Note
6 - Stock Plans and Share-Based Payments
Stock
Options
The
Company accounts for stock option grants to employees and non-employee directors under the provisions of ASC 718, Stock Compensation.
ASC 718 requires the recognition of the fair value of stock-based compensation in the statement of operations. In addition, the
Company accounts for stock option grants to consultants under the provisions of ASC 505-50, and as such, these stock options are
revalued at each reporting period through the vesting period.
The
fair value of stock option awards is estimated using a Black-Scholes option pricing model. The fair value of stock-based awards
that vest upon service conditions is amortized over the vesting period of the award using the straight-line method.
The
Company granted 195,520 stock options to employees and non-employee directors during the three months ended September 30, 2016.
The fair value of the stock options will be expensed over the vesting period. The grant date fair value of the stock options was
approximately $62,000.
The
Company granted 30,000 stock options to a consultant during the nine months ended September 30, 2016. The fair value of the stock
options will be expensed over the one-year vesting period. The fair value of the stock options as of September 30, 2016 was approximately
$9,000. In accordance with ASC 505-50, the stock options granted to the consultant are remeasured at each reporting period until
vested.
During
the three months ended September 30, 2016, previously issued stock options were modified for a non-employee director who is no
longer serving as a director for the Company. As a result of modification, approximately $5,000 was recognized as stock option
modification expense and included in stock-based compensation expense on the accompanying condensed consolidated statement of
operations and comprehensive loss.
The
Company calculates expected volatility for a stock-based grant based on historic monthly common stock price observations during
the period immediately preceding the grant that is equal in length to the expected term of the grant. The Company also estimates
future forfeitures, using historical employee behaviors related to forfeitures, as a part of the estimate of expense as of the
grant date. With respect to grants of options, the risk free rate of interest is based on the U.S. Treasury rates appropriate
for the expected term of the grant.
NEPHROS,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
6 - Stock Plans and Share-Based Payments (continued)
Stock-based
compensation expense for stock options was approximately $299,000 and $205,000 for the nine months ended September 30, 2016 and
2015, respectively. For the nine months ended September 30, 2016, approximately $277,000 and approximately $22,000 are included
in Selling, General and Administrative expenses and Research and Development expenses, respectively, on the accompanying condensed
consolidated statement of operations and comprehensive loss. For the nine months ended September 30, 2015, approximately $190,000
and approximately $15,000 are included in Selling, General and Administrative expenses and Research and Development expenses,
respectively, on the accompanying condensed consolidated statements of operations and comprehensive loss.
Stock-based
compensation expense was approximately $104,000 and $95,000 for the three months ended September 30, 2016 and 2015, respectively.
For the three months ended September 30, 2016, approximately $97,000 and approximately $7,000 are included in Selling, General
and Administrative expenses and Research and Development expenses, respectively, on the accompanying condensed consolidated statement
of operations and comprehensive loss. For the three months ended September 30, 2015, approximately $89,000 and approximately $6,000
are included in Selling, General and Administrative expenses and Research and Development expenses, respectively, on the accompanying
condensed consolidated statements of operations and comprehensive loss.
There
was no tax benefit related to expense recognized in the nine months ended September 30, 2016 and 2015, as the Company is in a
net operating loss position. As of September 30, 2016, there was approximately $968,000 of total unrecognized compensation cost
related
to unvested share-based compensation awards granted under the equity compensation plans. Approximately $158,000 of the $968,000
total unrecognized compensation will be recognized at the time that certain performance conditions are met. The remaining approximately
$810,000 will be amortized over the weighted average remaining requisite service period of 2.8 years. Such amount does not include
the effect of future grants of equity compensation, if any.
Restricted
Stock
During
the nine months ended September 30, 2016, the Company issued 480,398 shares of restricted stock as compensation for services previously
rendered by non-employee directors. The grant date fair value of the restricted stock awards was approximately $171,000. Approximately
$51,000 of the grant date fair value was previously accrued for services rendered during the fiscal year ended December 31, 2015.
Approximately $105,000 of stock based compensation expense was recognized during the three and nine months ended September 30,
2016. As of September 30, 2016, there was approximately $15,000 of unrecognized compensation expense related to these restricted
stock awards, which is expected to be recognized over the next five months, depending upon the respective restricted stock agreements.
During
the nine months ended September 30, 2016, the Company issued 154,427 shares of restricted stock as payment for non-employee services
to be rendered. The grant date fair value of the outstanding restricted stock awards was approximately $46,000 and was based on
the fair value of the common stock on the date of grant. Of the total grant date fair value of approximately $46,000, approximately
$5,000 and $46,000, respectively, of stock based compensation expense was recorded during the three and nine months ended September
30, 2016.
Additionally,
stock-based compensation expense of approximately $38,000 was recorded during the nine months ended September 30, 2016 related
to shares of restricted stock issued to employees during the year ended December 31, 2015.
Total
stock-based compensation expense for the restricted stock grants, including expense recognized for grants to non-employees, was
approximately $110,000 and $189,000 for the three and nine months ended September 30, 2016, respectively, and is included in Selling,
General and Administrative expenses on the accompanying condensed consolidated statements of operations and comprehensive loss.
During
the nine months ended September 30, 2015, the Company issued 116,613 shares of restricted stock, with a grant date fair value
of approximately $67,000, as payment for non-employee services rendered. Stock based compensation expense related to services
rendered as of September 30, 2015 was approximately $47,000 and is included in Selling, General and Administrative expenses for
the nine months ended September 30, 2015. The remaining expense was recognized in the three months ended December 31, 2015.
Total
stock-based compensation expense for the restricted stock grants, including expense recognized for grants to non-employees was
approximately $49,000 and $58,000 for the three and nine months ended September 30, 2015, respectively, and is included in Selling,
General and Administrative expenses on the accompanying condensed consolidated statements of operations and comprehensive loss.
NEPHROS,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
7 - Warrants
During
the nine months ended September 30, 2016, 19,621 warrants were exercised, resulting in proceeds of approximately $1,000 and the
issuance of 906 shares of the Company’s common stock. There were no warrants exercised during the three months ended September
30, 2016.
In
addition to the Lambda warrants exercised and discussed in Note 5, for the nine months ended September 30, 2015, 46,039 warrants
were exercised, resulting in proceeds of approximately $1,000 and the issuance of 2,127 shares of common stock.
Note
8 - Net Income (Loss) per Common Share
Basic
income (loss) per common share is calculated by dividing net income (loss) available to common shareholders by the number of weighted
average common shares issued and outstanding. Diluted earnings (loss) per common share is calculated by dividing net income (loss)
available to common shareholders, adjusted for amounts representing the potential dilutive effect from the exercise of stock options
and warrants, of any outstanding shares of unvested restricted stock and of the conversion of convertible securities, as applicable.
If applicable for a given period, the Company calculates dilutive potential common shares using the treasury stock method, which
assumes the Company will use the proceeds from the exercise of stock options and warrants to repurchase shares of common stock
to hold in its treasury stock reserves.
