As filed with the Securities and Exchange Commission on January 16, 2003
Registration No. 333-100673
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 2
TO
FORM SB-2
REGISTRATION STATEMENT
Under The Securities Act Of 1933
NEPHROS, INC.
(Exact name of registrant as specified in its charter)
Delaware 3841 13-3971809
--------------------- ----------------------- ----------------------
(State or other (Primary Standard (IRS Employer
jurisdiction of Industrial Identification Number)
incorporation or Classification Code
organization) Number)
3960 Broadway
New York, New York 10032
(212) 781-5113
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
Norman J. Barta
President and Chief Executive Officer
3960 Broadway
New York, New York 10032
(212) 781-5113
(Name, address, including zip code, and telephone number, including area
code, of agent for service)
Copies of all communications to:
Peter Smith, Esq. Alan J. Schaeffer, Esq.
Monica Lord, Esq. McDermott, Will & Emery
Kramer Levin Naftalis & Frankel LLP 600 Thirteenth Street, N.W.
919 Third Avenue Washington DC 20005
New York, New York 10022 202-756-8000
(212) 715-9100
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the Registration Statement becomes effective.
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act of 1933, check the following box and
list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_|
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act of 1933, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act of 1933, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If delivery of the prospectus is expected to be made pursuant to Rule 434, check
the following box. |_|
CALCULATION OF REGISTRATION FEE
- ---------------------------------------------------------------------------------------------
Title of Each Class of Amount to be Proposed Proposed Maximum Amount of
Securities Registered Maximum Aggregate Registration Fee
to be Registered Offering Price Offering Price(1)
Per Share
- ---------------------------------------------------------------------------------------------
common stock, $.001 2,875,000 $7.00 $20,125,000(2) $1851.50
par value per share
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(1) Estimated solely for the purpose of calculating the amount of the
registration fee in accordance with Rule 457 under the Securities Act of
1933.
(2) Includes 375,000 shares of common stock which may be purchased by the
underwriters to cover over-allotments, if any.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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The information in this prospectus is not complete and may be changed.
These securities may not be sold until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
Subject to completion: dated January 16, 2003
PROSPECTUS
2,500,000 Shares
[GRAPHIC OMITTED][GRAPHIC OMITTED]
Common Stock
---------------------
Nephros, Inc. is offering 2,500,000 shares of its common stock.
This is our initial public offering. We have applied to have our common
stock approved for quotation on the American Stock Exchange LLC under the symbol
"NEP." The initial public offering price will be between $6.00 and $7.00 per
share.
---------------------
Investing in our common stock involves a high degree of risk. See
"Risk Factors" beginning on page 5.
---------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
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Per Share Total
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Public Offering Price (1).................... $6.00 $15,000,000
Underwriting Discounts and Commissions....... $0.53 $ 1,325,000
Proceeds to Nephros, Inc. (2)................ $5.47 $13,675,000
===============================================================================
(1) Information set forth in this table is based on an assumed initial public
offering price of $6.00 per share.
(2) Before deducting expenses of this offering which are estimated to be
$1,325,000.
The underwriters have an option to purchase up to an additional 375,000
shares of common stock from us to cover over-allotments. The underwriters are
offering the shares on a firm commitment basis. The underwriters expect to
deliver the shares to purchasers on or about ________, 2003.
GunnAllen Financial, Inc. THE SHEMANO GROUP, INC.
---------------------
The date of this prospectus is _____, 2003
[INSIDE FRONT COVER PAGE - DESCRIPTION OF ARTWORK]
The top left of the inside front cover contains a color photograph of two
OLpur(TM) MD190's, our disposable dialyzers for use with hemodiafiltration
machines. The following text appears to the right of the photograph: "OLpur(TM)
MD190 Our hollow fiber filter designed specifically for mid-dilution
hemodiafiltration."
The bottom right of the inside front cover contains a color photograph of the
OLpur(TM) H2H(TM), our add-on module that can convert a hemodialysis machine
into a hemodiafiltration-capable machine. The OLpur(TM) H2H(TM) in the
photograph contains our logo. The following text appears to the left of the
photograph "OLpur(TM) H2H(TM) H2H module can convert current dialysis machines
into hemodiafiltration-capable systems."
The bottom left of the inside front cover page contains our logo.
TABLE OF CONTENTS
Prospectus Summary...........................................................1
Risk Factors.................................................................6
Cautionary Note Regarding Forward Looking Statements........................15
Important Assumptions in this Prospectus....................................16
Use of Proceeds.............................................................18
Dividend Policy.............................................................18
Capitalization..............................................................19
Dilution....................................................................21
Selected Financial Information..............................................23
Management's Discussion and Analysis of Financial
Condition and Results of Operations......................................25
Business....................................................................29
Management..................................................................45
Certain Transactions........................................................51
Principal Stockholders......................................................53
Description of Securities...................................................55
Shares Eligible for Future Sale.............................................59
Underwriting................................................................61
Transfer Agent and Registrar................................................63
Legal Matters...............................................................63
Experts.....................................................................63
Disclosure of Commission Position on Indemnification
for Securities Act Liabilities..............................................63
Where You Can Find More Information.........................................63
Index to Financial Statements..............................................F-1
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this
prospectus. This summary is not complete and does not contain all the
information you should consider before buying shares of our common stock in this
offering. You should read this entire prospectus carefully, especially the
investment risks discussed under "Risk Factors."
NEPHROS, INC.
Company Background
We are a development stage medical device and technology company that was
founded in 1997 by health professionals, scientists and engineers affiliated
with Columbia University to develop cost-effective, improved products for End
Stage Renal Disease, or ESRD, therapy. We have not derived any revenues from our
operations, hold minimal assets and have incurred losses since our inception
primarily as a result of our research and development efforts. To date, we have
relied on private sales of our securities and loans from our shareholders to
fund operations.
Our goal is to develop and market technologies and products to improve the
efficacy of ESRD therapy and, ultimately, the health of ESRD patients and, at
the same time, address the financial needs of dialysis clinics and other
providers of ESRD therapy. We believe our products and technologies will
uniquely and effectively meet this goal.
We are incorporated under the laws of the State of Delaware. We maintain
our principal executive offices at 3960 Broadway, New York, New York 10032. Our
telephone number at that address is (212) 781-5113.
The Offering
Common stock offered by us 2,500,000 shares
Common stock to be outstanding 6,118,247 shares. This does not include:
after this offering
o 375,000 shares of common stock reserved
for issuance upon exercise of the
underwriters' over-allotment option;
o 250,000 shares of common stock reserved
for issuance upon exercise of the
underwriters' warrants;
o 783,876 shares of common stock
underlying stock options granted and
outstanding pursuant to our equity
incentive plan;
o 128,154 shares of common stock
underlying stock options to be granted
to our president and chief executive
officer pursuant to our equity
incentive plan prior to the
consummation of this offering;
o 30,000 shares of common stock
underlying stock options to be granted
to certain of our directors pursuant to
our equity incentive plan upon the
consummation of this offering;
o 134,899 shares of common stock issuable
upon exercise of warrants issued in
June 2002 to a former supplier. See
"Description of Securities -- Warrants"
and "Business -- Settlement Agreement;"
o 28,104 shares of common stock issuable
upon conversion of shares of our series
A preferred stock which are themselves
issuable upon exercise of warrants
issued to convertible note holders; or
o 770,000 shares of common stock which
may be issuable as part of the
Potential Lancer Share Issuance, which
is described in "Important Assumptions
in this Prospectus -- Certain
Convertible Notes have not been
Converted."
You should read the discussion under the
heading "Capitalization" for more
information regarding outstanding shares
of our common stock, warrants or options
to purchase our common stock. You should
also read the discussion under the heading
"Underwriting" for more information
regarding the underwriters' over-allotment
option and the discussion under the
heading "Important Assumptions in this
Prospectus" for information about certain
important assumptions we have made in this
prospectus.
1
We currently intend to use the net o marketing and sales;
proceeds of this offering for:
o clinical trials;
o regulatory approvals;
o research and development;
o payment of certain dividends on our
convertible stock;
o repayment of loans to a related party
and another lender;
o payment of amounts due under a
settlement agreement with a former
supplier;
o working capital; and
o general corporate purposes.
You should read the discussion under the
heading "Use of Proceeds" for more
information.
Proposed American Stock Exchange NEP
Symbol:
Our Business
We have developed a next-generation hemodiafiltration, or HDF, device and
related products and technologies for treating patients with ESRD. We are
focused on bringing these devices and technologies to market, initially in
western Europe and then in the United States and worldwide.
ESRD is the stage of advanced chronic kidney disease characterized by the
irreversible loss of kidney function. Healthy kidneys remove waste products and
excess water from the blood, thus preventing toxin buildup and fluid overload.
ESRD patients require either kidney transplantation or ongoing treatment in the
form of renal replacement therapy to perform these functions and to sustain
life. Because the shortage of compatible kidneys limits the transplantation
option, most ESRD patients must rely on renal replacement therapy for the
functions normally provided by a healthy kidney. Once all residual function of
the ESRD patient's kidneys has ceased, a patient must rely solely on
extracorporeal renal replacement therapies.
Existing extracorporeal renal replacement therapies currently include:
o Hemodialysis - the patient's blood is filtered through a
semi-permeable filter known as a dialyzer which allows for the
diffusion of waste products and excess water into a solution for
dialysis known as dialysate.
o Hemofiltration - the patient's blood is filtered through a
semi-permeable membrane, using a negative pressure similar to a
vacuum effect, or a convection process, to draw out solute particles
without using a dialysate solution.
o Hemodiafiltration (HDF) - combines the diffusion process of
hemodialysis with the convection process of hemofiltration to
eliminate waste products and excess water.
Currently, hemodialysis is the most widely used extracorporeal renal
replacement therapy. Hemodialysis removes excess water and some waste products
sufficiently to sustain life but fails, in our view, to address adequately the
long-term health and quality of life of the ESRD patient. According to an
article by H. Tang et al. in the Hong Kong Journal of Nephrology, published in
2001, the HDF process offers statistically significant improvement over
hemodialysis therapies by removing more larger toxins (known in the industry as
"middle molecules" because of their heavier molecular weight) at a faster rate.
Accordingly, we plan to focus on the HDF segment of the extracorporeal renal
replacement market. The dialyzer (also referred to as a "dialysis filter" or an
"artificial kidney") is the primary disposable component of ESRD therapy and is
used in hemodialysis and HDF. Our first product will be a disposable dialyzer
for use with HDF machines.
Our Technology
We have developed three products with our patented technology that we
believe will improve the HDF treatment efficacy beyond both hemodialysis and
current HDF therapies and, therefore, will encourage and facilitate HDF therapy
in dialysis clinics. Our goal is to introduce these new products to the market
over the next four years. We believe our technology and devices will:
2
o reduce hospitalization, medication and care costs;
o reduce patient drug requirements;
o improve blood pressure control for the dialysis patient; and
o potentially improve the patient's health generally and the patient's
overall quality of life.
Our Products
OLpurTM MD190: our disposable dialyzer for use with HDF machines. When
compared to existing HDF standards in laboratory bench studies conducted by
members of our research and development staff, the OLpurTM MD190 improves toxin
removal by over 80% for a range of toxins, and in particular, middle molecules.
Subject to receipt of regulatory approval in the European Union (which we
anticipate obtaining during the spring of 2003), we plan to begin selling the
OLpurTM MD190 in western Europe in the spring of 2003.
OLpurTM H2H(TM): an add-on module controlled by advanced software with a
simplified user interface that can convert a hemodialysis machine into an
HDF-capable machine. The combined systems can then be used to deliver HDF
therapy with the OLpurTM MD190. A prototype OLpurTM H2H(TM) module has been
developed and bench-tested in our laboratories by members of our research and
development staff; however, we must first obtain regulatory approval before
selling this product. We anticipate obtaining approval in the United States and
western Europe no earlier than the last quarter of 2003.
OLpur(TM) NS2000: our advanced standalone HDF machine and associated
filter technology that we believe will offer improved clinical performance for
the ESRD patient and will provide a substantial financial benefit to dialysis
clinics. A prototype OLpur(TM) NS2000 system has been developed and bench-tested
in our laboratories by members of our research and development staff, but we
must first obtain regulatory approval before selling this product. We anticipate
obtaining approval in the United States no earlier than the last quarter of
2005.
The Market
According to an article by M.J. Lysaght, Professor of Medical Science and
Engineering at Brown University, published in the Journal of American Society of
Nephrology in January 2002 (the "Lysaght Article"), as of mid-year 2001, the
number of ESRD patients worldwide was estimated to be over 1.1 million and the
size of this population has been expanding at a rate of approximately 7% per
year. According to the same article, the number of dialysis patients worldwide
is expected to be over two million by 2010, assuming current trends in ESRD
prevalence continue. Based on a report on the dialysis industry prepared by
Merrill Lynch & Co., Inc. in September 2001 (the "Merrill Report"), and by our
calculations, we estimate that of the dialysis patients worldwide, approximately
27% are in the United States, approximately 23% are in Europe and approximately
50% are in regions outside of the United States and Europe.
Pursuant to Frost & Sullivan's 1997 World Renal Replacement Therapies
Equipment and Supply Market Report (the "1997 Frost & Sullivan Report"), the
world hemodialysis dialyzer market was projected to be $3.53 billion and to be
growing at a rate of approximately 10.8% per year in 2002. Based on this report,
we project that the worldwide hemodialysis dialyzer market alone could reach $8
billion by 2010.
Our Marketing Strategy
We intend to generate market acceptance and market share for our products
through the following three-stage approach:
o Once we receive regulatory approval, we will introduce our OLpurTM
MD190 through dialysis clinics in western Europe because of the
prevalence in western Europe of the HDF process and HDF machines
that are compatible with the OLpurTM MD190 and because of the
enhanced opportunity for OLpurTM MD190 sales in western Europe;
dialyzers currently are used only once in European dialysis clinics
rather than reprocessed and reused.
o After introducing the OLpurTM MD190 in western Europe for existing
HDF machines, once we obtain regulatory approval, we intend to
introduce our OLpurTM H2H(TM) device to convert dialysis machines to
HDF-enabled, and therefore OLpurTM MD190-capable, units. We believe
the OLpurTM H2H(TM) will expand our OLpurTM MD190 market opportunity
in western Europe. We also intend to simultaneously introduce the
OLpurTM H2H(TM) and the OLpurTM MD190 in the United States as soon
as we receive the requisite FDA approval. We believe that these
product introductions will open the U.S. markets to the utilization
of HDF therapy.
o After we have acclimated dialysis clinics and patients to improved
HDF technology through our OLpurTM MD190 and OLpurTM H2H(TM)
products and after we have received the requisite regulatory
approval, we intend to introduce our OLpurTM NS2000 stand-alone HDF
system to provide an upgrade in treatment performance and
efficiency.
3
SUMMARY FINANCIAL DATA
The following summary financial data should be read in connection with,
and are qualified by reference to, the financial statements and related notes
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this prospectus. The statement of operations
data for the years ended December 31, 2001 and 2000 and the balance sheet data
as of December 31, 2001 are derived from our financial statements, which have
been audited by Grant Thornton LLP, independent auditors. The statement of
operations information for the period from our inception on April 3, 1997
through September 30, 2002 and for the nine-month periods ended September 30,
2002 and 2001 and the balance sheet data as of September 30, 2002 are derived
from our unaudited financial statements. In the opinion of management, all
necessary adjustments, consisting only of normal recurring accruals, have been
included to present fairly the unaudited interim results when read in
conjunction with the audited financial statements and notes thereto appearing in
this prospectus. Historical results are not necessarily indicative of results
that may be expected for any future period. All share and per share data give
effect to an amendment to our certificate of incorporation to be filed prior to
the commencement of this offering which, among other things, will effect a
reverse stock split pursuant to which each share of our common stock then
outstanding will be converted into 0.2248318 of one share of our common stock.
Statement of Operations Data
Nine months ended Year Ended
From
Inception to
September 30, September 30, September 30, December 31, December 31,
2002 2002 2001 2001 2000
------------ ------------ ------------ ----------- ------------
(Unaudited) (Unaudited)
Revenue - other $ 300,000 $ -- $ -- $ 300,000 $ --
Operating Expenses:
Research and development 9,612,072 614,043 655,112 737,858 4,781,708
General and administrative 3,954,077 691,419 479,827 652,828 854,315
------------ ------------ ------------ ------------ ------------
Loss from operations (13,266,149) (1,305,462) (1,134,939) (1,090,686) (5,636,023)
Other income, net 553,010 343,974 5,147 5,497 53,440
------------ ------------ ------------ ------------ ------------
Net loss (12,713,139) (961,488) (1,129,792) (1,085,189) (5,582,583)
Cumulative preferred dividends and accretion (755,000) (272,000) (228,000) (314,000) (169,000)
------------ ------------ ------------ ------------ ------------
Net loss attributable to common stockholders (13,468,139) (1,233,488) (1,357,792) (1,399,189) (5,751,583)
============ ============ ============ ============ ============
Net loss per share:
Basic and Diluted $ (0.98) $ (1.08) $ (1.11) $ (4.64)
============ ============ ============ ============
Weighted average shares outstanding:
Basic and Diluted 1,261,194 1,259,547 1,259,957 1,238,711
============ ============ ============ ============
Pro forma per share data (unaudited):
Pro forma net loss per share (1)
Basic and Diluted $ (0.27) $ (0.34) $ (0.33) $ (2.01)
============ ============ ============ ============
Pro forma weighted-average shares outstanding:
Basic and Diluted 3,500,487 3,275,882 3,308,706 2,778,533
============ ============ ============ ============
(1) Pro forma net loss per share gives effect to conversion of all mandatorily
convertible preferred stock (including accrued preferred dividends) into
common stock.
4
Balance Sheet Data
September 30, 2002
December 31, ---------------------------------
------------
2001 Actual Pro Forma (1)
------------ -------------
------------ (Unaudited)
Cash and cash equivalents $ 277,526 $ 483,808 $ 483,808
Working capital (deficiency) (1,756,838) (742,423) (742,423)
Total assets 394,624 1,053,516 1,053,516
Short-term debt, net (2) 105,000 760,000 760,000
Redeemable preferred stock 5,520,550 5,792,550 --
Stockholders' equity (deficit) (2) $(7,163,151) $(6,451,639) $ (659,089)
- ----------------------
(1) Gives effect to the conversion of all mandatorily convertible preferred
stock (including accrued preferred dividends) into common stock upon
completion of this initial public offering.
(2) Actual and pro forma information do not give effect to conversion of the
$1,500,000 convertible note issued to Lancer Offshore, Inc. (see
"Important Assumptions in this Prospectus - Certain Convertible Notes have
not been Converted").
5
RISK FACTORS
Investing in our common stock involves a high degree of risk. You should
carefully consider the following risk factors and all other information
contained in this prospectus before purchasing our common stock. The risks and
uncertainties described below are those that we currently believe may materially
affect our company. Additional risks and uncertainties may also impair our
business operations. If the following risks actually occur, our business,
financial condition and results of operations could be seriously harmed, the
trading price of our common stock could decline and you could lose all or part
of your investment.
Risks Related to Our Company
We have a history of operating losses and a significant accumulated deficit,
and we may not achieve or maintain profitability in the future.
We have not been profitable since our inception in 1997. As of September
30, 2002, we had an accumulated deficit of approximately $13.5 million primarily
as a result of our research and development expenses. We expect to continue to
incur additional losses for the foreseeable future as a result of a high level
of operating expenses, significant up-front expenditures, production and
marketing activities and very limited revenue from the sale of our products. We
may never realize significant revenues from the sale of our products or be
profitable. Our independent auditors have included an explanatory paragraph in
the financial statements attached to this prospectus expressing doubt as to our
ability to continue as a going concern. Factors that will influence the timing
and amount of our profitability include: (1) regulatory approval or clearance of
our products; (2) market acceptance of our products; (3) our ability to
effectively and efficiently manufacture, market and distribute our products; and
(4) our ability to sell our products at competitive prices which exceed our per
unit costs.
We cannot sell our products until we obtain the requisite regulatory
approvals and clearances in the countries in which we intend to sell our
products. If there is a significant delay in receiving such approvals, then
we may not be able to get our products to market and generate revenues.
Our business strategy depends in part on our ability to get our products
into the market as quickly as possible. We currently plan to launch our western
European sales efforts for the OLpurTM MD190 during the spring of 2003 and to
launch our United States sales efforts for the OLpurTM MD190 and the OLpurTM
H2H(TM) by the end of 2003. We cannot sell our products in western Europe until
we obtain the Conformite Europeenne, or CE, mark, which demonstrates compliance
with the relevant European Union requirements. We have not yet obtained the CE
mark for any of our products. Similarly, we cannot sell our products in the
United States until we receive U.S. Federal Drug Administration, or FDA,
clearance. Until we complete the requisite U.S. human clinical trials and submit
premarket notification to the FDA pursuant to section 510(k) of the Federal
Food, Drug, and Cosmetic Act, or the FDC Act, we will not be eligible for FDA
approval for any of our products.
In addition to the premarket notification required pursuant to section
510(k) of the FDC Act, the FDA could require us to obtain premarket approval of
our products under Section 515 of the FDC Act, either because of legislative or
regulatory changes or because the FDA does not agree with our determination that
we are eligible to use the Section 510(k) premarket notification process. The
Section 515 premarket approval process is a significantly more costly, lengthy
and uncertain approval process and could delay our products coming to market by
several years. See "Governmental Regulation - Food and Drug Administration" for
additional details about the approval process.
The clearance and/or approval process in the European Union and the United
States can be lengthy and uncertain and each requires substantial commitments of
our financial resources and our management's time and effort. We may not be able
to obtain regulatory approval in the European Union or the United States in a
timely manner or at all. Even if we do obtain regulatory approval for any of our
products, approval may be only for limited uses with specific classes of
patients, processes or other devices. Our failure to obtain, or delays in
obtaining, the necessary regulatory clearance and/or approvals in the European
Union and the United States would prevent us from selling our products in these
regions. If we cannot sell our products in these regions, or if we are delayed
in selling while awaiting the necessary clearance and/or approvals, we will not
be able to generate revenues from our products.
If we are successful in our initial marketing efforts in western Europe
and the United States, then we plan to market our products in several countries
outside of western Europe and the United States, including Japan, Korea, Canada
and Mexico. Requirements pertaining to the sale of medical devices vary widely
from country to country. It may be very expensive and difficult for us to meet
the requirements for the sale of our products in many of these countries. As a
result, we may not be able to obtain the required approvals in a timely manner,
if at all. If we cannot sell our products outside of western Europe and the
United States, then the size of our potential market could be reduced, which
would reduce our sales and revenues.
6
Any modifications we make to our products may require additional approvals or
clearances before the modified product may be marketed and significant delays
in marketing such products would negatively impact our revenues.
Changes to devices cleared for marketing under section 510(k) of the FDC
Act that could significantly affect safety and effectiveness will require
clearance of a notification pursuant to section 510(k) and we may need to submit
clinical and manufacturing comparability data to obtain such approval or
clearance. We would be prohibited from marketing the modified device until we
received FDA clearance or approval. We cannot guarantee that the FDA would
timely, if at all, clear or approve any modified product for which section
510(k) is applicable. Failure to obtain timely clearance or approval for changes
to marketed products would impair our ability to sell such products and generate
revenues.
We cannot assure you that our products will be safe or effective and we are
required under the FDC Act to report any product-related deaths or serious
injuries or product malfunctions that could result in deaths or serious injuries
and such reports could trigger other events that could have a material adverse
effect on our business, financial condition and results of operations.
We cannot assure you that our products will be safe or effective. Under
the FDC Act, we are required to submit medical device reports, or MDRs, to the
FDA to report device-related deaths, serious injuries and product malfunctions
that could result in death or serious injury if they were to recur. Depending on
their significance, MDRs could have a material adverse effect on our business,
financial condition and results of operations, as a result of the following:
o information contained in the MDRs could trigger FDA regulatory
actions such as inspections, recalls and patient/physician
notifications;
o since the reports are publicly available, MDRs could become the
basis for private lawsuits, including class actions; and
o if we fail to submit a required MDR to the FDA, the FDA could take
enforcement action against us.
If we violate any provisions of the FDC Act or any other statutes or
regulations, we could be subject to enforcement actions by the FDA or other
governmental agencies.
We face a significant compliance burden under the FDC Act and other
applicable statutes and regulations which govern the testing, labeling, storage,
record keeping, distribution, sale, marketing, advertising and promotion of our
products. If we violate the FDC Act or other regulatory requirements at any time
during or after the product development and/or approval process, we could be
subject to enforcement actions by the FDA or other agencies, including (1)
fines; (2) injunctions; (3) civil penalties; (4) recalls or seizures of our
products; (5) total or partial suspension of the production of our products; (6)
withdrawal of existing approvals or premarket clearances of our products; (7)
refusal to approve or clear new applications or notices relating to our
products; (8) recommendations by the FDA that we not be allowed to enter into
government contracts and (9) criminal prosecution, any of which could have a
material adverse effect on our business, financial condition and results of
operations.
We could be subject to additional government regulation, which would be
costly, time consuming and subject us to unanticipated delays, which would
delay our ability to generate revenues and be profitable.
Additional laws and regulations that are applicable to our business may be
enacted or promulgated, and the interpretation, application or enforcement of
the existing laws and regulations may change. We cannot predict the nature of
any future laws, regulations, interpretations, applications or enforcements or
the effect any of these would have on our business. Any future laws,
regulations, interpretations, applications or enforcements could delay or
prevent regulatory approval or clearance of our products and our ability to
market our products. Moreover, changes that result in our failure to comply with
the requirements of applicable laws and regulations could result in the types of
enforcement actions by the FDA and/or other agencies as described above, all of
which could impair our ability to have manufactured and to sell the affected
products. As we do not yet have any established market or customer base, our
company is particularly vulnerable to such delays and impediments. Our major
competitors are significantly better capitalized then we are and can more easily
withstand such delays. If we are not able to market our products within the
anticipated time frames, then we may not be profitable.
Protecting our intellectual property in our technology through patents may be
costly and ineffective and if we are not able to protect our intellectual
property, we may not be able to compete effectively and we may not be
profitable.
Our future success depends in part on our ability to protect the
intellectual property for our technology through patents. We will only be able
to protect our products and methods from unauthorized use by third parties to
the extent that our products and methods are covered by valid and enforceable
patents or are effectively maintained as trade secrets. Assuming all of the US
Patent and Trademark office fees are paid, our granted U.S. patents will remain
in force until 2019 and cover the "Method and Apparatus for Efficient
Hemodiafiltration," the "Two Stage Diafiltration Method and Apparatus," the
"Non-Isosmotic
7
Diafiltration System" and the "Dual Stage Hemodiafiltration Cartridge." Our U.S.
patent, for the "Method and Apparatus for Efficient Hemodiafiltration," and the
pending patent application, for the "Dual Stage Filtration Cartridge," have
claims that cover the OLpurTM MD190 product and the method of hemodiafiltration
employed in the operation of the product. Although there are pending
applications with claims to the present embodiments of the OLpurTM H2H(TM) and
the OLpur(TM) NS2000 products, these products are still in the design stage and
we cannot determine if the applications (or the patents that may issue on them)
will also cover the ultimate commercial embodiment of these products. See
"Business -Intellectual Property - Patents" for additional details about our
patents. The protection provided by our patents, and patent applications if
issued, may not be broad enough to prevent competitors from introducing similar
products into the market. Our patents, if challenged or if we attempt to enforce
them, may not be upheld by the courts of any jurisdiction. Numerous publications
may have been disclosed by, and numerous patents may have been issued to, our
competitors and others relating to methods of dialysis of which we are not aware
and additional patents relating to methods of dialysis may be issued to our
competitors and others in the future. If any of those publications or patents
conflict with our patent rights, or cover our products, then any or all of our
patent applications could be rejected and any or all of our granted patents
could be invalidated, either of which could materially adversely affect our
competitive position.
Litigation and other proceedings relating to patent matters, whether
initiated by us or a third party, can be expensive and time consuming,
regardless of whether the outcome is favorable to us, and may require the
diversion of substantial financial, managerial and other resources. An adverse
outcome could subject us to significant liabilities to third parties or require
us to cease any related development product sales or commercialization
activities. In addition, if patents that contain dominating or conflicting
claims have been or are subsequently issued to others and the claims of these
patents are ultimately determined to be valid, we may be required to obtain
licenses under patents of others in order to develop, manufacture use, import
and/or sell our products. We may not be able to obtain licenses under any of
these patents on terms acceptable to us, if at all. If we do not obtain these
licenses, we could encounter delays in, or be prevented entirely from using,
importing, developing, manufacturing, offering or selling any products or
practicing any methods, or delivering any services requiring such licenses.
If we file patent applications or obtain patents in foreign countries, we
will be subject to laws and procedures that differ from those in the United
States, which could lead to some uncertainty about the level and extent of our
patent protection. Moreover, patent protection in foreign countries may be
different from patent protection under U.S. laws and may not be as favorable to
us.
If we are not able to protect our trade secrets through enforcement of our
confidentiality and non-competition agreements, then we may not be able to
compete effectively and we may not be profitable.
We attempt to protect our trade secrets, including the processes,
concepts, ideas and documentation associated with our technologies, through the
use of confidentiality agreements and non-competition agreements with our
current employees and with other parties to whom we have divulged such trade
secrets. If the employees or other parties breach our confidentiality agreements
and non-competition agreements or if these agreements are not sufficient to
protect our technology or are found to be unenforceable, our competitors could
acquire and use information that we consider to be our trade secrets and we may
not be able to compete effectively. Most of our competitors have substantially
greater financial, marketing, technical and manufacturing resources than we have
and we may not be profitable if our competitors are also able to take advantage
of our trade secrets.
If our trademarks and trade names are not adequately protected, then we may
not be able to build brand loyalty and our sales and revenues may suffer.
Our registered or unregistered trademarks or trade names may be
challenged, canceled, infringed, circumvented or declared generic or determined
to be infringing on other marks. See "Business--Intellectual Property." We may
not be able to protect our rights to these trademarks and trade names, which we
need to build brand loyalty. Over the long term, if we are unable to establish a
brand based on our trademarks and trade names, we may not be able to compete
effectively.
If we are not able to successfully commercialize our products, then we will
not be profitable.
Other than the units of our OLpurTM MD190 manufactured for our clinical
trial and a small number of units for commercialization scale-up, we have
produced only prototype units of our OLpurTM MD190 and OLpurTM H2H(TM) and the
OLpur(TM) NS2000 system. In order to commercialize our products, we need to be
able to produce them in a cost-effective way on a large scale to meet commercial
demand, while maintaining extremely high standards for quality and reliability.
If we fail to successfully commercialize our products, then we will not be
profitable.
We expect to rely on a limited number of independent manufacturers to
produce the OLpurTM MD190 and our other products for us. Our future
manufacturers' systems and procedures may not be adequate to support our
operations and may not be able to achieve the rapid execution necessary to
exploit the market for our products. Our manufacturers could experience
manufacturing and control problems as they begin to scale-up our future
manufacturing operations and we may not
8
be able to scale-up manufacturing in a timely manner or at a commercially
reasonable cost to enable production in sufficient quantities. If we experience
any of these problems with respect to our manufacturers' initial or future
scale-ups of manufacturing operations, then we may not be able to have our
products manufactured and delivered in a timely manner.
As of the date of this prospectus, we have not entered into any formal
agreements with any manufacturers to manufacture our products and components. We
cannot assure you that we will be able to enter into agreements with
manufacturers on terms acceptable to us in a timely manner, if at all. If we do
not enter into agreements for the manufacture of our products and components, we
could encounter delays in, or be prevented from, manufacturing and selling any
or all of our products and we will not be profitable.
If we are not able to ensure the timely delivery of our products, then we may
not be profitable.
Independent manufacturers of medical devices will manufacture all of our
products and components. As with any independent contractor, these manufacturers
will not be employed or otherwise controlled by us and will be generally free to
conduct their business at their own discretion. For us to be profitable, our
products must be manufactured on a timely basis in commercial quantities at
costs acceptable to us. If one or more of our independent manufacturers fails to
deliver our products in a timely manner, then we may not be able to find a
substitute manufacturer in the time required.
We may not be able to maintain sufficient quality controls, which could delay
or prevent our products from being approved or cleared by the European Union,
the FDA or other relevant authorities.
Approval or clearance of our products could be delayed by the European
Union, the FDA and the relevant authorities of other countries if our
manufacturing facilities do not comply with their respective manufacturing
requirements. The European Union imposes requirements on quality control systems
of manufacturers, which are inspected and certified on a periodic basis and may
be subject to additional unannounced inspections. Failure by our manufacturers
to comply with the European Union requirements could prevent us from obtaining
the CE mark and from marketing our products in western Europe. The FDA also
imposes requirements through quality system requirements, or QSR, regulations,
which include requirements for good manufacturing practices, or GMP. Failure by
our manufacturers to comply with these requirements could prevent us from
obtaining FDA approval of our products and from marketing our products in the
United States. Although some of the manufacturing facilities and processes that
we expect to use to manufacture our OLpurTM MD190 have been inspected by TUV
Product Service (Munich), a worldwide testing and certification agency that
performs conformity assessments to European Union requirements for medical
devices, they have not been inspected by the FDA. Similarly, although the FDA
has inspected some of the facilities and processes that we expect to use to
manufacture our OLpurTM H2H(TM) and OLpur(TM) NS2000, they have not been
inspected by any TUV organization. We cannot assure you that any of the
facilities or processes we use will comply or continue to comply with their
respective requirements on a timely basis or at all, which could delay or
prevent our obtaining the approvals we need to market our products in Europe and
the United States.
Even if we do obtain approval to market our products in Europe, the United
States and other countries, manufacturers of our products must continue to
comply or ensure compliance with the relevant manufacturing requirements.
Although we cannot control the manufacturers of our products, we may need to
expend time, resources and effort in product manufacturing and quality control
to assist with their continued compliance with these requirements. If violations
of applicable requirements are noted during periodic inspections of the
manufacturing facilities of our manufacturers, we may not be able to continue to
market the products manufactured in such facilities and our revenues may be
materially adversely affected.
The loss or interruption of services of any of our manufacturers could slow
or stop production of our products.
Because we are likely to rely on no more than two contract manufacturers
to manufacture each of our products and major components of our products, a stop
or significant interruption in the supply of our products or major components by
a single manufacturer, for any reason, could have a material adverse effect on
us. We expect most of our contract manufacturers will enter into contracts with
us to manufacture our products and major components and that these contracts
will be terminable by the contractors or us at any time under certain
circumstances. We have not made alternative arrangements for the manufacture of
our products or major components and we cannot assure you that acceptable
alternative arrangements could be made on a timely basis, or at all, if one or
more of our manufacturers failed to manufacture our products or major components
in accordance with the terms of our arrangements. Our inability to obtain
acceptable alternative arrangements for the manufacture of our products or major
components of our products would slow down or halt the production and sale of
our products and reduce our cash flow.
