Attached files
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EX-31.1 - NEPHROS INC | v179691_ex31-1.htm |
EX-31.2 - NEPHROS INC | v179691_ex31-2.htm |
EX-32.2 - NEPHROS INC | v179691_ex32-2.htm |
EX-32.1 - NEPHROS INC | v179691_ex32-1.htm |
EX-10.55 - NEPHROS INC | v179691_ex10-55.htm |
EX-10.54 - NEPHROS INC | v179691_ex10-54.htm |
EX-10.53 - NEPHROS INC | v179691_ex10-53.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
FORM
10-K
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
|
For
the fiscal year ended December 31,
2009
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
|
For
the Transition Period
from to
Commission
File Number 001-32288
NEPHROS,
INC.
(Exact
name of registrant specified in its charter)
Delaware
|
13-3971809
|
|
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
(I.R.S.
Employer
Identification
No.)
|
41
Grand Avenue
River
Edge, NJ 07661
(Address
of Principal Executive Offices)
(201)
343-5202
(Telephone
Number, Including Area Code)
Securities
Registered Pursuant to Section 12(b) of the Exchange Act: None
Securities
registered under Section 12(g) of the Exchange Act:
(Title of
Class)
Common
Stock, $.001 par value per share
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange
Act. Yes ¨
No x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes
x No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
Yes ¨ No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a smaller reporting company. See definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in
Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer ¨
|
|
Accelerated
filer ¨
|
|
Non-accelerated
filer ¨
|
Smaller
reporting company x
|
|
|
|
|
(Do not check if a smaller reporting company)
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No x
The
aggregate market value of the voting stock held by non-affiliates of the
registrant, as of June 30, 2009 , was approximately $29,370,000. Such aggregate
market value was computed by reference to the closing price of the common stock
as reported on the Over the Counter Bulletin Board on June 30,
2009. For purposes of making this calculation only, the registrant
has defined affiliates as including only directors and executive officers and
shareholders holding greater than 10% of the voting stock of the registrant as
of June 30, 2009.
As of
March 30, 2010 there were 41,604,798 shares of the registrant’s common stock,
$0.001 par value, outstanding.
NEPHROS,
INC. AND SUBSIDIARY
TABLE
OF CONTENTS
Page
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PART
I
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Item
1.Business
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1
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Item
2.Properties
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14
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Item
3.Legal Proceedings
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15
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Item
4.Submission of Matters to a Vote of Security Holders
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15
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PART
II
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Item
5.Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
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15
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Item
7.Management’s Discussion and Analysis of Financial Condition and Results
of Operations
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17
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Item
8.Financial Statements and Supplementary Data
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40
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Item
9.Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
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60
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Item
9A(T).Controls and Procedures
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60
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Item
9B.Other Information
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60
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PART
III
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Item
10.Directors, Executive Officers and Corporate Governance
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61
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Item
11.Executive Compensation
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64
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Item
12.Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
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69
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Item
13.Certain Relationships and Related Transactions, and Director
Independence
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70
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Item
14.Principal Accounting Fees and Services
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70
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Item
15.Exhibits
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71
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Signatures
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74
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PART
I
Item
1. Business
Overview
Founded
in 1997, we are a Delaware corporation that has been engaged primarily in the
development of hemodiafiltration, or HDF, products and technologies for treating
patients with End Stage Renal Disease, or ESRD. In January 2006, we
introduced our new Dual Stage Ultrafilter (the “DSU”) water filtration system,
which represents a new and complementary product line to our existing ESRD
therapy business.
We
currently have three products in various stages of development in the HDF
modality to deliver improved therapy to ESRD patients:
·
|
OLpur
MDHDF filter series (which we sell in various countries in Europe and
currently consists of our MD190 and MD220 diafilters); to our knowledge,
the only filter designed expressly for HDF therapy and employing our
proprietary Mid-Dilution Diafiltration
technology;
|
·
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OLpur
H2H, our add-on
module designed to allow the most common types of hemodialysis machines to
be used for HDF therapy; and
|
·
|
OLpur
NS2000 system, our stand-alone HDF machine and associated filter
technology.
|
We have
also developed our OLpur HD 190 high-flux dialyzer cartridge, which incorporates
the same materials as our OLpur MD series but does not employ our proprietary
Mid-Dilution Diafiltration technology. Our OLpur HD190 was designed for use with
either hemodialysis or hemodiafiltration machines, and received its approval
from the U.S. Food and Drug Administration, or FDA , under Section 510(k) of the
Food, Drug and Cosmetic Act, or the FDC Act, in June 2005.
OLpur and
H2H are among our
trademarks for which U.S. registrations are pending. H2H is a registered European
Union trademark. We have assumed that the reader understands that these terms
are source-indicating. Accordingly, such terms appear throughout the remainder
of this Annual Report without trademark notices for convenience only and should
not be construed as being used in a descriptive or generic sense.
We
believe that products in our OLpur MDHDF filter series are more effective than
any products currently available for ESRD therapy because they are better at
removing certain larger toxins (known in the industry as “middle molecules”
because of their heavier molecular weight) from blood. The accumulation of
middle molecules in the blood has been related to such conditions as
malnutrition, impaired cardiac function, carpal tunnel syndrome, and
degenerative bone disease in the ESRD patient. We also believe that OLpur H2H will, upon introduction,
expand the use of HDF as a cost-effective and attractive alternative for ESRD
therapy, and that, if approved in 2010, our OLpur H2H and MDHDF filters will be the
first, and only, HDF therapy available in the United States at that
time.
We
believe that our products will reduce hospitalization, medication and care costs
as well as improve patient health (including reduced drug requirements and
improved blood pressure profiles), and therefore, quality of life, by removing a
broad range of toxins through a more patient-friendly, better-tolerated process.
In addition, independent studies in Europe have indicated that, when compared
with dialysis as it is currently offered in the United States, HDF can reduce
the patient’s mortality risk by up to 35%. We believe that the OLpur MDHDF
filter series and the OLpur H2H will provide these benefits
to ESRD patients at competitive costs and without the need for ESRD treatment
providers to make significant capital expenditures in order to use our products.
We also believe that the OLpur NS2000 system, if successfully developed, will be
the most cost-effective stand-alone hemodiafiltration system
available.
In the
first quarter of 2007, we received approval from the FDA for our Investigational
Device Exemption (“IDE”) application for the clinical
evaluation of our OLpūr H2H module and OLpūr MD 220 filter. We completed the
patient treatment phase of our clinical trial during the second quarter of 2008.
We submitted our data to the FDA with our 510(k) application on these
products in November 2008. Following its review of the
application, the FDA requested additional information from us.
We replied to the FDA inquiries on March 13, 2009. The FDA has not
provided us with any additional requests for information or rendered a decision
on our application. We have made additional inquiries to the FDA
about the status of our application and, as of March 10, 2010, have been
informed that our application is still under their review
process.
1
In
January 2006, we introduced our new Dual Stage Ultrafilter (the “DSU”) water
filtration system. Our DSU represents a new and complementary product line to
our existing ESRD therapy business. The DSU incorporates our unique and
proprietary dual stage filter architecture and is, to our knowledge, the only
water filter that allows the user to sight-verify that the filter is properly
performing its cleansing function. Our research and development work on the
OLpur H2H and MD
Mid-Dilution filter technologies for ESRD therapy provided the foundations for a
proprietary multi-stage water filter that we believe is cost effective,
extremely reliable, and long-lasting. We believe our DSU can offer a robust
solution to a broad range of contaminated water and disease prevention issues.
Hospitals are particularly stringent in their water quality requirements;
transplant patients and other individuals whose immune systems are compromised
can face a substantial infection risk in drinking or bathing with standard tap
water that would generally not present a danger to individuals with normal
immune function. The DSU is designed to remove a broad range of bacteria, viral
agents and toxic substances, including salmonella, hepatitis, cholera, HIV,
Ebola virus, ricin toxin, legionella, fungi and e-coli. With over 5,800
registered hospitals in the United States alone (as reported by the American
Hospital Association in Fast Facts of November 11, 2009), we believe the
hospital shower and faucet market can offer us a valuable opportunity as a first
step in water filtration.
Due to
the ongoing concerns of maintaining water quality, on October 7, 2008, we filed
a 510(k) application for approval to market our DSU to dialysis clinics for
in-line purification of dialysate water. On July 1, 2009, we received FDA
approval of the DSU to be used to filter biological contaminants from water
and bicarbonate concentrate used in hemodialysis procedures.
During
the twelve months ended December 31, 2009, we were granted four new
patents. In the U.S., we were issued patent #7,534,349 for a Dual
Stage Ultrafilter with pump mechanism and/or shower feature. In Canada, we were
issued patent #2,430,575 for a valve mechanism used in Infusion Fluid systems
which is a feature used on our H2H module and patent
#2,396,852 for an Ionic Enhanced Dialysis/Diafiltration system which is related
to mid-dilution HDF. In China, we were issued patent
#200510092067.3 for a Dual Stage Hemodiafiltration cartridge used in its
OLpūr MD HDF
Filter.
In 2006,
the U.S. Defense Department budget included an appropriation for the U.S. Marine
Corps for development of a dual stage water ultra filter. In
connection with this Federal appropriation of approximately $1 million, we
worked on the development of a personal potable water purification system for
use by warfighters. Work on this project was completed in August 2009 and we
have billed approximately $900,000 during the twenty months ended August
2009. In August 2009, we were awarded a new $1.8 million research
contract from the Office of Naval Research (ONR) for development of a potable
dual-stage military water purifying filter. The research contract is an
expansion of our former ONR contract which is being performed as part of the
Marine Corps Advanced Technology Demonstration (ATD) project. The
primary objective of this expanded research program is to select concepts and
functional prototype filter/pump units which were developed during the first
phase of the project, and further develop them into smaller field-testable
devices that can be used for military evaluation purposes. An
advantage of our ultrafilter is the removal of viruses which are not removed
with commercially available off-the-shelf microfilter devices. Such devices
generally rely on a secondary chemical disinfection step to make the water safe
to drink. The expanded contract also includes research geared toward improving
membrane performance, improving device durability, developing larger squad-level
water purifier devices, and investigating desalination filter/pump devices for
emergency-use purposes. Approximately $423,000 has been billed to
this second project during the four months ended December 31, 2009.
We have
also introduced the DSU to various government agencies as a solution to
providing potable water in certain emergency response situations. We have also
begun investigating a range of commercial, industrial and retail opportunities
for our DSU technology.
Going
Concern
The
financial statements included in this Annual Report on Form 10-K have been
prepared assuming that we will continue as a going concern, however, there can
be no assurance that we will be able to do so. Our recurring losses and
difficulty in generating sufficient cash flow to meet our obligations and
sustain our operations raise substantial doubt about our ability to continue as
a going concern. Our consolidated financial statements do not include
any adjustments that might result from the outcome of this
uncertainty.
We have
incurred losses in our operations in each quarter since inception. For the years
ended December 31, 2009 and 2008, we have incurred net losses of $2,026,000 and
$6,337,000, respectively. In addition, we have not generated positive cash flow
from operations for the years ended December 31, 2009 and 2008. To become
profitable, we must increase revenue substantially and achieve and maintain
positive gross and operating margins. If we are not able to increase revenue and
gross and operating margins sufficiently to achieve profitability, our results
of operations and financial condition will be materially and adversely
affected.
At
December 31, 2009, we had $1,004,000 in cash and cash equivalents. There can be
no assurance that our cash and cash equivalents will provide the liquidity we
need to continue our operations. (See “Certain Risks and Uncertainties”). These
operating plans primarily include the continued development and support of our
business in the European and Canadian markets, organizational changes necessary
to enhance the commercialization of our water filtration business and the
completion of current year milestones which are included in the Office of Naval
Research appropriation.
There can
be no assurance that our future cash flow will be sufficient to meet our
obligations and commitments. If we are unable to generate sufficient cash flow
from operations in the future to service our commitments we will be required to
adopt alternatives, such as seeking to raise debt or equity capital, curtailing
our planned activities or ceasing our operations. There can be no assurance that
any such actions could be effected on a timely basis or on satisfactory terms or
at all, or that these actions would enable us to continue to satisfy our capital
requirements.
2
We
continue to investigate additional funding opportunities by talking to various
potential investors who could provide financing. However, there can be no
assurance that we will be able to obtain further financing, do so on reasonable
terms or do so on terms that would not substantially dilute your equity
interests in us. If we are unable to raise additional funds on a
timely basis, or at all, we will not be able to continue our
operations.
In
addition, on September 12, 2008, we received a letter from the NYSE Alternext US
LLC (formerly, the American Stock Exchange or “AMEX”) notifying us of our
noncompliance with certain continued listing standards.
In
response to that letter, we submitted a plan of compliance to the AMEX on
October 13, 2008 advising the AMEX of the actions we have taken, or will take,
that would bring us into compliance with the continued listing standards by
April 30, 2009.
On
January 8, 2009, we received a letter from the AMEX notifying us that it
was rejecting our plan of compliance regarding the following listing standards
to which we were in noncompliance of:
·
|
Section
1003(a)(iii), which states AMEX will normally consider suspending dealings
in, or removing from the list, securities of an issuer which has
stockholders’ equity of less than $6,000,000 if such issuer has sustained
net losses in its five most recent fiscal
years;
|
·
|
Section
1003(a)(ii), which states AMEX will normally consider suspending dealings
in, or removing from the list, securities of an issuer which has
stockholders’ equity of less than $4,000,000 if such issuer has sustained
net losses in its three of its four most recent fiscal years;
and
|
·
|
Section
1003(f)(v), which states AMEX will normally consider suspending dealings
in, or removing from the list, common stock that sells for a substantial
period of time at a low price per
share.
|
The AMEX
further stated that the AMEX intended to strike our common stock from the AMEX
by filing a delisting application with the SEC pursuant to Rule 1009(d) of the
AMEX Company Guide. Given the turmoil in the capital markets,
we decided not to seek an appeal of the AMEX’s intention to delist our
common stock.
On
January 22, 2009, we were informed by the AMEX that they had suspended trading
in our common stock effective immediately. Immediately following the
notification, our common stock was no longer traded on the AMEX.
Effective
February 4, 2009, our common stock was quoted on the Over the Counter Bulletin
Board under the symbol “NEPH.OB”.
In a
letter dated April 13, 2009, we received a copy of the AMEX’s application to
strike our common stock from the AMEX.
Current
ESRD Therapy Options
Current
renal replacement therapy technologies include (1) two types of dialysis,
peritoneal dialysis and hemodialysis, (2) hemofiltration and (3)
hemodiafiltration, a combination of hemodialysis and hemofiltration. Dialysis
can be broadly defined as the process that involves movement of molecules across
a semipermeable membrane. In hemodialysis, hemofiltration or hemodiafiltration,
the blood is exposed to an artificial membrane outside of the body. During
Peritoneal Dialysis (PD), the exchange of molecules occurs across the membrane
lining of the patient’s peritoneal cavity. While there are variations in each
approach, in general, the three major categories of renal replacement therapy in
the marketplace today are defined as follows:
3
·
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Dialysis
|
o
|
Peritoneal Dialysis, or
PD, uses the patient’s peritoneum, the membrane lining covering the
internal abdominal organs, as a filter by introducing injectable-grade
dialysate solution into the peritoneal cavity through a surgically
implanted catheter. After some period of time, the fluid is drained and
replaced. PD is limited in use because the peritoneal cavity is subject to
scarring with repeated episodes of inflammation of the peritoneal
membrane, reducing the effectiveness of this treatment approach. With
time, a PD patient’s kidney function continues to deteriorate and
peritoneal toxin removal alone may become insufficient to provide adequate
treatment. In such case the patient may switch to an extracorporeal renal
replacement therapy such as hemodialysis or
hemodiafiltration.
|
o
|
Hemodialysis uses an
artificial kidney machine to remove certain toxins and fluid from the
patient’s blood while controlling external blood flow and monitoring
patient vital signs. Hemodialysis patients are connected to a dialysis
machine via a vascular access device. The hemodialysis process occurs in a
dialyzer cartridge with a semi-permeable membrane which divides the
dialyzer into two chambers: while the blood is circulated through one
chamber, a premixed solution known as dialysate circulates through the
other chamber. Toxins and excess fluid from the blood cross the membrane
into the dialysate solution through a process known as
“diffusion.”
|
·
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Hemofiltration is a
cleansing process without dialysate solution where blood is passed through
a semi-permeable membrane, which filters out solute
particles.
|
·
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Hemodiafiltration, or
HDF, in its basic form combines the principles of hemodialysis with
hemofiltration. HDF uses dialysate solution with a negative pressure
(similar to a vacuum effect) applied to the dialysate solution to draw
additional toxins from the blood and across the membrane. This process is
known as “convection.” HDF thus combines diffusion with convection,
offering efficient removal of small solutes by diffusion, with improved
removal of larger substances (i.e., middle molecules) by
convection.
|
Hemodialysis
is the most common form of extracorporeal renal replacement therapy and is
generally used in the United States. Hemodialysis fails, in our opinion, to
address satisfactorily the long-term health or overall quality of life of the
ESRD patient. We believe that the HDF process, which is currently available in
our Target European Market and Japan, offers improvement over other dialysis
therapies because of better ESRD patient tolerance, superior blood purification
of both small and middle molecules, and a substantially improved mortality risk
profile.
Current
Dialyzer Technology used with HDF Systems
In our
view, treatment efficacy of current HDF systems is limited by current dialyzer
technology. As a result of the negative pressure applied in HDF, fluid is drawn
from the blood and across the dialyzer membrane along with the toxins removed
from the blood. A portion of this fluid must be replaced with a man-made
injectable grade fluid, known as “substitution fluid,” in order to maintain the
blood’s proper fluid volume. With the current dialyzer technology, fluid is
replaced in one of two ways: pre-dilution or post-dilution.
·
|
With
pre-dilution, substitution fluid is added to the blood before the blood
enters the dialyzer cartridge. In this process, the blood can be
over-diluted, and therefore more fluid can be drawn across the membrane.
This enhances removal of toxins by convection. However, because the blood
is diluted before entering the device, it actually reduces the rate of
removal by diffusion; the overall rate of removal, therefore, is reduced
for small molecular weight toxins (such as urea) that rely primarily on
diffusive transport.
|
·
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With
post-dilution, substitution fluid is added to blood after the blood has
exited the dialyzer cartridge. This is the currently preferred method
because the concentration gradient is maintained at a higher level, thus
not impairing the rate of removal of small toxins by diffusion. The
disadvantage of this method, however, is that there is a limit in the
amount of plasma water that can be filtered from the blood before the
blood becomes too viscous, or thick. This limit is approximately 20% to
25% of the blood flow rate. This limit restricts the amount of convection,
and therefore limits the removal of middle and larger
molecules.
|
4
The
Nephros Mid-Dilution Diafiltration Process
Our OLpur
MDHDF filter series uses a design and process we developed called Mid-Dilution
Diafiltration, or MDF. MDF is a fluid management system that optimizes the
removal of both small toxins and middle-molecules by offering the advantages of
pre-dilution HDF and post-dilution HDF combined in a single dialyzer cartridge.
The MDF process involves the use of two stages: in the first stage, blood is
filtered against a dialysate solution, therefore providing post-dilution
diafiltration; it is then overdiluted with sterile infusion fluid before
entering a second stage, where it is filtered once again against a dialysate
solution, therefore providing pre-dilution diafiltration. We believe that the
MDF process provides improved toxin removal in HDF treatments, with a resulting
improvement in patient health and concurrent reduction in healthcare
costs.
Our
ESRD Therapy Products
Our
products currently available or in development with respect to ESRD Therapy
include:
OLpur
MDHDF Filter Series
OLpur
MD190 and MD220 constitute our dialyzer cartridge series that incorporates the
patented MDF process and is designed for use with existing HDF platforms
currently prevalent in our Target European Market and Japan. Our MDHDF filter
series incorporates a unique blood-flow architecture that enhances toxin removal
with essentially no cost increase over existing devices currently used for HDF
therapy.
Laboratory
bench studies have been conducted on our OLpur MD190 by members of our research
and development staff and by a third party. We completed our initial clinical
studies to evaluate the efficacy of our OLpur MD190 as compared to conventional
dialyzers in Montpellier, France in 2003. The results from this clinical study
support our belief that OLpur MD190 is superior to post-dilution
hemodiafiltration using a standard high-flux dialyzer with respect to
§2-microglobulin clearance. In addition, clearances of urea, creatinine, and
phosphate met the design specifications proposed for the OLpur MD190 device.
Furthermore, adverse event data from the study suggest that hemodiafiltration
with our OLpur MD190 device was well tolerated by the patients and
safe.
We have
initiated longer term clinical studies in the United Kingdom, France, Germany,
Italy and Spain to further demonstrate the therapeutic benefits of our OLpur
MDHDF filter series. A multi-center study was started in March 2005. This study
encompassed seven centers in France, five centers in Germany and one center in
Sweden. Also commencing in 2005 were studies in the United Kingdom and in Italy.
A three-month study was conducted in Spain. All enrolled patients in the
multi-center and Spain studies completed the investigational period with the
Nephros OLpur MDHDF filter devices. Initial data is very positive, demonstrating
improved low-molecular weight protein removal, improvements in appetite, an
overall improved distribution of fluids and body composition, and optimal toxin
removal and treatment tolerance for patients suffering from limited vascular
access. Data was presented at the American Society of Nephrology meeting held in
November 2006.
We
contracted with TÜV Rheinland of North America, Inc., a worldwide testing and
certification agency (also referred to as a notified body) that performs
conformity assessments to European Union requirements for medical devices, to
assist us in obtaining the Conformité Européene, or CE mark, a mark which
demonstrates compliance with relevant European Union requirements. We
received CE marking on the OLpur MD190 (which also covers other dialyzers in our
MDHDF filter series), as well as certification of our overall quality system, on
July 31, 2003. In the fourth quarter of 2006 we received CE marking on the
DSU.
In
November 2007, the Therapeutic Products Directorate of Health Canada, the
Canadian health regulatory agency, approved our OLpur MDHDF filter series for
marketing in Canada.
We
initiated marketing of our OLpur MD190 in our Target European Market in March
2004. We have established a sales presence in countries throughout
our Target European Market, mainly through distributors, and we have developed
marketing material in the relevant local languages. We also attend trade shows
where we promote our product to several thousand people from the industry. Our
OLpur MD220 is a new product that we began selling in our Target European Market
in 2006. The OLpur MD220 employs the same technology as our OLpur MD190, but
contains a larger surface area of fiber. Because of its larger surface area, the
OLpur MD220 may provide greater clearance of certain toxins than the OLpur
MD190, and is suitable for patients of larger body mass.
We are
currently offering the OLpur MD190 and OLpur MD220 at a price comparable to the
existing “high performance” dialyzers sold in the relevant market. We are unable
at this time to determine what the market prices will be in the
future.
In the
first quarter of 2007, we received approval from the FDA for our Investigational
Device Exemption (“IDE”) application for the clinical evaluation of our OLpūr
H2H module and OLpūr MD 220 filter. We completed the patient treatment phase of
our clinical trial during the second quarter of 2008. We have submitted our data
to the FDA with our 510(k) application on these products in November
2008. Following its review of the application, the FDA has
requested additional information from us. We replied to the FDA
inquiries on March 13, 2009. The FDA has not provided
us with any additional requests for information or rendered a decision on our
application. We have made additional inquiries to the FDA about the
status of our application and, as of March 10, 2010, have been informed
that our application is still under their review process.
