PART
I - FINANCIAL INFORMATION
Item
1. Financial Statements.
NEPHROS,
INC. AND SUBSIDIARY
CONDENSED
CONSOLIDATED BALANCE SHEETS
(In
thousands, except share amounts)
|
|
March 31, 2017
|
|
|
December 31, 2016
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
803
|
|
|
$
|
275
|
|
Accounts receivable, net
|
|
|
582
|
|
|
|
388
|
|
Investment in lease, net-current portion
|
|
|
21
|
|
|
|
27
|
|
Inventory, net
|
|
|
401
|
|
|
|
479
|
|
Prepaid expenses and other current assets
|
|
|
121
|
|
|
|
95
|
|
Total current assets
|
|
|
1,928
|
|
|
|
1,264
|
|
Property and equipment, net
|
|
|
63
|
|
|
|
70
|
|
Investment in lease, net-less current portion
|
|
|
57
|
|
|
|
61
|
|
License and supply agreement, net
|
|
|
1,210
|
|
|
|
1,262
|
|
Other asset
|
|
|
21
|
|
|
|
21
|
|
Total assets
|
|
$
|
3,279
|
|
|
$
|
2,678
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
361
|
|
|
$
|
585
|
|
Accrued expenses
|
|
|
349
|
|
|
|
240
|
|
Deferred revenue, current portion
|
|
|
70
|
|
|
|
70
|
|
Total current liabilities
|
|
|
780
|
|
|
|
895
|
|
Unsecured long-term note payable, net of debt issuance costs and debt discount of $323 and $349, respectively
|
|
|
864
|
|
|
|
838
|
|
Long-term portion of deferred revenue
|
|
|
261
|
|
|
|
278
|
|
Total liabilities
|
|
|
1,905
|
|
|
|
2,011
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies (Note 13)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
Preferred stock, $.001 par value; 5,000,000 shares authorized at March 31, 2017 and December 31, 2016; no shares issued and outstanding at March 31, 2017 and December 31, 2016
|
|
|
-
|
|
|
|
-
|
|
Common stock, $.001 par value; 90,000,000 shares authorized at March 31, 2017 and December 31, 2016; 54,160,547 and 49,782,797 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively.
|
|
|
54
|
|
|
|
50
|
|
Additional paid-in capital
|
|
|
122,229
|
|
|
|
120,835
|
|
Accumulated other comprehensive income
|
|
|
68
|
|
|
|
67
|
|
Accumulated deficit
|
|
|
(120,977
|
)
|
|
|
(120,285
|
)
|
Total stockholders’ equity
|
|
|
1,374
|
|
|
|
667
|
|
Total liabilities and stockholders’ equity
|
|
$
|
3,279
|
|
|
$
|
2,678
|
|
The
accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.
NEPHROS,
INC. AND SUBSIDIARY
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In
thousands, except share and per share amounts)
(Unaudited)
|
|
Three
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Net revenues:
|
|
|
|
|
|
|
|
|
Product revenues
|
|
$
|
690
|
|
|
$
|
545
|
|
License and royalty
revenues
|
|
|
44
|
|
|
|
45
|
|
Total net revenues
|
|
|
734
|
|
|
|
590
|
|
Cost of goods
sold
|
|
|
279
|
|
|
|
295
|
|
Gross margin
|
|
|
455
|
|
|
|
295
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
231
|
|
|
|
269
|
|
Depreciation and
amortization
|
|
|
59
|
|
|
|
55
|
|
Selling,
general and administrative
|
|
|
770
|
|
|
|
777
|
|
Total operating
expenses
|
|
|
1,060
|
|
|
|
1,101
|
|
Loss from operations
|
|
|
(605
|
)
|
|
|
(806
|
)
|
Interest expense
|
|
|
(66
|
)
|
|
|
(14
|
)
|
Interest income
|
|
|
1
|
|
|
|
1
|
|
Other expense
|
|
|
(10
|
)
|
|
|
(17
|
)
|
Net loss
|
|
|
(680
|
)
|
|
|
(836
|
)
|
Other comprehensive
income, foreign currency translation adjustments
|
|
|
1
|
|
|
|
1
|
|
Total comprehensive
loss
|
|
$
|
(679
|
)
|
|
$
|
(835
|
)
|
Net loss per common share, basic and
diluted
|
|
$
|
(0.01
|
)
|
|
$
|
(0.02
|
)
|
Weighted average common shares outstanding,
basic and diluted
|
|
|
49,601,521
|
|
|
|
48,173,521
|
|
The
accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.
NEPHROS,
INC. AND SUBSIDIARY
CONSOLIDATED
STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(In
Thousands, Except Share Amounts)
(Unaudited)
|
|
Common
Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
Other Comprehensive
|
|
|
Accumulated
|
|
|
Total
Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Income
|
|
|
Deficit
|
|
|
Equity
|
|
Balance, December 31, 2016 (audited)
|
|
|
49,782,797
|
|
|
$
|
50
|
|
|
$
|
120,835
|
|
|
$
|
67
|
|
|
$
|
(120,285
|
)
|
|
$
|
667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(680
|
)
|
|
|
(680
|
)
|
Cumulative effect of change in accounting
principle
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
(12
|
)
|
|
|
-
|
|
Net unrealized gains on foreign currency
translation, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
1
|
|
Issuance of common stock, net of equity
issuance costs of $144
|
|
|
4,059,994
|
|
|
|
4
|
|
|
|
1,070
|
|
|
|
|
|
|
|
|
|
|
|
1,074
|
|
Issuance of common stock
|
|
|
300,000
|
|
|
|
|
|
|
|
113
|
|
|
|
|
|
|
|
|
|
|
|
113
|
|
Issuance of restricted stock
|
|
|
17,756
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Noncash stock-based
compensation
|
|
|
|
|
|
|
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
199
|
|
Balance, March 31, 2017
|
|
|
54,160,547
|
|
|
$
|
54
|
|
|
$
|
122,229
|
|
|
$
|
68
|
|
|
$
|
(120,977
|
)
|
|
$
|
1,374
|
|
The
accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.
