NOTES
TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (unaudited)
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. The Company was founded by health professionals, scientists and engineers affiliated with Columbia University to develop
advanced end stage renal disease (“ESRD”) therapy technology and products.
Beginning
in 2009, Nephros introduced high performance liquid purification filters to meet the demand for water purification in certain
medical markets. The Company’s filters, generally classified as ultrafilters, are primarily used in hospitals for the prevention
of infection from waterborne pathogens, such as legionella and pseudomonas, and in dialysis centers for the removal of biological
contaminants from water and bicarbonate concentrate. The Company also develops and sells water filtration products for commercial
applications, focusing on the hospitality and food service markets. The water filtration business is a reportable segment, referred
to as the Water Filtration segment.
The
Company’s pathogen detection system is a portable, real-time system designed to provide actionable data for infection control
teams on up to 15 different pathogens from a single water sample, in approximately one hour. The pathogen detection system is
a reportable segment, referred to as the Pathogen Detection segment.
In
July 2018, the Company formed a new subsidiary, Specialty Renal Products, Inc. (“SRP”), to drive the development of
its second-generation hemodiafiltration system and other products focused on improving therapies for patients with renal disease.
The Company transferred three patents to SRP, which were carried at zero book value. SRP is a reportable segment, referred to
as the Renal Products segment.
The
Company’s primary U.S. facilities are located at 380 Lackawanna Place, South Orange, New Jersey 07079, 3221 Polaris Avenue,
Las Vegas, Nevada 89102 and 1015 Telegraph Street, Unit B, Reno, Nevada 89502. These locations house the Company’s corporate
headquarters, research, manufacturing, and distribution facilities. In addition, the Company maintains small administrative offices
in various locations in the United States and Ireland.
Note
2 – Basis of Presentation and Liquidity
Interim
Financial Information
The
accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with generally accepted
accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article
8 and Article 10 of Regulation S-X. The condensed consolidated balance sheet as of December 31, 2019 was derived from the Company’s
audited financial statements. Accordingly, they do not include all of the information and footnotes required by GAAP for annual
financial statements. Results as of and for the three months ended March 31, 2020 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2020.
The
condensed consolidated interim financial statements and notes thereto should be read in conjunction with the consolidated financial
statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
Reverse
Stock Split
On
May 22, 2019, the Company’s Board of Directors authorized a 1-for-9 reverse stock split and approved an amendment to the
Company’s Certificate of Incorporation to affect the 1-for-9 reverse split of the Company’s common stock, which was
effected at 5:30 p.m. ET on July 9, 2019. Fractional shares were not issued and stockholders who otherwise would have been entitled
to receive a fractional share as a result of the reverse stock split received an amount in cash equal to $5.58 per share for such
fractional interests. All of the share and per share amounts discussed in the accompanying condensed consolidated financial statements
have been adjusted to reflect the effect of this reverse split.
Consolidation
The
accompanying condensed consolidated financial statements include the accounts of Nephros, Inc. and its subsidiaries, including
SRP, in which a controlling interest is maintained by the Company. Outside shareholders’ interest in SRP of 37.5% is shown
on the condensed consolidated balance sheet as noncontrolling interest. All intercompany accounts and transactions were eliminated
in the preparation of the accompanying condensed consolidated financial statements.
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, the assessment of expected cash flows used in evaluating
goodwill and other long-lived assets, value of contingent consideration, the assessment of the ability to continue as a going
concern and assumptions used in determining stock compensation such as expected volatility and risk-free interest rate.
Liquidity
The
Company has sustained operating losses and expects such losses to continue over the next several quarters. In addition, net cash
from operations has been negative since inception, generating an accumulated deficit of $128.4 million as of March 31, 2020.
On
February 4, 2020, the Company completed a confidentially marketed underwritten public offering whereby the Company sold 937,500
shares of its common stock for aggregate net proceeds of $6.8 million. The Company also has a loan agreement with a lender, which
provides a secured asset-based revolving credit facility of up to $2.5 million. Additionally, the Company received $478,700 in
U.S. Small Business Administration’s Paycheck Protection Program (“PPP”) funds on April 24, 2020.
On
September 5, 2018, SRP completed a private placement transaction whereby SRP sold preferred shares equivalent to 37.5% of its
outstanding equity interests for aggregate proceeds of $3.0 million. As of the date of issuance of the accompanying condensed
consolidated financial statements, SRP has $0.4 million in cash. The proceeds of this private placement are restricted to SRP
expenses and may not be used for the benefit of the Company or other affiliated entities, except to reimburse for expenses directly
attributable to SRP.
Based
on cash that is available for Company operations and projections of future Company operations, the Company believes that its cash
will be sufficient to fund the Company’s current operating plan – including the potential negative impact of the
Covid-19 pandemic – through at least the next 12 months from the date of issuance of the accompanying condensed consolidated
financial statements.
In
the event of unexpected decreased demand for the Company’s products, management’s operating plans are designed to
control operating costs until such time as the Company generates sufficient cash flows from operations. If there were a decrease
in the demand for the Company’s products due to the Covid-19 pandemic or other economic or competitive conditions, or management
were otherwise unable to achieve its revenue plan, the Company would cut costs as appropriate. Nevertheless, in this event, there
could be a significant reduction in liquidity due to the possible inability of the Company to cut costs sufficiently.
Recently
Adopted Accounting Pronouncements
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 adopted this guidance as of January
1, 2020 and the guidance did not have an impact on its consolidated financial statements.
