the Boag License. In the event of infringement of the
patent by third parties, the Company's right to enforce the patent is subject to
the licensor's superior right to bring suit on its own and to recover all
damages without accounting to the Company. There can be no assurance that the
Boag Patent will provide the Company significant exclusivity or benefit in its
markets. Furthermore, competitors may develop alternative technology that
achieves the same advantages as the Boag Patent.

Allergan License.   On March 11, 1996, the Company entered into a License
Agreement (the "Allergan License") with Allergan, Inc. for the use of a U.S.
patent entitled "Pressure Transducer Magnetically-Coupled Interface
Complementing Minimal Diaphragm Movement During Operation" issued on February
28, 1995, and its foreign counterparts (the "Allergan Patent").   The Company
has exclusive worldwide rights to the patented technology, limited to the field
of use of kidney dialysis machines and methods.  The Allergan License has a
duration for as long as the Allergan Patent remains in effect and provides for
royalty payments to Allergan based on manufacturing of the PHD System, which
incorporates the patented technology.   Royalty payments are to be made
quarterly, with minimum annual royalty payments beginning in 1998.  If the
Company fails to pay the full minimum annual royalties, the License Agreement
will terminate.  If the Company pays at least half of the minimum annual
royalties but does not pay such royalties in full, the License Agreement shall
be converted to a non-exclusive license.   There can be no assurance that the
Allergan Patent will provide the Company significant exclusivity or benefits in
its markets.   Furthermore, competitors may develop alternative technology that
achieves the same advantages as the Allergan Patent.

There can be no assurance that any of the Company's pending patent applications
will be approved by the patent offices in the various countries in which they
were filed.  In addition, there can be no assurance that the Company will
develop additional proprietary products or processes that are patentable or that
any patents that may issue to or be licensed by the Company will provide the
Company with competitive advantages.  There can be no assurance that the
Company's patent applications or patents that may issue to or be licensed by the
Company will not be challenged by any third parties or that the patents of
others will not prevent the commercialization of products incorporating the
Company's technologies.  Furthermore, there can be no assurance that others will
not or have not independently developed similar products, duplicated and
designed any of the Company's products or design around the patents that may
issue to or be licensed by the Company.  Any of the foregoing results could have
a material adverse effect on the Company.

The commercial success of the Company will depend, in part, on its ability to
avoid infringing patents issued to others.  The field of dialysis includes a
significant number of patents that have issued to third parties.  The Company
may receive from third parties, including potential or actual competitors,
notices claiming that it is infringing third party patents or other proprietary
rights.  If the Company were determined to be infringing any third-party patent,
the Company could 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 that compete or conflict with the
licensed patents or patent applications of the Company and such competing or
conflicting claims are ultimately determined to be valid, the Company may be
required to pay damages, to obtain licenses to these patents, to develop or
obtain alternative technology or to cease using such technology.  If the Company
is required to obtain any licenses, there can be no assurance that the Company
will be able to do so on commercially favorable terms, if at all.  The Company's
failure to obtain a license to any technology that it may require to
commercialize its products could have a material adverse impact on the Company's
business, operating results and financial condition.

                                       14
<PAGE>
 
In addition to patent licenses and applications for patents, the Company
possesses trade secrets, copyrights, proprietary know-how and unpatented
technological advances.  The Company seeks to protect these assets, in part, by
confidentiality agreements with its business partners, consultants and vendors
and non-competition agreements 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 the Company's trade secrets and
proprietary know-how will not otherwise become known or be independently
developed by others.

                                   Employees
                                        
As of December 31, 1998, the Company had 74 full-time employees, 64 of whom were
employed in research and development capacities.  The Company considers its
employee relations to be good.

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

Lawrence H.N. Kinet was appointed Chairman of the Board of Directors and Chief
Executive Officer of the Company in December 1994, and served as a director of
the Company since April 1993.  From July 1991 through December 1994, he served
as Chairman of the Board of Directors and Chief Executive Officer of Oculon
Corporation, a pharmaceutical development company engaged in the field of anti-
cataract drugs.  He was a Managing Partner of The Kensington Group, a provider
of management services to health care companies, from 1989 to 1992.  From 1985
through 1988, he was President of Baxter World Trade Corporation, the
international division of Baxter International Inc. and corporate Group Vice
President of Baxter International Inc.