9
Once our products are commercialized, we may face significant challenges in
obtaining market acceptance of our products, which could adversely affect our
potential sales and revenues.
Acceptance of our products in the marketplace by both potential users,
including ESRD patients, and potential purchasers, including nephrologists,
dialysis clinics and other health care providers, is uncertain, and our failure
to achieve sufficient market acceptance will significantly limit our ability to
generate revenue and be profitable. Market acceptance will require substantial
marketing efforts and the expenditure of significant funds by us to inform
dialysis patients and nephrologists, dialysis clinics and other health care
providers of the benefits of using our products. We may encounter significant
clinical and market resistance to our products and our products may never
achieve market acceptance. Factors that may affect our ability to achieve
acceptance of our products in the market place include whether:
o our products will be safe for use;
o our products will be effective;
o our products will be cost-effective;
o we will be able to demonstrate product safety, efficacy and
cost-effectiveness;
o there are unexpected side effects, complications or other safety
issues associated with our products; and
o reimbursement for the cost of our products is available at
reasonable rates, if at all.
If Hemodiafiltration, or HDF, does not become the preferred therapy for ESRD,
then the market for our products may be limited and we may not be profitable.
A significant portion of our success is dependent on the acceptance and
implementation of HDF as the preferred therapy for ESRD. There are many
treatment options currently available and others may be developed. HDF may not
become the preferred therapy for ESRD. If it does not, the market for our
products will be limited and we may not be able to sell a sufficient quantity of
our products to be profitable.
If we cannot develop adequate distribution, customer service and technical
support networks, then we may not be able to market and distribute our
products effectively and we may not be profitable.
Our strategy requires us to distribute our products and provide a
significant amount of customer service and maintenance and other technical
service. To provide these services, we will be required to develop networks of
employees or independent contractors in each of the areas in which we intend to
operate. We cannot assure you we will be able to organize and manage these
networks on a cost-effective basis, if at all. The failure to establish these
networks would materially adversely affect our operations and our profitability.
We may face significant risks associated with international operations, many
of which could have a material adverse effect on our business, financial
condition and results of operations.
We expect to manufacture and to market our products in western Europe and
elsewhere outside of the United States. We expect that our revenues from western
Europe will initially account for a significant portion of our revenues. Our
international operations are subject to a number of risks, including the
following:
o fluctuations in exchange rates of the United States dollar could
adversely affect our results of operations;
o we may face difficulties in enforcing and collecting accounts
receivable under some countries' legal systems;
o local regulations may restrict our ability to sell our products,
have our products manufactured or conduct other operations;
o political instability could disrupt our operations;
o some governments and customers may have longer payment cycles, with
resulting adverse effects on our cash flow; and
o some countries could impose additional taxes or restrict the import
of our products.
Any one or more of these factors could increase our costs, reduce our
revenues, or disrupt our operations, which could have a material adverse effect
on our business, financial condition and results of operations.
10
If we are not able to obtain adequate insurance or other protection against
product liability risks associated with the production, marketing and sale of
our products, then we could face liabilities that would materially adversely
affect our financial condition and our ability to be profitable.
The production, marketing and sale of kidney dialysis products have an
inherent risk of liability in the event of product failure or claim of harm
caused by product operation. Although we intend to acquire product liability
insurance upon commercialization of each of our products, we may not be able to
obtain this insurance on acceptable terms or at all. Because we may not be able
to obtain insurance that provides us with adequate protection against all
potential product liability claims, a successful claim in excess of our
insurance coverage could materially adversely affect our financial condition.
Moreover, any claim against us could generate negative publicity, which could
decrease the demand for our products, our ability to generate revenues and our
profitability.
Some of the agreements that we may enter into with manufacturers of our
products and components of our products may require us (1) to obtain product
liability insurance or (2) indemnify manufacturers against liabilities resulting
from the sale of our products. If we are not able to obtain and maintain
adequate product liability insurance, we will be in breach of these agreements,
which could materially adversely affect our ability to produce our products. If
we are able to obtain and maintain product liability insurance and a successful
claim in excess of our insurance coverage is made, we may have to indemnify some
or all of our manufacturers for their losses.
If we are unable to keep our key management and scientific personnel, then we
are likely to face significant delays at a critical time in our corporate
development and our business is likely to be damaged.
Our success depends upon the skills, experience and efforts of our
management and other key personnel, including our chief executive officer,
certain members of our scientific staff and our marketing executive. As a
relatively new company, much of our corporate, scientific and technical
knowledge is concentrated in the hands of these few individuals. We do not
maintain key-man life insurance on any of our management or other key personnel.
The loss of the services of one or more of our present management or other key
personnel could significantly delay the development and/or launch of our
products as there could be a learning curve of several months or more for any
replacement personnel. Furthermore, competition for the type of highly skilled
individuals we require is intense and we may not be able to attract and retain
new employees of the caliber needed to achieve our objectives. Failure to
replace key personnel could have a material adverse effect on our business,
financial condition and operations.
Our certificate of incorporation limits liability of our directors, which
could discourage you or other stockholders from bringing suits against our
directors in circumstances where you think they might otherwise be warranted.
Our certificate of incorporation provides, with specific exceptions, that
our directors are not personally liable to us or our stockholders for monetary
damages for any action or failure to take any action. In addition, we have
agreed, and our certificate of incorporation and bylaws provide for, mandatory
indemnification of directors and officers to the fullest extent permitted by
Delaware law. These provisions may discourage stockholders from bringing suit
against a director for breach of duty and may reduce the likelihood of
derivative litigation brought by stockholders on our behalf against any of our
directors.
Risks Related to Our Industry
We expect to face significant competition from existing suppliers of renal
replacement treatment devices, supplies and services. If we are not able to
compete with them effectively, then we may not be profitable.
We expect to compete in the kidney dialysis market with existing suppliers
of hemodialysis and peritoneal dialysis devices, supplies and services. Our
competitors include Fresenius Medical Care AG, The Gambro Company and Baxter
International Inc., currently the three primary machine manufacturers in
hemodialysis, as well as B. Braun Biotech International GmbH, Nipro Medical
Corporation, Asahi Kasei Corporation and other smaller machine manufacturers in
hemodialysis. Fresenius and Gambro also manufacture hemodiafiltration machines.
These companies and most of our other competitors have longer operating
histories and substantially greater financial, marketing, technical,
manufacturing and research and development resources and experience than we
have. Our competitors could use these resources and experiences to develop
products that are more effective or less costly than any or all of our products
or that could render any or all of our products obsolete. Our competitors could
also use their economic strength to influence the market to continue to buy
their existing products.
We do not have an established customer base and may encounter a high
degree of competition in developing one. Our potential customers are a limited
number of nephrologists, national, regional and local dialysis clinics and other
healthcare providers. The number of our potential customers may be further
limited to the extent any exclusive relationships are entered into between our
potential customers and our competitors. We cannot assure you that we will be
successful in marketing our
11
products to these potential customers. If we are not able to develop competitive
products and take and hold sufficient market share from our competitors, we will
not be profitable.
Because some of our competitors own or could acquire dialysis clinics
throughout the United States, Europe and other regions of the world, we may
not be able to successfully market our products to the dialysis clinics under
their ownership. If our potential market is significantly reduced, then we
may not be profitable.
Some of our competitors, including Fresenius and Gambro, manufacture their
own products and own dialysis clinics in the United States, Europe and other
regions of the world. Because these competitors have historically tended to use
their own products, we may not be able to successfully market our products to
the dialysis clinics under their ownership. According to the Merrill Report,
approximately 95% of the products then used by dialysis clinics owned by
Fresenius were products of Fresenius and approximately 40% of the products then
used by dialysis clinics owned by Gambro were products of Gambro. Based on the
same report, and by our calculations, we estimate that as of September 2001: (1)
Fresenius treated in its own dialysis clinics approximately 24.8% of the
dialysis patients in the United States, 4.6% of the dialysis patients in Europe
and 8.7% of the dialysis patients worldwide; and (2) Gambro treated in its own
dialysis clinics approximately 13.5% of the dialysis patients in the United
States, 2.3% of the dialysis patients in Europe and 4.5% of the dialysis
patients worldwide. If our competitors continue to grow their networks of
dialysis clinics and if we cannot successfully market our products to dialysis
clinics owned by these competitors or any other competitors, then our revenues
could be adversely affected.
If the size of the market for our products is significantly reduced due to
pharmacological or technological advances in preventative and alternative
treatments for ESRD, then we may not be profitable.
Pharmacological or technological advances in preventative or alternative
treatments for ESRD could significantly reduce the number of ESRD patients
needing our products. These pharmacological or technological advances may
include: (1) the development of new medications, or improvements to existing
medications, which help to delay the onset or prevent the progression of ESRD in
high-risk patients (such as those with diabetes and hypertension); (2) the
development of new medications, or improvements in existing medications, which
reduce the incidence of kidney transplant rejection; and (3) developments in the
use of kidneys obtained from genetically-engineered animals as a source of
transplants. If these or any other pharmacological or technological advances
reduce the number of patients needing treatment for ESRD and the size of the
market for our products, we may not be profitable.
If the number of ESRD patients needing ongoing treatment for ESRD does not
increase at the rate we estimate, then our potential market may be smaller
than we anticipate and we may not be profitable.
According to the Lysaght Article, as of mid-year 2001, the number of
dialysis patients worldwide was estimated to be over 1.1 million and the size of
this population has been expanding at rate of approximately 7% per year.
According to the same article, the number of dialysis patients is expected to be
over two million by 2010. If the number of ESRD patients needing ongoing
treatment for ESRD does not increase at that rate, the size of the market for
our products will not increase at the rate we estimate and, therefore, our
revenues could be adversely affected.
If government and other third party reimbursement programs discontinue their
coverage of ESRD treatment or reduce reimbursement rates for ESRD products,
then we may need to reduce the estimated prices of our products and we may
not be profitable.
Providers of renal replacement therapy are often reimbursed by government
programs, such as Medicare or Medicaid in the U.S., or other third-party
reimbursement programs, such as private medical care plans and insurers. We
believe that the amount of reimbursement for renal replacement therapy under
these programs has a significant impact on the decisions of nephrologists,
dialysis clinics and other health care providers regarding treatment methods and
products. Accordingly, changes in the extent of coverage for renal replacement
therapy or a reduction in the reimbursement rates under any or all of these
programs may cause a decline in recommendations or purchases of our products,
which would materially adversely affect the market for our products and reduce
our revenues.
As the number of managed health care plans increases in the United States,
amounts paid for our products by non-governmental programs may decrease and
we may not generate sufficient revenues to be profitable.
We expect to obtain a portion of our revenues from reimbursement provided
by non-governmental programs in the United States. Although non-governmental
programs generally pay higher reimbursement rates than governmental programs, of
the non-governmental programs, managed care plans generally pay lower
reimbursement rates than insurance plans. Reliance on managed care plans for
dialysis treatment may increase if future changes to the Medicare program
require non-governmental programs to assume a greater percentage of the total
cost of care given to dialysis patients over the term of their illness, or if
managed care plans otherwise significantly increase their enrollment of these
patients. If the reliance on managed care plans for
12
dialysis treatment increases, more patients join managed care plans or managed
care plans reduce reimbursements rates, we may need to reduce estimated prices
of our products and may not be profitable.
If the per-treatment costs for dialysis clinics using our products are higher
than the costs of clinics providing hemodialysis treatment, then we may not
achieve market acceptance of our products in the United States.
If the cost of our products results in an increased cost to the dialysis
clinic over hemodialysis therapies and such cost is not separately reimbursable
by governmental programs or private medical care plans and insurers outside of
the per-treatment fee, we will not gain market acceptance for our products in
the United States unless HDF therapy becomes the standard treatment method for
ESRD. If we do not gain market acceptance in the United States, then our market
and anticipated revenue will be reduced and we may not be profitable.
Proposals to modify the health care system in the United States or other
countries could affect the pricing of our products. If we cannot sell our
products at the prices we plan to, then we may not be profitable.
A substantial portion of the cost of treatment for ESRD in the United
States is currently reimbursed by the Medicare program at prescribed rates.
Proposals to modify the current health care system in the United States to
improve access to health care and control its costs are continually being
considered by the federal and state governments. We anticipate that the U.S.
Congress and state legislatures will continue to review and assess alternative
health care reform proposals. We cannot predict whether these reform proposals
will be adopted, when they may be adopted or what impact they may have on us if
they are adopted. Any spending decreases or other significant changes in the
Medicare program could affect the pricing of our products. As we are not yet
established in our business and it will take some time for us to begin to recoup
our research and development costs, our profit margins are likely initially to
be lower than those of our competitors and we may be more vulnerable to small
decreases in price than many of our competitors. If we are not able to generate
sufficient returns, then we will not be profitable.
Health administration authorities in countries other than the United
States may not provide reimbursement for our products at rates sufficient for us
to achieve profitability, or at all. Like the United States, these countries,
especially those in western Europe, have considered health care reform proposals
and could materially alter their government-sponsored health care programs by
reducing reimbursement rates for dialysis products. Any reduction in
reimbursement rates under foreign health care programs could negatively affect
the pricing of our products and we may not be profitable.
Risks Related to this Offering
We may invest or spend the proceeds of this offering in ways with which you
do not agree and in ways that may not yield a favorable return.
Our management will have broad discretion over the use of the net proceeds
from this offering. Stockholders may not deem such uses desirable. Our use of
the proceeds from this offering may vary substantially from our currently
planned uses and investors in this offering will be relying on the judgment of
our management with respect to the use of proceeds of this offering. We cannot
assure you that we will apply such proceeds effectively or that we will invest
such proceeds in a manner that will yield a favorable return or any return at
all.
Several provisions of the Delaware General Corporation Law, our amended and
restated certificate of incorporation and our bylaws could discourage, delay
or prevent a merger or acquisition, which could adversely affect the market
price of our common stock.
Several provisions of the Delaware General Corporation Law, our amended
and restated certificate of incorporation and our bylaws could discourage, delay
or prevent a merger or acquisition that stockholders may consider favorable.
These provisions include:
o authorizing our board of directors to issue "blank check" preferred
stock without stockholder approval;
o providing for a classified board of directors with staggered,
three-year terms;
o prohibiting us from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date
of the transaction in which the person became an interested
stockholder unless certain provisions are met;
o prohibiting cumulative voting in the election of directors;
o prohibiting stockholder action by written consent unless the written
consent is signed by all stockholders entitled to vote on the
action;
13
o limiting the persons who may call special meetings of stockholders;
and
o establishing advance notice requirements for nominations for
election to our board of directors or for proposing matters that can
be acted on by stockholders at stockholder meetings.
Our common stock price may be highly volatile and your investment in our
common stock could decline in value.
Prior to this offering, there has been no public market for our common
stock. We are a relatively new company with little or no name recognition
outside the nephrology community and few investors are familiar with either our
company or our products. As we will not be marketing our products directly to
the public, it may be difficult for us to generate the kind of interest in our
stock that other companies experience after an initial public offering. After
this offering, an active trading market in our common stock might not develop,
or if it does develop, might not continue. Additionally, the market price of our
common stock may fluctuate significantly in response to many factors, many of
which are beyond our control. You may not be able to resell your shares at or
above the initial public offering price due to the risks and uncertainties
described elsewhere in this "Risk Factors" section. In the past, following
periods of volatility in the market price of a particular company's securities,
securities class action litigation has often been brought against the company.
We may become involved in this type of litigation in the future. Litigation of
this type could be extremely expensive and divert management's attention and
resources from running our company.
Because our capital requirements have been and will continue to be significant,
we may need funds in addition to the net proceeds of this offering or we will
not be able to continue to operate our business. If our business fails, then you
could lose your entire investment.
Our capital requirements have been and will continue to be significant. To
date, we have been dependent primarily on the net proceeds of private placements
of our equity and debt securities, aggregating approximately $11.7 million. We
are dependent upon the net proceeds of this offering to fund our marketing and
sales efforts, clinical trials, regulatory approvals, research and development
as well as our other working capital requirements. We currently have no
committed sources of, or other arrangements with respect to, additional
financing. We cannot assure you that our existing capital resources, together
with the net proceeds from this offering and future operating cash flows, will
be sufficient to fund our future operations. Our capital requirements will
depend on numerous factors, including:
o the time and cost involved in obtaining regulatory approval for our
products;
o the cost involved in protecting our proprietary rights;
o the time and cost involved in manufacturing scale-up and in
establishing marketing acceptance;
o the time and cost involved in providing training and technical
support networks; and
o the effectiveness of other commercialization activities.
If we require additional capital beyond the cash generated from our
operations and the proceeds of this offering, we would need to seek other forms
of financing, through the sale of equity securities or otherwise, to achieve our
business objectives. We cannot assure you that we will be able to obtain
alternative financing on acceptable terms or at all. Our failure to obtain
financing when needed could have a material adverse effect on us. Any additional
equity financing could substantially dilute your equity interests in our company
and any debt financing could impose significant financial and operational
restrictions on us.
Our principal stockholders, directors and executive officers prior to the
offering will still control a significant portion of our stock after the
offering and, if they choose to vote together, could have sufficient voting
power to control the vote on substantially all corporate matters.
Our principal stockholders, directors and executive officers prior to the
offering will own, beneficially and/or of record, approximately 67% of our
outstanding common stock after this offering (without giving effect to the
exercise of the underwriters' over-allotment option). Our principal
stockholders, directors and executive officers will own, beneficially and/or of
record, approximately 57% of our outstanding common stock after this offering.
Should they act as a group, they will have the power to elect all of our
directors and to control the vote on substantially all other corporate matters
without the approval of other stockholders, including those stockholders who
purchase stock in this offering. This concentration in voting power may result
in the ability of those stockholders to delay or prevent another party from
taking control of our company.
14
Future sales of our common stock could cause the market price of our common
stock to decline.
The market price of our common stock could decline due to sales of a large
number of shares in the market after this offering, including sales of shares by
our large stockholders, or the perception that such sales could occur. These
sales could also make it more difficult or impossible for us to sell equity
securities in the future at a time and price that we deem appropriate to raise
funds through future offerings of common stock.
All of our existing security holders will be subject to lock-up agreements
which prohibit the sale of any of their shares of our common stock in the public
market until one year from the effective date of this prospectus and,
thereafter, on a cumulative basis for each holder, of more than 1/3 of our
common stock held by such holder prior to 15 months from the effective date of
this prospectus or more than 2/3 of our common stock held by such holder prior
to 18 months from the effective date of this prospectus. If we are required to
issue shares in connection with the Potential Lancer Share Issuance (see
"Important Assumptions in this Prospectus - Certain Convertible Notes have not
been Converted"), then Lancer Offshore Inc. will be subject to a lock-up
agreement that prohibits the sale of any of its shares in the public market
until 180 days after the effective date. We have entered into registration
rights agreements with many of our existing stockholders that entitle them to
have an aggregate of 2,190,115 shares registered for sale in the public market.
All of those shares could be sold in the public market after one year subject to
the limitations of Rule 144 under the Securities Act.
You will incur immediate and substantial dilution.
The assumed initial public offering price per share of our common stock is
substantially higher than the net tangible book value per share of our
outstanding common stock. As a result, investors purchasing common stock in this
offering will incur immediate and substantial dilution in the net tangible book
value of their common stock of $4.08 per share based on the assumed initial
public offering price of $6.00 per share; see "Important Assumptions in this
Prospectus - Certain Convertible Notes have not been Converted." To the extent
we raise additional capital by issuing equity securities in the future, you and
our other stockholders may experience substantial dilution and future investors
may be granted rights superior to those of our current stockholders. If the
above discussion were to include 600,000 shares of common stock, which may be
issuable upon conversion of the convertible note issued to Lancer Offshore,
Inc., then the immediate and substantial dilution would have been $4.19 per
share to new investors purchasing common stock in this offering. If the above
discussion were to assume the payment of such convertible note plus accrued
interest at the maturity date (March 15, 2003), then the immediate and
substantial dilution would have been $4.27 per share to new investors purchasing
common stock in this offering.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. These statements are
not historical facts, but rather are based on our current expectations,
estimates and projections about our industry, our beliefs and assumptions. Words
including "may," "could," "would," "will," "anticipates," "expects," "intends,"
"plans," "projects," "believes," "seeks," "estimates" and similar expressions
are intended to identify forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks, uncertainties
and other factors, some of which remain beyond our control, are difficult to
predict and could cause actual results to differ materially from those expressed
or forecasted in the forward-looking statements. These risks and uncertainties
are described in "Risk Factors" and elsewhere in this prospectus. We caution you
not to place undue reliance on these forward-looking statements, which reflect
our management's view only as of the date of this prospectus. We are not
obligated to update these statements or publicly release the result of any
revisions to them to reflect events or circumstances after the date of this
prospectus or to reflect the occurrence of unanticipated events.
15
IMPORTANT ASSUMPTIONS IN THIS PROSPECTUS
References to Shares of Common Stock in this Prospectus Assume Completion of
Reverse Stock Split
Prior to the effectiveness of the registration statement to which this
prospectus relates, we intend to file an amendment to our certificate of
incorporation, which, among other things, will effect a reverse stock split
pursuant to which each share of our common stock then outstanding will be
converted into 0.2248318 of one share of our common stock. See "Description of
Securities -- Reverse Stock Split."
Unless otherwise indicated, all references in this prospectus to (1) the
number of shares of our common stock outstanding, (2) the number of shares of
our common stock issuable upon exercise or conversion, as the case may be, of
options, warrants or convertible notes or (3) the number of shares of our common
stock reserved for issuance, assumes the filing of such amendment.
All Information in this Prospectus Assumes that we have Obtained all Required
Shareholder Approvals on or Prior to Effectiveness of the Registration Statement
to which this Prospectus Relates.
The following actions require shareholder approval prior to the
effectiveness of the Registration Statement to which this prospectus relates in
order to make certain information in this prospectus true and accurate:
o Filing of amendments and restatements of our certificate of
incorporation, to, among other things, (1) reallocate the number
of shares authorized for issuance among our preferred stock and
the various series of our preferred stock, (2) redesignate the
powers, preferences and rights of, and the qualifications,
limitations and restrictions granted to and imposed upon holders
of various series of our preferred stock, and (3) effect a
reverse stock split pursuant to which each share of our common
stock then outstanding will be converted into 0.2248318 of one
share of our common stock, all as described in this prospectus.
See "Description of Securities."
o Amendment and restatement of our 2000 Nephros Equity Incentive
Plan, to, among other things, increase the aggregate number of
shares of our common stock subject to options covered by our
equity incentive plan from 1,011,743 to 1,124,159, with the
adoption of our Amended and Restated 2000 Nephros Equity
Incentive Plan.
We anticipate that we will obtain the required shareholder approval prior
to the effectiveness of the registration statement to which this prospectus
relates. Accordingly, all information in this prospectus assumes that all such
shareholder approvals have been obtained.
Over-allotment Option Granted to the Underwriters has not been Exercised
Unless otherwise indicated, all information in this prospectus assumes
that the over-allotment option granted to the underwriters by us has not been
exercised.
Certain Convertible Notes have not been Converted
In August 2002, we entered into a subscription agreement with Lancer
Offshore, Inc., which we refer to in this prospectus as the "Lancer Subscription
Agreement." The Lancer Subscription Agreement required Lancer Offshore, Inc. to
purchase notes due March 15, 2003 in the aggregate principal amount of
$3,000,000 which would be convertible at the option of the holder into 1,200,000
shares of our common stock, and warrants to purchase an aggregate of 240,000
shares of our common stock at an exercise price of $2.50 per share until
December 2007 (in each case subject to antidilution adjustments; see "Important
Assumptions in this Prospectus - Warrants and Convertible Notes are Subject to
Antidilution Adjustments"). The Lancer Subscription Agreement also provided that
the convertible notes would be secured by the assets of the company and that the
convertible notes would automatically be converted into common stock upon a
public offering of our securities yielding gross proceeds of not less than
$10,000,000 and at an offering price per share of common stock equal to at least
$45,000,000 divided by the number of shares of common stock outstanding on a
fully diluted basis immediately preceding such public offering. The Lancer
Subscription Agreement required that immediately prior to an initial public
offering meeting the criteria described in the preceding sentence, we have
1,200,000 shares of common stock reserved for issuance upon conversion of the
convertible notes, 240,000 shares of common stock reserved for issuance upon the
exercise of the warrants and 50,000 shares of common stock reserved for issuance
upon the exercise of warrants to Hermitage Capital Corporation, a placement
agent in connection with the financing. See "Certain Transactions." We expect
that such placement agent warrants, if issued, would be exercisable at no more
than $2.50 per share. We refer to this as the "Lancer Investment."
In accordance with the Subscription Agreement, Lancer Offshore, Inc. paid
the first installment of $1,500,000 and we issued to Lancer Offshore, Inc.
convertible promissory notes in the aggregate principal amount of $1,500,000
(convertible into 600,000 shares of common stock, subject to antidilution
adjustments) and one-half of the warrants described in the preceding paragraph.
However, as of the date of this prospectus, Lancer Offshore, Inc. has defaulted
in its obligation to fund the additional installments totaling $1,500,000, which
were to be paid in two equal installments on September 15, 2002 and October 15,
2002, respectively. We are currently exploring possible ways to resolve this
matter without resorting to litigation. If we are not able to resolve this
matter in a manner that is satisfactory to us, then we intend to pursue
vigorously all available legal remedies against Lancer Offshore, Inc., including
seeking rescission of the convertible note and warrants issued in August 2002;
see "Legal Proceedings" and "Important Assumptions in This Prospectus - Warrants
and Convertible Notes are Subject to Antidilution Adjustments").
16
Pending resolution of the uncertainty surrounding the Lancer
Investment, we have not attempted to quantify the number of shares, if any, that
we may be required to issue in connection with the Lancer Subscription Agreement
(referred to as the "Potential Lancer Share Issuance"). Except as otherwise
indicated, all information in this prospectus assumes that:
(i) the $1,500,000 convertible note issued to Lancer Offshore,
Inc. in August 2002 has not been converted into shares of our
common stock and we, therefore, may be obligated to repay any
amounts due thereunder on March 15, 2003;
(ii) warrants to purchase shares of our common stock issued to
Lancer Offshore, Inc. in August 2002 have not been exercised
and warrants to purchase shares of common stock which may be
issuable to a placement agent in connection with the
convertible note issued to Lancer Offshore, Inc. have not been
exercised; and
(iii) no additional convertible notes or warrants will be issued in
connection with the Lancer Subscription Agreement.
Warrants and Convertible Notes are Subject to Antidilution Adjustments
Unless otherwise indicated, the number of shares of capital stock subject
to all options, warrants and convertible notes referred to in this prospectus
are subject to provisions known as "antidilution adjustments" that may increase
or decrease the number of shares issuable upon exercise or conversion thereof
and proportionately adjust the exercise price of options and warrants.
Dollar References are to U.S. Dollars
Unless otherwise indicated, all dollar references in this prospectus
are to U.S. dollars.
17
USE OF PROCEEDS
At an assumed initial offering price of $6.00 per share, net proceeds of
this offering will be approximately $12,350,000, after deducting underwriting
discounts and commissions and other expenses, and, if the underwriters'
over-allotment option is exercised, net proceeds of this offering will be
approximately $14,330,000, after deducting underwriting discounts and
commissions and other expenses. We estimate that underwriting discounts and
commissions and other expenses of this offering will be in the aggregate amount
of approximately $2,650,000 and, if the underwriters' over-allotment option is
exercised, approximately $2,920,000. As there has been no public market for our
common stock, the assumed initial public offering price of our common stock has
been determined by negotiation between us and the underwriters.
We intend to use approximately $110,000 of the net proceeds of this
offering to repay loans made to us during 2001 and 2002 from Eric A. Rose, M.D.,
the chairman of our board of directors, a director and a holder of more than 5%
of our common stock. See "Certain Transactions." These loans are payable when we
have sufficient funds available to repay them and do not bear any interest. We
intend to use approximately $250,000 (plus interest as described below) of the
net proceeds of this offering to repay a loan in the principal amount of
$250,000 made to us on December 26, 2002. This loan is payable on the earlier to
occur of 30 days after the consummation of this offering and December 26, 2003.
This loan bears interest, calculated quarterly in arrears, at a rate of 7% per
annum from December 26, 3002 to March 31, 2003, 10% per annum from April 1, 2003
to April 30, 2003, and 15% per annum from May 1, 2003 to December 26, 2003. We
intend to use approximately $3,600,000 of the net proceeds of this offering for
the marketing and sales of our products through active solicitation of customers
by exhibiting at trade shows, advertising in trade magazines and setting up a
sales group to solicit prospective customers. We intend to use approximately
$6,500,000 of the net proceeds to complete our clinical studies, obtain
appropriate regulatory approvals and expand our research and development with
respect to our products. We intend to use $350,000 of the net proceeds to pay
Plexus Services Corp., a former supplier, amounts due under our settlement
agreement with Plexus, $250,000 of which is due upon the consummation of this
offering and the remaining $100,000 of which is due in February 2003. See
"Business - Settlement Agreement." We intend to use a portion of the net
proceeds for payment of dividends on shares of our series B convertible
preferred stock and series C convertible preferred stock accruing from November
1, 2002 to the date of the consummation of this offering, which dividends shall
accrue at a rate of 6% per annum and which were approximately $59,000 as of
December 31, 2002. We intend to use the remaining amount of the net proceeds for
working capital purposes, including for additional salaries and wages as our
organization grows and as we establish offices in Europe, and for additional
professional fees and expenses and other operating costs. In the event the
underwriters' over-allotment option is exercised, we will realize additional net
proceeds, which we intend to use for working capital and general corporate
purposes.
The foregoing represents our best estimate of the allocation of the net
proceeds of this offering based upon the current status of our business. This
estimate is based on certain assumptions, including the development of our
business in the way we anticipate. If any of our assumptions prove incorrect, we
may find it necessary to reallocate a portion of the proceeds within the
above-described categories or use portions of the proceeds for other purposes.
For example, we may be obligated to repay up to $1,575,000 of principal and
interest on the convertible promissory note held by Lancer Offshore, Inc. on
March 15, 2003 and/or may use a portion of the proceeds of this offering to fund
costs associated with our attempt to exercise our remedies against Lancer
Offshore, Inc. Our estimates may prove to be inaccurate, new programs or
activities may be undertaken which will require considerable additional
expenditures or unforeseen expenses may occur. Pending use, we will invest the
net proceeds of this offering in bank certificates of deposit and other fully
insured investment grade interest bearing securities. See "Risk Factors - We may
invest or spend the proceeds of this offering in ways with which you may not
agree..."
DIVIDEND POLICY
We have not declared or paid any cash or stock dividends on our common
stock since our inception in April 1997. We presently intend to reinvest
earnings to fund the development and expansion of our business and do not
anticipate paying cash dividends on our common stock in the foreseeable future.
The declaration of dividends will be at the discretion of our board of directors
and will generally depend upon our earnings, capital requirements, financial
position and general economic conditions.
18
CAPITALIZATION
The following table sets forth our capitalization as of September 30,
2002:
o on an actual basis giving effect to an amendment to our certificate
of incorporation to be filed prior to the commencement of this
offering, which, among other things, will effect a reverse stock
split pursuant to which each share of our common stock then
outstanding will be converted into 0.2248318 of one share of our
common stock immediately prior to the effectiveness of the
registration statement to which this prospectus relates;
o on a pro forma basis after giving effect to (i) a reverse stock
split pursuant to which each share of our common stock then
outstanding will be converted into 0.2248318 of one share of our
common stock immediately prior to the effectiveness of the
registration statement to which this prospectus relates, and (ii)
the automatic conversion of all outstanding series A convertible
preferred stock, series B convertible preferred stock and series C
convertible preferred stock into 2,300,845 shares of our common
stock, simultaneously with the consummation of this offering; and
o on a pro forma basis as adjusted after giving effect to (i) a
reverse stock split pursuant to which each share of our common stock
then outstanding will be converted into 0.2248318 of one share of
our common stock immediately prior to the effectiveness of the
registration statement to which this prospectus relates, (ii) the
automatic conversion of all outstanding series A convertible
preferred stock, series B convertible preferred stock and series C
convertible preferred stock into 2,300,845 shares of our common
stock, simultaneously with the consummation of this offering (iii)
the receipt of net proceeds of $12,350,000 from the sale of the
2,500,000 shares of common stock in this offering at an assumed
initial public offering price of $6.00 per share, after deducting
underwriting discounts and commissions and estimated offering
expenses of $2,650,000, (iv) the repayment to a related party of a
short-term loan in the principal amount of $110,000 and (v) the
conversion of outstanding convertible notes in the aggregate
principal amount of $250,000 (see "Certain Transactions").
September 30, 2002
--------------------------------------------------
Pro Forma As
Actual (1) Pro Forma (1) Adjusted(1)
---------- ------------- ------------
(unaudited)
Loan from related party.........................................................$ 110,000 $ 110,000 $ -
Short-term convertible note payable............................................. 250,000 250,000 -
Short-term bridge financing, net of unamortized discount of
$1,100,000................................................................... 400,000 400,000 400,000
Series B Convertible Preferred Stock, par value $.001 per share:
2,333,333 shares authorized, 2,333,333 shares issued and outstanding;
pro forma - 2,333,333 shares authorized, none issued and outstanding;
pro forma as adjusted - none authorized, none issued and outstanding......... 2,296,500 - -
Series C Convertible Preferred Stock, par value $.001 per share: 3,140,000
shares authorized, 3,137,550 shares issued and outstanding; pro forma
-3,140,000 shares authorized, none issued and outstanding; pro forma as
adjusted - none authorized, none issued and outstanding...................... 3,496,050 - -
Stockholders' equity (deficit):
Series A Convertible Preferred Stock, par value $.001 per share: 4,500,000
shares authorized, 4,000,000 shares issued and outstanding; pro forma -
4,500,000 shares authorized, none issued and outstanding; pro forma as
adjusted - none authorized, none issued and outstanding...................... 4,000 - -
Common Stock, par value $.001 per share: 30,000,000 shares authorized,
1,261,194 shares issued and outstanding; pro forma - 30,000,000 shares
authorized, 3,562,039 shares issued and outstanding; pro forma as
adjusted -30,000,000 shares authorized, 6,118,247 shares issued and
outstanding (2).............................................................. 1,261 3,562 6,118
Additional paid-in capital...................................................... 7,011,239 12,805,488 25,402,932
Accumulated deficit from inception.............................................. (13,468139) (13,468,139) (13,468,139)
Total stockholders' equity (deficit)............................................------------ -------------- ------------
Total capitalization............................................................ (6,451,639) (659,089) 11,940,911
------------ -------------- -----------
$ 100,911 $ 100,911 $ 12,340,911
============ ============== ============
19
- ---------------------
(1) Actual, pro forma and pro forma as adjusted information do not give effect
to conversion of the $1,500,000 convertible note issued to Lancer
Offshore, Inc. or the exercise of warrants to which Lancer Offshore, Inc.
may be entitled.
