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. The Company was founded by health professionals, scientists and engineers affiliated with Columbia University to develop
advanced end stage renal disease (“ESRD”) therapy technology and products.
Beginning
in 2009, Nephros introduced high performance liquid purification filters to meet the demand for water purification in certain
medical markets. The Company’s filters, generally classified as ultrafilters, are primarily used in hospitals for the prevention
of infection from waterborne pathogens, such as legionella and pseudomonas, and in dialysis centers for the removal of biological
contaminants from water and bicarbonate concentrate. The Company also develops and sells water filtration products for commercial
applications, focusing on the hospitality and food service markets. The Company’s pathogen detection system is a portable,
real-time system designed to provide actionable data for infection control teams on up to 15 different pathogens from a single
water sample, in approximately one hour. The water filtration business is a reportable segment, referred to as the Water Filtration
segment.
In
July 2018, the Company formed a new subsidiary, Specialty Renal Products, Inc. (“SRP”), to drive the development of
its second-generation hemodiafiltration (“HDF”) system and other products focused on improving therapies for patients
with renal disease. The Company transferred three patents to SRP, which were carried at zero book value. SRP is a reportable segment,
referred to as the Renal Products segment.
On
December 31, 2018, the Company entered into a Membership Interest Purchase Agreement (the “Aether Agreement”) with
Biocon 1, LLC and Aether Water Systems, LLC (collectively, “Aether”), and Gregory Lucas, the sole member of Aether.
Pursuant to the terms of the Aether Agreement, the Company acquired 100% of the outstanding membership interests of Aether (the
“Aether Acquisition”, which has also been previously referred to as the “Biocon Acquisition”).
The
Company’s primary U.S. facilities are located at 380 Lackawanna Place, South Orange, New Jersey, 07079, and at 3221 Polaris
Avenue, Las Vegas, Nevada 89102. These locations house the Company’s corporate headquarters, research, manufacturing, and
distribution facilities. In addition, the Company maintains small administrative offices in various locations in the United States
and Ireland.
Note
2 - Summary of Significant Accounting Policies
Reverse
Stock Split
On
May 22, 2019, the Company’s Board of Directors authorized a 1-for-9 reverse stock split and approved an amendment to the
Company’s Certificate of Incorporation to affect the 1-for-9 reverse split of the Company’s common stock, which was
effected at 5:30 p.m. ET on July 9, 2019. Fractional shares were not issued and stockholders who otherwise would have been entitled
to receive a fractional share as a result of the reverse stock split received an amount in cash equal to $5.58 per share for such
fractional interests. All of the share and per share amounts discussed in the accompanying consolidated financial statements have
been adjusted to reflect the effect of this reverse split.
Principles
of Consolidation and Basis of Presentation
The
accompanying consolidated financial statements include the accounts of Nephros, Inc. and its subsidiaries, including SRP, in which
a controlling interest is maintained by the Company. Outside shareholders’ interest in SRP of 37.5% is shown on the consolidated
balance sheet as noncontrolling interest. All intercompany accounts and transactions were eliminated in the preparation of the
accompanying consolidated financial statements.
Use
of Estimates
The
preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States
of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported
amount of revenues and expenses, during the reporting period. Actual results could differ materially from those estimates. Included
in these estimates are assumptions about the collection of accounts receivable, value of inventories, useful life of fixed assets
and intangible assets, the assessment of expected cash flows used in evaluating goodwill and other long-lived assets, value of
contingent consideration, the assessment of the ability to continue as a going concern and assumptions used in determining stock
compensation such as expected volatility and risk-free interest rate.
Reclassifications
Certain reclassifications were made to the
prior year’s amounts to conform to the 2019 presentation. The receivable related to the income tax benefit of approximately
$93,000 recognized in the year ended December 31, 2018 previously presented in accounts receivable, net, at December 31, 2018
is now presented in prepaid expenses and other current assets.
Liquidity
The
Company has sustained operating losses and expects such losses to continue over the next several quarters. In addition, net cash
from operations has been negative since inception, generating an accumulated deficit of approximately $127,332,000 as of December
31, 2019. On February 4, 2020, the Company completed a confidentially marketed underwritten public offering whereby the Company
sold 937,500 shares of its common stock for aggregate net proceeds of approximately $6,765,000. The Company also has a loan agreement
with a lender, which provides a secured asset-based revolving credit facility. This loan agreement was amended on December 20,
2019 to increase the borrowing capacity from $1,000,000 to $2,500,000.
In
July 2018, the Company formed a new subsidiary, SRP, to drive the development of its second-generation HDF system and other products
focused on improving therapies for patients with renal disease. On September 5, 2018, SRP completed a private placement transaction
whereby SRP sold preferred shares equivalent to 37.5% of its outstanding equity interests for aggregate proceeds of $3,000,000.
As of the date of issuance of the accompanying consolidated financial statements, SRP has approximately $539,000 in cash.
The proceeds of this private placement are restricted to SRP expenses and may not be used for the benefit of the Company or other
affiliated entities, except to reimburse for expenses directly attributable to SRP.
Based
on cash that is available for Company operations and projections of future Company operations, the Company believes that its cash
will be sufficient to fund the Company’s current operating plan through at least the next 12 months from the date of issuance
of the accompanying consolidated financial statements. Additionally, management’s operating plans are designed to help
control operating costs, to increase revenue and to raise additional capital until such time as the Company generates sufficient
cash flows from operations. If there were a decrease in the demand for the Company’s products due to either economic or
competitive conditions, or management were unable to achieve its plan, there could be a significant reduction in liquidity due
to the possible inability of the Company to cut costs sufficiently.
Recently
Adopted Accounting Pronouncements
In
February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
2016-02, “Leases,” (“ASC 842”) which discusses how an entity should account for lease assets and lease
liabilities. The guidance specifies that an entity who is a lessee under lease agreements should recognize lease assets and lease
liabilities for those leases classified as operating leases under previous FASB guidance. The Company adopted the guidance on
January 1, 2019 using the transition method provided by ASU 2018-11, “Leases (Topic 842): Targeted Improvements.”
Under this transition method, the Company applied the new requirements to only those leases that existed as of January 1, 2019,
rather than at the earliest comparative period presented in the financial statements. Prior periods will be presented under existing
lease guidance. Upon transition, the Company applied the package of practical expedients permitted under the ASC 842 transition
guidance. As a result, the Company did not reassess (1) whether expired or existing contracts contain leases under the new definition
of a lease, including whether an existing or expired contract contains an embedded lease, (2) lease classification for expired
or existing leases and (3) any initial direct costs of existing leases. As a result of the adoption of this guidance on January
1, 2019, the Company recorded right-of-use assets of approximately $613,000, net of approximately $8,000 of deferred rent liability,
and lease liabilities of approximately $621,000. Adoption of the guidance did not have any impact on the Company’s consolidated
statements of operations and comprehensive loss or cash provided by or used in operating, investing or financing activities on
its consolidated statements of cash flows.
In
June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments,” which replaces the
current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration
of a broader range of reasonable and supportable information to inform credit loss estimates. The guidance is effective for the
Company beginning in the first quarter of fiscal year 2020. Early adoption is permitted beginning in the first quarter of fiscal
year 2019. The Company early adopted this guidance as of January 1, 2019 and the guidance did not have an impact on its consolidated
financial statements.
In
May 2018, the FASB issued ASU 2018-07, “Improvements to Nonemployee Share-Based Payment Accounting,” which expands
the scope of Accounting Standards Codification (“ASC”) 718 to include share-based payment transactions for acquiring
goods and services from nonemployees. The Company adopted this guidance as of January 1, 2019 and the guidance did not have an
impact on its consolidated financial statements.
Concentration
of Credit Risk
The
Company deposits its cash in financial institutions. At times, such deposits may be in excess of insured limits. To date, the
Company has not experienced any impairment losses on its cash. The Company also limits its credit risk with respect to accounts
receivable by performing credit evaluations when deemed necessary.
Major
Customers
For
the years ended December 31, 2019 and 2018, the following customers accounted for the following percentages of the Company’s
revenues, respectively:
Customer
|
|
2019
|
|
|
2018
|
|
A
|
|
|
19
|
%
|
|
|
6
|
%
|
B
|
|
|
17
|
%
|
|
|
11
|
%
|
C
|
|
|
10
|
%
|
|
|
-
|
%
|
D
|
|
|
10
|
%
|
|
|
10
|
%
|
E
|
|
|
4
|
%
|
|
|
11
|
%
|
Total
|
|
|
60
|
%
|
|
|
38
|
%
|
As
of December 31, 2019 and 2018, the following customers accounted for the following percentages of the Company’s accounts
receivable, respectively:
Customer
|
|
2019
|
|
|
2018
|
|
A
|
|
|
26
|
%
|
|
|
5
|
%
|
B
|
|
|
11
|
%
|
|
|
1
|
%
|
E
|
|
|
6
|
%
|
|
|
11
|
%
|
F
|
|
|
-
|
%
|
|
|
15
|
%
|
D
|
|
|
-
|
%
|
|
|
11
|
%
|
Total
|
|
|
43
|
%
|
|
|
43
|
%
|
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 was approximately $25,000 and $15,000 as of December 31, 2019
and 2018, respectively. The increase of approximately $10,000 to the allowance for doubtful accounts was primarily due to provision
for bad debt expense of approximately $15,000 for the year ended December 31, 2019 offset by write-offs of accounts receivable
of approximately $5,000 which were fully reserved. For the year ended December 31, 2018, provision for bad debt expense was approximately
$40,000.
Inventory
For
all medical device products and some commercial products, the Company engages third parties to manufacture and package its finished
goods, which are shipped to the Company for warehousing, until sold to distributors or end customers. As a result of the Aether
Acquisition, some commercial products are manufactured at Company facilities. Inventory consists of finished goods and raw materials
and is valued at the lower of cost or net realizable value using the first-in, first-out method.
The
Company’s inventory reserve requirements are based on factors including product expiration dates and estimates for future
sales of the product. If estimated sales levels do not materialize, the Company will make adjustments to its assumptions for inventory
reserve requirements.