The
following potentially dilutive securities have been excluded from the computations of diluted weighted-average shares outstanding
as they would be anti-dilutive:
|
|
September
30,
|
|
|
|
2016
|
|
|
2015
|
|
Shares underlying warrants
outstanding
|
|
|
3,291,149
|
|
|
|
5,925,836
|
|
Shares underlying options outstanding
|
|
|
4,418,160
|
|
|
|
3,888,657
|
|
Unvested restricted stock
|
|
|
390,625
|
|
|
|
436,333
|
|
Note
9 - Recent Accounting Pronouncements
In
May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” related to revenue recognition. The
underlying principle of the new standard is that a business or other organization will recognize revenue to depict the transfer
of promised goods or services to customers in an amount that reflects what it expects to be entitled to in exchange for the goods
or services. The standard also requires more detailed disclosures and provides additional guidance for transactions that were
not addressed completely in prior accounting guidance. ASU 2014-09 provides alternative methods of initial adoption, and was to
be effective for fiscal years beginning after December 15, 2016, and interim periods within those annual periods. Early adoption
was not permitted. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers: Deferral of the
Effective Date.” The amendment in this ASU defers the effective date of ASU 2014-09 for all entities for one year. Public
business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09
to fiscal years beginning after December 15, 2017, including interim reporting periods within that fiscal year. Early adoption
is permitted only for fiscal years beginning after December 31, 2016, including interim reporting periods within that fiscal year.
The Company is currently reviewing the revised guidance and assessing the potential impact on its consolidated financial statements.
In
August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure
of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” ASU 2014-15 provides guidance about management’s
responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and
sets rules for how this information should be disclosed in the financial statements. ASU 2014-15 is effective for annual periods
ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted. The Company is currently evaluating
any impact the adoption of ASU 2014-15 might have on its consolidated financial statements.
In
July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory,” that requires inventory be measured
at the lower of cost and net realizable value and options that currently exist for market value to be eliminated. The standard
defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs
of completion, disposal, and transportation and is effective for fiscal years beginning after December 15, 2016 and interim periods
within those fiscal years, with early adoption permitted. The guidance should be applied prospectively. The Company does not believe
that the adoption of ASU 2015-11 will have a significant impact on its consolidated financial statements.
NEPHROS,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
9 - Recent Accounting Pronouncements (continued)
In
November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes,” that requires that deferred
tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The current requirement
that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is
not affected by this amendment. The new guidance is effective for fiscal years, and interim periods within those years, beginning
after December 15, 2016. Early adoption is permitted and the standard may be applied either retrospectively or on a prospective
basis to all deferred tax assets and liabilities. The Company does not believe that the adoption of ASU 2015-17 will have a significant
impact on its consolidated financial statements.
In
January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,”
that modifies certain aspects of the recognition, measurement, presentation, and disclosure of financial instruments. The accounting
standard update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and
early adoption is permitted. The Company is currently assessing the impact that adopting this new accounting guidance will have
on its financial statements.
In
February 2016, the FASB issued ASU 2016-02, “Leases,” that discusses how an entity should account for lease assets
and lease liabilities. The guidance specifies that an entity that is a lessee under lease agreements should recognize lease assets
and lease liabilities for those leases classified as operating leases under previous FASB guidance. Accounting for leases by lessors
is largely unchanged under the new guidance. The guidance is effective for the Company beginning in the first quarter of fiscal
year 2019. Early adoption is permitted. In transition, lessees and lessors are required to recognize and measure leases at the
beginning of the earliest period presented using a modified retrospective approach. The Company is evaluating the impact of adopting
this guidance on its consolidated financial statements.
In
March 2016, the FASB issued ASU 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),”
which clarifies the implementation guidance on principal versus agent considerations. The amendments in this update do not change
the core principle of ASU 2014-09. The effective date and transition requirements for the amendments in this update are the same
as the effective date and transition requirements of ASU 2014-09. As discussed above, ASU 2015-14 defers the effective date of
ASU 2014-09 by one year. The Company is currently assessing the impact that adopting this new accounting guidance will have on
its financial statements.
In
March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which simplifies
several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification
of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance is effective for the
Company beginning in the first quarter of fiscal year 2017. Early adoption is permitted. The Company is evaluating the impact
of adopting this guidance on its consolidated financial statements.
In
April 2016, the FASB issued ASU 2016-10, “Identifying Performance Obligations and Licensing,” which clarifies the
implementation guidance for performance obligations and licensing. The amendments in this update do not change the core principle
of ASU 2014-09. The effective date and transition requirements for the amendments in this update are the same as the effective
date and transition requirements of ASU 2014-09. As discussed above, ASU 2015-14 defers the effective date of ASU 2014-09 by one
year. The Company is currently assessing the impact that adopting this new accounting guidance will have on its financial statements.
In
May 2016, the FASB issued ASU 2016-12, “Narrow Scope Improvements and Practical Expedients,” which clarifies the accounting
for certain aspects of guidance issued in ASU 2014-09, including assessing collectability and noncash consideration. The clarifications
in this update do not change the core principle of ASU 2014-09. The effective date and transition requirements for the amendments
in this update are the same as the effective date and transition requirements of ASU 2014-09. As discussed above, ASU 2015-14
defers the effective date of ASU 2014-09 by one year. The Company is currently assessing the impact that adopting this new accounting
guidance will have on its financial statements.
In
June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments,” which replaces the
incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration
of a broader range of reasonable and supportable information to inform credit loss estimates. The guidance is effective for the
Company beginning in the first quarter of fiscal year 2020. Early adoption is permitted beginning in the first quarter of fiscal
year 2019. The Company is evaluating the impact of adopting this guidance on its consolidated financial statements.
NEPHROS,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
9 - Recent Accounting Pronouncements (continued)
In
August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which clarifies
how certain cash receipts and cash payments are presented and classified in the statement of cash flows in order to reduce diversity
in practice. The guidance is effective for the Company beginning in the first quarter of fiscal year 2018. Early adoption is permitted.
The Company is evaluating the impact of adopting this guidance on its consolidated financial statements.
Note
10 - Inventory, net
Inventory
is stated at the lower of cost or market using the first-in first-out method and consists entirely of finished goods. The Company’s
inventory as of September 30, 2016 and December 31, 2015 was as follows:
|
|
September
30, 2016
|
|
|
December
31, 2015
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
Total Gross Inventory, Finished
Goods
|
|
$
|
395,000
|
|
|
$
|
634,000
|
|
Less: Inventory
reserve
|
|
|
(54,000
|
)
|
|
|
(43,000
|
)
|
Total Inventory
|
|
$
|
341,000
|
|
|
$
|
591,000
|
|
Note
11 - Unsecured Promissory Notes and Warrants
On
June 7, 2016, the Company entered into a Note and Warrant Agreement (the “Agreement”) with new creditors as well as
existing shareholders under which the Company issued unsecured promissory notes (“Notes”) and warrants (“Warrants”)
resulting in total gross proceeds to the Company during June 2016 of approximately $1,187,000. The outstanding principal under
the Notes accrues interest at a rate of 11% per annum. The Company is required to make interest only payments on a semi-annual
basis, and all outstanding principal under the Notes is repayable in cash on June 7, 2019, the third anniversary of the date of
issuance. In addition to the Notes, the Company issued Warrants to purchase approximately 2.4 million shares of the Company’s
common stock to the investors in the Agreement. The warrants have an exercise price of $0.30 per share and are exercisable for
5 years from the issuance date. The Warrants issued under the Agreement are indexed to the Company’s common stock, therefore,
the Company is accounting for the Warrants as a component of equity. In connection with the Agreement, the Company incurred approximately
$13,000 in legal fees.
The
approximately $1,187,000 in gross proceeds from the Agreement, along with the legal fees of approximately $13,000, were allocated
between the Notes and Warrants based on their relative fair values. The portion of the proceeds, including fees, allocated to
the Warrants of approximately $393,000 was accounted for as additional paid-in capital. Approximately $4,000 of the legal fees
were allocated to the Warrants and recorded as a reduction to additional paid-in capital. The remainder of the proceeds of approximately
$794,000, including fees, was allocated to the Notes with the fair value of the Warrants resulting in a debt discount. The debt
discount is being amortized to interest expense using the effective interest method in accordance with ASC 835 over the term of
the Agreement. Approximately $23,000 and $29,000 was recognized as amortization of debt discount during the three and nine months
ended September 30, 2016, respectively, and is included in interest expense on the condensed consolidated interim statement of
operations and comprehensive loss. As of September 30, 2016, approximately $43,000 of interest expense has been accrued. As of
September 30, 2016, the portion of the outstanding unsecured promissory notes due to entities controlled by a member of management
and to the majority shareholder amounted to $30,000 and $300,000, respectively. There were no unsecured long-term notes payable
outstanding as of December 31, 2015.