Bruce E. Dobsch joined the Company in October 1998 as Senior Vice President of
Research and Development.  During his 28 years in the medical diagnostics field
with DuPont and Dade Behring, he was instrumental in overseeing the development
of numerous complex medical products from initial concept to commercialization.
From 1996 to 1998, he was Vice President of Research and Development for Dade
Behring's Chemistry and Engineering Skill Center. Previously, from 1989 through
1996, he was Director of Research and Development for DuPont's Chemistry
Division.

Rodney S. Kenley founded the Company in January 1991 and has served as a
director since such date.  Mr. Kenley has served as Vice President of Business
Development since November 1997.  Mr. Kenley served as the Company's Executive
Vice President and Chief Technical Officer from June 1997 until November 1997,
as its President and Chief Operating Officer from October 1994 until June 1997,
and as its President and Chief Executive Officer from January 1991 to October
1994.  Prior to founding the Company, Mr. Kenley worked for over 12 years at
Baxter International Inc., where he was involved principally in the development
and product management of dialysis therapies and products, including from
January 1990 until January 1991, when he served as Vice President of Electronic
Drug Infusion.

The following individuals are key employees of the Company:

Edward J. Argelander joined the Company in January 1999 as Vice President of
Business Quality Systems.  He has more than 30 years of experience in developing
instrumentation and was responsible for creating and implementing an ISO 9001-
based quality management system for the diagnostics division of DuPont.

Manuel Avila has served as Vice President of Manufacturing since July 1997.
From January 1997 until July 1997, he served as Director of Purchasing.  Prior
to joining the Company, Mr. Avila worked at Haemonetics Corporation from 1993
until 1996, most recently as Director of Operations.  Prior to joining
Haemonetics, Mr. Avila held various engineering positions with Polaroid
Corporation.

Carl M. Kjellstrand, M.D., Ph.D., joined the Company in April 1997 as Vice
President of Medical Affairs.  He joined us from the University of Alberta with
more than 40 years of medical teaching experience.  As a long-time advocate of
patients' rights, his research in dialysis has been published in more than 450
articles.  A former 

                                       15
<PAGE>
 
consultant to the U.S. Food and Drug Administration on medical devices and
former president of the Canadian Society of Nephrology, he is an active member
of leading scientific societies and editorial boards.

Thomas F. Scully joined the Company in January 1996 as Vice President of
Operations.   From 1971 to 1995, Mr. Scully worked at Baxter International Inc.
in various operational roles, including responsibilities as Vice President,
Sales and 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 operations network.

                           Product Liability Exposure

The Company's business exposes it to potential product liability risks that are
inherent in the production, marketing and sale of dialysis products.  There can
be no assurance that the Company will be able to avoid significant product
liability exposure.  The Company currently does not maintain product liability
insurance, but expects to acquire product liability insurance upon
commercialization of the PHD System.  There can be no assurance that it will be
able to obtain such insurance on acceptable terms or at all or that any
insurance policy if obtained will provide adequate protection against potential
claims.  Furthermore, the Company's agreements with contract manufacturers
require the Company to obtain product liability insurance, and the failure to
obtain such insurance could materially and adversely affect the Company's
ability to produce the PHD System.  A successful claim brought against the
Company in excess of any insurance coverage maintained by the Company could have
a material adverse effect upon the Company.  In addition, the Company has agreed
to indemnify certain of its contract manufacturers against certain liabilities
resulting from the sale of the PHD System.