License
and Supply Rights
The
Company’s rights under the License and Supply Agreement with Medica are capitalized and stated at cost, less accumulated
amortization, and are amortized using the straight-line method over the term of the License and Supply Agreement, which is from
April 23, 2012 through December 31, 2025. The Company determines amortization periods for licenses based on its assessment of
various factors impacting estimated useful lives and cash flows of the acquired rights. Such factors include the expected launch
date of the product, the strength of the intellectual property protection of the product and various other competitive, developmental
and regulatory issues, and contractual terms. See Note 10 – License and Supply Agreement, net for further discussion.
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 and are included in selling,
general and administrative expenses on the accompanying consolidated statement of operations and comprehensive loss.
Leases
The
Company determines if an arrangement contains a lease at inception. Operating leases are included in operating lease right-of-use
(“ROU”) assets and operating lease liabilities on the consolidated balance sheet.
Operating
lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments
over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, the Company uses
its incremental borrowing rate based on the information available at commencement date in determining the present value of future
payments. The operating lease ROU asset includes any lease payments made and initial direct costs incurred and excludes lease
incentives. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain
that the Company will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over
the lease term.
The
Company has elected, as an accounting policy not to apply the recognition requirements in ASC 842 to short-term leases. Short-term
leases are leases that have a term of 12 months or less and do not include an option to purchase the underlying asset that the
Company is reasonably certain to exercise. The Company recognizes the lease payments for short-term leases on a straight-line
basis over the lease term.
The
Company has also elected, as a practical expedient, by underlying class of asset, not to separate lease components from nonlease
components and, instead, account for them as a single component.
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.
The
Company adheres to Accounting Standards Codification (“ASC”) 360 and periodically evaluates whether current facts
or circumstances indicate that the carrying value of its depreciable assets to be held and used may not 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. For
long-lived assets, 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 fair value less costs
to sell. There were no impairment losses for long-lived assets recorded for the years ended December 31, 2019 and 2018.
Intangible
Assets
The
Company’s intangible assets include finite lived assets. Finite lived intangible assets, consisting of customer relationships,
tradenames, service marks and domain names are amortized on a straight-line basis over the estimated useful lives of the assets.
Finite
lived intangible assets are tested for impairment when events or changes in circumstances indicate that the carrying value of
the asset may not be recoverable. Impairment testing requires management to estimate the future undiscounted cash flows of an
intangible asset using assumptions believed to be reasonable, but which are unpredictable and inherently uncertain. Actual future
cash flows may differ from the estimates used in the impairment testing.
Goodwill
Goodwill
represents the excess of purchase price over the fair value of net assets acquired. In accordance with ASC 350, “Goodwill
and Other Intangibles,” rather than recording periodic amortization, goodwill is subject to an annual assessment for impairment
by applying a fair value based test. If the fair value of the reporting unit exceeds the reporting unit’s carrying value,
including goodwill, then goodwill is considered not impaired, making further analysis not required. The Company reviews goodwill
for possible impairment annually during the fourth quarter, or whenever events or circumstances indicate that the carrying amount
may not be recoverable.
Revenue
Recognition
The
Company recognizes revenue under ASC 606, “Revenue from Contracts with Customers.” ASC 606 prescribes a five-step
model for recognizing revenue, which includes (i) identifying contracts with customers; (ii) identifying performance obligations;
(iii) determining the transaction price; (iv) allocating the transaction price; and (v) recognizing revenue.
Shipping
and Handling Costs
Shipping
and handling costs charged to customers are recorded as cost of goods sold and were approximately $90,000 and $45,000 for the
years ended December 31, 2019 and 2018, respectively.
Research
and Development Costs
Research
and development costs are expensed as incurred.
Stock-Based
Compensation
The
fair value of stock options is recognized as stock-based compensation expense in the Company’s consolidated statement of
operations and comprehensive loss. The Company calculates stock-based compensation expense in accordance with ASC 718. The fair
value of the Company’s stock option awards is 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. 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.
Warrants
The
Company accounts for stock warrants as either equity instruments or derivative liabilities depending on the specific terms of
the warrant agreement.
Amortization
of Debt Issuance Costs and Debt Discounts
The
Company accounts for debt issuance costs in accordance with ASC 835 which requires that costs paid directly to the issuer of a
recognized debt liability be reported in the balance sheet as a direct deduction from the carrying amount of that debt liability,
consistent with debt discounts. The Company amortizes the debt discount, including debt issuance costs, in accordance with ASC
835 over the term of the associated debt. See Note 13 – Unsecured Promissory Notes and Warrants for a discussion of the
Company’s prior unsecured long-term note payable.
Other
Expense, net
Other
expense, net, of approximately $54,000 and approximately $35,000 for the years ended December 31, 2019 and 2018, respectively,
is primarily due to foreign currency transaction gains and losses.
Income
Taxes
The
Company accounts for income taxes in accordance with ASC 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, 2019 and 2018.
ASC
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 that 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 subsequent to 2013. During the years ended December 31, 2019 and 2018, 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.
The
Company recognized an income tax benefit of approximately $225,000 and $93,000 for the years ended December 31, 2019 and 2018,
respectively, from the sale of net operating loss and research and development credit carryforwards under the New Jersey Economic
Development Authority Technology Business Tax Certificate Transfer Program. These amounts are recorded on the consolidated financial
statements as income tax benefit in the year they are earned. See Note 16 – Income Taxes for further discussion.
Net
Income (Loss) per Common Share
Basic
net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders by the number
of weighted average common shares issued and outstanding. Diluted net income (loss) per common share is calculated by dividing
net income (loss) available to common shareholders by the weighted average number of common shares issued and outstanding for
the period, plus amounts representing the dilutive effect from the exercise of stock options and warrants, as applicable. The
Company calculates dilutive potential common shares using the treasury stock method, which assumes the Company will use the proceeds
from the exercise of stock options and warrants to repurchase shares of common stock to hold in its treasury stock reserves.
The
following securities have been excluded from the dilutive per share computation as they are antidilutive:
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Shares underlying options
outstanding
|
|
|
1,011,082
|
|
|
|
826,061
|
|
Shares underlying warrants outstanding
|
|
|
378,924
|
|
|
|
738,070
|
|
Unvested restricted stock
|
|
|
55,111
|
|
|
|
49,890
|
|
Foreign
Currency Translation
Foreign
currency translation is recognized in accordance with ASC 830. The functional currency of Nephros International Limited, the Company’s
Irish subsidiary, 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 consolidated statements of operations and comprehensive loss are 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)). The Company’s other comprehensive income (loss) consists only of foreign currency translation adjustments.
Recent
Accounting Pronouncements, Not Yet Effective
In
January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” which simplifies the test
for goodwill impairment. The guidance is effective for the Company beginning in the first quarter of fiscal year 2020. Early adoption
is permitted for interim or annual goodwill impairments tests after January 1, 2017. The Company has assessed the impact of adopting
this guidance and the adoption on January 1, 2020 will not have an impact on its consolidated financial statements.
In
August 2018, the FASB issued ASU 2018-13, “Disclosure Framework-Changes to the Disclosure Requirements for the Fair Value
Measurement,” which modifies the disclosure requirements on fair value measurements. The guidance is effective for the Company
beginning in the first quarter of fiscal year 2020. Early adoption is permitted. The Company has assessed the impact of adopting
this guidance and the adoption on January 1, 2020 will not have an impact on its consolidated financial statements.
In
August 2018, the FASB issued ASU 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing
Arrangement That is a Service Contract,” which aligns the requirements for capitalizing implementation costs incurred in
a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop
or obtain internal-use software. The guidance is effective for the Company beginning in the first quarter of fiscal year 2020.
Early adoption is permitted. The Company has assessed the impact of adopting this guidance and the adoption on January 1, 2020
will not have an impact on its consolidated financial statements.
In
November 2018, the FASB issued ASU 2018-18, “Collaborative Arrangements: Clarifying the Interaction Between Topic 808 and
Topic 606.” This guidance clarifies that, when the collaborative arrangement participant is a customer in the context of
a unit-of-account, revenue from contracts with customers guidance should be applied, adds unit-of-account guidance to collaborative
arrangements guidance, and requires, that in a transaction with a collaborative arrangement participant who is not a customer,
presenting the transaction together with revenue recognized under contracts with customers is precluded. The guidance is effective
for the Company beginning in the first quarter of fiscal year 2020. Early adoption is permitted. The Company has assessed the
impact of adopting this guidance and the adoption on January 1, 2020 will not have an impact on its consolidated financial statements.
In
November 2019, the FASB issued ASU 2019-08, “Codification Improvements – Share-Based Consideration Payable to a Customer,”
which requires that an entity measure and classify share-based payment awards granted to a customer by applying the guidance in
Topic 718. The guidance is effective for the Company beginning in the first quarter of fiscal year 2020. Early adoption is permitted.
The Company has assessed the impact of adopting this guidance and the adoption on January 1, 2020 will not have an impact on its
consolidated financial statements.
In
December 2019, the FASB issued ASU 2019-12, “Simplifying the Accounting for Income Taxes,” which removes certain exceptions
to the general principles of the accounting for income taxes and also improves consistent application of and simplification of
other areas when accounting for income taxes. The guidance is effective for the Company beginning in the first quarter of fiscal
year 2021. Early adoption is permitted. The Company is assessing the impact of adopting this guidance on its consolidated financial
statements.
Note
3 – Aether Acquisition
On
December 31, 2018, the Company completed the Aether Acquisition, which included the acquisition of 100% of the outstanding membership
interests of Aether. The purpose of the Aether Acquisition was to accelerate growth and to expedite entry into additional markets.
Transaction
costs associated with the Aether Acquisition of approximately $33,000 were recorded in selling, general and administrative expenses
for the year ended December 31, 2018.
The
Company has accounted for the Aether Acquisition as a business combination under the acquisition method of accounting.
The
following is a summary of total consideration for the Aether Acquisition, including a final working capital adjustment during
the year ended December 31, 2019 of approximately $11,000:
|
|
Total
Consideration
|
|
|
|
|
|
Fixed
purchase price
|
|
$
|
1,070,000
|
|
Acquisition
date fair value of contingent consideration
|
|
|
562,000
|
|
Total
consideration1
|
|
$
|
1,632,000
|
|
1Total
consideration of $1,632,000 consists of $5,000 in accrued expenses, $137,000 in working capital payments, $499,000 of contingent
consideration liabilities, and an upfront payment of $991,000, of which $250,000 was placed in escrow as of the date of the acquisition.