Note
12 - Commitments and Contingencies
Manufacturing
and Suppliers
The
Company has not and does not intend in the near future to manufacture any of its products and components. With regard to the OLpur
MD190 and MD220, on June 27, 2011, the Company entered into a license agreement (the “License Agreement”), effective
July 1, 2011, with Bellco S.r.l., an Italy-based supplier of hemodialysis and intensive care products, for the manufacturing,
marketing and sale of the Company’s patented mid-dilution dialysis filters (MD 190, MD 220), referred to herein as the Products.
Under the License Agreement, Nephros granted Bellco a license to manufacture, market and sell the Products under Bellco’s
own name, label and CE mark in Italy, France, Belgium, Spain and Canada on an exclusive basis, and to do the same on a non-exclusive
basis in the United Kingdom and Greece and, upon the Company’s written approval, other European countries where the Company
does not sell the Products as well as non-European countries (referred to as the “Territory”).
NEPHROS,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
12 - Commitments and Contingencies (continued)
On
February 19, 2014, the Company entered into the First Amendment to License Agreement (the “First Amendment”), by and
between the Company and Bellco, which amends the License Agreement. Pursuant to the First Amendment, the Company and Bellco agreed
to extend the term of the License Agreement from December 31, 2016 to December 31, 2021. The First Amendment also expands the
Territory covered by the License Agreement to include Sweden, Denmark, Norway, Finland, Korea, Mexico, Brazil, China and the Netherlands.
The First Amendment further provides new minimum sales targets which, if not satisfied, will, at the discretion of the Company,
result in conversion of the license to non-exclusive status. The Company has agreed to reduce the fixed royalty payment payable
to the Company for the period beginning on January 1, 2015 through and including December 31, 2021. Beginning on January 1, 2015
through and including December 31, 2021, Bellco will pay the Company a royalty based on the number of units of Products sold per
year in the Territory as follows: for the first 125,000 units sold in total, €1.75 (estimated at approximately $1.95 using
current exchange rates) per unit; thereafter, €1.25 (estimated at approximately $1.40 using current exchange rates) per unit.
In addition, the Company received a total of €450,000 (approximately $612,000) in upfront fees in connection with the First
Amendment, half of which was received on February 19, 2014 and the remaining half was received on April 4, 2014. In addition,
the First Amendment provides that, in the event that the Company pursues a transaction to sell, assign or transfer all right,
title and interest to the licensed patents to a third party, the Company will provide Bellco with written notice thereof and a
right of first offer with respect to the contemplated transaction for a period of thirty (30) days. See Note 4 for further discussion
of the licensing revenue recognized by the Company related to the upfront fees.
In
addition to the licensing revenue, the Company recognized royalty revenue related to the First Amendment with Bellco. For the
three and nine months ended September 30, 2016, the Company recognized approximately $27,000 and $84,000, respectively. For the
three and nine months ended September 30, 2015, the Company recognized approximately $29,000 and $58,000, respectively.
License
and Supply Agreement
On
April 23, 2012, the Company entered into a License and Supply Agreement (the “License and Supply Agreement”) with
Medica S.p.A. (“Medica”), an Italy-based medical product manufacturing company, for the marketing and sale of certain
filtration products based upon Medica’s proprietary Medisulfone ultrafiltration technology in conjunction with the Company’s
filtration products (collectively, the “Filtration Products”), and to engage in an exclusive supply arrangement for
the Filtration Products. Under the License and Supply Agreement, Medica granted to the Company an exclusive license, with right
of sublicense, to market, promote, distribute, offer for sale and sell the Filtration Products worldwide, excluding Italy for
the first three years, during the term of the License and Supply Agreement. In addition, the Company granted to Medica an exclusive
license under the Company’s intellectual property to make the Filtration Products during the term of the License and Supply
Agreement. In exchange for the rights granted, the Company agreed to make minimum annual aggregate purchases from Medica of €300,000
(approximately $400,000), €500,000 (approximately $700,000) and €750,000 (approximately $880,000) for the years 2012,
2013 and 2014, respectively. In the year ended December 31, 2015, the Company’s aggregate purchase commitments totaled approximately
€999,000 (approximately $1,119,000). For calendar years 2016 through 2022, annual minimum amounts will be mutually agreed
upon between Medica and the Company. In December 2015, the Company and Medica formalized the agreed upon minimum purchase level
for calendar year 2016 of €1,200,000 (approximately $1,500,000). In exchange for the license, the Company paid Medica a total
of €1,500,000 (approximately $2,000,000) in three installments: €500,000 (approximately $700,000) on April 23, 2012,
€600,000 (approximately $800,000) on February 4, 2013, and €400,000 (approximately $500,000) on May 23, 2013.
As
further consideration for the license and other rights granted to the Company, the Company granted Medica options to purchase
300,000 shares of the Company’s common stock. The fair market value of these stock options was approximately $273,000 as
of April 23, 2012, calculated as described in Note 6 under Stock Options. Together with the total installment payments described
above, the fair market value of the options has been capitalized as a long-term intangible asset. The gross value of the intangible
asset capitalized was approximately $2,250,000. Included in other long-term assets on the consolidated balance sheet is approximately
$1,315,000 and $1,473,000, as of September 30, 2016 and December 31, 2015, respectively, related to the License and Supply Agreement.
Accumulated amortization is approximately $935,000 and $777,000 as of September 30, 2016 and December 31, 2015, respectively.
The asset is
NEPHROS,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
12 - Commitments and Contingencies (continued)
being
amortized as an expense over the life of the License and Supply Agreement. Approximately $53,000 and $158,000 has been charged
to amortization expense for the three and nine months ended September 30, 2016 and 2015, respectively, on the condensed consolidated
statement of operations and comprehensive loss. Approximately $53,000 of amortization expense will be recognized in the remainder
of 2016 and approximately $210,000 will be recognized in each of the years ended December 31, 2017 through 2022. In addition,
for the period beginning April 23, 2014 through December 31, 2022, the Company will pay Medica a royalty rate of 3% of net sales
of the Filtration Products sold, subject to reduction as a result of a supply interruption, pursuant to the terms of the License
and Supply Agreement. Royalty expense of approximately $10,000 and $14,000 was included in accrued expenses as of September 30,
2016 and December 31, 2015, respectively. The term of the License and Supply Agreement commenced on April 23, 2012 and continues
in effect through December 31, 2022, unless earlier terminated by either party in accordance with the terms of the License and
Supply Agreement.
As
of September 2013, the Company has an understanding with Medica whereby the Company has agreed to pay interest to Medica at a
12% annual rate calculated on the principal amount of any outstanding invoices that are not paid pursuant to the original payment
terms. For the three and nine months ended September 30, 2016, approximately $9,000 and $37,000 of interest, respectively, was
recognized as interest expense. For the three and nine months ended September 30, 2015, approximately $9,000 and $29,000 of interest,
respectively, was recognized as interest expense.