NEPHROS,
INC. AND SUBSIDIARY
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In
thousands)
(Unaudited)
|
|
Three
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(680
|
)
|
|
$
|
(836
|
)
|
Adjustments to reconcile net loss to
net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation of
property and equipment
|
|
|
7
|
|
|
|
3
|
|
Amortization of
other assets
|
|
|
52
|
|
|
|
52
|
|
Non-cash stock-based
compensation, including stock options and restricted stock
|
|
|
199
|
|
|
|
127
|
|
Non-employee stock-based
compensation
|
|
|
-
|
|
|
|
20
|
|
Non-cash interest
expense
|
|
|
26
|
|
|
|
-
|
|
Inventory reserve
|
|
|
-
|
|
|
|
27
|
|
Allowance for doubtful
accounts reserve
|
|
|
2
|
|
|
|
9
|
|
Loss on foreign
currency transactions
|
|
|
2
|
|
|
|
14
|
|
(Increase) decrease in operating assets:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(185
|
)
|
|
|
(181
|
)
|
Inventory
|
|
|
78
|
|
|
|
106
|
|
Prepaid expenses
and other current assets
|
|
|
(26
|
)
|
|
|
7
|
|
Increase (decrease) in operating liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
|
(226
|
)
|
|
|
78
|
|
Accrued expenses
|
|
|
109
|
|
|
|
69
|
|
Deferred
revenue
|
|
|
(17
|
)
|
|
|
(17
|
)
|
Net
cash used in operating activities
|
|
|
(659
|
)
|
|
|
(522
|
)
|
Investing activities:
|
|
|
|
|
|
|
|
|
Purchase
of property, plant and equipment
|
|
|
-
|
|
|
|
(26
|
)
|
Net
cash used in investing activities
|
|
|
-
|
|
|
|
(26
|
)
|
Financing activities:
|
|
|
|
|
|
|
|
|
Proceeds from issuance
of common stock
|
|
|
1,187
|
|
|
|
-
|
|
Proceeds from
exercise of warrants
|
|
|
-
|
|
|
|
1
|
|
Net
cash provided by financing activities
|
|
|
1,187
|
|
|
|
1
|
|
Effect of exchange rates on cash
|
|
|
-
|
|
|
|
-
|
|
Net increase (decrease)
in cash
|
|
|
528
|
|
|
|
(547
|
)
|
Cash, beginning
of period
|
|
|
275
|
|
|
|
1,248
|
|
Cash, end of
period
|
|
$
|
803
|
|
|
$
|
701
|
|
Supplemental disclosure
of cash flow information
|
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
5
|
|
|
$
|
12
|
|
Cash
paid for income taxes
|
|
$
|
2
|
|
|
$
|
2
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure
of noncash investing and financing activities
|
|
|
|
|
|
|
|
|
Investment
in lease receivable, net
|
|
$
|
-
|
|
|
$
|
92
|
|
Cost
of equipment in direct financing lease
|
|
$
|
-
|
|
|
|
92
|
|
Restricted
stock issued to settle liability
|
|
$
|
-
|
|
|
$
|
16
|
|
Deposit
on inventory reclassified from prepaid expenses and other current assets to inventory
|
|
$
|
-
|
|
|
$
|
18
|
|
Deposit
on property and equipment reclassified from prepaid expenses and other current assets to property and equipment
|
|
$
|
-
|
|
|
$
|
98
|
|
The
accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
1 - Organization and Nature of Operations
Nephros,
Inc. (“Nephros” or the “Company”) was incorporated under the laws of the State of Delaware on April 3,
1997. Nephros was founded by health professionals, scientists and engineers affiliated with Columbia University to develop advanced
End Stage Renal Disease (“ESRD”) therapy technology and products. The Company has two products in the hemodiafiltration
(“HDF”) modality to deliver therapy for ESRD patients. These are the OLpūr mid-dilution HDF filter or “dialyzer,”
designed expressly for HDF therapy, and the OLpūr H2H HDF module, an add-on module designed to allow the most common types
of hemodialysis machines to be used for HDF therapy. In 2009, the Company introduced its Dual Stage Ultrafilter (“DSU”)
water filter, which represented a new and complementary product line to the Company’s ESRD therapy business. The DSU incorporates
the Company’s unique and proprietary dual stage filter architecture.
On
June 4, 2003, Nephros International Limited was incorporated under the laws of Ireland as a wholly-owned subsidiary of the Company.
In August 2003, the Company established a European Customer Service and financial operations center in Dublin, Ireland.
The
U.S. facilities, located at 41 Grand Avenue, River Edge, New Jersey, 07661, are used to house the Company’s corporate headquarters
and research facilities.
Note
2 - Basis of Presentation and Going Concern
Interim
Financial Information
The
accompanying unaudited condensed consolidated interim financial statements of Nephros, Inc. and its wholly owned subsidiary, Nephros
International Limited, should be read in conjunction with the audited consolidated financial statements and notes thereto included
in the Company’s 2016 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”)
on March 20, 2017. The accompanying consolidated financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with
the instructions to Form 10-Q and Article 8 and Article 10 of Regulation S-X. Accordingly, since they are interim statements,
the accompanying condensed consolidated interim financial statements do not include all of the information and notes required
by GAAP for a complete financial statement presentation. The condensed consolidated balance sheet as of December 31, 2016 was
derived from the Company’s audited consolidated financial statements but does not include all disclosures required by GAAP.
