UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(MARK ONE)
[x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2005
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from_______ to__________
Commission file number 001-32288
NEPHROS, INC.
________________________________________________________________________________
(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 13-3971809
------------------------------- -----------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
3960 Broadway
New York, NY 10032
-------------------------------------------
(Address of Principal Executive Offices)
(212) 781-5113
-------------------------------------------
(Registrant's telephone number,
including area code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES [X] NO [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Class Outstanding at August 2, 2005
------------------------------ -----------------------------
Common Stock, $.001 par value 12,304,498
Transitional Small Business Disclosure Format: YES [ ] NO [X]
NEPHROS, INC. AND SUBSIDIARY
Table of Contents
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 2005 and December 31, 2004 3
Condensed Consolidated Statements of Operations for
the Three and Six Months Ended June 30, 2005 and 2004 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2005 and 2004 5
Condensed Statement of Changes in Stockholders'
Equity (Deficit) for the Six Months Ended June 30, 2005
and for the Year Ended December 31, 2004 6
Notes to the Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis or Plan of Operations 9
Item 3. Controls and Procedures 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 17
Item 4. Submission of Matters to a Vote by Security Holders 17
Item 5. Other Information 18
Item 6. Exhibits 18
SIGNATURES 19
2
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements.
NEPHROS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2005 2004
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,817,064 $ 3,719,181
Short-term investments 5,996,560 5,995,940
Accounts receivable 219,720 174,797
Inventory 528,125 653,351
Prepaid expenses and other current assets 370,408 468,355
------------ ------------
Total current assets 9,931,877 11,011,624
Property and equipment, at cost less accumulated depreciation
of $739,719 and $584,130 at June 30, 2005 and December 31, 2004,
respectively 1,148,751 1,191,856
Other assets 3,822 3,822
------------ ------------
Total assets $ 11,084,450 $ 12,207,302
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 709,769 $ 629,814
Accrued expenses 517,517 362,789
Deferred revenue 21,031 64,058
Accrued liabilities 1,500,000 1,500,000
------------ ------------
Total current liabilities 2,748,317 2,556,661
------------ ------------
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000 and 31,000,000
shares authorized at June 30, 2005 and December 31,
2004, respectively; no shares issued and outstanding
at June 30, 2005 and December 31, 2004 -- --
Common stock, $.001 par value; 25,000,000 and 49,000,000
shares authorized at June 30, 2005 and December 31,
2004, respectively; 12,304,498 and 12,120,248 shares
issued and outstanding at June 30, 2005 and December 31, 2004,
respectively 12,304 12,120
Additional paid-in capital 54,739,869 53,740,171
Deferred compensation (2,188,424) (2,479,317)
Accumulated other comprehensive income (loss) -
foreign currency translation (24,250) 156,433
Accumulated other comprehensive loss - unrealized losses
on available-for-sale securities (3,440) (4,060)
Accumulated deficit (44,199,926) (41,774,706)
------------ ------------
Total stockholders' equity 8,336,133 9,650,641
------------ ------------
Total liabilities and stockholders' equity $ 11,084,450 $ 12,207,302
============ ============
See accompanying notes to the condensed consolidated financial statements.
3
NEPHROS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ---------------------------
2005 2004 2005 2004
------------ ------------ ------------ -----------
Net contract revenues $ -- $ -- $ 1,750,000 $ --
Net product revenues 226,426 -- 378,091 --
------------ ------------ ------------ ------------
Net revenues 226,426 -- 2,128,091 --
------------ ------------ ------------ ------------
Operating costs and expenses:
Cost of product revenue 113,681 54,304 249,049 66,922
Research and development 551,009 601,992 1,013,710 1,292,016
Selling, general and administrative 1,656,533 1,024,307 3,409,021 2,340,743
------------ ------------ ------------ ------------
Total operating expenses 2,321,223 1,680,603 4,671,780 3,699,681
------------ ------------ ------------ ------------
Loss from operations (2,094,797) (1,680,603) (2,543,689) (3,699,681)
------------ ------------ ------------ ------------
Other income:
Interest income 62,464 570 118,469 1,915
------------ ------------ ------------ ------------
Total other income 62,464 570 118,469 1,915
------------ ------------ ------------ ------------
Net loss (2,032,333) (1,680,033) (2,425,220) (3,697,766)
Dividends and accretion to redemption value of redeemable
convertible preferred stock -- (2,680,087) -- (4,751,587)
Net loss attributable to common stockholders $ (2,032,333) $ (4,360,120) $ (2,425,220) $ (8,449,353)
============ ============ ============ ============
Basic and diluted net loss attributable to common
stockholders per common share $ (0.17) $ (2.74) $ (0.20) $ (5.30)
============ ============ ============ ============
Shares used in computing basic and diluted net
loss attributable to common stockholders per common share 12,304,498 1,593,659 12,228,151 1,593,659
============ ============ ============ ============
See accompanying notes to the condensed consolidated financial statements.
4
NEPHROS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six months ended June 30,
-------------------------------
2005 2004
------------ ------------
Operating activities
Net loss $(2,425,220) $(3,697,766)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 155,589 71,554
Noncash stock-based compensation 290,893 417,608
(Increase) decrease in operating assets
Accounts receivable (44,923) (24,113)
Prepaid expenses and other current assets 97,947 (542,764)
Inventory 125,226 98,799
Increase (decrease) in operating liabilities
Accounts payable and accrued expenses 234,683 (165,507)
Deferred revenue (43,027) 38,830
----------- -----------
Net cash used in operating activities (1,608,832) (3,803,359)
----------- -----------
Investing activities
Purchase of property and equipment (112,484) (481,042)
----------- -----------
Net cash used in investing activities (112,484) (481,042)
----------- -----------
Financing activities
Proceeds from issuance of preferred stock, net -- 3,811,538
Proceeds from exercise of warrants -- 87,500
Proceeds from private placement issuance of common
stock subsequent to the initial public offering 955,521 --
Adjustment to proceeds from initial public offering
of common stock 44,361 --
----------- -----------
Net cash provided by financing activities 999,882 3,899,038
----------- -----------
Effect of exchange rates on cash (180,683) (38,397)
----------- -----------
Net decrease in cash and cash equivalents (902,117) (423,760)
Cash and cash equivalents, beginning of period 3,719,181 4,121,263
----------- -----------
Cash and cash equivalents, end of period $ 2,817,064 $ 3,697,503
=========== ===========
Supplemental disclosure of cash flow information
Cash paid for income taxes $ 11,630 $ 723
See accompanying notes to the condensed consolidated financial statements.