OLpur
HD190
OLpur
HD190 is our high-flux dialyzer cartridge, designed for use with either
hemodialysis or hemodiafiltration machines. The OLpur HD190 incorporates the
same materials as our OLpur MD190, but lacks our proprietary mid-dilution
architecture.
5
OLpur
H2H
OLpur H2H is our add-on module that converts
the most common types of hemodialysis machines — that is, those with
volumetric ultrafiltration control — into HDF-capable machines
allowing them to use our OLpur MDHDF filter. We have completed our OLpur
H2H design and laboratory bench testing,
all of which were conducted by members of our research and development staff.
Our design verification of the OLpur H2H was completed making the device ready
for U.S. clinical trial. We completed the patient treatment
phase of our clinical trial during the second quarter of 2008. We submitted our
data to the FDA with our 510(k) application on these products in November
2008. Following its review of the application, the FDA requested
additional information from us. We replied to the FDA inquiries on
March 13, 2009. The FDA has not provided us with any additional requests
for information or rendered a decision on our application. We have made
additional inquiries to the FDA about the status of our application and, as of
March 10, 2010, have been informed that our application is still under their
review process.
OLpur
NS2000
OLpur
NS2000 is our standalone HDF machine and associated filter technology, which is
in the development stage. The OLpur NS2000 will use a basic HDF platform which
will incorporate our H2H
technology including our proprietary substitution fluid systems.
We have
also designed and developed proprietary substitution fluid filter cartridges for
use with the OLpur NS2000, which have been subjected to pre-manufacturing
testing. We will need to obtain the relevant regulatory clearances prior to any
market introduction of our OLpur NS2000 in the United States.
Our
Water Filtration Product
In
January 2006, we introduced our Dual Stage Ultrafilter, or DSU, water filtration
system. The DSU incorporates our unique and proprietary dual stage filter
architecture. Our research and development work on the OLpur H2H and MD filter technologies
for ESRD therapy provided the foundations for a proprietary multi-stage water
filter that we believe is cost effective, extremely reliable, and long-lasting.
We believe our DSU can offer a robust solution to various contaminated water and
infection control issues. The DSU is designed to remove a broad range of
bacteria, viral agents and toxic substances, including salmonella, hepatitis,
cholera, HIV, Ebola virus, ricin toxin, legionella, fungi and e-coli. We believe
our DSU offers four distinct advantages over competitors in the water filtration
marketplace:
1)
|
the
DSU is, to our knowledge, the only water filter that provides the user
with a simple sight verification that the filter is properly performing
its cleansing function due to our unique dual-stage
architecture;
|
2)
|
the
DSU filters finer biological contaminants than other filters of which we
are aware in the water filtration
marketplace;
|
3)
|
the
DSU filters relatively large volumes of water before requiring
replacement; and
|
4)
|
the
DSU continues to protect the user even if the flow is reduced by
contaminant volumes, because contaminants do not cross the filtration
medium.
|
With over
5,000 registered hospitals in the United States alone, we believe the hospital
shower and faucet market can offer us a valuable opportunity as a first step in
water filtration. We hope to gain a foothold at U.S. and European facilities
that seek to become centers of excellence in infection control through the use
of our DSU products.
Due to
the ongoing concerns of maintaining water quality, on October 7, 2008, we filed
a 510(k) application for approval to market our DSU to dialysis clinics for
in-line purification of dialysate water. On July 1, 2009, we received FDA
approval of the DSU to be used to filter biological contaminants from water
and bicarbonate concentrate used in hemodialysis procedures.
In 2006,
the U.S. Defense Department budget included an appropriation for the U.S. Marine
Corps for development of a dual stage water ultra filter. In
connection with this Federal appropriation of approximately $1 million, we
worked on the development of a personal potable water purification
system for use by warfighters. Work on this project was completed in August 2009
and we have billed approximately $900,000 during the twenty months ended August
2009. In August 2009, we were awarded a new $1.8 million research
contract from the Office of Naval Research (ONR) for development of a potable
dual-stage military water purifying filter. The research contract is an
expansion of our former ONR contract which is being performed as part of the
Marine Corps Advanced Technology Demonstration (ATD) project. The
primary objective of this expanded research program is to select concepts and
functional prototype filter/pump units which were developed during the first
phase of the project, and further develop them into smaller field-testable
devices that can be used for military evaluation purposes. An
advantage of our ultrafilter is the removal of viruses which are not removed
with commercially available off-the-shelf microfilter devices. Such devices
generally rely on a secondary chemical disinfection step to make the water safe
to drink. The expanded contract also includes research geared toward improving
membrane performance, improving device durability, developing larger squad-level
water purifier devices, and investigating desalination filter/pump devices for
emergency-use purposes. Approximately $423,000 has been billed to
this second project during the four months ended December 31,
2009.
6
We have
also introduced the DSU to various government agencies as a solution to
providing potable water in certain emergency response situations. We have also
begun investigating a range of commercial, industrial and retail opportunities
for our DSU technology.
Our
Strategy
We
believe that current mortality and morbidity statistics, in combination with
quality of life issues faced by the ESRD patient, has generated demand for
improved ESRD therapies. We also believe that our products and patented
technology offer the ability to remove toxins more effectively than current
dialysis therapy, in a cost framework competitive with currently available,
less-effective therapies. The following are some highlights of our current
strategy:
Showcase Product Efficacy in our
Target European Market: As of March 2004, we initiated
marketing in our Target European Market for the OLpur MD190. There is
an opportunity for sales of the OLpur MDHDF filters in our Target
European Market because there is an established HDF machine base using
disposable dialyzers. We have engaged in a series of clinical trials throughout
our Target European Market to demonstrate the superior efficacy of our product.
We believe that by demonstrating the effectiveness of our MDHDF filter series we
will encourage more customers to purchase our products. Our MDHDF filter series
has been applied successfully in over 150,000 treatments to date.
Convert Existing Hemodialysis
Machines to Hemodiafiltration: Upon completion of the
appropriate documentation for our OLpur H2H technology, we plan to apply
for CE marking for our OLpur H2H during 2010. We plan to
complete our regulatory approval processes in the United States for both our
OLpur MDHDF filter series and our OLpur H2H in 2009. If successfully
approved, our OLpur H2H
product will enable HDF therapy using the most common types of hemodialysis
machines together with our OLpur MDHDF filters. Our goal is to achieve
market penetration by offering the OLpur H2H for use by healthcare
providers inexpensively, thus permitting the providers to use the OLpur H2H without a large initial
capital outlay. We do not expect to generate significant positive margins from
sales of OLpur H2H. We
believe H2H will provide a
basis for more MDHDF filter sales. We believe that, if approved in 2010, our
OLpur H2H and MDHDF
filters will be the first, and only, HDF therapy available in the United States
at that time.
Upgrade Dialysis Clinics to OLpur
NS2000: We believe the introduction of the OLpur NS2000 will
represent a further upgrade in performance for dialysis clinics by offering a
cost-effective stand-alone HDF solution that incorporates the benefits of our
OLpur H2H technology. We
believe dialysis clinics will entertain OLpur NS2000 as an alternative to their
current technology at such dialysis clinic’s machine replacement
point.
Develop a Foothold in the Healthcare
Arena by Offering our DSU as a Means to Control Environment-Acquired
Infections : We believe our DSU offers an effective, and
cost-effective, solution in conquering certain infection control issues faced by
hospitals, nursing homes, assisted living facilities and other patient
environments where chemical or heat alternatives have typically failed to
adequately address the problem. The DSU provides for simple implementation
without large capital expenses. We have established a goal in 2010 to gain a
foothold at U.S. and European facilities that seek to become centers of
excellence in infection control through the use of our DSU
products.
Pursue our Military Product
Development in Conjunction with Value-Adding Partners: For our
military development, we are engaging with strategic allies who offer added
value with respect to both new product and marketing opportunities. One of our
goals in pursuing this project is to maintain and expand our new product
development pipeline and achieve new products suitable for both military and
domestic applications.
Explore Complementary Product
Opportunities: Where appropriate, we are also seeking to
leverage our technologies and expertise by applying them to new markets. Our
H2H has potential
applications in acute patient care and controlled provision of ultrapure fluids
in the field. Our DSU represents a new and complementary product line to our
existing ESRD therapy business; we believe the Nephros DSU can offer a robust
solution to a broad range of contaminated water and infection control
issues.
7
Manufacturing
and Suppliers
We do not intend to manufacture any of
our products or components. We have entered into an agreement dated May 12,
2003, with a contract manufacturer (“CM”) to assemble and produce our OLpur
MD190, MD220 or other filter products at our option. The agreement requires us
to utilize this CM to manufacture the OLpur MD190s and MD220s or other filter
products that we directly market in Europe, or are marketed by our distributor.
In addition, our CM will be given first consideration in good faith for the
manufacture of OLpur MD190s, MD220s or other filter products that we do not
directly market. No less than semiannually, our CM will provide a report to
representatives of both parties to the agreement detailing any technical
know-how that they have developed that would permit them to manufacture the
filter products less expensively and both parties will jointly determine the
actions to be taken with respect to these findings. If the fiber wastage with
respect to the filter products manufactured in any given year exceeds 5%, then
the CM will reimburse us up to half of the cost of the quantity of fiber
represented by excess wastage. The CM will manufacture the OLpur MD190 or other
filter products in accordance with the quality standards outlined in the
agreement. Upon recall of any OLpur MD190 or other filter product due to
manufactured products that fail to conform to the required specifications or
having failed to manufacture one or more products in accordance with any
applicable laws, the CM will be responsible for the cost of recall. The
agreement also requires that we maintain certain minimum product-liability
insurance coverage and that we indemnify our CM against certain liabilities
arising out of our products that they manufacture, providing they do not arise
out of the CM’s breach of the agreement, negligence or willful misconduct. The
term of the agreement is through May 12, 2010, with successive automatic
one-year renewal terms, until either party gives the other notice that it does
not wish to renew at least 90 days prior to the end of the term. The agreement
may be terminated prior to the end of the term by either party upon the
occurrence of certain insolvency-related events or breaches by the other party.
Although we have no separate agreement with respect to such activities, our CM
has also been manufacturing our H2H filters and DSU in limited
quantities.
We also
entered into an agreement in December 2003, and amended in June 2005, with a
fiber supplier (“FS”), a manufacturer of medical and technical membranes for
applications like dialysis, to continue to produce the fiber for the OLpur MDHDF
filter series. Pursuant to the agreement, FS is our exclusive provider of the
fiber for the OLpur MDHDF filter series in the European Union as well as certain
other territories. On January 18, 2010 the FS notified us that they
are exercising their right to terminate the supply
agreement. Termination of the supply agreement will be effective on
July 18, 2010. The FS noted their desire to negotiate and execute a
new supply agreement with us. Negotiations on terms of a new supply
agreement have been taking place and we expect to execute a new agreement with
the FS, although we cannot assure you that we will be able to do
so.
Sales
and Marketing
We have established a distributor
network to sell ESRD products in our Target European Market and, when regulatory
approval is obtained, intend to establish a similar arrangement in the United
States. On February 25, 2010, we announced that we signed an exclusive
distribution agreement with Bellco Health Care Inc. (“BHC Medical”) to sell and
market Nephros’ OLpurTM MD 220 filter for on-line HDF therapy in
Canada. Under
the terms of the Agreement, Nephros and BHC Medical will work together to
promote the sale and distribution of Nephros’ OLpurTM MD 220 filters through
various advertising and promotional campaigns and by working with and training
BHC’s sales and support staff.
We have
established a customer service and financial processing facility in Dublin,
Ireland, available to our customer base in our Target European Market. We have
also initiated and completed various clinical studies designed to continue our
evaluation of effectiveness of the OLpur MDHDF filters when used on ESRD
patients in our Target European Market. These studies are intended to provide
us, and have provided us, with valuable information regarding the efficacy of
our product and an opportunity to introduce OLpur MDHDF filters to medical
institutions in our Target European Market. We have engaged a medical advisor to
help us in structuring our clinical study protocols and to support physicians’
technical inquiries regarding our products.
We are
marketing our ESRD products primarily to healthcare providers such as hospitals,
dialysis clinics, managed care organizations, and nephrology physician groups.
We ship our products to these customers both directly from our manufacturer,
where this is cost-effective, our distributors, and a public warehouse facility
in the U.S.
Our New
Jersey office oversees sales and marketing activity of our DSU products. We are
in discussions with several medical products and filtration products suppliers
to act as non-exclusive distributors of our DSU products to medical
institutions. For each prospective market for our DSU products, we are pursuing
alliance opportunities for joint product development and distribution. Our DSU
manufacturer in Europe shares certain intellectual property rights with us for
one of our DSU designs.
Research
and Development
Our
research and development efforts continue on several fronts directly related to
our current product lines. We are also working on additional machine
devices, next-generation user interface enhancements and other product
enhancements.
In the
area of water filtration, we have finalized our initial water filtration product
line for the healthcare sector.
8
In 2006,
the U.S. Defense Department budget included an appropriation for the U.S. Marine
Corps for development of a dual stage water ultra filter. In
connection with this Federal appropriation of approximately $1 million, we
worked on the development of a personal potable water purification
system for use by warfighters. Work on this project was completed in August 2009
and we have billed approximately $900,000 during the twenty months ended August
2009. In August 2009, we were awarded a new $1.8 million research
contract from the Office of Naval Research (ONR) for development of a potable
dual-stage military water purifying filter. The research contract is an
expansion of our former ONR contract which is being performed as part of the
Marine Corps Advanced Technology Demonstration (ATD) project. The
primary objective of this expanded research program is to select concepts and
functional prototype filter/pump units which were developed during the first
phase of the project, and further develop them into smaller field-testable
devices that can be used for military evaluation purposes. An
advantage of our ultrafilter is the removal of viruses which are not removed
with commercially available off-the-shelf microfilter devices. Such devices
generally rely on a secondary chemical disinfection step to make the water safe
to drink. The expanded contract also includes research geared toward improving
membrane performance, improving device durability, developing larger squad-level
water purifier devices, and investigating desalination filter/pump devices for
emergency-use purposes. Approximately $423,000 has been billed to
this second project during the four months ended December 31, 2009.
We have
also introduced the DSU to various government agencies as a solution to
providing potable water in certain emergency response situations. We have also
begun investigating a range of commercial, industrial and retail opportunities
for our DSU technology.
Our
research and development expenditures were primarily related to development
expenses associated with the H2H machine
and related salary expense for the years ended December 31, 2009 and
2008 and were $280,000 and $1,977,000, respectively.
Competition
The
dialyzer and renal replacement therapy market is subject to intense competition.
Accordingly, our future success will depend on our ability to meet the clinical
needs of physicians and nephrologists, improve patient outcomes and remain
cost-effective for payors.
We
compete with other suppliers of ESRD therapies, supplies and services. These
suppliers include Fresenius Medical Care AG, and Gambro AB, currently two of the
primary machine manufacturers in hemodialysis. At present, Fresenius Medical
Care AG and Gambro AB also manufacture HDF machines.
The
markets in which we sell our dialysis products are highly competitive. Our
competitors in the sale of hemodialysis products include Gambro AB, Baxter
International Inc., Asahi Kasei Medical Co. Ltd., Bellco S.p.A., a subsidiary of
the Sorin group, B. Braun Melsungen AG, Nipro Corporation Ltd., Nikkiso Co.,
Ltd., Terumo Corporation and Toray Medical Co., Ltd.
Other
competitive considerations include pharmacological and technological advances in
preventing the progression of ESRD in high-risk patients such as those with
diabetes and hypertension, technological developments by others in the area of
dialysis, the development of new medications designed to reduce the incidence of
kidney transplant rejection and progress in using kidneys harvested from
genetically-engineered animals as a source of transplants.
We are
not aware of any other companies using technology similar to ours in the
treatment of ESRD. Our competition would increase, however, if companies that
currently sell ESRD products, or new companies that enter the market, develop
technology that is more efficient than ours. We believe that in order to become
competitive in this market, we will need to develop and maintain competitive
products and take and hold sufficient market share from our competitors.
Therefore, we expect our methods of competing in the ESRD marketplace to
include:
·
|
continuing
our efforts to develop, have manufactured and sell products which, when
compared to existing products, perform more efficiently and are available
at prices that are acceptable to the
market;
|
·
|
displaying
our products and providing associated literature at major industry trade
shows in the United States, our Target European Market and
Canada;
|
·
|
initiating
discussions with dialysis clinic medical directors, as well as
representatives of dialysis clinical chains, to develop interest in our
products;
|
·
|
offering
the OLpur H2H at a
price that does not provide us with significant positive margins in order
to encourage adoption of this product and associated demand for our
dialyzers; and
|
·
|
pursuing
alliance opportunities in certain territories for distribution of our
products and possible alternative manufacturing
facilities.
|
With
respect to the water filtration market, we expect to compete with companies that
are well entrenched in the water filtration domain. These companies include Pall
Corporation, which manufactures end-point water filtration systems, as well as
CUNO (a 3M Company) and US Filter (a Siemens business). Our methods of
competition in the water filtration domain include:
9
·
|
developing
and marketing products that are designed to meet critical and specific
customer needs more effectively than competitive
devices;
|
·
|
offering
unique attributes that illustrate our product reliability,
“user-friendliness,” and performance
capabilities;
|
·
|
selling
products to specific customer groups where our unique product attributes
are mission-critical; and
|
·
|
pursuing
alliance opportunities for joint product development and
distribution.
|
Intellectual
Property
Patents
We
protect our technology and products through patents and patent applications. In
addition to the United States, we also applied for patents in other
jurisdictions, such as the European Patent Office, Canada and Japan, to the
extent we deem appropriate. We have built a portfolio of patents and
applications covering our products, including their hardware design and methods
of hemodiafiltration.
We
believe that our patent strategy will provide a competitive advantage in our
target markets, but our patents may not be broad enough to cover our
competitors’ products and may be subject to invalidation claims. Our U.S.
patents for the “Method and Apparatus for Efficient Hemodiafiltration” and for
the “Dual-Stage Filtration Cartridge,” have claims that cover the OLpur MDHDF
filter series and the method of hemodiafiltration employed in the operation of
the products. Although there are pending applications with claims to the present
embodiments of the OLpur H2H and the OLpur NS2000
products, these products are still in the development stage and we cannot
determine if the applications (or the patents that we may issue on them) will
also cover the ultimate commercial embodiment of these products. In addition,
technological developments in ESRD therapy could reduce the value of our
intellectual property. Any such reduction could be rapid and unanticipated. We
have applied for patents on our DSU water filtration products to cover various
applications in residential, commercial, and remote environments.
As of
December 2009, we have sixteen issued U.S. patents; one issued Eurasian patent;
four Mexican patents, four South Korean patents, three Russian patents, five
Chinese patents, five French patents, six German patents, four Israeli patents,
five Italian patents, two Spanish patents, six United Kingdom patents, eight
Japanese patents, two Hong Kong patents, and nine Canadian patents. Our issued
U.S. patents expire between 2018 and 2022. In addition, we have four pending
U.S. patent applications, ten pending patent applications in Canada, eight
pending patent applications in the European Patent Office, five pending patent
applications in Brazil, three pending patent applications in China, nine pending
patent applications in Japan, three pending patent applications in Mexico, one
pending patent application in South Korea, one pending patent application in
Hong Kong, two pending patent applications in India, two pending patent
applications in Israel and one pending patent application in Australia.. Our
pending patent applications relate to a range of dialysis technologies,
including cartridge configurations, cartridge assembly, substitution fluid
systems, and methods to enhance toxin removal. We also have pending patent
applications on our DSU water filtration system and pump/filter applications
related to our Office of Naval Research project.
We have
filed U.S. and International patent applications for a redundant ultra
filtration device that was jointly invented by one of our employees and an
employee of our CM. We and our CM are negotiating commercial arrangements
pertaining to the invention and the patent applications.
Trademarks
As of
December 31, 2009, we secured registrations of the trademarks CENTRAPUR, H2H, OLpur and the Arrows Logo in
the European Union. Applications for these trademarks are pending registration
in the United States. We also have applications for registration of a number of
other marks pending in the United States Patent and Trademark
Office.
Governmental
Regulation
The
research and development, manufacturing, promotion, marketing and distribution
of our ESRD therapy products in the United States, our Target European Market
and other regions of the world are subject to regulation by numerous
governmental authorities, including the FDA, the European Union and analogous
agencies.
United
States
The FDA
regulates the manufacture and distribution of medical devices in the United
States pursuant to the FDC Act. All of our ESRD therapy products are regulated
in the United States as medical devices by the FDA under the FDC Act. Under the
FDC Act, medical devices are classified in one of three classes, namely Class I,
II or III, on the basis of the controls deemed necessary by the FDA to
reasonably ensure their safety and effectiveness.
10
·
|
Class
I devices are medical devices for which general controls are deemed
sufficient to ensure their safety and effectiveness. General controls
include provisions related to (1) labeling, (2) producer registration, (3)
defect notification, (4) records and reports and (5) quality service
requirements, or QSR.
|
·
|
Class
II devices are medical devices for which the general controls for the
Class I devices are deemed not sufficient to ensure their safety and
effectiveness and require special controls in addition to the general
controls. Special controls include provisions related to (1) performance
and design standards, (2) post-market surveillance, (3) patient registries
and (4) the use of FDA
guidelines.
|
·
|
Class
III devices are the most regulated medical devices and are generally
limited to devices that support or sustain human life or are of
substantial importance in preventing impairment of human health or present
a potential, unreasonable risk of illness or injury.
Pre-market approval by the FDA is the required process of scientific
review to ensure the safety and effectiveness of Class III
devices.
|
Before a
new medical device can be introduced to the market, FDA clearance of a
pre-market notification under Section 510(k) of the FDC Act or FDA clearance of
a pre-market approval, or PMA, application under Section 515 of the FDC Act must
be obtained. A Section 510(k) clearance will be granted if the submitted
information establishes that the proposed device is “substantially equivalent”
to a legally marketed Class I or Class II medical device or to a Class III
medical device for which the FDA has not called for pre-market approval under
Section 515. The Section 510(k) pre-market clearance process is generally faster
and simpler than the Section 515 pre-market approval process. We understand that
it generally takes four to 12 months from the date a Section 510(k) notification
is accepted for filing to obtain Section 510(k) pre-market clearance, as is the
case with our OLpur H2H
module and OLpur MD 220 filter, and that it could take several years from the
date a Section 515 application is accepted for filing to obtain Section 515
pre-market approval, although it may take longer in both cases.