                               Foreign Operations
                                        
In April 1996, the Company established Aksys Japan, K.K. ("AJKK"), a wholly-
owned Japanese subsidiary.   AJKK had no employees as of December 31, 1998.
The Company has engaged the services of a business consultant to act on behalf
of AJKK in pursuing business opportunities in Japan.  The primary purpose of
AJKK is to establish a presence for regulatory, business development and
eventual technical and customer support as the Company progresses through the
stages of clinical studies, regulatory approval and market launch.   All efforts
and decisions are directed from the Company's headquarters in Lincolnshire,
Illinois.

On January 7, 1998, the Company established a strategic alliance with Teijin
Limited of Osaka, Japan, as a result of mutually initiated negotiations.  The
alliance is represented by a Stock Purchase Agreement and a Joint Development
Agreement.  Under the terms of the Stock Purchase Agreement, Teijin purchased
493,097 newly issued Aksys common shares at a price of  $10.14 per share and
received certain registration rights with respect to such shares.

The Joint Development Agreement provides that, conditional on the achievement of
certain milestones, Teijin will make additional cash payments to Aksys totaling
up to $5,000,000.  The first of those milestones, for agreeing to the regulatory
strategy in Japan, resulted in a payment to Aksys of $1,000,000 during 1998.
The Company expects to earn remaining milestone payments under the Joint
Development Agreement during 1999 and 2000, but there can be no assurance that 
the Company will meet the requisite milestones.

Pursuant to the Joint Development Agreement, Aksys and Teijin will cooperate to
commercialize the PHD System in Japan and will share equally the costs of
obtaining the necessary regulatory approvals.  While the Joint Development
Agreement remains effective, Aksys may not negotiate with any third party
regarding the assignment of rights to import or manufacture the PHD System for
sale in Japan.

Teijin is a leading Japanese manufacturer of synthetic fibers, chemicals and
plastics, with annual sales in excess of $5 billion, of which over $600 million
is derived from pharmaceuticals and medical products.  Teijin pioneered and
today is a leader in the home oxygen therapy business in Japan, and is also one
of the principal suppliers to the dialysis industry of the resins and fibers
used to produce dialyzers.

                                       16
<PAGE>
 
Item 2.  Properties.

The Company leases approximately 41,500 square feet of office space in
Lincolnshire, Illinois to conduct its research, development and administrative
functions.  The Company presently expects all manufacturing will be contracted
out to third party subcontractors.

Item 3.  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's stockholders during
the fourth quarter ended December 31, 1998.


PART II

Item 5.  Market for the Registrant's Common Stock and Related Stockholder
Matters.

The Company's Common Stock trades on the Nasdaq Stock Market (NNM) under the
symbol AKSY.  The following table lists the quarterly high and low prices of the
Common Stock for the period from January 1, 1997 through December 31, 1998.

             Fiscal         Fiscal
              Year          Quarter              High            Low
             ------         -------            --------        -------
 
              1998            1st                8.375           5.75
                              2nd                 7.50           5.75
                              3rd                8.875           4.75
                              4th                 7.50           3.50
 
              1997            1st                13.25           8.50
                              2nd                9.875           4.00
                              3rd                8.688           4.25
                              4th               11.375           5.25

There were 267 stockholders of record of the Company's Common Stock as of
March 4, 1999.  In addition, the Company estimates that there were
approximately 4,200 beneficial stockholders at March 4, 1999, who held
shares in "street name."  The Company has not paid cash dividends to date, and
management anticipates that future earnings will be retained for development of
the Company's business.

With respect to the use of proceeds of the initial public offering of the
Registrant in May 1996 (Registration Statement on Form S-1, Registration No.
333-2492, effective May 16, 1996), the proceeds therefrom have been and are
currently being used to fund the operation and development of the business of
the Registrant as it currently is experiencing no revenues from operations.  See
"Item 1. Business - Background," "Item 6. Selected Financial Data" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."

Item 6.  Selected Financial Data.

The selected statement of operations and balance sheet data set forth below have
been derived from the audited financial statements of the Registrant included as
Exhibit 13 to this Annual Report on Form 10-K.  The financial 

                                       17
<PAGE>
 
data for the Company should be read in conjunction with the financial statements
and notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this Annual Report on
Form 10-K.