Contractual
Obligations
The
Company has an operating lease that expires on November 30, 2018 for the rental of its U.S. office and research and development
facilities with a monthly cost of approximately $9,000. Included in other assets, net, on the condensed consolidated balance sheet
as of September 30, 2016 is approximately $21,000 related to a security deposit for the U.S. office facility. Rent expense was
approximately $31,000 and $29,000 for the three months ended September 30, 2016 and 2015, respectively. Rent expense was approximately
$98,000 and $95,000 for the nine months ended September 30, 2016 and 2015, respectively.
Investment
in Lease, net
On
October 8, 2015, the Company entered into an equipment lease agreement with Biocon 1, LLC. The lease commenced on January 1, 2016
with a term of 60 months and monthly rental payments of approximately $1,800 will be paid to the Company. At the completion of
the lease term, Biocon 1, LLC will own the equipment provided under the agreement. An investment in lease was established for
the sales-type lease receivable at the present value of the future minimum lease payments. Interest income will be recognized
monthly over the lease term using the effective-interest method. Cash received will be applied against the direct financing lease
receivable and will be presented within changes in operating assets and liabilities in the operating section of the Company’s
consolidated statement of cash flows. At lease inception, an investment in the lease of approximately $92,000 was recorded, net
of unearned interest of approximately $14,000. During the three and nine months ended September 30, 2016, approximately $1,000
and $4,000, respectively, was recognized in interest income. As of September 30, 2016, investment in lease, current, is approximately
$22,000, net of unearned interest of $4,000. As of September 30, 2016, investment in lease, noncurrent, is approximately $65,000,
net of unearned interest of $6,000.
As
of September 30, 2016, scheduled maturities of minimum lease payments receivable were as follows:
2016
|
|
|
$
|
12,000
|
|
2017
|
|
|
|
17,000
|
|
2018
|
|
|
|
18,000
|
|
2019
|
|
|
|
19,000
|
|
2020
|
|
|
|
21,000
|
|
|
|
|
|
87,000
|
|
Less:
Current portion
|
|
|
|
(22,000
|
)
|
Investment
in sales-type lease, noncurrent
|
|
|
$
|
65,000
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This
discussion should be read in conjunction with our consolidated financial statements included in this Quarterly Report on Form
10-Q and the notes thereto, as well as the other sections of this Quarterly Report on Form 10-Q, including the “Forward-Looking
Statements” section hereof, and our Annual Report on Form 10-K for the year ended December 31, 2015, including the “Risk
Factors” and “Business” sections thereof. This discussion contains a number of forward-looking statements, all
of which are based on our current expectations and could be affected by the uncertainties and risk factors described in this Quarterly
Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2015. Our actual results may differ materially.
Financial
Operations Overview
Revenue
Recognition:
Revenue is recognized in accordance with ASC Topic 605. Four basic criteria must be met before revenue can be
recognized: (i) persuasive evidence that an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii)
the fee is fixed and determinable; and (iv) collectability is reasonably assured.
Cost
of Goods Sold:
Cost of goods sold represents the acquisition cost for the products we purchase and sell from our third party
manufacturers as well as damaged and obsolete inventory written off.
Research
and Development:
Research and development expenses consist of costs incurred in identifying, developing and testing product
candidates. These expenses consist primarily of salaries and related expenses for personnel, fees of our scientific and engineering
consultants and subcontractors and related costs, clinical studies, machine and product parts and software and product testing.
We expense research and development costs as incurred.
Selling,
General and Administrative:
Selling, general and administrative expenses consist primarily of sales and marketing expenses
as well as personnel and related costs for general corporate functions, including finance, accounting, legal, human resources,
facilities and information systems expense.
Overview
Nephros
is a commercial stage medical device and commercial products company that develops and sells high performance liquid purification
filters and hemodiafiltration (“HDF”) systems. Our filters, which are generally classified as ultrafilters, are primarily
used in dialysis centers for the removal of biological contaminants from water and bicarbonate concentrate, and used in hospitals
for the prevention of infection from water borne pathogens, such as legionella and pseudomonas. Because our ultrafilters capture
contaminants as small as 0.005 microns in size, they minimize exposure to a wide variety of bacteria, viruses, fungi, parasites
and endotoxins.
Our
OLpūr H2H Hemodiafiltration System, used in conjunction with a standard hemodialysis machine, is the only FDA 510(k) cleared
medical device that enables nephrologists to provide hemodiafiltration treatment to patients with end stage renal disease (“ESRD”).
Additionally, we sell hemodiafilters, which serve the same purpose as dialyzers in an HD treatment, and other disposables used
in the hemodiafiltration treatment process.
We
were founded in 1997 by healthcare professionals affiliated with Columbia University Medical Center/New York-Presbyterian Hospital
to develop and commercialize an alternative method to hemodialysis (“HD”). We have extended our filtration technologies
to meet the demand for liquid purification in other areas, in particular water purification.
Going
Concern
The
accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. Our recurring
losses and difficulty in generating sufficient cash flow to meet our obligations and sustain our operations raise substantial
doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
We
have incurred significant losses in operations in each quarter and have not generated positive cash flow from operations since
inception. To become profitable, we must increase revenue substantially and achieve and maintain income from operations. If we
are not able to increase revenue and generate income from operations sufficiently to achieve profitability, our results of operations
and financial condition will be materially and adversely affected.
Based
on our current cash flow projections, we expect that our existing cash balances and our projected increases in product sales from
the launch of new products will allow us to fund our operations at least into the first quarter of fiscal year 2017, depending
on the timing and market up-take of our new products. This assumption excludes the impact of future cash receipts from recurring
operations. There can be no assurance that our future cash flow will be sufficient to meet our obligations and commitments. If
we are unable to generate sufficient cash flow from operations in the future to service our commitments, we will be required to
adopt alternatives, such as seeking to raise debt or equity capital, curtailing our planned activities or ceasing our operations.
There can be no assurance that any such actions could be effected on a timely basis or on satisfactory terms or at all, or that
these actions would enable us to continue to satisfy our capital requirements.
Our
Products
Presently,
we have two core product lines: HDF Systems and Ultrafiltration Products.
HDF
Systems
The
current standard of care in the U.S. for patients with chronic renal failure is HD, a process in which toxins are cleared via
diffusion. Patients typically receive HD treatment at least 3 times weekly for 3-4 hours per treatment. HD is most effective in
removing smaller, easily diffusible toxins. For patients with acute renal failure, the current standard of care in the U.S. is
hemofiltration (“HF”), a process where toxins are cleared via convection. HF offers a much better removal of larger
sized toxins when compared to HD. However, HF treatment is performed on a daily basis, and typically takes 12-24 hours.
Hemodiafiltration
(“HDF”) is an alternative dialysis modality that combines the benefits of HD and HF into a single therapy by clearing
toxins using both diffusion and convection. Though not widely used in the U.S., HDF is much more prevalent in Europe and is performed
in approximately 16% of patients. Clinical experience and literature show the following clinical and patient benefits of HDF:
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Enhanced
clearance of middle and large molecular weight toxins
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Improved
survival - up to a 35% reduction in mortality risk
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Reduction
in the occurrence of dialysis-related amyloidosis
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Reduction
in inflammation
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Reduction
in medication such as EPO and phosphate binders
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Improved
patient quality of life
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Reduction
in number of hospitalizations and overall length of stay
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However,
like HF, HDF can be resource intensive and can require a significant amount of time to deliver one course of treatment.
We
have developed a modified approach to HDF that we believe is more patient-friendly, less resource-intensive, and can be used in
conjunction with current HD machines. We refer to our approach as an online mid-dilution hemodiafiltration (“mid-dilution
HDF”) system and it consists of our OLpūr H2H Hemodiafiltration Module (“H2H Module”), our OLpūr MD
220 Hemodiafilter (“HDF Filter”) and our H2H Substitution Filter (“Dialysate Filter”).
The
H2H Module utilizes a standard HD machine to perform on-line hemodiafiltration therapy. The HD machine controls and monitors the
basic treatment functions, as it would normally when providing HD therapy. The H2H Module is a free-standing, movable device that
is placed next to either side of an HD machine. The H2H Module is connected to the clinic’s water supply, drain, and electricity.