5
NEPHROS, INC. AND SUBSIDIARY
CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
(unaudited)
Series A
Preferred Stock Common Stock Stock
--------------- ------------ Subscription Deferred
Shares Amount Shares Amount Receivable Compensation
------ ------ ------ ------ ---------- ------------
Balance, January 1, 2004 4,000,000 $ 4,000 1,593,659 $ 1,594 $ -- $ (2,049,940)
Comprehensive loss:
Net loss -- -- -- -- -- --
Net unrealized gains
on foreign currency
translation -- -- -- -- -- --
Net unrealized losses on
available-for-sale
securities -- -- -- -- -- --
Comprehensive loss
Noncash stock-based
compensation -- -- -- -- -- (1,223,133)
Beneficial conversion
recognized in connection
with issuance of preferred
stock -- -- -- -- -- --
Amortization of deferred
compensation -- -- -- -- -- 793,756
Cumulative preferred
dividend and accretion -- -- -- -- -- --
Exercise of warrants 87,500 88 -- -- -- --
Issuance of common stock
in connection with
initial public offering -- -- 2,100,000 2,100 -- --
Conversion of preferred
stock into common stock
upon initial public
offering (4,087,500) (4,088) 8,426,589 8,426 -- --
------------ ------------ ------------ ------------ -------- ------------
Balance, December 31, 2004 -- -- 12,120,248 12,120 -- (2,479,317)
Comprehensive loss:
Net loss -- -- -- -- -- --
Net unrealized losses
on foreign currency
translation -- -- -- -- -- --
Net unrealized gains
on available-for-sale
securities -- -- -- -- -- --
Comprehensive loss
Amortization of deferred
compensation -- -- -- -- -- 290,893
Adjustment to issuance
of common stock in
connection with initial
public offering -- -- -- -- -- --
Issuance of common stock
in connection with
private placement -- -- 184,250 184 -- --
------------ ------------ ------------ ------------ -------- ------------
Balance, June 30, 2005 -- $ -- 12,304,498 $ 12,304 $ -- $ (2,188,424)
============ ============ ============ ============ ======== ============
NEPHROS, INC. AND SUBSIDIARY
CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
(unaudited)
Accumulated
Additional Other
Paid-in Comprehensive Accumulated
Capital Income Deficit Total
---------- ------------- ------------- ------------
Balance, January 1, 2004 $ 19,005,356 $ 100,337 $(22,443,693) $ (5,382,346)
Comprehensive loss:
Net loss -- -- (7,596,480) (7,596,480)
Net unrealized gains
on foreign currency
translation -- 56,096 -- 56,096
Net unrealized losses on
available-for-sale
securities -- (4,060) -- (4,060)
----------
Comprehensive loss (7,544,444)
Noncash stock-based
compensation 1,223,133 -- -- --
Beneficial conversion
recognized in connection
with issuance of preferred
stock 3,811,538 -- -- 3,811,538
Amortization of deferred
compensation -- -- -- 793,756
Cumulative preferred
dividend and accretion -- -- (11,734,533) (11,734,533)
Exercise of warrants 87,412 -- -- 87,500
Issuance of common stock
in connection with
initial public offering 10,732,486 -- -- 10,734,586
Conversion of preferred
stock into common stock
upon initial public
offering 18,880,246 -- -- 18,884,584
------------ ------------ ------------ ------------
Balance, December 31, 2004 53,740,171 152,373 (41,774,706) 9,650,641
Comprehensive loss:
Net loss -- -- (2,425,220) (2,425,220)
Net unrealized losses
on foreign currency
translation -- (180,683) -- (180,683)
Net unrealized gains
on available-for-sale
securities -- 620 -- 620
----------
Comprehensive loss (2,605,283)
Amortization of deferred
compensation -- -- -- 290,893
Adjustment to issuance
of common stock in
connection with initial
public offering 44,361 -- -- 44,361
Issuance of common stock
in connection with
private placement 955,337 -- -- 955,521
------------ ------------ ------------ ------------
Balance, June 30, 2005 $ 54,739,869 $ (27,690) $(44,199,926) $ 8,336,133
============ ============ ============ ============
See accompanying notes to the condensed consolidated financial statements.
6
NEPHROS, INC. AND SUBSIDIARY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the periods ended June 30, 2005 and 2004
(unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Nephros, Inc. and its wholly owned subsidiary, Nephros International, Limited,
(together the "Company") should be read in conjunction with the audited
financial statements and notes thereto as of and for the year ended December 31,
2004 included in the Company's Annual Report on Form 10-KSB filed with the
Securities and Exchange Commission (the "SEC") on March 31, 2005. The
accompanying financial statements have been prepared in accordance with
accounting principles generally accepted in the United States ("GAAP") for
interim financial information and in accordance with the instructions to Form
10-QSB. Accordingly, since they are interim statements, the accompanying
financial statements do not include all of the information and notes required by
GAAP for a complete financial statement presentation. In the opinion of
management, the interim financial statements reflect all adjustments consisting
of normal, recurring adjustments that are necessary for a fair presentation of
the financial position, results of operations and cash flows for the interim
periods presented. Interim results are not necessarily indicative of results for
a full year.
Effective January 1, 2005, as a result of the product sales generated to date
from the Company's OLpurTM MD190 dialyzer, as well as the license agreement
signed on March 2, 2005 between the Company and Asahi Kasei Medical Co., Ltd.
("Asahi") (see Note 2), management has determined that the Company is no longer
in the development stage as defined in Financial Accounting Standards Board
("FASB") Statement No. 7, Accounting and Reporting for Development Stage
Companies. All references to cumulative statement of operations, stockholder's
equity (deficit), and statements of cash flows have been eliminated in the
accompanying financial statements.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and the accompanying notes. Actual results could differ
from those estimates.
2. Summary of Significant Accounting Policies
Revenue Recognition
Revenue is recognized in accordance with SEC Staff Accounting Bulletin ("SAB")
No. 104, Revenue Recognition. SAB No. 104 requires that four basic criteria must
be met before revenue can be recognized: (i) persuasive evidence of an
arrangement exists; (ii) delivery has occurred or services have been rendered;
(iii) the fee is fixed and determinable; and (iv) collectibility is reasonably
assured.
The Company's sales history does not yet provide a basis from which to
reasonably estimate rates of product return, and therefore revenues from certain
shipments during the three and six months ended June 30, 2005 were deferred.
Product sales are recognized thirty days after the date of shipment, when the
right of product return expires. In addition, cost of revenue to the extent of
amount billed was deferred and will be recognized when the revenue is
recognized.
On March 2, 2005, the Company entered into an agreement with Asahi, a business
unit of Asahi Kasei Corporation, granting Asahi exclusive rights to manufacture
and distribute filter products based on the Company's OLpur MD190 hemodiafilter
in Japan for 10 years commencing when the first such product receives Japanese
regulatory approval. In exchange for these rights, the Company received an up
front license fee in the amount of $1,750,000, and the Company is entitled to
receive additional royalties and milestone payments based on the future sales of
products in Japan, which sales are subject to Japanese regulatory approval.