                                       18
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                                                    Cumulative from
                                                                                                                    January 18, 1991
                                                           Year Ended December 31,                                    (inception)
                                    ----------------------------------------------------------------------------        through
                                         1998             1997            1996           1995           1994       December 31, 1998
                                     ------------     ------------    ------------    -----------    -----------   -----------------
<S>                               <C>               <C>              <C>             <C>            <C>            <C>
Consolidated Statement of
 Operations Data:
Revenues:
 Joint development
  income                             $  1,000,000     $         --    $         --    $        --    $        --       $  1,000,000
                                     ------------     ------------    ------------    -----------    -----------       ------------
Operating costs and expenses:
 Research and development              15,342,533       10,886,803       6,515,485      4,261,230      1,808,638         39,413,437

 Business development                   1,185,254        1,043,867         547,767        359,530             --          3,136,418

 General and administrative             3,304,747        3,848,701       2,559,441        876,613        266,418         11,185,911
                                     ------------     ------------    ------------    -----------    -----------       ------------
Total operating expenses               19,832,534       15,779,371       9,622,693      5,497,373      2,075,056         53,735,766
                                     ------------     ------------    ------------    -----------    -----------       ------------
 
Operating loss                        (18,832,534)     (15,779,371)     (9,622,693)    (5,497,373)    (2,075,056)       (52,735,766)

Other income, net                       1,677,807        2,272,769       1,803,656        152,710         40,174          6,047,871
                                     ------------     ------------    ------------    -----------    -----------       ------------

 
Net loss                             $(17,154,727)    $(13,506,602)   $ (7,819,037)   $(5,344,663)   $(2,034,882)      $(46,687,895)
                                     ============     ============    ============    ===========    ===========       ============

 
Net loss per share(1)                      $(1.17)          $(0.98)         $(0.63)
                                     ============     ============    ============
 
  
Weighted average shares
 outstanding(1)                        14,653,953       13,791,236      12,441,718
                                     ============     ============    ============
 
</TABLE>

<TABLE>
<CAPTION>
 
                                                                                December 31,
                                              ----------------------------------------------------------------------------------

                                                  1998              1997              1996              1995            1994
                                              --------------    -------------     -------------     ------------   -------------
<S>                                             <C>               <C>               <C>               <C>           <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents and 
 short-term investments                        $ 20,260,268      $ 29,195,656      $ 45,649,934       $ 3,957,105   $ 1,007,015

Working capital                                  18,009,636        28,432,501        45,041,960         3,565,263       723,512

Total assets                                     25,941,835        36,647,251        50,147,510         4,693,450     1,476,892

Long-term liabilities(2)                            123,041            77,269            19,630            35,761        84,436

Redeemable preferred stock                               --                --                --        12,406,761     3,900,000
Deficit accumulated during
 development stage                              (46,690,928)      (29,536,201)      (16,029,599)       (8,210,562)   (2,862,866)

Total stockholders' equity (deficit)             23,301,944        35,287,989        48,684,094        (8,201,948)   (2,845,166)
</TABLE>

(1) Computed on the basis described in Note 1 of Notes to Consolidated Financial
    Statements.
(2) Consists primarily of deferred rent under operating lease for facilities.

Item 7.  Management's Discussion and Analysis of Financial Condition and Results
of Operations.

Overview

Since its inception in January 1991, the Company has been engaged in the
development of hemodialysis products and services for patients suffering from
ESRD.  The Company has developed the PHD System, which is designed to enable
patients to perform daily hemodialysis at alternate sites, such as the patient's
home.  The Company has never generated sales revenue and has incurred losses
since its inception.  At December 31, 1998, the Company had a deficit
accumulated during the development stage of $46.7 million.  The Company expects
to incur additional losses in the foreseeable future at least until such time,
if ever, that it obtains necessary regulatory clearances or approvals 

                                       19
<PAGE>
 
from the FDA to market the PHD System in the United States or it is able to
secure equivalent regulatory approvals to market the PHD System in countries
other than the United States.