In the opinion of management, the condensed consolidated interim financial statements reflect all adjustments consisting of normal,
recurring adjustments that are necessary for a fair presentation of the financial position, results of operations and cash flows
for the condensed consolidated interim periods presented. Interim results are not necessarily indicative of results for a full
year. All intercompany transactions and balances have been eliminated in consolidation.
Use
of Estimates
The
preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, at the date of
the financial statements, and the reported amount of revenues and expenses, during the reporting period. Actual results could
differ materially from those estimates. Included in these estimates are assumptions about the collection of accounts receivable,
value of inventories, useful life of fixed assets and intangible assets, assumptions used in determining stock compensation such
as expected volatility and risk-free interest rate and the ability of the Company to continue as a going concern.
Going
Concern
The
accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.
The Company’s recurring losses and difficulty in generating sufficient cash flow to meet its obligations and sustain its
operations raise substantial doubt about its ability to continue as a going concern. The Company’s consolidated financial
statements do not include any adjustments that might result from the outcome of this uncertainty.
The
Company has incurred significant losses in operations in each quarter and has not generated positive cash flow from operations
since inception. To become profitable, the Company must increase revenue substantially and achieve and maintain income from operations.
If the Company is not able to increase revenue and generate income from operations sufficiently to achieve profitability, its
results from operations and its financial condition will be materially and adversely affected.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
On
March 22, 2017, the Company raised gross proceeds of approximately $1,218,000 through the private placement of 4,059,994 units
of its securities. See Note 12 for further discussion.
Based
on the Company’s current cash flow projections, the Company expects that its existing cash balances and projected increase
in product sales from the launch of new products, including the approximately $1.2 million raised in a private placement in March
2017, will allow the Company to fund its operations at least into 2018, if not longer, depending on the timing and market acceptance
of our new products. There can be no assurance that the Company’s future cash flow will be sufficient to meet its obligations
and commitments. If the Company is unable to generate sufficient cash flow from operations in the future to meet its operating
requirements and other commitments, the Company will be required to adopt alternatives, such as seeking to raise debt or equity
capital, curtailing its planned activities or ceasing its 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 the Company to continue to satisfy
its capital requirements.
Recently
Adopted Accounting Pronouncements
In
July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 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 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 adopted ASU 2015-11 during the
three months ended March 31, 2017 and the adoption of this guidance did not have a significant impact on the Company’s consolidated
financial statements.
In
November 2015, the FASB issued ASU No. 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 adopted ASU 2015-17 during the three months ended March 31, 2017
and the adoption of this guidance did not have a significant impact on the Company’s consolidated financial statements.
In
March 2016, the FASB issued ASU No. 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 adopted ASU 2015-17 during
the three months ended March 31, 2017 and elected to recognize forfeitures as they occur. Prior to the adoption of ASU 2016-09,
the Company recognized stock based compensation based on the estimated fair value of the award, net of expected forfeitures. As
of January 1, 2017, a cumulative effect adjustment of approximately $12,000 was recognized to reflect the forfeiture rate that
had been applied to unvested option awards prior to fiscal year 2017.
Note
3 - Major Customers and Concentration of Credit Risk
For
the three months ended March 31, 2017 and 2016, the following customers accounted for the following percentages of the Company’s
sales, respectively:
Customer
|
|
2017
|
|
|
2016
|
|
A
|
|
|
25
|
%
|
|
|
17
|
%
|
B
|
|
|
13
|
%
|
|
|
42
|
%
|
C
|
|
|
10
|
%
|
|
|
2
|
%
|
D
|
|
|
9
|
%
|
|
|
11
|
%
|
As
of March 31, 2017 and December 31, 2016, the following customers accounted for the following percentages of the Company’s
accounts receivable, respectively:
Customer
|
|
2017
|
|
|
2016
|
|
A
|
|
|
22
|
%
|
|
|
36
|
%
|
B
|
|
|
14
|
%
|
|
|
12
|
%
|
C
|
|
|
11
|
%
|
|
|
6
|
%
|
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
The
Company provides credit terms to customers in connection with purchases of the Company’s products. Management periodically
reviews customer account activity in order to assess the adequacy of the allowances provided for potential collection issues and
returns. Adjustments, if any, are made to reserve balances following the completion of these reviews to reflect management’s
best estimate of potential losses. The allowance for doubtful accounts was approximately $52,000 and $50,000 as of March 31, 2017
and December 31, 2016, respectively.
Note
4 - Revenue Recognition
Revenue
is recognized in accordance with Accounting Standards Codification (“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 or determinable; and (iv) collectability is reasonably assured.
The
Company recognizes revenue related to product sales when delivery is confirmed by its external logistics provider and the other
criteria of ASC Topic 605 are met. Product revenue is recorded net of returns and allowances. All costs and duties relating to
delivery are absorbed by the Company. Shipments for all products are currently received directly by the Company’s customers.
Deferred
revenue was approximately $331,000 and $348,000 on the accompanying consolidated balance sheets as of March 31, 2017 and December
31, 2016, respectively, and is related to the License Agreement with Bellco, which is being deferred over the remainder of the
expected obligation period. The Company has recognized approximately $2,745,000 of license revenue related to the License Agreement
to date and approximately $17,000 for the three months ended March 31, 2017 and 2016, respectively. Approximately $52,000 of revenue
will be recognized in the remaining nine months of fiscal year 2017 and approximately $69,000 of revenue will be recognized in
each of the years ended December 31, 2018 through 2021. Beginning on January 1, 2015, Bellco pays the Company a royalty based
on the number of units of certain products sold per year due one fiscal quarter in arrears. For the three months ended March 31,
2017 and 2016, the Company recognized royalty revenue of approximately $27,000 and $28,000, respectively. See Note 13, Commitments
and Contingencies, for further discussion of the Bellco License Agreement.