Because (i) the license agreement requires no continuing involvement in the
manufacture and delivery of the licensed product in the covered territory of
Japan; (ii) the criteria of SAB No. 104 have been met; and (iii) the license fee
received is non-refundable, the Company recognized $1,750,000 in contract
revenue on the effective date of the license agreement.
Stock-based Compensation
The Company accounts for non-employee stock-based awards in which goods or
services are the consideration received for the equity instruments issued based
on the fair value of the equity instruments issued in accordance with the
Emerging Issues Task Force ("EITF") 96-18, "Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction With
Selling, Goods or Services."
7
The Company accounts for stock-based compensation to employees under the
intrinsic-value-based method of accounting prescribed by Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and
discloses the effect of the differences which would result had the Company
applied the fair-value-based method of accounting on a pro forma basis, as
required by Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation." Had compensation expense for stock
options granted under the Nephros 2000 Equity Incentive Plan (the "2000 Plan")
and the Nephros, Inc. 2004 Stock Incentive Plan (the "2004 Plan") been
determined based on fair value at the grant dates, the Company's net loss and
net loss per share for the three and six months ended June 30, 2005 and 2004
would have been as follows:
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -------------------------
2005 2004 2005 2004
---- ---- ---- ----
Net loss attributable to common stockholders:
As reported $ (2,032,333) $(4,360,120) $(2,425,220) $(8,449,353)
Less - compensation recognized under the
intrinsic-value method 123,564 -- 290,893 417,608
Add - compensation under the fair value method (264,504) (126,054) (513,866) (488,150)
------------- ----------- ----------- -----------
Pro forma $ (2,173,273) $(4,486,175) $(2,648,193) $(8,519,895)
============= =========== =========== ===========
Net loss per share:
As reported $ (0.17) $ (2.74) $ (0.20) $ (5.30)
Pro forma $ (0.18) $ (2.82) $ (0.22) $ (5.34)
Comprehensive Loss
The Company complies with the provisions of SFAS No. 130, "Reporting
Comprehensive Income," which requires companies to report all changes in equity
during a period, except those resulting from investment by owners and
distributions to owners, for the period in which they are recognized.
Comprehensive income (loss) is the total of net income (loss) and all other
non-owner changes in equity (or other comprehensive income (loss)) such as
unrealized gains or losses on securities classified as available-for-sale and
foreign currency translation adjustments. For the three months ended June 30,
2005 and 2004, the comprehensive loss was $2,128,367 and $1,687,553,
respectively. For the six months ended June 30, 2005 and 2004, the comprehensive
loss was $2,605,283 and $3,736,162, respectively.
Income (Loss) per Common Share
In accordance with SFAS No. 128, "Earnings Per Share," net loss per common
share amounts ("basic EPS") were computed by dividing net loss attributable to
common stockholders by the weighted-average number of common shares outstanding
and excluding any potential dilution. Net loss per common share amounts assuming
dilution ("diluted EPS") is generally computed by reflecting potential dilution
from conversion of convertible securities and the exercise of stock options and
warrants. However, because their effect is antidilutive, the Company has
excluded stock options and warrants exercisable to purchase in the aggregate
2,314,857 and 9,715,200 common shares from the computation of diluted EPS for
both the three and six month periods ended June 30, 2005 and 2004, respectively.
3. Stockholders' Equity
On March 2, 2005, the Company entered into a Subscription Agreement with Asahi
pursuant to which Asahi purchased 184,250 shares of the Company's common stock
at an aggregate purchase price of $955,521. The Subscription Agreement contains
certain transfer restrictions with respect to the shares purchased thereunder.
Effective June 24, 2005, the Company's stockholders approved and adopted our
Fourth Amended and Restated Certificate of Incorporation, reducing the number of
authorized shares of common stock from 49,000,000 to 25,000,000, and reducing
the number of authorized shares of preferred stock from 31,000,000 to 5,000,000.
4. Commitments and Contingencies
In August 2002, the Company entered into a subscription agreement with Lancer
Offshore, Inc ("Lancer"). The subscription agreement provided, among other
things, that Lancer would purchase, in several installments, (1) $3,000,000
principal amount of secured notes due March 15, 2003 convertible into 340,920
shares of the Company's common stock, and (2) warrants to purchase until
December 2007, an aggregate of 68,184 shares of the Company's common stock at an
exercise price of approximately $8.80 per share. In accordance with the
subscription agreement, the first installments, consisting of $1,500,000
principal amount of the notes and 34,092 of the warrants, were tendered.
However, Lancer failed to fund the remaining installments. Following this
failure, the Company entered into a settlement agreement with Lancer dated as of
January 31, 2003, pursuant to which: (i) the parties terminated the subscription
agreement; (ii) Lancer agreed to surrender 12,785 of the
8
original 34,092 warrants issued to it; (iii) the warrants that were not
surrendered were amended to provide that the exercise price per share and the
number of shares issuable upon exercise thereof would not be adjusted as a
result of a 0.2248318-for-one reverse stock split of the Company's common stock
that was contemplated at such time but never consummated; and (iv) the secured
convertible note in the principal amount of $1,500,000 referred to above was
cancelled. Lancer agreed, among other things, to deliver to the Company at or
prior to a subsequent closing the cancelled note and warrants and to reaffirm
certain representations and warranties and, subject to the satisfaction of these
and other conditions, the Company agreed to issue to Lancer at such subsequent
closing an unsecured note in the principal amount of $1,500,000 bearing no
interest, not convertible into common stock and due on January 31, 2004 or
earlier under certain circumstances. Lancer never fulfilled the conditions to
the subsequent closing and, accordingly, the Company never issued the $1,500,000
note that the settlement agreement provided would be issued at such closing.
The above transaction resulted in the Company becoming a defendant in an
action captioned Marty Steinberg, Esq. as Receiver for Lancer Offshore, Inc. v.
Nephros, Inc., Case No. 04-CV-20547, pending in the U.S. District Court for the
Southern District of Florida (the "Ancillary Proceeding"). That action is
ancillary to a proceeding captioned Securities and Exchange Commission v.