Of the $250,000 placed in escrow, $187,000 and $63,000 are included in fixed purchase price and acquisition date fair value
of contingent consideration, respectively, in the total consideration table presented above.
The
Company has allocated the total consideration for the transaction based upon the fair value of net assets acquired and liabilities
assumed at the date of acquisition.
The
following is a summary of the purchase price allocation for the Aether Acquisition. Changes to the purchase price allocation from
amounts reported in the Company’s consolidated financial statements for the year ended December 31, 2018 were due to the
final working capital adjustment.
|
|
Fair
Values
|
|
Trade accounts receivable
|
|
$
|
164,000
|
|
Inventories
|
|
|
179,000
|
|
Equipment
|
|
|
39,000
|
|
Security deposit
|
|
|
7,000
|
|
Goodwill
|
|
|
759,000
|
|
Intangible assets
|
|
|
590,000
|
|
Total assets acquired,
net of cash acquired
|
|
|
1,738,000
|
|
Accounts payable
|
|
|
91,000
|
|
Accrued expenses
|
|
|
15,000
|
|
Total
liabilities assumed
|
|
|
106,000
|
|
Net
assets acquired, net of cash acquired
|
|
$
|
1,632,000
|
|
Intangible
Assets
The
acquired intangible assets are being amortized over their estimated useful lives as follows:
|
|
Fair
Values
|
|
|
Weighted
Average Useful Life
(Years)
|
|
Tradenames,
service marks and domain names
|
|
|
50,000
|
|
|
|
5
|
|
Customer
relationships
|
|
|
540,000
|
|
|
|
17
|
|
Total
intangible assets
|
|
$
|
590,000
|
|
|
|
|
|
Estimated
aggregate amortization expense for each of the next four years is estimated to be approximately $42,000, followed by approximately
$32,000 in the fifth year.
The
estimated fair value of the identifiable intangible assets was determined using the “income approach,” which is a
valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash
flows an asset would generate over its remaining useful life. The assumptions, including the expected projected cash flows, utilized
in the purchase price allocation and in determining the purchase price were based on the Company’s best estimates as of
December 31, 2018, the closing date of the Aether Acquisition.
Some
of the more significant assumptions inherent in the development of those asset valuations include the estimated net cash flows
for each year for each asset or product (including net revenues, cost of sales, research and development costs, selling and marketing
costs and working capital / contributory asset charges), the appropriate discount rate to select in order to measure the risk
inherent in each future cash flow stream, the assessment of each asset’s life cycle, the potential regulatory and commercial
success risks, competitive trends impacting the asset and each cash flow stream, as well as other factors. No assurances can be
given that the underlying assumptions used to prepare the discounted cash flow analysis will not change. For these and other reasons,
actual results may vary significantly from estimated results.
Goodwill
Goodwill
is calculated as the excess of the consideration transferred over the net assets recognized. Factors that contributed to the Company’s
recognition of goodwill include the Company’s intent to expand its product portfolio. Goodwill has been allocated to the
Water Filtration segment.
Unaudited
Pro Forma Results of Operations
The
following table reflects the unaudited pro forma combined results of operations for the year ended December 31, 2018 (assuming
the closing of the Aether Acquisition occurred on January 1, 2017):
|
|
Year
Ended
December 31, 2018
|
|
Total
revenues
|
|
$
|
6,412,000
|
|
Net
loss attributable to Nephros, Inc
|
|
$
|
(3,158,000
|
)
|
The
pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the actual results of
operations had the closing of the Aether Acquisition taken place on January 1, 2017. Furthermore, the pro forma results do not
purport to project the future results of operations of the Company.
The
unaudited pro forma information reflects the following adjustments:
|
●
|
Adjustment
to amortization expense for the year ended December 31, 2018 of approximately $21,000 related to identifiable intangible assets
acquired;
|
|
●
|
Adjustment,
net of a reduction, to depreciation expense for the year ended December 31, 2018 of approximately $10,000 related to equipment
acquired and for which the capitalization policy and useful lives were adjusted based on the Company’s policy;
|
|
●
|
Adjustment
to selling, general and administrative expense related to transaction costs directly attributable to the Aether Acquisition,
including the elimination of $33,000 of expenses incurred in the year ended December 31, 2018;
|
|
●
|
Eliminate
interest expense in the historical Aether results of operations and eliminate interest income in the Company’s historical
results of operations, each of which was approximately $4,000 for the year ended December 31, 2018, which interest was related
to a lease that was terminated as of the acquisition; and
|
|
●
|
Eliminate
sales, and related cost of goods, for products sold by Aether to the Company, with a gross margin impact of approximately
$5,000 for the year ended December 31, 2018.
|
Note
4 – Revenue Recognition
The
Company recognizes revenue related to product sales when product is shipped via external logistics provider and the other criteria
of ASC 606 are met. Product revenue is recorded net of returns and allowances. There was no allowance for sales returns at December
31, 2019 or 2018. In addition to product revenue, the Company recognizes revenue related to royalty and other agreements in accordance
with the five-step model in ASC 606. Royalty and other revenue recognized for the years ended December 31, 2019 and 2018 is comprised
of:
|
|
Years
Ended
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Royalty
revenue under the Sublicense Agreement with CamelBak (1)
|
|
$
|
16,000
|
|
|
$
|
100,000
|
|
Royalty
revenue under the License Agreement with Bellco
|
|
|
59,000
|
|
|
|
101,000
|
|
Other
revenue
|
|
|
77,000
|
|
|
|
29,000
|
|
Total
royalty and other revenue
|
|
$
|
152,000
|
|
|
$
|
230,000
|
|
|
(1)
|
In
May 2015, the Company entered into a Sublicense Agreement (the “Sublicense Agreement”) with CamelBak Products,
LLC (“CamelBak”). Under the Sublicense Agreement, the Company granted CamelBak an exclusive, non-transferable,
worldwide (with the exception of Italy) sublicense and license, in each case solely to market, sell, distribute, import and
export the Company’s individual water treatment device. In exchange for the rights granted to CamelBak, CamelBak agreed,
through December 31, 2022, to pay the Company a percentage of the gross profit on any sales made to a branch of the U.S. military,
subject to certain exceptions, and to pay a fixed per-unit fee for any other sales made. CamelBak was also required to meet
or exceed certain minimum annual fees payable to the Company, and if such fees are not met or exceeded, the Company was able
to convert the exclusive sublicense to a non-exclusive sublicense with respect to non-U.S. military sales. In the first quarter
of 2019, the Sublicense Agreement was amended to eliminate the minimum fee obligations starting May 6, 2018 and, as such,
Camelbak has no further minimum fee obligation.
|
Bellco
License Agreement
With
regard to the OLpūr MD190 and MD220, on June 27, 2011, the Company entered into a License Agreement (the “License Agreement”),
effective July 1, 2011, with Bellco S.r.l. (“Bellco”), an Italy-based supplier of hemodialysis and intensive care
products, for the manufacturing, marketing and sale of the Company’s patented mid-dilution dialysis filters (the “Products”).
Under the License Agreement, as amended, the Company granted Bellco a license to manufacture, market and sell the Products under
its own name, label, and CE mark in certain countries on an exclusive basis, and to do the same on a non-exclusive basis in certain
other countries. Under the License Agreement with Bellco, the Company received upfront payments which were previously deferred
and recognized as license revenue over the term of the License Agreement. As of the adoption of ASC 606, the remaining deferred
revenue of approximately $278,000 was recognized as a cumulative effect adjusted to accumulated deficit as of January 1, 2018
in accordance with ASC 606.
The
License Agreement, as amended, also provides minimum sales targets which, if not satisfied, will, at the discretion of the Company,
result in conversion of the license to non-exclusive status. Beginning on January 1, 2015 through and including December 31, 2021,
Bellco will pay the Company a royalty based on the number of units of Products sold per year in the covered territory as follows:
for the first 125,000 units sold in total, €1.75 (approximately $1.95) per unit; thereafter, €1.25 (approximately $1.40)
per unit. The License Agreement also provides for a fixed royalty payment payable to the Company for the period beginning on January
1, 2015 through and including December 31, 2021 if the minimum sales targets are not met.
The
Company recognized royalty income from Bellco pursuant to the License Agreement for the years ended December 31, 2019 and 2018
of approximately $59,000 and $101,000, respectively.
Note
5 – Fair Value Measurements
The
Company measures certain financial instruments and other items at fair value.
To
determine the fair value, the Company uses the fair value hierarchy for inputs used in measuring fair value that maximizes the
use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when
available. Observable inputs are inputs market participants would use to value an asset or liability and are developed based on
market data obtained from independent sources. Unobservable inputs are inputs based on assumptions about the factors market participants
would use to value an asset or liability.
To
measure fair value, the Company uses the following fair value hierarchy based on three levels of inputs, of which the first two
are considered observable and the last unobservable:
Level
1 - Quoted prices in active markets for identical assets or liabilities.
Level
2 - Inputs other than Level 1 that are observable for the asset or liability, either directly or indirectly, such as quoted
prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets
that are not active; or other inputs that are observable or can be corroborated by observable market data by correlation or other
means.
Level
3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the
assets or liabilities. Value is determined using pricing models, discounted cash flow methodologies, or similar techniques and
also includes instruments for which the determination of fair value requires significant judgment or estimation.
Assets
and Liabilities Measured at Fair Value on a Recurring Basis
The
Company evaluates its financial assets and liabilities subject to fair value measurements on a recurring basis to determine the
appropriate level of classification for each reporting period.
The
following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring
basis as of December 31, 2019:
|
|
Quoted
prices in
active
markets
for
identical
assets
(Level
1)
|
|
|
Significant
other
observable
inputs
(Level
2)
|
|
|
Significant
unobservable
inputs
(Level 3)
|
|
|
Total
|
|
At December
31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
contingent consideration liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
300,000
|
|
|
$
|
300,000
|
|
The
following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring
basis as of December 31, 2018:
|
|
Quoted
prices in active markets for
identical assets (Level 1)
|
|
|
Significant
other observable
inputs (Level 2)
|
|
|
Significant
unobservable inputs
(Level 3)
|
|
|
Total
|
|
At December
31, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
contingent consideration liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
499,000
|
|
|
$
|
499,000
|
|
The
following table summarizes the change in fair value, as determined by Level 3 inputs, for the contingent consideration liability
using unobservable Level 3 inputs for the year ended December 31, 2019:
|
|
Contingent
Consideration
|
|
Balance as of December 31, 2018
|
|
$
|
499,000
|
|
Payments against contingent consideration
|
|
|
(94,000
|
)
|
Change in fair value of contingent consideration
liability
|
|
|
(156,000
|
)
|
Accretion of
contingent consideration liability
|
|
|
51,000
|
|
Balance as of December 31, 2019
|
|
$
|
300,000
|
|
Accretion
expense of approximately $51,000 is included in interest expense on the accompanying consolidated statement of operation and comprehensive
loss for the year ended December 31, 2019.