In
August 2018, the FASB issued ASU 2018-13, “Disclosure Framework-Changes to the Disclosure Requirements for the Fair Value
Measurement,” which modifies the disclosure requirements on fair value measurements. The guidance is effective for the Company
beginning in the first quarter of fiscal year 2020. The Company adopted this guidance as of January 1, 2020 and the guidance did
not have an impact on its consolidated financial statements.
In
August 2018, the FASB issued ASU 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing
Arrangement That is a Service Contract,” which aligns the requirements for capitalizing implementation costs incurred in
a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop
or obtain internal-use software. The guidance is effective for the Company beginning in the first quarter of fiscal year 2020.
The Company adopted this guidance as of January 1, 2020 and the guidance did not have an impact on its consolidated financial
statements.
In
November 2018, the FASB issued ASU 2018-18, “Collaborative Arrangements: Clarifying the Interaction Between Topic 808 and
Topic 606.” This guidance clarifies that, when the collaborative arrangement participant is a customer in the context of
a unit-of-account, revenue from contracts with customers guidance should be applied, adds unit-of-account guidance to collaborative
arrangements guidance, and requires, that in a transaction with a collaborative arrangement participant who is not a customer,
presenting the transaction together with revenue recognized under contracts with customers is precluded. The guidance is effective
for the Company beginning in the first quarter of fiscal year 2020. The Company adopted this guidance as of January 1, 2020 and
the guidance did not have an impact on its consolidated financial statements.
In
November 2019, the FASB issued ASU 2019-08, “Codification Improvements – Share-Based Consideration Payable to a Customer,”
which requires that an entity measure and classify share-based payment awards granted to a customer by applying the guidance in
Topic 718. The guidance is effective for the Company beginning in the first quarter of fiscal year 2020. The Company adopted this
guidance as of January 1, 2020 and the guidance did not have an impact on its consolidated financial statements.
Recent
Accounting Pronouncements, Not Yet Effective
In
December 2019, the FASB issued ASU 2019-12, “Simplifying the Accounting for Income Taxes,” which removes certain exceptions
to the general principles of the accounting for income taxes and also improves consistent application of and simplification of
other areas when accounting for income taxes. The guidance is effective for the Company beginning in the first quarter of fiscal
year 2021. Early adoption is permitted. The Company is assessing the impact of adopting this guidance on its consolidated financial
statements.
Concentration
of Credit Risk
The
Company deposits its cash in financial institutions. At times, such deposits may be in excess of insured limits. To date, the
Company has not experienced any impairment losses on its cash. The Company also limits its credit risk with respect to accounts
receivable by performing credit evaluations when deemed necessary.
Major
Customers
For
the three months ended March 31, 2020 and 2019, the following customers, all of which are in the Water Filtration segment, accounted
for the following percentages of the Company’s revenues, respectively:
Customer
|
|
2020
|
|
|
2019
|
|
A
|
|
|
23
|
%
|
|
|
7
|
%
|
B
|
|
|
16
|
%
|
|
|
17
|
%
|
C
|
|
|
11
|
%
|
|
|
12
|
%
|
D
|
|
|
10
|
%
|
|
|
12
|
%
|
Total
|
|
|
60
|
%
|
|
|
48
|
%
|
As
of March 31, 2020 and December 31, 2019, the following customers accounted for the following percentages of the Company’s
accounts receivable, respectively:
Customer
|
|
2020
|
|
|
2019
|
|
A
|
|
|
26
|
%
|
|
|
11
|
%
|
B
|
|
|
13
|
%
|
|
|
26
|
%
|
Total
|
|
|
39
|
%
|
|
|
37
|
%
|
Cash
and Cash Equivalents
The
Company considers all highly liquid money market instruments with an original maturity of three months or less when purchased
to be cash equivalents. At March 31, 2020 and December 31, 2019, cash and cash equivalents were deposited in financial institutions
and consisted entirely of immediately available fund balances. The Company maintains its cash deposits and cash equivalents with
financial institutions it believes to be well-known and stable.
Accounts
Receivable
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. Factors considered include economic conditions, each customer’s payment and return history and credit worthiness.
Adjustments, if any, are made to reserve balances following the completion of these reviews to reflect management’s best
estimate of potential losses. There was no allowance for doubtful accounts as of March 31, 2020. The allowance for doubtful accounts
was approximately $25,000 as of December 31, 2019. For the three months ended March 31, 2020 and 2019, there was no provision
for bad debt expense. Write-offs of accounts receivable were approximately $25,000 for the three months ended March 31, 2020 which
were reserved for in a prior period. Write-offs of accounts receivable were approximately $4,000 for the three months ended March
31, 2019 which were reserved for in a prior period. There was no allowance for sales returns at March 31, 2020 or December 31,
2019.
Depreciation
Expense
Depreciation
related to equipment utilized in the manufacturing process is recognized in cost of goods sold on the consolidated statements
of operations and comprehensive loss. For the three months ended March 31, 2020 and 2019, depreciation expense was approximately
$5,000 and $8,000, respectively. Approximately $4,000 of the approximately $5,000 of depreciation expense for the three months
ended March 31, 2020 has been recognized in the cost of goods sold. Approximately $2,000 of the approximately $8,000 of depreciation
expense for the three months ended March 31, 2019 has been recognized in the cost of goods sold.