Note
5 - Fair Value of Financial Instruments
The
carrying amounts of cash, accounts receivable, accounts payable and accrued expenses approximate fair value due to the short-term
maturity of these instruments.
The
fair value guidance requires fair value measurements be classified and disclosed in one of the following three categories:
●
|
Level
1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets
or liabilities;
|
|
|
●
|
Level
2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially
the full term of the asset or liability;
|
|
|
●
|
Level
3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable
(i.e., supported by little or no market activity).
|
Fair
Value of Investment in Lease, net
The
carrying value of the investment in lease, net, approximates fair value as of March 31, 2017.
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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
6 - Stock Plans and Share-Based Payments (continued)
The
Company granted stock options to purchase 579,571 shares of common stock to an employee during the three months ended March 31,
2017. These stock options will be expensed over their respective applicable vesting periods, which are based on service and performance
conditions. The fair value of all stock-based awards granted during the three months ended March 31, 2017 was approximately $223,000.
The
fair value of stock-based awards is amortized over the vesting period of the award. For stock-based awards that vest based on
performance conditions (e.g., achievement of certain milestones), expense is recognized when it is probable that the condition
will be met. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.
The below assumptions for the risk-free interest rates, expected dividend yield, expected lives and expected stock price volatility
were used for the awards granted during the three months ended March 31, 2017.
|
|
Three
Months Ended
|
|
Assumptions
for Option Grants
|
|
|
March
31, 2017
|
|
Stock Price Volatility
|
|
|
110.9
|
%
|
Risk-Free Interest Rates
|
|
|
2.08
|
%
|
Expected Life (in years)
|
|
|
6.01
|
|
Expected Dividend Yield
|
|
|
-
|
%
|
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. 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. As
a result of adopting ASU 2016-09, the Company has elected to recognize forfeitures as they occur.
Stock-based
compensation expense was approximately $102,000 for each of the three months ended March 31, 2017 and 2016. For the three months
ended March 31, 2017, approximately $94,000 and approximately $8,000 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 March 31, 2016, approximately $95,000 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.
There
was no tax benefit related to expense recognized in the three months ended March 31, 2017 and 2016, as the Company is in a net
operating loss position. As of March 31, 2017, there was approximately $1,100,000 of total unrecognized compensation cost related
to unvested share-based compensation awards granted under the equity compensation plans. Approximately $211,000 of the $1,100,000
total unrecognized compensation will be recognized at the time that certain performance conditions are met. The remaining unrecognized
compensation expense of approximately $889,000 will be amortized over the weighted average remaining requisite service period
of 2.1 years. Such amount does not include the effect of future grants of equity compensation, if any.
Restricted
Stock
On
March 31, 2017, the Company issued 17,756 shares of restricted stock as compensation for services to its chief executive officer
in consideration of deferred cash salary of $7,000 for the three months ended March 31, 2017. The grant date fair value of the
outstanding restricted stock awards was approximately $7,000.
Total
stock based compensation for the restricted stock grants was approximately $97,000 and $45,000 for the three months ended March
31, 2017 and 2016, respectively, and is included in Selling, General and Administrative expenses on the accompanying condensed
consolidated statement of operations and comprehensive loss. As of March 31, 2017, there was approximately $88,000 of unrecognized
compensation expense related to the restricted stock awards, which is expected to be recognized over the next three to six months,
dependent upon the respective restricted stock grant dates.
Note
7 - Warrants
There
were no warrants exercised during the three months ended March 31, 2017. For the three months ended March 31, 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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
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 the change in the fair value of the warrant liability by the weighted average number
of common shares issued and outstanding for the period, plus amounts representing the dilutive effect from the exercise of stock
options and warrants, as applicable. 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:
|
|
March
31,
|
|
|
|
|
2017
|
|
|
|
2016
|
|
Shares underlying warrants
outstanding
|
|
|
7,432,342
|
|
|
|
917,149
|
|
Shares underlying options outstanding
|
|
|
5,040,306
|
|
|
|
4,192,640
|
|
Unvested restricted stock
|
|
|
584,467
|
|
|
|
356,231
|
|
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 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 No. 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date”.
The amendment in this ASU defers the effective date of ASU No. 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. Earlier application is permitted only as
of fiscal years beginning after December 31, 2016, including interim reporting periods with that fiscal year. The Company is currently
reviewing the revised guidance and assessing the potential impact on its consolidated financial statements.
In
January 2016, the FASB issued ASU No. 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 consolidated financial statements.
In
February 2016, the FASB issued ASU No. 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 the Company 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. 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 assessing the impact that adopting this new accounting guidance will have 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 consolidated financial
statements.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
9 - Recent Accounting Pronouncements (continued)
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 consolidated 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.
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.
In
November 2016, the FASB issued ASU 2016-17, “Restricted Cash,” which clarifies how restricted cash is presented and
classified in the statement of cash flows. 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.
In
January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business,” which clarifies the definition
of a business in a business combination. 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.
In
January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” which simplifies the test
for goodwill impairment. The guidance is effective for the Company beginning in the first quarter of fiscal year 2020. Early adoption
is permitted for interim or annual goodwill impairments tests after January 1, 2017. 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 net realizable value using the first-in first-out method and consists entirely of finished goods.