(2) The number of shares of common stock to be outstanding after this offering
is based on the number of shares outstanding as of September 30, 2002, and
does not include the following:
o 375,000 shares of common stock issuable upon exercise of the
underwriters' over-allotment option;
o 250,000 shares of common stock issuable upon the exercise of the
underwriters' warrants;
o 783,876 shares of common stock underlying stock options granted and
outstanding pursuant to our equity incentive plan;
o 128,154 shares of common stock underlying stock options to be
granted to our president and chief executive officer pursuant to our
equity incentive plan prior to the consummation of this offering;
o 30,000 shares of common stock underlying stock options to be granted
to certain of our directors pursuant to our equity incentive plan
upon the consummation of this offering;
o 134,899 shares of common stock issuable upon exercise of warrants
issued in June 2002 to Plexus Services Corp., a former supplier. See
"Description of Securities -- Other Warrants" and "Business --
Settlement Agreement;"
o 28,104 shares of common stock issuable upon conversion of shares of
our series A preferred stock which are themselves issuable upon
exercise of warrants issued to convertible note holders; or
o shares of our common stock which may be issuable upon conversion of
the $1,500,000 convertible note issued to Lancer Offshore, Inc. and
any shares of our common stock issuable upon exercise of any
warrants to which Lancer Offshore, Inc. may be entitled. See
"Important Assumptions in this Prospectus -- Certain Convertible
Notes have not been Converted."
20
DILUTION
Purchasers of our common stock in this offering will experience immediate
and substantial dilution in the net tangible book value of the common stock from
the initial public offering price. Net tangible book value per share represents
the amount of our tangible assets reduced by the amount of our total
liabilities, divided by the number of shares of common stock outstanding.
As of September 30, 2002, our pro forma net tangible book value was
$(1,145,089), or approximately $(0.32) per share of common stock after giving
effect to our reverse stock split and the conversion of all outstanding shares
of our series A convertible preferred stock, series B convertible preferred
stock and series C convertible preferred stock into shares of our common stock.
As of September 30, 2002, our pro forma net tangible book value as
adjusted for (1) the sale of the 2,500,000 shares of our common stock offered in
this offering and application of the net proceeds of $12,350,000 (at the assumed
initial public offering price of $6.00 per share and after deducting the
underwriting discounts and commissions and estimated offering expenses of
$2,650,000), (2) the repayment to a related party of a short-term loan in the
principal amount of $110,000 and (3) the conversion of outstanding convertible
notes in the aggregate principal amount of $250,000 (see "Certain
Transactions"), would have been approximately $1.92 per share.
This represents an immediate increase of $2.25 per share to existing
stockholders and an immediate and substantial dilution of $4.08 per share to new
investors purchasing common stock in this offering.
The following table illustrates this per share dilution:
Per Share of
Common Stock
------------
Assumed initial public offering price
per share of common stock..................................... $6.00
Pro forma net tangible book value as of
September 30, 2002........................................ $(0.32)
Increase attributable to new investors...................... 2.25
Pro forma net tangible book value after this offering........... 1.92
Dilution of net tangible book value to investors in this
offering...................................................... $4.08
The following table summarizes on a pro forma basis, as of September 30,
2002, the number of shares of common stock purchased from us, the total
consideration paid and the average price per share paid by existing holders of
our common stock, including the conversion of the all outstanding series A
convertible preferred stock, series B convertible preferred stock and series C
convertible preferred stock as well as conversion of outstanding convertible
notes in the aggregate principal amount of $250,000 into shares of our common
stock, and investors in this offering, assuming the sale of all 2,500,000 shares
offered by this prospectus at the price indicated above and before deducting any
underwriting discounts and offering expenses payable by us.
Shares Total Consideration
------------------------ ----------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ---------- ------- -------------
Existing Stockholders ................... 3,618,247 59% $10,387,550 41% $ 2.87
New Investors ........................... 2,500,000 41% $15,000,000 59% $ 6.00
----------- ------- ----------- -----
Total ................................ 6,118,247 100% $25,387,550 100%
=========== ======= =========== =====
The above discussion and tables exclude:
o 375,000 shares of common stock issuable upon exercise of the
underwriters' over-allotment option;
o 250,000 shares of common stock issuable upon the exercise of the
underwriters' warrants;
o 783,876 shares of common stock underlying stock options granted and
outstanding pursuant to our equity incentive plan;
21
o 128,154 shares of common stock underlying stock options to be
granted to our president and chief executive officer pursuant to our
equity incentive plan prior to the consummation of this offering;
o 30,000 shares of common stock underlying stock options to be granted
to certain of our directors pursuant to our equity incentive plan
upon the consummation of this offering;
o 134,899 shares of common stock issuable upon exercise of warrants
issued in June 2002 to Plexus Services Corp., a former supplier. See
"Description of Securities -- Other Warrants" and "Business --
Settlement Agreement;"
o 28,104 shares of common stock issuable upon conversion of shares of
our series A preferred stock which are themselves issuable upon
exercise of warrants issued to convertible note holders; and
o shares of our common stock which may be issuable upon conversion of
the $1,500,000 convertible note issued to Lancer Offshore, Inc. and
any shares of our common stock issuable upon the exercise of any
warrants to which Lancer Offshore, Inc. may be entitled as part of
the Potential Lancer Share Issuance. See "Important Assumptions in
this Prospectus -- Certain Convertible Notes have not been
Converted." If the above discussion and table were to include
600,000 shares of common stock, which may be issuable upon
conversion of this convertible note, then the pro forma net tangible
book value after this offering would be $1.81 per share of our
common stock, which represents an immediate increase of $2.13 per
share to existing stockholders and an immediate and substantial
dilution of $4.19 per share to new investors purchasing common stock
in this offering. If the above discussion and table were to assume
the payment of this convertible note plus accrued interest at the
maturity date (March 15, 2003), then the pro forma net tangible book
value after this offering would be $1.73 per share of our common
stock, which represents an immediate increase of $2.05 per share to
existing stockholders and an immediate and substantial dilution of
$4.27 per share to new investors purchasing common stock in this
offering.
22
SELECTED FINANCIAL INFORMATION
The following selected financial information should be read in
connection with, and are qualified by reference to, the financial statements and
related notes and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" appearing elsewhere in this prospectus. The statement
of operations data for the years ended December 31, 2001 and 2000 and the
balance sheet data as of December 31, 2001 are derived from our financial
statements, which have been audited by Grant Thornton LLP, independent auditors.
The statement of operations information for the period from our inception on
April 3, 1997 through September 30, 2002 and the nine-month periods ended
September 30, 2002 and 2001 and the balance sheet data as of September 30, 2002
are derived from our unaudited financial statements. In the opinion of
management, all necessary adjustments, consisting only of normal recurring
accruals, have been included to present fairly the unaudited interim results
when read in conjunction with the audited financial statements and notes thereto
appearing in this prospectus. Historical results are not necessarily indicative
of results that may be expected for any future period. All share and per share
data give effect to an amendment to our certificate of incorporation to be filed
prior to the commencement of this offering which, among other things, will
effect a reverse stock split pursuant to which each share of our common stock
then outstanding will be converted into 0.2248318 of one share of our common
stock immediately prior to the effectiveness of the registration statement to
which this prospectus relates.
Statement of Operations Data
Nine months ended Year Ended
From Inception
to September 30, September 30, September 30, December 31, December 31,
2002 2002 2001 2001 2000
--------------- ------------ ------------ ----------- -----------
(Unaudited) (Unaudited)
Revenue - other $ 300,000 $ -- $ -- $ 300,000 $ --
Operating Expenses:
Research and development 9,612,072 614,043 655,112 737,858 4,781,708
General and administrative 3,954,077 691,419 479,827 652,828 854,315
------------ ------------ ------------ ------------ ------------
Loss from operations (13,266,149) (1,305,462) (1,134,939) (1,090,686) (5,636,023)
Other income, net 553,010 343,974 5,147 5,497 53,440
------------ ------------ ------------ ------------ ------------
Net loss (12,713,139) (961,488) (1,129,792) (1,085,189) (5,582,583)
Cumulative preferred dividends and accretion (755,000) (272,000) (228,000) (314,000) (169,000)
Net loss attributable to common stockholders (13,468,139) (1,233,488) (1,357,792) (1,399,189) (5,751,583)
============ ============ ============ ============ ============
Net loss per share:
Basic and Diluted $ (0.98) $ (1.08) $ (1.11) $ (4.64)
============ ============ ============ ============
Weighted average shares outstanding:
Basic and Diluted 1,261,194 1,259,547 1,259,957 1,238,711
============ ============ ============ ============
Pro forma per share data (unaudited):
Pro forma net loss per share (1)
Basic and Diluted $ (0.27) $ (0.34) $ (0.33) $ (2.01)
============ ============ ============ ============
Pro forma weighted-average shares outstanding:
Basic and Diluted 3,500,487 3,275,882 3,308,706 2,778,533
============ ============ ============ ============
(1) Pro forma net loss per share gives effect to conversion of all mandatorily
convertible preferred stock (including accrued preferred dividends) into
common stock.
23
Balance Sheet Data
September 30, 2002
---------------------------------
December 31, Actual Pro Forma (1)
2001 ------------- --------------
-------------- (Unaudited)
Cash and cash equivalents $ 277,526 $ 483,808 $ 483,808
Working capital (deficiency) (1,756,838) (742,423) (742,423)
Total assets 394,624 1,053,516 1,053,516
Short-term debt, net (2) 105,000 760,000 760,000
Redeemable preferred stock 5,520,550 5,792,550 -
Stockholders' equity (deficit) (2) $ (7,163,151) $ (6,451,639) $ (659,089)
- -------------------
(1) Gives effect to the conversion of all mandatorily convertible preferred
stock (including accrued preferred dividends) into common stock upon
completion of this initial public offering.
(2) Actual and pro forma information do not give effect to conversion of the
$1,500,000 convertible note issued to Lancer Offshore, Inc. (see
"Important Assumptions in this Prospectus - Certain Convertible Notes have
not been Converted").
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and notes thereto included elsewhere in this prospectus.
Overview
Since our inception in April 1997, we have been engaged in the development
of hemodiafiltration products and technologies for treating patients with End
Stage Renal Disease, or ESRD. Our products include the OLpurTM MD190, a
dialyzer, OLpurTM H2H(TM), an add-on module designed for use with existing
hemodialysis machines and controlled by advanced software with a simplified user
interface, and the OLpur(TM) NS2000 system, a stand-alone HDF machine and
associated filter technology. We have developed prototypes for all of these
products.
To date, we have devoted substantially all of our efforts to research,
clinical development and establishing strategic alliances for the development,
production and sale of our products in Europe and the United States upon their
approval by appropriate regulatory authorities. We have not derived any revenues
from product sales and expect to generate product revenues no earlier than 2003.
Because we intend to initially introduce our products in Europe, we will be
subject to price fluctuations of the Euro and possibly other foreign currencies.
We have incurred losses since our inception. At September 30, 2002, we had
a deficit accumulated during the development stage of $13.5 million. We expect
to incur additional losses in the foreseeable future at least until such time,
if ever, that we successfully complete the development of our products, obtain
the required regulatory clearances and successfully manufacture and market our
products.
The following trends, events and uncertainties may have a material impact
on our potential sales, revenue and income from operations: (1) the completion
of our regulatory approval process; (2) the completion of our clinical trials;
(3) our ability to influence the adoption of our technology and other processes
by physicians, nephrologists and other medical professionals in our target
markets; and (4) the consolidation of dialysis clinics into larger clinical
groups. To the extent we are unable to succeed in accomplishing (1) through (3),
we may not be able to generate any sales or our sales could be lower than
expected and dramatically affect our ability to generate income from operations.
With respect to (4), the impact may be positive in the case where dialysis
clinics consolidate into independent chains, or a negative in the case where
competitors acquire these dialysis clinics and use their own products, which
they have historically tended to do.
Plan of Operation
Based on our cash flow projections, we expect that the net proceeds from
this offering will be sufficient to satisfy our cash needs, with no further
financing required to obtain positive cash flow, through July 2004. Based on our
sales projections, we expect to obtain a positive cash flow by July 2004. If our
sales do not meet our projections, 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 profits would be adversely
affected.
We intend to focus our research and development efforts for the next
twelve months primarily on:
o achieving regulatory approval for the OLpurTM MD190 in western
Europe and the United States;
o continuing our clinical studies on the OLpurTM MD190 to provide
definitive demonstration of the OLpurTM MD190's efficacy; and
o completing our OLpurTM H2H(TM) product and achieving regulatory
approval for the OLpurTM H2H(TM) in western Europe and the United
States.
We estimate that our purchase of production-related equipment and tooling
for placement at facilities of our manufacturers in order to reduce our
manufacturing costs will be approximately $1.0 million for the fiscal year
ending December 31, 2003.
We plan to add four to six members to our sales staff in each of Europe
and the United States, as well as three to four members to our administrative
staff in Europe. We intend to make our European staff additions at or around the
time we obtain
25
regulatory approval of the OLpurTM MD190 in the European Union, which we have
targeted for the spring of 2003. We intend to make our U.S. staff additions at
or around the time we obtain regulatory approval for the OLpurTM MD190 in the
United States, which we have targeted for the last quarter of 2003. While we
intend for our European sales staff to be compensated on a primarily salary
basis due to European employment rules, we intend for our U.S. sales staff to be
compensated on a combined salary-and-commission basis.
Results of Operations
Nine Months Ended September 30, 2002 Compared to the Nine Months Ended September
30, 2001
Revenues. There were no revenues for the nine months ended September 30,
2002 and for the nine months ended September 30, 2001.
Research and Development. Research and development expenses are comprised
of personnel and scientific and engineering consultants and related costs,
machine and product parts and software, product testing, patent expenses and
clinical studies.
Research and development expenses were $614,043 for the nine months ended
September 30, 2002 compared to $655,112 for the nine months ended September 30,
2002, a decrease of $41,069. The decrease was primarily due to capital
constraints in the nine months ended September 30, 2002.
General and Administrative. Our general and administrative expenses
consist primarily of personnel and related costs for general corporate
functions, including finance, accounting, legal, human resources, facilities and
information systems expense.
General and administrative expenses were $691,419 for the nine months
ended September 30, 2002 compared to $479,827 for the nine months ended
September 30, 2001, an increase of $211,592. The increase was primarily due to
legal and accounting expenses.
Other Income, Net. Other income, net consists of interest income earned on
cash deposits and short-term investments, reduced by interest expense on notes
payable and gains and losses in sales of property and assets. In the first nine
months of 2002, other income also included a gain that resulted from a
settlement in June 2002 with Plexus Services Corp., a supplier of engineering
consulting services, with respect to a claim for payment by us to Plexus of
approximately $1,900,000 for engineering consulting services relating to the
research and development of our OLpur(TM) NS2000. Pursuant to the settlement
agreement, Plexus agreed to release us from liability with respect to its claim
in exchange for (1) our issuance to Plexus of warrants to purchase 134,899
shares of our common stock and (2) our payment to Plexus of an aggregate amount
of $650,000 in three installments. We paid the first installment of $300,000 in
August 2002. The second installment of $100,000 is due in February 2003 and the
third installment of $250,000 is due when we raise $1,250,000 of additional
capital. See "Business -- Settlement Agreement."
Other income, net was $343,974 for the nine months ended September 30,
2002 compared to $5,147 for the nine months ended September 30, 2001, an
increase of $338,827. The increase was primarily due to a gain that resulted
from the forgiveness of indebtedness by Plexus pursuant to the settlement
agreement in June 2002 (see "Business--Settlement Agreement"), offset by
financing costs related to the short-term convertible notes.
Net Income (Loss). As a result of the foregoing, we incurred a net loss of
approximately $1.0 million for the nine months ended September 30, 2002 compared
to a net loss of approximately $1.1 million for the nine months ended September
30, 2001.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Revenues. Revenues were $300,000 for the year ended December 31, 2001
compared to zero for the year ended December 31, 2000. The increase was due to a
collaborative product feasibility study we had contemplated with Gambro Renal
Products, a division of The Gambro Company, that was initiated and terminated
during the last quarter of 2001. Prior to initiating the study, Gambro
terminated our agreement and paid us a termination fee of $300,000. As of the
date of this prospectus, we do not have any plans to enter into any agreements
of this nature.
26
Research and Development. Research and development expenses were $737,858
for the year ended December 31, 2001 compared to approximately $4.8 million for
the year ended December 31, 2000, a decrease of approximately $4.1 million. The
decrease was primarily due to our discontinued use of Plexus Service Corp.'s
engineering consulting services with respect to the research and development of
our OLpur(TM) NS2000 in 2001. In 2000, our research and development expenses
attributable to Plexus' services were approximately $2.0 million. Due to capital
restraints and a refocus on disposable products as a possible means of
penetrating the market sooner, we decided to increase our research and
development efforts with respect to our products under development internally,
the OLpurTM MD190 and OLpurTM H2H(TM), thereby utilizing our own employees and
resources rather than making additional payments to an outside engineering
consulting firm. As a result of this decision, we have revised our target for
commencing the marketing of our OLpur(TM) NS2000 from 2004 to 2006 and our
financial projections through 2006 have been adjusted to reflect the revised
target. See "Business--Settlement Agreement."
General and Administrative Expenses. General and administrative expenses
were approximately $0.7 million for the year ended December 31, 2001 compared to
approximately $0.9 million for the year ended December 31, 2000, a decrease of
approximately $0.2 million. The decrease was primarily due to lower staffing
levels.
Other Income, Net. Other income, net was $5,497 for the year ended
December 31, 2001 compared to $53,440 in the year ended December 31, 2000, a
decrease of $47,943. The decrease was primarily due to lower interest income in
2001 owing to lower average cash deposits and short-term investments on hand and
lower interest rates and to gain on the disposal of an asset in 2000.
Net Income (Loss). As a result of the foregoing, we incurred a net loss of
approximately $1.1 million for the year ended December 31, 2001 compared to a
net loss of approximately $5.6 million for the year ended December 31, 2000.
Liquidity and Capital Resources
We have incurred losses since our inception. At September 30, 2002, we had
a deficit accumulated during the development stage of $13.5 million. We expect
to incur additional losses in the foreseeable future at least until such time,
if ever, that we successfully complete the development of our products, obtain
the required regulatory clearances and successfully manufacture and market our
products. Our independent auditors have included an explanatory paragraph in the
financial statements attached to this prospectus which expresses doubt as to our
ability to continue as a going concern.
We have financed our operations to date primarily through private sales of
our equity and debt securities. Through September 30, 2002, we had received net
offering proceeds from private sales of equity and debt securities of
approximately $11.7 million. Since our inception in 1997 through September 30,
2002, we made approximately $400,000 of net capital expenditures and used $10.8
million in cash to support our operations. At September 30, 2002, we had cash,
cash equivalents and short-term investments of $483,808 and a working capital
deficit of $742,423.
On December 26, 2002, we obtained a short-term loan from a lender in the
principal amount of $250,000. This loan is payable on the earlier to occur of 30
days after the consummation of this offering and December 26, 2003. This loan
bears interest, calculated quarterly in arrears, at a rate of 7% per annum from
December 26, 3002 to March 31, 2003, 10% per annum from April 1, 2003 to April
30, 2003, and 15% per annum from May 1, 2003 to December 26, 2003.
We expect to use the proceeds of this offering (1) to repay short-term
loans to a related party and another lender; (2) for the marketing and sales of
our products through active solicitation of customers by exhibiting at trade
shows, advertising in trade magazines and setting up a sales group to solicit
prospective customers; (3) to complete our clinical studies, obtain appropriate
regulatory approvals and expand our research and development with respect to our
products; (4) for payment of amounts due under a settlement agreement with a
former supplier; (5) for payment of dividends on shares of our series B
convertible preferred stock and series C convertible preferred stock accruing
from November 1, 2002 to the date of the consummation of this offering; and (6)
for working capital purposes, including for additional salaries and wages as our
organization grows and we establish offices in Europe, and for additional
professional fees and expenses and other operating costs. In addition, we may be
obligated to repay up to $1,575,000 in principal and interest under a
convertible promissory note on March 15, 2003. For a description of this
convertible note, see "Important Assumptions in this Prospectus -- Certain
Convertible Notes have not been Converted" and for a description of our sales of
debt and equity securities generally, see "Certain Transactions." In the event
the underwriters' over-allotment option is exercised, we will realize additional
net proceeds, which we intend to use for working capital and general corporate
purposes. See "Use of Proceeds." We anticipate, based on our currently proposed
plans and assumptions, that
27
the net proceeds of this offering will be sufficient to satisfy our cash
requirements, with no further financing to obtain positive cash flow, through
July 2004.
Our funding needs will depend on many factors, including the timing and
costs associated with obtaining European or United States regulatory approval,
continued progress in research and development, clinical studies, manufacturing
scale-up, the cost involved in filing and enforcing patent claims and the status
of competitive products. In the event that our plans change, our assumptions
change or prove inaccurate, or if the proceeds of this offering, together with
other funding resources, otherwise prove to be insufficient to fund operations,
we could be required to seek additional financing sooner than currently
anticipated. We have no current arrangements with respect to sources of
additional financing. There can be no assurance that European Union or FDA
clearance or approval will be obtained in a timely manner or at all or that
additional financing will be available to us when needed, on commercially
reasonable terms, or at all.
We have not generated taxable income to date. At December 31, 2001, the
net operating losses available to offset future taxable income were
approximately $11.8 million. The carryforwards expire at various dates beginning
in 2017 through 2021. As a result of change in control, the carryforwards may be
subject to an annual limitation, so that a portion of these carryforwards may
expire before ultimately becoming available to reduce federal income tax
liabilities.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board, or FASB, issued
SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that all business combinations be
accounted for by the purchase method and that intangible assets acquired in a
business combination be recognized as assets apart from goodwill. SFAS No. 142
requires that goodwill and intangible assets that have indefinite useful lives
not be amortized but be tested at least annually for impairment. Intangible
assets that have finite useful lives will continue to be amortized over their
useful lives. SFAS No. 141 became effective for all business combinations
initiated after June 30, 2001 and for all business combinations accounted for by
the purchase method for which the date of acquisition is July 1, 2001 or later.
The provisions of SFAS No. 142 are effective for fiscal years beginning after
December 15, 2001. The adoption of these statements is not expected to have a
material effect on our financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which is effective for fiscal years beginning after
June 15, 2002. SFAS No. 143 requires that the fair value of an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value of the obligation can be made. The adoption of the
provisions of SFAS No. 143 is not expected to have a material effect on our
financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which is effective for fiscal
years beginning after December 15, 2001. SFAS No. 144 addresses financial
accounting and reporting for the impairment of long-lived assets (excluding
goodwill) or assets to be disposed of. The adoption of SFAS No. 144 is not
expected to have a material effect on our financial position or results of
operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of commitment to an exit or disposal plan. SFAS
146 will be applied to exit or disposal activities after December 31, 2002 and
is not expected to have a material effect on the Company's financial position or
results of operations.
28
BUSINESS
Overview
We are a Delaware corporation founded in 1997 by health professionals,
scientists and engineers affiliated with Columbia University to develop advanced
End Stage Renal Disease, or ESRD, technology and products that would address
both patient treatment needs and the clinical and financial needs of the
treatment provider. We have developed three products to deliver an improved
hemodiafiltration, or HDF, process for ESRD patients. These are the OLpurTM
MD190, a dialyzer, OLpurTM H2H(TM), an add-on module designed for use with
existing hemodialysis machines and controlled by advanced software with a
simplified user interface, and the OLpur(TM) NS2000 system, a stand-alone HDF
machine and associated filter technology. We believe these products are more
effective than any products currently available for ESRD therapy. In laboratory
bench studies conducted by members of our research and development staff, our
HDF products have been shown to remove a range of larger toxins, known
collectively as "middle molecules" due to their molecular weight, more
effectively than existing hemodialysis or hemodiafiltration methods. These
middle molecules are thought to contribute to such conditions as malnutrition,
impaired cardiac function, carpal tunnel syndrome, and degenerative bone disease
in the ESRD patient. See "Business -- Limitations of Extracorporeal Renal
Replacement Therapies."
One theory in the medical community, which we support and was documented
in an article by Dr. R. Ward in the Journal of American Society of Nephrology in
December 2000, is that some of the morbidity associated with chronic
hemodialysis is thought to result from the retention of middle molecules that
are not effectively removed by diffusion in conventional hemodialysis. According
to an article by H. Tang in the Hong Kong Journal of Nephrology, published in
2001, the HDF process offers some improvement over high-flux hemodialysis
therapies by removing more middle molecules at a faster rate. Further,
convective therapies such as HDF have been shown to improve treatment delivery
and treatment tolerance when compared to conventional hemodialysis, according to
an abstract by Bosch et. al in the journal Curr Opin Nephrol Hypertens in 1998.
We believe that our products will reduce hospitalization, medication and
care costs as well as improve patient health (including reduced drug
requirements and improved blood pressure profile), and, therefore, quality of
life, by removing a broad range of toxins through a more patient-friendly,
better-tolerated process. We believe that the OLpurTM MD190 and the OLpurTM
H2H(TM) will provide these benefits to ESRD patients without significant capital
expenditures for the ESRD treatment provider. We also believe that the OLpur(TM)
NS2000 system will increase profitability for the ESRD treatment provider by
providing a more effective treatment in less time. See "Business -- Our
Products."
We have not derived any revenues from our operations, hold minimal assets
and have incurred losses since our inception primarily as a result of our
research and development efforts. To date, we have relied on private sales of
our securities and loans from our shareholders to fund operations.
Industry Background
ESRD is characterized by irreversible loss of kidney function. A healthy
kidney removes excess water and various waste products from the blood stream, a
process critical to maintaining life. When kidney function drops below certain
parameters, treatment is required for patient survival. There are currently only
two methods for treating ESRD; renal replacement therapy and kidney
transplantation. According to Frost & Sullivan's 2000 European Renal Replacement
Equipment and Supplies Market Report, the shortage of suitable kidneys for
transplants will mean that patients will need some form of renal replacement
therapy, and the supplies it requires. The renal replacement treatment options
are described below under "Current ESRD Therapy Options."
According to U.S. Congressman Pete Stark's introduction of the proposed
End Stage Renal Disease Quality Improvement Act of 2002 (H.R. 5141) in the House
of Representatives on July 16, 2002, there were approximately 340,000 ESRD
patients in the United States. According to the Lysaght Article, as of mid-year
2001, the number of dialysis patients worldwide was estimated to be over 1.1
million and the size of this population has been expanding at rate of
approximately 7% per year. According to the United States Renal Data System's
2001 Annual Data Report, as of December 31, 1999, within the United States,
approximately 71% of the ESRD population received dialysis treatment,
approximately 87% of whom received hemodialysis treatment administered by care
providers on an outpatient basis at dialysis centers. Based on the Merrill
Report, and by our calculations, we estimate that of the dialysis patients
worldwide, approximately 27% are in the United States, approximately 23% are in
Europe and approximately 50% are in regions outside of the United States and
Europe.
29
According to the Lysaght Article, assuming current trends in ESRD
prevalence continue, the number of dialysis patients worldwide will exceed over
two million by 2010 and the total aggregate expenditure on ESRD patient care is
expected to exceed $1 trillion over the next decade. According to the 1997 Frost
& Sullivan Report, growth drivers of the ESRD population are the aging
population and the increase in incidence of diabetes. According to the same
report, in 2025, the number of people worldwide who are more than 65 years old
will have almost doubled from the 1950 figure reaching 800 million. According to
the U.S. Census Bureau and the Centers for Medicare and Medicaid Services
(formerly known as the Health Care Financing Administration), respectively, on
January 1, 2000, 21% of the U.S. population was 55 years old or older, but, as
of December 31, 1999, this group comprised a disproportionate 55% of U.S.
Medicare ESRD cases.
According to the 1997 Frost & Sullivan Report, dialysis machines are
generally replaced on average every seven years. According to this report, the
dialysis machine market was projected to grow from 1996 to 2003 at a compounded
annual rate of approximately 10.1% in the United States and 10.6% worldwide.
Based on these growth rates, by 2010, we expect that the dialysis machine market
will exceed $600 million in the United States and $2.5 billion worldwide, with
dialysis machine sales worldwide exceeding 120,000 units annually.
The dialysis filter (also referred to as a dialyzer or an "artificial
kidney") is the primary disposable component of ESRD therapy. According to the
1997 Frost & Sullivan Report, the world hemodialysis dialyzer market was
projected to be $3.53 billion and to be growing at a rate of approximately 10.8%
per year in 2002. According to this report, the world hemodialysis dialyzer
market was projected to grow from 1996 to 2003 at a compounded annual rate of
approximately 10.5%. Based on this growth rate, we expect that the world
hemodialysis dialyzer market could more than double in the next decade, reaching
approximately $8 billion by 2010. In 2002, approximately 33.4 million
hemodialysis dialyzers were projected to be shipped into European markets and
the number of hemodialysis patients in Europe was projected to reach 223,000,
according to Frost & Sullivan's 2000 European Renal Replacement Equipment and
Supplies Market Report.
We initially intend to compete in the HDF dialyzer market with our OLpurTM
MD190 in western Europe. If we can obtain FDA approval of the OLpurTM MD190 and
the OLpurTM H2H(TM), we will compete in the U.S. hemodialysis dialyzer market by
combining our OLpurTM MD190 with an OLpurTM H2H(TM) to enable the HDF process on
hemodialysis machines.
There is an important distinction between the United States and
European/Asian dialyzer markets. In the United States, a majority of dialysis
clinics re-use dialyzers. According to an article by P. Schoenfeld published in
Seminars in Nephrology in July 1997, dialyzers were reused 12-14 times on
average over the years from 1990 through 1995. A given dialyzer is, however,
always provided to the same patient; there is no crossover of dialyzers among
patients.
However, according to the 1997 Frost & Sullivan Report, reuse is not
generally accepted in Europe or Japan. According to the same report, in Japan,
dialyzer reuse is illegal and many countries in Europe also forbid the reuse of
dialyzers, although this is beginning to change in some regions. As a result,
Europe and Asia provide substantially larger disposables markets. Assuming
patients receive three treatments per week, we estimate that up to 156 dialyzers
per patient per year are used in the European and Asian markets where dialyzers
are generally not reused.
Current ESRD Therapy Options
Current renal replacement therapy technologies include (1) two types of
dialysis, peritoneal dialysis and hemodialysis, (2) hemofiltration and (3)
hemodiafiltration, a combination of hemodialysis and hemofiltration. While there
are variations in each approach, in general, the three major categories of renal
replacement therapy in the marketplace today are defined as follows:
o Peritoneal Dialysis, or PD, uses the patient's peritoneum, the
membrane lining covering the internal abdominal organs, as a filter
by introducing injectable-grade dialysate solution into the
peritoneal cavity through a surgically implanted catheter. After
some period of time, the fluid is drained and replaced. PD is
limited in use because (1) it requires the patient to have some
residual kidney function, and (2) the peritoneal cavity is subject
to scarring with repeated episodes of inflammation of the peritoneal
membrane, reducing the effectiveness of this treatment approach. As
a PD patient's kidney function continues to deteriorate, the patient
must switch to an extracorporeal renal replacement therapy such as
hemodialysis or hemodiafiltration.
30
o Hemodialysis uses an artificial kidney machine to remove certain
toxins and fluid from the patient's blood while controlling external
blood flow and monitoring patient vital signs. Hemodialysis patients
are connected to a dialysis machine via a vascular access device.
The hemodialysis process occurs in a dialyzer cartridge with a
semi-permeable membrane which divides the dialyzer into two
chambers: while the blood is circulated through one chamber, a
premixed solution known as dialysate circulates through the other
chamber. Toxins and excess fluid from the blood cross the membrane
into the dialysate solution through a process known as "diffusion."
o Hemodiafiltration, or HDF, in its basic form combines the principles
of hemodialysis with hemofiltration. Hemofiltration is a cleansing
process without dialysate solution where blood is passed through a
semi-permeable membrane which filters out solute particles. HDF uses
dialysate solution with a negative pressure (similar to a vacuum
effect) applied to the dialysate solution to draw additional toxins
from the blood and across the membrane. This process is known as
"convection." HDF thus combines diffusion with convection, offering
efficient removal of small solutes by diffusion, with improved
removal of larger substances (i.e. middle molecules) by convection.
Limitations of Current Extracorporeal Renal Replacement Therapies:
Hemodialysis, the traditional extracorporeal renal replacement therapy and
the extracorporeal therapy used in the United States, addresses the water and
waste issues sufficiently to sustain life, but fails, in our opinion, to address
satisfactorily the long-term health or overall quality of life of the ESRD
patient.
In particular, current hemodialysis practices effectively address the
removal of smaller toxic molecules such as urea, but do not effectively address
the removal of middle molecules, the accumulation of which may lead to such
conditions as carpal tunnel syndrome, malnutrition and resulting cardiovascular
death. For example, the most well-known middle molecule, a protein known as
a2Microglobulin, is produced by the body on a continuous basis and removed by a
healthy kidney; however, according to an article by Dr. R. Ward published in the
Journal of American Society of Nephrology in April 2000, solutes of this size
are not removed by conventional hemodialysis, and their removal by diffusion
through high-flux hemodialysis membranes is also limited. According to a report
on Amyloidosis and Kidney Disease published by the National Institutes of Health
in 2001, the accumulation of this protein in the body of the ESRD patient leads
to the formation of abnormal protein deposits (dialysis related amyloidosis) and
complications such as carpal tunnel syndrome, joint pain and stiffness. In an
article published in Blood Purification in 1999, L.W. Henderson noted the
inferential link between appetite-suppressing middle molecular weight substances
and the common observation of malnutrition in ESRD patients, and according to a
study by Fung et al published in American Journal of Kidney Diseases in August
2002, protein-energy malnutrition has been associated with a greater risk of
cardiovascular death.