We expect
that all of our ESRD therapy products and our DSU will be categorized as Class
II devices and that these products will not require clearance of pre-market
approval applications under Section 515 of the FDC Act, but will be eligible for
marketing clearance through the pre-market notification process under Section
510(k). We have determined that we are eligible to utilize the Section 510(k)
pre-market notification process based upon our ESRD therapy and DSU products’
substantial equivalence to previously legally marketed devices in the United
States. However, we cannot assure you:
·
|
that
we will not need to reevaluate the applicability of the Section 510(k)
pre-market notification process to our ESRD therapy and DSU products in
the future;
|
·
|
that
the FDA will agree with our determination that we are eligible to use the
Section 510(k) pre-market notification process;
or
|
·
|
that
the FDA will not in the future require us to submit a Section 515
pre-market approval application, which would be a more costly, lengthy and
uncertain approval process.
|
The FDA
has recently been requiring a more rigorous demonstration of substantial
equivalence than in the past and may request clinical data to support pre-market
clearance. As a result, the FDA could refuse to accept for filing a Section
510(k) notification made by us or request the submission of additional
information. The FDA may determine that any one of our proposed ESRD therapy
products is not substantially equivalent to a legally marketed device or that
additional information is needed before a substantial equivalence determination
can be made. A “not substantially equivalent” determination, or request for
additional data, could prevent or delay the market introduction of our products
that fall into this category, which in turn could have a material adverse effect
on our potential sales and revenues. Moreover, even if the FDA does clear one or
all of our products under the Section 510(k) process, it may clear a product for
some procedures but not others or for certain classes of patients and not
others.
For any
devices cleared through the Section 510(k) process, modifications or
enhancements that could significantly affect the safety or effectiveness of the
device or that constitute a major change to the intended use of the device will
require a new Section 510(k) pre-market notification submission. Accordingly, if
we do obtain Section 510(k) pre-market clearance for any of our ESRD therapy and
DSU products, we will need to submit another Section 510(k) pre-market
notification if we significantly affect that product’s safety or effectiveness
through subsequent modifications or enhancements.
11
If human
clinical trials of a device are required in connection with a Section 510(k)
notification and the device presents a “significant risk,” the sponsor of the
trial (usually the manufacturer or distributor of the device) will need to file
an IDE application prior to commencing human clinical trials. The IDE
application must be supported by data, typically including the results of animal
testing and/or laboratory bench testing. If the IDE application is approved,
human clinical trials may begin at a specific number of investigational sites
with a specific number of patients, as specified in the IDE. Sponsors of
clinical trials are permitted to sell those devices distributed in the course of
the study provided such compensation does not exceed recovery of the costs of
manufacture, research, development and handling. An IDE supplement must be
submitted to the FDA before a sponsor or investigator may make a change to the
investigational plan that may affect its scientific soundness or the rights,
safety or welfare of subjects. We submitted our original IDE application to the
FDA for our OLpur H2H
hemodiafiltration module and OLpur MD220 filter in May 2006. The FDA answered
our application with additional questions in June 2006, and we submitted
responses to the FDA questions in December 2006. In January 2007, we received
conditional approval for our IDE application from the FDA to begin human
clinical trials of our OLpur H2H hemodiafiltration module and
OLpur MD220 hemodiafilter. In March 2007, we received full approval on our IDE
application from the FDA to begin human clinical trials of our OLpur H2H
hemodiafiltration module and OLpur MD220 hemodiafilter. We completed the patient
treatment phase of our clinical trials during the second quarter of 2008 and
filed our 510(k) applications with respect to the OLpur MDHDF filter series and
the OLpur H2H module in November 2008. No IDE was required for our
DSU product. On July 1, 2009, we received FDA approval of the DSU to
be used to filter biological contaminants from water and bicarbonate concentrate
used in hemodialysis procedures. We hope to achieve U.S. regulatory
approval of ourl OLpūr H2H module and OLpūr
MD 220 filter products during 2010. Following its review of our
applications, the FDA has requested additional information from us.
We replied to the FDA inquiries on March 13, 2009. The FDA has not
provided us with any additional requests for information or rendered a decision
on our application. We have made additional inquiries to the FDA about the
status of our application and, as of March 10, 2010, have been informed that our
application is still under their review process.
The
Section 510(k) pre-market clearance process can be lengthy and uncertain. It
will require substantial commitments of our financial resources and management’s
time and effort. Significant delays in this process could occur as a result of
factors including:
·
|
our
inability to timely raise sufficient
funds;
|
·
|
the
FDA’s failure to schedule advisory review
panels;
|
·
|
changes
in established review
guidelines;
|
·
|
changes
in regulations or administrative interpretations;
or
|
·
|
determinations
by the FDA that clinical data collected is insufficient to support the
safety and effectiveness of one or more of our products for their intended
uses or that the data warrants the continuation of clinical
studies.
|
Delays in
obtaining, or failure to obtain, requisite regulatory approvals or clearances in
the United States for any of our products would prevent us from selling those
products in the United States and would impair our ability to generate funds
from sales of those products in the United States, which in turn could have a
material adverse effect on our business, financial condition, and results of
operations.
The FDC
Act requires that medical devices be manufactured in accordance with the FDA’s
current QSR regulations which require, among other things, that:
·
|
the
design and manufacturing processes be regulated and controlled by the use
of written procedures;
|
·
|
the
ability to produce medical devices which meet the manufacturer’s
specifications be validated by extensive and detailed testing of every
aspect of the process;
|
·
|
any
deficiencies in the manufacturing process or in the products produced be
investigated;
|
·
|
detailed
records be kept and a corrective and preventative action plan be in place;
and
|
·
|
manufacturing
facilities be subject to FDA inspection on a periodic basis to monitor
compliance with QSR
regulations.
|
If
violations of the applicable QSR regulations are noted during FDA inspections of
our manufacturing facilities or the manufacturing facilities of our contract
manufacturers, there may be a material adverse effect on our ability to produce
and sell our products.
12
Before
the FDA approves a Section 510(k) pre-market notification, the FDA is likely to
inspect the relevant manufacturing facilities and processes to ensure their
continued compliance with QSR. Although some of the manufacturing facilities and
processes that we expect to use to manufacture our ESRD and DSU filters have
been inspected and certified by a worldwide testing and certification agency
(also referred to as a notified body) that performs conformity assessments to
European Union requirements for medical devices, they have not all been
inspected by the FDA. Similarly, although some of the facilities and processes
that we expect to use to manufacture our OLpur H2H have been inspected by the
FDA, they have not all been inspected by any notified body. A “notified body” is
a group accredited and monitored by governmental agencies that inspects
manufacturing facilities and quality control systems at regular intervals and is
authorized to carry out unannounced inspections. Even after the FDA has cleared
a Section 510(k) submission, it will periodically inspect the manufacturing
facilities and processes for compliance with QSR. In addition, in the event that
additional manufacturing sites are added or manufacturing processes are changed,
such new facilities and processes are also subject to FDA inspection for
compliance with QSR. The manufacturing facilities and processes that will be
used to manufacture our products have not yet been inspected by the FDA for
compliance with QSR. We cannot assure you that the facilities and processes used
by us will be found to comply with QSR and there is a risk that clearance or
approval will, therefore, be delayed by the FDA until such compliance is
achieved.
In
addition to the requirements described above, the FDC Act requires
that:
·
|
all
medical device manufacturers and distributors register with the FDA
annually and provide the FDA with a list of those medical devices which
they distribute commercially;
|
·
|
information
be provided to the FDA on death or serious injuries alleged to have been
associated with the use of the products, as well as product malfunctions
that would likely cause or contribute to death or serious injury if the
malfunction were to recur;
and
|
·
|
certain
medical devices not cleared with the FDA for marketing in the United
States meet specific requirements before they are
exported.
|
European
Union
The
European Union began to harmonize national regulations comprehensively for the
control of medical devices in member nations in 1993, when it adopted its
Medical Devices Directive 93/42/EEC. The European Union directive applies to
both the manufacturer’s quality assurance system and the product’s technical
design and discusses the various ways to obtain approval of a device (dependent
on device classification), how to properly CE Mark a device and how to place a
device on the market. We have subjected our entire business in our Target
European Market to the most comprehensive procedural approach in order to
demonstrate the quality standards and performance of our operations, which we
believe is also the fastest way to launch a new product in the European
Community.
The
regulatory approach necessary to demonstrate to the European Union that the
organization has the ability to provide medical devices and related services
that consistently meet customer requirements and regulatory requirements
applicable to medical devices requires the certification of a full quality
management system by a notified body. We engaged TÜV Rheinland of North America,
Inc. (“TÜV Rheinland”) as the notified body to assist us in obtaining
certification to the International Organization for Standardization, or ISO,
13485/2003 standard, which demonstrates the presence of a quality management
system that can be used by an organization for design and development,
production, installation and servicing of medical devices and the design,
development and provision of related services.
European
Union requirements for products are set forth in harmonized European Union
standards and include conformity to safety requirements, physical and biological
properties, construction and environmental properties, and information supplied
by the manufacturer. A company demonstrates conformity to these requirements,
with respect to a product, by pre-clinical tests, biocompatibility tests,
qualification of products and packaging, risk analysis and well-conducted
clinical investigations approved by ethics committees.
Once a
manufacturer’s full quality management system is determined to be in compliance
with ISO 13485/2003 and other statutory requirements, and the manufacturer’s
products conform with harmonized European standards, the notified body will
recommend and document such conformity. The manufacturer will receive a CE
marking and ISO certifications, and then may place a CE mark on the relevant
products. The CE mark, which stands for Conformité Européenne, demonstrates
compliance with the relevant European Union requirements. Products subject to
these provisions that do not bear the CE mark cannot be imported to, or sold or
distributed within, the European Union.
In July
2003, we received a certification from TÜV Rheinland that our quality management
system conforms with the requirements of the European Community. At the same
time, TÜV Rheinland approved our use of the CE marking with respect to the
design and production of high permeability hemodialyzer products for ESRD
therapy. As of the date of filing of this Annual Report, the manufacturing
facilities and processes that we are using to manufacture our OLpur MDHDF filter
series have been inspected and certified by a notified body.
13
Regulatory
Authorities in Regions Outside of the United States and the European
Union
We also
plan to sell our ESRD therapy products in foreign markets outside the United
States which are not part of the European Union. Requirements pertaining to
medical devices vary widely from country to country, ranging from no health
regulations to detailed submissions such as those required by the FDA. We
believe the extent and complexity of regulations for medical devices such as
those produced by us are increasing worldwide. We anticipate that this trend
will continue and that the cost and time required to obtain approval to market
in any given country will increase, with no assurance that such approval will be
obtained. Our ability to export into other countries may require compliance with
ISO 13485, which is analogous to compliance with the FDA’s QSR requirements. In
November 2007, the Therapeutic Products Directorate of Health Canada, the
Canadian health regulatory agency, approved our OLpur MDHDF filter series for
marketing in Canada. Other than the CE marking and Canadian approval of our
OLpur MDHDF filter products, we have not obtained any regulatory approvals to
sell any of our products and there is no assurance that any such clearance or
certification will be issued.
Reimbursement
In both
domestic markets and markets outside of the United States, sales of our ESRD
therapy products will depend in part, on the availability of reimbursement from
third-party payors. In the United States, ESRD providers are reimbursed through
Medicare, Medicaid and private insurers. In countries other than the United
States, ESRD providers are also reimbursed through governmental and private
insurers. In countries other than the United States, the pricing and
profitability of our products generally will be subject to government controls.
Despite the continually expanding influence of the European Union, national
healthcare systems in its member nations, reimbursement decision-making
included, are neither regulated nor integrated at the European Union level. Each
country has its own system, often closely protected by its corresponding
national government.
Product
Liability and Insurance
The
production, marketing and sale of kidney dialysis products have an inherent risk
of liability in the event of product failure or claim of harm caused by product
operation. We have acquired product liability insurance for our products in the
amount of $5 million. A successful claim in excess of our insurance coverage
could materially deplete our assets. Moreover, any claim against us could
generate negative publicity, which could decrease the demand for our products,
our ability to generate revenues and our profitability.
Some of
our existing and potential agreements with manufacturers of our products and
components of our products do or may require us (1) to obtain product liability
insurance or (2) to indemnify manufacturers against liabilities resulting from
the sale of our products. If we are not able to maintain adequate product
liability insurance, we will be in breach of these agreements, which could
materially adversely affect our ability to produce our products. Even if we are
able to obtain and maintain product liability insurance, if a successful claim
in excess of our insurance coverage is made, then we may have to indemnify some
or all of our manufacturers for their losses, which could materially deplete our
assets.
Employees
As of
March 31, 2010, we employed a total of 9 employees, 7 of whom were full time and
2 who are employed on a part-time basis. We also engaged 2 consultants on an
ongoing basis. Of the 11 total employees and consultants, 4 were employed in a
sales/marketing/customer support capacity, 3 in general and administrative and 4
in research and development. Our President and Chief Executive
Officer resigned on March 30, 2010, as reported in our Current Report on Form
8-K filed on March 30, 2010.
Recent
Developments
In March
2007, we received full approval on our IDE application from the FDA to begin
human clinical trials of our OLpur H2H hemodiafiltration module and
OLpur MD220 hemodiafilter. We obtained approval from the IRBs and completed the
clinical trial near the end of the second quarter in 2008. The clinical data was
complied, analyzed, summarized and submitted with our FDA 510(k) in November
2008. Following its review of the application, the FDA has requested
additional information from us. We replied to the FDA inquiries on
March 13, 2009. The FDA has not provided us with any additional requests
for information or rendered a decision on our application. We have
made additional inquiries to the FDA about the status of our application and, as
of March 10, 2010, have been informed that our application is still under
their review process.
On March
30, 2010, Ernest Elgin, III resigned as our President and Chief Executive
Officer and also resigned from our Board of Directors. In connection
with Mr. Elgin’s resignation, we entered into a separation, release and
consulting agreement with him, pursuant to which we will pay Mr. Elgin his
current salary through April 16 and pay his applicable COBRA premiums through
April 30, 2010, and, during any time that his COBRA coverage is in effect in
2010, reimburse him for out-of-pocket payments made in 2010 under his healthcare
coverage up to $5,000, which is the deductible under the healthcare
coverage. Mr. Elgin will be available to consult with us for up to 15
hours a week until May 31, 2010, for which we will pay Mr. Elgin at the rate of
50% of his current salary from April 16 to May 31, 2010. We
have the right to extend the consulting period for an additional four months
during which Mr. Elgin would be available to consult with us for up to 7.5 hours
a week and during which we would pay Mr. Elgin 25% of his current
salary. We may terminate this consulting arrangement at any time upon
30 days notice.
Item
2. Properties
Our U.S.
facilities are located at 41 Grand Avenue, River Edge, New Jersey, 07661 and
consist of approximately 4,688 square feet of space. The term of the
rental agreement is for three years commencing December 2008 with a monthly cost
of approximately $7,423. We use our facilities to house our corporate
headquarters and research facilities.
14
Our
facilities in our Target European Market are currently located at 6 Eaton House,
Main Street, Rathcoole, Co. Dublin, Ireland, and consist of approximately 650
square feet of space. The lease agreement was entered into on
November 30, 2008. The lease term is 6 months beginning March 1, 2009
and is renewable for 6 month terms with a 3 month notice to
discontinue. Our monthly cost is 735 Euro (approximately
$1,000).
We use
our facilities to house our accounting, operations and customer service
departments. We believe this space will be adequate to meet our needs. We do not
own any real property for use in our operations or otherwise.
Item
3. Legal Proceedings
A former
employee in France filed a claim in October 2008 stating that the
individual is due 30,000 Euro or approximately $42,000 in back
wages. The individual left our employment four years ago and signed a
Separation Agreement which stated we had no further liability to the
individual. A final judgment dated October 15, 2009 was issued by a
French court whereby the claimant was awarded 11,707 Euro, approximately
$18,000. The award was paid in October 2009.
A former
employee in the United States filed a claim in March 2009 against us and
our CEO alleging breach of the individual’s employment agreement and
fraud. The individual was employed with us from April 2008 through
January 8, 2009. The claim was settled as of September 30, 2009 for
approximately $11,000. The settlement was paid in October
2009.
A third party has brought
a claim against us alleging they incurred damages as a result of our
cancellation of a transaction in 2008 involving the sale of Auction Rate
Securities. The claim has been referred to a Financial Industry
Regulatory Authority (FINRA) binding arbitration panel and was scheduled to be
heard in March 2010. There was no specific amount of damages identified in
the claim. A settlement of this claim was reached and paid in March
2010 in the amount of $20,000. The settlement amount has been accrued
as of December 2009.
There are
no other currently pending legal proceedings and, as far as we are aware, no
governmental authority is contemplating any proceeding to which we are a party
or to which any of our properties is subject.
Item
4. Submission of Matters to a Vote of Security Holders
On
October 22, 2009 we held our annual meeting of our shareholders at which our
shareholders of record as of September 18, 2009 were asked to vote on three
proposals.
Of the
41,604,798 shares of common stock eligible to vote at this meeting, a total of
approximately 32,373,586 shares of common stock were actually present or
represented by proxy. This represents a vote by approximately 77.8%
of the total shares eligible to vote.
The first
proposal was to elect one director to serve on our Board of Directors for a
three-year term. Paul A. Mieyal was re-elected.
The
second proposal was to approve the amendment of our Fourth Amended and Restated
Certificate of Incorporation to increase the authorized shares of our capital
stock from 65,000,000 shares to 95,000,000 shares and increase the authorized
shares of our common stock from 60,000,000 shares to 90,000,000
shares. An aggregate of approximately 64% of the total shares
outstanding was voted in favor of this proposal.
The third
proposal was to ratify the selection of Rothstein Kass & Company, P.C. as
our independent auditors for the year ending December 31, 2009. An
aggregate of approximately 75.9% of the total shares represented and voting at
the meeting was voted in favor of this proposal.
PART
II
Item
5. Market for Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
On
January 22, 2009 the AMEX removed our common stock from trading on the
AMEX. Until such date, our common stock had been trading on the AMEX
under the symbol NEP. Effective February 4, 2009, our common stock is now quoted
on the OTC Bulletin Board under the symbol “NEPH.OB”. The following
table sets forth the high and low sales prices for our common stock as reported
on the AMEX and the high and low bid and ask prices for our common stock as
reported on AMEX and the Over the Counter Bulletin Board for each quarter within
the years ended December 31, 2008 and 2009.
15
Quarter Ended
|
High
|
Low
|
||||||
March
31, 2008
|
$ | 1.60 | $ | .33 | ||||
June
30, 2008
|
$ | .97 | $ | .50 | ||||
September
30, 2008
|
$ | .65 | $ | .24 | ||||
December
31, 2008
|
$ | .48 | $ | .05 | ||||
March
31, 2009
|
$ | .15 | $ | .04 | ||||
June
30, 2009
|
$ | 1.77 | $ | .01 | ||||
September
30, 2009
|
$ | 2.63 | $ | .99 | ||||
December
31, 2009
|
$ | 1.75 | $ | .70 |
As of
March 29, 2010, there were approximately 35 holders of record and approximately
900 beneficial holders of our common stock.
We have
neither paid nor declared dividends on our common stock since our inception and
do not plan to pay dividends on our common stock in the foreseeable future. We
expect that any earnings which we may realize will be retained to finance our
growth. There can be no assurance that we will ever pay dividends on our common
stock. Our dividend policy with respect to the common stock is within the
discretion of the Board of Directors and its policy with respect to dividends in
the future will depend on numerous factors, including our earnings, financial
requirements and general business conditions.
The
following table provides information as of December 31, 2009 about compensation
plans under which shares of our common stock may be issued to employees,
consultants or members of our Board of Directors upon exercise of options or
warrants under all of our existing equity compensation plans, and warrants
issued to placement agents in connection with our 2007 financing. Our existing
equity compensation plans consist of our Amended and Restated Nephros 2000
Equity Incentive Plan and our Nephros, Inc. 2004 Stock Incentive Plan (together,
our “Stock Option Plans”) in which all of our employees and directors are
eligible to participate. Our Stock Option Plans and the issuance of the
placement agent warrants were approved by our stockholders.
16
(a)
|
(c)
|
|||||||||||
Number of
|
Number of securities
|
|||||||||||
securities to be
|
(b)
|
remaining available for
|
||||||||||
issued upon
|
Weighted-average
|
issuance under equity
|
||||||||||
exercise of
|
exercise price of
|
compensation plans
|
||||||||||
outstanding options,
|
outstanding options,
|
(excluding securities
|
||||||||||
Plan category
|
warrant and rights
|
warrant and rights
|
reflected in column (a))
|
|||||||||
Equity
compensation plans approved by our stockholders:
|
||||||||||||
Stock
Option Plans
|
1,885,782 | $ | 0.86 | 1,543,884 | ||||||||
Placement
Agent Warrants
|
129,681 | $ | 0.70 | — | ||||||||
Equity
compensation plans not approved by our stockholders:
|
||||||||||||
None
|
— | — | ||||||||||
All
Plans
|
2,015,463 | 1,543,884 |
Item
7. Management’s Discussion and Analysis or Plan of Operation
Business
Overview
Since our
inception in April 1997, we have been engaged primarily in the development of
hemodiafiltration, or HDF, products and technologies for treating patients with
End Stage Renal Disease, or ESRD. Our products include the OLpur MD190 and
MD220, which are dialyzers (our “OLpur MDHDF Filter Series”), OLpur H2H, an add-on module designed to
enable HDF therapy using the most common types of hemodialysis machines. We
began selling our OLpur MD190 dialyzer in some parts of our Target European
Market (consisting of France, Germany, Ireland, Italy and the United Kingdom
(U.K.), as well as Cyprus, Denmark, Greece, the Netherlands, Norway, Portugal,
Spain, Sweden and Switzerland) in March 2004, and have developed units suitable
for clinical evaluation for our OLpur H2H product. We are developing
our OLpur NS2000 product by modifying an existing HDF platform and incorporating
our proprietary H2H
technology.
To date,
we have devoted most of our efforts to research, clinical development, seeking
regulatory approval for our ESRD products, establishing manufacturing and
marketing relationships and establishing our own marketing and sales support
staff for the development, production and sale of our ESRD therapy products in
our Target European
Market and the United States upon their approval by appropriate regulatory
authorities. We submitted to the FDA our 510(k) application in November 2008 for
approval of our OLpūr H2H module and OLpūr MD 220 filter. Following its review
of the application, the FDA has requested additional information from
us. We replied to the FDA inquiries on March 13, 2009. The
FDA has not provided us with any additional requests for information or rendered
a decision on our application. We have made additional inquiries to
the FDA about the status of our application and, as of March 10, 2010, have
been informed that our application is still under their review
process.
We have
also applied our filtration technologies to water filtration and in 2006 we
introduced our new Dual Stage Ultrafilter (the “DSU”) water filtration system.
Our DSU represents a new and complementary product line to our existing ESRD
therapy business. The DSU incorporates our unique and proprietary dual stage
filter architecture and is, to our knowledge, the only water filter that allows
the user to sight-verify that the filter is properly performing its cleansing
function. The DSU is designed to remove a broad range of bacteria, viral agents
and toxic substances, including salmonella, hepatitis, cholera, HIV, Ebola
virus, ricin toxin, legionella, fungi and e-coli.
In the
fourth quarter of 2008, we also filed a 510(k) with the FDA for approval to use
our DSU product with reverse osmosis (RO) water systems found within dialysis
centers and hospitals. Due the nature of this application our DSU
will be categorized as a medical device and therefore requires a
510(k). While waiting for FDA action on both of our ESRD and DSU
510(k) applications we redirected much of our resources to our sales and
marketing efforts of our DSU product here in the US in its non-medical device
applications. Our goal is to expand distribution to the hospital market and
identify other short term applications. Following its review of our
DSU 510(k) application, the FDA requested additional information from us.