The Company’s inventory as of March 31, 2017 and December 31, 2016 was as follows:
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
Total gross inventory, finished
goods
|
|
$
|
447,000
|
|
|
$
|
528,000
|
|
Less: inventory
reserve
|
|
|
(46,000
|
)
|
|
|
(49,000
|
)
|
Total inventory,
net
|
|
$
|
401,000
|
|
|
$
|
479,000
|
|
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
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 gross proceeds
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 gross
proceeds of approximately $794,000, net of the remainder of the fees of approximately $9,000, 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. For the three months ended March 31, 2017,
approximately $26,000 was recognized as amortization of debt discount and is included in interest expense on the condensed consolidated
interim statement of operations and comprehensive loss. For the three months ended March 31, 2017, approximately $33,000 of interest
expense has been accrued. As of March 31, 2017, 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 March 31, 2016.
Note
12 – Stockholders’ Equity
March
2017 Private Placement
On March 22, 2017, the Company raised gross
proceeds of approximately $1,218,000 from new and existing shareholders through the private placement of 4,059,994 units
of its securities. Each unit consisted of one share of its common stock and a five-year warrant to purchase one share of the Company’s
common stock. The purchase price for each unit was $0.30. The 4,059,994 warrants are exercisable at a price of $0.30 per share
and are indexed to the Company’s common stock, therefore, the Company is accounting for the warrants as a component of equity.
The portion of the gross proceeds received from certain members of management and existing shareholders amounted to $315,000.
Proceeds, net of equity issuance costs of $144,000, recorded as a result of the private placement were approximately $1,074,000.
In addition to the equity issuance costs incurred as a result of the private placement, the Company also issued 81,199 warrants
to its placement agent. The form of the 81,199 warrants is substantially the same as the 4,059,994 warrants, except that the exercise
price is $0.33 per share.
July
2015 Purchase Agreement and Registration Rights Agreement
On
July 24, 2015, the Company entered into a purchase agreement, together with a registration rights agreement, with Lincoln Park
Capital Fund, LLC (“Lincoln Park”), an Illinois limited liability company. Under the terms and subject to the conditions
of the purchase agreement, the Company has the right to sell to and Lincoln Park is obligated to purchase up to $10.0 million
in shares of its common stock, subject to certain limitations, from time to time, over the 36-month period commencing on September
4, 2015. Pursuant to the Purchase Agreement, during the three months ended March 31, 2017, the Company issued and sold 300,000
shares of common stock to Lincoln Park resulting in gross proceeds of $113,000.
Note
13 - Commitments and Contingencies
Manufacturing
and Suppliers
The
Company has not and does not intend in the foreseeable 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 our 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 its 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 our written approval, other European countries where the Company does not sell the Products
as well as non-European countries (referred to as the “Territory”).
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, on an exclusive basis, Sweden, Denmark, Norway and Finland, and, on a non-exclusive
basis, 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 (approximately $1.87 using current exchange rates) per unit; thereafter, €1.25 (approximately $1.34
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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
13 - Commitments and Contingencies (continued)
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.
Our aggregate purchase commitments totaled approximately €1,200,000 (approximately $1,300,000) and €999,000 (approximately
$1,119,000) for the years ended December 31, 2016 and 2015, respectively. The Company and Medica formalized the agreed upon
minimum purchase level for calendar years 2017 through 2022 (see Note 14). 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 at
the time of their issuance, calculated as described in Note 6 under Stock-Based Compensation. Together with the total installment
payments described above, the fair market value of the options has been capitalized as license and supply agreement, net. The
gross value of the intangible asset capitalized was approximately $2,250,000. License and supply agreement, net, on the consolidated
balance sheet is approximately $1,210,000 and $1,262,000, as of March 31, 2017 and December 31, 2016, respectively. Accumulated
amortization is approximately $1,040,000 and $988,000 as of March 31, 2017 and December 31, 2016, respectively. The asset is being
amortized as an expense over the life of the License and Supply Agreement. Approximately $52,000 has been charged to amortization
expense for the three months ended March 31, 2017 and 2016 on the condensed consolidated statement of operations and comprehensive
loss. Approximately $158,000 of amortization expense will be recognized in the remainder of 2017 and approximately $210,000 will
be recognized in each of the years ended December 31, 2018 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. Approximately $19,000
and $18,000 is included in accrued expenses as of March 31, 2017 and December 31, 2016, 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 months ended March 31, 2017 and 2016, approximately $7,000 and $14,000 of interest, respectively, was recognized
as interest expense.
In May 2017, the Company and Medica amended
the License and Supply Agreement to re-define the licensed territory, expand the Medica technology included within the license
to the Company, and establish minimum purchase requirements for the period from 2017 to 2022. See Note 14 – Subsequent Event.
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 on the condensed consolidated balance sheet as
of March 31, 2017 and December 31, 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 March 31, 2017 and 2016, respectively.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
13 - Commitments and Contingencies (continued)
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 direct financing 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. Approximately $1,000 was recognized
in interest income during each of the three months ended March 31, 2017 and 2016. As of March 31, 2017, investment in lease,
current is approximately $21,000, net of unearned interest of $4,000. As of March 31, 2017, investment in lease, noncurrent,
is approximately $57,000, net of unearned interest of $5,000.
As
of March 31, 2017, scheduled maturities of minimum lease payments receivable were as follows:
2016
|
|
|
2,000
|
|
2017
|
|
|
18,000
|
|
2018
|
|
|
18,000
|
|
2019
|
|
|
19,000
|
|
2020
|
|
|
21,000
|
|
|
|
|
78,000
|
|
Less:
Current portion
|
|
|
(21,000
|
)
|
Investment
in sales-type lease, noncurrent
|
|
$
|
57,000
|
|
Included
in the above scheduled maturities of minimum lease payments receivable, approximately $7,000 was due as of March 31, 2017.