Michael Lauer, et. al., Case No.03-CV-80612, also pending in the U.S. District
Court for the Southern District of Florida, in which the court has appointed a
Receiver to manage Lancer and various related entities (the "Receivership"). In
the Ancillary Proceeding, the Receiver seeks payment of $1,500,000 together with
interest, costs and attorneys' fees as well as delivery of a warrant evidencing
the right to purchase until December 2007 an aggregate of 75,000 shares of the
Company's common stock for $2.50 per share (or 21,308 shares of the Company's
common stock for $8.80 per share, if adjusted for the 0.2841-for-one reverse
stock split effected by the Company on September 10, 2004 pursuant to the
antidilution provisions of such warrant, as amended), that the Receiver alleges
are due as a result of the Company's settlement agreement with Lancer. The
Company believes that it has valid defenses to the Receiver's claims, and it
intends to continue to contest them vigorously. Additionally, the Company has
asserted claims for damages against Lancer that exceed the amount sought in the
Ancillary Proceeding by submitting a proof of claim in the Receivership. During
the second quarter of 2005, both the Company and the Receiver filed motions for
summary judgment in the Ancillary Proceeding. The Company has discussed the
potential settlement of all claims with the Receiver, however, there can be no
assurance that the Company will settle or that the outcome of any of these
proceedings will be successful.
5. Reverse Stock Split
On September 10, 2004, the Company effected a reverse stock split pursuant to
which each share of its common stock then outstanding was converted into 0.2841
of one share of its common stock. All share and per share amounts for all
periods presented preceding September 10, 2004 have been retroactively restated
to give effect to this reverse stock split.
Item 2. Management's Discussion and Analysis or Plan of Operation.
The following discussion and analysis of our consolidated financial condition
and results of operations should be read in conjunction with our unaudited
consolidated financial statements and related notes included in this quarterly
report on Form 10-QSB (this "Quarterly Report") and the audited financial
statements and notes thereto as of and for the year ended December 31, 2004
included in our Annual Report on Form 10-KSB filed with the SEC on March 31,
2005. Operating results are not necessarily indicative of results that may occur
in future periods.
Business Overview
We were founded in 1997 by health professionals, scientists and engineers to
develop hemodiafiltration, or HDF, products and technologies for treating
patients with End Stage Renal Disease, or ESRD. Our products include the OLpur
MD190, a dialyzer that incorporates our proprietary Mid-Dilution Diafiltration
technologies designed for use with existing HDF platforms, OLpur HD190, a
high-flux dialyzer designed for use with either hemodialysis or HDF machines,
OLpurTM H2H, an add-on module designed to enable HDF therapy using the most
common types of hemodialysis machines, and the OLpurTM NS2000 system, a
stand-alone HDF machine with associated filter technology. We began selling our
OLpur MD190 dialyzer in some or all of Cyprus, Denmark, France, Germany, Greece,
Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland
and the United Kingdom (our "Target European Market") in March 2004. In June
2005 we received approval from the FDA to market our OLpur(TM) HD190 high flux
filter in the U.S. While we do not expect the Olpur(TM)HD190 to offer a
substantial sales opportunity in the foreseeable future, we believe that the FDA
approval of the Olpur(TM) HD190 is an important step in the regulatory process
to gain approval for our more advanced ESRD therapies in the U.S. We have also
developed prototypes for our OLpur H2H product and are developing our OLpur
NS2000 product in conjunction with an established machine manufacturer in Italy.
We are working with this manufacturer to modify an existing HDF platform they
currently offer for sale in parts of our Target European Market, incorporating
our proprietary H2H technology.
The following trends, events and uncertainties may have a material impact on
our potential sales, revenue and income from operations:
(1) the completion and success of additional clinical trials and of our
regulatory approval processes for each of our products in our target
territories;
9
(2) the market acceptance of HDF therapy in the United States and of our
technologies and products in each of our target markets;
(3) our ability to effectively and efficiently manufacture, market and
distribute our products;
(4) our ability to sell our products at competitive prices which exceed
our per unit costs; and
(5) the consolidation of dialysis clinics into larger clinical groups.
To the extent we are unable to succeed in accomplishing (1) through (4), our
sales could be lower than expected and dramatically impair our ability to
generate income from operations. With respect to (5), the impact could either be
positive, in the case where dialysis clinics consolidate into independent
chains, or negative, in the case where competitors acquire these dialysis
clinics and use their own products, as competitors have historically tended to
use their own products in clinics they have acquired.
Financial Operations Overview
Revenue
We began sales of our first product in March 2004. Accordingly, our sales
history does not yet provide a basis from which to reasonably estimate rates of
product return, if any. Consequently, and until we are able to estimate rates of
return, if any, more effectively, we do not recognize revenue from these sales
until the rights of return have expired.
On March 2, 2005, we entered into an agreement with Asahi, granting Asahi
exclusive rights to manufacture and distribute filter products based on our
OLpur MD190 hemodiafilter in Japan for 10 years commencing when the first such
product receives Japanese regulatory approval. In exchange for these rights, we
received an up front license fee in the amount of $1,750,000, and we are
entitled to receive additional royalties and milestone payments based on the
future sales of products in Japan, which sales are subject to Japanese
regulatory approval. Because (i) the license agreement requires no continuing
involvement in the manufacture and delivery of the licensed product in the
covered territory of Japan, (ii) the criteria of SAB No. 104 have been met, and
(iii) the license fee received is non-refundable, the Company recognized
$1,750,000 in contract revenue on the effective date of the license agreement.
Cost of Product Revenue
Cost of product revenue represents our acquisition cost for the products we
purchase from our third party manufacturers, as well as damaged and obsolete
inventory written off. Since our sales history does not yet provide a basis from
which to reasonably estimate rates of product return, we defer cost of goods
sold to the extent of amounts billed to customers until the rights of return
have expired.
Research and Development
Research and development expenses consist of costs incurred in identifying,
developing and testing product candidates. These expenses consist primarily of
salaries and related expenses for personnel, fees of our scientific and
engineering consultants and related costs, clinical studies, machine and product
parts and software and product testing. We expense research and development
costs as incurred.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of sales and
marketing expenses as well as personnel and related costs for general corporate
functions, including finance, accounting, legal, human resources, facilities and
information systems expense.
We expect our expense from sales, marketing and customer service activities,
including costs of distributing samples and expenses related to marketing
clinical trials, to increase in future periods. These increases are a result of
our plan to seek greater market penetration with our OLpur MD190 within our
Target European Market and to enter additional markets and introduce additional
products once we obtain the requisite regulatory approvals. We also anticipate
increases in general and administrative expenses for insurance, professional
services, investor relations and other activities associated with operating as a
publicly-traded company.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with GAAP. The preparation of financial statements in
accordance with GAAP requires application of management's subjective judgments,
often requiring the need to make estimates about the effect of matters that are
inherently uncertain and may change in subsequent periods. Our actual results
may differ substantially from these estimates under different assumptions or
conditions. While our significant accounting policies are described in more
detail in the notes to consolidated financial statements included in this
10
Quarterly Report and in our Annual Report on Form 10-KSB, we believe that the
following accounting policies require the application of significant judgments
and estimates.
