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 expanded into ultrapure water filtration products as a complement to the ESRD therapy business, introducing
its proprietary dual stage ultrafilter architecture. The company has since introduced a variety of ultrafiltration and microfiltration
products that address water quality and infection control in both medical and commercial applications.
The
Company is currently headquartered at 41 Grand Avenue, River Edge, New Jersey 07661, which houses the Company’s executive
offices and research facilities, and has a subsidiary, Nephros International Limited, in Dublin, Ireland.
Note
2 - Basis of Presentation and Going Concern
Interim
Financial Information
The
accompanying unaudited consolidated condensed financial statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form 10-Q and Article 8 and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles
for annual financial statements. Results for the period ended June 30, 2017 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2017.
The
consolidated condensed financial statements and notes thereto should be read in conjunction with the consolidated financial statements
and notes for the year ended December 31, 2016 included in our Annual Report on Form 10-K.
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 inability to generate 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.
In
order to support the Company’s cash needs, management is pursuing a short-term asset-based credit facility with a commercial
lender. In addition, the Company has received approval to sell a portion of its New Jersey net operating loss and research and
development tax credits through a program administered by the New Jersey Economic Development Authority (“NJEDA”),
which the Company anticipates will result in cash proceeds of approximately $1.5 million. Based on the Company’s existing
cash balances, its current cash flow projections, including projected increases in product sales from the launch of new products,
and the anticipated proceeds from the planned short-term asset-based credit facility and NJEDA tax credit program, the Company
believes it will have sufficient cash resources to fund its operations at least into 2018, if not longer. However, these transactions
have not been closed as of the filing date of this Form 10-Q. These estimates are subject to a number of uncertainties, including
the timing and market acceptance of the Company’s new products and the Company’s ability to obtain
the planned short-term credit facility and proceeds from the NJEDA tax credit program. There can be no assurance that
any of such events will occur, or 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, obtain the planned short-term credit facility or obtain the anticipated proceeds from the NJEDA tax credit
program, 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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
3 - Major Customers and Concentration of Credit Risk
For
the three months ended June 30, 2017 and 2016, the following customers accounted for the following percentages of the Company’s
revenues, respectively:
Customer
|
|
2017
|
|
|
2016
|
|
A
|
|
|
16
|
%
|
|
|
10
|
%
|
B
|
|
|
14
|
%
|
|
|
2
|
%
|
C
|
|
|
12
|
%
|
|
|
5
|
%
|
D
|
|
|
12
|
%
|
|
|
19
|
%
|
For
the six months ended June 30, 2017 and 2016, the following customers accounted for the following percentages of the Company’s
revenues, respectively:
Customer
|
|
2017
|
|
|
2016
|
|
A
|
|
|
21
|
%
|
|
|
14
|
%
|
B
|
|
|
13
|
%
|
|
|
23
|
%
|
C
|
|
|
11
|
%
|
|
|
10
|
%
|
D
|
|
|
11
|
%
|
|
|
8
|
%
|
As
of June 30, 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
|
|
|
13
|
%
|
|
|
12
|
%
|
C
|
|
|
13
|
%
|
|
|
6
|
%
|
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 $27,000 and $50,000 as of June 30, 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 product is shipped via external logistics provider and the other criteria
of ASC Topic 605 are met. Product revenue is recorded net of returns and allowances. Shipments for all products are currently
received directly by the Company’s customers.
License
Agreement Revenue
Deferred
revenue was approximately $313,000 and $348,000 on the accompanying consolidated balance sheets as of June 30, 2017 and December
31, 2016, respectively, and is related to the Company’s License Agreement with Bellco (see Note 13, below), which is being
deferred over the remainder of the expected obligation period. The Company has recognized approximately $2,763,000 of revenue
related to the Bellco License Agreement to date and approximately $18,000 and $35,000, respectively, for the three and six months
ended June 30, 2017. The Company recognized approximately $17,000 and $34,000, respectively, of revenue related to this License
Agreement for the three and six months ended June 30, 2016. Approximately $34,000 of revenue will be recognized in the remaining
six 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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
For
the three months ended June 30, 2017 and 2016, the Company recognized royalty revenue from Bellco of approximately $31,000 and
$29,000, respectively. For the six months ended June 30, 2017 and 2016, the Company recognized royalty revenue of approximately
$58,000 and $57,000, 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
carrying value of the investment in lease, net, approximates fair value as of June 30, 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.
During
the three and six months ended June 30, 2017, the Company granted stock options to purchase 418,709 shares and 998,280 shares,
respectively of common stock to an employee. 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 June 30, 2017 was approximately $98,000. The fair value of all stock-based awards granted during the six months ended June
30, 2017 was approximately $321,000.
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 weighted average 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 six months ended June 30, 2017.