Consideration
paid in a business combination may include potential future payments that are contingent upon the acquired business achieving
certain levels of earnings in the future (“contingent consideration”). Contingent consideration liabilities are measured
at their estimated fair value as of the date of acquisition, with subsequent changes in fair value recorded in the consolidated
statements of operations. Fair value as of the date of acquisition is estimated based on projections of expected future cash flows
of the acquired business. The Company estimated the contingent consideration liability using the income approach (discounted cash
flow method) which requires the Company to make estimates and assumptions regarding the future cash flows and profits. Changes
in these estimates and assumptions could have a significant impact on the amounts recognized.
There
were no transfers between levels in the fair value hierarchy during the year ended December 31, 2019.
Assets
and Liabilities Not Measured at Fair Value on a Recurring Basis
The
carrying amounts of cash, accounts receivable, secured revolving credit facility, accounts payable and accrued expenses approximate
fair value due to the short-term maturity of these instruments.
The
carrying amounts of the secured long-term note payable as of December 31, 2019 and 2018 and the carrying amounts of equipment
financing debt and operating lease liabilities as of December 31, 2019 approximate fair value as of December 31, 2019 and 2018
because those financial instruments bear interest at rates that approximate current market rates for similar agreements with similar
maturities and credit.
Assets
and Liabilities Measured at Fair Value on a Non-Recurring Basis
See
Note 3 – Aether Acquisition for the allocation of the total consideration for the Aether Acquisition based upon the fair
value of net assets acquired and liabilities assumed at the date of acquisition.
Note
6 - Inventory, net
The
Company’s inventory components as of December 31, 2019 and 2018 were as follows:
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Finished
goods
|
|
$
|
2,248,000
|
|
|
$
|
1,633,000
|
|
Raw
material
|
|
|
359,000
|
|
|
|
280,000
|
|
Less:
inventory reserve
|
|
|
(45,000
|
)
|
|
|
(49,000
|
)
|
Total
inventory, net
|
|
$
|
2,562,000
|
|
|
$
|
1,864,000
|
|
Note
7- Prepaid Expenses and Other Current Assets
Prepaid
expenses and other current assets as of December 31, 2019 and 2018 were as follows:
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Prepaid
insurance premiums
|
|
$
|
40,000
|
|
|
$
|
45,000
|
|
Deposit
for future services
|
|
|
200,000
|
|
|
|
200,000
|
|
Receivable
related to the sale of net operating loss and research and development credit carryforwards
|
|
|
225,000
|
|
|
|
93,000
|
|
Other
|
|
|
61,000
|
|
|
|
31,000
|
|
Prepaid
expenses and other current assets
|
|
$
|
526,000
|
|
|
$
|
369,000
|
|
Note
8 - Property and Equipment, Net
Property
and equipment as of December 31, 2019 and 2018 was as follows:
|
|
|
|
|
December
31,
|
|
|
|
Life
|
|
|
2019
|
|
|
2018
|
|
Manufacturing
equipment
|
|
|
3-7
years
|
|
|
$
|
782,000
|
|
|
$
|
768,000
|
|
Research
equipment
|
|
|
5
years
|
|
|
|
37,000
|
|
|
|
37,000
|
|
Computer
equipment
|
|
|
3-4
years
|
|
|
|
43,000
|
|
|
|
43,000
|
|
Furniture
and fixtures
|
|
|
7
years
|
|
|
|
37,000
|
|
|
|
37,000
|
|
Property
and equipment, gross
|
|
|
|
|
|
|
899,000
|
|
|
|
885,000
|
|
Less:
accumulated depreciation
|
|
|
|
|
|
|
(818,000
|
)
|
|
|
(794,000
|
)
|
Property
and equipment, net
|
|
|
|
|
|
$
|
81,000
|
|
|
$
|
91,000
|
|
Depreciation
related to equipment utilized in the manufacturing process is recognized in cost of goods sold on the consolidated statements
of operations and comprehensive loss. Depreciation expense for the years ended December 31, 2019 and 2018 was approximately $24,000
and $29,000, respectively. Approximately $14,000 of depreciation expense has been recognized in cost of goods sold for the year
ended December 31, 2019. There was no depreciation recognized in cost of goods sold for the year ended December 31, 2018.
Note
9 – Intangible Assets and Goodwill
Intangible
Assets
The
following table shows the gross carrying values and accumulated amortization of the Company’s intangible assets by type
as of December 31, 2019:
|
|
December
31, 2019
|
|
|
|
Gross
Carrying
Value
|
|
|
Accumulated
Amortization
|
|
|
Intangible
Assets, net
|
|
Tradenames,
service marks and domain names
|
|
$
|
50,000
|
|
|
$
|
(10,000
|
)
|
|
$
|
40,000
|
|
Customer
relationships
|
|
|
540,000
|
|
|
|
(32,000
|
)
|
|
|
508,000
|
|
Total
intangible assets
|
|
$
|
590,000
|
|
|
$
|
(42,000
|
)
|
|
$
|
548,000
|
|
The
Company recognized amortization expense of approximately $42,000 for the year ended December 31, 2019 in selling, general and
administrative expenses on the accompanying consolidated statement of operations and comprehensive loss.
As
of December 31, 2019, future amortization expense for the next five years is estimated to be:
|
2020
|
|
|
$
|
42,000
|
|
|
2021
|
|
|
$
|
42,000
|
|
|
2022
|
|
|
$
|
42,000
|
|
|
2023
|
|
|
$
|
42,000
|
|
|
2024
|
|
|
$
|
32,000
|
|
The
Company did not recognize any intangible asset impairment charges during the year ended December 31, 2019.
Goodwill
Goodwill
had a carrying value on the Company’s consolidated balance sheets of approximately $759,000 and $748,000 at December 31,
2019 and 2019, respectively. As a result of a final working capital adjustment, goodwill increased approximately $11,000 during
the year ended December 31, 2019. Goodwill has been allocated to the Water Filtration segment. The Company concluded the carrying
value of goodwill was not impaired as of December 31, 2019 as the Company determined that it was not more likely than not that
the fair value of goodwill was less than its carrying value.
Note
10 – License and Supply Agreement, net
On
April 23, 2012, the Company entered into a License and Supply Agreement (as thereafter amended, the “License and Supply
Agreement”) with Medica S.p.A. (“Medica”), an Italy-based medical product manufacturing company, for the marketing
and sale of certain filtration products based upon Medica’s proprietary Medisulfone ultrafiltration technology in conjunction
with the Company’s filtration products, and for an exclusive supply arrangement for the filtration products. Under the License
and Supply Agreement Medica granted to the Company an exclusive license, with right of sublicense, to market, promote, distribute,
offer for sale and sell the filtration products worldwide, with certain limitations on territory, during the term of the License
and Supply Agreement. In addition, the Company granted to Medica an exclusive license under the Company’s intellectual property
to make the filtration products during the term of the License and Supply Agreement. The filtration products covered under the
License and Supply Agreement include both certain products based on Medica’s proprietary Versatile microfiber technology
and certain filtration products based on Medica’s proprietary Medisulfone ultrafiltration technology. The term of the License
Agreement with Medica expires on December 31, 2025, unless earlier terminated by either party in accordance with the terms of
the License and Supply Agreement.
In
exchange for the license, the gross value of the intangible asset capitalized was approximately $2,250,000. License and supply
agreement, net, on the consolidated balance sheet is approximately $804,000 and $938,000 as of December 31, 2019 and 2018, respectively.
Accumulated amortization is approximately $1,446,000 and $1,312,000 as of December 31, 2019 and 2018, respectively. The intangible
asset is being amortized as an expense over the life of the License and Supply Agreement. Amortization expense of approximately
$134,000 was recognized in each of the years ended December 31, 2019 and 2018 on the consolidated statement of operations and
comprehensive loss.
As
of September 2013, the Company has an understanding with Medica whereby the Company has agreed to pay interest to Medica at a
12% annual rate calculated on the principal amount of any outstanding invoices that are not paid pursuant to the original payment
terms. There was no interest recognized for the year ended December 31, 2019. For the year ended December 31, 2018, approximately
$13,000 of interest expense was recognized on the consolidated statement of operations and comprehensive loss.
In
addition, for the period beginning April 23, 2014 through December 31, 2025, the Company will pay Medica a royalty rate of 3%
of net sales of the filtration products sold, subject to reduction as a result of a supply interruption pursuant to the terms
of the License and Supply Agreement. Approximately $273,000 and $161,000 for the year ended December 31, 2019 and 2018, respectively,
was recognized as royalty expense and is included in cost of goods sold on the consolidated statement of operations and comprehensive
loss. Approximately $83,000 and $50,000 are included in accounts payable as of December 31, 2019 and 2018, respectively.
Note
11 – Secured Revolving Credit Facility
On
August 17, 2017, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Tech Capital,
LLC (“Tech Capital”). The Loan Agreement initially provided for a secured asset-based revolving credit facility of
up to $1,000,000, which the Company may draw upon and repay from time to time during the term of the Loan Agreement. On December
20, 2019, the Company and Tech Capital entered into a First Modification to the Loan Agreement (“the Amendment”).
The Amendment increased the senior secured asset-based revolving credit facility from $1,000,000
to $2,500,000.
The
outstanding principal balance of the Loan Agreement was approximately $560,000 and $991,000 as of December 31, 2019 and 2018,
respectively. The Company is using these proceeds for working capital and general corporate purposes.