Revenue Recognition
Revenue is recognized in accordance with SAB No. 104, Revenue Recognition. SAB
No. 104 requires that four basic criteria must be met before revenue can be
recognized: (i) persuasive evidence of an arrangement exists; (ii) delivery has
occurred or services have been rendered; (iii) the fee is fixed and
determinable; and (iv) collectibility is reasonably assured. We began sales of
our first product in March 2004. Accordingly, our sales history does not yet
provide a basis from which to reasonably estimate rates of product return, if
any. Consequently, and until we can estimate rates of return, if any, more
effectively, we do not recognize revenue from these sales until the rights of
return have expired.
We enter into licensing arrangements with other parties whereby we receive
contract revenue based on the terms of the agreement. The timing of revenue
recognition is dependent on the level of our continuing involvement in the
manufacture and delivery of licensed products. If we have continuing
involvement, the revenue is deferred and recognized on a straight-line basis
over the period of continuing involvement. In addition, if the licensing
arrangements require no continuing involvement and payments are merely based on
the passage of time, we will assess such payments for revenue recognition under
the collectibility criteria of SAB No. 104.
Accrued Expenses
We are required to estimate accrued expenses as part of our process of
preparing financial statements. This process involves identifying services which
have been performed on our behalf, and the level of service performed and the
associated cost incurred for such service as of each balance sheet date in our
financial statements. Examples of areas in which subjective judgments may be
required include costs associated with services provided by contract
organizations for the preclinical development of our products, the manufacturing
of clinical materials, and clinical trials, as well as legal and accounting
services provided by professional organizations. In connection with such service
fees, our estimates are most affected by our understanding of the status and
timing of services provided relative to the actual levels of services incurred
by such service providers. The majority of our service providers invoice us
monthly in arrears for services performed. In the event that we do not identify
certain costs, which have begun to be incurred, or we under- or over-estimate
the level of services performed or the costs of such services, our reported
expenses for such period would be too low or too high. The date on which certain
services commence, the level of services performed on or before a given date and
the cost of such services are often determined based on subjective judgments. We
make these judgments based upon the facts and circumstances known to us in
accordance with GAAP.
Stock-Based Compensation
We account for non-employee stock-based awards in which goods or services are
the consideration received for the equity instruments issued based on the fair
value of the equity instruments issued in accordance with the EITF 96-18
"Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction With Selling, Goods or Services."
During December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
which requires companies to measure and recognize compensation expense for all
stock-based payments at fair value. Stock-based payments include stock option
grants. We grant options to purchase common stock to our employees and directors
under various plans at prices equal to the fair market value of the stock on the
dates the options were granted. SFAS No. 123R is effective for small business
issuers the first interim reporting period beginning after December 15, 2005.
Accordingly, we will adopt SFAS No. 123R commencing with the quarter ending
March 31, 2006.
We account for stock-based compensation to employees under the
intrinsic-value-based method of accounting prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and disclose the effect of the
differences which would result had we applied the fair-value-based method of
accounting on a pro forma basis, as required by SFAS No. 123, "Accounting for
Stock-Based Compensation."
We have elected to follow APB Opinion No. 25 and related interpretations in
accounting for our employee stock options because the alternative fair value
accounting provided for under SFAS No. 123, Accounting for Stock-Based
Compensation, or SFAS No. 123, as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure," requires use of option
valuation models that were not developed for use in valuing employee stock
options. Employee stock compensation expense, which is a non-cash charge, is
measured as the excess, if any, of the fair value of our underlying common stock
at the date of grant over the amount an employee must pay to acquire such stock.
This compensation cost is either amortized over the related vesting periods, or
expensed upon the reaching of certain Company milestones.
Plan of Operation
Based on our cash flow projections, we expect that our existing cash resources
will be sufficient to satisfy our cash needs, with no further financing
required, to obtain positive cash flow. However, if our sales do not meet our
projections or our expenses exceed our expectations,
11
then we may need to raise additional funds through additional public or private
offerings of our securities. In such event, if we are unable to raise additional
funds on a timely basis or at all, any progress with respect to our products,
and, therefore, our potential revenues, would be adversely affected. Even if we
generate no revenues, we believe our existing cash resources will be sufficient
to satisfy our cash needs, with no further financing required through the second
quarter of 2006.
We intend to focus our research and development efforts during the next 12
months on:
o advancing our OLpur H2H product development in order to eventually
apply for regulatory approval for the OLpur H2H product in the
European Community which we have targeted for the first quarter of
2006;
o advancing our OLpur H2H product development in order to eventually
apply for regulatory approval for the OLpur H2H and the OLpur MD190 in
the United States which we have targeted for the second half of 2006;
and
o advancing our OLpur NS2000 product development in conjunction with our
dialysis machine manufacturer in order to eventually obtain regulatory
approval in the European Community and in the United States in 2006.
We intend to focus our sales and marketing efforts over the next 12 months
primarily on expanding our marketing of OLpur MD190 in our Target European
Market, and on continuing our marketing clinical studies on the OLpur MD190 to
provide definitive demonstration of the OLpur MD190's superior efficacy,
including four such studies we have already initiated in our Target European
Market.
Over the next 12 months, we currently expect to spend approximately: $1.2
million for the marketing and sales of our OLpur MD190 product, including
marketing clinical studies, product sampling and exhibiting at trade shows;
$200,000 to continue our product engineering to complete our clinical grade
OLpur H2H product; $700,000 in costs associated with operating as a publicly
traded company, such as professional and insurance fees; and $800,000 to conduct
clinical studies and pursue U.S. regulatory approvals with respect to both our
OLpur MD190 and our OLpur H2H products.
In June 2005, we amended our supply agreement with our fiber supplier,
Membrana GmbH. Pursuant to the amended agreement, Membrana will be our exclusive
provider of the fiber for the OLpur MD190 in the European Union as well as
certain other territories through September 2009. Notwithstanding the
exclusivity provisions, we may purchase membranes from other providers if
Membrana is unable to timely satisfy our orders, or if Membrana cannot offer us
a price that is competitive with offers from other providers. If and when the
volume-discount pricing provisions of our agreement with Membrana become
applicable, for each period we will record inventory and cost of goods sold for
our fiber orders pursuant to our agreement with Membrana GmbH based on the
volume-discounted price level applicable to the actual year-to-date cumulative
orders at the end of such period. If, at the end of any subsequent period in the
same calendar year, actual year-to-date cumulative orders entitle us to a
greater volume-discount for such calendar year, then we will adjust inventory
and cumulative cost of goods sold amounts quarterly throughout the calendar year
to reflect the greater volume-discount.