Note
3 – Revenue Recognition
The
Company recognizes revenue related to product sales when product is shipped via external logistics provider and the other criteria
of ASC 606, “Revenue from Contracts with Customers” (“ASC 606”) are met. Product revenue is recorded net
of returns and allowances. In addition to product revenue, the Company recognizes revenue related to royalty and other agreements
in accordance with the five-step model in ASC 606. Royalty and other revenue recognized for the three months ended March 31, 2020
and 2019 is comprised of:
|
|
Three Months Ended
March 31,
|
|
|
|
2020
|
|
|
2019
|
|
|
|
(in thousands)
|
|
Royalty revenue under the Bellco License Agreement
|
|
$
|
16
|
|
|
$
|
26
|
|
Other revenue
|
|
|
38
|
|
|
|
14
|
|
Total royalty and other revenue
|
|
$
|
54
|
|
|
$
|
40
|
|
Bellco
License Agreement
With
regard to the OLpūr 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. (“Bellco”), an Italy-based supplier of hemodialysis and intensive care
products, for the manufacturing, marketing and sale of the Company’s patented mid-dilution dialysis filters (the “Products”).
Under the License Agreement, as amended, the Company granted Bellco a license to manufacture, market and sell the Products under
its own name, label, and CE mark in certain countries on an exclusive basis, and to do the same on a non-exclusive basis in certain
other countries. Under the License Agreement with Bellco, the Company received upfront payments which were previously deferred
and subsequently recognized as license revenue over the term of the License Agreement.
The
License Agreement, as amended, also provides minimum sales targets which, if not satisfied, will, at the discretion of the Company,
result in conversion of the license to non-exclusive status. 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 covered territory as follows:
for the first 125,000 units sold in total, €1.75 (approximately $1.90) per unit; thereafter, €1.25 (approximately $1.40)
per unit. The License Agreement also provides for a fixed royalty payment payable to the Company for the period beginning on January
1, 2015 through and including December 31, 2021 if the minimum sales targets are not met.
The
Company recognized royalty income from Bellco pursuant to the License Agreement for the three months ended March 31, 2020 and
2019 of approximately $16,000 and $26,000, respectively.
Note
4 – Fair Value Measurements
The
Company measures certain financial instruments and other items at fair value.
To
determine the fair value, the Company uses the fair value hierarchy for inputs used in measuring fair value that maximizes the
use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when
available. Observable inputs are inputs market participants would use to value an asset or liability and are developed based on
market data obtained from independent sources. Unobservable inputs are inputs based on assumptions about the factors market participants
would use to value an asset or liability.
To
measure fair value, the Company uses the following fair value hierarchy based on three levels of inputs, of which the first two
are considered observable and the last unobservable:
Level
1 – Quoted prices in active markets for identical assets or liabilities.
Level
2 – Inputs other than Level 1 that are observable for the asset or liability, either directly or indirectly, such as
quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities
in markets that are not active; or other inputs that are observable or can be corroborated by observable market data by correlation
or other means.
Level
3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value
of the assets or liabilities. Value is determined using pricing models, discounted cash flow methodologies, or similar techniques
and also includes instruments for which the determination of fair value requires significant judgment or estimation.
Assets
and Liabilities Measured at Fair Value on a Recurring Basis
The
Company evaluates its financial assets and liabilities subject to fair value measurements on a recurring basis to determine the
appropriate level of classification for each reporting period.
The
following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring
basis as of March 31, 2020:
|
|
Quoted prices in active markets for identical assets
(Level 1)
|
|
|
Significant other observable inputs
(Level 2)
|
|
|
Significant unobservable inputs
(Level 3)
|
|
|
Total
|
|
|
|
(in thousands)
|
|
At March 31, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contingent consideration liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
203
|
|
|
$
|
203
|
|
The
following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring
basis as of December 31, 2019:
|
|
Quoted prices in active markets for identical assets
(Level 1)
|
|
|
Significant other observable inputs
(Level 2)
|
|
|
Significant unobservable inputs
(Level 3)
|
|
|
Total
|
|
|
|
(in thousands)
|
|
At December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contingent consideration liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
300
|
|
|
$
|
300
|
|
The
following table summarizes the change in fair value, as determined by Level 3 inputs, for the contingent consideration liability
using unobservable Level 3 inputs for the three months ended March 31, 2020:
|
|
Contingent Consideration
|
|
|
|
(in thousands)
|
|
Balance as of December 31, 2019
|
|
$
|
300
|
|
Payments against contingent consideration
|
|
|
(63
|
)
|
Change in fair value of contingent consideration liability
|
|
|
(42
|
)
|
Accretion of contingent consideration liability
|
|
|
8
|
|
Balance as of March 31, 2020
|
|
$
|
203
|
|
During
the three months ended March 31, 2020 and 2019, a change in fair value of contingent consideration of approximately $42,000 and
$10,000, respectively, was recorded due to lower than planned performance.
Consideration
paid in a business combination may include potential future payments that are contingent upon the acquired business achieving
certain levels of earnings in the future (“contingent consideration”). Contingent consideration liabilities are measured
at their estimated fair value as of the date of acquisition, with subsequent changes in fair value recorded in the consolidated
statements of operations. Fair value as of the date of acquisition is estimated based on projections of expected future cash flows
of the acquired business. The Company estimated the contingent consideration liability using the income approach (discounted cash
flow method), which requires the Company to make estimates and assumptions regarding the future cash flows and profits. Changes
in these estimates and assumptions could have a significant impact on the amounts recognized.
There
were no transfers between levels in the fair value hierarchy during the three months ended March 31, 2020.
Assets
and Liabilities Not Measured at Fair Value on a Recurring Basis
The
carrying amounts of cash and cash equivalents, accounts receivable, secured revolving credit facility, accounts payable and accrued
expenses approximate fair value due to the short-term maturity of these instruments.