The HDF process, which is currently available in the European and Asian
marketplace, offers some improvement over dialysis therapies because of better
ESRD patient tolerance and superior blood purification of both small and middle
molecules. This superior blood purification may result in better over-all
patient health. A study by Locatelli et al, published in Kidney International in
1999, showed that when ESRD patients are treated with hemofiltration or HDF, the
need for carpal tunnel syndrome surgery, an indication of patient morbidity, was
reduced by 40%. According to another study by Kim et al, published in
Contributions to Nephrology in 1994, the aggressive removal of larger proteins
in the HDF process has shown to relieve some of the local and systemic
inflammatory processes. Furthermore, according to an article by Bonforte, et al,
published in the Journal of the International Society of Blood Purification in
2002, it has also been shown that as patients are placed on HDF machines, the
level of hemoglobin in their blood typically increases and the need for costly
hemoglobin medications is reduced.
Current Dialyzer Technology used with HDF Systems:
In our view, treatment efficacy of current HDF systems, as well as the
pace of the actual treatment, are limited by the current dialyzer technology.
As a result of the negative pressure applied in HDF, fluid is drawn from
the blood and across the dialyzer membrane along with the toxins removed from
the blood. A portion of this fluid must be replaced with a man-made
injectable-grade fluid, known as "substitution fluid," in order to maintain the
blood's proper fluid volume. With the current dialyzer technology, fluid is
replaced in one of two ways: pre-dilution or post-dilution.
o With pre-dilution, substitution fluid is added to the blood before
the blood enters the dialyzer cartridge. In this process, the blood
can be over-diluted, and therefore more fluid can be drawn across
the membrane. This enhances removal of
31
toxins by convection. However, because the blood is diluted before
entering the device, it actually reduces the rate of removal by
diffusion; the overall rate of removal, therefore, is reduced for
small molecular weight toxins (such as urea) that rely primarily on
diffusive transport.
o With post-dilution, substitution fluid is added to blood after the
blood has exited the dialyzer cartridge. This is the currently
preferred method because the concentration gradient is maintained at
a higher level, thus not impairing the rate of removal of small
toxins by diffusion. The disadvantage of this method, however, is
that there is a limit in the amount of plasma water that can be
filtered from the blood before the blood becomes too viscous, or
thick. This limit is approximately 25% to 30% of the blood flow
rate. This limit restricts the amount of convection, and therefore
limits the removal of middle and larger molecules.
The Nephros Mid-Dilution Diafiltration Process
Our OLpur(TM) MD190 uses a design and process we developed called
Mid-Dilution Diafiltration, or MDF. MDF is a fluid management system that
optimizes the removal of both small toxins and middle-molecules by offering the
advantages of pre-dilution HDF and post-dilution HDF combined in a single
dialyzer cartridge. The MDF process involves the use of two stages: in the first
stage, blood is filtered against a dialysate solution; it is then overdiluted
with sterile infusion fluid before entering a second stage, where it is filtered
once again against a dialysate solution. Based on laboratory bench studies
conducted on our OLpur(TM) MD190 by members of our research and development
staff, discussed below, we believe that the MDF process will provide improved
toxin removal in HDF treatments, with a resulting improvement in patient health.
See "Business -- Our Products -- OLpur(TM) MD190."
Our Products
Our products, which are currently in the development stage or subject to
our receipt of regulatory approval, include:
OLpurTM MD190
OLpurTM MD190 is our dialyzer cartridge that incorporates the patented MDF
process and is designed for use with the existing HDF platforms currently
prevalent in Europe and Asia. We believe the OLpurTM MD190 incorporates a unique
blood-flow characteristic that enhances toxin removal with almost no cost
increase over existing devices currently used for HDF therapy.
Laboratory bench studies have been conducted on our OLpurTM MD190 by
members of our research and development staff and by a third party. In
laboratory bench studies conducted by members of our research and development
staff, OLpurTM MD190 offered small molecule removal comparable to existing HDF
standards and an improvement of over 80% in removing middle molecules. In a
third-party study which was performed by the University of Kentucky in concert
with Baxter Renal Division, a division of Baxter Healthcare Corporation, each of
two prototypes of the OLpurTM MD190 offered urea (a small molecule) removal
comparable to an existing HDF dialyzer (which was used as a control device) and
an improvement of over 122% and 141%, respectively, in removing the protein
known as a2Microglobulin (a middle molecule), when compared to the existing HDF
dialyzer.
The OLpur(TM) MD190 is currently scheduled to enter its human clinical
trials in January 2003. We expect that these trials will be conducted in
Montpellier, France under the supervision of Dr. Bernard Canaud, in his capacity
as president of L'institut de Recherche et de Formation en Dialyse, a research
institution located in Montpellier, France. Dr. Canaud is a published
nephrologist associated with the Hospal Lapeyronie in Montepellier, France. See
"Business -- Clinical Testing."
TUV Rheinland of North America, Inc., a worldwide testing and
certification agency that performs conformity assessments to European Union
requirements for medical devices, has agreed to work with us to help us obtain
the Conformite Europeenne, or CE, mark, a mark which demonstrates compliance
with relevant European Union requirements. We have agreed to pay TUV Rheinland
of North America, Inc. approximately $18,300 in exchange for its services.
We anticipate initiating European sales of OLpurTM MD190 in the first
quarter of 2003. We plan to seek U.S. regulatory approval later in the same year
and to begin marketing in the United States as soon as we obtain such approval,
which we estimate will be by the end of 2003. We anticipate offering the OLpurTM
MD190 at a price comparable to the highest priced dialyzers currently sold in
the relevant market.
32
OLpurTM H2H(TM)
OLpurTM H2H(TM) is our add-on module that is designed to convert
hemodialysis machines into HDF-capable machines that can then be used with the
OLpurTM MD190. According to the United States Renal Data System's 2001 Annual
Data Report, as of December 31, 1999, there were 58,248 hemodialysis machines in
the United States. Based on the same report, we estimate that from 1990 through
1999, the number of hemodialysis machines in the United States was increasing at
an average annual growth rate of approximately 8.74%. At this average annual
growth rate, we estimate that there will be approximately 82,340 hemodialysis
machines in 2003. We also estimate that in 2003, approximately 85% of these
machines will be able to accommodate our OLpur(TM) H2H(TM). We base our estimate
on the following: (1) according to a survey of several equipment resellers that
we conducted, over 90% of used dialysis machines being resold in the United
States feature volumetric ultrafiltration control (the mechanism required to use
our H2H(TM) technology); and (2) the largest dialysis circuit card repair house
in the United States has indicated that at least 85% of the circuit cards it has
sold or repaired in the past year are used in machines with volumetric
ultrafiltration control.
We have completed our OLpurTM H2H(TM) design and laboratory bench testing,
all of which were conducted by members of our research and development staff. We
plan to submit to the FDA for 510(k) approval of OLpurTM H2H(TM) during the
third quarter of 2003 and seek to acquire the CE mark during the last quarter of
2003. We have targeted an introduction of the OLpurTM H2H(TM) in the United
States and Europe by the end of 2003. We plan to offer the OLpurTM H2H(TM) at a
nominal price in concert with long-term supply agreements for dialyzers and
other disposable products.
OLpur(TM) NS2000
OLpur(TM) NS2000 is our standalone HDF machine and associated filter
technology, which is in the development stage. In laboratory bench studies and
animal studies, conducted by members of our research and development staff,
OLpur(TM) NS2000 achieved industry standard urea removal 25% faster than current
hemodialysis technologies, while at the same time demonstrating over twice the
rate of clearance of HDF and over three times the rate of clearance of
hemodialysis in removing middle molecules. All studies on our OLpur(TM) NS2000
have been conducted by members of our research and development staff.
Prototype machines have been manufactured and we have begun preliminary
testing. Once testing is completed, we plan to seek regulatory approval in the
United States. We have also designed and developed cartridges for use with
OLpur(TM) NS2000, which have been subjected to pre-manufacturing testing.
OLpur(TM) NS2000 is currently targeted for market introduction in the United
States in 2006.
Our Strategy
We believe that the quality of life of the ESRD patients undergoing renal
replacement therapies, particularly hemodialysis, has generated demand for
improved treatments. We also believe that our products and patented technology
offer the ability to remove toxins more effectively than current dialysis
therapy. Our objective is to capitalize on the demand for improved therapy and
to generate market acceptance and market share for our products through a three
stage approach:
Showcase product efficacy in Western Europe:
Subject to our receipt of regulatory approval, we plan to initiate western
European sales for the OLpurTM MD190 during the spring of 2003. We believe that
there is an immediate opportunity for sales of the OLpurTM MD190 in western
Europe because there is an established HDF machine base using disposable (rather
than re-usable) dialyzers. Assuming a three-times-per-week treatment schedule
using disposable dialyzers, one ESRD patient in Europe will use approximately
156 dialyzers a year. Consequently, we believe that this presents a substantial
sales opportunity.
We intend to market directly to major dialysis centers of the European
market, including to approximately 50 prominent practitioners in ESRD therapy.
We believe that an endorsement of our products by these specialists will
encourage others to follow.
Convert existing hemodialysis machines to hemodiafiltration in Europe and the
U.S.:
Concurrent with our western European introduction of OLpurTM MD190, we
will seek to complete comprehensive clinical trials to validate OLpurTM H2H(TM),
to complete our regulatory approval processes in western Europe for OLpurTM
H2H(TM)
33
and to complete our regulatory approval processes in the United States for both
OLpurTM MD190 and OLpurTM H2H(TM). Our goal is to initiate U.S. and European
sales for the OLpurTM H2H(TM) and the OLpurTM MD190 in 2003. Through the OLpurTM
H2H(TM), we intend to introduce HDF technology to the U.S. dialysis market.
Upgrade dialysis clinics to OLpur(TM) NS2000:
We believe the introduction of the OLpur(TM) NS2000, targeted for 2006,
represents a further upgrade in performance for the dialysis clinic, which will
offer a substantial reduction in treatment time with markedly improved efficacy.
We believe the dialysis clinic will entertain OLpur(TM) NS2000 as an alternative
to its current technology at the dialysis clinic's machine replacement point.
According to the 1997 Frost & Sullivan Report, dialysis machines are generally
replaced on average every seven years.
Manufacturing and Suppliers
We do not intend to manufacture any of our products or components. As of
the date of this prospectus, we are negotiating an agreement with Medica s.r.l.,
a developer and manufacturer of medical products with corporate headquarters
located in Italy, to assemble and produce our OLpurTM MD190 and are negotiating
with Membrana Gmbh, a manufacturer of medical and technical membranes for
applications like dialysis with corporate headquarters located in Germany, to
continue to produce the fiber for the OLpurTM MD190. We are in the process of
negotiating with additional independent manufacturers to ensure multiple
sourcing for our products and supplies. See "Risk Factors -- If we are not able
to successfully commercialize our products, then we will not be profitable; If
we are not able to ensure the timely delivery of our products, then we may not
be profitable; We may not be able to maintain sufficient quality controls...;
and The loss or interruption of services of any of our manufacturers could slow
or stop production of our products."
Sales and Marketing
We are establishing our own sales and marketing organization to sell
products in western Europe and the United States. Our marketing staff has
experience in both these areas. From 1987 to 1996, our vice president-marketing
and sales held several senior positions at Fresenius Medical Care AG, including
the positions of vice president of sales and director of marketing. During the
second quarter of 2002, we engaged two marketing consultants based in Paris on a
contract basis to support the development of our sales and marketing
organization in Europe. To date, these consultants have participated in our
general marketing activities in Europe, including initiating contacts within the
physician community in Europe. In exchange for their consulting services, we
have granted these consultants non-qualified options to purchase an aggregate of
134,899 shares of our common stock, half of which vest on a periodic basis over
the next four years and the other half of which vest when certain milestones are
met.
Our marketing strategy involves the marketing of our OLpur(TM) MD190 and
OLpur(TM) H2H(TM) within the ESRD therapy market in the following two phases:
Phase I: In the first phase, we intend to market the OLpur(TM) MD190 to
healthcare providers such as hospitals, dialysis clinics, managed care
organizations and nephrology physician groups, which already own the
equipment necessary to use the OLpur(TM) MD190 and/or understand
hemodiafiltration therapy. We expect that we will be able to demonstrate
the clearance advantages of the OLpur(TM) MD190 to those healthcare
providers who have a working knowledge of hemodiafiltration therapy. We
expect that our sales and marketing expenses during the first year of this
marketing phase will be approximately $2.8 million. We plan to begin
marketing the OLpurTM MD190 in western Europe and the United States as
soon as we obtain the respective requisite approvals.
Phase II: In the second phase, we intend to introduce the OLpur(TM)
H2H(TM) to all healthcare providers within the ESRD therapy market. Our
goal is to achieve market penetration by offering the OLpur(TM) H2H(TM)
for use by healthcare providers at a nominal price in concert with
long-term supply agreements for dialyzers and other disposable products,
thus permitting the providers to use the OLpur(TM) H2H(TM) without a large
initial outlay of capital. We believe that this will allow healthcare
providers to upgrade their performance profile at an acceptable increase
on a per treatment basis, without replacing their existing machines. We
estimate that the sales and marketing expenses during the first year of
this marketing phase will be approximately $5.2 million. We plan to begin
marketing the OLpur(TM) H2H(TM) in western Europe and the United States as
soon as we obtain the respective requisite approvals.
34
As part of our marketing strategy, we also intend to introduce the OLpur(TM)
NS2000 in the United States if and when we obtain the requisite U.S. regulatory
approval. We have targeted the OLpur(TM) NS2000 for market introduction in the
United States in 2006.
We have begun implementation of other plans to further our sales and
marketing efforts with respect to the OLpur(TM) MD190 and OLpur(TM) H2H(TM). For
example, we participated in the 29th Annual Congress of European Renal
Association - European Dialysis and Transplant Association in Copenhagen,
Denmark in July 2002 and the American Society of Nephrology's 35th Annual
Meeting in Philadelphia, Pennsylvania in November 2002. We also intend to
participate in the 30th Annual Congress of European Renal Association - European
Dialysis and Transplant Association in Berlin, Germany in June 2003 where we
will seek to obtain support for our anticipated launch of the OLpur(TM) MD190
and OLpur(TM) H2H(TM). We estimate that the cost of our participation in the
meeting in Berlin, Germany in June 2003 will be approximately $70,000. We have
also initiated two studies designed to evaluate the actual effectiveness of the
OLpurTM MD190 when used on ESRD patients in western Europe. We intend for these
studies to provide us with valuable information regarding the efficacy of our
product and an opportunity to introduce the OLpurTM MD190 to medical
institutions in western Europe. We initiated the first of these studies in
November 2002 and expect this first study to continue through January 2003. We
intend to initiate the second of these studies in March or April of 2003 and
expect this second study to continue through March or April of 2004. We estimate
that the total cost of these studies to us will be approximately $1.76 million
dollars.
A potential increase in managed care in the United States presents both a
challenge and an opportunity for us. While an increase in managed care may lead
to a reduction in product pricing, we believe that, as a result of increased
managed care, healthcare providers will focus on the following global costs: (1)
the total cost of hospitalizations or admissions and (2) the total cost of daily
medications required to sustain the ESRD patients. Based on a study by Locatelli
published in Kidney International in 1999, an article by Canaud published in
Nephrology Dialysis Transplantation in 1999 and an article by Maduell published
in Nephrology Dialysis Transplantation in 1999, the costs associated with
ESRD-related medical procedures including Carpal Tunnel Syndrome surgery and
medication for ESRD patients are reduced for hemodiafiltration patients.
Accordingly, even if managed care increases in the United States, we believe our
products will be attractive to health care providers if our products can offer
improved therapy at lower costs than competing products.
As discussed above, we intend to market our products primarily to
healthcare providers such as hospitals, dialysis clinics, managed care
organizations, and nephrology physician groups. We intend to ship our products
to these potential customers with the assistance of the manufacturers of our
products. See "Risk Factors -- If we are not able to successfully commercialize
our products...." We are also in discussion with major medical device
manufacturers/providers in Japan and Central and South America regarding license
opportunities for our technology.
Research and Development
Our research and development efforts continue on several fronts directly
related to our current product line. In particular, we are examining ways to
enhance further the removal of toxins from the blood by modifying certain blood
characteristics. We have applied, and will continue to apply, if and when
available, for U.S. Government grants in relation to this research, and will
apply for further grants as appropriate. We are also working on additional
machine devices, next-generation user interface enhancements and other product
enhancements. Our research and development expenditures were $737,858 for the
fiscal year ended December 31, 2001 and $4,781,708 for the fiscal year ended
December 31, 2000.
Clinical Testing
We intend to begin clinical studies on the OLpur(TM) MD190 in Montpellier,
France in January 2003, under the supervision of Bernard Canaud, M.D., in Dr.
Canaud's capacity as president of L'institut de Recherche et de Formation en
Dialyse, a research institute located in Montpellier, France. In September 2002,
L'institut de Recherche et de Formation en Dialyse agreed to provide us with Dr.
Canaud's services for supervising the clinical studies on our OLpur(TM) MD190,
throughout which Dr. Canaud shall, among other things, evaluate the efficacy of
our OLpur(TM) MD190 as compared to the efficacy of conventional dialyzers. We
anticipate that the clinical studies will be completed during the first quarter
of 2003.
Throughout 2003, we also intend to engage in additional clinical studies
across western Europe to demonstrate additional safety and benefits of our
products.
35
Competition
The dialyzer and renal replacement therapy market is subject to intense
competition. Accordingly, our future success will depend on our ability to meet
the clinical needs of physicians and nephrologists, improve patient outcomes and
remain cost-effective for payors.
We expect to compete with other suppliers of ESRD therapies, supplies and
services. There are currently three primary machine manufacturers in
hemodialysis: Fresenius Medical Care AG, The Gambro Company and Baxter
International Inc. At present, Fresenius and Gambro also manufacture
hemodiafiltration machines. These companies and a number of our other
competitors have substantially greater financial, scientific and technical
resources, research and development resources, marketing and manufacturing
resources and sales experience than we have and greater experience in developing
products, providing services and obtaining regulatory approvals.
Some of our competitors, including Fresenius and Gambro, manufacture their
own products and own dialysis clinics in the United States, Europe and other
regions of the world. Because these competitors tend to use their own products,
we may not be able to successfully market our products to the dialysis clinics
under their ownership. According to the Merrill Report, approximately 95% of the
products then used by dialysis clinics owned by Fresenius were products of
Fresenius and approximately 40% of the products then used by dialysis clinics
owned by Gambro were products of Gambro. Based on the same report, and by our
calculations, we estimate that as of September 2001: (1) Fresenius treated in
its own dialysis clinics approximately 24.8% of the dialysis patients in the
United States, 4.6% of the dialysis patients in Europe and 8.7% of the dialysis
patients worldwide; and (2) Gambro treated in its own dialysis clinics
approximately 13.5% of the dialysis patients in the United States, 2.3% of the
dialysis patients in Europe and 4.5% of the dialysis patients worldwide. See
"Risk Factors -- We expect to face significant competition from existing
suppliers..."
Other competitive considerations include pharmacological and technological
advances in preventing the progression of ESRD in high-risk patients such as
those with diabetes and hypertension, technological developments by others in
the area of dialysis, the development of new medications designed to reduce the
incidence of kidney transplant rejection and progress in using kidneys harvested
from genetically-engineered animals as a source of transplants. See "Risk
Factors -- If the size of the market for our products is significantly reduced
due to pharmacological or technological advances in preventative and alternative
treatments for ESRD..."
We are not aware of any other companies using technology similar to ours
in the treatment of ESRD. Our competition would increase, however, if companies
that currently sell ESRD products, or new companies that enter the market,
develop technology that is more efficient than ours. Barriers to entry in our
industry include (1) a large investment in research and development; (2)
numerous costly and time-consuming regulatory hurdles to overcome before any
products can be marketed and sold; (3) high costs for marketing and for building
an effective distribution network, both of which are particularly difficult in a
market already dominated by a few well-established key players; and (4) the
ability to obtain financing during the entire start up period, which may be
difficult in the current financial environment.
We believe that in order to become competitive, we will need to develop
and maintain competitive products and take and hold sufficient market share from
our competitors. Our methods of competition, therefore, include (1) continuing
our efforts to develop, have manufactured and sell products which, when compared
to existing products, perform more efficiently and are available at prices that
are acceptable to the market; (2) displaying our products and providing
associated literature at major industry trade shows in the United States and
Europe; (3) initiating discussions with dialysis clinic medical directors, as
well as representatives of dialysis clinical chains, to develop interest in our
products; and (4) pursuing alliance opportunities in Central and South America
and Asia for distribution of our products and possible alternative manufacturing
facilities.
Intellectual Property
Patents
We attempt to protect our technology and products through patents and
patent applications. In addition to the United States, we are also applying for
patents in other markets, such as Europe, Canada and Japan, to the extent we
deem appropriate. We have built a portfolio of patents and applications covering
our products, including their hardware design and methods of hemodiafiltration.
36
We believe that our patent strategy will provide a competitive advantage
in our target markets, but our patents may not be broad enough to cover our
competitors' products and may be subject to invalidation claims. Our U.S. patent
for the "Method and Apparatus for Efficient Hemodiafiltration" and the pending
U.S. patent application for the "Dual Stage Filtration Cartridge," have claims
that cover the OLpurTM MD190 product and the method of hemodiafiltration
employed in the operation of the product. Although there are pending
applications with claims to the present embodiments of the OLpurTM H2H(TM) and
the OLpur(TM) NS2000 products, these products are still in the design stage and
we cannot determine if the applications (or the patents that may issue on them)
will also cover the ultimate commercial embodiment of these products. See "Risk
Factors - Protecting our intellectual property in our technology through patents
may be costly and ineffective..." In addition, technological developments in
ESRD therapy could reduce the value of our intellectual property. Any such
reduction could be rapid and unanticipated.
As of the date of this prospectus, we have four issued U.S. patents, five
pending U.S. patent applications and seven pending International patent
applications designating all the Patent Cooperation Treaty member countries,
including the United States, covering proposed products and methods of using
such products. We have one additional invention under review by our patent
counsel and expect a patent application for this invention to be filed shortly.
The titles, patent numbers and normal expiration dates (assuming all the U.S.
Patent and Trademark Office fees are paid) of our four issued U.S. patents are
set forth in the chart below.
Title Patent Number Expiration Date
----- ------------- ---------------
Method and Apparatus for
Efficient Hemodiafiltration 6,303,036 July 30, 2019
Two Stage Diafiltration Method
and Apparatus 6,406,631 July 30, 2019
Non-Isosmotic Diafiltration System 6,423,231 October 29, 2019
Dual Stage Hemodiafiltration Cartridge 6,315,895 December 30, 2019
For each of our U.S. patents identified above and for at least three of
our pending U.S. patent applications, we have also filed or plan to file,
counterpart patent applications in Japan, Canada and in certain member states of
the European Patent Convention. Our remaining patent applications are pending
and relate to a range of dialysis technologies, including cartridge
configurations, cartridge assembly, substitution fluid systems, and methods to
enhance toxin removal. For our international patent applications, the titles,
agencies or countries in which such applications were filed, serial numbers and
filing dates are set forth in the chart below.
Title Agency/Country Serial No. Filing Date
----- -------------- ---------- -----------
Method and Apparatus for Efficient Canadian Patent Office 2,338,952 July 30, 1999
Hemodiafiltration
European Patent Office 99943641.3 July 30, 1999
Japanese Patent Office 2000-562134 July 30, 1999
Non-Isosmotic Diafiltration System Canadian Patent Office 2,349,363 October 29, 1999
European Patent Office 99958752.0 October 29, 1999
Japanese Patent Office 2000-579334 October 29, 1999
Method and Apparatus for Generating a Sterile World Intellectual PCT/US01/50719 October 19, 2001
Infusion Fluid Property Organization
Dual Stage Hemodiafiltration Cartridge Canadian Patent Office National Filing of December 29, 2000
PCT/US00/35717
European Patent Office 00989637.4 December 29, 2000
Japanese Patent Office 2001-549759 December 29, 2000
Sterile Fluid Filtration Cartridge and Method Canadian Patent Office National Filing of December 29, 2000
for Using Same PCT/US00/35716 December 29, 2000
European Patent Office 00990428.5 December 29, 2000
Japanese Patent Office 2001-549758
Thermally Enhanced Dialysis/Diafiltration Canadian Patent Office National Filing of January 11, 2001
System PCT/US01/01024 January 11, 2001
European Patent Office 01902018.9 January 11, 2001
Japanese Patent Office 2001-551599
37
Title Agency/Country Serial No. Filing Date
----- -------------- ---------- -----------
Ionic Enhanced Dialysis/Diafiltration System Canadian Patent Office National Filing of January 11, 2001
PCT/US01/01023
European Patent Office 01902017.1 January 11, 2001
Japanese Patent Office 2001-551598 January 11, 2001
Two Stage Diafiltration Method and Apparatus World Intellectual PCT/US01/45368 October 30, 2001
Property Organization
Valve Mechanism for Infusion Fluid Systems World Intellectual PCT/US01/47211 December 7, 2001
Property Organization
Dual Stage Filtration Cartridge World Intellectual PCT/US01/45369 October 30, 2001
Property Organization
Hemodiafiltration/Hemofiltration Method and World Intellectual PCT/US01/50503 December 20, 2001
Apparatus Property Organization
Mid-Dilution Hemo/Dia-Filtration Cartridges World Intellectual PCT/US01/47541 December 11, 2001
Property Organization
Method and Apparatus for a Hemodiafiltration World Intellectual PCT/US02/03741 February 7, 2002
Delivery Module Property Organization
Trademarks
As of the date of this prospectus, we do not have any registered
trademarks. Centrapur,TM OLpur,TM and H2H(TM) are among our non-registered
trademarks, for which trademark registration applications are pending.
License Agreement
On November 1, 1999, we entered into a license agreement with the Trustees
of Columbia University in the City of New York, pursuant to which Columbia
granted us an exclusive right to develop, manufacture, use, sell or lease
products or services covered by certain patent applications or the patents that
may be granted on such applications, collectively referred to in this paragraph
as the "licensed patents." As consideration for this license, we made an initial
payment of $2,500 in cash and issued 2,140 shares of our common stock and are
required to pay to Columbia royalties of 0.33% on leases, rentals, net sales or
transfers of all products or services covered by the licensed patents and 0.33%
of all lump-sum payments we receive in connection with the sale or transfer of
rights in the licensed patents, or in the products or services covered by the
licensed patents. In addition, we are required to make the following payments to
Columbia if we meet the following milestones: (1) $2,500 in cash upon the filing
of the first Nephros-sponsored pre-market application or a foreign equivalent
for the products or services covered by the licensed patents, with the FDA, or
its foreign equivalent; (2) $50,000 upon the cumulative net sales or transfers
of $25,000,000 of products or services covered by the licensed patents; and (3)
$125,000 upon the cumulative net sales or transfers of $200,000,000 of products
or services covered by the licensed patents. As of December 31, 2002, we had not
met any of these milestones. The exclusive license granted under this license
agreement extends until the later to occur of (1) expiration of the last to
expire of the licensed patents or (2) ten years from the date of first sale of a
product or service covered by the licensed patents. Since neither of these
events has occurred, the license agreement is currently in effect. Although the
license agreement is in effect, we do not anticipate making any further payments
under the license agreement as we have discontinued the development of any
products covered by the licensed patents.
Settlement Agreement
In June 2002 we entered into a settlement agreement with Plexus Services
Corp., a supplier of engineering consulting services, with respect to a claim
for payment by us to Plexus of approximately $1,900,000 for engineering
consulting services relating to the research and development of our OLpur(TM)
NS2000. Pursuant to this settlement agreement, Plexus agreed to release us from
liability with respect to its claim in exchange for (1) our issuance to Plexus
of warrants to purchase 134,899 shares of our common stock at an exercise price
of $13.34 per share which expire in June 2007; and (2) our payment to Plexus of
an aggregate amount of $650,000 in three installments. We paid the first
installment of $300,000 in August 2002. The second
38
installment of $100,000 is due in February 2003 and the third installment of
$250,000 is due when we raise $1,250,000 of additional capital. We will be
released from all liability with respect to the claim and the project once all
payments required under this settlement agreement are made. We also agreed to
release each other from any and all other claims or liabilities that we had
against the other as of the date of the settlement agreement.
Governmental Regulation
The research and development, manufacturing, promotion, marketing and
distribution of our products in the United States, Europe and other regions of
the world are subject to regulation by numerous governmental authorities,
including the U.S. Food and Drug Administration, or the FDA, the European Union
and corresponding foreign agencies.
Food and Drug Administration
The FDA regulates the manufacture and distribution of medical devices in
the United States pursuant to the Food, Drug and Cosmetic Act of 1938, or the
FDC Act. All of our products are regulated in the United States as medical
devices by the FDA under the FDA Act. Noncompliance with applicable requirements
can result in, among other things, (1) fines, (2) injunctions, (3) civil
penalties, (4) recall or seizure of products, (5) total or partial suspension of
production, (6) withdrawal of existing approvals or premarket clearances of our
products, (7) refusal to approve or clear new applications or notices relating
to our products, (8) recommendations by the FDA that we not be allowed to enter
into government contracts and (9) criminal prosecution. The FDA also has
authority to require repair, replacement or refund of the cost of any device
illegally manufactured or distributed by us.
Under the FDC Act, medical devices are classified in one of three classes,
Class I, II or III, on the basis of the controls deemed necessary by the FDA to
reasonably ensure their safety and effectiveness.
o Class I devices are medical devices for which general controls
are deemed sufficient to ensure their safety and
effectiveness. General controls include provisions related to
(1) labeling, (2) producer registration, (3) defect
notification, (4) records and reports and (5) quality service
requirements, or QSR.
o Class II devices are medical devices for which the general
controls for the Class I devices are deemed not sufficient to
ensure their safety and effectiveness and require special
controls in addition to the general controls. Special controls
include provisions related to (1) performance and design
standards, (2) post-market surveillance, (3) patient
registries and (4) the use of FDA guidelines.
o Class III devices are medical devices generally limited to
life-sustaining, life-supporting or implantable devices or new
devices which have been found not to be substantially
equivalent to legally marketed devices, that the FDA deems to
require the most restrictive controls to ensure their safety
and effectiveness.
Before a new medical device can be introduced to the market, FDA clearance
of a premarket notification under Section 510(k) of the FDC Act or FDA clearance
of a premarket approval application under Section 515 of the FDC Act must be
obtained. A Section 510(k) clearance will be granted if the submitted
information establishes that the proposed device is "substantially equivalent"
to a legally marketed Class I or Class II medical device or to a Class III
medical device for which the FDA has not called for premarket approval under
Section 515. The Section 510(k) premarket clearance process is generally faster
and simpler than the Section 515 premarket approval process. We understand that
it generally takes three to 12 months from the date a Section 510(k)
notification is accepted for filing to obtain Section 510(k) premarket clearance
and that it may take several years from the date a Section 515 application is
accepted for filing to obtain Section 515 premarket approval, although it may
take longer in both cases.
We expect that all of our products will be categorized as Class II devices
and that these products will not require clearance of premarket approval
applications under Section 515 of the FDC Act, but will be eligible for
marketing clearance through the premarket notification process under Section
510(k). We have determined that we are eligible to utilize the Section 510(k)
premarket notification process based upon our products' substantial equivalence
to previously legally marketed devices in the United States. We cannot assure
you, however, that (1) we will not need to reevaluate the applicability of the
Section 510(k) premarket notification process to our products in the future, (2)
the FDA will agree with our determination that we are eligible to use the
Section 510(k) premarket notification process, or (3) the FDA will not in the
future require us to submit a Section 515 premarket approval application, which
would be a more costly, lengthy and uncertain approval process.
39
The FDA has recently been requiring a more rigorous demonstration of
substantial equivalence than in the past and may request clinical data to
support premarket clearance. As a result, the FDA could refuse to accept for
filing a Section 510(k) notification made by us pending the submission of
additional information. The FDA may determine that any one of our proposed
products is not substantially equivalent to a legally marketed device or that
additional information is needed before a substantial equivalence determination
can be made. A "not substantially equivalent" determination, or request for
additional data, can prevent or delay the market introduction of our products
that fall into this category. Such a determination or request regarding any of
our products could have a material adverse effect on our business, financial
condition and results of operations. Even if the FDA does clear one or all of
our products under Section 510(k) process, it may clear a product for some
procedures but not others or for certain classes of patients and not others.
For any devices cleared through the Section 510(k) process, modifications
or enhancements that could significantly affect the safety or effectiveness of
the device or that constitute a major change to the intended use of the device
will require a new Section 510(k) premarket notification submission.
Accordingly, if we do obtain Section 510(k) premarket clearance for any of our
products, we will need to submit another Section 510(k) premarket notification
if we significantly affect that product's safety or effectiveness through
subsequent modifications or enhancements.
If human clinical trials of a device are required in connection with a
Section 510(k) notification and the device presents a "significant risk," the
sponsor of the trial (usually the manufacturer or distributor of the device)
will need to file an Investigational Device Exemption, or IDE, application prior
to commencing human clinical trials. The IDE application must be supported by
data, typically including the results of animal testing and/or laboratory bench
testing. If the IDE application is approved, human clinical trials may begin at
a specific number of investigational sites with a specific number of patients,
as specified in the IDE. Sponsors of clinical trials are permitted to sell those
devices distributed in the course of the study provided such compensation does
not exceed recovery of the costs of manufacture, research, development and
handling. An IDE supplement must be submitted to the FDA before a sponsor or
investigator may make a change to the investigational plan that may affect its
scientific soundness or the rights, safety or welfare of subjects. We intend to
file an IDE with respect to the OLpurTM MD190 and the OLpurTM H2H(TM), and an
IDE with respect to the OLpur(TM) NS2000. As of the date of this prospectus, we
have filed a pre-IDE application with respect to the OLpurTM MD190 and the
OLpurTM H2H(TM) and have initiated discussions with the FDA to facilitate the
510(k) approval process.
The Section 510(k) premarket clearance process can be lengthy and
uncertain. It will require substantial commitments of our financial resources
and management's time and effort. Significant delays in this process could occur
as a result of (1) the FDA's failure to schedule advisory review panels, (2)
changes in established review guidelines, (3) changes in regulations or
administrative interpretations or (4) determinations by the FDA that clinical
data collected is insufficient to support the safety and effectiveness of one or
more of our products for their intended uses or that the data warrants the
continuation of clinical studies. Delays in obtaining, or failure to obtain,
requisite regulatory approvals or clearances in the United States for any of our
products would prevent us from selling those products in the United States and
would impair our ability to generate funds from sales of those products in the
United States, which in turn could have a material adverse effect on our
business, financial condition, and results of operations. See "Risk Factors-- We
cannot sell our products until we obtain the requisite regulatory approvals and
clearances..."