Our European customer service and financial operations center is located in
Dublin, Ireland. Our sales staffs are based in various parts of our Target
European Market. We have a clinical services staff that provides customer
support and training. We intend to add one to three members to our sales staff
as well as one to two members to our administrative or our clinical services
staff in our Target European Market. We intend to make these staff additions as
we expand our presence in our Target European Market and such expansion is
currently in process.
Results of Operations
Fluctuations in Operating Results
Our results of operations have fluctuated significantly from period to period
in the past and are likely to continue to do so in the future. We anticipate
that our quarterly results of operations will be impacted for the foreseeable
future by several factors including the progress and timing of expenditures
related to our research and development efforts, as well as marketing expenses
related to product launches. Due to these fluctuations, we believe that the
period to period comparisons of our operating results are not a good indication
of our future performance.
Three Months Ended June 30, 2005 Compared to the Three Months Ended June 30,
2004
Revenues
Revenues increased to $226,426 for the three months ended June 30, 2005 from
$0 for the three months ended June 30, 2004. Revenues for the three months ended
June 30, 2005 represented $226,426 in receivables with respect to sales of our
OLpur MD190 product to customers in our Target European Market where the rights
of return have expired. We made no shipments of our products in the three months
ended June 30, 2004.
12
Cost of Product Revenue
Cost of product revenue increased to $113,681 for the three months ended June
30, 2005 from $54,304 for the three months ended June 30, 2004. Cost of product
revenue represented the cost of our OLpur MD190 product sold to customers in our
Target European Market where the rights of return have expired as well as
obsolete inventory written-off due to the incorporation of improved fiber into
our dialyzers. Cost of product revenue increased because of increased sales of
our OLpur MD190 product where the rights of return have expired during the three
months ended June 30, 2005.
Research and Development
Research and development expenses decreased to $551,009 for the three months
ended June 30, 2005 from $601,992 for the three months ended June 30, 2004. This
$50,983 decrease was primarily due to a decrease in development expenses related
to our OLpur H2H product of approximately $42,000 due to a reduced number of
hours spent on the project by our outside developers.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $1,656,533 for the
three months ended June 30, 2005 from $1,024,307 for the three months ended June
30, 2004. This $632,226 increase was primarily due to an increase of
approximately $335,000, in personnel costs due to the hiring of sales and sales
support personnel in our Target European Market as well as senior management
personnel in the United States, approximately $75,000 in expenses related to
marketing trials of our OLpur MD190, an increase in product sampling of
approximately $90,000 in our Target European Market and approximately $118,000
in expenses associated with being a public company, including legal, accounting
and insurance expenses. We anticipate increases to selling, general and
administrative expenses in future periods as we plan to seek greater market
penetration of our OLpur MD190 within our Target European Market and to enter
additional markets and introduce additional products once we obtain the
requisite regulatory approvals. We also expect to continue to incur costs for
insurance and professional fees associated with operating as a public company
that we did not have prior to our initial public offering in September 2004.
Other Income
Our other income increased to $62,464 for the three months ended June 30, 2005
from $570 for the three months ended June 30, 2004. This $61,894 increase
represents increased interest income earned on cash deposits and short-term
investments as a result of higher balances of our cash and cash equivalents and
short-term investments at June 30, 2005.
Dividends and Accretion to Redemption Value of Redeemable Convertible Preferred
Stock
Dividends and accretion to redemption value of redeemable convertible
preferred stock decreased to $0 for the three months ended June 30, 2005 from
$2,680,087 for the three months ended June 30, 2004. This decrease is due to the
conversion of our redeemable convertible preferred stock into common stock in
conjunction with the completion of our initial public offering in September
2004.
Six Months Ended June 30, 2005 Compared to the Six Months Ended June 30, 2004
Revenues
Revenues increased to $2,128,091 for the six months ended June 30, 2005 from
$0 for the six months ended June 30, 2004. Revenues for the six months ended
June 30, 2005 represented licensing revenues of $1,750,000 resulting from our
agreement with Asahi and $378,091 in receivables with respect to sales of our
OLpur MD190 product to customers in our Target European Market where the rights
of return have expired. Although we began sales of our product during the six
months ended June 30, 2004, revenues related to such sales were deferred since
rights of return on our product had not yet expired.
Cost of Product Revenue
Cost of product revenue increased to $249,049 for the six months ended June
30, 2005 from $66,922 for the six months ended June 30, 2004. Cost of product
revenue represented the cost of our OLpur MD190 product sold to customers in our
Target European Market where the rights of return have expired as well as
obsolete inventory written-off due to the incorporation of improved fiber into
our dialyzers.
13
Research and Development
Research and development expenses decreased to $1,013,710 for the six months
ended June 30, 2005 from $1,292,016 for the six months ended June 30, 2004. This
$278,306 decrease was primarily due to a decrease in development expenses of
approximately $235,000 related to our OLpur H2H product due to a reduced number
of hours spent on the project by our outside developers, as well as a decrease
in salaries expense of approximately $50,000 due to the reduction in deferred
compensation expense in the period ended June 30, 2005.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $3,409,021 for the
six months ended June 30, 2005 from $2,340,743 for the six months ended June 30,
2004. This $1,068,278 increase was primarily due to an increase of approximately
$353,000 in personnel costs due to the hiring of sales and sales support
personnel in our Target European Market as well as senior management personnel
in the United States, approximately $104,000 in expenses related to marketing
trials of our OLpur MD190, an increase in product sampling of approximately
$196,000 in our Target European Market, approximately $277,000 in expenses
associated with being a public company, including legal, accounting and
insurance expenses, and approximately $41,000 in expenses related to the
improvement of the manufacturing of our OLpur MD190. We anticipate increases to
selling, general and administrative expenses in future periods as we plan to
seek greater market penetration of our OLpur MD190 within our Target European
Market and to enter additional markets and introduce additional products once we
obtain the requisite regulatory approvals. We also expect to continue to incur
costs for insurance and professional fees associated with operating as a public
company that we did not have prior to our initial public offering in September
2004.
Other Income
Our other income increased to $118,469 for the six months ended June 30, 2005
from $1,915 for the six months ended June 30, 2004. This $116,554 increase
represents increased interest income earned on cash deposits and short-term
investments as a result of higher balances of our cash and cash equivalents and
short-term investments at June 30, 2005.
Dividends and Accretion to Redemption Value of Redeemable Convertible Preferred
Stock
Dividends and accretion to redemption value of redeemable convertible
preferred stock decreased to $0 for the six months ended June 30, 2005 from
$4,751,587 for the six months ended June 30, 2004. This decrease is due to the
conversion of our redeemable convertible preferred stock into common stock in
conjunction with the completion of our initial public offering in September
2004.