Assumptions
for Option Grants
|
|
Six
Months
Ended
June 30, 2017
|
|
Stock Price Volatility
|
|
|
108.0
|
%
|
Risk-Free Interest Rates
|
|
|
2.04
|
%
|
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 for the Three Months Ended June 30, 2017
Stock-based
compensation expense was approximately $111,000 and $92,000 for the three months ended June 30, 2017 and 2016, respectively. For
the three months ended June 30, 2017, approximately $103,000 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 June 30, 2016, approximately $84,000 and approximately $8,000 are included
in Selling, General and Administrative expenses and Research and Development expenses, respectively, on the accompanying condensed
consolidated statements of operations and comprehensive loss.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Stock-Based
Compensation for the Six Months Ended June 30, 2017
Stock-based
compensation expense was approximately $213,000 and $194,000 for the six months ended June 30, 2017 and 2016, respectively. For
the six months ended June 30, 2017, approximately $194,000 and approximately $19,000 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 six months ended June 30, 2016, approximately $179,000 and approximately $15,000 are included
in Selling, General and Administrative expenses and Research and Development expenses, respectively, on the accompanying condensed
consolidated statements of operations and comprehensive loss.
There
was no tax benefit related to expense recognized in the six months ended June 30, 2017 and 2016, as the Company is in a net operating
loss position. As of June 30, 2017, there was approximately $1,087,000 of total unrecognized compensation cost related to unvested
share-based compensation awards granted under the equity compensation plans. Approximately $230,000 of the $1,087,000 total unrecognized
compensation will be recognized at the time that certain performance conditions are met. The remaining unrecognized compensation
expense of approximately $857,000 will be amortized over the weighted average remaining requisite service period of 1.9 years.
Such amount does not include the effect of future grants of equity compensation, if any.
Restricted
Stock
During
the six months ended June 30, 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. The grant date fair value of the outstanding restricted
stock awards was approximately $7,000.
Total
stock-based compensation expense for the restricted stock grants was approximately $85,000 and $35,000 for the three months ended
June 30, 2017 and 2016, respectively, and is included in Selling, General and Administrative expenses on the accompanying condensed
consolidated statements of operations and comprehensive loss.
Total
stock-based compensation expense for the restricted stock grants was approximately $182,000 and $79,000 for the six months ended
June 30, 2017 and 2016, respectively, and is included in Selling, General and Administrative expenses on the accompanying condensed
consolidated statements of operations and comprehensive loss.
As
of June 30, 2017, there was approximately $3,000 of unrecognized compensation expense related to the restricted stock awards,
which is expected to be recognized over the next three months, dependent upon the respective restricted stock grant dates.
Note
7 - Warrants
There
were no warrants exercised during the six months ended June 30, 2017. For the six months ended June 30, 2016, 19,621 warrants
were exercised, resulting in proceeds of approximately $1,000 and the issuance of 906 shares of the Company’s common stock.
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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
The
following potentially dilutive securities have been excluded from the computations of diluted weighted-average shares outstanding
as they would be anti-dilutive:
|
|
June
30,
|
|
|
|
2017
|
|
|
2016
|
|
Shares underlying warrants
outstanding
|
|
|
7,432,342
|
|
|
|
3,291,149
|
|
Shares underlying options outstanding
|
|
|
5,459,015
|
|
|
|
4,222,640
|
|
Unvested restricted stock
|
|
|
17,756
|
|
|
|
128,234
|
|
Note
9 - Recent Accounting Pronouncements
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 2016-09
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.
Recent
Accounting Pronouncements, Not Yet Effective
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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM 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 assessing 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.
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 assessing 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 assessing 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 assessing 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 assessing 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 assessing the impact of adopting
this guidance on its consolidated financial statements.
In
May 2017, the FASB issued ASU 2017-09, “Scope of Modification Accounting,” which clarifies the application of stock
based accounting guidance when a change is made to the terms or conditions of a share-based payment award. The guidance is effective
for the Company beginning in the first quarter of fiscal year 2018. Early adoption is permitted. The Company is assessing the
impact of adopting this guidance on its consolidated financial statements.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
Note
10 - Inventory, net
Inventory
is stated at the lower of cost or net realizable value using the standard cost method and consists entirely of finished goods.
The Company’s inventory as of June 30, 2017 and December 31, 2016 was as follows:
|
|
June
30, 2017
|
|
|
December
31, 2016
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
Total gross inventory, finished
goods
|
|
$
|
646,000
|
|
|
$
|
528,000
|
|
Less: inventory
reserve
|
|
|
(43,000
|
)
|
|
|
(49,000
|
)
|
Total inventory,
net
|
|
$
|
603,000
|
|
|
$
|
479,000
|
|
Note
11 - Unsecured Promissory Notes and Warrants
On
June 7, 2016, the Company entered into a Note and Warrant Purchase Agreement (the “2016 Purchase Agreement”) with
certain accredited investors identified therein under which the Company issued and sold unsecured promissory notes (“Notes”)
and common stock warrants (“Warrants”) resulting in total gross proceeds to the Company of approximately $1,187,000
over multiple closings under the Purchase Agreement during June 2016. 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 in June 2019, the third anniversary of the date of issuance. In connection with
the transactions contemplated by the 2016 Purchase Agreement, the Company incurred approximately $13,000 in legal fees.