The FDC Act requires that medical devices be manufactured in accordance
with the FDA's current quality service requirements, or QSR, regulations. These
regulations require, among other things, that:
o the design and manufacturing processes be regulated and controlled
by the use of written procedures;
o the ability to produce medical devices which meet the manufacturer's
specifications be validated by extensive and detailed testing of
every aspect of the process;
o any deficiencies in the manufacturing process or in the products
produced be investigated;
o detailed records be kept and a corrective and preventative action
plan be in place; and
o manufacturing facilities be subject to FDA inspection on a periodic
basis to monitor compliance with QSR requirements.
40
If violations of the applicable QSR regulations are noted during FDA inspections
of our manufacturing facilities or the manufacturing facilities of our contract
manufacturers, there may be a material adverse effect on our ability to produce
and sell our products.
Before the FDA approves a Section 510(k) premarket notification, the FDA
is likely to inspect the utilized manufacturing facilities and processes to
ensure their continued compliance with QSR. Although some of the manufacturing
facilities and processes that we expect to use to manufacture our OLpurTM MD190
have been inspected by TUV Product Service (Munich), they have not been
inspected by the FDA. Similarly, although some of the facilities and processes
that we expect to use to manufacture our OLpurTM H2H(TM) and OLpur(TM) NS2000
have been inspected by the FDA, they have not been inspected by any TUV
organization. Even after the FDA has cleared a Section 510(k) submission, it
will periodically inspect the manufacturing facilities and processes for
compliance with QSR. In addition, in the event that additional manufacturing
sites are added or manufacturing processes are changed, such new facilities and
processes are also subject to FDA inspection for compliance with QSR. The
manufacturing facilities and processes that will be used to manufacture our
products have not yet been inspected by the FDA for compliance with QSR. We
cannot assure you that the facilities and processes utilized by us will remain
in compliance with QSR and there is a risk that clearance or approval will,
therefore, be delayed by the FDA until such compliance is achieved.
In addition to the requirements described above, the FDC Act requires
that:
o All medical device manufacturers and distributors register with the
FDA annually and provide the FDA with a list of those medical
devices which they distribute commercially.
o Information be provided to the FDA on death or serious injuries
alleged to have been associated with the use of the products, as
well as product malfunctions that would likely cause or contribute
to death or serious injury if the malfunction were to recur.
o Certain medical devices not cleared with the FDA for marketing in
the United States meet specific requirements before they are
exported.
European Union
The European Union began to harmonize national regulations comprehensively
for the control of medical devices in Europe in 1993, when it adopted its
Medical Devices Directive. The European Union directive applies to both the
manufacturer's quality control system and the product's technical design.
Depending on the class of medical devices, a manufacturer may choose alternative
regulatory approaches to demonstrate compliance with European Union provisions.
To assure and demonstrate the high quality standards and performance of our
operations, we have subjected our entire European business to the most
comprehensive procedural approach, which is also the fastest way to launch a new
product in the European Union.
The regulatory approach we have chosen to demonstrate compliance with
European Union provisions requires the certification of a full quality
management system by a "notified body" charged with examining the quality
management system. A "notified body" is a group accredited and monitored by
governmental agencies that inspects manufacturing facilities and quality control
systems at regular intervals and is authorized to carry out unannounced
inspections. We have engaged TUV Rheinland of North America, Inc. as the
notified body to assist us in obtaining a European Union certificate for the
quality management system of the facilities we expect to use to manufacture our
products and in demonstrating our compliance with the European Union
requirements. As of the date of this prospectus, some, but not all, of the
manufacturing facilities and processes that we expect to use to manufacture our
OLpurTM MD190 have been inspected by TUV Product Service (Munich).
Under the regulatory approach we have chosen to demonstrate compliance
with European Union provisions, only after a company receives a European Union
certificate for the quality management system of a particular facility may the
company assess whether products developed and manufactured in the facility
satisfy European Union requirements. European Union requirements for products
are set forth in harmonized European Union standards and include conformity to
safety requirements, physical and biological properties, construction and
environmental properties, and information supplied by the manufacturer. A
company demonstrates conformity to these requirements by pre-clinical tests,
biocompatibility tests, qualification of products and packaging, risk analysis
and well-conducted clinical investigations approved by ethics committees.
41
Once a manufacturer having a European Union-certified full quality
management system has assessed the conformity of its products with harmonized
European standards and has determined that its products conform with these
standards, the manufacturer then declares and documents such conformity and
places a "CE" mark on the relevant products. The CE mark, which stands for
Conformite Europeenne, demonstrates compliance with the relevant European Union
requirements. Products subject to these provisions that do not bear the CE mark
cannot be imported to, or sold or distributed within, the European Union.
Regulatory Authorities in Regions outside of the United States and Europe
We also plan to sell our products in foreign markets outside the United
States which are not part of the European Union. Requirements pertaining to
medical devices vary widely from country to country, ranging from no health
regulations to detailed submissions such as those required by the FDA. We
believe the extent and complexity of regulations for medical devices such as
those produced by us are increasing worldwide. We anticipate that this trend
will continue and that the cost and time required to obtain approval to market
in any given country will increase, with no assurance that such approval will be
obtained. Our ability to export into other countries may require compliance with
ISO 9000, which is analogous to compliance with the FDA's QSR requirements. We
have not obtained any regulatory approvals to sell any of our products outside
of the United States and there is no assurance that any such clearance or
certification will be issued.
Reimbursement
In both domestic markets and markets outside of the United States, sales
of our products will depend in part, on the availability of reimbursement from
third-party payors. In the United States, ESRD providers are reimbursed through
Medicare and Medicaid and private insurers. In countries other than the United
States, ESRD providers are also reimbursed through governmental and private
insurers. In countries other than the United States, the pricing and
profitability of our products generally will be subject to government controls.
Despite the continually expanding influence of the European Union, national
healthcare systems in Europe, reimbursement decision-making included, are
neither regulated nor integrated at the European level. Each country has its own
system, often closely protected by its corresponding national government.
Medicare Reimbursement
Medicare generally provides health insurance coverage for persons who are
age 65 or older and for persons who are completely disabled. Medicare also
provides coverage for other eligible patients, regardless of age, who have been
medically determined to have ESRD. For patients eligible for Medicare based
solely on ESRD (generally patients under age 65), Medicare eligibility begins
three months after the month in which the patient begins dialysis. During this
three-month waiting period, Medicaid, private insurance or the patient is
responsible for payment for dialysis services. This waiting period is waived for
individuals who participate in a self-care dialysis-training program.
For ESRD patients under age 65 who have any employer group health
insurance coverage (regardless of the size of the employer or the individual's
employment status), Medicare coverage is generally secondary to the employer
coverage during a 30-month coordination period that follows the establishment of
Medicare eligibility or entitlement based on ESRD. During the coordination
period, an employer group health plan is responsible for paying primary benefits
at the rate specified in the plan, which may be a negotiated rate or the
healthcare provider's usual and customary rate. As the secondary payer during
this coordination period, Medicare will make payments up to the applicable
composite rate for dialysis services to supplement any primary payments by the
employer group health plan if the plan covers the services but pays only a
portion of the charge for the services.
Medicare generally is the primary payer for ESRD patients after the
30-month coordination period. Under current rules, Medicare is also the primary
payer for ESRD patients during the 30-month coordination period if, before
becoming eligible for Medicare on the basis of ESRD, the patient was already age
65 or over (or eligible for Medicare based on disability) unless covered by an
employer group health plan (other than a "small" employer plan) because of
current employment. This rule eliminates for many dual-eligible beneficiaries
the 30-month coordination period during which the employer plan would serve as
primary payer and reimburse health care providers at a rate that we believe may
be higher than the Medicare composite rate. The rule regarding entitlement to
primary Medicare coverage when the patient is eligible for Medicare on the basis
of both age (or disability) and ESRD has been the subject of frequent
legislative and regulatory change in recent years and there can be no assurance
that the rule will remain unchanged in the future.
42
When Medicare is the primary payer, it reimburses 80% of the composite
rate set by the Medicare prospective reimbursement system for each dialysis
treatment. The beneficiary is responsible for the remaining 20%, as well as any
unmet Medicare deductible amount, although an approved Medicare supplement
insurance policy, other private health insurance or Medicaid may pay on the
beneficiary's behalf. The composite payment rates, effective January 1, 2002,
for urban renal facilities published in February 2001 by the Department of
Health and Human Services for outpatient dialysis services ranged from $121.24
to $144.50 per treatment depending on the location of the renal facility.
Reimbursement rates are subject to periodic adjustment based on certain factors,
including legislation and executive and congressional budget reduction and
control processes, inflation and costs incurred in rendering the services, but
in the past have had little relationship to the cost of conducting business.
We are unable to predict what, if any, future changes may occur in the
Medicare composite reimbursement rate. or in any other reimbursement program.
Any reductions in the Medicare composite reimbursement rate or in any other
reimbursement program could have a material adverse effect on our revenues and
net earnings. In addition, there have been various legislative proposals for the
reform of numerous aspects of Medicare, including extension of the coordination
period and expanded enrollment of Medicare beneficiaries in managed care
programs. See "--Potential Health Care Legislation."
Private Reimbursement
Some ESRD patients have private insurance that covers dialysis services.
As discussed above, health care providers receive reimbursement for ESRD
treatments from the patient or private insurance during a "waiting period" of up
to three months before the patient becomes eligible for Medicare. In addition,
if the private payer is an employer group health plan, it is generally required
to continue to make primary payments for dialysis services during the 30-month
period following eligibility or entitlement to Medicare. In general, employers
may not reduce coverage or otherwise discriminate against ESRD patients by
taking into account the patient's eligibility or entitlement to Medicare
benefits.
We believe that before Medicare primary coverage is established, private
payers may reimburse dialysis expenses at rates significantly higher than
compensation under the Medicare composite rate on a per-treatment basis. When
Medicare becomes a patient's primary payer, private insurance often covers the
per-treatment 20% coinsurance that Medicare does not pay.
Medicaid
Reimbursement Medicaid programs are state-administered programs partially
funded by the federal government. These programs are intended to provide
coverage for patients whose income and assets fall below state defined levels
and who are otherwise uninsured. The programs may also serve as supplemental
insurance programs for the Medicare co-insurance portion and provide certain
coverages (e.g., oral medications) that are not covered by Medicare. Some
Medicaid programs require Medicare recipients to pay a share of the cost of
services based upon the recipient's level of income or assets, but other
programs provide for coverage without coinsurance amounts.
Potential Health Care Legislation
Because the Medicare program represents a substantial portion of the
federal budget, Congress takes action in almost every legislative session to
modify the Medicare program for the purpose of reducing the amounts otherwise
payable by the program to health care providers in order to achieve deficit
reduction targets or meet other political goals. Legislation and/or regulations
may be enacted in the future that may significantly modify the Medicare ESRD
program or substantially affect reimbursement for dialysis services.
Product Liability and Insurance
The production, marketing and sale of kidney dialysis products have an
inherent risk of liability in the event of product failure or claim of harm
caused by product operation. Although we intend to acquire product liability
insurance upon commercialization of each of our products, we may not be able to
obtain this insurance on acceptable terms or at all. Because we may not be able
to obtain insurance that provides us with adequate protection against all
potential product liability claims, a successful claim in excess of our
insurance coverage could materially adversely affect our financial condition.
Moreover, any claim against us could generate negative publicity, which could
decrease the demand for our products, our ability to generate revenues and our
profitability.
43
Some of the agreements that we may enter into with manufacturers of our
products and components of our products may require us (1) to obtain product
liability insurance or (2) indemnify manufacturers against liabilities resulting
from the sale of our products. If we are not able to obtain and maintain
adequate product liability insurance, we will be in breach of these agreements,
which could materially adversely affect our ability to produce our products. If
we are able to obtain and maintain product liability insurance and a successful
claim in excess of our insurance coverage is made, we may have to indemnify some
or all of our manufacturers for their losses. This would materially adversely
affect our results of operations and financial condition. See "Risk Factors --
If we are not able to obtain adequate insurance or other protection against
product liability risks..."
Employees
As of December 31, 2002, we employed a total of eleven employees, eight of
which were full time and three of which were on a consulting basis or part-time.
Of these employees, five were in research and development, three were in
marketing and sales and three were in general and administrative functions.
We intend to add four to six members to our sales staff in each of Europe
and the United States, as well as three to four members to our administrative
staff in Europe. We intend to make our European staff additions at or around the
time we obtain regulatory approval of the OLpurTM MD190 in the European Union,
which we have targeted for the spring of 2003. We intend to make our U.S. staff
additions at or around the time we obtain regulatory approval for the OLpurTM
MD190 in the United States, which we have targeted for the last quarter of 2003.
No employees are covered by collective bargaining agreements. We consider
our relationship with our employees generally to be good.
Facilities
Our facilities are located at 3960 Broadway, 4th Floor, New York, New York
10032 and consist of approximately 2,100 square feet of space. On July 1, 2002,
we entered into a lease for this space. The term of the lease is for one year
with a monthly rent of $6,086.
We use our facilities to house our corporate headquarters and research
facilities. Our offices and laboratories are housed in the Marie Lasker
Biotechnology Research Center, a part of the Audubon Technology Complex
administered by Columbia University, which is equipped to accommodate
biotechnology and medical product development companies. Of the space we lease,
1,500 square feet is dedicated laboratory space, which is equipped with
laboratory equipment, including laboratory benches, fume hoods, gas, air and
water suction systems, and the remaining 600 square feet is dedicated office
space.
We believe that our existing facilities are suitable as laboratory space
and office space and are adequate to meet our current U.S. requirements. We also
believe that our insurance coverage adequately covers our interest in our leased
space. We intend to lease space in Europe for sales and marketing offices.
We do not own any real property for use in our operations or otherwise.
Legal Proceedings
There are no current or pending legal proceedings to which we are a party
or to which any of our properties is subject. We are currently in discussions
with representatives of Lancer Offshore, Inc. with respect to its failure to
comply with the terms of the Lancer Subscription Agreement. If we are not able
to resolve this issue in a manner that is satisfactory us, then we intend to
pursue vigorously all available legal remedies against Lancer Offshore, Inc.,
including seeking rescission of the convertible note and the warrants issued to
Lancer Offshore, Inc. in August 2002. However, the resolution of this dispute
could be costly and there can be no assurance that a judicial resolution will
not uphold some or all of the terms of the Lancer Subscription Agreement and no
assurance that we might not have to issue a large number of additional shares of
our common stock to Lancer Offshore, Inc. pursuant to the terms of the Lancer
Subscription Agreement. See "Important Assumptions in this Prospectus -- Certain
Convertible Notes have not been Converted."
44
MANAGEMENT
Information Concerning Directors, Executive Officers and Key Employees
Directors and Executive Officers.
The following table sets forth information regarding our directors and
executive officers:
Name Age Position
--------------------------------------------------------------------------
Eric A. Rose, M.D. 51 Chairman of the Board and Director
Norman J. Barta 46 President, Chief Executive Officer,
Chief Financial Officer and Director
Lawrence J. Centella 61 Director
Howard Davis 47 Director and Secretary
Donald G. Drapkin 54 Director
William J. Fox 46 Director
W. Townsend Ziebold, Jr. 41 Director
----------------------
Eric A. Rose, M.D. has served as chairman of our board of directors and
a director since our inception in 1997. Dr. Rose served as our president and
chief executive officer from May 1999 until July 2002. Since 1994, Dr. Rose
has been the Morris and Rose Millstein/Johnson & Johnson Professor and
Chairman of the Department of Surgery at the Columbia University College of
Physicians and Surgeons, and Surgeon in Chief at the Columbia Presbyterian
Medical Center. Dr. Rose is a director of SIGA Technologies, Inc. Dr. Rose
received a B.A., summa cum laude, in Psychology from Columbia College and an
M.D. from Columbia University College of Physicians and Surgeons.
Norman J. Barta has served as our president and chief executive officer
and as a director since July 2002, and has served as our chief financial officer
since October 1998. Mr. Barta served as our chief operating officer from October
1999 to July 2002 and our treasurer and secretary from May 1999 to October 1999.
From 1994 to 1997, Mr. Barta provided financial planning and management for the
research and development division of National Medical Care (currently a division
of the Fresenius Medical Care AG), which prior to its acquisition by Fresenius,
was one of the largest dialysis providers in the world. Prior to that, Mr. Barta
was a consultant for Corestates Bank, where he restructured and optimized cash
management and treasury areas for the bank's corporate and public-sector
clients. Mr. Barta received a B.S. in Mathematics and Economics from
Carnegie-Mellon University and an M.B.A. from the University of Chicago.
Lawrence J. Centella has served as a director of our company since January
2001. Mr. Centella has served as president of Renal Patient Services, LLC, a
company that owns and operates dialysis centers, since June 1998. From 1997 to
1998, Mr. Centella served as executive vice president and chief operating
officer of Gambro Healthcare, Inc., an integrated dialysis company that
manufactures dialysis equipment, supplies dialysis equipment and operates
dialysis clinics. From 1993 to 1997, Mr. Centella served as president and chief
executive officer of Gambro Healthcare Patient Services, Inc. (formerly REN
Corporation). Prior to that, Mr. Centella served as president of COBE Renal
Care, Inc., Gambro Hospal, Inc., LADA International, Inc. and Gambro, Inc. Mr.
Centella is also the founder of LADA International, Inc. Mr. Centella received a
B.S. in Marketing from DePaul University.
Howard Davis will begin to serve as a director and as secretary of our
company upon the consummation of this offering. Since 1997, Mr. Davis has served
as the executive vice president of GunnAllen Financial Inc., one of the
underwriters of this offering, where he is the executive responsible for the
investment banking and finance division. From 1990 to 1997, Mr. Davis served as
the president and chief executive officer of Kensington Securities, Inc., a
National Association of Securities Dealers, Inc. broker dealer. Prior to joining
Kensington Securities, Inc. in 1990, Mr. Davis had served as the president, and,
prior to that, as chief financial officer, of Numero Uno Franchise Corporation,
a Los Angeles based franchisor of pizzeria and Italian restaurants. Mr. Davis is
also a former instructor at California State University. Mr. Davis currently
serves as member of the board of directors and the audit and compensation
committees of Intellicheck, Inc., a corporation which files reports pursuant to
the Securities Exchange Act of 1934. Mr. Davis attended the University of
Southern California; California State University, Northridge; and Kent State
University, where he majored in Finance and Accounting.
Donald G. Drapkin has served as a director of our company since our
inception in 1997. Mr. Drapkin served as our interim president, chief executive
officer and treasurer from 1997 until May 1999. Mr. Drapkin has been a director
and vice
45
chairman of MacAndrews & Forbes Holdings Inc. and various of its affiliates
since 1987, including, as of the date of this prospectus, the following
corporations which file reports pursuant to the Securities Exchange Act of 1934:
Panavision Inc., Revlon Consumer Products Corporation and Revlon, Inc.
MacAndrews & Forbes Holdings Inc. is a holding company which has no business
operations of its own; it holds investments in various businesses from time to
time. Prior to joining MacAndrews & Forbes, Mr. Drapkin was a partner in the law
firm of Skadden, Arps, Slate, Meagher & Flom LLP for more than five years. In
addition to those listed above, Mr. Drapkin is a director of the following
corporations which file reports pursuant to the Securities Exchange Act of 1934:
Anthracite Capital, Inc.; Black Rock Asset Investors; The Molson Companies
Limited; Playboy Enterprises, Inc.; Playboy.com, Inc.; SIGA Technologies, Inc.
and The Warnaco Group, Inc. Mr. Drapkin received a B.A. from Brandeis University
and a J.D. from Columbia University.
William J. Fox will begin to serve as a director of our company upon the
consummation of this offering. Since February 1999, Mr. Fox has served as
chairman, president and chief executive officer of AKI, Inc. and president,
chief executive officer and a director of AKI Holdings, Inc., a marketing and
interactive advertising company. Prior to that, Mr. Fox served as president of
Strategic and Corporate Development for Revlon Worldwide and chief executive
officer of Revlon Technologies. From 1994 to April 1999, Mr. Fox served as a
director, and from 1997 to 1999, Mr. Fox served as senior executive vice
president, of both Revlon Inc. and Revlon Consumer Products Corporation. For the
five years ending 1999, Mr. Fox was also senior vice president of MacAndrews &
Forbes Holdings, Inc. Mr. Fox currently serves as co-chairman of the board and a
director of Loehmann's Holding Inc. and has served as a vice-chairman of the
board and a director of Hain Food Group, Inc. and of The Cosmetic Centers, Inc.
W. Townsend Ziebold, Jr. has served as a director of our company since
1999. Mr. Ziebold was elected as a director of our company by the holders of
shares of our series B convertible preferred stock in accordance with certain
voting rights that terminate upon the mandatory conversion of such shares into
shares of our common stock upon the consummation of this offering. The shares of
our series B convertible preferred stock are beneficially owned by Cypress
Capital Assets, L.P., a beneficial holder of more than 5% of our common stock of
which Wasserstein & Co., L.P. is a limited partner. Since 1996, Mr. Ziebold has
been senior partner and president of Wasserstein Ventures, the venture capital
affiliate of Wasserstein & Co., L.P., where Mr. Ziebold has led several of
Wasserstein & Co., L.P.'s investments. Mr. Ziebold is also a director and
non-executive chairman of Imax Corporation, a leading large-screen film
projection company, and a former director of Collins & Aikman Corporation, a $2
billion sales diversified manufacturing company, and Maybelline, Inc., a leading
mass market cosmetics manufacturer. Mr. Ziebold currently serves as a member of
the Board of Fellows of Trinity College and as President of the Board of
Trustees at West Side Montessori School in New York City. Mr. Ziebold received a
B.A. in Economics from Trinity College and an M.B.A. from the Stanford School of
Business.
There are no family relationships among any of our directors and executive
officers.
Our board of directors currently consists of seven members. Our amended
and restated certificate of incorporation provides for a classified board of
directors consisting of three classes of directors, each serving staggered,
three-year terms. Except as otherwise provided by our bylaws for filling
vacancies on our board of directors, a portion of our board of directors will be
elected each year at our annual meeting of stockholders and hold office until
their respective successors are elected, or until their earlier resignation or
removal. The underwriters of this offering have the right to designate an
individual as a non-voting advisor to our board of directors who will be
entitled to attend any or all of the meetings of our board of directors and to
receive all information provided to our directors.
Key Employees
Gregory Collins, Ph.D. has served as our senior scientist since 1998.
From 1993 to 1997, Dr. Collins was a research and development program manager
at National Medical Care, where he was responsible for research and
development projects relating to dialyzer cartridges and bloodlines. From
1990 to 1993, Dr. Collins served as a senior level research and development
engineer at National Medical Care, where he applied basic scientific theory
to practical device development using his training in solute transport, and
gained technical expertise in the spinning of hollow fiber semi-permeable
membranes, dialyzer cartridge design and assembly techniques, and novel test
method development. Dr. Collins received a B.S., summa cum laude, in
Chemical Engineering from Arizona State University and a Ph.D., magna cum
laude, in Bioengineering from U.C. San Diego. Dr. Collins is 42 years old.
Bruce W. Crook has served as our vice president-marketing and sales
since June 2002. From 1998 to 2002, Mr. Crook worked as an independent
marketing consultant for a variety of medical device companies. From 1996 to
1998, Mr. Crook
46
owned and was involved in the management of approximately 8 dialysis clinics
throughout the United States and Puerto Rico. From 1987 to 1996, Mr. Crook held
several senior positions at Fresenius Medical Care AG, including the position of
vice president of sales and director of marketing. Mr. Crook received a B.S. in
Business Administration from Arizona State University. Mr. Crook is 47 years
old.
Board Committees
Upon the consummation of this offering, our compensation committee will
consist of two members, Eric A. Rose, M.D. and Howard Davis, each of whom is an
independent director. The compensation committee will be responsible for
establishing executive officers' compensation and fringe benefits. It will also
administer our Nephros 2000 Stock Incentive Plan and will be authorized to grant
options under this plan.
Upon the consummation of this offering, our audit committee will consist
of three members, Lawrence J. Centella, Howard Davis and William J. Fox, each of
whom is an independent director. The audit committee will recommend the
appointment of independent accountants and will review and discuss with the
accountants the scope of their examination, their proposed fee and the overall
approach to the audit. The audit committee will review with the accountants and
our financial management the annual financial statements and discuss the
effectiveness of internal accounting controls.
Director Compensation
We will pay our directors $500 per meeting for board meetings attended in
person and $100 per meeting for board meetings attended telephonically and will
reimburse our directors for expenses incurred by them in connection with serving
on our board of directors. We will pay the chairman of the Audit Committee $500
per meeting for meetings of the Audit Committee attended in person and $100 per
meeting attended telephonically.
For each director who becomes a director of our company on or after the
consummation of this initial public offering, (1) for the first year of service
as a director of our company, we will grant such director options to purchase
10,000 shares of our common stock, and (2) for each year of service as a
director of our company thereafter, we will grant such director options to
purchase 5,000 shares of our common stock at an exercise price per share equal
to the fair market value price per share of our common stock on the grant date.
We will also grant to W. Townsend Ziebold, Jr., a current director, (1) upon the
consummation of this offering, options to purchase 10,000 shares of our common
stock, and (2) for each of year of service as a director of our company
thereafter, options to purchase 5,000 shares of our common stock at an exercise
price per share equal to the fair market value price per share of our common
stock on the grant date.
Executive Compensation
The following tables set forth in summary form information concerning the
compensation paid by us during the fiscal years ended December 31, 2002, 2001
and 2000, to our chief executive officer and our other executive officers whose
salary and bonus for the year exceeded $100,000 and who served as an executive
officer as of December 31, 2002.
SUMMARY COMPENSATION TABLE
Annual Compensation Long Term Compensation
------------------- ----------------------
Awards
------
Salary Bonus Number of Securities
Name and Principal Position Year (dollars) (dollars) Underlying Options
--------------------------- ---- --------- --------- ------------------
Eric A. Rose, M.D 2002 0 0 0
Chairman of the Board (1) 2001 0 0 0
2000 21,154 0 0
Norman J. Barta 2002 139,331 0 0
President, Chief Executive Officer 2001 130,000 250 0
and Chief Financial Officer (2) 2000 130,000 30,349 112,416(3)
47
---------------------------
(1) Eric A. Rose, M.D. served as our president and our chief executive
officer during the fiscal years ended December 31, 2001 and 2000. We
paid Dr. Rose compensation for his services in such capacity.
(2) Mr. Barta served as our chief operating officer from October 1999
until July 2002. We are currently conducting an executive search for
a chief financial officer. (3)Represents options to purchase shares
of our common stock at an exercise price of $0.40 per share, a
portion of which are exercisable and the remainder of which will
vest over time and upon the achievement of certain milestones.
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
The following table sets forth information concerning the number of
unexercised options and the December 31, 2002 fiscal year-end value of
unexercised options on an aggregated basis held by Norman J. Barta. As we have
not granted any stock appreciation rights, there were no stock appreciation
rights outstanding at the end of fiscal year ended December 31, 2002.
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at Fiscal
Shares Options at Fiscal Year-End Year-End (dollars) (1)
--------------------------- ----------------------
Acquired Value
Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- ----------- -------- ----------- ------------- ----------- -------------
Norman J. Barta 0 0 67,450 44,966 $377,720 $251,810
(1) Options are "in-the-money" if, on December 31, 2002, the fair market
value of our common stock exceeded the exercise price of those
options. The amount shown under the column "Value of Unexercised
In-the-Money Options at Fiscal Year-End" is calculated by
determining the difference between the aggregate fair market value
of our common stock underlying the options on December 31, 2002 and
the aggregate exercise price of the options. For purposes of this
calculation, since there had been no public trading market for our
common stock as of December 31, 2002, the assumed initial public
offering price of $6.00 per share was used as the fair market per
share value of our common stock on such date. Notwithstanding the
foregoing, the assumed initial public offering price of $6.00 per
share does not necessarily represent the actual per share value of
our common stock on December 31, 2002.
Employment Agreements and Incentive Bonus Programs
Agreement with Mr. Norman J. Barta
Norman J. Barta is serving as our president and chief executive officer
under a written employment agreement with us. This agreement has a term of three
years, ending on November 21, 2005. This agreement provides Mr. Barta with an
annual base salary upon the consummation of this offering of $225,000. On March
31, 2004, Mr. Barta's annual base salary will be increased by the dollar amount
paid to Mr. Barta in respect of six milestones discussed below. During each year
that Mr. Barta is employed with us, our compensation committee will review Mr.
Barta's performance and determine, in its sole discretion, whether to further
increase Mr. Barta's annual base salary.
We have agreed to pay Mr. Barta a bonus equal to 10% of his salary at the
time each of the following six milestones is achieved: (1) the OLpurTM MD190
hemodiafiltration device or a related device is deemed ready to enter a clinical
trial by the FDA or an analogous body outside of the United States in a region
where there exists significant market opportunity for the sale of the device;
(2) the completion of a clinical trial of the device in such a region; (3) the
first regulatory approval of the device in such a region; (4) a second
hemodiafiltration device is deemed ready to enter a clinical trial by the FDA or
an analogous body outside of the United States in a region where there exists
significant market opportunity for the sale of such device; (5) the completion
of the clinical trial of the second device in such a region; and (6) the first
regulatory approval of the second device in such region. After March 2004, at
least two realistic milestones will be set for each year, with the total
potential payment for these additional milestones, if achieved, each year
equaling at least 20% of Mr. Barta's annual base salary as of the date the
milestones are set. We have also agreed to pay to Mr. Barta a bonus of one
percent of the license fee or technology access fee not tied directly to sales
or expressed as a percentage of receipts or by reference to units produced which
is paid to us with respect to any consummated licensing agreement of the ESRD
therapy machines or dialyzer technology devices, subject to a maximum bonus of
$500,000 per license agreement (including renewals and amendments) and to an
aggregate maximum of $2,000,000.
48
In January 2003, we will grant to Mr. Barta additional options, pursuant
to our equity incentive plan, to purchase 128,154 shares of our common stock at
an exercise price of $3.50 per share, a portion of which will be immediately
exercisable and the remainder of which will vest upon the achievement of certain
milestones. See "Equity Incentive Plan."
Mr. Barta's employment agreement provides that upon termination by us for
cause, as defined in the agreement, death or disability, we will pay to him only
the base salary and any milestone bonuses due and payable under the terms of
this agreement through the date of termination and those that become due and
payable within 90 days of that date. If we terminate Mr. Barta for any other
reason, Mr. Barta will be entitled to (1) any accrued but unpaid base salary for
services rendered through the date of termination; (2) any unpaid milestone
bonuses due and payable on or prior to the date of termination or within 90 days
thereafter; (3) any unpaid licensing bonuses due and payable on or prior to the
date of termination or in respect of licenses consummated during the 90 days
following the date of termination; and (4) the continued payment of the base
salary (in the amount as of the date of termination) for the remainder of the
three-year term (to be paid at the times such base salary would have been paid
had his employment not been terminated).
Option/SAR Grants in Last Year
We did not grant stock options to the executive officers or directors
named above or reprice any stock options during the year ended December 31,
2002.
Equity Incentive Plan
In January 2000, we adopted the Nephros 2000 Equity Incentive Plan. In
January 2003, our board of directors approved and adopted the Amended and
Restated Nephros 2000 Equity Incentive Plan.
Under both plans our compensation committee, another designated committee
of our board of directors or our board of directors, may grant a variety of
stock based incentive awards to our employees, directors, officers and other
individuals or entities whom the compensation committee (or other committee or
our board of directors) believes are key to our success. The compensation
committee may award shares of our common stock, incentive stock options,
nonqualified stock options or any combination thereof.
The compensation committee has broad latitude under both plans in
determining who shall receive awards, the amount of an award and the terms and
conditions of an award; however, under the Nephros 2000 Equity Incentive Plan,
no individual or entity may receive awards that together equal more than 20% of
the total shares of our common stock subject to option grants under the plan,
while under the Amended and Restated Nephros 2000 Equity Incentive Plan, no
individual or entity may receive awards that together equal more than 30% of the
total shares of our common stock subject to option grants under the plan during
any three-year period. Both plans provide that, under certain circumstances, our
compensation committee may adjust the numbers of shares available for award, as
well as outstanding awards, to reflect changes in our corporate structure or
other unusual events affecting us. We have designed these plans to allow awards
to be "performance based" compensation within the meaning of section 162(m) of
the U.S. Internal Revenue Code of 1986, as amended, and thus not to count
against the million dollar cap on deductible compensation paid annually to our
five top officers, if the compensation committee so chooses.
The terms of the Amended and Restated Nephros 2000 Equity Incentive Plan
increase the aggregate number of shares of our common stock subject to options
covered by our 2000 Nephros Equity Incentive Plan from 1,011,743 to 1,124,159.
As of December 31, 2002, we had granted incentive stock options and nonqualified
stock options to purchase 461,467 shares of common stock at a weighted average
price of $0.40 per share under the provisions of the Nephros 2000 Equity
Incentive Plan, of which stock options to purchase 424,820 shares of common
stock were then outstanding. As of December 31, 2002, options for 257,916 shares
were vested and eligible for exercise and none of the stock options were
exercised. In January 2003, we granted nonqualified stock options to purchase
359,056 shares of common stock at an exercise price of $3.50 per share, a
portion of which were immediately exercisable and the remainder of which will
vest over time or upon the achievement of certain milestones. In January 2003,
our board of directors approved our grant to Mr. Barta, prior to the
consummation of this offering, of nonqualified stock options to purchase 128,154
shares of common stock at an exercise price of $3.50 per share, a portion of
49
which will be immediately exercisable and the remainder of which will vest upon
the achievement of certain milestones.
Nephros 2000 Equity Incentive Plan Information
As of December 31, 2002
Number of Shares
of Common Stock
Number of Shares of Remaining Available
Common Stock to be Weighted-Average for Future Issuance
Issued upon Exercise Exercise Price of under Equity
of Outstanding Options Outstanding Options Incentive Plan (1)
Nephros 2000 Equity Incentive 424,820 $0.40 586,923
Plan Information
- ---------------
(1) Excludes shares of our common stock to be issued upon exercise of
outstanding options.
Limitations on liability and indemnification
We are a Delaware corporation. The Delaware General Corporation Law
provides that Delaware corporations may indemnify any of their directors or
officers who are or are threatened to be a party to any legal action resulting
from fulfilling their duties to the corporation against reasonable expenses,
judgments and fees (including attorneys' fees) incurred in connection with such
action if the director or officer acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. The termination of any
action, suit or proceeding by judgment, order, settlement, conviction, or upon a
plea of no contest, or its equivalent, will not create a presumption that the
person did not act in good faith and in a manner which he reasonably believed to
be in or not opposed to the best interests of the corporation, and, with respect
to any criminal action or proceeding, had reasonable cause to believe his
conduct was unlawful. However, no indemnification will be permitted in cases
where it is determined that the director or officer was liable for negligence or
misconduct in the performance of his duty to the corporation, unless the court
in which such action was brought determines that the person is fairly and
reasonably entitled to indemnity, and then only for the expenses that the court
deems proper. A corporation is permitted to advance payment for expenses
occurred in defense of an action if its board of directors decides to do so.