Liquidity and Capital Resources
At June 30, 2005, we had a deficit accumulated of $44.2 million, and we expect
to incur additional losses in the foreseeable future at least until such time,
if ever, that we manufacture and market our products profitably. We have
financed our operations since inception primarily through the private placements
of equity and debt securities, our initial public offering and from licensing
revenue received from Asahi in March 2005.
At June 30, 2005, we had approximately $2.8 million in cash and cash
equivalents and approximately $6.0 million in short-term investments. Net cash
used in operating activities was approximately $1.6 million for the six months
ended June 30, 2005 compared to approximately $3.8 million for the six months
ended June 30, 2004. The $2.2 million decrease in net cash used in operating
activities during the six months ended June 30, 2005 was primarily due to a
smaller net loss of approximately $1.3 million in the six months ended June 30,
2005 and a net increase in the adjustments in net operating assets of
approximately $1.0 million in the aggregate.
Net cash used in investing activities was $112,484 for the six months ended
June 30, 2005 compared to $481,042 for the six months ended June 30, 2004. This
decrease was due to a decreased amount of fixed asset purchases, mainly
manufacturing equipment, in the six months ended June 30, 2005.
Net cash provided by financing activities was approximately $1.0 million for
the six months ended June 30, 2005 compared to approximately $3.9 million for
the six months ended June 30, 2004. The net cash provided by financing
activities in the six months ended June 30, 2005 was primarily due to the net
proceeds of approximately $956,000 from Asahi in exchange for 184,250 shares of
our common stock pursuant to a Subscription Agreement dated March 2, 2005. The
net cash provided by financing activities in the six months ended June 30, 2004
was primarily due to the net proceeds raised from the issuance of Series D
convertible preferred stock.
We expect to put our current capital resources to the following uses:
o for the marketing and sales of our products;
14
o to complete certain clinical studies, obtain appropriate regulatory
approvals and expand our research and development with respect to our
products;
o to continue our product engineering;
o to pay a former supplier, Plexus Services Corp., amounts due under our
settlement agreement; and
o for working capital purposes, including for additional salaries and
wages as our organization grows and as we expand our presence in our
Target European Market and establish operations in the United States
and other markets, and for additional professional fees and expenses
and other operating costs.
We have consumed substantial amounts of capital since our inception. We
currently expect our long-term future liquidity source to be gross margins
generated from sales of our products. Nonetheless, we believe our existing
resources would be sufficient to fund our currently planned operations through
the first half of 2006, even if we were not to generate any gross revenues from
sales of our products. Our future liquidity sources and requirements will depend
on many factors, including:
o the market acceptance of our products, and our ability to effectively
and efficiently produce and market our products;
o the timing and costs associated with obtaining the Conformite
Europeene, or CE, mark, which demonstrates compliance with the
relevant European Union requirements and is a regulatory prerequisite
for selling our products in the European Union and certain other
countries that recognize CE marking (for products other than our OLpur
MD190, for which the CE mark was obtained in July 2003), or United
States regulatory approval;
o the continued progress in and the costs of clinical studies and other
research and development programs;
o the costs associated with manufacturing scale-up;
o the costs involved in filing and enforcing patent claims and the
status of competitive products; and
o the cost of litigation, including potential patent litigation and
actual, current and threatened litigation.
Our forecast of the period of time through which our financial resources will
be adequate to support our operations is a forward-looking statement that
involves risks and uncertainties, and actual results could vary materially. In
the event that our plans change, our assumptions change or prove inaccurate, or
if our existing cash resources, together with other funding resources including
anticipated sales of our products, otherwise prove to be insufficient to fund
our operations, we could be required to seek additional financing. We have no
current arrangements with respect to sources of additional financing.
Safe Harbor for Forward-Looking Statements
This report contains certain "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995, as amended.
Such statements include statements regarding the efficacy and intended use of
our technologies under development, the timelines for bringing such products to
market and the availability of funding sources for continued development of such
products and other statements that are not historical facts, including
statements which may be preceded by the words "intends," "may," "will," "plans,"
"expects," "anticipates," "projects," "predicts," "estimates," "aims,"
"believes," "hopes," "potential" or similar words. For such statements, we claim
the protection of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance, are
based on certain assumptions and are subject to various known and unknown risks
and uncertainties, many of which are beyond our control. Actual results may
differ materially from the expectations contained in the forward-looking
statements. Factors that may cause such differences include the risks that:
o products that appeared promising in research or clinical trials to us
may not demonstrate anticipated efficacy, safety or cost savings in
subsequent pre-clinical or clinical trials;
o we may not obtain appropriate or necessary governmental or regulatory
approvals to achieve our business plan;
o product orders may be cancelled, patients currently using our products
may cease to do so and patients expected to begin using our products
may not;
15
o we may not be able to obtain funding if and when needed;
o we may encounter unanticipated internal control deficiencies or
weaknesses or ineffective disclosure controls and procedures;
o HDF therapy may not be accepted in the United States and/or our
technology and products may not be accepted in current or future
target markets, which could lead to failure to achieve market
penetration of our products;
o we may not be able to sell our products at competitive prices or
profitably;
o we may not be able to secure or enforce adequate legal protection,
including patent protection, for our products;
o FDA approval relating to our OLpur HD190 filter may not facilitate or
have any effect on the regulatory approval process for our other
products; and
o we may not be able to achieve sales growth in Europe or expand into
other key geographic markets.
More detailed information about us and the risk factors that may affect
the realization of forward-looking statements, including the forward-looking
statements in this Quarterly Report, is set forth in our filings with the SEC,
including our Annual Report on Form 10-KSB filed with the SEC for the fiscal
year ended December 31, 2004. We urge investors and security holders to read
those documents free of charge at the SEC's web site at www.sec.gov. We do not
undertake to publicly update or revise our forward-looking statements as a
result of new information, future events or otherwise.
Item 3. Controls and Procedures.
Prior to the filing of this Quarterly Report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of
the end of the period covered by this Quarterly Report. Disclosure controls and
procedures are designed to ensure that information required to be disclosed in
our periodic reports filed or submitted under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. Based upon that evaluation, our Chief Executive Officer
and our Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this Quarterly
Report. In conjunction with our preparation toward compliance with Section 404
of the Sarbanes-Oxley Act of 2002, we are in the process of implementing certain
enhancements with respect to our internal controls over financial reporting.
These matters are being discussed with our independent accountants and with the
Audit Committee of our Board of Directors. Management, including the Chief
Executive Officer and Chief Financial Officer, expects that these enhancements
will be in place by June 30, 2006.