Note on Forward-Looking Information

Certain statements in this Form 10-K and in the future filings made by the
Company with the Securities and Exchange Commission and in the Company's written
and oral statements made by or with the approval of an officer of the Company
constitute "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
and the Company intends that such forward-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 the Company's views as of the date they are
made with respect to future events and financial performance, but are subject 
to many uncertainties and factors which may cause the actual results of the 
Company to be materially different from any future results expressed or implied
by such forward-looking statements. Examples of such uncertainties and factors
include, but are not limited to, (i) risks related to the failure to meet
development and manufacturing milestones on a timely basis, (ii) the Company's
need to achieve manufacturing scale-up in a timely manner with its primary
manufacturing contractor, SeaMED Corporation, and its need to provide for the
efficient manufacturing of sufficient quantities of its products, (iii) changes
in GMP requirements, (iv) the Company's need to develop the marketing,
distribution, customer service and technical support and other functions
critical to the success of the Company's business plan, (v) the uncertainty
regarding the effectiveness and ultimate market acceptance of the PHD System,
the Company's primary product in development, (vi) changing market conditions,
(vii) the need to further establish the clinical benefits of daily hemodialysis,
(viii) the capital requirements necessary to fund the development and
commercialization of the Company's products and services and effectively compete
with its competitors, many of whom have substantially greater resources, (ix)
the potential adverse impact of possible changes to Medicare reimbursement
policies and rates, (x) the Company's dependence on key personnel and on patents
and proprietary information, and (xi) risks related to the regulatory approval
process. Regulatory risks include whether and when the Company will obtain an
approved Investigational Device Exemption (IDE), the timing, scope and results
of the Company's clinical trials, and whether and when the Company will obtain
clearance from the FDA of a 510(k) pre-market notification or PMA (and
equivalent regulatory clearances for Europe and Japan), and what additional
clinical and other data the Company might have to obtain in connection with
seeking such clearances. The Company does not undertake any obligation to update
or revise any forward-looking statement made by it or on its behalf, whether as
a result of new information, future events, or otherwise.

Results of Operations

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

Net loss for the year ended December 31, 1998 was $17.2 million ($1.17 per
share), compared with $13.5 million ($0.98 per share), 1997 fiscal year.  The
increase in net loss during 1998 compared with 1997 is due to increased
operating expenses, offset by income from the Company's joint development
agreement with Teijin Limited of Osaka, Japan.  The Company's use of cash to
fund operations resulted in a reduction of interest bearing investments and a
related decrease in interest income during 1998 as compared to 1997.

Joint development income.  During July 1998, the Company received a
milestone payment of $1.0 million under the terms of a joint development
agreement entered into during January 1998.  The milestone payment signifies the
completion of a written strategy for Aksys and Teijin to develop the PHD System
for use in Japan.

Research and development expenses.   For the year ended December 31, 1998,
research and development expenses increased to $15.3 million from $10.9 million
for the year ended December 31, 1997. The increase of $4.4 million included one-
time charges related to delivery of PHD Systems to be used during the 1999
clinical evaluation.  

                                       20
<PAGE>
 
Excluding the one-time charge, research and development expenses increased by
$2.8 million, reflecting increased activity as the Company completes development
work and prepares for clinical trials in 1999.

Business development expenses.   During 1998, business development expenses
increased $0.2 million, from $1.0 million in 1997 to $1.2 million in 1998.  The
increase is attributable to the Company preparing for commercialization of the
PHD System in Europe and expenses related to operations of Aksys Japan, K.K.,
the Company's wholly-owned subsidiary in Japan.

General and administrative expenses.   For the year ended December 31, 1998,
general and administrative expenses decreased from $3.8 million in 1997 to $3.3
in 1998.  The decrease of $0.5 million results from the Company's efforts to
keep administrative and overhead costs to a minimum and direct its funds toward
the Company's development efforts.