The
H2H Module utilizes the HDF Filter and is very similar to a typical hollow fiber dialyzer assembled with a single hollow fiber
bundle made with a high-flux (or high-permeability) membrane. The fiber bundle is separated into two discrete, but serially connected
blood paths. Dialysate flows in one direction that is counter-current to blood flow in Stage 1 and co-current to blood flow in
Stage 2.
In
addition to the HDF Filter, the H2H Module also utilizes a Dialysate Filter during patient treatment. The Dialysate Filter is
a hollow fiber, ultrafilter device that consists of two sequential (redundant) ultrafiltration stages in a single housing. During
on-line HDF with the H2H Module, fresh dialysate is redirected by the H2H Module’s hydraulic (substitution) pump and passed
through this dual-stage ultrafilter before being infused as substitution fluid into the extracorporeal circuit. Providing ultrapure
dialysate is crucial for the success of on-line HDF treatment.
Our
HDF System is cleared by the FDA to market for use with an ultrafiltration controlled hemodialysis machine that provides ultrapure
dialysate in accordance with current ANSI/AAMI/ISO standards, for the treatment of patients with chronic renal failure in the
United States. Our on-line mid-dilution HDF system is the only on-line mid-dilution HDF system of its kind to be cleared by the
FDA to date.
In
May 2014, DaVita Healthcare Partners initiated an evaluation of our HDF System to treat patients at DaVita’s North Colorado
Springs Clinic. In February 2015, we announced that, in the course of the evaluation, DaVita informed Nephros that it would require
additional validation of the system. Nephros and DaVita agreed upon a protocol for the additional validation work which was completed
in March 2015. We do not believe that DaVita will restart the evaluation in the near term.
In
March 2015, we announced that the Renal Research Institute (“RRI”), a research division of Fresenius Medical Care,
was conducting an ongoing evaluation of our HDF system in its clinic. As of June 2016, our HDF Systems had performed over 1,200
patient treatments. Over the last 18 months of commercial use, we have gathered direct feedback from users of our HDF System to
help improve our system and our training methodology. In January 2016, we updated our training procedures and rolled out a software
update, which was focused on improving the system’s alignment with nurse work flow. In June 2016, after approximately 5
months of successfully completed patient treatments with the updated software, we concluded the evaluation project with RRI.
We
expect that a dialysis clinic associated with Vanderbilt University will begin treating patients with our HDF Systems before the
end of 2016. Our goal over the next 12-18 months is to develop a better understanding of how our system best fits into the current
clinical and economic ESRD treatment paradigm with the ultimate goals of a) improving the quality of life for the patient, b)
reducing overall expenditure compared to other dialysis modalities, c) minimizing the impact on nurse work flow at the clinic,
and d) demonstrating the pharmacoeconomic benefit of the HDF technology to the U.S. healthcare system, as has been done in Europe
with other HDF systems. In addition, we are in the process of developing version 2.0 of our HDF System, which will enable us to
manufacture at scale, as well as potentially reduce the per treatment cost of performing HDF.
Ultrafiltration
Products
Our
ultrafiltration products target a number of markets.
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Hospitals
and Other Healthcare Facilities
: Filtration of water to be used for patient washing and drinking as an aid in infection
control. The filters also produce water that is suitable for wound cleansing, cleaning of equipment used in medical procedures
and washing of surgeons’ hands.
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Dialysis
Centers - Water/Bicarbonate
: Filtration of water or bicarbonate concentrate used in HD devices.
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Military
and Outdoor Recreation
: Individual water purification devices used by soldiers and backpackers to produce drinking water
in the field, as well as filters customized to remote water processing systems.
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Commercial
Facilities
: Filtration of water for washing and drinking, including use in ice machines and soda fountains.
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Our
Target Markets
Hospitals
and Other Healthcare Facilities.
According to the American Hospital Association approximately 5,700 hospitals, with approximately
915,000 beds, treated over 35 million patients in the U.S. in 2013. The United States Centers for Disease Control and Prevention
estimates that healthcare associated infections(“HAI”) occurred in approximately 1 out of every 25 hospital patients.
HAIs affect patients in a hospital or other healthcare facility, and are not present or incubating at the time of admission. They
also include infections acquired by patients in the hospital or facility but appearing after discharge, and occupational infections
among staff. Many HAIs are waterborne bacteria and viruses that can thrive in aging or complex plumbing systems often found in
healthcare facilities. The Affordable Care Act, which was passed in March 2010, puts in place comprehensive health insurance reforms
that aim to lower costs and enhance quality of care. With its implementation, healthcare providers have substantial incentives
to deliver better care or be forced to absorb the expenses associated with repeat medical procedures or complications like HAIs.
As a consequence, hospitals and other healthcare facilities are proactively implementing strategies to reduce the potential for
HAIs. Our ultrafilters are designed to aid in infection control in the hospital and healthcare setting by treating facility water
at the point of delivery, for example, from sinks and showers.
On
June 30, 2014 we submitted to the FDA, for 510(k) clearance, the DSU-H and SSU-H Ultrafilters to filter EPA quality drinking water
to remove microbiological contaminants and waterborne pathogens. On October 28, 2014, we announced that we received 510(k) clearance
from the FDA to market our DSU-H and SSU-H Ultrafilters as medical devices for use in the hospital setting. The DSU-H and SSU-H
Ultrafilters are intended to be used to filter EPA quality drinking water. The filters retain bacteria, viruses and endotoxin.
By providing ultrapure water for patient washing and drinking, the filters aid in infection control. The filters also produce
water that is suitable for wound cleansing, cleaning of equipment used in medical procedures and washing of a surgeon’s
hands. The filters are not intended to provide water that can be used as a substitute for United States Pharmacopeia (“USP”)
sterile water.
In
May 2015, we received a warning letter from the FDA resulting from an October 2014 inspection. In the letter, the FDA alleged
deficiencies relating to our compliance with the quality system regulation and the medical device reporting regulation. The warning
letter did not restrict our ability to manufacture, produce or ship any of our products, nor did it require the withdrawal of
any product from the marketplace. In August 2015, we received a subsequent letter from the FDA noting that it had received our
response correspondence detailing our completed corrective actions. The corrective actions included revisions to our standard
operating procedures relating to purchasing and supplier controls, adverse event reporting, and complaint handling and monitoring.
In February 2016, the FDA performed another on-site inspection. There were no observations, or 483’s, cited at the conclusion
of the inspection. In April 2016, we received a third letter from the FDA noting that the FDA had completed its evaluation of
our corrective actions and that, based on its evaluation, it appeared that we had addressed the deficiencies specified in the
May 2015 warning letter.
In
June 2015, the American Society of Heating, Refrigerating, and Air-Conditioning Engineers, Inc. (“ASHRAE”) approved
Standard 188-2015, “Legionellosis: Risk Management for Building Water Systems”. We believe the approval of ASHRAE
188-2015 (“S188”) as a national standard will have a positive impact on point of delivery filtration market. The S188
applies to any human occupied building that is not a single family residence; requires the building to have a plan to control
for waterborne infection; requires heat, chemical or both cleaning in the event of a suspected or confirmed presence of legionella;
and recommends point-of-use filters in areas of high risk. We are enhancing our efforts to support our distributors by developing
and delivering focused sales training to their sales forces on the use of our filters to support an overall program of infection
risk prevention; and by, whenever possible, doing joint sales calls with our distributors on potential hospital customers to both
serve as a product expert and to field train their sales representatives.