The
carrying amounts of the secured long-term note payable, lease liabilities and equipment financing approximate fair value as of
March 31, 2020 and December 31, 2019 because those financial instruments bear interest at rates that approximate current market
rates for similar agreements with similar maturities and credit.
Note
5 – Inventory, net
Inventory
is stated at the lower of cost or net realizable value using the first-in, first-out method and consists of raw materials and
finished goods. The Company’s inventory components as of March 31, 2020 and December 31, 2019 were as follows:
|
|
March 31, 2020
|
|
|
December 31, 2019
|
|
|
|
(in thousands)
|
|
Finished goods
|
|
$
|
3,330
|
|
|
$
|
2,248
|
|
Raw materials
|
|
|
365
|
|
|
|
359
|
|
Less: inventory reserve
|
|
|
(46
|
)
|
|
|
(45
|
)
|
Total inventory, net
|
|
$
|
3,649
|
|
|
$
|
2,562
|
|
Note
6 – Intangible Assets and Goodwill
Intangible
Assets, net
Intangible
assets for the three months ended March 31, 2020 and 2019 are set forth in the table below. Gross carrying values and accumulated
amortization of the Company’s intangible assets by type are as follows:
|
|
March 31, 2020
|
|
|
December 31, 2019
|
|
|
|
Cost
|
|
|
Accumulated Amortization
|
|
|
Net
|
|
|
Cost
|
|
|
Accumulated Amortization
|
|
|
Net
|
|
|
|
(in thousands)
|
|
Tradenames, service marks and domain names
|
|
$
|
50
|
|
|
$
|
(12
|
)
|
|
$
|
38
|
|
|
$
|
50
|
|
|
$
|
(10
|
)
|
|
$
|
40
|
|
Customer relationships
|
|
|
540
|
|
|
|
(40
|
)
|
|
|
500
|
|
|
|
540
|
|
|
|
(32
|
)
|
|
|
508
|
|
Total intangible assets
|
|
$
|
590
|
|
|
|
(52
|
)
|
|
$
|
538
|
|
|
$
|
590
|
|
|
|
(42
|
)
|
|
|
548
|
|
The
Company recognized amortization expense of approximately $10,000 for each of the three months ended March 31, 2020 and 2019 and
such amounts are included in selling, general and administrative expenses on the accompanying condensed consolidated statement
of operations and comprehensive loss.
As
of March 31, 2020, future amortization expense for each of the next five years is (in thousands):
Fiscal Years
|
|
|
|
2020 (excluding the three months ended March 31, 2020)
|
|
$
|
32
|
|
2021
|
|
|
42
|
|
2022
|
|
|
42
|
|
2023
|
|
|
42
|
|
2024
|
|
|
32
|
|
The
Company did not recognize any intangible asset impairment charges during the three months ended March 31, 2020 or 2019.
Goodwill
Goodwill
had a carrying value on the Company’s condensed consolidated balance sheets of $0.8 million at March 31, 2020 and December
31, 2019. Goodwill has been allocated to the Water Filtration segment.
Note
7 – License and Supply Agreement, net
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, and for an exclusive supply arrangement for the filtration products. Under the License and Supply Agreement,
as amended, 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, with certain limitations on territory, 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. The filtration products covered under the
License and Supply Agreement includes both certain products based on Medica’s proprietary Versatile microfiber technology
and certain filtration products based on Medica’s proprietary Medisulfone ultrafiltration technology. The term of the License
Agreement with Medica expires on December 31, 2025, unless earlier terminated by either party in accordance with the terms of
the License and Supply Agreement.
In
exchange for the license, the gross value of the intangible asset capitalized was $2.3 million. License and supply agreement,
net, on the condensed consolidated balance sheet is $0.8 million as of March 31, 2020 and December 31, 2019, respectively. Accumulated
amortization is $1.5 million as of March 31, 2020 and December 31, 2019, respectively. The intangible asset is being amortized
as an expense over the life of the License and Supply Agreement. Amortization expense of approximately $34,000 was recognized
in each of the three months ended March 31, 2020 and 2019 on the condensed consolidated statement of operations and comprehensive
loss.
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. There was no interest recognized for the three months ended March 31, 2020 or March 31, 2019.
In
addition, for the period beginning April 23, 2014 through December 31, 2025, 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 $69,000 and $47,000 for the three months ended March 31, 2020 and 2019, respectively,
was recognized as royalty expense and is included in cost of goods sold on the condensed consolidated statement of operations
and comprehensive loss. Approximately $69,000 in royalties are included in accrued expenses as of March 31, 2020. Approximately
$83,000 in royalties are included in accounts payable as of December 31, 2019.
Note
8 – Secured Revolving Credit Facility
On
August 17, 2017, the Company entered into the Loan Agreement and Security Agreement (the “Loan Agreement”) with Tech
Capital, LLC (“Tech Capital”). The Loan Agreement initially provided for a secured asset-based revolving credit facility
of up to $1.0 million, which the Company may draw upon and repay from time to time during the term of the Loan Agreement. On December
20, 2019, the Company and Tech Capital entered into a First Modification to the Loan Agreement (“the Amendment”).
The Amendment increased the senior secured asset-based revolving credit facility from $1.0 million to $2.5 million. The outstanding
principal balance of the Loan Agreement was $0.5 million and $0.6 million as of March 31, 2020 and December 31, 2019, respectively.
The Company is using these proceeds for working capital and general corporate purposes.