Note
14 – Subsequent Event
On
May 5, 2017, the Company entered into a Third Amendment to License and Supply Agreement (the “Third Amendment”) with
Medica, which amended the original License and Supply Agreement, dated April 23, 2012 (as amended, the “License and Supply
Agreement”). Pursuant to the Third Amendment, Medica expanded the products covered by the original License and Supply Agreement
to include both certain filtration products based on Medica’s proprietary Versatile microfiber technology and certain filtration
products based on Medica’s proprietary Medisulfone ultrafiltration technology (collectively, the “Filtration Products”).
The Third Amendment also limits the territory in which Medica granted the Company an exclusive license, with right of sublicense,
to market, promote, distribute, offer for sale, and sell the Filtration Products to North America, Central America, Columbia,
Venezuela, Chile, Ecuador, Peru, Ireland, the United Kingdom, Australia and New Zealand. The Company’s multinational distributors
retain the right to market certain of the products worldwide, other than in Italy, on a non-exclusive basis.
In
exchange for the rights granted, the Company has agreed to make minimum annual aggregate purchases from Medica of €1,600,000
(approximately $1,700,000 using current exchange rates), €2,500,000 (approximately $2,700,000 using current exchange rates),
€3,000,000 (approximately $3,300,000 using current exchange rates), €3,150,000 (approximately $3,400,000 using current
exchange rates), €3,300,000 (approximately $3,600,000 using current exchange rates), and €3,475,000 (approximately $3,800,000
using current exchange rates) in each of calendar years 2017, 2018, 2019, 2020, 2021 and 2022, respectively.
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, 2016, 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, 2016. 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 are 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 projected increase in product sales from the
launch of new products, including the approximately $1.2 million raised in a private placement in March 2017, will allow us to
fund our operations at least into 2018, if not longer, depending on the timing and market acceptance of our new products. 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 meet our operating requirements and other commitments, we will
be required to adopt alternatives, such as seeking to raise debt or equity capital, curtailing its planned activities or ceasing
its 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 United States 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 United
States 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 United States, HDF is much more prevalent in Europe
and is performed in a growing number 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, is 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.
Both
DaVita Healthcare Partners and the Renal Research Institute, a research division of Fresenius Medical Care, have conducted an
evaluation of our hemodiafiltration system in their clinics. We 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.
Vanderbilt
University began treating patients with our HDF Systems early in 2017. 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 United States in 2013. The U.S. 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.
We
currently have 510(k) clearance on the following portfolio of medical device products for use in the hospital setting to aid in
infection control:
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The
DSU-H is an in-line, 0.005 micron ultrafilter that provides dual-stage protection from water borne pathogens. The DSU-H is
primarily used to filter potable water feeding ice machines, sinks and medical equipment, such as endoscope washers and surgical
room humidifiers. The DSU-H has an up to 6 month product life when used in the hospital setting.
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The
SSU-H is a 0.005 micron ultrafilters that provides single-stage protection from water borne pathogens. The SSU-H is primarily
used to filter potable water feeding sinks, showers and medical equipment. The SSU-H has an up to 3 month product life when
used in the hospital setting.
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The
S100 is a Point of Use, 0.01 micron microfilter that provides protection from water borne pathogens. The S100 is primarily
used to filter potable water at sinks and showers. The S100 has an up to 3 month product life when used in the hospital setting.
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The
HydraGuard is a 0.005 micron cartridge ultrafilter that provides single-stage protection from water borne pathogens. The HydraGuard
is primarily used to filter potable water feeding ice machines and medical equipment, such as endoscope washers and surgical
room humidifiers. The HydraGuard has an up to 6 month product life when used in the hospital setting.
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We
received 510(k) clearance from the FDA to market the HydraGuard in December 2016, and we expect to begin shipping the HydraGuard
in May of 2017, ramping to full production in the third quarter of 2017.
In
the third quarter of 2017, we expect to launch a flushable version of the HydraGuard with an up to 12 month product life.
The
complete hospital infection control product line, including in-line, point of use and cartridge 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.
We
currently have 510(k) clearance on the following portfolio of medical device products for use in the dialysis setting to aid in
bacteria, virus and endotoxin retention:
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The
DSU-D, SSU-D and SSUmini are in-line, 0.005 micron ultrafilters that provide protection from bacteria, virus and endotoxins.
The DSU-D, SSU-D and SSUmini all have an up to 12 month product life in the dialysis setting and are used to filter water
following treatment with a reverse osmosis (“RO”) system and to filter bicarbonate concentrate. The ultrafilters
are primarily used in the water lines and bicarbonate concentrate lines leading into dialysis machines, and as a polish filter
for portable RO machines.
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EndoPur
is a 0.005 micron cartridge ultrafilter that provides single-stage protection from bacteria, virus and endotoxins. The EndoPur
has an up to 12 month product life in the dialysis setting and is used to filter water following treatment with a RO system.
Specifically, the EndoPur is primarily used to filter water in large RO systems designed to provide ultrapure water to an
entire dialysis clinic.
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In
March 2017, we received 510(k) clearance from the FDA to market the EndoPur 10” filter. We expect to begin shipping the
EndoPur 10” filter late in the second quarter of 2017, and the 20” and 30” versions of the filter early in August
2017.
Military
and Outdoor Recreation
. 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.
In
May 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. During the fiscal year ended December 31, 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 based on our filter’s ability to meet the NSF Protocol P248 standard. 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
and Industrial Facilitie
s. We currently market the following portfolio of proprietary products for use in the commercial,
industrial and food service setting:
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The
NanoGuard-D is an in-line, 0.005 micron ultrafilter that provides dual-stage retention of any organic or inorganic particle
larger than 15,000 Daltons. The NanoGuard-D is primarily used to filter potable water feeding ice machines, sinks and equipment
that requires or benefits from ultrafiltered water, and filters up to 10,000 gallons of potable water, depending upon the
particle load.