On February 24, 2009, we provided a formal response to the FDA. On July 1,
2009, we received FDA approval of the DSU to be used to filter biological
contaminants from water and bicarbonate concentrate used in hemodialysis
procedures.
17
In 2006,
the U.S. Defense Department budget included an appropriation for the U.S. Marine
Corps for development of a dual stage water ultra filter. In
connection with this Federal appropriation of approximately $1 million, we
worked on the development of a personal potable water purification
system for use by warfighters. Work on this project was completed in August 2009
and we have billed approximately $900,000 during the twenty months ended August
2009. In August 2009, we were awarded a new $1.8 million research
contract from the Office of Naval Research (ONR) for development of a potable
dual-stage military water purifying filter. The research contract is an
expansion of our former ONR contract which is being performed as part of the
Marine Corps Advanced Technology Demonstration (ATD) project. The
primary objective of this expanded research program is to select concepts and
functional prototype filter/pump units which were developed during the first
phase of the project, and further develop them into smaller field-testable
devices that can be used for military evaluation purposes. An
advantage of our ultrafilter is the removal of viruses which are not removed
with commercially available off-the-shelf microfilter devices. Such devices
generally rely on a secondary chemical disinfection step to make the water safe
to drink. The expanded contract also includes research geared toward improving
membrane performance, improving device durability, developing larger squad-level
water purifier devices, and investigating desalination filter/pump devices for
emergency-use purposes. Approximately $423,000 has been billed to
this second project during the four months ended December 31, 2009.
Since our
inception, we have incurred annual net losses. As of December 31, 2009, we had
an accumulated deficit of $89,975,000, and we expect to incur additional losses
in the foreseeable future. We recognized net losses of $2,026,000 and $6,337,000
for the years ended December 31, 2009 and 2008, respectively.
Since our
inception, we have financed our operations primarily through sales of our equity
and debt securities. From inception through December 31, 2009, we received net
offering proceeds from private sales of equity and debt securities and from the
initial public offering of our common stock (after deducting underwriters’
discounts, commissions and expenses, and our offering expenses) of approximately
$53.3 million in the aggregate. An additional source of finances was our license
agreement with Asahi, pursuant to which we received an up front license fee of
$1.75 million in March 2005.
The
following trends, events and uncertainties may have a material impact on our
potential sales, revenue and income from operations:
1)
|
receiving
regulatory approval for each of our ESRD therapy products and our DSU
product in our target territories;
|
|
2)
|
the
completion and success of additional clinical
trials;
|
3)
|
the
market acceptance of HDF therapy in the United States and of our
technologies and products in each of our target
markets;
|
4)
|
our
ability to effectively and efficiently manufacture, market and distribute
our products;
|
5)
|
our
ability to sell our products at competitive prices which exceed our per
unit costs;
|
6)
|
the
consolidation of dialysis clinics into larger clinical groups;
and
|
7)
|
the
current U.S. healthcare plan is to bundle reimbursement for dialysis
treatment which may force dialysis clinics to change therapies due to
financial reasons.
|
To the
extent we are unable to succeed in accomplishing (1) through (7), our sales
could be lower than expected and dramatically impair our ability to generate
income from operations. With respect to (6), the impact could either be
positive, in the case where dialysis clinics consolidate into independent
chains, or negative, in the case where competitors acquire these dialysis
clinics and use their own products, as competitors have historically tended to
use their own products in clinics they have acquired.
NYSE
Alternext US LLC (formerly, the American Stock Exchange or “AMEX”)
Issues
On
September 12, 2008, we received a letter from the AMEX notifying us of our
noncompliance with certain continued listing standards. The following
are the listing standards that we were in noncompliance of:
·
|
Section
1003(a)(iii), which states AMEX will normally consider suspending dealings
in, or removing from the list, securities of an issuer which has
stockholders’ equity of less than $6,000,000 if such issuer has sustained
net losses in its five most recent fiscal
years;
|
·
|
Section
1003(a)(ii), which states AMEX will normally consider suspending dealings
in, or removing from the list, securities of an issuer which has
stockholders’ equity of less than $4,000,000 if such issuer has sustained
net losses in its three of its four most recent fiscal years;
and
|
18
·
|
Section
1003(f)(v), which states AMEX will normally consider suspending dealings
in, or removing from the list, common stock that sells for a substantial
period of time at a low price per
share.
|
In
response to that letter, we submitted a plan of compliance to the AMEX on
October 13, 2008 advising the AMEX of the actions we have taken, or will take,
that would bring us into compliance with the continued listing standards by
April 30, 2009.
Subsequent
to December 31, 2008, on January 8, 2009, we received a letter from the AMEX
notifying us that it was rejecting our plan. The AMEX further
notified us that the AMEX intends to strike the common stock from the AMEX by
filing a delisting application with the Securities and Exchange Commission
(“SEC”) pursuant to Rule 1009(d) of the AMEX Company Guide. Given the
turmoil in the capital markets, we have decided not to seek an appeal of the
AMEX’s intention to delist our common stock.
On
January 22, 2009, we were informed by the AMEX that the AMEX had suspended
trading in our common stock effective immediately. Immediately
following the notification, our common stock was no longer traded on the
AMEX.
Effective
February 4, 2009, our common stock is now quoted on the Over the Counter (“OTC”)
Bulletin Board under the symbol “NEPH.OB”.
In a
letter dated April 13, 2009, we received a copy of the AMEX’s application to
strike our common stock from the AMEX.
Recently
Issued and Adopted Accounting Standards
We
follow accounting standards set by the Financial Accounting Standards Board
(“FASB”). The FASB sets generally accepted accounting principles
(“GAAP”) that we follow to ensure we consistently report our financial
condition, results of operations, and cash flows. References to GAAP
issued by the FASB in these footnotes are to the FASB Accounting Standards
Codification, ™ sometimes referred to as the Codification or
“ASC.” In June 2009, the FASB issued ASC Topic 105, Generally
Accepted Accounting Principals, which became the single source of authoritative
nongovernmental U.S. GAAP, superseding existing FASB, American Institute of
Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”), and
related accounting literature. This pronouncement reorganizes the
thousands of GAAP pronouncements into roughly 90 accounting topics and displays
them using a consistent structure. Also included is relevant SEC
guidance organized using the same topical structure in separate sections and has
been adopted by us for the year ended December 31, 2009. This has an
impact on our financial disclosures since all future references to authoritative
accounting literature will be referenced in accordance with ASC Topic
105.
Fair
Value Measurements – In September 2006, the FASB issued guidance regarding fair
value measurements. This guidance defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurements. It applies to other accounting pronouncements where the
FASB requires or permits fair value measurements but does not require any new
fair value measurements. In February 2008, FASB issued a
pronouncement, which delayed the effective date of its prior guidance regarding
fair value measurements, specifically for certain non-financial assets and
non-financial liabilities to fiscal years beginning after November 15, 2008, and
interim periods within those fiscal years. We adopted the guidance
for financial assets and liabilities on January 1, 2008. It did not
have any impact on our results of operations or financial position and did not
result in any additional disclosures and we adopted the guidance for
non-financial assets and non-financial liabilities on January 1, 2009, resulting
in no impact to our consolidated financial position, results of operations or
cash flows.
In
April 2009, the FASB issued new accounting guidance on determining fair value
when the volume and level of activity for the asset or liability have
significantly decreased and identifying transactions that are not
orderly. The guidance affirms that the objective of fair value when
the market for an asset is not active is the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date under current market
conditions. It provides guidance for estimating fair value when the
volume and level of market activity for an asset or liability have significantly
decreased and determining whether a transaction was orderly. It
applies to all fair value measurements when appropriate. The adoption
of this guidance did not have a significant impact on our consolidated financial
position, results of operations or cash flows, or related
footnotes.
In
April 2009, the FASB issued new accounting guidance on interim disclosures about
fair value of financial instruments, which is effective for our quarterly period
beginning April 1, 2009. The guidance requires an entity to provide
the annual disclosures required by a prior pronouncement regarding disclosures
about fair value of financial instruments, in its interim financial statements.
The application of the guidance did not have a significant impact on our
consolidated financial position, results of operations or cash flows, or related
footnotes.
In
August 2009, the FASB issued an update to provide further guidance on how to
measure the fair value of a liability, an area where practitioners have been
seeking further guidance. It primarily does three
things: 1) sets forth the types of valuation techniques to be used to
value a liability when a quoted price in an active market for the identical
liability is not available, 2) clarifies that when estimating the fair value of
a liability, a reporting entity is not required to include a separate input or
adjustment to other inputs relating to the existence of a restriction that
prevents the transfer of the liability and 3) clarifies that both a quoted price
in an active market for the identical liability at the measurement date and the
quoted price for the identical liability when traded as an asset in an active
market when no adjustments to the quoted price of the asset are required are
Level 1 fair value measurements. This standard is effective beginning
the fourth quarter of 2009. The adoption of this standard update is
not expected to impact our consolidated financial position, results of
operations or cash flows.
19
Business
Combinations – In December 2007, the FASB issued new accounting guidance on
business combinations. The pronouncement establishes principles and requirements
for how the acquirer in a business combination recognizes and measures in its
financial statements the fair value of identifiable assets acquired, the
liabilities assumed and any noncontrolling interest in the acquiree at the
acquisition date. The pronouncement determines what information to disclose to
enable users of the financial statements to evaluate the nature and financial
effects of the business combination. It is effective for fiscal years beginning
after December 15, 2008. We adopted the pronouncement on January 1, 2009
resulting in no impact to our consolidated financial position, results of
operations or cash flows.
Subsequent
Events – On May 28, 2009, the FASB issued guidance regarding subsequent events,
which we adopted on a prospective basis beginning April 1, 2009. The
guidance is intended to establish general standards of accounting and disclosure
of events that occur after the balance sheet date but before financial
statements are issued or are available to be issued. It requires the
disclosure of the date through which an entity has evaluated subsequent events
and the basis for selecting that date. The application of the
pronouncement did not have an impact on our consolidated financial position,
results of operations or cash flows.
Recognition
and Presentation of Other-Than-Temporary Impairments – In April 2009, the
FASB issued an accounting pronouncement, which is effective for our interim and
annual reporting periods ending after June 15, 2009, that amends existing
guidance for determining whether an other than temporary impairment of debt
securities has occurred. Among other changes, the FASB replaced the
existing requirement that an entity’s management assert it has both the intent
and ability to hold an impaired security until recovery with a requirement that
management assert (a) it does not have the intent to sell the security, and
(b) it is more likely than not it will not have to sell the security before
recovery of its cost basis. We have no debt securities as of December 31, 2009
therefore there is no impact on our December 31, 2009 consolidated financial
position, results of operations or cash flows.
New
Accounting Pronouncements
In
December 2009, the FASB issued ASU No. 2009-17, Consolidations (Topic
810)-Improvements to Financial Reporting By Enterprises Involved with Variable
Interest Entities (ASU No. 2009-17). ASU No. 2009-17 requires a
qualitative approach for determining the primary beneficiary of a variable
interest entity and replaces the quantitative evaluation previously set forth
under FASB Interpretation No. 46 (revised December 2003), Consolidation of
Variable Interest Entities . This approach is focused on identifying the
reporting entity that has the ability to direct the activities of a variable
interest entity that most significantly affects the entity's economic
performance and has the obligation to absorb the entity's losses or has the
right to receive benefits from the entity. ASU No. 2009-17, among other things,
will require enhanced disclosures about a reporting entity's involvement in
variable interest entities. The guidance under ASU No. 2009-17 will be effective
for the first annual period beginning after November 15, 2009, and interim
periods within that first annual period. We are assessing what impact, if any,
adoption of this standard will have on our consolidated financial
statements.
Critical
Accounting Policies and Estimates
Our
discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of financial statements in accordance with generally accepted
accounting principles in the United States requires application of management’s
subjective judgments, often requiring the need to make estimates about the
effect of matters that are inherently uncertain and may change in subsequent
periods. Our actual results may differ substantially from these estimates under
different assumptions or conditions. While our significant accounting policies
are described in more detail in the notes to consolidated financial statements
included in this annual report on Form 10-K, we believe that the following
accounting policies require the application of significant judgments and
estimates.
Revenue
Recognition
Revenue
is recognized in accordance with ASC Topic 605. Four basic criteria
must be met before revenue can be recognized: (i) persuasive evidence of an
arrangement exists; (ii) delivery has occurred or services have been rendered;
(iii) the fee is fixed and determinable; and (iv) collectibility is reasonably
assured.
We
recognize revenue related to product sales when delivery is confirmed by its
external logistics provider and the other criteria of ASC Topic 605 are met.
Product revenue is recorded net of returns and allowances. All costs
and duties relating to delivery are absorbed by Nephros. All shipments are
currently received directly by our customers.
20
Stock-Based
Compensation
We
account for stock-based compensation in accordance with ASC 718 by recognizing
the fair value of stock-based compensation in net income. The fair value of our
stock option awards are estimated using a Black-Scholes option valuation model.
This model requires the input of highly subjective assumptions and elections
including expected stock price volatility and the estimated life of each award.
In addition, the calculation of compensation costs requires that we estimate the
number of awards that will be forfeited during the vesting period. The fair
value of stock-based awards is amortized over the vesting period of the
award. For stock 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.
Accounts
Receivable
We
provide credit terms to our customers in connection with purchases of our
products. We periodically review 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 our best
estimate of potential losses.
Inventory
Reserves
Our
inventory reserve requirements are based on factors including the products’
expiration date and estimates for the future sales of the product. If estimated
sales levels do not materialize, we will make adjustments to its assumptions for
inventory reserve requirements.
Accrued
Expenses
We are
required to estimate accrued expenses as part of our process of preparing
financial statements. This process involves identifying services which have been
performed on our behalf, and the level of service performed and the associated
cost incurred for such service as of each balance sheet date in our financial
statements. Examples of areas in which subjective judgments may be required
include costs associated with services provided by contract organizations for
the preclinical development of our products, the manufacturing of clinical
materials, and clinical trials, as well as legal and accounting services
provided by professional organizations. In connection with such service fees,
our estimates are most affected by our understanding of the status and timing of
services provided relative to the actual levels of services incurred by such
service providers. The majority of our service providers invoice us monthly in
arrears for services performed. In the event that we do not identify certain
costs, which have begun to be incurred, or we under- or over-estimate the level
of services performed or the costs of such services, our reported expenses for
such period would be too low or too high. The date on which certain services
commence, the level of services performed on or before a given date and the cost
of such services are often determined based on subjective judgments. We make
these judgments based upon the facts and circumstances known to us in accordance
with generally accepted accounting principles.
Results
of Operations
Fluctuations
in Operating Results
Our
results of operations have fluctuated significantly from period to period in the
past and are likely to continue to do so in the future. We anticipate that our
annual results of operations will be impacted for the foreseeable future by
several factors including the progress and timing of expenditures related to our
research and development efforts, marketing expenses related to product
launches, timing of regulatory approval of our various products and market
acceptance of our products. Due to these fluctuations, we believe that the
period to period comparisons of our operating results are not a good indication
of our future performance.
The
Fiscal Year Ended December 31, 2009 Compared to the Fiscal Year Ended December
31, 2008
Product
Revenues
Total
product revenues for the year ended December 31, 2009 were $2,661,000 compared
to $1,473,000 for the year ended December 31, 2008. The $1,188,000, or 81%,
increase is primarily due to $1,093,000 related to revenue generated from the
Office of Naval Research project in the United States. The revenue
derived from this project was $1,093,000 for the twelve months ended December
31, 2009 compared to $196,000 for the same period in 2008, which was the
project’s initial period beginning in January
2008. Sales of the OLpūr MD190 and MD220 Dialyzers in Europe were
$1,265,000 for the twelve months ended December 31, 2009 compared to $1,228,000
for the same period in 2008. This $37,000 or 3% increase in revenue
was impacted by the adverse currency translation of the Euro to the U.S.
dollar. Units sold were 47,532 for the twelve months ended December
31, 2009 compared to 44,623 units for the same period in 2008, a 6.5%
increase. Although the sales price of these units, which is in Euro,
remained constant approximately $53,000 was lost due to currency
translation. In addition, revenues in the United
States from sales of the Dual Stage Ultrafilter (the “DSU”) water
filter were $303,000 for the twelve months ended December 31, 2009 compared to
$49,000 for the same period in 2008. The DSU represents a new and complementary
product line introduced in 2008.
21
Cost of
Goods Sold
Cost of
goods sold was $1,744,000 for the year ended December 31, 2009 compared to
$1,064,000 for the year ended December 31, 2008. The $680,000, or 64%, increase
is primarily due to costs related to the Office of Naval Research project in the
United States. The cost of goods sold related to the Office of Naval
Research project was $692,000 for the twelve months ended December 31, 2009
compared to $141,000 for the same period in 2008, an increase of
$551,000. The increased cost is correlated to the higher revenue recognized from
this project for the year ended December 31, 2009 compared to the same period in
2008. Cost of goods sold related to the OLpūr MD190 and MD220 Dialyzers sold in
Europe for the year ended December 31, 2009 was $969,000 an increase of
$46,000, or 5%, over the comparable period in 2008. This
increase was due primarily to higher sales volume. Units sold were 47,532 for
the twelve months ended December 31, 2009 compared to 44,623 units for the same
period in 2008, a 6.5% increase. Cost of
goods sold related to the DSU water filters sold in the United States were
$83,000 for the year ended December 31, 2009. The DSU represents a
new and complementary product line introduced in 2008 and there were no cost of
goods sold incurred for the year ended December 31, 2008.
Research
and Development
Research
and development expenses were $280,000 for the year ended December 31, 2009
compared to $1,977,000 for the year ended December 31, 2008, a decrease of
$1,697,000 or 86%. This decrease is related to the fact that a clinical trial
was conducted in 2008 and there was no clinical trial conducted during
2009. Clinical trial expenses decreased by approximately $964,000
during the twelve months ended December 31, 2009 compared to the same period in
2008. Related reductions in personnel and lab testing resulted in
reduced expenses of $491,000 and $226,000 respectively during the twelve months
ended December 31, 2009 compared to the same period in 2008. A
reduction in travel expenses in the amount of $23,000 was offset by an increase
of $13,000 in development expenses related to the DSU water filter
during the twelve months ended December 31, 2009 compared to the same period in
2008.
Depreciation
and Amortization Expense
Depreciation
expense was $231,000, for the year ended December 31, 2009 compared to $447,000
for the year ended December 31, 2008, a decrease of $216,000, or 48.3%. An
additional $59,000 of depreciation was recorded in 2008 related to furniture and
fixtures and tooling to reflect the assessed utility of these assets as of
December 31, 2008.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses were $2,812,000 for the year ended December
31, 2009 compared to $4,702,000 for the year ended December 31, 2008, a decrease
of $1,890,000 or 40%. A reduction in personnel and related
expenses resulted in a decrease of $1,072,000 for the twelve months ended
December 31, 2009 compared to the same period in
2008. Reductions of $246,000 in legal expenses, $232,000 in
marketing expenses, $186,000 in recruiting expenses, $70,000 in insurance
expenses and $85,000 in facility expenses for the twelve months ended December
31, 2009 compared to the same period in 2008 were also achieved. The
legal expense reduction was due to less activity and transition to a new law
firm in 2009. Marketing activities related to trade shows were
curtailed in 2009. Recruiting fees were incurred for four hires in
2008 and none in 2009. The reduction in facility expenses resulted
from both the Ireland and U.S. offices moving to less expensive locations for
2009.
Interest
Income
Interest
income was $9,000 for the year ended December 31, 2009 compared to $199,000 for
the year ended December 31, 2008. The decrease of $190,000, or 95.5%, reflects
the impact of having less cash on hand in 2009 compared to 2008 and therefore,
fewer investments to generate interest income.
Interest
Expense
We
incurred approximately $2,000 of interest expense for the year ended December
31, 2009. This interest relates primarily to financing of premiums
for product liability insurance. No interest expense was incurred
during 2008. We had no outstanding debt during 2009 or 2008.
22
Impairment
of Auction Rate Securities and Gain on sale of investments
During
the fiscal year 2008, we had investments in auction rate securities (“ARS”)
which are long-term debt instruments with interest rates reset through periodic
short-term auctions. If there are insufficient buyers when such a periodic
auction is held, then the auction “fails” and the holders of the ARS are unable
to liquidate their investment through such auction. With the liquidity issues
experienced in global credit and capital markets, the ARS held by us had
experienced multiple failed auctions since February 2008, and as a result, we
did not consider these affected ARS liquid in the first quarter of 2008.
Accordingly, while we had classified its ARS as current assets as of January 1,
2008, we reclassified them as noncurrent assets at March 31, 2008.
Based
upon an analysis of other-than-temporary impairment factors, we wrote down ARS
with an original par value of $4,400,000 to an estimated fair value of
$4,286,000 as of March 31, 2008. We reviewed impairments associated with the
above in accordance with ASC Topic 320 to determine the classification of the
impairment as “temporary” or “other-than-temporary.” We determined the ARS
classification to be “other-than-temporary,” and charged an impairment loss of
$114,000 on the ARS to its results of operations for the three months ended
March 31, 2008 and twelve months ended December 31, 2008.
During
the three months ended June 30, 2008, $300,000 of principal on our ARS had been
paid back by the debtor, resulting in our investment in ARS having decreased
from $4,400,000 to $4,100,000 (par value) at June 30, 2008. The net
book value of our ARS at June 30, 2008 was $3,986,000 million, due to
the approximate $114,000 impairment recorded at March 31, 2008. On
July 22, 2008 we sold our ARS to a third party at 100% of par value, for
proceeds of $4,100,000. We reclassified the ARS from Available-for-Sale to
Trading Securities due to the sale of the investments in July 2008.
In
accordance with ASC Topic 320, the ARS, classified as Trading Securities, were
valued at their fair value of $4,100,000 at June 30, 2008. The
adjustment of the investment’s carrying value from $3,986,000 net book value to
$4,100,000 fair value resulted in an Unrealized Holding Gain of $114,000 which
is included in our Statement of Operations for the three and six months ended
June 30, 2008.
We
subsequently reversed the Unrealized Holding Gain and recorded in the results of
operations for the twelve months ended December 31, 2008, a Realized Gain on
Sale of Investments of $114,000 in July 2008 due to the sale transaction being
executed.
We
had no investments in Auction Rate Securities during the year ended December 31,
2009.
Other
Income
Other
income in the amount of approximately $373,000 and $181,000 for the years ended
December 31, 2009 and December 31, 2008, respectively, resulted primarily from
receipt of New York State Qualified Emerging Technology Company (“QETC”) tax
refunds in each of these periods. Tax credits for the years 2006 and
2007 were received and recognized during the year ended December 31,
2009. The tax credit for the year 2005 was received and recognized
during the year ended December 31, 2008.
Off-Balance
Sheet Arrangements
We did
not engage in any off-balance sheet arrangements during the periods ended
December 31, 2009 and December 31, 2008.