The
Loan Agreement has a term of 12 months and, as a result of the Amendment, will automatically renew for successive 12-month periods,
measured from the date of the Amendment. Availability under the Loan Agreement will be based upon periodic borrowing base certifications
valuing certain of the Company’s accounts receivable and inventory. Outstanding borrowings under the Loan Agreement accrue
interest, which is payable monthly based on the average daily outstanding balance, at a rate equal to 3.5% plus the prime rate
per annum, provided that such prime rate will not be less than 4.25% per annum and provided that such monthly interest payment
is not less than $6,500. As of March 31, 2020, the current interest rate was 6.75% per annum
The
Company also granted to Tech Capital a first priority security interest in its assets, including its accounts receivable and inventory,
to secure all of its obligations under the Loan Agreement. In addition, Nephros International Limited, a wholly-owned subsidiary
of the Company, unconditionally guaranteed the Company’s obligations under the Loan Agreement.
As
a result of the Amendment, the Company was required to pay Tech Capital 0.50% of the maximum amount of credit available under
the Loan Agreement on the date the Company entered into the Amendment and on each anniversary thereof while there remain outstanding
amounts under the Loan Agreement.
For
the three months ended March 31, 2020 and 2019, approximately $19,000 and $11,000, respectively, was recognized as interest expense
on the condensed consolidated statement of operations and comprehensive loss. As of March 31, 2020, approximately $6,500 of the
$19,000 of interest expense incurred for the three months ended March 31, 2020 is included in accrued expenses on the condensed
consolidated balance sheet.
Note
9 – Secured Note Payable
On
March 27, 2018, the Company entered into a Secured Promissory Note Agreement (the “Secured Note”) with Tech Capital
for a principal amount of $1.2 million. As of March 31, 2020, the principal balance of the Secured Note was $0.8 million.
The
Secured Note has a maturity date of April 1, 2023. The unpaid principal balance accrues interest at a rate of 8% per annum. Principal
and interest payments are due on the first day of each month commencing on May 1, 2018. The Secured Note is subject to the terms
and conditions of and is secured by security interests granted by the Company in favor of Tech Capital under the Loan and Security
Agreement between the Company and Tech Capital, dated August 16, 2017 and all of the riders and amendments thereto (see Note 8
– Secured Revolving Credit Facility). An event of default under such Loan Agreement is an event of default under the Secured
Note and vice versa. In the event the principal balance under the Loan Agreement is due, all amounts due under the Secured Note
also become due.
During
each of the three months ended March 31, 2020 and 2019, the Company made payments under the Secured Note of approximately $72,000.
Included in the total payments made, approximately $16,000 and $20,000, respectively, was recognized as interest expense on the
condensed consolidated statement of operations and comprehensive loss for the three months ended March 31, 2020 and 2019.
As
of March 31, 2020, future principal maturities are as follows (in thousands):
Fiscal Years
|
|
|
|
2020 (excluding the three months ended March 31, 2020)
|
|
$
|
155
|
|
2021
|
|
|
249
|
|
2022
|
|
|
269
|
|
2023
|
|
|
95
|
|
Total
|
|
$
|
768
|
|
Note
10 – Leases
The
Company has operating leases for corporate offices, an automobile and office equipment. The leases have remaining lease terms
of 1 year to 4 years.
The
Company entered into an operating lease in March 2020 for 1015 Telegraph Street, Unit B, Reno, Nevada 89502. The rental agreement
commenced in March 2020 and expires in February 2022 with an option to extend for two additional years that the Company is reasonably
certain to exercise. The monthly cost is approximately $5,000. Approximately $5,000 related to a security deposit for this office
facility is classified as other assets on the condensed consolidated balance sheet as of March 31, 2020.
The
Company entered into a finance lease in February 2020 for office equipment. The rental agreement commenced in February 2020 and
expires in January 2023 with a monthly cost of approximately $1,000.
Operating
lease cost, as presented below, includes costs associated with leases for which ROU assets have been recognized as well as short-term
leases.