In addition, Delaware corporations may purchase and maintain insurance on
behalf of any person who is or was a director or officer of the corporation
against any liability asserted against him and incurred by him in such capacity
whether or not the corporation would have the power to indemnify him against
such liability under the provisions of the Delaware General Corporation Law. We
currently have directors' and officers' liability insurance to provide our
directors and officers with insurance coverage for losses arising from claims
based on breaches of duty, negligence, errors and other wrongful acts.
50
CERTAIN TRANSACTIONS
Prior to our fiscal year ended December 31, 2000, we completed three
private placements of our equity securities, in which some of our current and
former directors and holders of more than 5% of our common stock purchased
equity securities. In 1997, we consummated our private placement of an aggregate
of 4,000,000 shares of our series A convertible preferred stock. In February
2000, we consummated our private placement of an aggregate of 2,333,333 shares
of our series B convertible preferred stock. In May 2000 we consummated our
private placement of an aggregate of 2,197,550 shares of our series C
convertible preferred stock. The current and former directors and holders of
more than 5% of our common stock who purchased equity securities in these
private placements purchased equity securities on substantially the same terms
and conditions as the other purchasers of equity securities in these private
placements.
As of October 2001, we had issued ten convertible notes in the aggregate
principal amount of $940,000, pursuant to which we agreed to pay, in June 2001,
to the holders the principal amount due under each holder's convertible note,
together with interest on the unpaid principal amount at the rate of 9% per
annum, compounded semi-annually, from the date of the convertible note. As of
November 30, 2001, all of these notes were converted into an aggregate of
940,000 shares of our series C convertible preferred stock. Eric A. Rose, M.D.
and Donald G. Drapkin, two of our directors and holders of more than 5% of our
common stock, Ronald O. Perelman, a holder of more than 5% of our common stock,
and WP Nephros Partners, LLC, which subsequently transferred its notes to
Cypress Capital Assets, L.P., a beneficial holder of more than 5% of our common
stock, purchased such notes, as set forth below.
Number of Shares
of Series C
Convertible
Preferred Stock
Principal Issued/Issuable
Amount of Upon Conversion
Name Convertible Note of Convertible Note
---- ---------------- -------------------
Eric A. Rose, M.D. $240,000 240,000
Donald G. Drapkin $50,000 50,000
Ronald O. Perelman $100,000 100,000
WP Nephros Partners, LLC $150,000 150,000
In April 2002, we issued eight convertible notes in the aggregate
principal amount of $250,000, pursuant to which we agreed to pay, in August
2002, to the holders the principal amount due under each holder's convertible
note, together with interest on the unpaid principal amount at the rate of 6%
per annum, compounded semi-annually, from the date of the convertible note. The
holders of these notes have since agreed to irrevocably convert them into an
aggregate of 250,000 shares of our series A convertible preferred stock
immediately prior to our receipt, if ever, of the remaining $1,500,000 due under
the Lancer Subscription Agreement (see "Important Assumptions in this Prospectus
- -- Certain Convertible Notes have not been Converted"), or at such earlier time
as the holders may elect, provided that such shares of series A convertible
preferred stock need not be issued by the Company until the Company has
increased the number of authorized shares of series A convertible preferred
stock by amending its certificate of incorporation. At any time prior to the
date of delivery to the holders of such shares, the holders may require us to
issue to them, in lieu of such shares, the number of shares of our common stock
into which such number of shares of series A convertible preferred stock is
convertible. The holders have accepted the right to receive the foregoing shares
in full satisfaction of our obligation to repay the notes. We have also agreed
to issue to the holders of these notes, prior to the effectiveness of this
prospectus, warrants to purchase an aggregate of 125,000 shares of our series A
convertible preferred stock, or such shares of our common stock as may be
issuable upon mandatory conversion of our series A convertible preferred stock,
at a price of $1.00 per share, to be exercisable through April 2004. Each of
Eric A. Rose, M.D., Donald G. Drapkin and Ronald O. Perelman purchased
securities in this transaction. Each of them acquired (1) convertible notes in
the principal amount set forth in the table below, (2) the number of shares of
our series A convertible preferred stock set forth in the table below and (3)
warrants to purchase the number of shares of our series A convertible preferred
stock set forth in the table below.
51
Number of Shares of
Series A Convertible Number of Shares of
Preferred Stock Series A Convertible
Issuable Upon Preferred Stock
Principal Amount Conversion of Issuable Upon
Name of Convertible Note Convertible Note Exercise of Warrants
---- ------------------- ---------------- --------------------
Eric A. Rose, M.D $75,000 75,000 37,500
Donald G. Drapkin $25,000 25,000 12,500
Ronald O. Perelman $25,000 25,000 12,500
During 2001 and 2002, Eric A. Rose, M.D. made loans to us, which loans are
payable when we have sufficient funds available to repay them and do not bear
any interest. As of the date of this prospectus, the outstanding balance due
under these loans was $110,000. We intend to use a portion of the net proceeds
of this offering to repay the outstanding balance. See "Use of Proceeds."
We believe that all of the transactions described above were made and are
on terms no less favorable to us than those that could have been obtained from
independent third parties in arms-length negotiations.
In August 2002, we entered into the Lancer Subscription Agreement, which
is described under the heading "Important Assumptions in this Prospectus -
Certain Convertible Notes have not been Converted." Pursuant to the terms of a
letter agreement dated April 30, 2002, between us and Hermitage Capital
Corporation, we paid Hermitage Capital Corporation, as placement agent, an
aggregate amount of $150,000 in connection with this transaction. In addition,
certain placement agent warrants may be issuable to Hermitage Capital
Corporation, as described under the heading "Important Assumptions in this
Prospectus - Certain Convertible Notes have not been Converted." The terms of
our letter agreement with Hermitage Capital Corporation also provide for us to
pay Hermitage Capital Corporation a placement fee of 10% of the total amount of
funds raised in any further financing, if any, successfully consummated prior to
September 30, 2007 with an investor or lender that was introduced to us by
Hermitage Capital Corporation during the term of the agreement. The stated term
of the agreement is from April 30, 2002 through September 30, 2004. We
understand that a principal of Hermitage Capital Corporation, John W. Bendall,
Jr., serves on the board of directors of Lancer Offshore, Inc.
In December 2002, we obtained a short-term loan in the principal
amount of $250,000. See "Use of Proceeds." In connection with this loan, we paid
Hermitage Capital Corporation, as placement agent, an aggregate amount of
$25,000.
52
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding beneficial ownership
of our common stock before this offering and as adjusted to reflect the sale of
shares of our common stock in this offering, by:
o each person, group or entity who beneficially owns more than 5% of
our common stock;
o each of our directors;
o each of our named executive officers; and
o all of our directors and executive officers as a group.
The following table reflects the number of shares of our common stock
outstanding as of the date of this prospectus and assumes (i) the completion of
the reverse stock split pursuant to which each share of our common stock then
outstanding will be converted into 0.2248318 of one share of our common stock
immediately prior to the effectiveness of the registration statement to which
this prospectus relates; and (ii) the automatic conversion of all shares of
series A convertible preferred stock, series B convertible preferred stock and
series C convertible preferred stock outstanding upon the consummation of this
offering, which includes certain shares of our series A convertible preferred
stock issuable upon conversion of outstanding convertible notes in the aggregate
principal amount of $250,000 (see "Certain Transactions"), into 2,357,053 shares
of our common stock, immediately prior to the consummation of this offering. The
table reflects percentages of beneficial ownership (i) if the underwriters'
over-allotment option is not exercised and (ii) if the underwriters'
over-allotment option is exercised in full.
The amounts and percentages of common stock beneficially owned are
reported on the basis of regulations of the Securities and Exchange Commission
governing the determination of beneficial ownership of securities. Under the
rules of the Securities and Exchange Commission, a person is deemed to be a
"beneficial owner" of a security if that person has or shares "voting power,"
which includes the power to vote or to direct the voting of that security, or
"investment power," which includes the power to dispose of or to direct the
disposition of that security. A person is also deemed to be a beneficial owner
of any security as to which that person has a right to acquire beneficial
ownership presently or within 60 days. Under these rules, more than one person
may be deemed to be a beneficial owner to the same securities, and a person may
be deemed to be the beneficial owner of the same securities as to which that
person has no economic interest. Including those shares in the tables does not,
however, constitute an admission that the named stockholder is a direct or
indirect beneficial owner of those shares.
Unless otherwise indicated, each person or entity named in the table has
sole voting power and investment power (or shares that power with that person's
spouse) with respect to all shares of capital stock listed as owned by that
person or entity.
Percentage of Beneficial Ownership
----------------------------------
Number of Shares After Offering After Offering
of Common Stock (Assuming No (Assuming
Beneficially Exercise of Exercise of
Owned Before Before Over-Allotment Over-Allotment
Name and Address Offering Offering Option) Option in Full)
- ---------------- --------------- -------- -------------- ---------------
Norman J. Barta(1) .................................. 240,570 6.4 4.4 4.1
Eric A. Rose, M.D.(2) ............................... 462,483 13.1 8.8 8.2
Lawrence J. Centella(3) ............................. 22,483 * * *
Howard Davis(4) ..................................... 10,000 * * *
Donald G. Drapkin(5) ................................ 263,076 7.5 5.0 4.7
William J. Fox(6) ................................... 36,103 1.0 1.0 1.0
W. Townsend Ziebold, Jr.(7) ......................... 10,000 * * *
Cypress Capital Assets, L.P.(8) ..................... 630,278 18.0 11.9 11.2
Ronald O. Perelman (9) .............................. 291,944 8.3 5.5 5.2
Lindsay A. Rosenwald(10) ............................ 317,875 9.1 6 5.6
Lancer Offshore, Inc.(11) ........................... 720,000 17.1 12.0 11.3
- ------------------------
* Represents less than 1% of the outstanding shares of our common stock.
(1) Mr. Barta's address is c/o Nephros, Inc., 3960 Broadway New York, New York
10032. The shares identified as being beneficially owned by Mr. Barta
include (i) 112,416 shares of our common stock issuable upon exercise of
options to
53
purchase shares of our common stock at an exercise price of $.40 per
share, a portion of which are exercisable and the remainder of which will
vest upon the achievement of certain milestones, and (ii) 128,154 shares
of our common stock issuable upon exercise of options to purchase shares
of our common stock at an exercise price of $3.50 per share, which will be
granted to Mr. Barta prior to the consummation of this offering, a portion
of which will be immediately exercisable and the remainder of which will
vest upon the achievement of certain milestones.
(2) Dr. Rose's address is c/o Nephros, Inc., 3960 Broadway New York, New York
10032. The shares identified as being beneficially owned by Dr. Rose
include (i) 98,926 shares of our common stock issuable upon the automatic
conversion of shares of our series C convertible preferred stock upon the
consummation of this offering, and (ii) 25,236 shares of our common stock
issuable upon conversion of our series A convertible preferred stock and
shares of our series A convertible preferred stock which are themselves
issuable upon exercise of warrants at an exercise price of $1.00 per
share.
(3) Mr. Centella's address is c/o Nephros, Inc., 3960 Broadway New York, New
York 10032.
(4) Mr. Davis' address is c/o GunnAllen Financial, Inc., 1715 North Westshore
Blvd., Suite 700, Tampa, Florida 33607. The shares identified as being
beneficially owned by Mr. Davis include 10,000 shares of our common stock
issuable upon exercise of options to purchase shares of our common stock
at an exercise price of $3.50 per share, which will be granted to Mr.
Davis upon the consummation of this offering and which will be immediately
exercisable.
(5) Mr. Drapkin's address is 35 East 62nd Street, New York, New York 10021.
The shares identified as being beneficially owned by Mr. Drapkin include
(i) 24,239 shares of our common stock issuable upon automatic conversion
of shares of our series A convertible preferred stock and shares of our
series A convertible preferred stock which are themselves issuable upon
exercise of warrants at an exercise price of $1.00 per share upon the
consummation of this offering, and (ii) 24,998 shares of our common stock
issuable upon automatic conversion of shares of our series C convertible
upon the consummation of this offering.
(6) Mr. Fox's address is c/o Arcade Marketing, Inc., 1700 Broadway, Suite
2200, New York, New York 10019. The shares identified as being
beneficially owned by Mr. Fox include (i) 17,987 shares of our common
stock issuable upon automatic conversion of our series A convertible
preferred stock upon the consummation of this offering, (ii) 8,116 shares
of our common stock issuable upon automatic conversion of our series C
convertible preferred stock upon the consummation of this offering, and
(iii) 10,000 shares of our common stock issuable upon exercise of options
to purchase shares of our common stock at an exercise price of $3.50 per
share, which will be granted to Mr. Fox upon the consummation of this
offering and which will be immediately exercisable.
(7) Mr. Ziebold's address is 1301 Avenue of the Americas, 44th Floor, New
York, New York 10019. The shares identified as being beneficially owned by
Mr. Ziebold include 10,000 shares of our common stock issuable upon
exercise of options to purchase shares of our common stock at an exercise
price of $3.50 per share, which will be granted to Mr. Ziebold and upon
the consummation of this offering and which will be immediately
exercisable.
(8) Cypress Capital Assets, LP's address is c/o Wasserstein & Co., L.P., 1301
Avenue of the Americas, 44th Floor, New York NY 10019. The general partner
of Cypress Capital Assets, LP ("CCA") is Cypress Capital Advisors, LLC.
The board of Cypress Capital Advisors, LLC is comprised of Bruce
Wasserstein, Pamela Wasserstein and Ellis Jones. The shares identified as
being beneficially owned by CCA include (i) 524,687 shares of our common
stock issuable upon automatic conversion of shares of our series B
convertible preferred stock upon the consummation of this offering, which
are owned by WPPN, LP, the general partner of which is Cypress Management
Partners, LLC, of which CCA is the sole member, and WP Plan Management
Partners, an entity controlled by CAA, and (ii) 105,671 shares of our
common stock issuable upon automatic conversion of shares of our series C
convertible preferred stock upon the consummation of this offering, all of
which shares of series C convertible preferred stock are owned by CCA
(which shares CCA acquired from WP Nephros Partners, LLC).
(9) Mr. Perelman's address is 35 East 62nd Street, New York, New York 10021.
The shares identified as being beneficially owned by Mr. Perelman include
(i) 188,297 shares of our common stock issuable upon automatic conversion
of shares of our series A convertible preferred stock upon the
consummation of this offering, and (ii) 103,647 shares of our common stock
issuable upon automatic conversion of shares of our series C convertible
preferred stock upon the consummation of this offering.
(10) Mr. Rosenwald's address is c/o Paramount Capital Asset Management, Inc.,
787 Seventh Avenue, New York, NY 10019. Mr. Rosenwald is a former director
of our company. The shares identified as being beneficially owned by Mr.
Rosenwald include (i) 89,933 shares of our common stock issuable upon
automatic conversion of shares of our series A convertible preferred stock
upon the consummation of this offering, and (ii) 40,582 shares of our
common stock issuable upon automatic conversion of shares of our series C
convertible preferred stock upon the consummation of this offering.
(11) Lancer Offshore, Inc.'s address is Kaya Flamboyan 9, Curacao, Netherlands
Antilles. The shares identified as being beneficially owned by Lancer
Offshore, Inc. include (i) 120,000 shares of our common stock which may be
issuable upon exercise of warrants to purchase shares of our common stock
at an exercise price of $2.50 per share and (ii) 600,000 shares of our
common stock, which may be issuable upon the conversion of a $1,500,000
convertible note issued to Lancer Offshore, Inc., both of which are
subject to antidilution adjustments; see "Important Assumptions in this
Prospectus - Warrants and Convertible Notes are Subject to Antidilution
Adjustments." These shares do not include 50,000 shares of common stock
underlying warrants which may be issuable to Hermitage Capital
Corporation; we understand that a principal of Hermitage Capital
Corporation, John W. Bendall, Jr., also serves on the board of directors
of Lancer Offshore, Inc.; see "Important Assumptions in this Prospectus -
Warrants and Convertible Notes are Subject to Antidilution Adjustments."
See also "Legal Proceedings."
54
DESCRIPTION OF SECURITIES
Authorized and Outstanding Capital Stock
Our authorized capital stock consists of 30,000,000 shares of common stock
and 10,000,000 shares of preferred stock. As of the date of this prospectus and
giving effect to a reverse stock split, discussed in detail below, there were
1,261,194 shares of common stock outstanding and 9,470,883 shares of preferred
stock outstanding, held by 45 stockholders of record. Of our preferred stock,
there were 4,000,000 shares of our series A convertible preferred stock
outstanding, 2,333,333 shares of our series B convertible preferred stock
outstanding, and 3,137,550 shares of our series C convertible preferred stock
outstanding.
Immediately prior to the effectiveness of the registration statement to
which this prospectus relates, each share of our common stock then outstanding
will be converted into 0.2248318 of one share of our common stock, as described
below under the heading "-- Reverse Stock Split." Simultaneously with the
consummation of this offering, all outstanding series A convertible preferred
stock, series B convertible preferred stock and series C convertible preferred
stock will automatically be converted into 2,300,845 shares of our common stock.
After giving effect to the reverse stock split and the conversions
discussed in the preceding paragraph, but without giving effect to the sale of
shares of our common stock pursuant to this offering, there will be 3,562,039
shares of common stock outstanding and no shares of preferred stock outstanding.
After giving effect to the reverse stock split and the conversions of our
convertible preferred stock as well as our convertible notes in the aggregate
principal amount of $250,000 and the sale of shares of our common stock pursuant
to this offering, there will be a total of 6,118,247 shares of common stock
outstanding and no shares of preferred stock outstanding, assuming that the
underwriters do not exercise their over-allotment option.
Common Stock
Holders of our common stock are entitled to one vote for each share held
of record on all matters submitted to a vote of our stockholders and do not have
cumulative voting rights. Accordingly, holders of a majority of the shares of
our common stock entitled to vote in any election of directors may elect all of
the directors standing for election. Apart from preferences that may be
applicable to any holders of preferred stock outstanding at the time, holders of
our common stock are entitled to receive dividends, if any, ratably as may be
declared from time to time by our board of directors out of funds legally
available therefor. Upon our liquidation, dissolution or winding up, the holders
of our common stock are entitled to receive ratably our net assets available
after the payment of all liabilities and liquidation preferences on any
outstanding preferred stock. Holders of our common stock have no preemptive,
subscription, redemption or conversion rights, and there are no redemption or
sinking fund provisions applicable to our common stock. The rights, preferences
and privileges of holders of our common stock are subject to, and may be
adversely affected by, the rights of the holders of shares of any series of
preferred stock which we may designate and issue in the future.
Preferred Stock
Under the terms of our amended and restated certificate of incorporation,
our board of directors has authority, without any vote or action of our
stockholders, to issue up to 10,000,000 shares of "blank check" preferred stock
in one or more series and to fix the related rights, preferences, privileges and
restrictions, including voting rights, dividend rights, conversion rights,
redemption terms (including sinking fund provisions) and liquidation preferences
and the number of shares constituting a series or the designation of such
series.
The rights of the holders of our common stock will be subject to, and
could be adversely affected by, the rights of the holders of any preferred stock
that we may issue in the future. Our board of directors may designate and fix
rights, preferences, privileges and restrictions of each series of preferred
stock which are greater than those of our common stock. Our issuance of
preferred stock could, among other things:
o restrict dividends on our common stock;
o dilute the voting power of our common stock;
o impair the liquidation rights of our common stock; or
o discourage, delay or prevent a change of control of our company.
Although we currently have no plans to issue shares of blank check preferred
stock, we may issue them in the future.
55
Underwriter's Warrants
Subject to the approval of the National Association of Securities Dealers,
Inc., upon the consummation of this offering, we will issue to the underwriters
or their respective designees, in exchange for $100, warrants to purchase up to
an aggregate of 250,000 shares of our common stock. We have reserved an
equivalent number of shares of common stock for issuance upon exercise of these
warrants. Each warrant represents the right to purchase one share of common
stock for a period of four years commencing one year from the effective date of
this offering. The exercise price of the warrants is 165% of the price at which
our shares of common stock are sold pursuant to this offering. The warrants
contain provisions that protect their holders against dilution by adjustment of
the exercise price and number of shares issuable upon exercise on the occurrence
of specific events, such as stock dividends or other changes in the number of
our outstanding shares except for shares issued under certain circumstances,
including shares issued under our equity incentive plan and any equity
securities for which adequate consideration is received. No holder of these
warrants will possess any rights as a stockholder unless the warrant is
exercised. The holders of the warrants will be entitled to customary
"piggy-back" registration rights to register the shares underlying the warrants.
Such registration rights shall continue for a period of five years from the
effective date of this offering.
Other Warrants
In June 2002, in settlement of certain amounts owed by us to Plexus
Services Corp., a former supplier of engineering consulting services, we issued
warrants to purchase 134,899 shares of our common stock at an exercise price of
$13.34 per share, which are exercisable through June 2007. See "Description of
Securities -- Other Warrants" and "Business -- Settlement
Agreement."
In connection with our issuance in April 2002 of eight convertible notes
in the aggregate principal amount of $250,000, we issued warrants to the holders
of these notes to purchase an aggregate of 125,000 shares of our series A
convertible preferred stock, or such shares of our common stock as may be
issuable upon mandatory conversion of our series A convertible preferred stock,
at an exercise price of $1.00 per share, which are exercisable through April
2004.
Additional warrants to purchase shares of our common stock at an exercise
price of $2.50 per share, exercisable through December 2007, may be issuable in
connection with the Potential Lancer Share Issuance. See "Important Assumptions
in this Prospectus - Certain Convertible Notes have not been Converted" and
"Important Assumptions in this Prospectus - Warrants and Convertible Notes are
Subject to Antidilution Adjustments."
Reverse Stock Split
Immediately prior to the effectiveness of the registration statement of
which this prospectus is a part, the Company effected a reverse stock split
pursuant to which each share of our common stock then outstanding was converted
into 0.2248318 of one share of our common stock.
Registration Rights
We granted registration rights to holders of shares of our series A
convertible preferred stock pursuant to a stock purchase agreement. Pursuant to
the stock purchase agreement, we granted each of these holders piggy-back
registration rights to, on up to two occasions, include the shares of common
stock underlying their respective shares of our series A convertible preferred
stock in any registration statement we file on our own behalf or on behalf of
our other stockholders, at any time after this offering. The piggy-back
registration rights will expire once the stockholders' shares of common stock
become freely saleable under Rule 144 or Rule 701 during any 90-day period,
provided, that these provisions do not apply to any stockholder who owns more
than 2% of our outstanding common stock. Subject to lock-up agreements, we could
be required to file additional registration statements, covering up to 899,327
shares in the aggregate, for the stockholders who hold these shares.
We have also entered into registration rights agreements with holders of
shares of our series B convertible preferred stock and our series C convertible
preferred stock. Pursuant to these registration rights agreements, we granted
each of these holders (1) demand registration rights to, on no more than two
occasions at any time six months after the effective date of this prospectus,
request that we file a registration statement on Form S-1 under the Securities
Act on their behalf to register the shares of common stock underlying their
respective shares of preferred stock; (2) piggy-back registration rights to
include the shares of common stock underlying their respective shares of
preferred stock in any registration statement we file on our own behalf or on
56
behalf of our other stockholders, and (3) unlimited rights to request that we
file a registration statement on Form S-3 on their behalf to register the shares
of common stock underlying their respective shares of preferred stock. The
registration rights will expire once the existing stockholders' shares of common
stock become freely saleable under Rule 144. Subject to lock-up agreements, we
could be required to file additional registration statements, covering up to
1,401,517 shares in the aggregate, for the stockholders who hold these shares.
We have also entered into a subscription agreement with Lancer Offshore,
Inc., pursuant to which we granted Lancer Offshore, Inc. (1) demand registration
rights to, on one occasion at any time six months after the effective date of
this prospectus, request that we file a registration statement under the
Securities Act on their behalf to register the shares of common stock underlying
the $3,000,000 in principal amount of convertible note and warrants to purchase
an aggregate of 240,000 shares of our common stock which they had agreed to
purchase in the Lancer Subscription Agreement; see "Important Assumptions in
this Prospectus -- Certain Convertible Notes have not been Converted"; and (2)
piggy-back registration rights to include the shares of common stock underlying
their notes and warrants in any registration statement we file on our own behalf
or on behalf of our other stockholders. The piggy-back registration rights will
expire once the existing stockholders' shares of common stock become freely
saleable under Rule 144. Subject to lock-up agreements, we could be required to
file additional registration statements, covering up to 720,000 shares in the
aggregate, for the holder of these convertible notes and warrants.
We have also entered into a registration rights agreement with our
underwriters. Pursuant to this agreement, the holders of the underwriters'
warrants will be entitled to customary "piggy-back" registration rights to
register the shares of common stock underlying the warrants. Such registration
rights shall continue for a period of five years from the effective date of this
offering.
Anti-Takeover Effects of Provisions of the Delaware General Corporation Law and
Our Charter Documents.
Several provisions of the Delaware General Corporation Law and our amended
and restated certificate of incorporation and bylaws may have anti-takeover
effects. These provisions are intended to avoid costly takeover battles, lessen
our vulnerability to a hostile change of control and enhance the ability of our
board of directors to maximize stockholder value in connection with any
unsolicited offer to acquire us. However, these anti-takeover provisions, which
are summarized below, could also discourage, delay or prevent (1) the merger or
acquisition of our company by means of a tender offer, a proxy contest or
otherwise, that a stockholder may consider in its best interest and (2) the
removal of incumbent officers and directors.
Blank Check Preferred Stock
Under the terms of our amended and restated certificate or incorporation,
our board of directors has authority, without any further vote or action by our
stockholders, to issue up to 10,000,000 shares of blank check preferred stock.
Our board of directors may issue shares of preferred stock on terms calculated
to discourage, delay or prevent a change of control of our company or the
removal of our management.
Classified Board of Directors
Our amended and restated certificate of incorporation provides for the
division of our board of directors into three classes of directors, with each
class as nearly equal in number as possible, serving staggered, three-year
terms. Approximately one-third of our board of directors will be elected each
year. This classified board provision could discourage a third party from making
a tender offer for our shares or attempting to obtain control of our company. It
could also delay stockholders who do not agree with the policies of the board of
directors from removing a majority of the board of directors for two years.
57
Business Combinations
As a Delaware corporation, we are subject to Section 203 of the Delaware
General Corporation Law which contains specific provisions regarding "business
combinations" between corporations organized under the laws of the State of
Delaware and "interested stockholders." These provisions prohibit us from
engaging in a business combination with an interested stockholder for a period
of three years after the date of the transaction in which the person became an
interested stockholder, unless:
o prior to such date, our board of directors approved either the
business combination or the transaction that resulted in the
stockholder becoming an interested stockholder;
o upon consummation of the transaction that resulted in the
stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced; or
o on or subsequent to such date, the business combination is approved
by the board of directors and authorized at an annual or special
meeting of stockholders by the affirmative vote of at least 66 2/3%
of the outstanding voting stock that is not owned by the interested
stockholder.
For purposes of these provisions, a "business combination" includes mergers,
consolidations, exchanges, asset sales, leases and other transactions resulting
in a financial benefit to the interested stockholder and an "interested
stockholder" is any person or entity that beneficially owns 15% or more of our
outstanding voting stock and any person or entity affiliated with or controlling
or controlled by that person or entity.
Election and Removal of Directors
Our amended and restated certificate of incorporation does not provide for
cumulative voting in the election of directors. Our by-laws require parties
other than the board of directors to give advance written notice of nominations
for the election of directors. Our amended and restated certificate of
incorporation also provide that our directors may be removed only for cause and
only upon the affirmative vote of the holders of at least a majority of the
outstanding shares of our common stock entitled to vote for such directors.
These provisions may discourage, delay or prevent the removal of incumbent
officers and directors.
Limited Actions by Stockholders
Our amended and restated certificate of incorporation and our by-laws
provide that any action required or permitted to be taken by our stockholders
must be effected at an annual or special meeting of stockholders or by the
unanimous written consent of our stockholders. Our amended and restated
certificate of incorporation provide that, subject to certain exceptions, only
our board of directors, the chairman of our board of directors, our president,
vice president or secretary may call special meetings of our stockholders. Our
bylaws also contain advance notice requirements for proposing matters that can
be acted on by the stockholders at a stockholder meeting. Accordingly, a
stockholder may be prevented from calling a special meeting for stockholder
consideration of a proposal over the opposition of our board of directors and
stockholder consideration of a proposal may be delayed until the next annual
meeting.
American Stock Exchange Listing
We have applied for approval of our common stock for quotation on the
American Stock Exchange under the symbol "NEP." Even if we are approved for
listing on the AMEX, we cannot assure you that a trading market for our
securities will develop or be sustained, or at what price the securities will
trade. In addition, we may fail to meet certain minimum standards for continued
listing. In such event, our common stock will be delisted, and its price will no
longer be quoted. This may make it extremely difficult to sell or trade our
common stock.
58
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, we will have 6,118,247 shares of common
stock outstanding, assuming the underwriters' over-allotment option is not
exercised. Of these shares, the shares of common stock offered hereby will be
freely tradable without restriction unless these shares are held by affiliates
as defined in Rule 144(a) under the Securities Act. The remaining 3,618,247
shares of common stock to be outstanding after this offering will be restricted
shares under the Securities Act. Restricted securities may be sold in the public
market only if registered or if they qualify for an exemption from registration
under Rule 144. Subject to the lock-up agreements described below and the
provisions of Rule 144, additional shares will become available for sale in the
public market.
In general, under Rule 144, an affiliate of ours, or a person, or persons
whose shares are aggregated, who has beneficially owned restricted shares for at
least one year, will be entitled to sell that number of shares in any
three-month period that does not exceed the greater of:
o one percent of the then outstanding shares of our common stock,
which will be approximately 65,539 shares immediately after this
offering, assuming no exercise of the underwriters' over-allotment
option, or
o the average weekly trading volume during the four calendar weeks
preceding the date on which notice of the sale is filed with the
Securities and Exchange Commission.
Sales pursuant to Rule 144 are subject to certain requirements relating to
manner of sale, notice and availability of current public information about us.
A person or persons whose restricted shares are aggregated who is not deemed to
have been our affiliate at any time during the 90 days immediately preceding the
sale and who has beneficially owned his or her shares for at least two years is
entitled to sell his or her restricted shares pursuant to Rule 144(k) without
regard to the limitations described above.
All of our existing security holders will be subject to lock-up agreements
which prohibit the sale of all of their shares of our common stock in the public
market until one year from the effective date of this prospectus, and thereafter
to the extent such sales, on a cumulative basis for each holder, exceed 1/3 of
our common stock held by such holder prior to 15 months from the effective date
or 2/3 of our common stock held by such holder prior to 18 months from the
effective date. If we are required to issue shares in connection with the
Potential Lancer Share Issuance, Lancer Offshore Inc. will be subject to a
lock-up agreement which prohibits the sale of all of its shares in the public
market until 180 days after the effective date. There are presently no
agreements between the underwriters and any of our stockholders or affiliates
releasing them from these lock-up agreements prior to the expiration of the
applicable period.
We granted registration rights to holders of shares of our series A
convertible preferred stock pursuant to a stock purchase agreement. Pursuant to
the stock purchase agreement, we granted each of these holders piggy-back
registration rights to, on up to two occasions, include the shares of common
stock underlying their respective shares of our series A convertible preferred
stock in any registration statement we file on our own behalf or on behalf of
our other stockholders, at any time after this offering. The piggy-back
registration rights will expire once the stockholders' shares of common stock
become freely saleable under Rule 144 or Rule 701 during any 90-day period,
provided, that these provisions do not apply to any stockholder who owns more
than 2% of our outstanding common stock. Subject to lock-up agreements, we could
be required to file additional registration statements, covering up to 899,327
shares in the aggregate, for the stockholders who hold these shares.
We have also entered into registration rights agreements with holders of
shares of our series B convertible preferred stock and our series C convertible
preferred stock and certain of our convertible notes and warrants. Pursuant to
these registration rights agreements, we granted each of these holders (1)
demand registration rights to, on no more than two occasions at any time six
months after the effective date of this prospectus, request that we file a
registration statement on Form S-1 under the Securities Act on their behalf to
register the shares of common stock underlying their respective shares of
preferred stock; (2) piggy-back registration rights to include the shares of
common stock underlying their respective shares of preferred stock in any
registration statement we file on our own behalf or on behalf of our other
stockholders, and (3) unlimited rights to request that we file a registration
statement on Form S-3 on their behalf to register the shares of common stock
underlying their respective shares of preferred stock, notes and warrants. The
registration rights will expire once the existing stockholders' shares of common
stock become freely saleable under Rule 144. Subject to lock-up agreements, we
could be required to file additional registration statements, covering up to
1,401,517 shares in the aggregate, for the stockholders who hold these shares.
59
We have also entered into a subscription agreement with Lancer Offshore,
Inc., pursuant to which we granted Lancer Offshore, Inc. (1) demand registration
rights to, on one occasion at any time six months after the effective date of
this prospectus, request that we file a registration statement under the
Securities Act on their behalf to register the shares of common stock underlying
the $3,000,000 in principal amount of convertible note and warrants to purchase
an aggregate of 240,000 shares of our common stock which they had agreed to
purchase in the Lancer Subscription Agreement; See "Important in this Prospectus
- -- Certain Conversion Notes have not been Converted"; and (2) piggy-back
registration rights to include the shares of common stock underlying their notes
and warrants in any registration statement we file on our own behalf or on
behalf of our other stockholders. The piggy-back registration rights will expire
once the existing stockholders' shares of common stock become freely saleable
under Rule 144. Subject to lock-up agreements, we could be required to file
additional registration statements, covering up to 720,000 shares in the
aggregate, for the holder of these convertible notes and warrants.
We have also entered into a registration rights agreement with our
underwriters. Pursuant to this agreement, the holders of the underwriters'
warrants will be entitled to customary "piggy-back" registration rights to
register the shares of common stock underlying the warrants. Such registration
rights shall continue for a period of five years from the effective date of this
offering.