On
October 27, 2015, we announced that we had submitted the S100 Point of Use filter to the FDA for 510(k) clearance. In late December
2015, the FDA requested additional information. On April 14, 2016, we announced that we received 510(k) clearance from the FDA
to market our S100 Point of Use filter.
On
May 27, 2016, we submitted the PathoGuard™ 10” cartridge filter to the FDA for 510(k) under the Special 510(k): Device
Modification process. Following our meeting with the FDA on August 15, 2016, and additional follow-up communications, we initiated
some additional biocompatibility studies and other related testing of our products. The testing was completed in early November
and we will submit the additional information for the HydraGuard™ (change from PathoGuard™) Special 510(k) before
the end of November 2016.
The
complete hospital infection control product line, including in-line and point of use filters, can be viewed on our website at
http://www.nephros.com/infection-control/
. We are not including the information on our website as a part of, or incorporating
it by reference into, this report.
Dialysis
Centers - Water/Bicarbonate
. To perform hemodialysis, all dialysis clinics have dedicated water purification systems to produce
water and bicarbonate concentrate. Water and bicarbonate concentrate are essential ingredients for making dialysate, the liquid
that removes waste material from the blood. According to the American Journal of Kidney Diseases, there are approximately 6,300
dialysis clinics in the United States servicing approximately 430,000 patients annually. We estimate that there are over 100,000
hemodialysis machines in operation in the United States.
Medicare
is the main payer for dialysis treatment in the U.S. To be eligible for Medicare reimbursement, dialysis centers must meet the
minimum standards for water and bicarbonate concentrate quality set by the Association for the Advancement of Medical Instrumentation
(“AAMI”), the American National Standards Institute (“ANSI”) and the International Standards Organization
(“ISO”). We anticipate that the stricter standards approved by these organizations in 2009 will be adopted by Medicare
in the near future.
Published
studies have shown that the use of ultrapure dialysate can reduce the overall need for erythropoietin stimulating agents (“ESA”),
expensive drugs used in conjunction with HD. By reducing the level of dialysate contaminants, specifically cytokine-inducing substances
that can pass into a patient’s blood stream, the stimulation of inflammation-inducing cytokines is reduced, thus reducing
systemic inflammation. When inflammation is low, inflammatory morbidities are reduced and a patient’s responsiveness to
erythropoietin (“EPO”) is enhanced, consequently the overall need for ESAs is reduced.
We
believe that our ultrafilters are attractive to dialysis centers because they exceed currently approved and newly proposed standards
for water and bicarbonate concentrate purity, assist in achieving those standards and may help dialysis centers reduce costs associated
with the amount of ESA required to treat a patient. Our in-line filters are easily installed into the fluid circuits supplying
water and bicarbonate concentrate just prior to entering each dialysis machine.
In
March 2016, we launched the SSUmini product, developed to provide a lower cost ultrafiltration solution for water and bicarbonate
flowrates of 0.5 gallons per minutes (“GPM”) or less. The SSUmini can be used as a polish filter for small, portable
reverse osmosis (“RO”) water systems or on bicarbonate concentrate lines in dialysis clinics with centralized bicarbonate
concentrate systems.
The
endotoxin cartridge filter, EndoPurTM, is designed to provide hemodialysis quality water through ultrafiltration of the water
in a dialysis clinic’s reverse osmosis loop. The EndoPurTM filter retains particles as small as 0.005 microns, is designed
to handle higher flowrates and will be offered in 10”, 20”, 30” or 40” sizes upon FDA clearance. In April
2016, we filed for Special 510(k) clearance of an endotoxin cartridge filter. Because we believed that the EndoPurTM conformed
to the design controls of the SSU-D, and had the same intended use, we believed that the cartridge qualified for the Special 510(k):
Device Modification process. In May 2016, after discussion with the FDA, we converted the submission to a traditional 510(k) for
the 20”, 30” and 40” versions of the EndoPurTM cartridge and filed a Special 510(k) for the 10” version
of the EndoPurTM cartridge. On July 1, 2016, the FDA sent us a request for additional information. Following our meeting with
the FDA on August 15, 2016, and additional follow-up communications, we converted the EndoPur 10” cartridge submission to
a traditional 510(k), and initiated some additional biocompatibility studies and other related testing of our products. The testing
was completed in early November and we will submit the additional information for the EndoPur™ 10” cartridge Traditional
510(k) before the end of November 2016. We expect to submit the full package for a traditional 510(k) for the EndoPur™ 20”,
30” and 40” ultrafilters by the middle of December 2016.
Military
and Outdoor Recreation
. Water is a key requirement for the soldier to be fully mission-capable. The availability of water
supplies and immediate on-site water purification is critical to enhance the ability to operate in any environment. Currently,
the military is heavily reliant on the use of bottled water to support its soldiers in the field. Bottled water is not always
available, is very costly to move, is resource intensive, and is prone to constant supply disruptions. Soldiers conducting operations
in isolated and rugged terrain must be able to use available local water sources when unable to resupply from bulk drinking water
sources or bottled water. Therefore, the soldier needs the capability to purify water from indigenous water sources in the absence
of available potable water. Soldiers must have the ability to remove microbiological contaminants in the water to Environmental
Protection Agency (“EPA”) specified levels.
We
developed our individual water treatment device (“IWTD”) in both in-line and point-of-use configurations. Our IWTD
allows a soldier in the field to derive drinking water from any fresh water source. This enables the soldier to remain hydrated,
which will maintain mission effectiveness and unit readiness, and extend mission reach. Our IWTD is one of the few portable filters
that has been validated by the military to meet the NSF Protocol P248 standard. It has also been approved by U.S. Army Public
Health Command and U.S. Army Test and Evaluation Command for deployment.
On
May 6, 2015, we entered into a Sublicense Agreement with CamelBak Products, LLC (“CamelBak”). Under this Sublicense
Agreement, we granted CamelBak an exclusive, non-transferable, worldwide (with the exception of Italy) sublicense and license,
in each case solely to market, sell, distribute, import and export the IWTD. In exchange for the rights granted to CamelBak, CamelBak
agreed, through December 31, 2022, to pay us a percentage of the gross profit on any sales made to a branch of the U.S. military,
subject to certain exceptions, and to pay us a fixed per-unit fee for any other sales made. CamelBak is also required to meet
or exceed certain minimum annual fees payable to us, and if such fees are not met or exceeded, we may convert the exclusive sublicense
to a non-exclusive sublicense with respect to non-U.S. military sales. In the three and nine months ended September 30, 2016,
we recognized royalty revenue of $10,000 related to the Sublicense Agreement with CamelBak.
In
2015, we began working with multiple companies developing portable water purification systems designed to provide potable water
in remote locations. Specifically, we have provided flushable filter prototypes to these companies for validation as one potential
component in systems that employ multiple technologies to purify water from streams, lakes and rivers.
Commercial
Facilitie
s. In 2014, we launched NanoGuard-D and NanoGuard-S in-line ultrafilters for the filtration of water which is to
be used for non-medical drinking and washing in non-transient non-community water systems, or commercial facilities. The NanoGuard-D
and NanoGuard-S trap particulates greater than 0.005 micons in size and can be used as a component of a facility water treatment
system, or to filter water used in ice machines and soda fountains.
In
November 2015, we announced a strategic partnership with Biocon 1, LLC. Biocon 1’s AETHER® Water Systems technology,
which includes patented water filtration media and water filtration products, provides solutions for customers to address all
contaminate issues and to provide clean-tasting, sediment-free, scale-free, and bacteria-free water for the food service industry.