The
components of total lease costs were as follows:
|
|
Three months ended
March 31, 2020
|
|
|
Three months ended
March 31, 2019
|
|
|
|
(in thousands)
|
|
Operating lease cost
|
|
$
|
91
|
|
|
$
|
58
|
|
Finance lease cost:
|
|
|
|
|
|
|
|
|
Amortization of right-of-use assets
|
|
|
1
|
|
|
|
-
|
|
Interest on lease liabilities
|
|
|
-
|
|
|
|
-
|
|
Total finance lease cost
|
|
|
1
|
|
|
|
-
|
|
Variable lease cost
|
|
|
13
|
|
|
|
2
|
|
Total lease cost
|
|
$
|
105
|
|
|
$
|
60
|
|
Supplemental
cash flow information related to leases was as follows:
|
|
Three months ended
March 31, 2020
|
|
|
Three months ended
March 31, 2019
|
|
|
|
(in thousands)
|
|
Cash paid for amounts included in the measurement of lease liabilities:
|
|
|
|
|
|
|
|
|
Operating cash flows from operating leases
|
|
$
|
89
|
|
|
$
|
57
|
|
Financing cash flows from finance leases
|
|
|
1
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
ROU assets obtained in exchange for lease obligations:
|
|
|
|
|
|
|
|
|
Operating leases
|
|
$
|
201
|
|
|
$
|
20
|
|
Finance leases
|
|
|
17
|
|
|
|
-
|
|
Supplemental
balance sheet information related to leases was as follows:
|
|
March 31, 2020
|
|
|
December 31, 2019
|
|
|
|
(in thousands)
|
|
Operating lease right-of-use assets
|
|
$
|
1,238
|
|
|
$
|
1,106
|
|
Finance lease right-of-use assets
|
|
$
|
15
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Current portion of operating lease liabilities
|
|
$
|
307
|
|
|
$
|
262
|
|
Operating lease liabilities, net of current portion
|
|
|
978
|
|
|
|
889
|
|
Total operating lease liabilities
|
|
$
|
1,285
|
|
|
$
|
1,151
|
|
|
|
|
|
|
|
|
|
|
Current portion of finance lease liabilities
|
|
$
|
5
|
|
|
$
|
-
|
|
Finance lease liabilities, net of current portion
|
|
|
10
|
|
|
|
-
|
|
Total finance lease liabilities
|
|
$
|
15
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Weighted average remaining lease term
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
3.8 years
|
|
|
|
4 years
|
|
Finance leases
|
|
|
2.8 years
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Weighted average discount rate
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
8.0
|
%
|
|
|
8.0
|
%
|
Finance leases
|
|
|
8.0
|
%
|
|
|
-
|
|
As
of March 31, 2020, maturities of lease liabilities were as follows:
|
|
Operating Leases
|
|
|
Finance Leases
|
|
|
|
(in thousands)
|
|
2020 (excluding the three months ended March 31, 2020)
|
|
$
|
295
|
|
|
$
|
5
|
|
2021
|
|
|
389
|
|
|
|
6
|
|
2022
|
|
|
388
|
|
|
|
6
|
|
2023
|
|
|
261
|
|
|
|
1
|
|
2024
|
|
|
154
|
|
|
|
-
|
|
Total future minimum lease payments
|
|
|
1,487
|
|
|
|
18
|
|
Less imputed interest
|
|
|
(202
|
)
|
|
|
(3
|
)
|
Total
|
|
$
|
1,285
|
|
|
$
|
15
|
|
Note
11 – Stock Plans and Share-Based Payments
The
fair value of stock options and restricted stock is recognized as stock-based compensation expense in the Company’s condensed
consolidated statement of operations and comprehensive loss. The Company calculates stock-based compensation expense in accordance
with ASC 718. The fair value of stock-based awards is amortized over the vesting period of the award.
Stock
Options
During
the three months ended March 31, 2020, the Company granted stock options to purchase 13,611 shares of common stock to employees.
These stock options are being expensed over the respective vesting period, which is based on a service condition. The fair value
of the stock options granted during the three months ended March 31, 2020 was approximately $79,000.
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 utilized for
the stock options granted during the three months ended March 31, 2020.
Assumptions for Option Grants
|
|
|
|
Stock Price Volatility
|
|
|
75.5
|
%
|
Risk-Free Interest Rates
|
|
|
1.22
|
%
|
Expected Life (in years)
|
|
|
6.25
|
|
Expected Dividend Yield
|
|
|
-
|
%
|
Stock-based compensation expense related to stock options was $168,000
and $143,000 for the three months ended March 31, 2020 and 2019, respectively. For the three months ended March 31, 2020, approximately
$152,000 and $16,000 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,
2019, approximately $124,000 and $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.
During
the three months ended March 31, 2020, stock options to purchase 556 shares of the Company’s common stock were exercised
for proceeds of approximately $2,000, resulting in the issuance of 556 shares of the Company’s common stock. During the
three months ended March 31, 2020, stock options to purchase 1,112 shares of the Company’s common stock were exercised in
a cashless exercise, resulting in the issuance of 755 shares of the Company’s common stock.
There
was no tax benefit related to expense recognized in the three months ended March 31, 2020 and 2019, as the Company is in a net
operating loss position. As of March 31, 2020, there was $1.3 million of total unrecognized compensation expense related to unvested
stock-based awards granted under the equity compensation plans, which will be amortized over the weighted average remaining requisite
service period of 2.8 years. Such amount does not include the effect of future grants of equity compensation, if any.
Restricted
Stock
Total
stock-based compensation expense for restricted stock was approximately $28,000 and $15,000 for the three months ended March 31,
2020 and 2019, respectively. For the three months ended March 31, 2020, approximately $23,000 and $5,000 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, 2019, approximately $14,000 and $1,000 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.
As
of March 31, 2020, there was approximately $24,000 of unrecognized compensation expense related to restricted stock awards, which
is expected to be recognized over the next three months.
The
aggregate shares of common stock legally issued and outstanding as of March 31, 2020 is greater than the aggregate shares of common
stock outstanding for accounting purposes by the amount of unvested restricted shares.
SRP
Equity Incentive Plan
SRP’s
2019 Equity Incentive Plan was approved on May 7, 2019 under which 150,000 shares of SRP’s common stock are reserved for
the issuance of options and other awards.
There
were no SRP stock options granted during the three months ended March 31, 2020. Stock-based compensation expense related to the
SRP stock options was approximately $26,000 for the three months ended March 31, 2020. For the three months ended March 31, 2020,
approximately $12,000 and $14,000 are included in selling, general and administrative expenses and research and development expenses,
respectively, on the accompanying consolidated statement of operations and comprehensive loss. There were no SRP stock options
outstanding during the three months ended March 31, 2019. Stock-based compensation expense related to the SRP stock options is
presented by the Company as noncontrolling interest on the consolidated balance sheet as of March 31, 2020.