An evaluation was also performed under the supervision and with the
participation of our management, including our Chief Executive Officer and our
Chief Financial Officer, of any change in our internal control over financial
reporting that occurred during our last fiscal quarter and that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. That evaluation did not identify any change in our
internal control over financial reporting that occurred during our latest fiscal
quarter and that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within the Company have been detected. The design of any system
of controls is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions.
16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
There have been no material developments in the pending legal proceedings as
described in our Form 10-KSB for the fiscal year ended December 31, 2004.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(b) Use of Proceeds from Registered Securities
The initial public offering of our common stock, par value $.001 (the
"Offering"), was effected through a Registration Statement on Form S-1 (File No.
333-116162) that was declared effective by the Securities and Exchange
Commission on September 20, 2004. From September 20, 2004 through June 30, 2005,
of the net $10.8 million of proceeds from the Offering, we had used:
approximately $1.8 million for the marketing and sales of our products;
approximately $1.0 million on product engineering; approximately $400,000 for
capital expenditures; approximately $350,000 on payments of preferred dividends;
and approximately $1.1 million for working capital and other purposes. As of
June 30, 2005, we held approximately $6.0 million of the remaining proceeds from
the Offering in short term investments and approximately $100,000 in cash and
cash equivalents. None of the expenses, or application of the net proceeds from
the Offering, were paid, directly or indirectly, to any of our directors or
officers (or their associates), to persons owning 10 percent or more of our
common stock or to any of our affiliates (other than directors' compensation and
salaries to officers arising out of normal operating activities, and payments of
dividends to former holders of shares of our series B, series C and series D
convertible preferred stocks).
Item 4. Submission of Matters to a Vote of Security Holders
2005 Annual Meeting
On June 23, 2005, we held our 2005 Annual Meeting of Stockholders (the "Annual
Meeting"). The holders of 9,399,387 shares of our common stock were present in
person or represented by proxy at the Annual Meeting. At the Annual Meeting, our
stockholders approved the following:
1. Election of Directors
Our stockholders elected the following persons to serve as directors for
terms of three years, or until their successors are duly elected and
qualified. Votes were cast as follows:
-----------------------------------------------------------------------------
Votes For Votes Withheld
-----------------------------------------------------------------------------
Howard Davis 9,367,187 32,200
-----------------------------------------------------------------------------
Bernard Salick, M.D. 9,376,187 23,200
-----------------------------------------------------------------------------
W. Townsend Ziebold, Jr. 9,374,187 25,200
-----------------------------------------------------------------------------
These three will join our other directors whose respective terms of office
continued beyond the Annual Meeting, namely, Norman J. Barta, Lawrence J.
Centella, Donald G. Drapkin, William J. Fox and Eric A. Rose, M.D.
2. Our stockholders approved and adopted our Fourth Amended and Restated
Certificate of Incorporation, which became effective on June 24, 2005.
Votes were cast as follows:
-------------------------------------------------------------------------
Votes For Votes Against Votes Abstained Broker Non-Votes
-------------------------------------------------------------------------
7,953,491 81,900 5,500 1,358,536
-------------------------------------------------------------------------
3. Our stockholders approved the amendment to our 2004 Stock Incentive Plan.
Votes were cast as follows:
-------------------------------------------------------------------------
Votes For Votes Against Votes Abstained Broker Non-Votes
-------------------------------------------------------------------------
7,928,151 101,200 11,500 1,358,536
-------------------------------------------------------------------------
17
4. Our stockholders approved the appointment of Deloitte & Touche LLP as our
independent registered public accounting firm for the fiscal year ending
December 31, 2005. Votes were cast as follows:
------------------------------------------------------------------
Votes For Votes Against Votes Abstained
------------------------------------------------------------------
9,390,587 3,500 5,300
------------------------------------------------------------------
Item 5. Other Information.
(a) In June 2005, we amended our supply agreement with our fiber supplier,
Membrana GmbH. Pursuant to the amended agreement, Membrana will be our exclusive
provider of the fiber for the OLpur MD190 in the European Union as well as
certain other territories through September 2009. Notwithstanding the
exclusivity provisions, we may purchase membranes from other providers if
Membrana is unable to timely satisfy our orders, or if Membrana cannot offer us
a price that is competitive with offers from other providers. If and when the
volume-discount pricing provisions of our agreement with Membrana become
applicable, for each period we will record inventory and cost of goods sold for
our fiber orders pursuant to our agreement with Membrana GmbH based on the
volume-discounted price level applicable to the actual year-to-date cumulative
orders at the end of such period. If, at the end of any subsequent period in the
same calendar year, actual year-to-date cumulative orders entitle us to a
greater volume-discount for such calendar year, then we will adjust inventory
and cumulative cost of goods sold amounts quarterly throughout the calendar year
to reflect the greater volume-discount.
Item 6. Exhibits.
3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant
(incorporated by reference to Exhibit 4.4 filed with the Company's
Registration Statement on Form S-8 (No. 333-127264) as filed with the SEC
on August 5, 2005)
10.1 Amendment No. 1 to Nephros, Inc. 2004 Stock Incentive Plan (incorporated by
reference to Exhibit 4.3 filed with the Company's Registration Statement on
Form S-8 (No. 333-127264) as filed with the SEC on August 5, 2005) (1)
10.2 Amended Supply Agreement between Nephros, Inc. and Membrana GmbH dated as
of June 16, 2005 (2)
31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section
1350, as adopted Cursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(1) Management contract or compensatory plan arrangement.
(2) Portions omitted pursuant to a request for confidential treatment.
18
SIGNATURES
In accordance with the requirements of the Securities Exchange Act, this
registrant caused this report to be signed below on its behalf by the
undersigned, thereunto duly authorized.
NEPHROS, INC.
Date: August 15, 2005 By /s/ NORMAN J. BARTA
------------------------------------
Norman J. Barta
President and Chief Executive Officer
(Principal Executive Officer)
Date: August 15, 2005 By /s/ MARC L. PANOFF
-------------------------------------
Marc L. Panoff
Chief Financial Officer
(Principal Financial and Accounting
Officer)
19
Exhibit Index
3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant
(incorporated by reference to Exhibit 4.4 filed with the Company's
Registration Statement on Form S-8 (No. 333-127264) as filed with the SEC
on August 5, 2005)
10.1 Amendment No. 1 to Nephros, Inc. 2004 Stock Incentive Plan (incorporated
by reference to Exhibit 4.3 filed with the Company's Registration
Statement on Form S-8 (No. 333-127264) as filed with the SEC on August 5,
2005) (1)
10.2 Amended Supply Agreement between Nephros, Inc. and Membrana GmbH dated as
of June 16, 2005 (2)
31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section
1350, as adopted Cursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(1) Management contract or compensatory plan arrangement.
(2) Portions omitted pursuant to a request for confidential treatment.
20