In
addition to the Notes, the Company issued Warrants to purchase approximately 2.4 million shares of the Company’s common
stock to the Note investors. The Warrants are exercisable at $0.30 per share for a period of 5 years from the issuance date. The
Warrants issued under the 2016 Purchase Agreement are indexed to the Company’s common stock, therefore, the Company is accounting
for the Warrants as a component of equity.
The
approximately $1,187,000 in gross proceeds from the 2016 Purchase 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 2016 Purchase Agreement.
For
the three and six months ended June 30, 2017, approximately $27,000 and $54,000, respectively, 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 and six months ended June 30, 2016, approximately $6,000 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 and six months ended June 30, 2017, approximately $33,000 and $66,000, respectively, of interest expense has been incurred.
As of June 30, 2017, approximately $12,000 is included in accrued expenses on the condensed consolidated interim balance sheet.
As of June 30, 2017 and December 31, 2016, the portion of the outstanding unsecured promissory notes due to entities controlled
by a member of management and to the majority shareholder amounted to $30,000 and $300,000, respectively.
Note
12 – Stockholders’ Equity
March
2017 Private Placement
On
March 22, 2017, the Company entered into a Securities Purchase Agreement with certain accredited investors identified therein
pursuant to which the Company issued and sold in a private placement 4,059,994 units of its securities resulting in gross proceeds
to the Company of approximately $1,218,000. Each unit consisted of one share of the Company’s common stock and a five-year
warrant to purchase one additional share of common stock. The purchase price for each unit was $0.30. The 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 $152,000, recorded as a result of the private placement
were approximately $1,066,000. In addition to the equity issuance costs incurred as a result of the private placement, the Company
also issued a warrant to purchase 81,199 shares of its common stock to the placement agent engaged in connection with the private
placement. The form and terms of the placement agent warrant is substantially the same as the form of warrants issued to the investors
under the Securities Purchase Agreement, except that the exercise price is $0.33 per share.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
July
2015 Purchase Agreement and Registration Rights Agreement
On
July 24, 2015, the Company entered into both a securities purchase agreement and 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 securities purchase agreement, the Company has the right to sell to Lincoln Park, and Lincoln Park is obligated to purchase,
up to $10.0 million in shares of the Company’s common stock, subject to certain limitations, from time to time, over the
36-month period commencing on September 4, 2015. Pursuant to the securities purchase agreement, in January 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.
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. 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.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
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 $1,157,000 and $1,262,000, as of June 30, 2017 and December 31, 2016, respectively. Accumulated
amortization is approximately $1,093,000 and $988,000 as of June 30, 2017 and December 31, 2016, respectively. The asset is being
amortized as an expense over the life of the License and Supply Agreement. Approximately $53,000 has been charged to amortization
expense for the three months ended June 30, 2017 and 2016 on the condensed consolidated statement of operations and comprehensive
loss. Approximately $105,000 has been charged to amortization expense for the six months ended June 30, 2017 and 2016 on the condensed
consolidated statement of operations and comprehensive loss. Approximately $105,000 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 $22,000 and $18,000 is included in accrued expenses as of June 30, 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 and six months ended June 30, 2017, approximately $2,000 and $10,000 of interest, respectively, was recognized
as interest expense. For the three and six months ended June 30, 2016, approximately $14,000 and $26,000 of interest, respectively,
was recognized as interest expense.
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.
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 June 30, 2017 and December 31, 2016 is approximately $21,000 related to a security deposit for the U.S. office facility. Rent
expense was approximately $28,000 and $38,000 for the three months ended June 30, 2017 and 2016, respectively. Rent expense was
approximately $59,000 and $67,000 for the six months ended June 30, 2017 and 2016, respectively.
NEPHROS,
INC. AND SUBSIDIARY
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
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. During the three and six
months ended June 30, 2017, approximately $1,000 and $2,000, respectively, was recognized in interest income. During the three
and six months ended June 30, 2016, approximately $1,000 and $3,000, respectively, was recognized in interest income. As of June
30, 2017, investment in lease, current is approximately $15,000, net of unearned interest of $4,000. As of June 30, 2017, investment
in lease, noncurrent, is approximately $54,000, net of unearned interest of $4,000.
As
of June 30, 2017, scheduled maturities of minimum lease payments receivable were as follows:
2017
|
|
|
11,000
|
|
2018
|
|
|
18,000
|
|
2019
|
|
|
19,000
|
|
2020
|
|
|
21,000
|
|
|
|
|
69,000
|
|
Less: Current
portion
|
|
|
(15,000
|
)
|
Investment in
sales-type lease, noncurrent
|
|
$
|
54,000
|
|
Included
in the above scheduled maturities of minimum lease payments receivable, approximately $2,000 was due as of June 30, 2017.
NEPHROS,
INC. AND SUBSIDIARY