Interest income.  For the year ended December 31, 1998, interest income was $1.7
million, compared with $2.3 million for the year ended December 31, 1997, a
decrease of $0.6 million. The Company's use of cash to fund operations resulted
in a reduction of interest bearing investments and a related decrease in
interest income during the year ended December 31, 1998.

Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

Research and development expenses were $10.9 million for the year ended December
31, 1997 compared to $6.5 million for the year ended December 31, 1996, an
increase of $4.4 million.  The increase was primarily due to hiring additional
research and development personnel, making prototypes of the PHD System and
otherwise preparing for manufacturing scale-up.

Business development expenses increased $0.5 million from $0.5 million in 1996
to $1.0 million in 1997.  The increase is due to business development expenses
in Japan and Europe.

General and administrative expenses were $3.8 million for the year ended
December 31, 1997 compared to $2.6 million for the year ended December 31, 1996,
an increase of $1.2 million.  The increase was primarily due to hiring
additional management personnel and related support of the Company's continued
development of the PHD System.

Interest income was $2.3 million for the year ended December 31, 1997 compared
to $1.8 million for the year ended December 31, 1996, an increase of $0.5
million. The increase in interest income was primarily due to the investment of
proceeds from the Company's initial public offering in May 1996 for a full year
in fiscal 1997, as opposed to only approximately 7 months in fiscal 1996, offset
by funds expended on the development of the PHD System.

As a result of the foregoing, the Company's net loss was $13.5 million ($0.98
per share) for the year ended December 31, 1997, an increase of $5.7 million
($0.35 per share) from the net loss of $7.8 million ($0.63 per share) for the
year ended December 31, 1996.

Liquidity and Capital Resources

The Company has financed its operations to date primarily through public and
private sales of its equity securities.  Through December 31, 1998, the Company
had received net offering proceeds from public and private sales of equity
securities of approximately $69.9 million.  Since its inception in 1991 through
December 31, 1998, the Company made $6.3 million of capital expenditures and
used $42.5 million in cash to support its operations.  At December 31, 1998, the
Company had cash, cash equivalents and short-term investments of $20.3 million,
working capital of $18.0 million and long-term investments of $0.8 million.

                                       21
<PAGE>
 
The Company estimates that during 1999 it will spend approximately $13 to $15
million for operations, clinical evaluation and preparation for
commercialization of the PHD System. The Company expects that substantially all
of this amount will be used to (i) purchase PHD Systems to be used in clinical
trials, (ii) fund product testing and validation including the purchase of PHD
Systems for use in clinical trials from such independent contractors, and (iii)
conduct clinical studies using the PHD System. The Company expects to continue
to incur substantial expenses related to manufacturing scale-up and
commercialization of the PHD System and the protection of patent and other
proprietary rights. The Company believes that cash and investments as of
December 31, 1998, together with future milestone payments to be received from
Teijin under the terms of the joint development agreement, are sufficient to
finance the Company's operations, except for working capital needs related to
production of machines, through the date the Company files for 510(k) approval
of the PHD System.

Generally, the Company expects U.S. customers to purchase  PHD Systems and enter
into contracts whereby the Company will provide all products and services
related to the PHD Systems for a single monthly price, which would include all
consumables, service and product support.  As an alternative, U.S. customers may
enter into lease agreements for the PHD Systems, under which the single monthly
price would also include a lease payment.  The Company's present
commercialization plan for markets outside of the United States is to develop a
partnership in those markets to distribute the PHD System and related
consumables and service.  Financing production of the PHD System in quantities
necessary for commercialization will require a significant investment in working
capital.  This need for working capital is likely to increase to the extent that
demand for the PHD System increases.  The Company would, therefore, have to rely
on sources of capital beyond cash generated from operations to finance
production of the PHD System even if the Company were successful in marketing
its products and services.  The Company currently intends to finance the working
capital requirements associated with these arrangements through equipment and
receivable financing with a commercial lender.  If the Company is unable to
obtain such equipment financing, it would need to seek other forms of financing,
through the sale of equity securities or otherwise, to achieve its business
objectives.  The Company has not yet obtained a commitment for such equipment
financing, and there can be no assurance that the Company will be able to obtain
equipment financing or alternative financing on acceptable terms or at all.