The
Loan Agreement has a term of 12 months and, as a result of the Amendment, will automatically renew for
successive 12-month periods, measured from the date of the Amendment. Availability under the Loan Agreement will be based
upon periodic borrowing base certifications valuing certain of the Company’s accounts receivable and inventory. Outstanding
borrowings under the Loan Agreement accrue interest, which is payable monthly based on the average daily outstanding balance,
at a rate equal to 3.5% plus the prime rate per annum, provided that such prime rate is not less than 4.25% per annum and provided
that such monthly interest payment is not less than $6,500. As of December 31, 2019,
the current interest rate was 8.25% per annum.
The
Company also granted to Tech Capital a first priority security interest in its assets, including its accounts receivable and inventory,
to secure all of its obligations under the Loan Agreement. In addition, Nephros International Limited, the Company’s wholly-owned
subsidiary, unconditionally guaranteed the Company’s obligations under the Loan Agreement.
As
a result of the Amendment, the Company was required to pay to Tech Capital 0.50% of the maximum amount of credit available under
the Loan Agreement and on each anniversary thereof while there remain outstanding amounts under the Loan Agreement.
For
the years ended December 31, 2019 and 2018, approximately $67,000 and $22,000, respectively, was recognized as interest expense
on the consolidated statement of operations and comprehensive loss. Included in interest expense was approximately $14,000 of
fees related to the Amendment. As of December 31, 2019, approximately $7,000 of the $67,000 of interest expense incurred for the
year ended December 31, 2019 is included in accrued expenses on the consolidated balance sheet. As of December 31, 2018, approximately
$2,000 of the $22,000 of interest expense incurred for the year ended December 31, 2018 is included in accrued expenses on the
consolidated balance sheet.
Note
12 – Secured Note Payable
On
March 27, 2018, the Company entered into a Secured Promissory Note Agreement (the “Secured Note”) with Tech Capital,
LLC (“Tech Capital”) for a principal amount of $1,187,000. The Company used the proceeds from the Secured Note to
repay the Company’s 11% unsecured promissory notes issued in June 2016 pursuant to the Note and Warrant Agreement (see Note
13 – Unsecured Promissory Notes and Warrants). As of December 31, 2019 and 2018, the principal balance of the Secured Note
was approximately $824,000 and $1,038,000, respectively.
The
Secured Note has a maturity date of April 1, 2023. The unpaid principal balance accrues interest at a rate of 8% per annum. Principal
and interest payments are due on the first day of each month commencing on May 1, 2018. The Secured Note is subject to the terms
and conditions of and is secured by security interests granted by the Company in favor of Tech Capital under the Loan Agreement
(see Note 11 – Secured Revolving Credit Facility). An event of default under such Loan Agreement will be an event of default
under the Secured Note and vice versa. In the event the principal balance under the Loan Agreement is due, all amounts due under
the Secured Note will also be due.
During
the years ended December 31, 2019 and 2018, the Company made payments under the Secured Note of approximately $289,000 and $216,000,
respectively. Included in the total payments made, approximately $75,000 and $67,000 was recognized as interest expense on the
consolidated statement of operations and comprehensive loss for the year ended December 31, 2019 and 2018, respectively. Debt
issuance costs of approximately $6,000 were recognized as interest expense on the consolidated statement of operations and comprehensive
loss for the year ended December 31, 2018.
As
of December 31, 2019, future principal maturities are as follows:
2020
|
|
$
|
211,000
|
|
2021
|
|
|
249,000
|
|
2022
|
|
|
269,000
|
|
2023
|
|
|
95,000
|
|
Total
|
|
$
|
824,000
|
|
Note
13 - Unsecured Promissory Notes and Warrants
In
June 2016, the Company entered into a Note and Warrant Agreement (the “Note and Warrant Agreement”) with new creditors
as well as existing stockholders under which the Company issued unsecured promissory notes and warrants resulting in total gross
proceeds to the Company of approximately $1,187,000. The outstanding principal under the notes accrued interest at a rate of 11%
per annum. The notes required the Company to make interest only payments on a semi-annual basis, with all outstanding principal
under the notes being repayable in cash on the third anniversary of the date of issuance. In addition to the notes, the Company
issued warrants to purchase approximately 300,000 shares of the Company’s common stock. The portion of the gross proceeds
allocated to the warrants, approximately $393,000, was accounted for as additional paid-in capital resulting in a debt discount.
The debt discount, which included approximately $9,000 of debt issuance costs in addition to the fair value of the warrants, was
being amortized to interest expense using the effective interest method in accordance with ASC 835 over the term of the Note and
Warrant Agreement.
On
March 30, 2018, the principal balance of the notes, along with the remaining accrued interest of approximately $43,000, was repaid
in full. Approximately $30,000 of the approximately $43,000 was recognized as interest expense on the Company’s consolidated
statement of operations and comprehensive loss for the year ended December 31, 2018. The remaining approximately $13,000 was accrued
in the prior year. The remaining debt discount of approximately $199,000 was recorded as loss on extinguishment of debt in the
Company’s consolidated statement of operations and comprehensive loss for the year ended December 31, 2018.
For
the year ended December 31, 2018, approximately $34,000 was recognized as amortization of debt discount and is included in interest
expense on the consolidated statement of operations and comprehensive loss.
For
the year ended December 31, 2018, the amount of interest expense recognized related to related parties comprised of entities controlled
by a member of management and by Lambda Investors, LLC, the Company’s largest stockholder, was approximately $1,000.
Note
14 – Leases
The
Company has operating leases for corporate offices, an automobile and office equipment. The leases have remaining lease terms
of approximately 1 year to 5 years.
The
Company entered into an operating lease that began in December 2017 for 380 Lackawanna Place, South Orange, New Jersey 07079,
which consists of approximately 7,700 square feet of space. The rental agreement expires in November 2022 with a monthly cost
of approximately $11,000. Approximately $11,000 related to a security deposit for this U.S. office facility is classified as other
assets on the consolidated balance sheet as of December 31, 2019 and 2018. The Company uses this facility to house its corporate
headquarters and research facilities.
The
Company entered into an operating lease that began in February 2019 for 211 Donelson Pike, Nashville, Tennessee 37214, for office
space. The rental agreement expires in January 2021 with a monthly cost of approximately $850. Approximately $1,000 related to
a security deposit for this office facility is classified as other assets on the consolidated balance sheet as of December 31,
2019.
The
Company entered into an operating lease in March 2019 for approximately 16,000 total square feet of office space at 3221 Polaris
Avenue, Las Vegas, Nevada 89118. The rental agreement commenced in June 2019 and expires in August 2024 with a monthly cost of
approximately $15,000. The Company recognized a ROU asset and lease liability of approximately $800,000 as a result of this lease.
Approximately $20,000 related to a security deposit for this office facility is classified as other assets on the consolidated
balance sheet as of December 31, 2019.
As
of August 31, 2019, the Company terminated its rental agreement for 591 East Sunset Road, Henderson, Nevada 89011, which consisted
of approximately 8,000 total square feet of space. In connection with the lease termination, the Company and the lessor agreed
to a lease termination penalty of $27,000. For the year ended December 31, 2019, the Company paid a lease termination liability
of $20,000, consisting of the $27,000 lease termination penalty offset partially by a security deposit of $7,000. The $20,000
loss on lease termination is included in selling, general and administrative expenses on the accompanying consolidated statement
of operations and comprehensive loss for the year ended December 31, 2019.
The
lease agreement for the Company’s office space in Ireland was entered into on August 1, 2019 and includes a twelve-month
term.
The
Company also has lease agreements for an automobile and office equipment.
Prior
to the adoption of ASC 842, operating lease expense of approximately $162,000 was recognized in the Company’s consolidated
statement of operations and comprehensive loss for the year ended December 31, 2018.
Operating
lease expense was approximately $301,000 for the year ended December 31, 2019 in the Company’s consolidated statement of
operations and comprehensive loss and includes costs associated with leases for which ROU assets have been recognized as well
as short-term leases.
Supplemental
cash flow information related to leases was as follows:
|
|
Year
ended
December 31, 2019
|
|
Operating
activities:
|
|
|
|
|
Cash
paid for amounts included in the measurement of lease liabilities:
|
|
|
|
|
Operating
cash flows from operating leases
|
|
$
|
251,000
|
|
|
|
|
|
|
Noncash
investing and financing activities:
|
|
|
|
|
ROU
assets obtained in exchange for lease liability
|
|
|
|
|
Operating
leases
|
|
$
|
800,000
|
|
Supplemental
balance sheet information related to leases was as follows:
|
|
December
31, 2019
|
|
|
|
|
|
Operating
ROU assets
|
|
$
|
1,106,000
|
|
|
|
|
|
|
Current
portion of operating lease liabilities
|
|
$
|
262,000
|
|
Operating
lease liabilities, net of current portion
|
|
|
889,000
|
|
Total
operating lease liabilities
|
|
$
|
1,151,000
|
|
|
|
|
|
|
Weighted
average remaining lease term, operating leases
|
|
|
4.0
years
|
|
|
|
|
|
|
Weighted
average discount rate, operating leases
|
|
|
8.0
|
%
|
As
of December 31, 2019, maturities of lease liabilities were as follows:
2020
|
|
$
|
339,000
|
|
2021
|
|
|
333,000
|
|
2022
|
|
|
329,000
|
|
2023
|
|
|
201,000
|
|
2024
|
|
|
137,000
|
|
Total
future minimum lease payments
|
|
|
1,339,000
|
|
Less
imputed interest
|
|
|
(188,000
|
)
|
Total
|
|
$
|
1,151,000
|
|
Note
15 - Accrued Expenses
Accrued
expenses as of December 31, 2019 and 2018 were as follows:
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Accrued
legal
|
|
$
|
14,000
|
|
|
$
|
90,000
|
|
Accrued
sales commission
|
|
|
50,000
|
|
|
|
42,000
|
|
Accrued
research and development
|
|
|
-
|
|
|
|
65,000
|
|
Accrued
accounting
|
|
|
-
|
|
|
|
8,000
|
|
Accrued
interest
|
|
|
7,000
|
|
|
|
2,000
|
|
Accrued
other
|
|
|
65,000
|
|
|
|
189,000
|
|
|
|
$
|
136,000
|
|
|
$
|
396,000
|
|
Note
16 - Income Taxes
The
income tax benefit attributable to loss before income taxes for the years ended December 31, 2019 and 2018 is as follows:
|
|
Years
Ended December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Current:
|
|
|
|
|
|
|
State
|
|
$
|
(225,000
|
)
|
|
$
|
(93,000
|
)
|
Total
current tax benefit
|
|
|
(225,000
|
)
|
|
|
(93,000
|
)
|
Total
deferred tax benefit
|
|
|
-
|
|
|
|
-
|
|
Income
tax benefit
|
|
$
|
(225,000
|
)
|
|
$
|
(93,000
|
)
|
A
reconciliation of the income tax benefit computed at the statutory tax rate to the Company’s effective tax rate for the
years ended December 31, 2019 and 2018 is as follows:
|
|
Years
Ended December 31,
|
|
|
|
2019
|
|
|
2018
|
|
U.S.