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The
NanoGuard-S is an in-line, 0.005 micron ultrafilter that provides single-stage retention of any organic or inorganic particle
larger than 15,000 Daltons. The NanoGuard-S is primarily used to filter potable water feeding ice machines, sinks, showers
and equipment that requires or benefits from ultrafiltered water, and filters up to 3,000 gallons of potable water, depending
upon the particle load.
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The
NanoGuard-E is a 0.005 micron ultrafilter cartridge that plugs into an Everpure® filter manifold and provides single-stage
retention of any organic or inorganic particle larger than 15,000 Daltons. The NanoGuard-E is primarily used to filter potable
water feeding ice machines and equipment that requires or benefits from ultrafiltered water, and filters up to 10,000 gallons
of potable water, depending upon the particle load.
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The
NanoGuard-C is a 0.005 micron cartridge ultrafilter that fits with most 10”, 20”, 30” and 40” cartridge
housings and provides single-stage retention of any organic or inorganic particle larger than 15,000 Daltons. The NanoGuard-C
is primarily used to filter potable water feeding ice machines and equipment that requires or benefits from ultrafiltered
water, and filters up to 10,000 gallons of potable water per 10” of length, depending upon the particle load.
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The
NanoGuard-F is a 0.005 micron flushable cartridge ultrafilter that comes in 10” or 20” sizes and provides single-stage
retention of any organic or inorganic particle larger than 15,000 Daltons. The NanoGuard-F is primarily used to filter potable
water feeding ice machines, sinks and equipment that requires or benefits from ultrafiltered water. The NanoGuard-F has an
up to 12 month product life and can filter up to 2.5 gallons per minute per 10” length, depending upon the particle
load.
|
In
April 2017, we announced a partnership with WorldWater & Solar Technology to provide ultrafiltration capabilities to their
drinking water systems. This partnership centers on our NanoGuard-F product line.
In
the third quarter of 2017, we expect to launch a lead filtration system that will address both soluble and particulate lead in
potable water, with the ability to treat up to 10,000 gallons of water between filter change-outs.
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. Our strategic distribution
partners who place our filters in hospitals and medical facilities, also support a wide range of commercial and industrial customers.
We believe that our existing distributor relationships will facilitate growth in filter sales outside of the medical industry.
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 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, 2016. Other than the adoption of ASU
No. 2016-09, “Improvements to Employee Share-Based Payment Accounting” by which the Company elected to recognize forfeitures
of share based awards as they occur, 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, 2016.
In
March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 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.
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 fiscal years. Early adoption
was not permitted. In August, 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers: Deferral of
the Effective Date”. The amendment in this ASU defers the effective date of ASU No. 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. Earlier
application is permitted only as of fiscal years beginning after December 31, 2016, including interim reporting periods with that
fiscal year. We are continuing to evaluate the impact of the new revenue guidance. The majority of our revenue relates to the
sale of finished product to various customers and we do not believe that the adoption of the new standard will have a material
impact on these transactions. We are continuing to evaluate the impact of certain less significant transactions involving collaborative
arrangements. We expect to adopt the standard in fiscal year 2018 using the modified retrospective approach.
In
January 2016, the FASB issued ASU No. 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
consolidated financial statements.
In
February 2016, the FASB issued ASU No. 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 No. 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 consolidated
financial statements.
In
April 2016, the FASB issued ASU No. 2016-10, “Identifying Performance Obligations and Licensing,” which clarifies
the implementation guidance 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 consolidated 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 our consolidated 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 our 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.
In
November 2016, the FASB issued ASU 2016-17, “Restricted Cash,” which clarifies how restricted cash is presented and
classified in the statement of cash flows. 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.
In
January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business,” which clarifies the definition
of a business in a business combination. 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.
In
January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” which simplifies the test
for goodwill impairment. The guidance is effective for us beginning in the first quarter of fiscal year 2020. Early adoption is
permitted for interim or annual goodwill impairments tests after January 1, 2017. 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 March 31, 2017 Compared to the Three Months Ended March 31, 2016
Revenues
Total
net revenues for the three months ended March 31, 2017 were approximately $734,000 compared to approximately $590,000 for the
three months ended March 31, 2016, an increase of approximately $144,000 or 24%. This increase was primarily driven by an increase
in the number of filters sold in 2017 versus in 2016.
Cost
of Goods Sold
Cost
of goods sold was approximately $279,000 for the three months ended March 31, 2017 compared to approximately $295,000 for the
three months ended March 31, 2016, a decrease of approximately $16,000, or 5%. The decrease was related to an adjustment to the
inventory reserve during the three months ended March 31, 2016 for which there was no comparable adjustment recognized during
the three months ended March 31, 2017.
Research
and Development
Research
and development expenses were approximately $231,000 and $269,000 for the three months ended March 31, 2017 and March 31, 2016,
respectively. This decrease of approximately $46,000, or 17%, is primarily due to a decrease in full-time research and development
employees during the three months ended March 31, 2017 compared to the three months ended March 31, 2016.
Depreciation
and Amortization Expense
Depreciation
and amortization expense was approximately $59,000 for the three months ended March 31, 2017 compared to approximately $55,000
for the three months ended March 31, 2016. Amortization expense related to the asset recognized in conjunction with the License
and Supply Agreement with Medica S.p.A was $52,000 for each of the three months ended March 31, 2017 and 2016. The remaining $7,000
and $3,000 recognized in the three months ended March 31, 2017 and 2016, respectively, was depreciation on equipment and tools.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were approximately $770,000 for the three months ended March 31, 2017 compared to approximately
$777,000 for the three months ended March 31, 2016, a decrease of approximately $7,000, or 1%. The decrease is primarily due to
decreased professional service fees, including regulatory consulting, legal and marketing services, which were offset partially
by additional salary and benefit expenses for increased selling, general and administrative personnel.