AETHER® Water Systems are used with ice machines, coffee stations, and soda fountains in hotels, casual dining restaurants,
fast food restaurants and convenience stores. As part of the collaboration, we have access to Biocon 1’s anti-scale and
related water filtration technology to develop filter products for the medical industry. In March 2016, Nephros shipped the first
lot of filter cartridges to Biocon 1 for inclusion with its AETHER® line of filtration products. Also in March 2016, Biocon
1 shipped the first anti-scale filter samples to Nephros for testing in the medical setting.
While
our EndoPur
TM
ultrafilter cartridge platform was designed initially for use in the dialysis setting, we are working
with our distributors to identify other opportunities for our ultrafilters to provide value to customers in multiple commercial
and industrial settings. The NanoGuard-C, a 10” cartridge filter that inserts into standard 10” housings, will be
available on a limited basis in the fourth quarter of 2016, and we expect to make the product broadly available in 2017.
Many
potential customers in the commercial and industrial space currently utilize an Everpure® filter system. The NanoGuard-E,
a version of our ultrafilter that plugs into an Everpure® housing system, is now available on a limited basis and will be
available more broadly in 2017.
Over
the last few years, we have been developing a high-throughput, auto-flushing filter system capable of handling 25 GPM, or greater,
through our proprietary 0.005 micron fiber membrane. The flushable filter system is designed to remove submicron particulates
in closed loop water systems, including cooling systems for data centers and hot water return loops in commercial buildings. Initial
data suggests the ability to remove both organic and inorganic particulates. We have released a limited number of systems to specific
customers for additional testing and validation.
We
intend to develop flushable filter cartridges capable to filtering 2.5, 5 and 10 GPM through our fiber membrane. These smaller
flushable filter systems have potential utility as a point-of-entry water purification system in restaurants, convenience stores
and households. We intend to provide limited release of these products in the fourth quarter of 2016.
Going
forward, as we grow our water filtration business, we will be exploring opportunities for new applications for our filter products
and will be open to evaluating new potential partnerships to expand our water filtration foot print.
Critical
Accounting Policies
The
discussion and analysis of our consolidated financial condition and results of operations are based upon our condensed consolidated
interim financial statements. These condensed consolidated financial statements have been prepared following the requirements
of accounting principles generally accepted in the United States (“GAAP”) and Rule 8-03 of Regulation S-X for interim
periods and require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related
to going concern, allowance for doubtful accounts, reserve for inventory obsolescence, impairment analysis of capitalized license
fees, and share-based compensation expense. As these are condensed consolidated financial statements, you should also read expanded
information about our critical accounting policies and estimates provided in “Management’s Discussion and Analysis
of Financial Condition and Results of Operations,” included in our Form 10-K for the year ended December 31, 2015. There
have been no material changes to our critical accounting policies and estimates from the information provided in our Form 10-K
for the year ended December 31, 2015.
Recent
Accounting Pronouncements
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
2014-09, “Revenue from Contracts with Customers,” related to revenue recognition. The underlying principle of the
new standard is that a business or other organization will recognize revenue to depict the transfer of promised goods or services
to customers in an amount that reflects what it expects to be entitled to in exchange for the goods or services. The standard
also requires more detailed disclosures and provides additional guidance for transactions that were not addressed completely in
prior accounting guidance. ASU 2014-09 provides alternative methods of initial adoption, and was to be effective for fiscal years
beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption was not permitted. In August
2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date.” The amendment
in this ASU defers the effective date of ASU 2014-09 for all entities for one year. Public business entities, certain not-for-profit
entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to fiscal years beginning after December
15, 2017, including interim reporting periods within that fiscal year. Early adoption is permitted only for fiscal years beginning
after December 31, 2016, including interim reporting periods within that fiscal year. We are currently reviewing the revised guidance
and assessing the potential impact on our consolidated financial statements.
In
August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure
of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” ASU 2014-15 provides guidance about management’s
responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and
sets rules for how this information should be disclosed in the financial statements. ASU 2014-15 is effective for annual periods
ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted. We are currently evaluating any impact
the adoption of ASU 2014-15 might have on our consolidated financial statements.
In
July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory,” that requires inventory be measured
at the lower of cost and net realizable value and options that currently exist for market value to be eliminated. The standard
defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs
of completion, disposal, and transportation and is effective for fiscal years beginning after December 15, 2016 and interim periods
within those fiscal years, with early adoption permitted. The guidance should be applied prospectively. We do not believe that
the adoption of ASU 2015-11 will have a significant impact on our consolidated financial statements.
In
November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes,” that requires that deferred
tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The current requirement
that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is
not affected by this amendment. The new guidance is effective for fiscal years, and interim periods within those years, beginning
after December 15, 2016. Early adoption is permitted and the standard may be applied either retrospectively or on a prospective
basis to all deferred tax assets and liabilities. We do not believe that the adoption of ASU 2015-17 will have a significant impact
on our consolidated financial statements.
In
January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,”
that modifies certain aspects of the recognition, measurement, presentation, and disclosure of financial instruments. The accounting
standard update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and
early adoption is permitted. We are currently assessing the impact that adopting this new accounting guidance will have on our
financial statements.
In
February 2016, the FASB issued ASU 2016-02, “Leases,” that discusses how an entity should account for lease assets
and lease liabilities. The guidance specifies that an entity who is a lessee under lease agreements should recognize lease assets
and lease liabilities for those leases classified as operating leases under previous FASB guidance. Accounting for leases by lessors
is largely unchanged under the new guidance. The guidance is effective for us beginning in the first quarter of 2019. Early adoption
is permitted. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest
period presented using a modified retrospective approach. We are evaluating the impact of adopting this guidance on our consolidated
financial statements.
In
March 2016, the FASB issued ASU 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),”
which clarifies the implementation guidance on principal versus agent considerations. The amendments in this update do not change
the core principle of ASU 2014-09. The effective date and transition requirements for the amendments in this update are the same
as the effective date and transition requirements of ASU 2014-09. As discussed above, ASU 2015-14 defers the effective date of
ASU 2014-09 by one year. We are currently assessing the impact that adopting this new accounting guidance will have on our financial
statements.
In
March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which simplifies
several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification
of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance is effective for us
beginning in the first quarter of fiscal year 2017. Early adoption is permitted. We are evaluating the impact of adopting this
guidance on our consolidated financial statements.
In
April 2016, the FASB issued ASU 2016-10, “Identifying Performance Obligations and Licensing,” which clarifies the
implementation guidance for performance obligations and licensing. The amendments in this update do not change the core principle
of ASU 2014-09. The effective date and transition requirements for the amendments in this update are the same as the effective
date and transition requirements of ASU 2014-09. As discussed above, ASU 2015-14 defers the effective date of ASU 2014-09 by one
year. We are currently assessing the impact that adopting this new accounting guidance will have on our financial statements.
In
May 2016, the FASB issued ASU 2016-12, “Narrow Scope Improvements and Practical Expedients,” which clarifies the accounting
for certain aspects of guidance issued in ASU 2014-09, including assessing collectability and noncash consideration. The clarifications
in this update do not change the core principle of ASU 2014-09. The effective date and transition requirements for the amendments
in this update are the same as the effective date and transition requirements of ASU 2014-09. As discussed above, ASU 2015-14
defers the effective date of ASU 2014-09 by one year. We are currently assessing the impact that adopting this new accounting
guidance will have on its financial statements.