federal statutory rate
|
|
|
21.00
|
%
|
|
|
21.00
|
%
|
State
taxes
|
|
|
(8.30
|
)%
|
|
|
5.25
|
%
|
Sale
of NJ NOLS and credits
|
|
|
5.22
|
%
|
|
|
(2.78
|
)%
|
Expired
NOLs and credits
|
|
|
(31.19
|
)%
|
|
|
-
|
%
|
Stock
based compensation
|
|
|
(3.21
|
)%
|
|
|
(1.96
|
)%
|
Federal
research and development credits
|
|
|
4.93
|
%
|
|
|
2.28
|
%
|
Other
|
|
|
(2.96
|
)%
|
|
|
(0.11
|
)%
|
Valuation
allowance
|
|
|
21.12
|
%
|
|
|
(26.46
|
)%
|
Effective
tax rate
|
|
|
6.61
|
%
|
|
|
(2.78
|
)%
|
Significant
components of the Company’s deferred tax assets as of December 31, 2019 and 2018 are as follows:
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
|
Net
operating loss carry forwards
|
|
$
|
18,060,000
|
|
|
$
|
18,671,000
|
|
Research
and development credits
|
|
|
1,459,000
|
|
|
|
1,399,000
|
|
Nonqualified
stock option compensation expense
|
|
|
515,000
|
|
|
|
497,000
|
|
Other
temporary book - tax differences
|
|
|
28,000
|
|
|
|
58,000
|
|
Total
deferred tax assets
|
|
|
20,062,000
|
|
|
|
20,625,000
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
|
|
|
|
|
Fixed
and intangible asset basis difference
|
|
|
(134,000
|
)
|
|
|
(21,000
|
)
|
Total
deferred tax liabilities
|
|
|
(134,000
|
)
|
|
|
(21,000
|
)
|
|
|
|
|
|
|
|
|
|
Deferred
tax assets (liabilities), net
|
|
|
19,928,000
|
|
|
|
20,604,000
|
|
Valuation
allowance for deferred tax assets
|
|
|
(19,928,000
|
)
|
|
|
(20,604,000
|
)
|
Deferred
tax assets (liabilities), net after valuation allowance
|
|
$
|
-
|
|
|
$
|
-
|
|
During
the years ended December 31, 2019 and 2018, the Company recorded an income tax benefit of approximately $225,000 and $93,000,
respectively, due to the sale of net operating loss and research and development credit carryforwards under the New Jersey Economic
Development Authority Technology Business Tax Certificate Transfer Program. These amounts are recorded in the consolidated financial
statements as an income tax benefit in the year they are earned. As a result of the sale of net operating loss and research and
development credit carryforwards during these years, the Company’s deferred tax assets decreased by approximately $239,000
and $99,000, respectively. The gross amounts of the net operating loss and research and development credit carryforwards that
were sold during the years ended December 31, 2019 and 2018 were approximately $2,193,000 and $613,000, respectively, and $41,000
and $44,000, respectively.
A
valuation allowance has been recognized to offset the Company’s net deferred tax asset as it is more likely than not that
such net asset will not be realized. The Company primarily considered its historical loss and potential Internal Revenue Code
Section 382 limitations to arrive at its conclusion that a valuation allowance was required. The Company’s valuation allowance
decreased approximately $676,000 from December 31, 2018 to December 31, 2019.
At
December 31, 2019, the Company had Federal income tax net operating loss carryforwards of $78,650,000 and New Jersey income tax
net operating loss carryforwards of $35,000. Foreign income tax net operating loss carryforwards were $7,286,000 as of December
31, 2019. The Company had Federal research and development tax credit carryforwards of $1,289,000 and $1,330,000 at December 31,
2019 and 2018, respectively. The Company also had state research and development tax credit carryforwards of $78,000 and $42,000
at December 31, 2019 and 2018, respectively. The Company’s net operating losses and research and development tax credits
may ultimately be limited by Section 382 of the Internal Revenue Code and, as a result, it may be unable to offset future taxable
income (if any) with losses, or its tax liability with credits, before such losses and credits expire. Included in the Federal
net operating loss carryforwards are $3,015,000 of losses generated from 2018 onward that have an indefinite carryover period.
The remaining Federal and New Jersey net operating loss carryforwards and Federal and New Jersey tax credit carryforwards will
expire at various times between 2020 and 2038 unless utilized.
The
Company has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related
to uncertain tax positions. The Company is subject to income tax examinations by major taxing authorities for all tax years subsequent
to 2015 and does not anticipate a change in its uncertain tax positions within the next twelve months. The Company’s policy
is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
Note
17 - Stock Plans and Share-Based Payments
Stock
Plans
In
2015, the Board of Directors adopted the Nephros, Inc. 2015 Equity Incentive Plan (“2015 Plan”) and reserved and authorized
777,777 shares of common stock for issuance pursuant to stock options, restricted stock and other equity incentive awards to the
Company’s employees, directors and consultants. In December 2017, the Board of Directors approved an amendment to the 2015
Plan increasing the number of shares of common stock authorized thereunder to 1,111,110 shares and in May 2019, the Board of Directors
approved an amendment to the 2015 Plan increasing the number of shares of common stock authorized thereunder to 1,333,332. The
maximum contractual term for stock options granted under the 2015 Plan is 10 years.
As
of December 31, 2019, options to purchase 892,926 shares of common stock had been issued to employees under the 2015 Plan and
were outstanding. The options issued to employees expire on various dates between April 15, 2025 and December 16, 2029. As of
December 31, 2019, options to purchase 3,334 shares of common stock issued to non-employees under the 2015 Plan were outstanding
and will expire on May 31, 2021. Taking into account all options and restricted stock granted under the 2015 Plan, there are 29,516
shares available for future grant under the 2015 Plan. Options currently outstanding are fully vested or will vest upon a combination
of the following: immediate vesting, performance-based vesting or straight-line vesting of two or four years. Of the 896,260 options
outstanding as of December 31, 2019, 130,354 options vested on February 1, 2020 as specified performance criteria were met as
of December 31, 2019.
The
Company’s previously adopted and approved plan, the 2004 Stock Incentive Plan (“2004 Plan”), expired in the
year ended December 31, 2014. As of December 31, 2019, options to purchase 65,097 shares of common stock had been issued to employees
under the 2004 Plan and were outstanding. The options expire on various dates between January 8, 2020 and March 26, 2024. As of
December 31, 2019, 49,725 options had been issued to non-employees under the 2004 Plan and were outstanding. Such options expire
at various dates between March 24, 2021 and November 17, 2024. No shares are available for future grants under the 2004 Plan.
Options currently outstanding are fully vested.
Stock
Options
The
Company has elected to recognize forfeitures as they occur. Stock-based compensation expense recognized for the years ended December
31, 2019 and 2018 was approximately $867,000 and $525,000, respectively.
Approximately
$802,000 and $500,000 has been recognized in selling, general and administrative expenses on the consolidated statement of operations
and comprehensive loss for the years ended December 31, 2019 and 2018, respectively. Approximately $65,000 and $25,000 has been
recognized in research and development expenses on the consolidated statement of operations and comprehensive loss for the years
ended December 31, 2019 and 2018, respectively.
The
following table summarizes the option activity for the years ended December 31, 2019 and 2018:
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Outstanding at December 31, 2017
|
|
|
752,367
|
|
|
$
|
4.91
|
|
Options granted
|
|
|
126,952
|
|
|
|
5.57
|
|
Options forfeited or expired
|
|
|
(42,147
|
)
|
|
|
4.14
|
|
Options exercised
|
|
|
(11,111
|
)
|
|
|
2.70
|
|
Outstanding at December 31, 2018
|
|
|
826,061
|
|
|
$
|
5.04
|
|
Options granted
|
|
|
218,290
|
|
|
|
7.26
|
|
Options forfeited or expired
|
|
|
(29,103
|
)
|
|
|
6.72
|
|
Options exercised
|
|
|
(4,166
|
)
|
|
|
5.13
|
|
Outstanding at December 31, 2019
|
|
|
1,011,082
|
|
|
$
|
5.51
|
|
The
following table summarizes the options exercisable and vested and expected to vest as of December 31, 2019 and 2018:
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Exercisable at December
31, 2018
|
|
|
297,532
|
|
|
$
|
5.82
|
|
Vested and expected
to vest at December 31, 2018
|
|
|
795,406
|
|
|
$
|
5.10
|
|
Exercisable at December 31, 2019
|
|
|
551,948
|
|
|
$
|
5.20
|
|
Vested and expected
to vest at December 31, 2019
|
|
|
984,452
|
|
|
$
|
5.50
|
|
The
fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the below
assumptions for the risk-free interest rates, expected dividend yield, expected lives and expected stock price volatility.
|
|
Option
Pricing Assumptions
|
|
Grant
Year
|
|
2019
|
|
|
2018
|
|
Stock Price Volatility
|
|
|
81.73
|
%
|
|
|
92.42
|
%
|
Risk-Free Interest Rates
|
|
|
1.93
|
%
|
|
|
2.71
|
%
|
Expected Life (in years)
|
|
|
6.13
|
|
|
|
6.15
|
|
Expected Dividend Yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Expected
volatility is based on historical volatility of the Company’s common stock at the time of grant. The risk-free interest
rate is based on the U.S. Treasury yields in effect at the time of grant for periods corresponding with the expected life of the
options. For the expected life, the Company is using the simplified method as described in the SEC Staff Accounting Bulletin 107.
This method assumes that stock option grants will be exercised based on the average of the vesting periods and the option’s
life.