Interest
Expense
Interest
expense of approximately $66,000 for the three months ended March 31, 2017 consisted of approximately $33,000 of interest related
to the June 2016 Note and Warrant Agreement, approximately $26,000 related the amortization of debt discount and approximately
$7,000 of interest due on outstanding payables to a vendor. Interest expense of approximately $14,000 for the three months ended
March 31, 2016 relates to interest due on outstanding payables owed to a vendor.
Interest
Income
Interest
income of approximately $1,000 for each of the three months ended March 31, 2017 and 2016 relates to interest income recognized
on a lease receivable.
Other
Income (Expense)
Other
income (expense) relates to foreign currency gains and losses on invoices paid to an international supplier. Foreign currency
losses of approximately $10,000 and $17,000, respectively, were recognized for the three months ended March 31, 2017 and March
31, 2016.
Liquidity
and Capital Resources
The
following table summarizes our liquidity and capital resources as of March 31, 2017 and 2016 and is intended to supplement the
more detailed discussion that follows. The amounts stated are expressed in thousands.
Liquidity
and capital resources
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
Cash
|
|
$
|
803
|
|
|
$
|
275
|
|
Other current assets
|
|
|
1,125
|
|
|
|
989
|
|
Working capital surplus
|
|
|
1,148
|
|
|
|
(
369
|
)
|
Stockholders’ equity
|
|
|
1,374
|
|
|
|
(
667
|
)
|
At
March 31, 2017, we had an accumulated deficit of approximately $120,977,000 and we expect to incur additional operating losses
in the foreseeable future at least until such time, if ever, that we are able to increase product sales or license revenue. We
have financed our operations since inception primarily through the private placements of equity and debt securities, our initial
public offering, license revenue, and rights offerings.
Our
future liquidity sources and requirements will depend on many factors, including:
●
|
the
availability of additional financing, through the sale of equity securities or otherwise, on commercially reasonable terms
or at all;
|
|
|
●
|
the
market acceptance of our products, and our ability to effectively and efficiently produce and market our products;
|
|
|
●
|
the
continued progress in, and the costs of, clinical studies and other research and development programs;
|
|
|
●
|
the
costs involved in filing and enforcing patent claims and the status of competitive products; and
|
|
|
●
|
the
cost of litigation, including potential patent litigation and any other actual or threatened litigation.
|
We
expect to put our current capital resources to the following uses:
●
|
for
the marketing and sales of our water-filtration products;
|
|
|
●
|
to
pursue business development opportunities with respect to our chronic renal treatment system; and
|
|
|
●
|
for
working capital purposes.
|
At
March 31, 2017, we had cash totaling approximately $803,000 and total assets of approximately $2,069,000, excluding other intangible
assets (related to the Medica License and Supply Agreement) of approximately $1,210,000.
Based
on our current cash flow projections, we expect that our existing cash balances and projected increase in product sales from the
launch of new products, including the approximately $1.2 million raised in a private placement in March 2017, will allow us to
fund our operations at least into 2018, if not longer, depending on the timing and market acceptance of our new products. 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 meet our operating requirements and other commitments, we will
be required to adopt alternatives, such as seeking to raise debt or equity capital, curtailing its planned activities or ceasing
its 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.
Net
cash used in operating activities was approximately $659,000 for the three months ended March 31, 2017 compared to approximately
$522,000 for the three months ended March 31, 2016. Our net loss was approximately $836,000 for the three months ended March 31,
2016 compared to approximately $680,000 for the three months ended March 31, 2017, a decrease of approximately $156,000.
Offsetting
the decrease in the net loss, the most significant items contributing to the net increase of approximately $137,000 in cash used
in operating activities during the three months ended March 31, 2017 compared to the three months ended March 31, 2016 are highlighted
below:
●
|
our
accounts payable decreased by approximately $226,000 during the 2017 period compared to an decrease of approximately $78,000
during the 2016 period primarily as a result of timing of payments;
|
●
|
our
prepaid expenses increased by approximately $26,000 during the 2017 period compared to an decrease of approximately $7,000
during the 2016 period as a result of timing of payments;
|
|
|
●
|
our
inventory decreased by approximately $78,000 during the 2017 period compared to an decrease of approximately $106,000 during
the 2016 period as a result of managing inventory levels; and
|
|
|
●
|
our
inventory reserve increased by approximately $27,000 during the 2016 period compared to no change during the 2017 period.
|
Partially
offsetting the above changes:
●
|
our
stock-based compensation expense increased approximately $52,000 during the 2017 period compared to the 2016 period related
to an increase in stock-based awards granted as a result of an increase in selling, general and administrative personnel;
and
|
|
|
●
|
our
amortization of debt discount was approximately $26,000 during the 2017 period with no amortization of debt discount recognized
in the 2016 period.
|
There
was no cash used in investing activities for the three months ended March 31, 2017. Net cash used in investing activities was
approximately $26,000 for the three months ended March 31, 2016 as a result of the purchase of property, plant and equipment.
Net
cash provided by financing activities for the three months ended March 31, 2017 was approximately $1,187,000 resulting from the
issuance of common stock. Net cash provided by financing activities during the three months ended March 31, 2016 was approximately
$1,000 as a result of proceeds received from the exercise of warrants.
Off-Balance
Sheet Arrangements
We
do not have any off-balance sheet arrangements as of March 31, 2017 or 2016.