Liquidity
and Capital Resources
Our
future liquidity sources and requirements will depend on many factors,
including:
·
|
the
availability of additional financing, through the sale of equity
securities or otherwise, on commercially reasonable terms or at
all;
|
|
·
|
the
market acceptance of our products, and our ability to effectively and
efficiently produce and market our
products;
|
·
|
the
timing and costs associated with obtaining United States regulatory
approval or the Conformité Européene, or CE, mark, which demonstrates
compliance with the relevant European Union requirements and is a
regulatory pre requisite for selling our ESRD therapy products in the
European Union and certain other countries that recognize CE marking (for
products other than our OLpur MDHDF filter series, for which the CE mark
was obtained in July 2003);
|
·
|
the
continued progress in and the costs of clinical studies and other research
and development programs;
|
·
|
the
costs involved in filing and enforcing patent claims and the status of
competitive products; and
|
23
|
·
|
the
cost of litigation, including potential patent litigation and any other
actual or threatened litigation.
|
We expect
to put our current capital resources to the following uses:
|
·
|
for
the marketing and sales of our
products;
|
|
·
|
to
obtain appropriate regulatory approvals and expand our research and
development with respect to our ESRD therapy
products;
|
|
·
|
to
continue our ESRD therapy product
engineering;
|
|
·
|
to
pursue business opportunities with respect to our DSU water-filtration
product; and
|
|
·
|
for
working capital purposes.
|
In
response to liquidity issues experienced with our auction rate securities, and
in order to facilitate greater liquidity in our short-term investments, on March
27, 2008, our board of directors adopted an Investment, Risk Management and
Accounting Policy. Such policy limits the types of instruments or securities in
which we may invest our excess funds in the future to: U.S. Treasury Securities;
Certificates of Deposit issued by money center banks; Money Funds by money
center banks; Repurchase Agreements; and Eurodollar Certificates of Deposit
issued by money center banks. This policy provides that our primary objectives
for investments shall be the preservation of principal and achieving sufficient
liquidity to meet our forecasted cash requirements. In addition, provided that
such primary objectives are met, we may seek to achieve the maximum yield
available under such constraints.
Our
forecast of the period of time through which our financial resources will be
adequate to support our operations is a forward-looking statement that involves
risks and uncertainties, and actual results could vary materially. In the event
that our plans change, our assumptions change or prove inaccurate, or if our
existing cash resources, together with other funding resources including
increased sales of our products, otherwise prove to be insufficient to fund our
operations and we are unable to obtain additional financing, we will be required
to adopt alternatives, such as curtailing our planned activities or ceasing our
operations.
In June
2006, we entered into subscription agreements with certain investors who
purchased an aggregate of $5,200,000 principal amount of our 6% Secured
Convertible Notes due 2012 (the “Old Notes”). The Old Notes were secured by
substantially all of our assets. However, as of September 19, 2007, the Old
Notes were exchanged for New Notes as further described in the paragraphs
below.
We
entered into a Subscription Agreement (“Subscription Agreement”) with Lambda
Investors LLC (“Lambda”) on September 19, 2007 (the “First Closing Date”), GPC
76, LLC on September 20, 2007, Lewis P. Schneider on September 21, 2007 and Enso
Global Equities Partnership LP (“Enso”) on September 25, 2007 (collectively, the
“New Investors”) pursuant to which the New Investors purchased an aggregate of
$12,677,000 principal amount of our Series A 10% Secured Convertible Notes due
2008 (the “Purchased Notes”), for the face value thereof (the “Offering”).
Concurrently with the Offering, we entered into an Exchange Agreement (the
“Exchange Agreement”) with each of Southpaw Credit Opportunities Master Fund LP,
3V Capital Master Fund Ltd., Distressed/High Yield Trading Opportunities, Ltd.,
Kudu Partners, L.P. and LJHS Company (collectively, the “Exchange Investors” and
together with the New Investors, the “Investors”), pursuant to which the
Exchange Investors agreed to exchange the principal and accrued but unpaid
interest in an aggregate amount of $5,600,000 under our Old Notes, for our new
Series B 10% Secured Convertible Notes due 2008 in an aggregate principal amount
of $5,300,000 (the “Exchange Notes”, and together with the Purchased Notes, the
“New Notes”) (the “Exchange”, and together with the Offering, the
“Financing”).
We
obtained the approval of our stockholders representing a majority of our
outstanding shares to the issuance of shares of our common stock upon conversion
of our New Notes and exercise of our Class D Warrants (as defined below)
issuable upon such conversion, as further described below. The stockholder
approval became effective on November 13, 2007, and the New Notes converted into
shares of our common stock on November 14, 2007.
All
principal and accrued but unpaid interest (the “Conversion Amount”) under our
New Notes automatically converted into (i) shares of our common stock at a
conversion price per share of our common stock (the “Conversion Shares”) equal
to $0.706 and (ii) in the case of our Purchased Notes, but not our Exchange
Notes, Class D Warrants (the “Class D Warrants”) for purchase of shares of our
common stock (the “Warrant Shares”) in an amount equal to 50% of the number of
shares of our common stock issued to the New Investors in accordance with clause
(i) above with an exercise price per share of our common stock equal to $0.90
(subject to anti-dilution adjustments). The Class D Warrants have a term of five
years and are non-callable by us.
24
National
Securities Corporation (“NSC”) and Dinosaur Securities, LLC (“Dinosaur” and
together with NSC, the “Placement Agent”) acted as co-placement agents in
connection with the Financing pursuant to an Engagement Letter, dated June 6,
2007 and a Placement Agent Agreement dated September 18, 2007. The Placement
Agent received (i) an aggregate cash fee equal to 8% of the face amount of the
Lambda Purchased Note and the Enso Purchased Note allocated and paid 6.25% to
NSC and 1.75% to Dinosaur, and (ii) warrants (“Placement Agent Warrant”) with a
term of five years from the date of issuance to purchase 10% of the aggregate
number of shares of our common stock issued upon conversion of the Lambda
Purchased Note and the Enso Purchased Note with an exercise price per share of
our common stock equal to $0.90.
In
connection with the sale of the New Notes, we entered into a Registration Rights
Agreement with the Investors, dated as of the First Closing Date (the
“Registration Rights Agreement”), pursuant to which we agreed to file an initial
resale registration statement (“Initial Resale Registration Statement”) with the
SEC no later than 60 days after we file a definitive version of our Information
Statement on Schedule 14C with the SEC, and we filed such Initial Resale
Registration Statement on December 20, 2007. We also agreed to use our
commercially reasonable best efforts to have the Initial Resale Registration
Statement declared effective within 240 days after filing of a definitive
version of our Information Statement on Schedule 14C. The Initial Resale
Registration Statement was declared effective on May 5, 2008.
On July
24, 2009, we raised gross proceeds of $1,251,000 through the private placement
to eight accredited investors of an aggregate of 1,345,161 shares of its common
stock and warrants to purchase an aggregate of 672,581 shares of its common
stock, representing 50% of the shares of common stock purchased by each
investor. We sold the shares to investors at a price per share equal
to $0.93. The warrants have an exercise price of $1.12, are
exercisable immediately and will terminate on July 24, 2014.
At
December 31, 2009, we had an accumulated deficit of $89,975,000, and we expect
to incur additional losses in the foreseeable future at least until such time,
if ever, that we are able to increase product sales or licensing revenue. We
have financed our operations since inception primarily through the private
placements of equity and debt securities and our initial public offering in
September 2004, from licensing revenue received from Asahi Kasei Medical Co.,
Ltd. (“Asahi”) in March 2005, a private placement of convertible debenture in
June 2006 and a private investment in public equity in September 2007 and a
private placement in July 2009.
Net cash
used in operating activities was $2,612,000 for the year ended December 31, 2009
compared to $5,725,000 for the year ended December 31, 2008.
During
2009, the net cash used in operating activities was $3,113,000 less than
the net cash used in operating activities during 2008. The most significant
items contributing to the reduction in cash used in operating cash are
highlighted below:
|
·
|
Our
net loss in 2009 was $2,026,000 compared to $6,337,000 in
2008. This represents an improvement of $4,311,000 in operating
cash in 2009. Noncash adjustments to reconcile net loss to net
cash used in operating activities were: stock-based compensation was
$108,000 and $155,000 in 2009 and 2008 respectively, a reduction of
$47,000, depreciation expense was $231,000 and $447,000 in 2009 and 2008
respectively, a reduction of $216,000 and an increase to the inventory
reserve of $18,000 in 2009.
|
|
·
|
During
2009, our accounts receivable, other current assets and other assets
increased by $193,000. This compares to a decrease of $236,000
in 2008. This represents a $429,000 use of operating cash in
2009.
|
|
·
|
During
2009, our inventory decreased by $75,000. This compares to an increase in
inventory of $409,000 in 2008. This represents a $484,000
source of operating cash in 2009.
|
|
·
|
During
2009, accounts payable and accrued expenses decreased by $807,000. This
compares to an increase in accounts payable and accrued expenses of
$183,000 during 2008. This represents a $990,000 use of
operating cash in 2009.
|
Net cash
used by investing activities was $21,000 for the year ended December 31, 2009
compared to $4,599,000 of net cash provided by investing activities for the year
ended December 31, 2008. In 2009, $28,000 was used to purchase equipment and
$7,000 was provided by the maturity of a short-term investment. In
2008, $4,693,000 was provided due to the maturity of short-term
investments. Approximately $97,000 of funds was used to purchase
property, plant and equipment and $3,000 was provided by the sale of
equipment.
Net cash
provided by financing activities was $1,336,000 for the year ended December 31,
2009 resulting from the sale of common stock of $1,251,000 and proceeds from the
exercise of stock options of $85,000. There were no financing activities in
2008.
25
Contractual
Obligations and Commercial Commitments
The
following tables summarize our approximate minimum contractual obligations and
commercial commitments as of December 31, 2009:
Payments Due in Period
|
||||||||||||||||||||
Total
|
Within
1 Year
|
Years
1 – 3
|
Years
3 – 5
|
More than
5 Years
|
||||||||||||||||
Leases
|
$
|
186,000
|
$
|
101,000
|
$
|
85,000
|
$
|
—
|
$
|
—
|
||||||||||
Employment
Contracts
|
244,000
|
195,000
|
49,000
|
|||||||||||||||||
Total
|
$
|
430,000
|
$
|
296,000
|
$
|
134,000
|
$
|
—
|
$
|
—
|
Certain
Risks and Uncertainties
Certain
statements in this Annual Report on Form 10-K, including certain statements
contained in “Description of Business” and “Management’s Discussion and
Analysis,” constitute “forward-looking statements” within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The words or phrases “can be,” “may,” “could,”
“would,” “expects,” “believes,” “seeks,” “estimates,” “projects” and similar
words and phrases are intended to identify such forward-looking statements. Such
forward-looking statements are subject to various known and unknown risks and
uncertainties, including those described on the following pages, and we caution
you that any forward-looking information provided by us is not a guarantee of
future performance. Our actual results could differ materially from those
anticipated by such forward-looking statements due to a number of factors, some
of which are beyond our control. All such forward-looking statements are current
only as of the date on which such statements were made. We do not undertake any
obligation to publicly update any forward-looking statement to reflect events or
circumstances after the date on which any such statement is made or to reflect
the occurrence of unanticipated events.
Risks
Related to Our Company
Our
independent registered public accountants, in their audit report related to our
financial statements for the year ended December 31, 2009, expressed substantial
doubt about our ability to continue as a going concern.
Our
independent registered public accounting firm has included an explanatory
paragraph in their report on our financial statements included in this Annual
Report on Form 10-K expressing doubt as to our ability to continue as a going
concern. The accompanying financial statements have been prepared assuming that
we will continue as a going concern, however, there can be no assurance that we
will be able to do so. Our recurring losses and difficulty in generating
sufficient cash flow to meet our obligations and sustain our operations, raise
substantial doubt about our ability to continue as a going concern, and our
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. Based on our current cash flow
projections, we will need to raise additional funds through either the licensing
or sale of our technologies or the additional public or private offerings of our
securities. However, there is no guarantee that we will be able to obtain
further financing, or do so on reasonable terms. If we are unable to raise
additional funds on a timely basis, or at all, we would be materially adversely
affected.
We
have a history of operating losses and a significant accumulated deficit, and we
may not achieve or maintain profitability in the future.
We have
not been profitable since our inception in 1997. As of December 31, 2009, we had
an accumulated deficit of $89,975,000 primarily as a result of our research and
development expenses and selling, general and administrative expenses. We expect
to continue to incur additional losses for the foreseeable future as a result of
a high level of operating expenses, significant up-front expenditures including
the cost of clinical trials, production and marketing activities and very
limited revenue from the sale of our products. We began sales of our first
product in March 2004, and we may never realize sufficient revenues from the
sale of our products or be profitable. Each of the following factors, among
others, may influence the timing and extent of our profitability, if
any:
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the
completion and success of additional clinical trials and of our regulatory
approval processes for each of our ESRD therapy products in our target
territories;
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the
market acceptance of HDF therapy in the United States and of our
technologies and products in each of our target
markets;
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our
ability to effectively and efficiently manufacture, market and distribute
our products;
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our
ability to sell our products at competitive prices which exceed our per
unit costs; and
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the
consolidation of dialysis clinics into larger clinical
groups.
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26
We
require additional financing in the near future to fund our
operations.
At December
31, 2009, we had cash, cash equivalents and short-term investments totaling
approximately $1,004,000 and tangible assets of approximately
$1,648,000. We estimate that these funds will allow us to keep
operating through June 2010. We must seek and obtain additional
financing to fund our operations. If we cannot raise sufficient
capital, our ability to operate will be significantly limited and we might need
to cease operations.
We
have limited experience selling our DSU water filtration system to dialysis
clinics, and we might be unsuccessful in increasing our sales.
Our
business strategy depends in part on our ability to sell our DSU water
filtration system to hospitals and other healthcare facilities that include
dialysis clinics. On July 1, 2009, we received approval from the FDA
to market our DSU to dialysis clinics. We have limited experience at
sales and marketing. If we are unsuccessful at manufacturing, marketing and
selling our DSU, our operations and potential revenues might be adversely
affected.
Certain
customers individually account for a large portion of our product sales, and the
loss of any of these customers could have a material adverse effect on our
sales.
For the
year ended December 31, 2009, one of our customers accounted for 46% of our
product sales. Also, this customer represented 44% of our accounts receivable as
of December 31, 2009. We believe that the loss of this customer would have a
material adverse effect on our product sales, at least temporarily, while we
seek to replace such customer and/or self-distribute in the territories
currently served by such customer.
We
cannot sell our ESRD therapy products, including certain modifications thereto,
until we obtain the requisite regulatory approvals and clearances in the
countries in which we intend to sell our products. We have not obtained FDA
approval for any of our ESRD therapy products, except for our HD190 filter, and
cannot sell any of our other ESRD therapy products in the United States unless
and until we obtain such approval. If we fail to receive, or experience a
significant delay in receiving, such approvals and clearances then we may not be
able to get our products to market and enhance our revenues.
Our
business strategy depends in part on our ability to get our products into the
market as quickly as possible. We obtained the Conformité Européene, or CE,
mark, which demonstrates compliance with the relevant European Union
requirements and is a regulatory prerequisite for selling our products in the
European Union and certain other countries that recognize CE marking
(collectively, “European Community”), for our OLpur MDHDF filter series product
in 2003 and received CE marking in November 2006 for our water filtration
product, the Dual Stage Ultrafilter (“DSU”). We have not yet obtained the CE
mark for any of our other products. Similarly, we cannot sell our ESRD therapy
products in the United States until we receive FDA clearance.
In
addition to the pre-market notification required pursuant to Section 510(k) of
the FDC Act, the FDA could require us to obtain pre-market approval of our ESRD
therapy products under Section 515 of the FDC Act, either because of legislative
or regulatory changes or because the FDA does not agree with our determination
that we are eligible to use the Section 510(k) pre-market notification process.
The Section 515 pre-market approval process is a significantly more costly,
lengthy and uncertain approval process and could materially delay our products
coming to market. If we do obtain clearance for marketing of any of our devices
under Section 510(k) of the FDC Act, then any changes we wish to make to such
device that could significantly affect safety and effectiveness will require
clearance of a notification pursuant to Section 510(k), and we may need to
submit clinical and manufacturing comparability data to obtain such approval or
clearance. We could not market any such modified device until we received
FDA clearance or approval. We cannot guarantee that the FDA would timely, if at
all, clear or approve any modified product for which Section 510(k) is
applicable. Failure to obtain timely clearance or approval for changes to
marketed products would impair our ability to sell such products and generate
revenues in the United States.
The
clearance and/or approval processes in the European Community and in the United
States can be lengthy and uncertain and each requires substantial commitments of
our financial resources and our management’s time and effort. We may not be able
to obtain further CE marking or any FDA approval for any of our ESRD therapy
products in a timely manner or at all. Even if we do obtain regulatory approval,
approval may be only for limited uses with specific classes of patients,
processes or other devices. Our failure to obtain, or delays in obtaining, the
necessary regulatory clearance and/or approvals with respect to the European
Community or the United States would prevent us from selling our affected
products in these regions. If we cannot sell some of our products in these
regions, or if we are delayed in selling while waiting the necessary clearance
and/or approvals, our ability to generate revenues from these products will be
limited.
If we are
successful in our initial marketing efforts in some or all of our Target
European Market and the United States, then we plan to market our ESRD therapy
products in several countries outside of our Target European Market and the
United States, including Korea and China, Canada and Mexico. Requirements
pertaining to the sale of medical devices vary widely from country to country.
It may be very expensive and difficult for us to meet the requirements for the
sale of our ESRD therapy products in many of these countries. As a result, we
may not be able to obtain the required approvals in a timely manner, if at all.
If we cannot sell our ESRD therapy products outside of our Target European
Market and the United States, then the size of our potential market could be
reduced, which would limit our potential sales and revenues.
27
Clinical
studies required for our ESRD therapy products are costly and time-consuming,
and their outcome is uncertain.
Before
obtaining regulatory approvals for the commercial sale of any of our ESRD
therapy products in the United States and elsewhere, we must demonstrate through
clinical studies that our products are safe and effective. We received
conditional approval for our IDE application from the FDA to begin human
clinical trials of our OLpur H2H hemodiafiltration module and
OLpur MD220 hemodiafilter. We were granted this approval on the condition that,
by March 5, 2007, we submit a response to two informational questions from the
FDA. We responded to these questions. We obtained approval from Western IRB,
Inc., which enabled us to proceed with our clinical trial. We
completed the patient treatment phase of our clinical trial during the second
quarter of 2008. We have submitted our data to the FDA with our 510(k)
application on these products in November 2008. Following its review
of the application, the FDA has requested additional information from us.
We replied to the FDA inquiries on March 13, 2009. The FDA has
not provided us with any additional requests for information or rendered a
decision on our application. We have made additional inquiries to the
FDA about the status of our application and, as of March 10, 2010, have
been informed that our application is still under their review
process.
For
products other than those for which we have already received marketing approval,
if we do not prove in clinical trials that our ESRD therapy products are safe
and effective, we will not obtain marketing approvals from the FDA and other
applicable regulatory authorities. In particular, one or more of our ESRD
therapy products may not exhibit the expected medical benefits, may cause
harmful side effects, may not be effective in treating dialysis patients or may
have other unexpected characteristics that preclude regulatory approval for any
or all indications of use or limit commercial use if approved. The length of
time necessary to complete clinical trials varies significantly and is difficult
to predict. Factors that can cause delay or termination of our clinical trials
include:
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slower
than expected patient enrollment due to the nature of the protocol, the
proximity of subjects to clinical sites, the eligibility criteria for the
study, competition with clinical trials for similar devices or other
factors;
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lower
than expected retention rates of subjects in a clinical
trial;
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inadequately
trained or insufficient personnel at the study site to assist in
overseeing and monitoring clinical
trials;
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delays
in approvals from a study site’s review board, or other required
approvals;
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longer
treatment time required to demonstrate
effectiveness;
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lack
of sufficient supplies of the ESRD therapy
product;
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adverse
medical events or side effects in treated subjects;
and
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lack
of effectiveness of the ESRD therapy product being
tested.
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Even if
we obtain positive results from clinical studies for our products, we may not
achieve the same success in future studies of such products. Data obtained from
clinical studies are susceptible to varying interpretations that could delay,
limit or prevent regulatory approval. In addition, we may encounter delays or
rejections based upon changes in FDA policy for device approval during the
period of product development and FDA regulatory review of each submitted new
device application. We may encounter similar delays in foreign countries.
Moreover, regulatory approval may entail limitations on the indicated uses of
the device. Failure to obtain requisite governmental approvals or failure to
obtain approvals of the scope requested will delay or preclude our licensees or
marketing partners from marketing our products or limit the commercial use of
such products and will have a material adverse effect on our business, financial
condition and results of operations.
In
addition, some or all of the clinical trials we undertake may not demonstrate
sufficient safety and efficacy to obtain the requisite regulatory approvals,
which could prevent or delay the creation of marketable products. Our product
development costs will increase if we have delays in testing or approvals, if we
need to perform more, larger or different clinical trials than planned or if our
trials are not successful. Delays in our clinical trials may harm our financial
results and the commercial prospects for our products. Additionally, we may be
unable to complete our clinical trials if we are unable to obtain additional
capital.
We
may be required to design and conduct additional clinical trials.
We may be
required to design and conduct additional clinical trials to further demonstrate
the safety and efficacy of our ESRD therapy product, which may result in
significant expense and delay. The FDA and foreign regulatory authorities may
require new or additional clinical trials because of inconclusive results from
current or earlier clinical trials, a possible failure to conduct clinical
trials in complete adherence to FDA good clinical practice standards and similar
standards of foreign regulatory authorities, the identification of new clinical
trial endpoints, or the need for additional data regarding the safety or
efficacy of our ESRD therapy products. It is possible that the FDA or foreign
regulatory authorities may not ultimately approve our products for commercial
sale in any jurisdiction, even if we believe future clinical results are
positive.
28
We
cannot assure you that our ESRD therapy products will be safe and we are
required under applicable law to report any product-related deaths or serious
injuries or product malfunctions that could result in deaths or serious
injuries, and such reports could trigger recalls, class action lawsuits and
other events that could cause us to incur expenses and may also limit our
ability to generate revenues from such products.
We cannot
assure you that our ESRD therapy products will be safe. Under the FDC Act, we
are required to submit medical device reports, or MDRs, to the FDA to report
device-related deaths, serious injuries and product malfunctions that could
result in death or serious injury if they were to recur. Depending on their
significance, MDRs could trigger events that could cause us to incur expenses
and may also limit our ability to generate revenues from such products, such as
the following:
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information
contained in the MDRs could trigger FDA regulatory actions such as
inspections, recalls and patient/physician
notifications;
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because
the reports are publicly available, MDRs could become the basis for
private lawsuits, including class actions;
and
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if
we fail to submit a required MDR to the FDA, the FDA could take
enforcement action against us.
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If any of
these events occur, then we could incur significant expenses and it could become
more difficult for us to gain market acceptance of our ESRD therapy products and
to generate revenues from sales. Other countries may impose analogous reporting
requirements that could cause us to incur expenses and may also limit our
ability to generate revenues from sales of our ESRD therapy
products.
Product
liability associated with the production, marketing and sale of our products,
and/or the expense of defending against claims of product liability, could
materially deplete our assets and generate negative publicity which could impair
our reputation.