The
weighted-average fair value of options granted in 2019 and 2018 is $5.05 and $4.32, respectively. The aggregate intrinsic values
of stock options outstanding and stock options vested or expected to vest as of December 31, 2019 were approximately $4,532,000
and $4,423,000, respectively. A stock option has intrinsic value, at any given time, if and to the extent that the exercise price
of such stock option is less than the market price of the underlying common stock at such time. The weighted-average remaining
contractual life of options vested or expected to vest as of December 31, 2019 was 6.89 years.
During
the year ended December 31, 2019, stock options to purchase 4,166 shares of the Company’s common stock were exercised by
a member of management for proceeds of approximately $21,000, resulting in the issuance of 4,166 shares of the Company’s
common stock.
The
aggregate intrinsic values of stock options outstanding and of stock options vested or expected to vest as of December 31, 2018
were approximately $441,000 and $421,000, respectively. The weighted-average remaining contractual life of options vested or expected
to vest as of December 31, 2018 was 7.24 years.
During
the year ended December 31, 2018, stock options to purchase 11,111 shares of the Company’s common stock were exercised in
a cashless exercise, resulting in the issuance of 2,471 shares of the Company’s common stock.
As
of December 31, 2019, there was approximately $1,424,000 of total unrecognized compensation cost related to unvested share-based
compensation awards granted under the equity compensation plans which will be amortized over the weighted average remaining requisite
service period of 2.9 years.
Restricted
Stock
The
Company has issued restricted stock as compensation for the services of certain employees and non-employee directors. The grant
date fair value of restricted stock is based on the fair value of the common stock on the date of grant, and compensation expense
is recognized based on the period in which the restrictions lapse.
The
following table summarizes restricted stock activity for the years ended December 31, 2019 and 2018:
|
|
|
Shares
|
|
|
Weighted
Average
Grant Date
Fair Value
|
|
Nonvested
at December 31, 2017
|
|
|
|
88,821
|
|
|
$
|
4.50
|
|
Granted
|
|
|
|
49,890
|
|
|
|
5.58
|
|
Vested
|
|
|
|
(83,725
|
)
|
|
|
4.50
|
|
Forfeited
|
|
|
|
(5,096
|
)
|
|
|
4.50
|
|
Nonvested at December
31, 2018
|
|
|
|
49,890
|
|
|
|
5.58
|
|
Granted
|
|
|
|
55,111
|
|
|
|
8.57
|
|
Vested
|
|
|
|
(45,160
|
)
|
|
|
5.58
|
|
Forfeited
|
|
|
|
(4,730
|
)
|
|
|
5.58
|
|
Nonvested
at December 31, 2019
|
|
|
|
55,111
|
|
|
$
|
8.57
|
|
The
total fair value of restricted stock that vested during the years ended December 31, 2019 and 2018 was approximately $252,000
and $377,000, respectively.
Total
stock-based compensation expense for the restricted stock granted to employees and non-employee directors was approximately $451,000
and $460,000, respectively, for the years ended December 31, 2019 and 2018. Approximately $367,000 and $416,000 is included in
selling, general and administrative expenses on the accompanying consolidated statement of operations and comprehensive loss for
the years ended December 31, 2019 and 2018, respectively. Approximately $84,000 and $44,000 is included in research and development
expenses on the accompanying consolidated statement of operations and comprehensive loss for the years ended December 31, 2019
and 2018, respectively. As of December 31, 2019, there was approximately $52,000 of unrecognized compensation expense related
to the restricted stock awards, which is expected to be recognized over the next six months.
The
aggregate shares of common stock legally issued and outstanding as of December 31, 2019 is greater than the aggregate shares of
common stock outstanding for accounting purposes by the amount of unvested restricted shares.
SRP
Equity Incentive Plan
SRP’s
2019 Equity Incentive Plan was approved on May 7, 2019 under which 150,000 shares of SRP’s common stock are reserved for
the issuance of options and other awards. During the year ended December 31, 2019, SRP granted stock options to purchase 23,040
shares of common stock to its directors and one employee. These stock options are being expensed over the respective vesting period,
which is based on a service condition. The fair value of the stock options granted during the year ended December 31, 2019 was
approximately $88,000.
The
fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. The below weighted
average assumptions for the risk-free interest rates, expected dividend yield, expected lives and expected stock price volatility
were utilized for the stock options granted by SRP during the year ended December 31, 2019.
Weighted
Average Assumptions for Option Grants
|
|
|
|
Stock Price Volatility
|
|
|
92.4
|
%
|
Risk-Free Interest Rates
|
|
|
2.3
|
%
|
Expected Life (in years)
|
|
|
6.10
|
|
Expected Dividend Yield
|
|
|
-
|
%
|
Stock-based
compensation expense related to the SRP stock options was approximately $14,000 for the year ended December 31, 2019, respectively.
For the year ended December 31, 2019, approximately $4,000 and $10,000 are included in selling, general and administrative expenses
and research and development expenses, respectively, on the accompanying consolidated statement of operations and comprehensive
loss. Stock-based compensation expense related to the SRP stock options is presented by the Company as noncontrolling interest
on the consolidated balance sheet as of December 31, 2019.
Note
18 - Stockholders’ Equity
Reverse
Stock Split
On
July 9, 2019, the Company effected a reverse stock split, in which every nine shares of its common stock issued and outstanding
immediately prior to the effective time, which was 5:30 p.m. ET on July 9, 2019, were combined into one share of common stock.
Fractional shares were not issued and stockholders who otherwise would have been entitled to receive a fractional share as a result
of the reverse stock split received an amount in cash equal to $5.58 per share for such fractional interests. The number of shares
of Company common stock issued and outstanding was reduced from approximately 69,000,000 to approximately 7,700,000.
May
2019 Private Placement
On
May 15, 2019, the Company entered into a Stock Purchase Agreement with certain accredited investors identified therein pursuant
to which the Company issued and sold in a private placement 493,827 shares of the Company’s common stock resulting in gross
proceeds to the Company of approximately $2,000,000. The purchase price for each share was $4.05. Proceeds, net of equity issuance
costs of $8,000, recorded as a result of the private placement were approximately $1,992,000. Of the 493,827 shares of the Company’s
common stock issued, 12,346 shares, resulting in proceeds of approximately $50,000, were sold to a member of management.
April
2018 Private Placement
On
April 10, 2018, the Company entered into a Stock Purchase Agreement with certain accredited investors identified therein pursuant
to which the Company issued and sold in a private placement 726,735 shares of the Company’s common stock resulting in gross
proceeds to the Company of approximately $2,943,000. The purchase price for each share was $4.05. Proceeds, net of equity issuance
costs of $19,000, recorded as a result of the private placement were approximately $2,924,000. Of the 726,735 shares of the Company’s
common stock issued, 24,331 shares, resulting in proceeds of $98,550, were sold to members of management, including immediate
family members.
July
2015 Purchase Agreement and Registration Rights Agreement
On
July 24, 2015, the Company entered into both a securities purchase agreement and registration rights agreement with Lincoln Park
Capital Fund, LLC (“Lincoln Park”). Under the terms and subject to the conditions of the securities purchase agreement,
the Company had the right to sell to Lincoln Park, and Lincoln Park was obligated to purchase, up to $10.0 million in shares of
the Company’s common stock, subject to certain limitations, from time to time, over the 36-month period commencing on September
4, 2015. Pursuant to the securities purchase agreement, during the nine months ended September 30, 2018, the Company issued and
sold approximately 211,111 shares of its common stock to Lincoln Park. The issuance of the common shares to Lincoln Park resulted
in gross proceeds of $854,000 for the nine months ended September 30, 2018. The securities purchase agreement expired on September
4, 2018.
Noncontrolling
Interest
In
July 2018, the Company formed a new, wholly-owned subsidiary, SRP, to drive the development of its second-generation HDF system
and other products focused on improving therapies for patients with renal disease.
On
September 5, 2018, SRP entered into a Series A Preferred Stock Purchase Agreement with certain purchasers pursuant to which SRP
sold 600,000 shares of its Series A Preferred Stock (“Series A Preferred”) for $5.00 per share, or aggregate gross
proceeds of $3,000,000. SRP incurred transaction-related expenses of approximately $30,000, which were included in selling, general
and administrative expenses on the accompanying consolidated statement of operations and comprehensive loss for the year ended
December 31, 2018. The net proceeds from the issuance of the Series A Preferred are restricted to SRP expenses, and may not be
used for the benefit of the Company or other affiliated entities, except to reimburse for expenses directly attributable to SRP.
Following the Series A Preferred transaction, the Company retained a 62.5% ownership interest in SRP, holding 100% of the outstanding
common shares, and holders of Series A Preferred retained a 37.5% interest in SRP on a fully diluted basis, holding 100% of the
outstanding preferred shares. Of the 600,000 shares of Series A Preferred issued, the shares purchased by related parties comprised
of persons controlled by members of management and by Lambda Investors, LLC, the Company’s largest stockholder, amounted
to 18,000 and 400,000 shares, respectively.
Each
share of Series A Preferred is initially convertible into one share of SRP common stock, subject to adjustment for stock splits
and recapitalization events. Subject to customary exempt issuances, in the event SRP issues additional shares of its common stock
or securities convertible into common stock at a per share price that is less than the original Series A Preferred price, the
conversion price of the Series A Preferred will automatically be reduced to such lower price.
In
the event of any voluntary or involuntary liquidation, dissolution or winding up of SRP, the holders of the Series A Preferred
are entitled to be paid out of the assets of SRP available for distribution to its stockholders or, in the case of a deemed liquidation
event, out of the consideration payable to stockholders in such deemed liquidation event or the available proceeds, before any
payment is made to the holders of SRP common stock by reason of their ownership thereof, an amount per share equal to one times
(1x) the Series A Preferred original issue price, plus any accruing dividends accrued but unpaid thereon, whether or not declared,
together with any other dividends declared but unpaid thereon (the “Series A Liquidation Preference”). If upon any
such liquidation, dissolution or winding up of SRP or deemed liquidation event, the assets of SRP available for distribution to
its stockholders are insufficient to pay the Series A Liquidation Preference in full, the holders of Series A Preferred will share
ratably in any distribution of the assets available for distribution in proportion to the respective amounts which would otherwise
be payable in respect of the shares held by them upon such distribution if all amounts payable on or with respect to such shares
were paid in full. After the full payment of the Series A Liquidation Preference, the holders of the Series A Preferred and the
holders of common stock will share ratably in any remaining proceeds available for distribution on an as-converted to common stock
basis.