In
June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments,” which replaces the
incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration
of a broader range of reasonable and supportable information to inform credit loss estimates. The guidance is effective for us
beginning in the first quarter of fiscal year 2020. Early adoption is permitted beginning in the first quarter of fiscal year
2019. We are evaluating the impact of adopting this guidance on its consolidated financial statements.
In
August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which clarifies
how certain cash receipts and cash payments are presented and classified in the statement of cash flows in order to reduce diversity
in practice. The guidance is effective for us beginning in the first quarter of fiscal year 2018. Early adoption is permitted.
We are evaluating the impact of adopting this guidance on our consolidated financial statements.
Results
of Operations
Fluctuations
in Operating Results
Our
results of operations have fluctuated significantly from period to period in the past and are likely to continue to do so in the
future. We anticipate that our quarterly results of operations will be impacted for the foreseeable future by several factors
including the progress and timing of expenditures related to our research and development efforts, as well as marketing expenses
related to product launches. Due to these fluctuations, we believe that the period to period comparisons of our operating results
are not a good indication of our future performance.
Three
Months Ended September 30, 2016 Compared to the Three Months Ended September 30, 2015
Revenues
Total
net revenues for the three months ended September 30, 2016 were approximately $475,000 compared to approximately $320,000 for
the three months ended September 30, 2015, an increase of approximately $155,000, or 48%. This increase was primarily caused by
an increase in hospital filter revenues that was offset by a decrease in dialysis filter and hemodiafiltration revenues.
Cost
of Goods Sold
Cost
of goods sold was approximately $159,000 for the three months ended September 30, 2016 compared to approximately $154,000 for
the three months ended September 30, 2015. The increase of approximately $5,000, or 3%, during the three months ended September
30, 2016 compared to the same period in 2015 is primarily due to an increase in units sold of approximately 10% during the three
months ended September 30, 2016. The cost of goods did not increase proportionally with revenue because direct sales were higher
during the three months ended September 30, 2016 than in the three months ended September 30, 2015.
Research
and Development Expenses
Research
and development expenses were approximately $241,000 and $226,000 for the three months ended September 30, 2016 and September
30, 2015, respectively. This increase of approximately $15,000, or 7%, is primarily due to additional salary and stock compensation
expenses for increased research and development personnel, offset by a decrease in expenses related to product development.
Depreciation
and Amortization Expense
Depreciation
and amortization expense was approximately $60,000 for the three months ended September 30, 2016 compared to approximately $53,000
for the three months ended September 30, 2015. Amortization expense related to the asset recognized in conjunction with the License
and Supply Agreement with Medica S.p.A was $53,000 for each of the three months ended September 30, 2016 and 2015. The remaining
$7,000 recognized in the three months ended September 30, 2016 was depreciation on property and equipment.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were approximately $652,000 for the three months ended September 30, 2016 compared to approximately
$974,000 for the three months ended September 30, 2015, a decrease of approximately $322,000 or 33%. The decrease is primarily
due to decreased professional service fees, including regulatory consulting and legal services, which were partially offset by
additional salary and benefit expenses for increased selling, general and administrative personnel and by increased marketing
expenses.
Change
in Fair Value of Warrant Liability
Certain
warrants were classified as liabilities at their fair value and adjusted to their fair value at each reporting period. The fair
value of such warrants issued was estimated using a binomial options pricing model. For the three months ended September 30, 2015,
the change in fair value of the warrant liability was an increase of approximately $2,287,000. These liability-classified warrants
were exercised in full on September 29, 2015.
Warrant
Modification Expense
During
the three months ended September 30, 2015, the modification of the exercise price of the liability-classified warrants resulted
in an increase in the warrant liability, immediately before exercise, of approximately $1,761,000.
Interest
Expense
Interest
expense of approximately $65,000 for the three months ended September 30, 2016 is comprised of approximately $33,000 of interest
related to the June 2016 Note and Warrant Agreement, approximately $23,000 related to the amortization of debt discount and approximately
$9,000 of interest due on outstanding payables to a vendor. Interest expense of approximately $9,000 for the three months ended
September 30, 2015 related to interest due on outstanding payables owed to a vendor.
Interest
Income
Interest
income of approximately $1,000 for the three months ended September 30, 2016 related to interest income recognized on a lease
receivable.
Other
Income (Expense)
Other
expenses for the three months ended September 30, 2016 and 2015 of approximately $5,000 and $11,000, respectively, are related
to foreign currency losses on invoices paid to an international supplier.
Nine
Months Ended September 30, 2016 Compared to the Nine Months Ended September 30, 2015
Revenues
Total
net revenues for the nine months ended September 30, 2016 were approximately $1,575,000 compared to approximately $1,433,000 for
the nine months ended September 30, 2015. Total net revenues increased approximately $142,000, or 10%, arising from an increase
in hospital filter revenue, which was partially offset by a decrease in dialysis filter revenue.
Cost
of Goods Sold
Cost
of goods sold was approximately $667,000 for the nine months ended September 30, 2016 compared to approximately $626,000 for the
nine months ended September 30, 2015. The increase of approximately $41,000, or 7%, is primarily due to adjustments in inventory
reserve in the periods.
Research
and Development Expenses
Research
and development expenses were approximately $763,000 and $582,000 for the nine months ended September 30, 2016 and September 30,
2015, respectively. This increase of approximately $181,000, or 31%, is primarily due to additional salary and stock compensation
expenses for increased research and development personnel, partially offset by a decrease in product development expenses.
Depreciation
and Amortization Expense
Depreciation
and amortization expense was approximately $171,000 for the nine months ended September 30, 2016 compared to approximately $159,000
for the nine months ended September 30, 2015. Amortization expense related to the asset recognized in conjunction with the License
and Supply Agreement with Medica S.p.A was $157,000 and $158,000 for the nine months ended September 30, 2016 and 2015, respectively.
The remaining $14,000 and $1,000 recognized in the nine months ended September 30, 2016 and 2015, respectively, was depreciation
on property and equipment.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were approximately $2,234,000 for the nine months ended September 30, 2016 compared to approximately
$2,551,000 for the nine months ended September 30, 2015, a decrease of approximately $317,000, or 12%. The decrease is primarily
due to decreased professional service fees, including regulatory consulting and legal services, which were offset by additional
salary and benefit expenses for increased selling, general and administrative personnel and by increased marketing expenses.
Change
in Fair Value of Warrant Liability
Certain
warrants were classified as liabilities at their fair value and adjusted to their fair value at each reporting period. The fair
value of such warrants issued have been estimated using a binomial options pricing model. For the nine months ended September
30, 2015, the change in fair value of the warrant liability was an increase of approximately $2,099,000. These liability-classified
warrants were exercised in full on September 29, 2015.
Warrant
Modification Expense
During
the nine months ended September 30, 2015, the modification of the exercise price of the liability-classified warrants resulted
in an increase in the warrant liability, immediately before exercise, of approximately $1,761,000.
Interest
Expense
Interest
expense of approximately $109,000 for the nine months ended September 30, 2016 consisted of approximately $43,000 of interest
related to the June 2016 Note and Warrant Agreement, approximately $29,000 related the amortization of debt discount and approximately
$37,000 of interest due on outstanding payables to a vendor. Interest expense of approximately $30,000 for the nine months ended
September 30, 2015 relates to interest due on outstanding payables owed to a vendor.
Interest
Income
Interest
income of approximately $4,000 for the nine months ended September 30, 2016 related to interest income recognized on a lease receivable.
Other
Income (Expense)
Other
expense for the nine months ended September 30, 2016 of approximately $12,000 related to foreign currency losses of approximately
$14,000 on invoices paid to an international supplier offset partially by miscellaneous other income of approximately $2,000.
A foreign currency gain was recognized for the nine months ended September 30, 2015 of approximately $24,000 on invoices paid
to an international supplier.