Prior to this offering, there has been no public market for our common
stock. Sales of substantial amounts of common stock or the availability of such
shares for sale could adversely affect prevailing market prices of our common
stock and our ability to raise additional capital. You should read the
discussion under the heading entitled "Risk Factors -- Future sales of our
common stock could cause the market price of our common stock to decline" for
further information about the effect future sales could have on the market price
of our common stock.
60
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement between
us and GunnAllen Financial, Inc. and The Shemano Group, Inc., the underwriters
of this offering, a copy of which agreement is filed as an exhibit to the
registration statement of which this prospectus forms a part, we have agreed to
sell to the underwriters, and the underwriters have agreed to purchase all
2,500,000 shares of our common stock offered. The underwriters have severally
agreed to purchase the respective number of shares of our common stock set forth
in the table below. Howard Davis, executive vice president of GunnAllen
Financial, Inc., will serve as a director and as secretary of our company upon
consummation of this offering.
Underwriter Address Number of Shares
----------- ------- ----------------
GunnAllen Financial, Inc. 1715 North Westshore 1,250,000
Blvd. Suite 700
Tampa, Florida 33607
The Shemano Group, Inc. 601 California Street 1,250,000
Suite 1150
San Francisco,
California 94108
The underwriters have advised us that they will offer the shares as set
forth on the cover page of this prospectus, which includes the underwriting
discount indicated there, and that they will initially allow concessions not in
excess of $0.30 per share on sales to certain dealers. After the initial public
offering, concessions to dealer terms may be changed by the underwriters.
The underwriters have advised us that they do not intend to confirm sales
of the shares to any account over which they exercise discretionary authority in
an aggregate amount in excess of five (5%) percent of the total securities
offered hereby.
We have granted to the underwriters an option which expires 45 days after
the date of this prospectus, exercisable as provided in the underwriting
agreement, to purchase up to an additional 375,000 shares of our common stock at
a net price of $6.00 per share which option may be exercised only for the
purpose of covering over-allotments, if any. To the extent that the underwriters
exercise this option, each of the underwriters will become obligated, subject to
certain conditions, to purchase approximately the same percentage of additional
shares of common stock as the number of shares of common stock to be purchased
by it in the above table bears to 2,500,000, and we will be obligated, pursuant
to this option, to sell these shares to the underwriters to the extent this
option is exercised.
The underwriting agreement provides that we will reimburse the
underwriters for their expenses on a non-accountable basis in the aggregate
amount equal to 3% of the gross proceeds of this offering, $30,000 of which has
been paid to date and the balance of which shall be paid upon the consummation
of this offering. The underwriting agreement provides for reciprocal
indemnification between us and the underwriters against certain liabilities in
connection with the registration statement, including liabilities under the
Securities Act of 1933, as amended. For a period of three years following the
effective date of this offering, GunnAllen Financial Inc., one of our
underwriters, will have the right to have one representative attend each meeting
of our board of directors and each meeting of any committee thereof and to
participate in all discussions of each such meeting.
Subject to the approval of the National Association of Securities Dealers,
Inc., upon the consummation of this offering, we will sell to the underwriters
or their respective designees at an aggregate purchase price of $100, warrants
to purchase up to an aggregate of 250,000 shares of our common stock. Each
warrant represents the right to purchase one share of common stock for a period
of four years commencing one year from the effective date of this offering. The
exercise price of the warrants is 165% of the price at which our shares of
common stock are sold pursuant to this offering. The warrants contain provisions
that protect their holders against dilution by adjustment of the exercise price
and number of shares issuable upon exercise on the occurrence of specific
events, such as stock dividends or other changes in the number of our
outstanding shares except for shares issued under certain circumstances,
including shares issued under our equity incentive plan and any equity
securities for which adequate consideration is received. No holder of these
warrants will possess any rights as a stockholder unless the warrant is
exercised. The warrants may not be sold, transferred, assigned or hypothecated
for a period of one year from the effective date of this offering, except to
officers or partners (but not directors) of the underwriters and members of the
selling group and/or their officers or partners.
61
The holders of the warrants will be entitled to customary "piggy-back"
registration rights to register the shares underlying the warrants. Such
registration rights shall continue for a period of five years from the effective
date of this offering. Any profit realized from the sale of shares of common
stock underlying the underwriters' warrants may be deemed additional
underwriting compensation. The exercise of the underwriters' over-allotment
option will not result in an increase in the number of shares of common stock
underlying the underwriters' warrants or in the granting of any additional
warrants to the underwriters.
All of our existing security holders will be subject to lock-up agreements
which prohibit the sale of all of their shares of our common stock in the public
market until one year from the effective date of this prospectus, and thereafter
to the extent such sales, on a cumulative basis for each holder, exceed 1/3 of
our common stock held by such holder prior to 15 months from the effective date
or 2/3 of our common stock held by such holder prior to 18 months from the
effective date. If we are required to issue shares in connection with the
Potential Lancer Share Issuance, Lancer Offshore Inc. will be subject to a
lock-up agreement which prohibits the sale of all of its shares in the public
market until 180 days after the effective date. There are presently no
agreements between the underwriters and any of our stockholders or affiliates
releasing them from these lock-up agreements prior to the expiration of the
applicable period.
The underwriters may engage in over-allotment, stabilizing transactions,
syndicate covering transactions, penalty bids and "passive" market making in
accordance with Regulation M under the Securities Exchange Act of 1934.
Over-allotment involves syndicate sales in excess of the offering size, which
creates a syndicate short position. Stabilizing transactions permit bids to
purchase the underlying security so long as the stabilizing bids do not exceed a
specified maximum. Syndicate covering transactions involve purchases of the
shares of common stock or warrants in the open market after the distribution has
been completed in order to cover syndicate short positions. Penalty bids permit
the underwriters to reclaim a selling concession from a syndicate member when
the shares of common stock or warrants originally sold by such syndicate member
are purchased in a syndicate covering transaction to cover syndicate short
positions. In "passive" market making, market makers in the securities who are
underwriters or prospective underwriters may, subject to certain limitations,
make bids for or purchases of the securities until the time, if any, at which a
stabilizing bid is made. These stabilizing transactions, syndicate covering
transactions and penalty bids may cause the price of the common stock to be
higher than they would otherwise be in the absence of these transactions. These
transactions may be effected on the AMEX or otherwise and, if commenced, may be
discontinued at any time.
In connection with the offering, the underwriters may make short sales of
our shares and may purchase our shares on the open market to cover positions
created by short sales. Short sales involve the sale by the underwriters of a
greater number of shares than they are required to purchase in the offering.
"Covered" short sales are sales made in an amount not greater than the
underwriters' over-allotment option to purchase additional shares in the
offering. The underwriters may close out any covered short position by either
exercising their over-allotment option or purchasing shares in the open market.
In determining the source of shares to close out the covered short position, the
underwriters will consider, among other things, the price of shares available
for purchase in the open market as compared to the price at which they may
purchase shares through the over-allotment option. "Naked" short sales are sales
in excess of the over-allotment option. The underwriters must close out any
naked short position by purchasing shares in the open market. A naked short
position is more likely to be created if the underwriters are concerned that
there might be downward pressure on the price of the shares in the open market
after pricing that could adversely affect investors who purchase in the
offering. Similar to other purchase transactions, the underwriters' purchases to
cover the short sales may have the effect of raising or maintaining the market
price of our common stock or preventing or retarding a decline in the market
price of our common stock. As a result, the price of our common stock may be
higher than the price that might otherwise exist in the open market.
Prior to this offering, there has been no public market for our common
stock. Consequently, the assumed initial public offering price of our common
stock has been determined by negotiation between us and the underwriters.
Factors considered in determining the public offering price of such stock
included our net worth and earnings, the amount of dilution per share of common
stock to the public investors, the estimated amount of proceeds believed
necessary to accomplish our proposed goals, prospects for our business and the
industry in which we operate, the present state of our activities and the
general condition of the securities markets at the time of the offering.
62
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Continental Stock
Transfer & Trust Company. Its address is 17 Battery Place, New York, New York
10004.
LEGAL MATTERS
Certain legal matters in connection with this offering have been passed
upon for us by Kramer Levin Naftalis & Frankel LLP, New York, New York. Certain
legal matters relating to our patents and patent applications in connection with
this offering will be passed upon for us by Darby & Darby P.C., New York, New
York.
EXPERTS
Our financial statements as of December 31, 2001 and for the years ended
December 31, 2001 and 2000, included in this prospectus and elsewhere in the
registration statement to which this prospectus relates, have been audited by
Grant Thornton LLP, independent certified public accountants, as stated in their
report with respect thereto and are included in this prospectus and elsewhere in
the registration statement in reliance upon the authority of said firm as
experts in accounting and auditing.
Certain matters dealing with patents set forth in "Risk Factors --
Protecting intellectual property in our technology through patents, If we are
not able to protect our intellectual property..." and "Business -- Intellectual
Property" have been included in this prospectus in reliance upon the written
opinion of Darby & Darby, P.C., New York, New York.
DISCLOSURE OF COMMISSION POSITION ON
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to our directors, officers and controlling persons
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by us of expenses incurred or paid by one of
our directors, officers or controlling persons in the successful defense of any
action, suit or proceeding) is asserted by that director, officer or controlling
person in connection with the securities being registered, we will, unless in
the opinion of our counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether that
indemnification by us is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of that issue.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed a registration statement on Form SB-2 with the Securities
and Exchange Commission relating to the common stock offered by this prospectus.
This prospectus does not contain all of the information set forth in the
registration statement and the exhibits and schedules to the registration
statement. Statements contained in this prospectus concerning the contents of
any contract or other document referred to are not necessarily complete and in
each instance we refer you to the copy of the contract or other document filed
as an exhibit to the registration statement, each such statement being qualified
in all respects by such reference.
For further information with respect to us and the common stock we are
offering, please refer to the registration statement. A copy of the registration
statement can be inspected by anyone without charge at the public reference room
of the Securities and Exchange Commission, Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for further
information on the operation of the public reference room. Copies of these
materials can be obtained by mail from the Public Reference Section of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. The Commission maintains a Web site (http://www.sec.gov) that contains
information regarding registrants that file electronically with the Commission.
63
INDEX TO FINANCIAL STATEMENTS
NEPHROS, INC.
(A Development Stage Company)
Page
----
Report of Independent Certified Public Accountants F-2
Financial Statements
Balance Sheets F-3
Statements of Operations F-4
Statement of Stockholders' Equity (Deficit) F-5
Statements of Cash Flows F-6
Notes to Financial Statements F-8
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
After the effect of the reverse stock split discussed in Note 9, the undersigned
would be able to render the following audit report.
New York, New York
October 15, 2002
To the Board of Directors and Shareholders of Nephros, Inc.
We have audited the accompanying balance sheet of Nephros, Inc. (a Delaware
corporation in the development stage) as of December 31, 2001, and the related
statements of operations and cash flows for the years ended December 31, 2001
and 2000 and the related statement of stockholders' equity (deficit) for the
period from inception (April 3, 1997) to December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Nephros, Inc. as of December
31, 2001, and the results of its operations and its cash flows for the years
ended December 31, 2001 and 2000 in conformity with accounting principles
generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has a stockholders' deficit as well as working capital deficiency that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regards to these matters are also described in Note 1. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
F-2
Nephros, Inc.
(A Development Stage Company)
BALANCE SHEETS
Pro forma
September 30, September 30, December 31,
ASSETS 2002 2002 2001
----------- ----------- ----------
(unaudited) (unaudited)
Current assets
Cash and cash equivalents $ 483,808 $ 277,526
Prepaid expenses and other current assets 374 2,861
Deferred IPO and debt issuance costs 486,000 --
------------ ------------
Total current assets 970,182 280,387
Property and equipment, at cost less accumulated depreciation of
$327,979 and $285,573 in 2002 and 2001, respectively 73,062 102,783
Other assets 10,272 11,454
------------ ------------
Total assets $ 1,053,516 $ 394,624
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable $ 62,605 $ 1,891,295
Accrued expenses 583,000 40,930
Accrued IPO costs 307,000 --
Loan from related party 110,000 105,000
Short-term convertible note payable, net of unamortized
discount of $1,100,000 650,000 --
------------ ------------
Total current liabilities 1,712,605 2,037,225
Series B preferred stock, $.001 par value; 2,333,333 shares authorized;
2,333,333 shares issued and outstanding at December 31, 2001 and September
30, 2002 - liquidation preference at September 30, 2002 and December 31, 2001
of $2,330,666 and $2,227,666, respectively; none
outstanding on a pro forma basis -- 2,296,500 2,186,000
Series C preferred stock, $.001 par value; 3,140,000 shares
authorized; 3,137,550 shares issued and outstanding at December 31, 2001 and
September 30, 2002 - liquidation preference at September 30, 2002 and
December 31, 2001 of $3,523,550 and $3,369,550, respectively; none
outstanding on a pro forma basis -- 3,496,050 3,334,550
Stockholders' equity (deficit)
Series A preferred stock, $.001 par value; 4,000,000 shares authorized;
4,000,000 shares issued and outstanding at September 30, 2002 and December
31, 2001 - liquidation preference of $5,000,000; none outstanding
on a pro forma basis -- 4,000 4,000
Common stock, $.001 par value; 30,000,000 shares authorized;
1,261,194 shares issued and outstanding at September 30, 2002
and December 31, 2001; 3,562,039 outstanding on a
pro forma basis $ 3,562 1,261 1,261
Additional paid-in capital 12,805,488 7,011,239 5,066,239
Accumulated deficit from inception (13,468,139) (13,468,139) (12,234,651)
------------ ------------ ------------
Total stockholders' equity (deficit) (659,089) (6,451,639) (7,163,151)
------------ ------------ ------------
Total liabilities and stockholders' equity (deficit) $ 1,053,516 $ 394,624
============ ============
The accompanying notes are an integral part of these statements.
F-3
Nephros, Inc.
(A Development Stage Company)
STATEMENTS OF OPERATIONS
Period From
Inception to Nine months ended September 30, Year ended December 31,
September 30, ------------------------------ ---------------------------
2002 2002 2001 2001 2000
------------ ---------- ---------- ----------- ------------
(unaudited) (unaudited) (unaudited)
Revenue - other $ 300,000 $ -- $ -- $ 300,000 $ --
Operating expenses
Research and development 9,612,072 614,043 655,112 737,858 4,781,708
General and administrative 3,954,077 691,419 479,827 652,828 854,315
------------ ------------ ------------ ------------ ------------
Total operating expenses 13,566,149 1,305,462 1,134,939 1,390,686 5,636,023
------------ ------------ ------------ ------------ ------------
Loss from operations (13,266,149) (1,305,462) (1,134,939) (1,090,686) (5,636,023)
------------ ------------ ------------ ------------ ------------
Other income, net
Interest expense (490,000) (490,000) -- -- --
Interest income 173,097 181 5,147 5,497 22,765
Forgiveness of indebtedness 833,793 833,793 -- -- --
Gain on disposal of assets 30,007 -- -- -- 30,007
Other income 6,113 -- -- -- 668
553,010 343,974 5,147 5,497 53,440
------------ ------------ ------------ ------------ ------------
NET LOSS (12,713,139) (961,488) (1,129,792) (1,085,189) (5,582,583)
Cumulative preferred dividends and
accretion (755,000) (272,000) (228,000) (314,000) (169,000)
------------ ------------ ------------ ------------ ------------
Net loss attributable to
common stockholders $(13,468,139) ($ 1,233,488) $ (1,357,792) $ (1,399,189) $ (5,751,583)
============ ============ ============ ============ ============
Net loss per share -
Basic and Diluted $ .98 $ (1.08) $ (1.11) $ (4.63)
============ ============ ============ ============
Weighted-average shares outstanding -
Basic and Diluted 1,261,194 1,259,547 1,259,957 1,238,711
============ ============ ============ ============
Pro forma per share data (unaudited):
Pro forma net loss per share
Basic and Diluted ($ 0.27) $ (0.34) $ (0.33) $ (2.01)
============ ============ ============ ============
Pro forma weighted-average shares outstanding
Basic and Diluted 3,500,487 3,275,882 3,308,706 2,778,533
============ ============ ============ ============
The accompanying notes are an integral part of these statements.
F-4
Nephros, Inc.
(A Development Stage Company)
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
Series A
preferred stock Common stock Stock Additional
--------------------------- ------------------------- subscription Paid-in
Shares Amount Shares Amount receivable capital
------------ ------------ ---------- ------------- ------------- -------------
Issuance of common
stock upon inception -- $ -- 1,236,575 $ 1,237 $ (5,500) $ 4,263
Issuance of preferred
stock 4,000,000 4,000 -- -- (2,500,000) 4,996,000
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1997 4,000,000 4,000 1,236,575 1,237 (2,505,500) 5,000,263
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 4,00,0000 4,000 1,236,575 1,237 (2,505,500) 5,000,263
Noncash stock-based
compensation -- -- 2,136 2 -- 998
Collection of stock
subscription receivable -- -- -- -- 2,505,500 --
Net loss -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1999 4,000,000 4,000 1,238,711 1,239 -- 5,001,261
Noncash stock-based
compensation -- -- -- -- -- 5,000
Cumulative preferred
dividend and accretion -- -- -- -- -- --
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2000 4,000,000 4,000 1,238,711 1,239 -- 5,006,261
Noncash stock-based
compensation -- -- 22,483 22 -- 59,978
Cumulative preferred
dividend and accretion -- -- -- -- -- --
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2001 4,000,000 4,000 1,261,194 1,261 -- 5,066,239
Issuance of warrants -- -- -- -- -- 430,000
Noncash stock-based
compensation -- -- -- -- -- 15,000
Beneficial conversion and
warrants issued in with
convertible note payable -- -- -- -- -- 1,500,000
Cumulative preferred
dividend and accretion -- -- -- -- -- --
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, September 30, 2002
(unaudited) 4,000,000 $ 4,000 1,261,194 $ 1,261 $ -- $ 7,011,239
============ ============ ============ ============ ============ ============
Accumulated
loss from
inception Total
-------------- -----------
Issuance of common
stock upon inception -- --
Issuance of preferred
stock -- 2,500,000
Net loss (453,001) (453,001)
------------ ------------
Balance, December 31, 1997 (453,001) 2,046,999
Net loss (1,146,061) (1,146,061)
------------ ------------
Balance, December 31, 1998 (1,599,062) 900,938
Noncash stock-based
compensation -- 1,000
Collection of stock
subscription receivable -- 2,505,500
Net loss (3,484,817) (3,484,817)
------------ ------------
Balance, December 31, 1999 (5,083,879) (77,379)
Noncash stock-based
compensation -- 5,000
Cumulative preferred
dividend and accretion (169,000) (169,000)
Net loss (5,582,583) (5,582,583)
------------ ------------
Balance, December 31, 2000 (10,835,462) (5,823,962)
Noncash stock-based
compensation -- 60,000
Cumulative preferred
dividend and accretion (314,000) (314,000)
Net loss (1,085,189) (1,085,189)
------------ ------------
Balance, December 31, 2001 (12,234,651) (7,163,151)
Issuance of warrants -- 430,000
Noncash stock-based
compensation -- 15,000
Beneficial conversion and
warrants issued in with
convertible note payable -- 1,500,000
Cumulative preferred
dividend and accretion (272,000) (272,000)
Net loss (961,488) (961,488)
------------ ------------
Balance, September 30, 2002
(unaudited) $(13,468,139) $ (6,451,639)
============ ============
The accompanying notes are an integral part of this statement.
F-5
Nephros, Inc.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS
Period from
inception to
September 30, Nine months ended September 30, Year ended December 31,
------------------------------- ----------------------------
2002 2002 2001 2001 2000
------------- ------------- ------------- ------------ ------------
(unaudited) (unaudited) (unaudited)
Cash flows from operating activities
Net loss $(12,713,139) $ (961,488) $ (1,129,792) $ (1,085,189) $ (5,582,583)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 357,986 42,406 52,232 70,466 86,545
Forgiveness of indebtedness (833,793) (833,793) -- -- --
Noncash stock-based compensation 81,000 15,000 57,500 60,000 5,000
Amortization of debt discount 490,000 490,000 -- -- --
Gain on disposal of assets (30,007) -- -- -- (30,007)
(Increase) decrease in operating assets
Prepaid expenses (374) 2,487 3,140 4,094 (3,808)
Other assets (10,272) 1,182 567 1,690 2,173
Increase (decrease) in operating
liabilities
Accounts payable and accrued expenses 1,864,398 (67,827) (17,857) 27,351 1,320,949
------------ ------------ ------------ ------------ ------------
Net cash used in operating activities (10,794,201) (1,312,033) (1,034,210) (921,588) (4,201,731)
------------ ------------ ------------ ------------ ------------
Cash flows from investing activities
Purchase of property and equipment (484,393) (12,685) (8,807) (8,807) (105,882)
Proceeds from disposal of property and
equipment 83,352 -- -- -- 83,352
------------ ------------ ------------ ------------ ------------
Net cash used in investing
activities (401,041) (12,685) (8,807) (8,807) (22,530)
------------ ------------ ------------ ------------ ------------
F-6
Nephros, Inc.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS (continued)
Period from
inception to
September 30, Nine months ended September 30, Year ended December 31,
------------------------------- -----------------------
2002 2002 2001 2001 2000
------------- ------------ ------------ ---------- ----------
(unaudited) (unaudited) (unaudited)
Cash flows from financing activities
Proceeds from issuance of preferred stock, net $ 9,097,550 $ -- $ -- $ -- $ 4,097,550
Issuance of common stock 5,500 -- -- -- --
Loan from related party, net 110,000 5,000 -- 105,000 --
Proceeds from issuance of convertible notes
payable, net 2,466,000 1,526,000 940,000 940,000 --
----------- ----------- ----------- ----------- -----------
Net cash provided by financing
activities 11,679,050 1,531,000 940,000 1,045,000 4,097,550
----------- ----------- ----------- ----------- -----------
Net increase (decrease) in cash 483,808 206,282 (103,017) 114,605 (126,711)
Cash, beginning of period -- 277,526 162,921 162,921 289,632
----------- ----------- ----------- ----------- -----------
Cash, end of period $ 483,808 $ 483,808 $ 59,904 $ 277,526 $ 162,921
=========== =========== =========== =========== ===========
Supplemental disclosure of cash flow information
Non cash investing and financing activities:
Issuance of warrants in connection with
settlement with a supplier 400,000 400,000 -- -- --
Beneficial conversion and warrants issued in
connection with issuance of short-term
convertible notes 1,530,000 1,530,000 -- -- --
Cumulative preferred dividend and accretion 755,000 272,000 228,000 314,000 169,000
Conversion of Notes payable into preferred stock 940,000 -- 790,000 940,000 --
The accompanying notes are an integral part of these statements.
F-7
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 1 - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Nephros, Inc. ("Nephros" or the "Company") was founded in 1997 by health
professionals, scientists and engineers affiliated with Columbia University
to develop advanced End Stage Renal Disease ("ESRD") technology and products
that would address both patient treatment needs and the clinical and
financial needs of the treatment provider. The Company has developed three
products to deliver an improved hemodiafiltration process for ESRD patients.
These are the OLpurTM MD190, a dialyzer, OLpurTM H2H(TM), an add-on module
designed for use with existing hemodialysis machines and controlled by
advanced software with a simplified user interface, and the OLpur(TM) NS2000
system, a stand-alone hemodiafiltration machine and associated filter
technology. The Company believes these products are significantly more
effective than any products currently available for ESRD therapy. In its
laboratory bench studies, its hemodiafiltration products have been shown to
remove a range of larger toxins, known collectively as "middle molecules" due
to their molecular weight, more effectively than existing hemodialysis or
hemodiafiltration methods. These middle molecules are thought to contribute
to such conditions as malnutrition, impaired cardiac function, carpal tunnel
syndrome, and degenerative bone disease in the ESRD patient.
The Company is a development stage company, as defined by Statement of
Financial Accounting Standards ("SFAS") No. 7, "Accounting and Reporting by
Development Stage Enterprises," as it continues to devote substantially all
of its efforts to establishing a new business, and it has not yet commenced
its planned principal operations. Revenues earned by the Company to date are
primarily related to consulting services rendered to third parties outside of
the planned principal operations.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business.
Through December 31, 2001, the Company had incurred development stage losses
totaling approximately $12 million. At December 31, 2001, the Company had
minimal cash and cash equivalents to fund short-term working capital
requirements and had approximately $1.7 million of working capital
deficiency. The Company's ability to continue as a going concern and its
future success is dependent upon its ability to raise capital in the near
future to continue: (1) its research and development efforts, (2) hiring and
retaining key employees, (3) satisfaction of its commitments and (4) the
successful development, production and marketing of its products. These
factors raise substantial doubt about the Company's ability to continue as a
going concern.
The Company is actively pursuing additional sources of financing. The Company
believes that the proceeds from the financings closed subsequent to December
31, 2001 as well as the proceeds from the proposed initial public offering
(Note 9), will be sufficient to fund the Company's operations into the first
quarter of 2004. However, there can be no assurance that all funds from such
financings or any alternative financings will be available, when required, to
permit the Company to realize its business plan, or even if such capital is
available, that it will be at terms favorable to the Company. Additionally,
there can be no assurance that the Company's efforts to produce a
commercially viable product will be successful, or that the Company will
generate sufficient revenues to provide positive cash flows from operations.
The financial statements do not include any adjustments that might result
from the outcome of these uncertainties.
F-8
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 1 (continued)
Pro Forma Presentation
The unaudited pro forma presentation at September 30, 2002 gives effect to
the mandatory conversion of all of the convertible preferred stock (including
accrued preferred dividend) into common stock (see Notes 2 and 3), upon the
completion of the Company's proposed initial public offering (see Note 9).
Unaudited Interim Financial Statements
The accompanying unaudited financial statements as of September 30, 2002 and
for the nine months ended September 30, 2002 and 2001 and for the period from
inception to September 30, 2002 have been prepared in accordance with
accounting principles generally accepted in the United States of America. In
the opinion of management, the unaudited financial statements furnished
herein include all adjustments necessary for a fair presentation of the
Company's financial position at September 30, 2002 and the results of its
operations and its cash flows for the nine-month periods ended September 30,
2002 and 2001 and for the period from inception to September 30, 2002. All
such adjustments are of a normal recurring nature. Interim financial
statements are prepared on a basis consistent with the Company's annual
financial statements. Results of operations for the nine-month period ended
September 30, 2002 are not necessarily indicative of the operating results
that may be expected for the entire year ended December 31, 2002.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
Concentration of Risk
Cash and cash equivalents are financial instruments which potentially subject
the Company to concentrations 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 and cash equivalents.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts payable and debt
approximate fair value due to the short-term maturity of these instruments.
Cash and Cash Equivalents
The Company considers all highly liquid instruments with an original maturity
of three months or less at the date of purchase to be cash equivalents. Cash
equivalents consist primarily of overnight commercial paper and are stated at
cost, which approximates market value, and are considered available for sale.
F-9
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 1 (continued)
Property and Equipment
Property and equipment are stated at cost and are being depreciated over the
estimated useful lives of the assets, which range between three and five
years. Research equipment is being depreciated using an accelerated method of
200% declining balance. Computer equipment is being depreciated using the
straight-line method.
Property and equipment are comprised of the following:
September 30, December 31,
2002 2001
--------- -----------
(unaudited)
Research equipment $ 337,448 $ 334,998
Computer equipment 58,245 53,358
Furniture & Fixtures 5,348 --
--------- ---------
401,041 388,356
Less accumulated depreciation (327,979) (285,573)
--------- ---------
$ 73,062 $ 102,783
========= =========
Depreciation expense for the nine months ended September 30, 2002 and 2001
and for the years ended December 31, 2001 and 2000 was $42,405, $52,232,
$70,466 and $86,545, respectively.
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.
Accounting for Long-lived Assets
The Company accounts for long-lived assets in accordance with the provisions
of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of." This statement establishes financial
accounting and reporting standards for the impairment of long-lived assets,
certain identifiable intangibles and goodwill related to those assets to be
held and used, and for long-lived assets and certain identifiable intangibles
to be disposed of. Management has performed a review of all long-lived assets
and has determined that no impairment of the carrying values of its
long-lived assets exists as of December 31, 2001.
F-10
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 1 (continued)
Stock-based Compensation
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 SFAS No. 123, "Accounting for Stock-Based
Compensation."
The Company accounts for nonemployee 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."
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," 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.
Research and Development Costs
Research and development costs are expensed as incurred.
Income (Loss) per Common Share
Historical -
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") were computed by reflecting
potential dilution from conversion of convertible securities and the exercise
of stock options and warrants. Common equivalent shares of 3,472,477,
2,557,098, 2,561,370 and 2,379,487 have been excluded from the computation of
diluted EPS for the nine months ended September 30, 2002 and 2001 and for the
years ended December 31, 2001 and 2000, respectively, as their effect is
antidilutive.
F-11
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 1 (continued)
Pro forma (unaudited) -
Pro forma net loss per share is calculated assuming conversion of all
convertible Preferred Stock and accumulated dividends, which convert upon the
completion of the Company's proposed initial public offering (see Note 9). The
following table reconciles the numerator and denominator for the calculation:
Nine Months ended September 30, Year Ended December 31,
2002 2001 2001 2000
------------ ----------- ----------- -----------
Numerator:
Net loss attributable to common stockholders $(1,233,488) $(1,357,792) $(1,399,189) $(5,751,583)
Preferred dividend and accretion 272,000 228,000 314,000 169,000
----------- ----------- ----------- -----------
Pro forma net loss $ (961,488) $(1,129,792) $(1,085,189) $(5,582,583)
=========== =========== =========== ===========
Denominator:
Weighted average basic shares outstanding 1,261,194 1,259,547 1,259,957 1,238,711
Assumed conversion of preferred stock and preferred
dividend 2,239,293 2,016,335 2,048,749 1,539,822
----------- ----------- ----------- -----------
Pro forma weighted average basic shares outstanding 3,500,487 3,275,882 3,308,706 2,778,533
=========== =========== =========== ===========
Comprehensive Income (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,
foreign currency translation adjustments and minimum pension liability
adjustments. Comprehensive income (loss) must be reported on the face of the
annual financial statements. The Company's operations did not give rise to any
material items includable in comprehensive loss, which were not already in net
loss for the years ended December 31, 2001 and 2000 and for the nine months
ended September 30, 2002 and 2001. Accordingly, the Company's comprehensive loss
is the same as its net loss for all periods presented.
F-12
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 1 (continued)
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations be accounted for
by the purchase method and that intangible assets acquired in a business
combination be recognized as assets apart from goodwill. SFAS No. 142 requires
that goodwill and intangible assets that have indefinite useful lives not be
amortized but be tested at least annually for impairment. Intangible assets that
have finite useful lives will continue to be amortized over their useful lives.
SFAS No. 141 became effective for all business combinations initiated after June
30, 2001 and for all business combinations accounted for by the purchase method
for which the date of acquisition is July 1, 2001 or later. The provisions of
SFAS No. 142 are effective for fiscal years beginning after December 15, 2001.
The adoption of these statements is not expected to have a material effect on
the Company's financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which is effective for fiscal years beginning after June 15, 2002.
SFAS No. 143 requires that the fair value of an asset retirement obligation be
recognized in the period in which it is incurred if a reasonable estimate of
fair value of the obligation can be made. The adoption of the provisions of SFAS
No. 143 is not expected to have a material effect on the Company's financial
position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which is effective for fiscal years beginning
after December 15, 2001. SFAS No. 144 addresses financial accounting and
reporting for the impairment of long-lived assets (excluding goodwill) or assets
to be disposed of. The adoption of SFAS No. 144 is not expected to have a
material effect on the Company's financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS 146 requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of commitment to an exit or disposal plan. SFAS 146 will be
applied to exit or disposal activities after December 31, 2002 and is not
expected to have a material effect on the Company's financial position or
results of operations.
NOTE 2 - MANDATORILY REDEEMABLE PREFERRED STOCK
During February through April 2000, the Company issued 2,333,333 shares of $.001
par value Series B preferred stock at a price of $0.86 per share for aggregate
proceeds of approximately $2 million. The Series B stockholders are entitled to
a cumulative dividend at the rate of 6% per annum, when, as and if declared by
the Board of Directors, and to a liquidation preference of $.86 per share plus
any accrued and unpaid dividends. The Series B preferred stock can be converted
at any time to common stock at the conversion price of $3.82 per share and is
automatically converted upon a qualified public offering of the Company, as
defined in the Company's amended and restated certificate of incorporation.
The Series B preferred stock is redeemable on or at any time after February
2005, at the election of the holders of at least two thirds of the shares of
Series B and Series C preferred stock voting together as a class calculated on
an as converted basis. The redemption price will be equal to the greater of
$0.86 (plus any accrued and unpaid dividends) or the then fair market value per
share of the Series B preferred stock.
F-13
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 2 (continued)
Cumulative preferred dividends on Series B preferred stock were $103,000,
$97,000, $129,000 and $92,000 for the nine months ended September 30, 2002 and
2001 and for the years ended December 31, 2001 and 2000, respectively.
During May through October 2000, the Company issued 2,197,550 shares of $.001
per value Series C preferred stock at a price of $1.00 per share. The Series C
stockholders are entitled to a cumulative dividend at a rate of 6% per annum,
when, as and if declared by the Board of Directors, and to a liquidation
preference of $1.00 per share plus any accrued and unpaid dividends. The Series
C preferred stock can be converted at any time to common stock at the conversion
price of $4.45 per share and is automatically converted upon a qualified initial
public offering of the Company, as defined in the Company's amended and restated
certificate of incorporation.
The Series C preferred stock is redeemable on or at any time after May 2005, at
the election of the holders of at least two thirds of the shares of Series B and
Series C preferred stock voting together as a class calculated on an
as-converted basis. The redemption price will be equal to the greater of $1.00
(plus any accrued and unpaid dividends) or the then fair market value per share
of the Series C preferred stock.
During March through October 2001, the Company issued convertible notes payable
for aggregate proceeds of $940,000. During June through November 2001, such
notes were converted into an additional 940,000 shares of Series C preferred
stock at a price of $1.00 per share.
Cumulative preferred dividends on Series C preferred stock were $154,000,
$116,000, $165,000 and $67,000 for the nine months ended September 30, 2002 and
2001, and for the years ended December 31, 2001 and 2000, respectively.
In connection with the issuance of Series B and C preferred stock, the Company
incurred issuance cost of approximately $100,000. Such cost was recorded as a
reduction in the carrying amount of such preferred stock and is being accreted
over the five-year period to the earliest redemption date. Accretion of
preferred stock issuance cost was $15,000, $15,000, $20,000 and $10,000 for the
nine months ended September 30, 2002 and 2001 and for the years ended December
31, 2001 and 2000, respectively.