The
production, marketing and sale of kidney dialysis and water-filtration products
have inherent risks of liability in the event of product failure or claim of
harm caused by product operation. Furthermore, even meritless claims of product
liability may be costly to defend against. Although we have acquired product
liability insurance in the amount of $5,000,000 for our products, we may not be
able to maintain or obtain this insurance on acceptable terms or at all. Because
we may not be able to obtain insurance that provides us with adequate protection
against all potential product liability claims, a successful claim in excess of
our insurance coverage could materially deplete our assets. Moreover, even if we
are able to obtain adequate insurance, any claim against us could generate
negative publicity, which could impair our reputation and adversely affect the
demand for our products, our ability to generate sales and our
profitability.
Some of
the agreements that we may enter into with manufacturers of our products and
components of our products may require us:
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To
obtain product liability insurance;
or
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To
indemnify manufacturers against liabilities resulting from the sale of our
products.
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For
example, the agreement with our CM requires that we obtain and maintain certain
minimum product liability insurance coverage and that we indemnify our CM
against certain liabilities arising out of our products that they manufacture,
provided they do not arise out of our CM’s breach of the agreement, negligence
or willful misconduct. If we are not able to obtain and maintain adequate
product liability insurance, then we could be in breach of these agreements,
which could materially adversely affect our ability to produce our products and
generate revenues. Even if we are able to obtain and maintain product liability
insurance, if a successful claim in excess of our insurance coverage is made,
then we may have to indemnify some or all of our manufacturers for their losses,
which could materially deplete our assets.
If
we violate any provisions of the FDC Act or any other statutes or regulations,
then we could be subject to enforcement actions by the FDA or other governmental
agencies.
We face a
significant compliance burden under the FDC Act and other applicable statutes
and regulations which govern the testing, labeling, storage, record keeping,
distribution, sale, marketing, advertising and promotion of our ESRD therapy
products. If we violate the FDC Act or other regulatory requirements at any time
during or after the product development and/or approval process, we could be
subject to enforcement actions by the FDA or other agencies,
including:
29
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fines;
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injunctions;
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civil
penalties;
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recalls
or seizures of products;
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total
or partial suspension of the production of our
products;
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withdrawal
of any existing approvals or pre-market clearances of our
products;
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refusal
to approve or clear new applications or notices relating to our
products;
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recommendations
by the FDA that we not be allowed to enter into government contracts;
and
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criminal
prosecution.
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Any of
the above could have a material adverse effect on our business, financial
condition and results of operations.
Significant
additional governmental regulation could subject us to unanticipated delays
which would adversely affect our sales and revenues.
Our
business strategy depends in part on our ability to get our products into the
market as quickly as possible. Additional laws and regulations, or changes to
existing laws and regulations that are applicable to our business may be enacted
or promulgated, and the interpretation, application or enforcement of the
existing laws and regulations may change. We cannot predict the nature of any
future laws, regulations, interpretations, applications or enforcements or the
specific effects any of these might have on our business. Any future laws,
regulations, interpretations, applications or enforcements could delay or
prevent regulatory approval or clearance of our products and our ability to
market our products. Moreover, changes that result in our failure to comply with
the requirements of applicable laws and regulations could result in the types of
enforcement actions by the FDA and/or other agencies as described above, all of
which could impair our ability to have manufactured and to sell the affected
products.
Access
to the appropriations from the U.S. Department of Defense regarding the
development of a dual-stage water ultrafilter could be subject to unanticipated
delays which could adversely affect our potential revenues.
Our
business strategy with respect to our DSU products depends in part on the
successful development of DSU products for use by the military. Beginning in
January 2008, we contracted with the U.S. Office of Naval Research to develop a
personal potable water purification system for warfighters under a first
contract in an amount not to exceed $866,000. In August 2009, we
entered into a second contract with a value not to exceed $2
million. These contracts would utilize the Federal appropriations
from the U.S. Department of Defense not to exceed $3 million that have been
approved for this purpose. If there are unanticipated delays in receiving the
appropriations from the U.S. Department of Defense, our operations and potential
revenues may be adversely affected. Further, if we do not
successfully complete the contract work or renew the contract work in the event
that the research and development needs additional work to reach completion, our
operations and potential revenues may be adversely affected.
Protecting
our intellectual property in our technology through patents may be costly and
ineffective. If we are not able to adequately secure or enforce protection of
our intellectual property, then we may not be able to compete effectively and we
may not be profitable.
Our
future success depends in part on our ability to protect the intellectual
property for our technology through patents. We will only be able to protect our
products and methods from unauthorized use by third parties to the extent that
our products and methods are covered by valid and enforceable patents or are
effectively maintained as trade secrets. Our 16 granted U.S. patents will expire
at various times from 2018 to 2022, assuming they are properly
maintained.
30
The
protection provided by our patents, and patent applications if issued, may not
be broad enough to prevent competitors from introducing similar products into
the market. Our patents, if challenged or if we attempt to enforce them, may not
necessarily be upheld by the courts of any jurisdiction. Numerous publications
may have been disclosed by, and numerous patents may have been issued to, our
competitors and others relating to methods and devices for dialysis of which we
are not aware and additional patents relating to methods and devices for
dialysis may be issued to our competitors and others in the future. If any of
those publications or patents conflict with our patent rights, or cover our
products, then any or all of our patent applications could be rejected and any
or all of our granted patents could be invalidated, either of which could
materially adversely affect our competitive position.
Litigation
and other proceedings relating to patent matters, whether initiated by us or a
third party, can be expensive and time-consuming, regardless of whether the
outcome is favorable to us, and may require the diversion of substantial
financial, managerial and other resources. An adverse outcome could subject us
to significant liabilities to third parties or require us to cease any related
development, product sales or commercialization activities. In addition, if
patents that contain dominating or conflicting claims have been or are
subsequently issued to others and the claims of these patents are ultimately
determined to be valid, then we may be required to obtain licenses under patents
of others in order to develop, manufacture, use, import and/or sell our
products. We may not be able to obtain licenses under any of these patents on
terms acceptable to us, if at all. If we do not obtain these licenses, we could
encounter delays in, or be prevented entirely from using, importing,
developing, manufacturing, offering or selling any products or practicing any
methods, or delivering any services requiring such licenses.
If we
file patent applications or obtain patents in foreign countries, we will be
subject to laws and procedures that differ from those in the United States. Such
differences could create additional uncertainty about the level and extent of
our patent protection. Moreover, patent protection in foreign countries may be
different from patent protection under U.S. laws and may not be as favorable to
us. Many non-U.S. jurisdictions, for example, prohibit patent claims covering
methods of medical treatment of humans, although this prohibition may not
include devices used for such treatment.
If
we are not able to secure and enforce protection of our trade secrets through
enforcement of our confidentiality and non-competition agreements, then our
competitors may gain access to our trade secrets, we may not be able to compete
effectively and we may not be profitable. Such protection may be costly and
ineffective.
We
attempt to protect our trade secrets, including the processes, concepts, ideas
and documentation associated with our technologies, through the use of
confidentiality agreements and non-competition agreements with our current
employees and with other parties to whom we have divulged such trade secrets. If
these employees or other parties breach our confidentiality agreements and
non-competition agreements or if these agreements are not sufficient to protect
our technology or are found to be unenforceable, then our competitors could
acquire and use information that we consider to be our trade secrets and we may
not be able to compete effectively. Policing unauthorized use of our trade
secrets is difficult and expensive, particularly because of the global nature of
our operations. The laws of other countries may not adequately protect our trade
secrets.
If
our trademarks and trade names are not adequately protected, then we may not be
able to build brand loyalty and our sales and revenues may suffer.
Our
registered or unregistered trademarks or trade names may be challenged,
cancelled, infringed, circumvented or declared generic or determined to be
infringing on other marks. We may not be able to protect our rights to these
trademarks and trade names, which we need to build brand loyalty. Over the long
term, if we are unable to establish a brand based on our trademarks and trade
names, then we may not be able to compete effectively and our sales and revenues
may suffer.
If
we are not able to successfully scale-up production of our products, then our
sales and revenues will suffer.
In order
to commercialize our products, we need to be able to produce them in a
cost-effective way on a large scale to meet commercial demand, while maintaining
extremely high standards for quality and reliability. If we fail to successfully
commercialize our products, then we will not be profitable.
We expect
to rely on a limited number of independent manufacturers to produce our OLpur
MDHDF filter series and our other products, including the DSU. Our
manufacturers’ systems and procedures may not be adequate to support our
operations and may not be able to achieve the rapid execution necessary to
exploit the market for our products. Our manufacturers could experience
manufacturing and control problems as they begin to scale-up our future
manufacturing operations, if any, and we may not be able to scale-up
manufacturing in a timely manner or at a commercially reasonable cost to enable
production in sufficient quantities. If we experience any of these problems with
respect to our manufacturers’ initial or future scale-ups of manufacturing
operations, then we may not be able to have our products manufactured and
delivered in a timely manner. Our products are new and evolving, and our
manufacturers may encounter unforeseen difficulties in manufacturing them in
commercial quantities or at all.
31
We
will not control the independent manufacturers of our products, which may affect
our ability to deliver our products in a timely manner. If we are not able to
ensure the timely delivery of our products, then potential customers may not
order our products, and our sales and revenues would be adversely
affected.
Independent
manufacturers of medical devices will manufacture all of our products and
components. We have contracted with our CM to assemble and produce our OLpur
MD190, MD220 and possibly other filters, including our DSU, and have an
agreement with FS, a manufacturer of medical and technical membranes for
applications like dialysis, to produce the fiber for the OLpur MDHDF filter
series. As with any independent contractor, these manufacturers will not be
employed or otherwise controlled by us and will be generally free to conduct
their business at their own discretion. For us to compete successfully, among
other things, our products must be manufactured on a timely basis in commercial
quantities at costs acceptable to us. If one or more of our independent
manufacturers fails to deliver our products in a timely manner, then we may not
be able to find a substitute manufacturer. If we are not or if potential
customers believe that we are not able to ensure timely delivery of our
products, then potential customers may not order our products, and our sales and
revenues would be adversely affected.
The
loss or interruption of services of any of our manufacturers could slow or stop
production of our products, which would limit our ability to generate sales and
revenues.
Because
we are likely to rely on no more than two contract manufacturers to manufacture
each of our products and major components of our products, a stop or significant
interruption in the supply of our products or major components by a single
manufacturer, for any reason, could have a material adverse effect on us. We
expect most of our contract manufacturers will enter into contracts with us to
manufacture our products and major components and that these contracts will be
terminable by the contractors or us at any time under certain circumstances. We
have not made alternative arrangements for the manufacture of our products or
major components and we cannot be sure that acceptable alternative arrangements
could be made on a timely basis, or at all, if one or more of our manufacturers
failed to manufacture our products or major components in accordance with the
terms of our arrangements. If any such failure occurs and we are unable to
obtain acceptable alternative arrangements for the manufacture of our products
or major components of our products, then the production and sale of our
products could slow down or stop and our cash flow would suffer.
If
we are not able to maintain sufficient quality controls, then the approval or
clearance of our ESRD therapy products by the European Union, the FDA or other
relevant authorities could be delayed or denied and our sales and revenues will
suffer.
Approval
or clearance of our ESRD therapy products could be delayed by the European
Union, the FDA and the relevant authorities of other countries if our
manufacturing facilities do not comply with their respective manufacturing
requirements. The European Union imposes requirements on quality control systems
of manufacturers, which are inspected and certified on a periodic basis and may
be subject to additional unannounced inspections. Failure by our manufacturers
to comply with these requirements could prevent us from marketing our ESRD
therapy products in the European Community. The FDA also imposes requirements
through quality system requirements, or QSR, regulations, which include
requirements for good manufacturing practices, or GMP. Failure by our
manufacturers to comply with these requirements could prevent us from obtaining
FDA approval of our ESRD therapy products and from marketing such products in
the United States. Although the manufacturing facilities and processes that we
use to manufacture our OLpur MDHDF filter series have been inspected and
certified by a worldwide testing and certification agency (also referred to as a
notified body) that performs conformity assessments to European Union
requirements for medical devices, they have not been inspected by the FDA.
Similarly, although some of the facilities and processes that we expect to use
to manufacture our OLpur H2H and OLpur NS2000 have been
inspected by the FDA, they have not been inspected by any notified body. A
“notified body” is a group accredited and monitored by governmental agencies
that inspects manufacturing facilities and quality control systems at regular
intervals and is authorized to carry out unannounced inspections. We cannot be
sure that any of the facilities or processes we use will comply or continue to
comply with their respective requirements on a timely basis or at all, which
could delay or prevent our obtaining the approvals we need to market our
products in the European Community and the United States.
To market
our ESRD therapy products in the European Community, the United States and other
countries, where approved, manufacturers of such products must continue to
comply or ensure compliance with the relevant manufacturing requirements.
Although we cannot control the manufacturers of our ESRD therapy products, we
may need to expend time, resources and effort in product manufacturing and
quality control to assist with their continued compliance with these
requirements. If violations of applicable requirements are noted during
periodic inspections of the manufacturing facilities of our manufacturers, then
we may not be able to continue to market the ESRD therapy products manufactured
in such facilities and our revenues may be materially adversely
affected.
If
our products are commercialized, we may face significant challenges in obtaining
market acceptance of such products, which could adversely affect our potential
sales and revenues.
Our
products are new to the market, and we do not yet have an established market or
customer base for our products. Acceptance of our ESRD therapy products in the
marketplace by both potential users, including ESRD patients, and potential
purchasers, including nephrologists, dialysis clinics and other health care
providers, is uncertain, and our failure to achieve sufficient market acceptance
will significantly limit our ability to generate revenue and be profitable.
Market acceptance will require substantial marketing efforts and the expenditure
of significant funds by us to inform dialysis patients and nephrologists,
dialysis clinics and other health care providers of the benefits of using our
ESRD therapy products. We may encounter significant clinical and market
resistance to our products and our products may never achieve market acceptance.
We may not be able to build key relationships with physicians, clinical groups
and government agencies, pursue or increase sales opportunities in Europe or
elsewhere, or be the first to introduce hemodiafiltration therapy in the United
States. Product orders may be cancelled, patients or customers currently using
our products may cease to do so and patients or customers expected to begin
using our products may not. Factors that may affect our ability to achieve
acceptance of our ESRD therapy products in the marketplace include
whether:
32
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such
products will be safe for use;
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such
products will be effective;
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such
products will be cost-effective;
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we
will be able to demonstrate product safety, efficacy and
cost-effectiveness;
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there
are unexpected side effects, complications or other safety issues
associated with such products; and
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government
or third party reimbursement for the cost of such products is available at
reasonable rates, if at all.
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Acceptance
of our water filtration products in the marketplace is also uncertain, and our
failure to achieve sufficient market acceptance and sell such products at
competitive prices will limit our ability to generate revenue and be profitable.
Our water filtration products and technologies may not achieve expected
reliability, performance and endurance standards. Our water filtration products
and technology may not achieve market acceptance, including among hospitals, or
may not be deemed suitable for other commercial, military, industrial or retail
applications.
Many of
the same factors that may affect our ability to achieve acceptance of our ESRD
therapy products in the marketplace will also apply to our water filtration
products, except for those related to side effects, clinical trials and third
party reimbursement.
If
we cannot develop adequate distribution, customer service and technical support
networks, then we may not be able to market and distribute our products
effectively and/or customers may decide not to order our products, and, in
either case, our sales and revenues will suffer.
Our
strategy requires us to distribute our products and provide a significant amount
of customer service and maintenance and other technical service. To provide
these services, we have begun, and will need to continue, to develop a network
of distribution and a staff of employees and independent contractors in each of
the areas in which we intend to operate. We cannot assure you we will be able to
organize and manage this network on a cost-effective basis. If we cannot
effectively organize and manage this network, then it may be difficult for us to
distribute our products and to provide competitive service and support to our
customers, in which case customers may be unable, or decide not, to order our
products and our sales and revenues will suffer.
We
may face significant risks associated with international operations, which could
have a material adverse effect on our business, financial condition and results
of operations.
We expect
to manufacture and to market our products in our Target European Market and
elsewhere outside of the United States. We expect that our revenues from our
Target European Market will initially account for a significant portion of our
revenues. Our international operations are subject to a number of risks,
including the following:
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fluctuations
in exchange rates of the United States dollar could adversely affect our
results of operations;
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we
may face difficulties in enforcing and collecting accounts receivable
under some countries’ legal
systems;
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local
regulations may restrict our ability to sell our products, have our
products manufactured or conduct other
operations;
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political
instability could disrupt our
operations;
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some
governments and customers may have longer payment cycles, with resulting
adverse effects on our cash flow;
and
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some
countries could impose additional taxes or restrict the import of our
products.
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Any one
or more of these factors could increase our costs, reduce our revenues, or
disrupt our operations, which could have a material adverse effect on our
business, financial condition and results of operations.
33
If
we are unable to keep our key management and scientific personnel, then we are
likely to face significant delays at a critical time in our corporate
development and our business is likely to be damaged.
Our
success depends upon the skills, experience and efforts of our management and
other key personnel, including our chief executive officer, certain members of
our scientific and engineering staff and our marketing executives. As a
relatively new company, much of our corporate, scientific and technical
knowledge is concentrated in the hands of these few individuals. We do not
maintain key-man life insurance on any of our management or other key personnel.
The recent resignation of our Chief Executive Officer or the loss of the
services of one or more of our present management or other key personnel could
significantly delay the development and/or launch of our products as there could
be a learning curve of several months or more for any replacement personnel.
Furthermore, competition for the type of highly skilled individuals we require
is intense and we may not be able to attract and retain new employees of the
caliber needed to achieve our objectives. Failure to replace key personnel could
have a material adverse effect on our business, financial condition and
operations.
Risks
Related to the ESRD Therapy Industry
We
expect to face significant competition from existing suppliers of renal
replacement therapy devices, supplies and services. If we are not able to
compete with them effectively, then we may not be profitable.
We expect
to compete in the ESRD therapy market with existing suppliers of hemodialysis
and peritoneal dialysis devices, supplies and services. Our competitors include
Fresenius Medical Care AG and Gambro AB, currently two of the primary machine
manufacturers in hemodialysis, as well as B. Braun Biotech International GmbH,
and Nikkiso Corporation and other smaller machine manufacturers in hemodialysis.
B. Braun Biotech International GmbH, Fresenius Medical Care AG, Gambro AB and
Nikkiso Corporation also manufacture HDF machines. These companies and most of
our other competitors have longer operating histories and substantially greater
financial, marketing, technical, manufacturing and research and development
resources and experience than we have. Our competitors could use these resources
and experiences to develop products that are more effective or less costly than
any or all of our products or that could render any or all of our products
obsolete. Our competitors could also use their economic strength to influence
the market to continue to buy their existing products.
We do not
have a significant established customer base and may encounter a high degree of
competition in further developing one. Our potential customers are a limited
number of nephrologists, national, regional and local dialysis clinics and other
healthcare providers. The number of our potential customers may be further
limited to the extent any exclusive relationships exist or are entered into
between our potential customers and our competitors. We cannot assure you that
we will be successful in marketing our products to these potential customers. If
we are not able to develop competitive products and take and hold sufficient
market share from our competitors, we will not be profitable.
Some
of our competitors own or could acquire dialysis clinics throughout the United
States, our Target European Market and other regions of the world. We may not be
able to successfully market our products to the dialysis clinics under their
ownership. If our potential market is materially reduced in this manner, then
our potential sales and revenues could be materially reduced.
Some of
our competitors, including Fresenius Medical Care AG and Gambro AB, manufacture
their own products and own dialysis clinics in the United States, our Target
European Market and/or other regions of the world. In 2005, Gambro AB divested
its U.S. dialysis clinics to DaVita, Inc. and entered a preferred, but not
exclusive, ten-year supplier arrangement with DaVita, Inc., whereby DaVita, Inc.
will purchase a significant amount of renal products and supplies from Gambro AB
Renal Products. Because these competitors have historically tended to use their
own products in their clinics, we may not be able to successfully market our
products to the dialysis clinics under their ownership. According to the
Fresenius Medical Care AG Form 20-F annual report for the year ended December
31, 2009, Fresenius Medical Care AG provides treatment in its own dialysis
clinics to approximately 195,651 patients in its facilities around the world
including facilities located in the North America. According to DaVita, Inc.’s
Annual Report for the year ended December 31, 2009, DaVita, Inc. provides
treatment in 1,530 outpatient dialysis centers serving approximately 118,000
patients in the United States.
We believe
that there is currently a trend among ESRD therapy providers towards greater
consolidation. If such consolidation takes the form of our competitors acquiring
independent dialysis clinics, rather than such dialysis clinics banding together
in independent chains, then more of our potential customers would also be our
competitors. If our competitors continue to grow their networks of dialysis
clinics, whether organically or through consolidation, and if we cannot
successfully market our products to dialysis clinics owned by these competitors
or any other competitors and do not acquire clinics ourselves, then our revenues
could be adversely affected.
34
If
the size of the potential market for our products is significantly reduced due
to pharmacological or technological advances in preventative and alternative
treatments for ESRD, then our potential sales and revenues will
suffer.
Pharmacological
or technological advances in preventative or alternative treatments for ESRD
could significantly reduce the number of ESRD patients needing our products.
These pharmacological or technological advances may include:
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the
development of new medications, or improvements to existing medications,
which help to delay the onset or prevent the progression of ESRD in
high-risk patients (such as those with diabetes and
hypertension);
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the
development of new medications, or improvements in existing medications,
which reduce the incidence of kidney transplant rejection;
and
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developments
in the use of kidneys harvested from genetically-engineered animals as a
source of transplants.
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If these
or any other pharmacological or technological advances reduce the number of
patients needing treatment for ESRD, then the size of the market for our
products may be reduced and our potential sales and revenues will
suffer.
If
government and other third party reimbursement programs discontinue their
coverage of ESRD treatment or reduce reimbursement rates for ESRD products, then
we may not be able to sell as many units of our ESRD therapy products as
otherwise expected, or we may need to reduce the anticipated prices of such
products and, in either case, our potential revenues may be
reduced.
Providers
of renal replacement therapy are often reimbursed by government programs, such
as Medicare or Medicaid in the United States, or other third-party reimbursement
programs, such as private medical care plans and insurers. We believe that the
amount of reimbursement for renal replacement therapy under these programs has a
significant impact on the decisions of nephrologists, dialysis clinics and other
health care providers regarding treatment methods and products. Accordingly,
changes in the extent of coverage for renal replacement therapy or a reduction
in the reimbursement rates under any or all of these programs may cause a
decline in recommendations or purchases of our products, which would materially
adversely affect the market for our products and reduce our potential sales.
Alternatively, we might respond to reduced reimbursement rates by reducing the
prices of our products, which could also reduce our potential
revenues.
As
the number of managed health care plans increases in the United States, amounts
paid for our ESRD therapy products by non-governmental programs may decrease and
we may not generate sufficient revenues to be profitable.
We expect
to obtain a portion of our revenues from reimbursement provided by
non-governmental programs in the United States. Although non-governmental
programs generally pay higher reimbursement rates than governmental programs, of
the non-governmental programs, managed care plans generally pay lower
reimbursement rates than insurance plans. Reliance on managed care plans for
dialysis treatment may increase if future changes to the Medicare program
require non-governmental programs to assume a greater percentage of the total
cost of care given to dialysis patients over the term of their illness, or if
managed care plans otherwise significantly increase their enrollment of these
patients. If the reliance on managed care plans for dialysis treatment
increases, more patients join managed care plans or managed care plans reduce
reimbursement rates, we may need to reduce anticipated prices of our ESRD
therapy products or sell fewer units, and, in either case, our potential
revenues would suffer.