Each
share of Series A Preferred accrues dividends at the rate per annum of $0.40 per share. The accruing dividends accrue from day
to day, whether or not declared, and are cumulative and are payable only when, as, and if declared by the Board.
Holders
of Series A Preferred are entitled to cast the number of votes equal to the number of whole shares of common stock into which
the shares of Series A Preferred held by such holder are convertible as of the record date for determining stockholders entitled
to vote. Except as provided by law or by the other provisions, the holders of Series A Preferred vote together with the holders
of common stock as a single class. Notwithstanding the foregoing, for as long as at least 150,000 shares of Series A Preferred
are outstanding, SRP is required to obtain the affirmative vote or written consent of a majority of the Series A Preferred in
order to effect certain corporate transactions, including without limitation, the issuance of any securities senior to or on parity
with the Series A Preferred, a liquidation or deemed liquidation of SRP, amendments to SRP’s charter documents, the issuance
of indebtedness in excess of $250,000, any annual budget for the Company’s operations, and the hiring or firing of any executive
officers of SRP. In addition, the holders of the Series A Preferred are entitled to elect two members of SRP’s board of
directors.
The
noncontrolling interest in SRP held by holders of the Series A Preferred has been classified as equity on the accompanying consolidated
balance sheet, as the noncontrolling interest is redeemable only upon the occurrence of events that are within the control of
the Company.
Warrants
The
Company accounts for stock warrants as either equity instruments or derivative liabilities depending on the specific terms of
the warrant agreement. As of December 31, 2019 and 2018, all of the Company’s outstanding warrants are classified as equity.
The
following table summarizes certain terms of all of the Company’s outstanding warrants at December 31, 2019 and 2018:
|
|
|
|
|
|
Exercise
|
|
|
Total
Common
Shares Issuable as of
December 31,
|
|
Title
of Warrant
|
|
Date
Issued
|
|
Expiry
Date
|
|
Price
|
|
|
2019
|
|
|
2018
|
|
Equity-classified warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 2015 – private
placement warrants
|
|
5/18/2015
|
|
5/18/2020
|
|
$
|
7.65
|
|
|
|
89,438
|
|
|
|
101,917
|
|
June 2016 – Note and Warrant Agreement
|
|
6/7/2016
|
|
6/7/2021
|
|
$
|
2.70
|
|
|
|
127,121
|
|
|
|
253,790
|
|
March 2017 –
private placement warrants
|
|
3/22/2017
|
|
3/22/2022
|
|
$
|
2.70
|
|
|
|
162,365
|
|
|
|
382,363
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
378,924
|
|
|
|
738,070
|
|
The
weighted average exercise price of the outstanding warrants was $3.87 as of December 31, 2019 and $3.38 as of December 31, 2018.
Warrants
Exercised During 2019 and 2018
During
the year ended December 31, 2019, warrants to purchase 359,146 shares of the Company’s common stock were exercised, resulting
in proceeds of approximately $731,000 and the issuance of 327,351 shares of the Company’s common stock. Of the warrants
exercised during the year ended December 31, 2019, warrants to purchase 111,114 shares of the Company’s common stock were
exercised in a cashless exercise, resulting in the issuance of 79,316 shares of the Company’s common stock. Of the warrants
exercised during the year ended December 31, 2019, warrants to purchase 4,444 shares of the Company’s common stock were
exercised by members of management, resulting in proceeds of approximately $12,000.
During
the year ended December 31, 2018, warrants to purchase 50,739 shares of the Company’s common stock were exercised, resulting
in proceeds of approximately $138,000 and the issuance of 50,739 shares of the Company’s common stock. Of the warrants exercised
during the year ended December 31, 2018, warrants to purchase 8,147 shares of the Company’s common stock were exercised
by members of management, resulting in proceeds of approximately $22,000.
Note
19 – Savings Incentive Match Plan
On
January 1, 2017, the Company established a Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA),
which covers all employees. The SIMPLE IRA Plan provides for voluntary employee contributions up to statutory IRA limitations.
The Company matches 100% of employee contributions to the SIMPLE IRA Plan, up to 3% of each employee’s salary. The Company
contributed and expensed approximately $69,000 and $52,000 to this plan in 2019 and 2018, respectively.
Note
20 - Commitments and Contingencies
Purchase
Commitments
In
exchange for the rights granted under the License and Supply Agreement with Medica (see Note 10 – License and Supply Agreement,
net), the Company agreed to make certain minimum annual aggregate purchases from Medica over the term of the License and Supply
Agreement. For the year ended December 31, 2019, the Company agreed to make minimum annual aggregate purchases from Medica of
€3,000,000 (approximately $3,400,000). For the year ended December 31, 2019, the Company’s aggregate purchase commitments
totaled approximately €5,699,000 (approximately $6,382,000).
Contractual
Obligations and Commercial Commitments
The
following table summarizes the Company’s approximate minimum contractual obligations and commercial commitments as of December
31, 2019:
|
|
Payments
Due in Period
|
|
|
|
Total
|
|
|
Within
1
Year
|
|
|
Years
2 - 3
|
|
|
Years
4
- 5
|
|
|
More
than
5
Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum
Purchase Commitments1
|
|
$
|
24,000,000
|
|
|
$
|
3,500,000
|
|
|
$
|
7,600,000
|
|
|
$
|
8,400,000
|
|
|
$
|
4,500,000
|
|
Leases2
|
|
|
1,339,000
|
|
|
|
339,000
|
|
|
|
662,000
|
|
|
|
338,000
|
|
|
|
-
|
|
Total
|
|
$
|
25,339,000
|
|
|
$
|
3,839,000
|
|
|
$
|
8,262,000
|
|
|
$
|
8,738,000
|
|
|
$
|
4,500,000
|
|
1
Reflects minimum purchase commitments pursuant to the License and Supply agreement with Medica.
2
In addition to lease obligations for office space, these obligations include a lease for various office equipment which
expires in 2020 and an automobile lease which expires in 2021. See Note 14 – Leases for further discussion.
Note
21 – Segment Reporting
The
Company has defined its two reportable segments as Water Filtration and Renal Products. The Water Filtration segment develops
and sells high performance liquid purification filters. The Renal Products segment is focused on the development of medical device
products for patients with renal disease, including a second-generation hemodiafiltration system, for the treatment of patients
with ESRD.
The
Company’s chief operating decision maker evaluates the financial performance of the Company’s segments based upon
segment revenues, gross margin and operating expenses which include research and development and selling, general and administrative
expenses.
The
accounting policies for the Company’s segments are the same as those described in Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” of this
Annual Report on Form 10-K and Note 2 – Summary of Significant Accounting Policies.
The
tables below present segment information reconciled to total Company loss from operations, with segment operating loss including
gross profit less direct research and development expenses and direct selling, general and administrative expenses to the extent
specifically identified by segment:
|
|
Year
Ended December 31, 2019
|
|
|
|
Water
Filtration
|
|
|
Renal
Products
|
|
|
Nephros,
Inc.
Consolidated
|
|
Total
net revenues
|
|
$
|
10,334,000
|
|
|
$
|
-
|
|
|
$
|
10,334,000
|
|
Gross margin
|
|
|
6,084,000
|
|
|
|
-
|
|
|
|
6,084,000
|
|
Research and development expenses
|
|
|
1,717,000
|
|
|
|
1,373,000
|
|
|
|
3,090,000
|
|
Depreciation and amortization expense
|
|
|
186,000
|
|
|
|
-
|
|
|
|
186,000
|
|
Selling, general and administrative
expenses
|
|
|
5,960,000
|
|
|
|
159,000
|
|
|
|
6,119,000
|
|
Change in fair
value of contingent consideration
|
|
|
(156,000
|
)
|
|
|
-
|
|
|
|
(156,000
|
)
|
Total operating
expenses
|
|
|
7,707,000
|
|
|
|
1,532,000
|
|
|
|
9,239,000
|
|
Loss from operations
|
|
$
|
(1,623,000
|
)
|
|
$
|
(1,532,000
|
)
|
|
$
|
(3,155,000
|
)
|
|
Year Ended December 31, 2018
|
|
|
Water
Filtration
|
|
|
Renal
Products
|
|
|
Nephros,
Inc. Consolidated
|
|
Total
net revenues
|
|
$
|
5,687,000
|
|
|
$
|
-
|
|
|
$
|
5,687,000
|
|
Gross margin
|
|
|
3,203,000
|
|
|
|
-
|
|
|
|
3,203,000
|
|
Research and development expenses
|
|
|
808,000
|
|
|
|
731,000
|
|
|
|
1,539,000
|
|
Depreciation and amortization expense
|
|
|
163,000
|
|
|
|
-
|
|
|
|
163,000
|
|
Selling, general
and administrative expenses
|
|
|
4,340,000
|
|
|
|
177,000
|
|
|
|
4,517,000
|
|
Total operating
expenses
|
|
|
5,311,000
|
|
|
|
908,000
|
|
|
|
6,219,000
|
|
Loss from operations
|
|
$
|
(2,108,000
|
)
|
|
$
|
(908,000
|
)
|
|
$
|
(3,016,000
|
)
|
As
of December 31, 2019, approximately $945,000 of total assets are in the Renal Products segment. The $945,000 consists primarily
of the remaining cash received of approximately $733,000 from the sale of Series A Preferred during the year ended December 31,
2019 and prepaid expenses and other current assets of approximately $200,000.
As
of December 31, 2018, approximately $2,500,000 of total assets are in the Renal Products segment. The $2,500,000 consisted of
the remaining cash received of approximately $2,300,000 from the sale of Series A Preferred during the year ended December 31,
2018 and prepaid expenses and other current assets of approximately $200,000.
Note
22 – Subsequent Event
On
January 31, 2020, the Company announced the sale of 937,500 shares of common stock through a confidentially marketed underwritten
public offering at a price of $8.00 per share. The transaction closed on February 4, 2020 with aggregate proceeds of $7,500,000
and net proceeds after underwriting discounts and offering expenses of approximately $6,765,000. The shares were offered pursuant
to an effective shelf registration statement on Form S-3 (File No. 333-234528) that was previously filed with the Securities and
Exchange Commission and declared effective on December 6, 2019.