Note
12 – Stockholders’ Equity
February
2020 Common Stock Issuance
On
February 4, 2020, the Company issued 937,500 shares of common stock through a confidentially marketed underwritten public offering
resulting in gross proceeds to the Company of $7.5 million. The purchase price for each share was $8.00. Proceeds, net of equity
issuance costs of $0.7 million, recorded as a result of the offering were $6.8 million.
Noncontrolling
Interest
On
September 5, 2018, SRP entered into a Series A Preferred Stock Purchase Agreement with certain purchasers pursuant to which SRP
sold 600,000 shares of its Series A Preferred Stock (“Series A Preferred”) for $5.00 per share. The aggregate purchase
price was $3.0 million. SRP incurred transaction-related expenses of approximately $30,000, which were included in selling, general
and administrative expenses on the accompanying consolidated statement of operations and comprehensive loss for the three and
nine months ended September 30, 2018. The net proceeds from the issuance of the Series A Preferred are restricted to SRP expenses,
and may not be used for the benefit of the Company or other affiliated entities, except to reimburse for expenses directly attributable
to SRP. Following the Series A Preferred transaction, the Company retained a 62.5% ownership interest in SRP, holding 100% of
the outstanding common shares, and holders of Series A Preferred retained a 37.5% interest in SRP on a fully diluted basis, holding
100% of the outstanding preferred shares. Of the 600,000 shares of Series A Preferred issued, the shares purchased by related
parties comprised of persons controlled by members of management and by the Company’s largest shareholder amounted to 18,000
and 400,000 shares, respectively.
Each
share of Series A Preferred is initially convertible into one share of SRP common stock, subject to adjustment for stock splits
and recapitalization events. Subject to customary exempt issuances, in the event SRP issues additional shares of its common stock
or securities convertible into common stock at a per share price that is less than the original Series A Preferred price, the
conversion price of the Series A Preferred will automatically be reduced to such lower price.
In
the event of any voluntary or involuntary liquidation, dissolution or winding up of SRP, the holders of the Series A Preferred
are entitled to be paid out of the assets of SRP available for distribution to its stockholders or, in the case of a deemed liquidation
event, out of the consideration payable to stockholders in such deemed liquidation event or the available proceeds, before any
payment shall be made to the holders of SRP common stock by reason of their ownership thereof, an amount per share equal to one
times (1x) the Series A Preferred original issue price, plus any accruing dividends accrued but unpaid thereon, whether or not
declared, together with any other dividends declared but unpaid thereon (the “Series A Liquidation Preference”). If
upon any such liquidation, dissolution or winding up of SRP or deemed liquidation event, the assets of SRP available for distribution
to its stockholders shall be insufficient to pay the Series A Liquidation Preference in full, the holders of Series A Preferred
shall share ratably in any distribution of the assets available for distribution in proportion to the respective amounts which
would otherwise be payable in respect of the shares held by them upon such distribution if all amounts payable on or with respect
to such shares were paid in full. After the full payment of the Series A Liquidation Preference, the holders of the Series A Preferred
and the holders of common stock will share ratably in any remaining proceeds available for distribution on an as-converted to
common stock basis.
Each
share of Series A Preferred accrues dividends at the rate per annum of $0.40 per share. The accruing dividends shall accrue from
day to day, whether or not declared, and shall be cumulative and shall be payable only when, as, and if declared by the Board.
Holders
of Series A Preferred shall be entitled to cast the number of votes equal to the number of whole shares of common stock into which
the shares of Series A Preferred held by such holder are convertible as of the record date for determining stockholders entitled
to vote. Except as provided by law or by the other provisions, the holders of Series A Preferred vote together with the holders
of common stock as a single class. Notwithstanding the foregoing, for as long as at least 150,000 shares of Series A Preferred
are outstanding, SRP is required to obtain the affirmative vote or written consent of a majority of the Series A Preferred in
order to effect certain corporate transactions, including without limitation, the issuance of any securities senior to or on parity
with the Series A Preferred, a liquidation or deemed liquidation of SRP, amendments to SRP’s charter documents, the issuance
of indebtedness in excess of $250,000, any annual budget for the Company’s operations, and the hiring or firing of any executive
officers of SRP. In addition, the holders of the Series A Preferred are entitled to elect two members of SRP’s board of
directors.
The
noncontrolling interest in SRP held by holders of the Series A Preferred has been classified as equity on the accompanying consolidated
interim balance sheet, as the noncontrolling interest is redeemable only upon the occurrence of events that are within the control
of the Company.
Warrants
During
the three months ended March 31, 2020, warrants to purchase 18,889 shares of the Company’s common stock were exercised,
resulting in proceeds of approximately $51,000 and the issuance of 18,889 shares of the Company’s common stock.
There
were no warrants exercised during the three months ended March 31, 2019.
Note
13 – Net Loss per Common Share
Basic
loss per common share is calculated by dividing net loss available to common shareholders by the number of weighted average common
shares issued and outstanding. Diluted loss per common share is calculated by dividing net loss available to common shareholders
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 antidilutive:
|
|
March 31,
|
|
|
|
2020
|
|
|
2019
|
|
Shares underlying warrants outstanding
|
|
|
360,035
|
|
|
|
738,070
|
|
Shares underlying options outstanding
|
|
|
1,007,370
|
|
|
|
832,790
|
|
Unvested restricted stock
|
|
|
55,111
|
|
|
|
49,364
|
|
Note
14 – Commitments and Contingencies
Purchase
Commitments
In
exchange for the rights granted under the License and Supply Agreement with Medica (see Note 7 – License and Supply Agreement,
net), the Company agreed to make certain minimum annual aggregate purchases from Medica over the term of the License and Supply
Agreement. For the year ended December 31, 2020, the Company has agreed to make minimum annual aggregate purchases from Medica
of €3.2 million (approximately $3.5 million). As of March 31, 2020, the Company’s aggregate purchase commitments totaled
€2.6 million (approximately $2.9 million).