If
HDF does not become a preferred therapy for ESRD, then the market for our ESRD
therapy products may be limited and we may not be profitable.
A
significant portion of our success is dependent on the acceptance and
implementation of HDF as a preferred therapy for ESRD. There are several
treatment options currently available and others may be developed. HDF may not
increase in acceptance as a preferred therapy for ESRD. If it does not, then the
market for our ESRD therapy products may be limited and we may not be able to
sell a sufficient quantity of our products to be profitable.
If
the per-treatment costs for dialysis clinics using our ESRD therapy products are
higher than the costs of clinics providing hemodialysis treatment, then we may
not achieve market acceptance of our ESRD therapy products in the United States
and our potential sales and revenues will suffer.
If the
cost of our ESRD therapy products results in an increased cost to the dialysis
clinic over hemodialysis therapies and such cost is not separately reimbursable
by governmental programs or private medical care plans and insurers outside of
the per-treatment fee, then we may not gain market acceptance for such products
in the United States unless HDF therapy becomes the standard treatment method
for ESRD. If we do not gain market acceptance for our ESRD therapy products in
the United States, then the size of our market and our anticipated sales and
revenues will be reduced.
35
Proposals
to modify the health care system in the United States or other countries could
affect the pricing of our products. If we cannot sell our products at the prices
we plan to, then our margins and our profitability will be adversely
affected.
A
substantial portion of the cost of treatment for ESRD in the United States is
currently reimbursed by the Medicare program at prescribed rates. Proposals to
modify the current health care system in the United States to improve access to
health care and control its costs are continually being considered by
the federal and state governments. In March 2010, the U.S. Congress passed
landmark healthcare legislation. We cannot predict what impact on
federal reimbursement policies this legislation will have in general or on our
business specifically. We anticipate that the U.S. Congress and state
legislatures will continue to review and assess this legislation and possibly
alternative health care reform proposals. We cannot predict whether new
proposals will be made or adopted, when they may be adopted or what impact they
may have on us if they are adopted. Any spending decreases or other significant
changes in the Medicare program could affect the pricing of our ESRD therapy
products. As we are not yet established in our business and it will take some
time for us to begin to recoup our research and development costs, our profit
margins are likely initially to be lower than those of our competitors and we
may be more vulnerable to small decreases in price than many of our
competitors.
Health
administration authorities in countries other than the United States may not
provide reimbursement for our products at rates sufficient for us to achieve
profitability, or at all. Like the United States, these countries have
considered health care reform proposals and could materially alter their
government-sponsored health care programs by reducing reimbursement rates for
dialysis products.
Any
reduction in reimbursement rates under Medicare or foreign health care programs
could negatively affect the pricing of our ESRD therapy products. If we are not
able to charge a sufficient amount for our products, then our margins and our
profitability will be adversely affected.
If
patients in our Target European Market were to reuse dialyzers, then our
potential product sales could be materially adversely affected.
In the
United States, a majority of dialysis clinics reuse dialyzers — that
is, a single dialyzer is disinfected and reused by the same patient. However,
the trend in our Target European Market is towards not reusing dialyzers, and
some countries (such as France, Germany, Italy and the Netherlands) actually
forbid the reuse of dialyzers. As a result, each patient in our Target European
Market can generally be expected to purchase more dialyzers than each United
States patient. The laws forbidding reuse could be repealed and it may become
generally accepted to reuse dialyzers in our Target European Market, just as it
currently is in the United States. If reuse of dialyzers were to become more
common among patients in our Target European Market, then there would be demand
for fewer dialyzer units and our potential product sales could be materially
adversely affected.
Risks
Related to Our Common Stock
There
currently is a limited market for our common stock.
Our
common stock is quoted on the Over-the-Counter, or OTC, Bulletin
Board. Prior to January 22, 2009, our common stock was listed on the
AMEX. Trading in our common stock on both AMEX and the OTC Bulletin
Board has been very limited, which could affect the price of our stock. We have
no plans, proposals, arrangements or understandings with any person with regard
to the development of an active trading market for our common stock, and no
assurance can be given that an active trading market will develop.
The prices at which shares of our
common stock trade have been and will likely continue to be
volatile.
In the
two years ended December 31, 2009, our common stock has traded at prices ranging
from a high of $2.63 to a low of $0.01 per share. Due to the lack of
an active market for our common stock, you should expect the prices at which our
common stock might trade to continue to be highly volatile. The expected
volatile price of our stock will make it difficult to predict the value of your
investment, to sell your shares at a profit at any given time, or to plan
purchases and sales in advance. A variety of other factors might also affect the
market price of our common stock. These include, but are not limited
to:
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publicity
regarding actual or potential clinical or regulatory results relating to
products under development by our competitors or
us;
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delays
or failures in initiating, completing or analyzing clinical trials or the
unsatisfactory design or results of these
trials;
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achievement
or rejection of regulatory approvals by our competitors or
us;
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announcements
of technological innovations or new commercial products by our competitors
or us;
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developments
concerning proprietary rights, including
patents;
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regulatory
developments in the United States and foreign
countries;
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economic
or other crises and other external
factors;
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period-to-period
fluctuations in our results of
operations;
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changes
in financial estimates by securities analysts;
and
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sales
of our common stock.
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We are
not able to control many of these factors, and we believe that period-to-period
comparisons of our financial results will not necessarily be indicative of our
future performance.
In
addition, the stock market in general, and the market for biotechnology
companies in particular, has experienced extreme price and volume fluctuations
in recent years that might have been unrelated or disproportionate to the
operating performance of individual companies. These broad market and industry
factors might seriously harm the market price of our common stock, regardless of
our operating performance.
We
have never paid dividends and do not intend to pay cash dividends.
We have
never paid dividends on our common stock and currently do not anticipate paying
cash dividends on our common stock for the foreseeable future. Consequently, any
returns on an investment in our common stock in the foreseeable future will have
to come from an increase in the value of the stock itself. As noted above, the
lack of an active trading market for our common stock will make it difficult to
value and sell our common stock. While our dividend policy will be based on the
operating results and capital needs of our business, it is anticipated that all
earnings, if any, will be retained to finance our future
operations.
Because
we are subject to the “penny stock” rules, you may have difficulty in selling
our common stock.
Our
common stock is subject to regulations of the SEC relating to the market for
penny stocks. Penny stock, as defined by the Penny Stock Reform Act, is any
equity security not traded on a national securities exchange or quoted on any
market of the NASDAQ Stock Market that has a market price of less than $5.00 per
share. The penny stock regulations generally require that a disclosure schedule
explaining the penny stock market and the risks associated therewith be
delivered to purchasers of penny stocks and impose various sales practice
requirements on broker-dealers who sell penny stocks to persons other than
established customers and accredited investors. The broker-dealer must make a
suitability determination for each purchaser and receive the purchaser’s written
agreement prior to the sale. In addition, the broker-dealer must make certain
mandated disclosures, including the actual sale or purchase price and actual bid
offer quotations, as well as the compensation to be received by the
broker-dealer and certain associated persons. The regulations applicable to
penny stocks may severely affect the market liquidity for your common stock and
could limit your ability to sell your securities in the secondary
market.
Our
fourth amended and restated certificate of incorporation, as amended, limits
liability of our directors and officers, which could discourage you or other
stockholders from bringing suits against our directors or officers in
circumstances where you think they might otherwise be warranted.
Our
fourth amended and restated certificate of incorporation, as amended, provides,
with specific exceptions required by Delaware law, that our directors are not
personally liable to us or our stockholders for monetary damages for any action
or failure to take any action. In addition, we have agreed to, and our fourth
amended and restated certificate of incorporation, as amended, and our second
amended and restated bylaws provide for, mandatory indemnification of directors
and officers to the fullest extent permitted by Delaware law. These provisions
may discourage stockholders from bringing suit against a director or officer for
breach of duty and may reduce the likelihood of derivative litigation brought by
stockholders on our behalf against any of our directors or
officers.
If
and to the extent we are found liable in certain proceedings or our expenses
related to those or other legal proceedings become significant, then our
liquidity could be materially adversely affected and the value of our
stockholders’ interests in us could be impaired.
In April
2002, we entered into a letter agreement with Hermitage Capital Corporation
(“Hermitage”), as placement agent, the stated term of which was from April 30,
2002 through September 30, 2004. As of February 2003, we entered into a
settlement agreement with Hermitage pursuant to which, among other things: the
letter agreement was terminated; the parties gave mutual releases relating to
the letter agreement; and we agreed to issue Hermitage or its designees, upon
the closing of certain transactions contemplated by a separate settlement
agreement between us and Lancer Offshore, Inc., warrants exercisable until
February 2006 to purchase an aggregate of 60,000 shares of common stock for
$2.50 per share (or 17,046 shares of our common stock for $8.80 per share, if
adjusted for the reverse stock split pursuant to the antidilution provisions of
such warrant, as amended). Because Lancer Offshore, Inc. never satisfied the
closing conditions and, consequently, a closing has not been held, we have not
issued any warrants to Hermitage in connection with our settlement with them. In
June 2004, Hermitage threatened to sue us for warrants it claims are due to it
under its settlement agreement with us as well as a placement fee and additional
warrants it claims are, or will be, owed in connection with our initial public
offering completed on September 24, 2004, as compensation for allegedly
introducing us to one of the underwriters. We had some discussions with
Hermitage in the hopes of reaching an amicable resolution of any potential
claims, most recently in January 2005. We have not heard from Hermitage since
then.
37
If and to
the extent we are found to have significant liability to Hermitage in any
lawsuit Hermitage may bring against us, then our liquidity could be materially
adversely affected and/or our stockholders could experience dilution in their
investment in us and the value of our stockholders’ interests in us could be
impaired.
We
may use our financial resources in ways with which you do not agree and in ways
that may not yield a favorable return.
Our
management has broad discretion over the use of our financial resources,
including the net proceeds from all of our equity financings. Stockholders may
not deem such uses desirable. Our use of our financial resources may vary
substantially from our currently planned uses. We cannot assure you that we will
apply such proceeds effectively or that we will invest such proceeds in a manner
that will yield a favorable return or any return at all.
Several
provisions of the Delaware General Corporation Law, our fourth amended and
restated certificate of incorporation, as amended, and our second amended and
restated bylaws could discourage, delay or prevent a merger or acquisition,
which could adversely affect the market price of our common stock.
Several
provisions of the Delaware General Corporation Law, our fourth amended and
restated certificate of incorporation, as amended, and our second amended and
restated bylaws could discourage, delay or prevent a merger or acquisition that
stockholders may consider favorable, and the market price of our common stock
could be reduced as a result. These provisions include:
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authorizing
our board of directors to issue “blank check” preferred stock without
stockholder approval;
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providing
for a classified board of directors with staggered, three-year
terms;
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prohibiting
us from engaging in a “business combination” with an “interested
stockholder” for a period of three years after the date of the transaction
in which the person became an interested stockholder unless certain
provisions are met;
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prohibiting
cumulative voting in the election of
directors;
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limiting
the persons who may call special meetings of stockholders;
and
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establishing
advance notice requirements for nominations for election to our board of
directors or for proposing matters that can be acted on by stockholders at
stockholder meetings.
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As
a relatively new company with little or no name recognition and with several
risks and uncertainties that could impair our business operations, we are not
likely to generate widespread interest in our common stock. Without widespread
interest in our common stock, our common stock price may be highly volatile and
an investment in our common stock could decline in value.
Unlike
many companies with publicly traded securities, we have little or no name
recognition in the investment community. We are a relatively new company and
very few investors are familiar with either our company or our products. We do
not have an active trading market in our common stock, and one might never
develop, or if it does develop, might not continue.
Additionally,
the market price of our common stock may fluctuate significantly in response to
many factors, many of which are beyond our control. Risks and uncertainties,
including those described elsewhere in this “Certain Risks and Uncertainties”
section could impair our business operations or otherwise cause our operating
results or prospects to be below expectations of investors and market analysts,
which could adversely affect the market price of our common stock. As a result,
investors in our common stock may not be able to resell their shares at or above
their purchase price and could lose all of their investment.
Securities
class action litigation is often brought against public companies following
periods of volatility in the market price of such company’s securities. As a
result, we may become subject to this type of litigation in the future.
Litigation of this type could be extremely expensive and divert management’s
attention and resources from running our company.
If
we fail to maintain an effective system of internal controls over financial
reporting, we may not be able to accurately report our financial results, which
could have a material adverse effect on our business, financial condition and
the market value of our securities.
Effective
internal controls over financial reporting are necessary for us to provide
reliable financial reports. If we cannot provide reliable financial reports, our
reputation and operating results may be harmed.
As of
December 31, 2007, management reported a material weakness in our internal
control over financial reporting due to an insufficient number of resources in
the accounting and finance department that does not allow for a thorough review
process. Throughout fiscal year 2008, we implemented the following
measures which resulted in the remediation of this material weakness as of
December 31, 2008:
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Developed
procedures to implement a formal quarterly closing calendar and process
and held quarterly meetings to address the quarterly closing
process;
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Established
a detailed timeline for review and completion of financial reports to be
included in our Forms 10-Q and
10-K;
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Enhanced
the level of service provided by outside accounting service providers to
further support and provide additional resources for internal preparation
and review of financial reports and supplemented our internal staff in
accounting and related areas; and
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Employed
the use of appropriate supplemental SEC and U.S. GAAP checklists in
connection with our closing process and the preparation of our Forms 10-Q
and 10-K.
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In
addition, beginning with our financial statements for the year ending
December 31, 2010, we will be subject to the requirements of
Section 404(b) of the Sarbanes-Oxley Act of 2002 that require a report by
our independent registered public accounting firm addressing the effectiveness
of our internal control over financial reporting. If the
auditors were unable to express an opinion on the effectiveness of our internal
controls, we could lose investor confidence in the accuracy and completeness of
our financial reports. Any failure to achieve and maintain effective
internal controls could have an adverse effect on our business, financial
position and results of operations.
Our
directors, executive officers and principal stockholders control a significant
portion of our stock and, if they choose to vote together, could have sufficient
voting power to control the vote on substantially all corporate
matters.
As of
December 31, 2009, our directors, executive officers and principal stockholders
beneficially owned approximately 60.8% of our outstanding common stock. As of
December 31, 2009, Lambda Investors LLC beneficially owned 44.27% of our
outstanding common stock. As of December 31, 2000, Stagg Capital Group LLC
beneficially owned 9.03% of our outstanding common stock. As of December 31,
2000, AFS Holdings One LLC beneficially owned 7.6% of our outstanding common
stock.
Our
principal stockholders may have significant influence over our policies and
affairs, including the election of directors. Should they act as a group, they
will have the power to elect all of our directors and to control the vote on
substantially all other corporate matters without the approval of other
stockholders. Furthermore, such concentration of voting power could enable those
stockholders to delay or prevent another party from taking control of our
company even where such change of control transaction might be desirable to
other stockholders.
Future
sales of our common stock could cause the market price of our common stock to
decline.
The
market price of our common stock could decline due to sales of a large number of
shares in the market, including sales of shares by our large stockholders, or
the perception that such sales could occur. These sales could also make it more
difficult or impossible for us to sell equity securities in the future at a time
and price that we deem appropriate to raise funds through future offerings of
common stock.
Prior to
our initial public offering we entered into registration rights agreements with
many of our existing security holders that entitled them to have an aggregate of
10,020,248 shares registered for sale in the public market. Moreover, many of
those shares, as well as the 184,250 shares we sold to Asahi, could be sold in
the public market without registration once they have been held for one year,
subject to the limitations of Rule 144 under the Securities Act. In addition, we
entered into a registration rights agreement with the holders of our New Notes
pursuant to which we granted the holders certain registration rights with
respect to the shares of common stock issuable upon conversion of the New Notes
and upon exercise of the Class D Warrants.
39
Item
8. Financial Statements
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders of
Nephros,
Inc.
We have
audited the accompanying consolidated balance sheets of Nephros, Inc. and
Subsidiary (collectively, “the Company”) as of December 31, 2009 and 2008, and
the related consolidated statements of operations, stockholders’ equity and cash
flows for each of the years then ended. These consolidated financial statements
are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Nephros, Inc. and Subsidiary
as of December 31, 2009 and 2008, and the results of their operations and their
cash flows for each of the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has incurred negative cash flow
from operations and net losses since inception. These conditions, among others,
raise substantial doubt about its ability to continue as a going concern.
Management’s plans in regard to these matters are also described in Note 2. The
accompanying consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/
ROTHSTEIN, KASS & COMPANY, P.C.
Roseland,
New Jersey
March 31,
2010
40
NEPHROS,
INC. AND SUBSIDIARY
CONSOLIDATED
BALANCE SHEETS
(In
Thousands, Except Share Amounts)
December 31, 2009
|
December 31, 2008
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 1,004 | $ | 2,306 | ||||
Short-term
investments
|
- | 7 | ||||||
Accounts
receivable, less allowances of $0 and $4, respectively
|
629 | 404 | ||||||
Inventory,
less allowances of $18 and $0, respectively
|
653 | 724 | ||||||
Prepaid
expenses and other current assets
|
135 | 162 | ||||||
Total
current assets
|
2,421 | 3,603 | ||||||
Property
and equipment, net
|
210 | 412 | ||||||
Other
assets
|
21 | 21 | ||||||
Total
assets
|
$ | 2,652 | $ | 4,036 | ||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Accounts
payable
|
$ | 455 | $ | 986 | ||||
Accrued
expenses
|
239 | 411 | ||||||
Accrued
severance expense
|
- | 105 | ||||||
Total
current liabilities
|
694 | 1,502 | ||||||
Total
liabilities
|
694 | 1,502 | ||||||
Commitments
and Contingencies (Note 11)
|
||||||||
Stockholders’
equity:
|
||||||||
Preferred
stock, $.001 par value; 5,000,000 shares authorized at December 31, 2009
and 2008; no shares issued and outstanding at December 31, 2009 and
2008
|
- | - | ||||||
Common
stock, $.001 par value; 90,000,000 and 60,000,000 authorized at December
31, 2009 and 2008, respectively; 41,604,798 and 38,165,380 shares issued
and outstanding at December 31, 2009 and 2008,
respectively.
|
42 | 38 | ||||||
Additional
paid-in capital
|
91,815 | 90,375 | ||||||
Accumulated
other comprehensive income
|
76 | 70 | ||||||
Accumulated
deficit
|
(89,975 | ) | (87,949 | ) | ||||
Total
stockholders’ equity
|
1,958 | 2,534 | ||||||
Total
liabilities and stockholders’ equity
|
$ | 2,652 | $ | 4,036 |
The
accompanying notes are an integral part of these consolidated financial
statements.
41
NEPHROS,
INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In
Thousands, Except Share and Per Share Amounts)
Years
Ended December 31
|
||||||||
|
2009
|
2008
|
||||||
Product
revenue
|
$
|
2,661
|
$
|
1,473
|
||||
Cost
of goods sold
|
1,744
|
1,064
|
||||||
Gross
margin
|
917
|
409
|
||||||
Operating
expenses:
|
|
|||||||
Research
and development
|
280
|
1,977
|
||||||
Depreciation
and amortization
|
231
|
447
|
||||||
Selling,
general and administrative
|
2,812
|
4,702
|
||||||
Total
operating expenses
|
3,323
|
7,126
|
||||||
Loss
from operations
|
(2,406)
|
(6,717)
|
||||||
Interest
income
|
9
|
199
|
||||||
Interest
expense
|
(2)
|
-
|
||||||
Impairment
of auction rate securities
|
-
|
(114)
|
||||||
Gain
on sale of investments
|
-
|
114
|
||||||
Other
income
|
373
|
181
|
||||||
Net
loss
|
$
|
(2,026)
|
$
|
(6,337)
|
||||
Net
loss per common share, basic and diluted
|
$
|
(0.05)
|
$
|
(0.17)
|
||||
Weighted
average common shares outstanding, basic and diluted
|
39,629,346
|
38,165,380
|
The
accompanying notes are an integral part of these consolidated financial
statements.
42
NEPHROS,
INC. AND SUBSIDIARY
CONSOLIDATED
STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(In
Thousands, Except Share Amounts)
Additional
|
Accumulated
|
|||||||||||||||||||||||
Common Stock
|
Paid-in
|
Other
|
Accumulated
|
|||||||||||||||||||||
Shares
|
Amount
|
Capital
|
Income (Loss)
|
Deficit
|
Total
|
|||||||||||||||||||
Balance,
January 1, 2008
|
38,165,380 | $ | 38 | $ | 90,220 | $ | 110 | $ | (81,612 | ) | $ | 8,756 | ||||||||||||
Comprehensive
income:
|
||||||||||||||||||||||||
Net
loss
|
(6,337 | ) | (6,337 | ) | ||||||||||||||||||||
Net
unrealized losses on foreign currency translation
|
(40 | ) | (40 | ) | ||||||||||||||||||||
Comprehensive
loss
|
(6,377 | ) | ||||||||||||||||||||||
Noncash
stock-based compensation
|
155 | 155 | ||||||||||||||||||||||
Balance,
December 31, 2008
|
38,165,380 | $ | 38 | $ | 90,375 | $ | 70 | $ | (87,949 | ) | $ | 2,534 | ||||||||||||
Comprehensive
income:
|
||||||||||||||||||||||||
Net
loss
|
(2,026 | ) | (2,026 | ) | ||||||||||||||||||||
Net
unrealized gains on foreign currency translation
|
6 | 6 | ||||||||||||||||||||||
Comprehensive
loss
|
(2,020 | ) | ||||||||||||||||||||||
Cashless
exercise of warrants
|
1,829,476 | 2 | (2 | ) | - | |||||||||||||||||||
Private
placement sale of common stock
|
1,345,161 | 1 | 1,250 | 1,251 | ||||||||||||||||||||
Exercise
of stock options
|
264,781 | 1 | 84 | 85 | ||||||||||||||||||||
Noncash
stock-based compensation
|
108 | 108 | ||||||||||||||||||||||
Balance,
December 31, 2009
|
41,604,798 | $ | 42 | $ | 91,815 | $ | 76 | $ | (89,975 | ) | $ | 1,958 |
The
accompanying notes are an integral part of these consolidated financial
statements.