The Company's funding needs will depend on many factors, including the timing
and costs associated with obtaining FDA clearance or approval, continued
progress in research and development, the extent and results of clinical
studies, manufacturing scale-up, the cost involved in filing and enforcing
patent claims and the status of competitive products. In the event that the
Company's plans change, its assumptions change or prove inaccurate or it is
unable to obtain production financing on commercially reasonable terms, the
Company could be required to seek additional financing sooner than currently
anticipated. In addition, in the future the Company will require substantial
additional financing to fund full-scale production and marketing of the PHD
System and related services. The Company has no current arrangements with
respect to sources of additional financing. There can be no assurance that FDA
clearance or approval will be obtained in a timely manner or at all or that
additional financing will be available to the Company when needed, on
commercially reasonable terms, or at all.

The Company has not generated taxable income to date.  At December 31, 1998, the
net operating losses available to offset future taxable income were
approximately $49.9 million.  Because the Company has experienced ownership
changes, future utilization of the carryforwards may be limited in any one
fiscal year pursuant to Internal Revenue Code regulations.  The carryforwards
expire at various dates beginning in 2008.  As a result of the annual
limitation, a portion of these carryforwards may expire before ultimately
becoming available to reduce federal income tax liabilities.

Item 7A.  Quantitative and Qualitative Disclosure About Market Risk.

The investments of the Company have been made for investment (as opposed to
trading) purposes.  Interest rate risk with respect to the investments of the
Company is not significant as substantially all of such investments are in U.S.
dollar cash equivalents and short-term investments (with maturities of less than
18 months), which are by their 

                                       22
<PAGE>
 
nature less sensitive to interest rate movements. The investments of the Company
are generally made in U.S. government and federal agency bonds and high-grade
commercial paper and corporate bonds.

Item 8.  Financial Statements and Supplementary Data.

The Consolidated Balance Sheets as of December 31, 1998 and 1997, and the
Consolidated Statements of Operations, Stockholders' Equity and Cash Flows for
the years ended December 31, 1998, 1997 and 1996 and for the period from January
18, 1991 (inception) through December 31, 1998, the Notes to the Consolidated
Financial Statements and the Independent Auditors' Report set forth on pages 11
through 22 of the 1998 Annual Report to Stockholders of the Registrant are
incorporated herein by reference.

Item 9.  Changes in and Disagreements with Accountants on Accounting and
         Financial Disclosure.

Not applicable.


PART III

Item 10.  Directors and Executive Officers of the Registrant.

Information with respect to the Directors of the Company is set forth in the
Proxy Statement under the heading "Election of Directors," which information is
incorporated herein by reference.  Information regarding the executive officers
and certain key employees is set forth above under "Business - Employees."
Information required by Item 405 of Regulation S-K is set forth in the Proxy
Statement under the heading "Section 16 (a) Beneficial Ownership Reporting
Compliance," which information is incorporated herein by reference.

Item 11.  Executive Compensation.

Information with respect to executive compensation is set forth in the Proxy
Statement under the heading "Compensation of Executive Officers," which
information is incorporated herein by reference.

Item 12.  Security Ownership of Certain Beneficial Owners and Management.

Information with respect to security ownership of certain beneficial owners and
management is set forth in the Proxy Statement under the heading "Beneficial
Ownership of Common Stock," which information is incorporated herein by
reference.

Item 13.  Certain Relationships and Related Transactions.

Information with respect to certain relationships and related transactions is
set forth in the Proxy Statement  under the heading "Election of Directors
Certain Relationships and Related Transactions," which information is
incorporated herein by reference.

                                       23
<PAGE>
 
PART IV

Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a)  Financial Statements:

   1.  Financial Statements.

       The Consolidated Balance Sheets as of December 31, 1998 and 1997, and the
       Consolidated Statements of Operations, Stockholders' Equity and Cash
       Flows for the years ended December 31, 1998, 1997 and 1996 and for the
       period from January 18, 1991 (inception) through December 31, 1998, the
       Notes to the Consolidated Financial Statements and the Independent
       Auditors' Report set forth on pages 11 through 22 of the 1998 Annual
       Report to Stockholders of the Registrant are incorporated herein by
       reference.