NOTE 3 - STOCKHOLDERS' EQUITY
In July 1997, the Company issued 4,000,000 shares of $.001 par value Series A
preferred stock at a price of $1.25 per share for aggregate proceeds of
$5,000,000. The Series A stockholders are entitled to voting and dividend rights
equal to common stockholders. The Series A preferred stock has a liquidation
preference of $1.25 per share plus any accrued but unpaid dividends. The Series
A preferred stock can be converted at any time to common stock at the conversion
price of $5.56 and is automatically converted upon the Company's initial public
offering as set forth in the Company's amended and restated certificate of
incorporation.
NOTE 4 - STOCK-BASED COMPENSATION
In 2000, the Company adopted the Nephros 2000 Equity Incentive Plan (the
"Plan"), under which 1,011,743 shares of common stock have been authorized for
issuance upon exercise of options granted and which may be granted by the
Company. As of December 31, 2001, 419,086 options have been issued to employees.
The options expire December 31, 2009, and vest as follows:
F-14
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 4 (continued)
- 20% of the options are exercisable on grant date
- 20% of the options are exercisable on the anniversary of the grant date
until 60% of the options are fully exercisable - 20% of the options are
exercisable at such a time that a hemodiafiltration device is available
for use in clinical trials
- 20% of the options are exercisable at such a time that Nephros, Inc. has
obtained regulatory approval for use by humans for its hemodiafiltration
device
As of December 31, 2001, 12,928 options have been issued to nonemployees.
Such options expire December 31, 2006 and vest over four years.
Option activity for the years ended December 31, 2001 and 2000 is summarized
as follows:
Weighted-
average
exercise
Shares price
------ ---------
Outstanding at December 31, 1999 -- $ --
Options granted 461,467 .40
Options exercised -- --
Options canceled -- --
-------- ------
Outstanding at December 31, 2000 461,467 .40
Options granted -- --
Options exercised -- --
Options canceled (29,453) .40
-------- ------
Outstanding at December 31, 2001 432,014 $ .40
======== ======
Exercisable at December 31, 2001 170,867 $ .40
======== ======
At December 31, 2001, there were 579,729 shares available for future grant
under the Plan.
The portion of stock options granted to employees which is time-based vested
(60%) is accounted for as a fixed award. No compensation has been recorded on
such portion as it had no intrinsic value at the date of grant.
The portion of stock options granted to employees which vests based on
performance achievement (40%) is accounted for as a variable award. As
vesting depends upon discrete events, the measurement date and the expense
recognition will occur when such targets are achieved. The intrinsic value of
such options at September 30, 2002 is approximately $1,000,000.
F-15
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 4 (continued)
Options issued to non-employees were valued using the Black-Scholes options
pricing model. The Company has recorded compensation in the amounts of
$15,000, $7,500, $10,000 and $5,000 for the nine months ended September 30,
2002 and 2001 and for the years ended December 31, 2001 and 2000,
respectively, in connection with options granted to nonemployees.
The weighted-average fair value of options granted in 2000 is $.27. The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: risk-free interest rate of 6%; no expected dividend yield;
expected lives of five years; and expected stock price volatility of 80%.
The following table summarizes information about stock options outstanding at
December 31, 2001:
Options outstanding Options exercisable
--------------------------------------------------- ----------------------------
Number Weighted- Number
outstanding average Weighted- exercisable Weighted-
as of remaining average as of average
Range of December 31, contractual exercise December 31, exercise
exercise prices 2001 life price 2001 price
--------------- --------------- ------------- ------------- -------------- ---------
$ 0.40 432,014 7.9 $ .40 170,867 $ .40
The Company has elected to continue to account for stock-based compensation
under APB Opinion No. 25, under which no compensation expense has been
recognized for stock options granted to employees at fair market value. Had
compensation expense for stock options granted under the Plan been determined
based on fair value at the grant dates, the Company's net loss and net loss
per share for the years ended December 31, 2001 and 2000 would have been
increased to the pro forma amounts shown below.
2001 2000
----------- ----------
Net loss
As reported $(1,085,189) $(5,582,583)
Pro forma (1,110,189) (5,632,795)
Net loss per share
As reported $(1.11) $(4.64)
Pro forma (1.13) (4.68)
F-16
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 5 - 401(k) PLAN
The Company has established a 401(k) deferred contribution retirement plan
which covers all employees. The Plan provides for voluntary employee
contributions of up to 15% of annual compensation, as defined. The Company
does not match employee contributions or otherwise contribute to the 401(k)
Plan.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
Leases
In September 2001, the Company entered into a noncancelable operating lease
for the rental of its office and research and development facility, which
expires in September 2002. Rent expense for the nine months ended September
30, 2002 and 2001 and for the years ended December 31, 2001 and 2000 totaled
approximately $55,000, $54,000, $73,000 and $66,000, respectively.
Annual future minimum lease payments as of December 31, 2001 are $33,140, all
payable during the year ended December 31, 2002.
License Agreement
On November 1, 1999, the Company entered into an exclusive license agreement
(the "Agreement") with the Trustees of Columbia University in the City of New
York ("Columbia") whereby Columbia granted the Company an exclusive right to
develop, manufacture, use, sell or lease products or services covered by
certain patent applications or the patents that may be granted on such
applications (collectively, the "Licensed Patents")
In consideration of the license granted under the Agreement, the Company
shall pay to Columbia: (i) a royalty of one-third of one percent (0.33%) on
net sales or transfers of all products or services covered by the Licensed
Patents; and (ii) a royalty of one-third of one percent (0.33%) of all
lump-sum payments received by the Company on account of the sale or transfer
of rights in the Licensed Patents, or in the products or services covered by
the Licensed Patents.
The Company is required to pay the following milestone payments to Columbia
in accordance with the following schedule: (i) $2,500 and the delivery of
2,140 shares of common stock of the Company within 60 days from the date of
the Agreement; (ii) $2,500 upon the filing of the first Company-sponsored
Pre-Market Application ("PMA") or its foreign equivalent for the product or
services covered by the Licensed Patents, with the United States Food and
Drug Administration (the "FDA") or its foreign equivalent; (iii) $50,000 upon
the cumulative net sales or transfers of $25,000,000 of all products or
services covered by the Licensed Patents; and (iv) $125,000 upon the
cumulative net sales or transfers of $200,000,000 of all products or services
covered by the Licensed Patents.
As of December 31, 2001, only the first milestone payment was made as the
Company has not yet met the conditions for the other payments. The Company
does not anticipate making any further payments under this license agreement
as it has discontinued the development of any products covered by the
Licensed Patents.
In addition, the Agreement provided that the Company shall sponsor research
at Columbia in an amount of not less than $40,000 per year for a period of
two (2) years pursuant to a Research Agreement entered into by and between
the
F-17
Nephros, Inc.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 6 (continued)
Company and Columbia. During the years ended December 31, 2001 and 2000, the
Company fulfilled such obligation by paying $30,000 and $50,000,
respectively, pursuant to such Research Agreement.
Litigation
The Company may, from time to time, be a party to litigation arising during
the normal course of business. The Company is currently not a party to any
litigation.
NOTE 7 - INCOME TAXES
At December 31, 2001, the Company had Federal, New York State, and New York
City income tax net operating loss carryforwards of approximately $11,800,000
each. The Company also has Federal and New York State research tax credit
carryforwards of approximately $430,000 and $30,000, respectively. The
Federal net operating loss and tax credit carryforwards will expire in 2012 -
2021 unless previously utilized.
Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of
the Company's net operating loss and credit carryforwards may be limited if a
cumulative change in ownership of more than 50% occurs within a three-year
period.
Significant components of the Company's deferred tax assets as of December
31, 2001 are shown below:
Deferred tax assets
Net operating loss carryforwards $5,300,000
Research and development credits 460,000
-----------
Total deferred tax assets 5,760,000
Deferred tax liability -
Valuation allowance for deferred tax assets (5,760,000)
----------
Net deferred tax assets $ -
==========
A valuation allowance of $5,760,000 has been recognized to offset the
deferred tax assets as realization of such assets is uncertain.
The effective tax rate for the years ended December 31, 2001 and 2000 is
different from the tax benefit that would result from applying the
statutory tax rates due to the valuation allowance that has been
recognized.
F-18
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 8 - RELATED PARTY TRANSACTION
Prior to December 31, 2000, the Company completed three private placements of
its equity securities (See Notes 2 and 3), in which some of the Company's
current and former directors and holders of more than 5% of the Company's
common stock purchased equity securities. The current and former directors
and holders of more than 5% of the Company common stock who purchased equity
securities in these private placements purchased equity securities on
substantially the same terms and conditions as the other participants.
During 2001, the Company had issued convertible notes in the aggregate
principal amount of $940,000, pursuant to which the Company agreed to pay to
the holders the principal amount due under each holder's convertible note,
together with interest on the unpaid principal amount at the rate of 9% per
annum, compounded semi-annually, from the date of the convertible note. As of
November 30, 2001, all of these notes were converted into an aggregate of
940,000 shares of the Company's series C convertible preferred stock. Eric A.
Rose, M.D. and Donald G. Drapkin, two of the Company's directors and holders
of more than 5% of the Company common stock, Ronald O. Perelman, a holder of
more than 5% of the Company common stock, and WP Nephros Partners, LLC, which
subsequently transferred its notes to Cypress Capital Assets, L.P., a
beneficial holder of more than 5% of the Company common stock, purchased such
notes, as set forth below.
Number of Shares
of Series C
Convertible
Preferred Stock
Issueable Upon
Principal Amount of Conversion of
Name Convertible Note Convertible Note
---- ---------------- ----------------
Eric A. Rose, M.D. $240,000 240,000
Donald G. Drapkin $50,000 50,000
Ronald O. Perelman $100,000 100,000
WP Nephros Partners, LLC $150,000 150,000
In April 2002, the Company issued convertible notes in the aggregate
principal amount of $250,000, pursuant to which the Company agreed to pay, in
August 2002, to the holders the principal amount due under each holder's
convertible note, together with interest on the unpaid principal amount at
the rate of 6% per annum, compounded semi-annually, from the date of the
convertible note. The holders of these notes have since agreed to irrevocably
convert them into an aggregate of 250,000 shares of the Company's series A
convertible preferred stock immediately prior to its receipt, if ever, of the
remaining $1,500,000 due under a subscription agreement (see Note 9), or at
such earlier time as the holders may elect, provided that such shares of
series A convertible preferred stock need not be issued by the Company until
the Company has increased the number of authorized shares of series A
convertible preferred stock by amending its certificate of incorporation. At
any time prior to the date of delivery to the holders of such shares, the
holders may require the Company to issue to them, in lieu of such shares, the
number of shares of its common stock into which such number of shares of
series A convertible preferred stock is convertible. The holders have
accepted the right to receive the foregoing shares in full satisfaction of
the Company's obligation to repay the notes. The Company has also agreed to
issue to the holders of these notes warrants to purchase an aggregate of
125,000 shares of its series A convertible preferred stock, or such shares of
its common stock as may be issuable upon mandatory conversion of its series A
convertible preferred stock, at a price of $1.00 per share, to be exercisable
through April 2004, and the Company expects to issue such warrants prior to
the effectiveness of the proposed initial public offering (see Note 9). Each
of Eric A. Rose, M.D., Donald G. Drapkin and Ronald O. Perelman purchased
securities in this transaction, as set forth in the table below.
F-19
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 8 (continued)
Number of Shares of Series A Number of Shares of Series
Convertible Preferred Stock A Convertible Preferred
Issuable Upon Conversion of Stock Issuable Upon
Principal Amount Convertible Note Exercise of Warrants
Name of Convertible Note
Eric A. Rose, M.D $75,000 75,000 37,500
Donald G. Drapkin $25,000 25,000 12,500
Ronald O. Perelman $25,000 25,000 12,500
The Company received unsecured advances from its Chairman of the Board to
ensure that it met operating needs. The advances are to be repaid when
sufficient funds become available and bear no interest. At September 30, 2002
and December 31, 2001, the Company was indebted for $110,000 and $105,000,
respectively.
In July 1998, the Company entered into a consulting agreement with a
shareholder. Per the agreement, the Company paid such shareholder consulting
fees in the amount of $75,000 per year. The agreement was terminated in
October 2000. Consulting fees for the year ended December 31, 2000 were
$62,500.
NOTE 9 - SUBSEQUENT EVENT
In April 2002, the Company issued $250,000 in principal amount of 6%
convertible notes payable due August 2002 (the "Notes"). The Notes are
convertible into either Series A preferred stock, Series C preferred stock,
or substantially equivalent capital stock, at a price of $1.00 per share. The
holders of the Notes have since agreed to irrevocably convert them into an
aggregate of 250,000 shares of the Company's series A convertible preferred
stock immediately prior to its receipt, if ever, of the remaining $1,500,000
due under a subscription agreement (see below), or at such earlier time as
the holders may elect, provided that such shares of series A convertible
preferred stock need not be issued by the Company until the Company has
increased the number of authorized shares of series A convertible preferred
stock by amending its certificate of incorporation. At any time prior to the
date of delivery to the holders of such shares, the holders may require the
Company to issue to them, in lieu of such shares, the number of shares of its
common stock into which such number of shares of series A convertible
preferred stock is convertible. The holders have accepted the right to
receive the foregoing shares in full satisfaction of the Company's obligation
to repay the notes. The Company has also agreed to issue to the holders of
these notes warrants to purchase an aggregate of 125,000 shares of its series
A convertible preferred stock, or such shares of its common stock as may be
issuable upon mandatory conversion of its series A convertible preferred
stock, at a price of $1.00 per share, to be exercisable through April 2004,
and the Company expects to issue such warrants prior to the effectiveness of
the proposed initial public offering (see below). The warrants will be
exercisable at any time through April 2004. The warrants were valued at
$30,000 using the Black-Scholes model and were recorded as a debt discount,
which was being amortized over the term of the debt (four months).
F-20
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 9 (continued)
In June 2002, the Company entered into a settlement agreement with one of its
suppliers. The Company had an outstanding liability to such supplier in the
amount of approximately $1,900,000. In exchange for a full release of this
liability, the Company has issued warrants giving the supplier the right to
purchase 134,899 shares of common stock of the Company for an exercise price
of $13.34 per share. The warrants are exercisable at any time through June
2007. The warrants were valued at $400,000 using the Black-Scholes model. In
addition, Nephros shall pay the supplier the following amounts: (i) the first
installment of $300,000 is due upon infusion of capital into the Company of
at least $500,000 of net cash proceeds, after the date of settlement; (ii) a
second installment of $100,000 is due six months after the first installment
is paid; (iii) a third installment of $250,000 is due if and when the Company
receives net cash proceeds of $1,250,000 in connection with a subsequent
offering of capital stock. In the event the capital raised by the Company
after the date of settlement is less than the above thresholds, Nephros shall
be obligated to pay the supplier 20% of the gross proceeds of any capital
infusion. Accordingly, the Company recorded a gain of approximately $850,000
based on such settlement agreement. On August 7, 2002, the Company satisfied
the first $300,000 installment of the agreement.
On July 2002, the Company entered into a one year operating lease for the
rental of its office and research and development facility. The lease
provides for annual rent of approximately $73,000.
In August, 2002, the Company entered into a Subscription Agreement with a
lender for additional financing. The new financing was to have provided funds
to the Company totaling $3,000,000 and, contemplated the issuance of
$3,000,000 aggregate principal amount of convertible notes of the Company due
March 2003. In August 2002, the Company issued to Lancer Offshore, Inc. a
convertible note in the principal amount of $1,500,000 and warrants to
purchase 120,000 shares of common stock (subject to antidilution
adjustments). The Subscription Agreement with Lancer Offshore, Inc.,
contemplated that additional convertible notes in the aggregate principal
amount of $1,500,000 and warrants to purchase an additional 120,000 shares of
common stock (subject to antidilution adjustments) would be issued, subject
to the payment of the additional aggregate principal amount of $1,500,000. As
of the date hereof, Lancer Offshore, Inc. has defaulted in its obligation to
pay the remaining $1,500,000. The Company is currently exploring possible
ways, without resorting to litigation, to resolve its issue with Lancer
Offshore, Inc. with respect to its failure to comply with the terms of the
Lancer Subscription Agreement. If the Company is not able to resolve this
issue in a manner that is satisfactory to it, then it intends to pursue
vigorously all available legal remedies against Lancer Offshore, Inc.,
including seeking rescission of the $1,500,000 convertible note and the
warrants issued to Lancer Offshore, Inc. in August 2002. However, there can
be no assurance that a judicial resolution will not uphold some or all of the
terms of the Subscription Agreement. The $1,500,000 note issued on August
2002 contained a beneficial conversion of $1,110,000 which was recorded as a
debt discount and is being amortized over the term of the debt (7.5 months).
In connection with the issuance of such note, the Company incurred issuance
costs of approximately $224,000. Such costs are recorded as debt issuance
costs and are being amortized over the term of the debt (7.5 months). The
notes were originally to bear interest at the rate of 8% per annum and be
convertible at any time into up to 1,200,000 shares common stock at a price
of $2.50 per share (subject to antidilution adjustments). The notes were to
automatically convert into shares of common stock upon a qualified public
offering of the Company, as defined in the convertible promissory note. The
Subscription Agreement provided for the issuance to the lender of warrants to
purchase 240,000 shares of common stock at $2.50 per share, exercisable at
any time through December 2007 (subject to antidilution adjustments). In
connection with the first installment in August 2002, the Company issued
warrants to purchase 120,000 shares of common stock (subject to antidilution
adjustments). The warrants were valued at $390,000 using the Black-Scholes
model and were recorded as a debt discount, which is being amortized over the
term of the debt (7.5 months). The Subscription Agreement also
F-21
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS (continued)
(Information as of September 30, 2002 and for the nine months ended September
30, 2002 and 2001 is unaudited)
NOTE 9 (continued)
required that immediately prior to the initial public offering, the Company
have 50,000 shares of common stock reserved for issuance upon the exercise of
warrants to a placement agent in connection with the financing. The Company
expects that such placement agent warrants, if issued, would be exercisable
at no more than $2.50 per share.
The Company is pursuing an initial public offering of its common stock
yielding proceeds to the Company of minimum $15 million before taking into
account applicable underwriting discounts, commissions and offering expenses.
Immediately prior to the consummation of the initial public offering, the
Company will effect a reverse stock split pursuant to which each share of its
common stock will be converted into 0.2248318 of one share of common stock.
Unless otherwise noted, all shares and per share data for all periods
presented have been retroactively restated to give effect to this reverse
stock split.
NOTE 10 - SUBSEQUENT EVENT (UNAUDITED)
On December 26, 2002, the Company issued a $250,000 promissory note (the
"Note") payable on December 26, 2003. The Note bears an increasing interest
rate of 7% to 15% per annum and it is mandatory payable no later then 30 days
after the consummation of the Company's initial public offering.
In January 2003, the Company's board of directors voted to increase to
1,124,159 the aggregate number of shares of the Company's common stock
reserved for issuance under the Plan, subject to the requisite stockholder
approval.
In January 2003, the Company granted nonqualified stock options to purchase
359,056 shares of common stock at an exercise price of $3.50 per share, a
portion of which were immediately exercisable and the remainder of which will
vest over time or upon the achievement of certain milestones. Also in January
2003, the Company's board of directors approved, subject to shareholder
approval of certain changes to the Plan, the grant, prior to the consummation
of the Company's proposed initial public offering, of nonqualified stock
options to purchase 128,154 shares of common stock at an exercise price of
$3.50 per share, a portion of which will be immediately exercisable and the
remainder of which will vest upon the achievement of certain milestones.
F-22
[INSIDE BACK COVER PAGE - DESCRIPTION OF ARTWORK]
The inside back cover contains a color photograph of the OLpur(TM) NS2000, our
standalone hemodiafiltration machine. The following text appears above the
photograph: "OLpur(TM) NS2000 Our next generation system designed to provide
on-line hemodiafiltration."
The bottom right side of the inside front cover page contains our logo.
No dealer, salesman or other person has been authorized to give any
information or to make representations other than those contained in this
prospectus, and if given or made, such information or representations must not
be relied upon as having been authorized by us. Neither the delivery of this
prospectus nor any sale hereunder will, under any circumstances, create an
implication that the information herein is correct as of any time subsequent to
its date. This prospectus does not constitute an offer to or solicitation of
offers by anyone in any jurisdiction in which such an offer or solicitation is
not authorized or in which the person making such an offer is not qualified to
do so or to anyone to whom it is unlawful to make such an offer or solicitation.
2,500,000 SHARES
NEPHROS, INC.
COMMON STOCK
--------------------------------
PROSPECTUS
--------------------------------
_________, 2003
You should rely only on the information contained in this document or to
those which we have referred you. We have not authorized anyone to provide you
with any other information. This document may be used only where it is legal to
sell these securities. The information in this document may not be accurate
after the date on its cover.
Until ______, 200_, all dealers effecting transactions in the registered
securities, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law (the "DGCL") permits a
corporation, under specified circumstances, to indemnify its directors,
officers, employees or agents against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlements actually and reasonably
incurred by them in connection with any action, suit or proceeding brought by
third parties by reason of the fact that they were or are directors, officers,
employees or agents of the corporation, if such directors, officers, employees
or agents acted in good faith and in a manner they reasonably believed to be in
or not opposed to the best interests of the corporation and, with respect to any
criminal action or proceeding, had no reason to believe their conduct was
unlawful. In a derivative action, that is one by or in the right of the
corporation, indemnification may be made only for expenses actually and
reasonably incurred by directors, officers, employees or agents in connection
with the defense or settlement of an action or suit, and only with respect to a
matter as to which they will have acted in good faith and in a manner they
reasonably believed to be in or not opposed to the best interests of the
corporation, except that no indemnification will be made if such person will
have been adjudged liable to the corporation, unless and only to the extent that
the court in which the action or suit was brought will determine upon
application that the defendant directors, officers, employees or agents are
fairly and reasonably entitled to indemnity for such expenses despite such
adjudication of liability.
The Registrant's Amended and Restated Certificate of Incorporation
provides for indemnification of directors and officers of the Registrant to the
fullest extent permitted by the DGCL. The Registrant has obtained liability
insurance for each director and officer for certain losses arising from claims
or charges made against them while acting in their capacities as directors or
officers of the Registrant.
Item 25. Other Expenses of Issuance and Distribution.
The Registrant estimates that expenses payable by the Registrant in connection
with the offering described in this Registration Statement will be as follows:
Total
-----
SEC registration fee (actual) .......................................$1,851.50
NASD filing fee......................................................$2,512.50
Accounting fees and expenses ......................................$300,000.00
American Stock Exchange LLC listing fee..............................$5,000.00
Legal fees and expenses............................................$400,000.00
Printing and engraving expenses.....................................$75,000.00
Blue Sky fees and expenses..........................................$10,000.00
Directors and officers' insurance...................................$50,000.00
Transfer agent and registrar fees....................................$5,000.00
Miscellaneous expenses..............................................$25,636.00
Item 26. Recent Sales of Unregistered Securities
The number of shares of the Registrant's Common Stock, par value $.001 per
share ("Common Stock"), set forth below have been adjusted to reflect the
Registrant's reverse stock split to be completed upon effectiveness of this
Registration Statement. See the description under the heading "Description of
Securities -- Reverse Stock Split" in Part I of this Registration Statement.
II-1
On November 1, 1999, the Registrant issued to the Trustees of Columbia
University in the City of New York 2,136 shares of Common Stock in connection
with a licensing agreement between the Registrant and the Trustees of Columbia
University in the City of New York.
As of February 8, 2000, the Registrant issued to WPPN, LP (formerly, WPPN,
Inc.) and NEP Employee Partners LLC 1,866,666 and 466,667 shares, respectively,
of its Series B Convertible Preferred Stock, par value $.001 per share, for an
aggregate purchase price of $2,006,666. Each of WPPN, LP and NEP Employee
Partners LLC are controlled by Cypress Capital Assets, LP.
As of May 17, 2000, the Registrant issued 2,197,550 shares of its Series C
Convertible Preferred Stock, par value $.001 per share ("Series C Preferred
Stock"), for an aggregate purchase price of $2,197,550, to Donald G. Drapkin,
William J. Fox, Ronald Perelman, Eric A. Rose, Lindsay Rosenwald, Bruce J.
Wasserstein, and WP Nephros Partners, LLC (which subsequently transferred its
shares to Cypress Capital Assets, L.P.), and certain other existing and new
investors.
During March through October 2001, the Registrant issued 940,000 shares of
Series C Preferred Stock for an aggregate purchase price of $940,000, to Donald
G. Drapkin, Ronald Perelman; Eric A. Rose and WP Nephros Partners, LLC (which
subsequently transferred its shares to Cypress Capital Assets, L.P.), and
certain other existing and new investors.
In April 2002, the Registrant issued convertible promissory notes in the
principal amount of $250,000 to the following investors: Donald G. Drapkin,
Ronald Perelman and Eric A. Rose, and certain other existing and new investors.
In connection with this April 2002 issuance, the Registrant has agreed to issue
to the holders of these notes warrants to purchase an aggregate of 125,000
shares of the Registrant's Series A Convertible Preferred Stock, par value $.001
per share (the "Series A Preferred Stock"), or such shares of Common Stock as
may be issuable upon mandatory conversion of the Series A Preferred Stock, at a
conversion price of $1.00 per share, which warrants expire in April 2004.
In June 2002, in settlement of certain amounts owed by the Registrant to
Plexus Services Corp., a former supplier of engineering consulting services, the
Registrant issued warrants to purchase 134,899 shares of Common Stock at an
exercise price of $13.34 per share, which warrants expire in June 2007.
In August 2002, the Registrant issued to Lancer Offshore, Inc. a
convertible note in the principal amount of $1,500,000 and warrants to purchase
120,000 shares of common stock (subject to antidilution adjustments; see
"Important Assumptions in this Prospectus - Warrants and Convertible Notes are
subject to Antidilution Adjustments"). In connection with this transaction, the
Registrant entered into a Subscription Agreement with Lancer Offshore, Inc.,
which contemplated that additional convertible notes in the aggregate principal
amount of $1,500,000 and warrants to purchase an additional 120,000 shares of
common stock (subject to antidilution adjustments) would be issued, subject to
the payment of the additional aggregate principal amount of $1,500,000. As of
the date hereof, Lancer Offshore, Inc. has defaulted in its obligation to pay
the remaining $1,500,000. The Registrant is currently exploring possible ways,
without resorting to litigation, to resolve its issue with Lancer Offshore, Inc.
with respect to its failure to comply with the terms of the Lancer Subscription
Agreement. If it is not able to resolve this issue in a manner that is
satisfactory to it, then it intends to pursue vigorously all available legal
remedies against Lancer Offshore, Inc., including seeking rescission of the
$1,500,000 convertible note and the warrants issued to Lancer Offshore, Inc. in
August 2002. However, there can be no assurance that a judicial resolution will
not uphold some or all of the terms of the Subscription Agreement and no
assurance that the Registrant will not have to issue common stock to Lancer
Offshore, Inc. pursuant to the terms of the Subscription Agreement. See
"Important Assumptions in this Prospectus -- Certain Convertible Notes have not
been Converted" of the prospectus to which this registration statement relates.
In connection with the $1,500,000 convertible note issued to Lancer Offshore,
Inc., the Company paid an aggregate commission of $150,000 to Hermitage Capital
Corporation, as placement agent.
In December 2002, we issued promissory notes in the aggregate principal
amount of $250,000 to a lender. This loan is payable on the earlier to occur of
30 days after the consummation of this offering and December 26, 2003. This loan
bears interest, calculated quarterly in arrears, at a rate of 7% per annum from
December 26, 3002 to March 31, 2003, 10% per annum from April 1, 2003 to April
30, 2003, and 15% per annum from May 1, 2003 to December 26, 2003. In connection
with this loan, we paid Hermitage Capital Corporation, as placement agent, an
aggregate amount of $25,000
II-2
The issuances of the above securities were considered to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act, or Regulation D promulgated thereunder, as transactions by an
issuer not involving a public offering. The recipients of securities in each of
these transactions represented their intention to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates and other instruments issued in these transactions. All recipients
either received adequate information about us or had access to such information.
Item 27. Exhibits.
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
1.1*** Form of Underwriting Agreement.
3.1*** Amended and Restated Certificate of Incorporation of the
Registrant.
3.2*** Amended and Restated By-laws of the Registrant.
4.1*** Specimen of Common Stock Certificate of the Registrant.
4.2*** Form of Underwriter's Warrant.
5.1*** Opinion of Kramer, Levin, Naftalis & Frankel LLP.
5.2*** Opinion of Darby & Darby P.C.
10.1 Amended and Restated 2000 Nephros Equity Incentive Plan.
10.2* Form of Subscription Agreement dated as of June 1997 between
the Registrant and each Purchaser of Series A Convertible
Preferred Stock.
10.3* Form of Registration Rights Agreement dated as of February 8,
2000 between the Registrant and WP Nephros Partners, LLC, as
Purchaser of Series B Convertible Preferred Stock.
10.4* Form of Registration Rights Agreement dated as of May 17, 2000
between the Registrant and each Purchaser of Series C
Convertible Preferred Stock.
10.5*** Form of Warrant dated April 8, 2002 issued to each Holder of
Certain Convertible Promissory Notes of the Registrant.
10.6* Subscription Agreement dated August 6, 2002 between Lancer
Offshore, Inc. and the Registrant, together with exhibits.
10.7*** Form of Promissory Note issued in connection with funds in the
aggregate principal amount of $250,000 received by the Company
on December 26, 2002.
10.8** Employment Agreement dated as of July 1, 2002 between Norman
Barta and the Registrant.
10.9* Form of Employee Patent and Confidential Information
Agreement.
10.10* Form of Employee Confidentiality Agreement.
10.11* Settlement Agreement dated June 19, 2002 between Plexus
Services Corp. and the Registrant
23.1 Consent of Grant Thornton LLP.
23.2*** Consent of Kramer, Levin, Naftalis & Frankel LLP (included in
its opinion filed as Exhibit 5.1 hereto).
23.3*** Consent of Darby & Darby P.C. (included in its opinion filed
as Exhibit 5.1 hereto).
24.1* Power of Attorney.
II-3
- -----------------------
* Filed with our Form SB-2 filed with the Securities and Exchange Commission
on October 22, 2002.
** Filed with Amendment No. 1 to our Form SB-2 filed with the Securities and
Exchange Commission on December 23, 2002.
*** To be filed by amendment.
Item 28. Undertakings.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement:
i. To include any prospectus required by Section 10(a)(3) of the
Securities Act;
ii. To reflect in the prospectus any facts or events which, individually
or together, represent a fundamental change in the information in
the Registration Statement; and notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in
the aggregate, the changes in the volume and price represent no more
than a 20% change in the maximum aggregate offering price set forth
in the "Calculation of Registration Fee" table in the effective
Registration Statement; and
iii. To include any additional or changed material information on the
plan of distribution;
provided, however, that clauses (i) and (ii) do not apply if the
Registration Statement is on Form S-3 or Form S-8, and the information
required to be included in a post-effective amendment by such clauses is
contained in periodic reports filed with or furnished to the Commission by
the Registrant pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 that are incorporated by reference in the Registration
Statement;
(2) That, for the purpose of determining any liability under the Securities
Act, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof;
(3) To remove from registration by means of a post-effective amendment any of
the securities being registered which remain unsold at the termination of
the offering.
II-4
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the City of New
York, State of New York, on January 16, 2003.
By: /s/ Norman J. Barta
----------------------------------
Norman J. Barta
President, Chief Executive Officer
and Chief Financial Officer
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Norman J. Barta
- ------------------------- President, Chief January 16, 2003
Norman J. Barta Executive Officer,
Chief Financial
Officer, Principal
Accounting Officer
and Director
/s/ Eric A. Rose, M.D.*
- ------------------------- Chairman of the January 16, 2003
Eric A. Rose, M.D. Board of Directors
and Director
/s/ Lawrence J. Centella*
- ------------------------- Director January 16, 2003
Lawrence J. Centella
/s/ Donald G. Drapkin* Director January 16, 2003
- -------------------------
Donald G. Drapkin
/s/ W. Townsend Ziebold, Jr.* Director January 16, 2003
- -----------------------------
W. Townsend Ziebold, Jr.
*By: /s/ Norman J. Barta
---------------------------
Norman J. Barta
Attorney-in-Fact
II-5
EXHIBIT INDEX
Exhibit No. Description
1.1*** Form of Underwriting Agreement.
3.1*** Amended and Restated Certificate of Incorporation of the
Registrant.
3.2*** Amended and Restated By-laws of the Registrant.
4.1*** Specimen of Common Stock Certificate of the Registrant.
4.2*** Form of Underwriter's Warrant.
5.1*** Opinion of Kramer, Levin, Naftalis & Frankel LLP.
5.2*** Opinion of Darby & Darby P.C.
10.1 Amended and Restated 2000 Nephros Equity Incentive Plan.
10.2* Form of Subscription Agreement dated as of June 1997 between
the Registrant and each Purchaser of Series A Convertible
Preferred Stock.
10.3* Form of Registration Rights Agreement dated as of February 8,
2000 between the Registrant and WP Nephros Partners, LLC, as
Purchaser of Series B Convertible Preferred Stock.
10.4* Form of Registration Rights Agreement dated as of May 17, 2000
between the Registrant and each Purchaser of Series C
Convertible Preferred Stock.
10.5*** Form of Warrant dated April 8, 2002 issued to each Holder of
Certain Convertible Promissory Notes of the Registrant.
10.6* Subscription Agreement dated August 6, 2002 between Lancer
Offshore, Inc. and the Registrant, together with exhibits.
10.7*** Form of Promissory Note issued in connection with funds in the
aggregate principal amount of $250,000 received by the Company
on December 26, 2002.
10.8** Employment Agreement dated as of July 1, 2002 between Norman
Barta and the Registrant.
10.9* Form of Employee Patent and Confidential Information
Agreement.
10.10* Form of Employee Confidentiality Agreement.
10.11* Settlement Agreement dated June 19, 2002 between Plexus
Services Corp. and the Registrant
23.1 Consent of Grant Thornton LLP.
23.2*** Consent of Kramer, Levin, Naftalis & Frankel LLP (included in
its opinion filed as Exhibit 5.1 hereto).
23.3*** Consent of Darby & Darby P.C. (included in its opinion filed
as Exhibit 5.1 hereto).
24.1* Power of Attorney.
- -----------------------
* Filed with our Form SB-2 filed with the Securities and Exchange Commission
on October 22, 2002.
** Filed with our with Amendment No. 1 to our Form SB-2 filed with the
Securities and Exchange Commission on December 23, 2002.
*** To be filed by amendment.
II-6