Contractual
Obligations
See
Note 10 – Leases for a discussion of the Company’s contractual obligations.
Note
15 – Segment Reporting
On
January 1, 2020, the Company began reporting the results of its Pathogen Detection Systems business as a new segment, known as
the Pathogen Detection segment. Prior to the additional reporting of Pathogen Detection as a reporting segment, the Company had
two operating segments, Water Filtration and Renal Products. The Company has reflected the new segment measures beginning in the
three months ended March 31, 2020, and prior periods have been restated for comparability.
The
Company has defined three reportable segments: Water Filtration, Pathogen Detection and Renal Products. The Water Filtration segment
primarily develops and sells high performance water purification filters. The Pathogen Detection segment develops and sells portable,
real-time water testing systems designed to provide actionable data on waterborne pathogens in approximately one hour. The Renal
Products segment is focused on the development of medical device products for patients with renal disease, including a 2nd
generation hemodiafiltration system for the treatment of patients with ESRD.
The
Company’s chief operating decision maker evaluates the financial performance of the Company’s segments based upon
segment revenues, gross margin and operating expenses which include research and development and selling, general and administrative
expenses. Items below loss from operations are not reported by segment, since they are excluded from the measure of segment profitability
reviewed by the Company’s chief operating decision maker. The Company does not report balance sheet information by segment
since it is not reviewed by the Company’s chief operating decision maker.
The
accounting policies for the Company’s segments are the same as those described in the Company’s Annual Report on Form
10-K for the year ended December 31, 2019.
The
tables below present segment information reconciled to total Company loss from operations, with segment operating loss including
gross profit less direct research and development expenses and direct selling, general and administrative expenses to the extent
specifically identified by segment:
|
|
Three Months Ended March 31, 2020
|
|
|
|
(in thousands)
|
|
|
|
Water Filtration
|
|
|
Pathogen Detection
|
|
|
Renal Products
|
|
|
Nephros, Inc. Consolidated
|
|
Total net revenues
|
|
$
|
2,511
|
|
|
$
|
18
|
|
|
$
|
-
|
|
|
$
|
2,529
|
|
Gross margin
|
|
|
1,480
|
|
|
|
11
|
|
|
|
-
|
|
|
|
1,491
|
|
Research and development expenses
|
|
|
310
|
|
|
|
52
|
|
|
|
201
|
|
|
|
563
|
|
Depreciation and amortization expense
|
|
|
46
|
|
|
|
-
|
|
|
|
-
|
|
|
|
46
|
|
Selling, general and administrative expenses
|
|
|
1,715
|
|
|
|
125
|
|
|
|
110
|
|
|
|
1,950
|
|
Change in fair value of contingent consideration
|
|
|
(42
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(42
|
)
|
Total operating expenses
|
|
|
2,029
|
|
|
|
177
|
|
|
|
311
|
|
|
|
2,517
|
|
Loss from operations
|
|
$
|
(549
|
)
|
|
$
|
(166
|
)
|
|
$
|
(311
|
)
|
|
$
|
(1,026
|
)
|
|
|
Three Months Ended March 31, 2019
|
|
|
|
(in thousands)
|
|
|
|
Water Filtration
|
|
|
Pathogen Detection
|
|
|
Renal Products
|
|
|
Nephros, Inc. Consolidated
|
|
Total net revenues
|
|
$
|
1,769
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,769
|
|
Gross margin
|
|
|
998
|
|
|
|
-
|
|
|
|
-
|
|
|
|
998
|
|
Research and development expenses
|
|
|
219
|
|
|
|
126
|
|
|
|
411
|
|
|
|
756
|
|
Depreciation and amortization expense
|
|
|
50
|
|
|
|
-
|
|
|
|
-
|
|
|
|
50
|
|
Selling, general and administrative expenses
|
|
|
1,469
|
|
|
|
-
|
|
|
|
34
|
|
|
|
1,503
|
|
Change in fair value of contingent consideration
|
|
|
(10
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(10
|
)
|
Total operating expenses
|
|
|
1,728
|
|
|
|
126
|
|
|
|
445
|
|
|
|
2,299
|
|
Loss from operations
|
|
$
|
(730
|
)
|
|
$
|
(126
|
)
|
|
$
|
(445
|
)
|
|
$
|
(1,301
|
)
|
Note 16 – Subsequent Events
On April 24, 2020, the Company was granted
a loan in the amount of approximately $478,700 under the U.S. Small Business Administration’s Paycheck Protection Program
(“PPP”). The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES
Act”) enacted on March 27, 2020, provides for loans to qualifying businesses for amounts up to 2.5 times of the average
monthly payroll expenses of the qualifying business. In connection with the PPP loan, the Company issued a promissory note dated
April 24, 2020, in the principal amount of $478,700. The loan matures on April 24, 2022 and bears interest at a rate of 1.0% per
annum, payable monthly commencing November 24, 2020. The note may be prepaid at any time prior to maturity with no prepayment
penalties. Funds from the loan may only be used for payroll costs, benefits, rent, utilities and interest on other debt obligations
incurred prior to February 15, 2020. The Company intends to use the entire amount for such qualifying expenses. Under the terms
of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses during the first eight weeks
of the loan.