   2.  Financial Statement Schedules.

       None.

(b)   Reports on Form 8-K.

   None.

(c)   Exhibits.

   See "Exhibits Index" below.

                                       24
<PAGE>
 
SIGNATURES

   Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 31st day of
March, 1999.

                                             AKSYS, LTD.

                                             By     /s/ Steven A. Bourne
                                               -------------------------------
                                                     Steven A. Bourne
                                                    Controller and Acting
                                                   Chief Financial Officer

          Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities indicated on this 31st day of March, 1999.

          Signature                           Capacity
          ---------                           --------
 
 
 
   /s/ Lawrence H.N. Kinet    Chairman, Chief Executive Officer and Director
-----------------------------
     Lawrence H.N. Kinet      (Principal Executive Officer)
 
 
 
   /s/ Steven A. Bourne       Controller  and Acting Chief Financial Officer
-----------------------------
     Steven A. Bourne
 
 
 
   /s/ Rodney S. Kenley       Vice President, Business Development and Director
-----------------------------
    Rodney  S. Kenley
 
 
   /s/ Richard B. Egen        Director
-----------------------------
    Richard B. Egen
 
 
   /s/ Peter H. McNerney      Director
-----------------------------
    Peter H. McNerney
 
 
   /s/ K. Shan Padda          Director
-----------------------------
    K. Shan Padda
 
 
  /s/ W. Dekle Rountree, Jr.  Director
-----------------------------
    W. Dekle Rountree, Jr.
 
 
   /s/ Bernard R. Tresnowski  Director
-----------------------------
    Bernard R. Tresnowski

                                       25
<PAGE>
 
                                  AKSYS, LTD.
                                 EXHIBIT INDEX
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)................................
10.1        Aksys, Ltd. 1993 Stock Option Plan (1)............................
10.2        Aksys, Ltd. 1996 Stock Awards Plan (2)............................
10.3        Severance, Confidentiality and Noncompetition Agreement,
               dated as of October 1, 1994, between the Company and
               Lawrence H.N. Kinet (1)........................................
10.4        Severance, Confidentiality and Noncompetition Agreement,
               dated as of April 2, 1993, between the Company and
               Rodney S. Kenley (1)...........................................
10.5        Manufacturing Agreement, dated as of November 15, 1994,
               between the Company and SeaMED Corporation (1).................
10.6        Manufacturing Agreement, dated as of January 23, 1996,
               between the Company and Texas Medical Products, Inc. (1).......
10.7        License Agreement, dated as of April 1, 1993, between the
               Company and Zbylut J. Twardowski (1)...........................
10.8        License Agreement, dated as of April 1, 1993, between the
               Company and Cynthia P. Walters (1).............................
10.9        Form of Indemnification Agreement (1).............................
10.10       License Agreement, dated as of March 11, 1996, between the
               Company and Allergan, Inc. (1).................................
10.11       Lease for Property at Two Marriott Drive (3)......................
10.12       Severance, Confidentiality and Post-Employment Restrictions
               Agreement, dated as of October 12, 1998, between the Company 
               and Bruce E. Dobsch (4)........................................
11          Statement regarding computation of net loss per share (4).........
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 (4)....................................
21          Subsidiaries of the Company (1)...................................
23          Consent of KPMG LLP (4)..............................
27          Financial Data Schedule (4).......................................

(1)    Incorporated by reference to the Company's Registration Statement on
       Form S-1 (Registration No. 333-2492).
(2)    Incorporated by reference to the Company's Registration Statement on
       Form S-8 (Registration No. 333-18073).
(3)    Incorporated by reference to the Company's Annual Report on Form 10-K for
       the year ended December 31, 1997.
(4)    Filed herewith.

                                       26