43
NEPHROS,
INC. AND SUBSIDIARY
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
Thousands)
Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Operating
activities:
|
||||||||
Net
loss
|
$ | (2,026 | ) | $ | (6,337 | ) | ||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
Depreciation
of property and equipment
|
231 | 447 | ||||||
Impairment
of auction rate securities
|
— | 114 | ||||||
Noncash
stock-based compensation
|
108 | 155 | ||||||
Gain
on sale of investments
|
— | (114 | ) | |||||
Inventory
reserve
|
18 | |||||||
(Increase)
decrease in operating assets:
|
||||||||
Accounts
receivable
|
(220 | ) | 1 | |||||
Inventory
|
57 | (409 | ) | |||||
Prepaid
expenses and other current assets
|
27 | 227 | ||||||
Other
assets
|
— | 8 | ||||||
Increase
(decrease) in operating liabilities:
|
||||||||
Accounts
payable and accrued expenses
|
(702 | ) | 138 | |||||
Accrued
severance expense
|
(105 | ) | 45 | |||||
Net
cash used in operating activities
|
(2,612 | ) | (5,725 | ) | ||||
Investing
activities
|
||||||||
Purchase
of property and equipment
|
(28 | ) | (97 | ) | ||||
Proceeds
from sales of property and equipment
|
— | 3 | ||||||
Maturities
of short-term investments
|
7 | 4,693 | ||||||
Net
cash provided by (used in) investing activities
|
(21 | ) | 4,599 | |||||
Financing
activities
|
||||||||
Proceeds
from stock options exercised
|
85 | — | ||||||
Proceeds
from issuance of common stock
|
1,251 | — | ||||||
Net
cash provided by financing activities
|
1,336 | — | ||||||
Effect
of exchange rates on cash
|
(5 | ) | (17 | ) | ||||
Net
decrease in cash
|
(1,302 | ) | (1,143 | ) | ||||
Cash,
beginning of year
|
2,306 | 3,449 | ||||||
Cash,
end of year
|
$ | 1,004 | $ | 2,306 | ||||
Supplemental
disclosure of cash flow information
|
||||||||
Cash
paid for interest
|
$ | 2 | $ | — | ||||
Cash
paid for taxes
|
$ | 6 | $ | 1 |
The
accompanying notes are an integral part of these consolidated financial
statements.
44
NEPHROS,
INC.
NOTES
TO CONSOLIDATED 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 three products in various stages of development in the hemodiafiltration, or
HDF, modality to deliver improved therapy for ESRD patients. These are the
OLpur TM
MDHDF filter series or “dialyzers,” designed expressly for HDF
therapy, the OLpur TM
H2H TM, an add-on module
designed to allow the most common types of hemodialysis machines to be used for
HDF therapy, and the OLpur TM NS2000 system, a
stand-alone hemodiafiltration machine and associated filter technology. In 2006,
the Company introduced its Dual Stage Ultrafilter (“DSU”) water filter system,
which represents a new and complementary product line to the Company’s existing
ESRD therapy business. The DSU incorporates the Company’s unique and proprietary
dual stage filter architecture.
On June
4, 2003, Nephros International Limited was incorporated under the laws of
Ireland as a wholly-owned subsidiary of the Company. In August 2003, the Company
established a European Customer Service and financial operations center in
Dublin, Ireland.
Note
2 — Summary of Significant Accounting Policies
Principles
of Consolidation and Basis of Presentation
The
accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiary, Nephros International Limited. All
intercompany accounts and transactions have been eliminated in
consolidation.
These
financial statements were approved by management and the Board of Directors and
are available for issuance as of the date of the audit
opinion. Subsequent events have been evaluated through this
date.
Use
of Estimates in the Preparation of Financial Statements
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 amounts of revenues and expenses,
during the reporting period. Actual results could differ from those
estimates.
Going
Concern and Management’s Response
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. The Company’s recurring losses and difficulty
in generating sufficient cash flow to meet its obligations and sustain its
operations raise substantial doubt about its ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty. Based on the Company’s
current cash flow projections, it will need to raise additional funds through
either the licensing or sale of its technologies or additional public or private
offerings of its securities. The Company continues to investigate strategic
funding opportunities as they are identified. However, there is no guarantee
that the Company will be able to obtain further financing. If it is unable to
raise additional funds on a timely basis or at all, the Company would not be
able to continue its operations.
The
Company has incurred significant losses in its operations in each quarter since
inception. For the years ended December 31, 2009 and 2008, the Company has
incurred net losses of approximately $2,026,000 and $6,337,000, respectively. In
addition, the Company has not generated positive cash flow from operations for
the years ended December 31, 2009 and 2008. To become profitable, the Company
must increase revenue substantially and achieve and maintain positive gross and
operating margins. If the Company is not able to increase revenue and gross and
operating margins sufficiently to achieve profitability, the Company’s results
of operations and financial condition will be materially and adversely
affected.
The
Company’s current operating plans primarily include the continued development
and support of the Company’s business in the European market, organizational
changes necessary to begin the commercialization of the Company’s water
filtration business and the completion of current year milestones which are
included in the Office of Naval Research appropriation.
45
NEPHROS,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
2 — Summary of Significant Accounting
Policies – (continued)
There can
be no assurance that the Company’s future cash flow will be sufficient to meet
its obligations and commitments. If the Company
is unable to generate sufficient cash flow from operations in the future to
service its commitments the Company will be required
to adopt alternatives, such as seeking to raise debt or equity capital,
curtailing its planned activities or ceasing its operations. There can
be no assurance that any such actions could be effected on a timely basis or on
satisfactory terms or at all, or that these actions would enable the Company to
continue to satisfy its capital requirements.
The
Company continues to investigate additional funding
opportunities. However, there can be no assurance that the Company
will be able to obtain further financing, do so on reasonable terms or do so on
terms that would not substantially dilute the equity interests in the Company.
If the Company is unable to raise additional funds on a timely basis, or at all,
the Company will not be able to continue its operations.
Cash
and Cash Equivalents
The
Company invests its excess cash in bank deposits and money market
accounts. The Company considers all highly liquid investments
purchased with original maturities of three months or less from the date of
purchase to be cash equivalents. Cash equivalents are carried at fair
value, which approximate cost, and primarily consist of money market funds
maintained at major U.S. financial institutions.
Short-Term
Investments
The
Company had no short-term investments at December 31, 2009. The
Company had $7,000 of short-term investments consisting of a certificate of
deposit at December 31, 2008.
See Note
3 for a further discussion of short-term investments as of December 31, 2009 and
December 31, 2008.
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. The
allowance for doubtful accounts at December 31, 2009 and 2008 was $0 and $4,000,
respectively. There was no allowance for sales returns at December 31, 2009 or
2008. There were no write offs of accounts receivable to bad debt
expense during 2009 or 2008.
Inventory
The
Company engages third parties to manufacture and package inventory held for
sale, takes title to certain inventory once manufactured, and warehouses such
goods until packaged for final distribution and sale. Inventory consists of
finished goods and raw materials (fiber) held at the manufacturers’ facilities,
and are valued at the lower of cost or market using the first-in, first-out
method.
Patents
The
Company has filed numerous patent applications with the United States Patent and
Trademark Office and in foreign countries. All costs and direct expenses
incurred in connection with patent applications have been expensed as
incurred.
Property
and Equipment, net
Property
and equipment, net is stated at cost less accumulated
depreciation. These assets are depreciated over their estimated
useful lives of three to seven years using the straight line
method.
Impairment
for Long-Lived Assets
The
Company adheres to ASC Topic 360 and periodically evaluates whether current
facts or circumstances indicate that the carrying value of its depreciable
assets to be held and used may be recoverable. If such circumstances are
determined to exist, an estimate of undiscounted future cash flows produced by
the long-lived assets, or the appropriate grouping of assets, is compared to the
carrying value to determine whether impairment exists. If an asset is determined
to be impaired, the loss is measured based on the difference between the asset’s
fair value and its carrying value. An estimate of the asset’s fair value is
based on quoted market prices in active
markets, if available. If quoted market prices are not available, the estimate
of fair value is based on various valuation techniques,
including a discounted value of estimated future cash flows. The Company reports
an asset to be disposed of at the lower of its carrying value or its estimated
net realizable market value. There were no impairment losses for long-lived
assets recorded for the years ended December 31, 2009 and December 31,
2008.
46
NEPHROS,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
2 — Summary of Significant Accounting Policies
– (continued)
Fair
Value of Financial Instruments
The
carrying amounts of cash and cash equivalents, short-term investments, accounts
receivable, accounts payable and accrued expenses approximate fair value due to
the short-term maturity of these instruments.
Revenue
Recognition
Revenue
is recognized in accordance with ASC Topic 605. Four basic criteria
must be met before revenue can be recognized: (i) persuasive evidence of an
arrangement exists; (ii) delivery has occurred or services have been rendered;
(iii) the fee is fixed or determinable; and (iv) collectability is reasonably
assured.
The
Company recognizes revenue related to product sales when delivery is confirmed
by its external logistics provider and the other criteria of ASC Topic 605 are
met. Product revenue is recorded net of returns and allowances. All
costs and duties relating to delivery are absorbed by Nephros. All shipments are
currently received directly by the Company’s customers.
Shipping and Handling
Costs
Shipping
and handling costs are recorded as cost of goods sold and are approximately
$19,000 and $31,000 for the years ended December 31, 2009 and 2008,
respectively.
Research
and Development Costs
Research
and development costs are expensed as incurred.
Stock-Based
Compensation
The
Company accounts for stock-based compensation in accordance with ASC Topic 718
by recognizing the fair value of stock-based compensation in the statement of
operations. The fair value of the Company’s stock option awards are
estimated using a Black-Scholes option valuation model. This model requires the
input of highly subjective assumptions and elections including expected stock
price volatility and the estimated life of each award. In addition, the
calculation of compensation costs requires that the Company estimate the number
of awards that will be forfeited during the vesting period. 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.
Other
Income
Other
income in the amount of approximately $373,000 and $181,000 for the years ended
December 31, 2009 and December 31, 2008, respectively, resulted primarily from
receipt of New York State Qualified Emerging Technology Company (“QETC”) tax
refunds in each of these periods. Tax credits for the years 2006 and
2007 were received and recognized during the year ended December 31,
2009. The tax credit for the year 2005 was received and recognized
during the year ended December 31, 2008 and no further tax credits are
expected.
Income
Taxes
The
Company accounts for income taxes in accordance with ASC Topic 740, which
requires accounting for deferred income taxes under the asset and liability
method. Deferred income taxes are recognized for the tax consequences of
temporary differences by applying enacted statutory tax rates applicable in
future years to differences between the financial statement carrying amounts and
the tax basis of existing assets and liabilities.
For
financial reporting purposes, the Company has incurred a loss in each period
since its inception. Based on available objective evidence, including the
Company’s history of losses, management believes it is more likely than not that
the net deferred tax assets will not be fully realizable. Accordingly, the
Company provided for a full valuation allowance against its net deferred tax
assets at December 31, 2009 and December 31, 2008.
47
NEPHROS,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
2 — Summary of Significant Accounting
Policies – (continued)
ASC Topic
740 prescribes, among other things, a recognition threshold and measurement
attributes for the financial statement recognition and measurement of uncertain
tax positions taken or expected to be taken in a company’s income tax
return. ASC 740 utilizes a two-step approach for evaluating uncertain
tax positions. Step one or recognition, requires a company to
determine if the weight of available evidence indicates a tax position is more
likely than not to be sustained upon audit, including resolution of related
appeals or litigation processes, if any. Step two or measurement, is based on
the largest amount of benefit, which is more likely than not to be realized on
settlement with the taxing authority. The Company is subject to
income tax examinations by major taxing authorities for all tax years prior to
2006. The adoption of the provisions of ASC 740 did not have a
material impact on the Company’s consolidated financial
statements. During the year ended December 31, 2009 and 2008, the
Company recognized no adjustments for uncertain tax
positions. However, management’s conclusions regarding this policy
may be subject to review and adjustment at a later date based on factors
including, but not limited to, on-going analyses of and changes to tax laws,
regulation and interpretations, thereof.
Loss
per Common Share
In
accordance with ACS 260-10, net loss per common share amounts (“basic EPS”) are
computed by dividing net loss attributable to common stockholders by the
weighted-average number of common shares outstanding and excluding any potential
dilution. Net loss per common share amounts assuming dilution (“diluted EPS”) is
generally computed by reflecting potential dilution from conversion of
convertible securities and the exercise of stock options and warrants. The
following securities have been excluded from the dilutive per share computation
as they are antidilutive.
2009
|
2008
|
|||||||
Stock
options
|
1,885,782
|
2,696,225
|
||||||
Warrants
|
8,191,827
|
11,090,248
|
Foreign
Currency Translation
Foreign
currency translation is recognized in accordance with ASC Topic
830. The functional currency of Nephros International Limited is the
Euro and its translation gains and losses are included in accumulated other
comprehensive income. The balance sheet is translated at the year-end rate. The
statement of operations is translated at the weighted average rate for the
year.
Comprehensive
Income (Loss)
Comprehensive
income (loss), as defined in ASC 220, is the total of net income (loss)
and all other non-owner changes in equity (or other comprehensive income (loss))
such as unrealized gains or losses on securities classified as
available-for-sale and foreign currency translation adjustments. For the years
ended December 31, 2009 and 2008, the comprehensive loss was approximately
$2,020,000 and $6,377,000, respectively.
Recent
Issued and Adopted Accounting Standards
Fair
Value Measurements – In September 2006, the FASB issued guidance regarding fair
value measurements. This guidance defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurements. It applies to other accounting pronouncements where the
FASB requires or permits fair value measurements but does not require any new
fair value measurements. In February 2008, FASB issued a
pronouncement, which delayed the effective date of its prior guidance regarding
fair value measurements, specifically for certain non-financial assets and
non-financial liabilities to fiscal years beginning after November 15, 2008, and
interim periods within those fiscal years. The Company adopted the
guidance for financial assets and liabilities on January 1, 2008. It
did not have any impact on the Company’s results of operations or financial
position and did not result in any additional disclosures and the Company
adopted the guidance for non-financial assets and non-financial liabilities on
January 1, 2009, resulting in no impact to the Company’s consolidated financial
position, results of operations or cash flows.
48
NEPHROS,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
2 — Summary of Significant Accounting
Policies – (continued)
In April
2009, the FASB issued new accounting guidance on determining fair value when the
volume and level of activity for the asset or liability have significantly
decreased and identifying transactions that are not orderly. The
guidance affirms that the objective of fair value when the market for an asset
is not active is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date under current market conditions. It provides
guidance for estimating fair value when the volume and level of market activity
for an asset or liability have significantly decreased and determining whether a
transaction was orderly. It applies to all fair value measurements
when appropriate. The adoption of this guidance did not have a
significant impact on the Company’s consolidated financial position, results of
operations or cash flows, or related footnotes.
In April
2009, the FASB issued new accounting guidance on interim disclosures about fair
value of financial instruments, which is effective for the Company for the
quarterly period beginning April 1, 2009. The guidance requires an
entity to provide the annual disclosures required by a prior pronouncement
regarding disclosures about fair value of financial instruments, in its interim
financial statements. The application of the guidance did not have a significant
impact on the Company’s consolidated financial position, results of operations
or cash flows, or related footnotes.
In August
2009, the FASB issued an update to provide further guidance on how to measure
the fair value of a liability, an area where practitioners have been seeking
further guidance. It primarily does three things: 1) sets
forth the types of valuation techniques to be used to value a liability when a
quoted price in an active market for the identical liability is not available,
2) clarifies that when estimating the fair value of a liability, a reporting
entity is not required to include a separate input or adjustment to other inputs
relating to the existence of a restriction that prevents the transfer of the
liability and 3) clarifies that both a quoted price in an active market for the
identical liability at the measurement date and the quoted price for the
identical liability when traded as an asset in an active market when no
adjustments to the quoted price of the asset are required are Level 1 fair value
measurements. This standard is effective beginning in the fourth
quarter of 2009 for the Company. The adoption of this standard update
is not expected to impact the Company’s consolidated financial position, results
of operations or cash flows.
Business
Combinations – In December 2007, the FASB issued new accounting guidance on
business combinations. The pronouncement establishes principles and
requirements for how the acquirer in a business combination recognizes and
measures in its financial statements the fair value of identifiable assets
acquired, the liabilities assumed and any noncontrolling interest in the
acquiree at the acquisition date. The pronouncement determines what information
to disclose to enable users of the financial statements to evaluate the nature
and financial effects of the business combination. It is effective
for fiscal years beginning after December 15, 2008. The Company
adopted the pronouncement on January 1, 2009 resulting in no impact to the
Company’s consolidated financial position, results of operations or cash
flows.
Subsequent
Events – On May 28, 2009, the FASB issued guidance regarding subsequent events,
which the Company adopted on a prospective basis beginning April 1,
2009. The guidance is intended to establish general standards of
accounting and disclosure of events that occur after the balance sheet date but
before financial statements are issued or are available to be
issued. It requires the disclosure of the date through which an
entity has evaluated subsequent events and the basis for selecting that
date. The application of the pronouncement did not have an impact on
the Company’s consolidated financial position, results of operations or cash
flows.
FASB
Accounting Standards Codification – On June 29, 2009, the FASB issued an
accounting pronouncement establishing the FASB Accounting Standards Codification
as the source of authoritative accounting principles recognized by the FASB to
be applied by nongovernmental entities. This pronouncement was
effective for financial statements issued for interim and annual periods ending
after September 15, 2009, for most entities. On the effective date,
all non-SEC accounting and reporting standards will be
superseded. The Company adopted this new accounting pronouncement for
the quarterly period ended September 30, 2009, as required, and adoption did not
have a material impact on the Company’s consolidated financial position, results
of operations or cash flows.
Recognition
and Presentation of Other-Than-Temporary Impairments – In April 2009, the
FASB issued an accounting pronouncement, which is effective for the Company for
interim and annual reporting periods ending after June 15, 2009, that amends
existing guidance for determining whether an other than temporary impairment of
debt securities has occurred. Among other changes, the FASB replaced
the existing requirement that an entity’s management assert it has both the
intent and ability to hold an impaired security until recovery with a
requirement that management assert (a) it does not have the intent to sell
the security, and (b) it is more likely than not it will not have to sell
the security before recovery of its cost basis. The adoption of this accounting
pronouncement did not have an impact on the Company’s consolidated financial
position, results of operations or cash flows.
49
NEPHROS,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
2 — Summary of Significant Accounting
Policies – (continued)
New
Accounting Pronouncements
In
December 2009, the FASB issued ASU No. 2009-17, Consolidations (Topic
810)-Improvements to Financial Reporting By Enterprises Involved with Variable
Interest Entities (ASU No. 2009-17). ASU 2009-17 requires a
qualitative approach for determining the primary beneficiary of a variable
interest entity and replaces the quantitative evaluation previously set forth
under FASB Interpretation No. 46 (revised December 2003), Consolidation of
Variable Interest Entities. This approach is focused on identifying the
reporting entity that has the ability to direct the activities of a variable
interest entity that most significantly affects the entity's economic
performance and has the obligation to absorb the entity's losses or has the
right to receive benefits from the entity. ASU No. 2009-17, among other things,
will require enhanced disclosures about a reporting entity's involvement in
variable interest entities. The guidance under ASU No. 2009-17 will be effective
for the first annual period beginning after November 15, 2009, and interim
periods within that first annual period. The Company is assessing what impact,
if any, adoption of this standard will have on its consolidated financial
statements.
Note 3 — Short-Term
Investments
ASC Topic
820 provides a framework for measuring fair value under generally accepted
accounting principles in the United States and requires expanded disclosures
regarding fair value measurements. ASC 820 defines fair value as the
exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measurement date. ASC 820 also establishes a fair value hierarchy
that requires an entity to maximize the use of observable inputs, where
available, and minimize the use of unobservable inputs when measuring fair
value. The standard describes three levels of inputs that may be used to measure
fair value:
Level 1 —
Quoted prices in active markets for identical assets or
liabilities.
Level 2 —
Observable inputs, other than Level 1 prices, such as quoted prices in active
markets for similar assets and liabilities, quoted prices for identical or
similar assets and liabilities in markets that are not active, or other inputs
that are observable or can be corroborated by observable market
data.
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, including
certain pricing models, discounted cash flow methodologies and similar
techniques.
The
Company had no financial assets at December 31, 2009.
The
following table details the fair value measurements within the fair value
hierarchy of the Company’s financial assets at December 31,
2008:
Total Fair Value at
|
Fair Value Measurements at Reporting
Date Using
|
|||||||||||||||
December 31, 2008
|
Level 1
|
Level 2
|
Level 3
|
|||||||||||||
Certificates
of deposit
|
$
|
7,000
|
$
|
7,000
|
$
|
—
|
$
|
—
|
||||||||
Total
|
$
|
7,000
|
$
|
7,000
|
$
|
—
|
$
|
—
|
50
NEPHROS,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
3 — Short-Term Investments (continued)
The
following table reflects the activity for the Company’s ARS measured at fair
value using Level 3 inputs for the year ended December 31,
2008:
Auction Rate
Securities
|
||||
Balance
as of December 31, 2007
|
$
|
4,700,000
|
||
Sale
of Securities
|
(4,700,000
|
)
|
||
Gain
on sale of investments
|
114,000
|
|||
Impairment
of auction rate securities
|
(114,000
|
)
|
||
Balance
as of December 31, 2008
|
$
|
—
|
As of
December 31, 2008, the Company had grouped certificates of deposit using a
Level 1 valuation because market prices are readily available in active
markets.
The
Company invested in auction rate securities (“ARS”), which are long-term debt
instruments with interest rates reset through periodic short-term
auctions. If there are insufficient buyers when such a periodic
auction is held, then the auction “fails” and the holders of the ARS are unable
to liquidate their investment through such auction. With the
liquidity issues experienced in global credit and capital markets, the ARS held
by the Company experienced multiple failed auctions in the first quarter of
fiscal year 2008. As
a result of the failed auctions, the Company did not consider the affected ARS
liquid and accordingly, the Company classified its ARS as noncurrent assets as
of March 31, 2008.
Based
upon an analysis of other-than-temporary impairment factors, the Company wrote
down ARS with an original par value of $4,400,000 to an estimated fair value of
$4,286,000 as of March 31, 2008. The Company reviewed impairments
associated with the above in accordance with ASC Topic 320 to determine the
classification of the impairment as “temporary” or
“other-than-temporary.” The Company determined the ARS classification
to be “other-than-temporary”, and charged an impairment loss of $114,000 on the
ARS to its results of operations during the three months ended March 31,
2008. Subsequently during the three months ended June 30, 2008,
$300,000 of principal on the Company’s ARS had been paid back from the
debtor. As a result of the payment, the Company’s investment
decreased from a par value of $4,400,000 to approximately
$4,100,000. The net book value of the Company’s ARS at June 30, 2008
was $3,986,000. On July 22, 2008, the Company sold its ARS to a third
party at 100% of par value, for proceeds of $4,100,000 and as a result, the
Company reclassified the ARS from Available-for-Sale to Trading
Securities.
In
accordance with ASC 320 the ARS, classified as Trading Securities, were valued
at their fair value of $4,100,000 at June 30, 2008. The adjustment of
the ARS’ carrying value from $3,986,000 net book value to $4,100,000 fair value
resulted in an Unrealized Holding Gain of $114,000 which was recorded in the
Company’s Consolidated Statement of Operations for the three and six months
ended June 30, 2008. As a result of the sale of investment on July
22, 2008, the Company reclassified the unrealized holding gain of $114,000 to a
realized gain on sale of investments.
The
Company had no investment in Auction Rate Securities during 2009.
Note
4 — Inventory
The
Company’s inventory components as of December 31, 2009 and 2008 were as
follows:
December 31,
|
||||||||
2009
|
2008
|
|||||||
Raw
Materials
|
$
|
257,000
|
$
|
382,000
|
||||
Finished
Goods
|
414,000
|
342,000
|
||||||
Total
Gross Inventory
|
671,000
|
724,000
|
||||||
Less:
Inventory reserve
|
(18,000
|
)
|
—
|
|||||
Total
Inventory
|
$
|
653,000
|
$
|
724,000
|
51
NEPHROS,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
5 — Prepaid Expenses and Other Current Assets
Prepaid
expenses and other current assets as of December 31, 2009 and 2008 were as
follows: