-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, D0vzVFWq7rEgLcPbFE8gCwL1dV1s1H8f0Iy4EOaI7TlYp7u5uGcIqHpcTwNiuVtK wl4fhwz0gfWqn3byiUpR6g== 0000922423-02-001110.txt : 20021022 0000922423-02-001110.hdr.sgml : 20021022 20021022172630 ACCESSION NUMBER: 0000922423-02-001110 CONFORMED SUBMISSION TYPE: SB-2 PUBLIC DOCUMENT COUNT: 10 FILED AS OF DATE: 20021022 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NEPHROS INC CENTRAL INDEX KEY: 0001196298 IRS NUMBER: 133971809 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SB-2 SEC ACT: 1933 Act SEC FILE NUMBER: 333-100673 FILM NUMBER: 02795400 BUSINESS ADDRESS: STREET 1: 3960 BROADWAY CITY: NEW YORK STATE: NY ZIP: 10032 BUSINESS PHONE: 2127815113 SB-2 1 kl10022_sb-2.txt SB-2 As filed with the Securities and Exchange Commission on October 22, 2002 Registration No. __________ ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 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 jurisdiction of (Primary Standard Industrial (IRS Employer incorporation or organization) Classification Code Number) Identification 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 Securities Proposed Maximum Aggregate Amount of to be Registered Offering Price(1) Registration Fee - -------------------------------------------------------------------------------------------------------------- common stock, $.001 par value per share $17,250,000(2) $1,587.00 - --------------------------------------------------------------------------------------------------------------
(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 ____ 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. ================================================================================ Subject to completion: dated October 22, 2002 PROSPECTUS __________ Shares [NEPHROS LOGO] Common Stock Nephros, Inc. is offering _______ shares of its common stock. This is our initial public offering. We intend to apply 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 $________ and $________ per share. Investing in our common stock involves a high degree of risk. See "Risk Factors" beginning on page 7. 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.
=============================================================================================== Per Share Total - ----------------------------------------------------------------------------------------------- Public Offering Price................................. $______ $______ Underwriting Discounts and Commissions................ $______ $______ Proceeds to Nephros, Inc. (1)......................... $______ $______ ===============================================================================================
(1) Before deducting expenses of this offering. The underwriter has an option to purchase up to an additional _________ shares of common stock from us to cover over-allotments. The underwriter is offering the shares on a firm commitment basis. The underwriter expects to deliver the shares to purchasers on or about ________, 2002. 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. GUNNALLEN FINANCIAL, INC. The date of this prospectus is _____, 2002 [INSIDE FRONT COVER PAGE - DESCRIPTION OF ARTWORK] The top of the inside front cover contains a computer-generated, three-dimensional, color picture of the OLpur(TM) H(2)H(TM), our add-on module that can convert a hemodialysis machine into a hemodiafiltration-capable machine. The OLpur(TM) H(2)H(TM) in the picture contains our logo. The middle of the inside front cover contains a computer-generated, three dimensional, color picture of the OLpur(TM) MD190, our disposable dialyzer for use with hemodiafiltration machines, with arrows and text identifying the direction of the flow of blood, substitution fluid and dialysate through the OLpur(TM) MD190. The bottom of the inside front cover page contains our logo. TABLE OF CONTENTS Prospectus Summary...........................................................1 Risk Factors.................................................................7 Cautionary Note Regarding Forward Looking Statements........................16 Important Assumptions in this Prospectus....................................17 Use of Proceeds.............................................................18 Dividend Policy.............................................................18 Capitalization..............................................................19 Dilution....................................................................21 Selected Financial Information..............................................22 Management's Discussion and Analysis of Financial Condition and Results of Operations...................................24 Business....................................................................27 Management..................................................................40 Certain Transactions........................................................45 Principal Stockholders......................................................47 Description of Securities...................................................49 Shares Eligible for Future Sale.............................................53 Underwriting................................................................55 Transfer Agent and Registrar................................................56 Legal Matters...............................................................57 Experts.....................................................................57 Disclosure of Commission Position on Indemnification for Securities Act Liabilities..............................................57 Where You Can Find More Information.........................................57 Index to Financial Statements..............................................F-1 2 - -------------------------------------------------------------------------------- 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. Our Business We are a development stage medical device and technology company that has developed a next-generation proprietary hemodiafiltration device and related products and technologies for treating patients with End Stage Renal Disease (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. Existing renal replacement technologies currently include: o Dialysis Peritoneal Dialysis - the patient's peritoneum, the membrane lining covering the internal abdominal organs, is used as a filter by introducing injectable-grade dialysate solution into the peritoneal cavity through a surgically implanted catheter. 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 dialysate solution. 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. All of these technologies (except peritoneal dialysis) cleanse the blood outside the body, or extracorporeally, using a semi-permeable filter, which functions as an artificial kidney, in conjunction with pumps, controls and sensors. Currently, hemodialysis is the most widely used extracorporeal renal replacement therapy. Hemodiafiltration is used on a more limited basis in western Europe and Asia. Hemodiafiltration is not currently available in the United States, which we believe is primarily due to the high cost of hemodiafiltration technology relative to expense reimbursement from third-party payors, such as Medicare and Medicaid. According to an article by W. Lornoy, et al., published in Nephrology Dialysis Transplantation in 2000, the costs related to currently available HDF were $11 more per session as compared to hemodialysis. Standard 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. Dialysis patients often suffer from complications such as malnutrition, impaired cardiac function, carpal tunnel syndrome and degenerative bone disease which may exist, in part, because current hemodialysis therapy fails to remove effectively a range of larger toxins (known in the industry as "middle molecules" because of their heavier molecular weight) that are eliminated as a matter of course by the healthy kidney. 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 April 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. In our view, however, treatment efficacy of the current HDF process is limited by the current dialyzer designs and technology. We believe that our OLpur(TM) MD190 will provide substantial improvement over the current HDF process and that our OLpur(TM) H(2)H(TM) will provide an opportunity for dialysis clinics to provide HDF therapy as a less expensive alternative to currently available HDF technology and at a cost similar to current hemodialysis therapy. See "Business - Limitations of Current Extracorporeal Renal Replacement Therapies." - -------------------------------------------------------------------------------- 1 - -------------------------------------------------------------------------------- Our Solution We have developed three products with our patented proprietary HDF technology that we believe will improve the HDF treatment efficacy beyond current HDF and hemodialysis therapies and, therefore, will encourage and facilitate HDF therapy in hemodialysis clinics. Our goal is to introduce these new products to the market over the next four years. We believe the benefits of our technology and devices will include: o reduced hospitalization, medication and care costs; o reduced patient drug requirements; o improved blood pressure control for the dialysis patient; and o potential improvement in the patient's health generally and overall quality of life. Our Products OLpur(TM) MD190: our proprietary disposable dialyzer for use with HDF machines. When compared to existing dialyzers in our laboratory bench studies, the OLpur(TM) 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 first quarter of 2003), we plan to begin selling the OLpur(TM) MD190 in western Europe in the first quarter of 2003. OLpur(TM) H(2)H(TM): an add-on module controlled by advanced proprietary 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 OLpur(TM) MD190. A prototype OLpur(TM) H(2)H(TM) module has been developed and bench-tested in our laboratories, 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 proprietary filter technology that we believe will offer superior 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, 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 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 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 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 worldwide is expected to be over two million by 2010. 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. Pursuant to the Merrill Report, the worldwide hemofiltration/HDF market segment was estimated to be growing at a rate of 23% per year, or approximately three times the annual rate of the overall dialysis market. We believe that this growth rate is indicative of the growing market acceptance of HDF as an improved method of treatment. Our Marketing Strategy Our goal is to provide better ESRD therapy by expanding the use of HDF in a cost-effective way, so that patients worldwide can receive better treatment, live longer and have an opportunity to improve their quality of life. We believe we have developed a line of innovative products that will accomplish this goal. We intend to introduce our OLpur(TM) 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 OLpur(TM) MD190. We believe that our products and technology will develop strong support among leading physicians and others in the dialysis community, and that this support will prove invaluable to our product market penetration. Additionally, the western European market will offer an enhanced opportunity for OLpur(TM) MD190 sales because dialyzers - -------------------------------------------------------------------------------- 2 currently are used only once in European dialysis clinics rather than reprocessed and reused. According to an article by P. Schoenfeld published in Seminars in Nephrology in July 1997, in the United States, dialyzers were reused 12-14 times on average over the years from 1990 through 1995. After introducing the OLpur(TM) MD190 in western Europe for existing HDF machines, we intend to market our OLpur(TM) H(2)H(TM) device to convert dialysis machines to HDF-enabled, and therefore OLpur(TM) MD190-capable, units. We believe that the introduction of the OLpur(TM) H(2)H(TM) technology into the United States will open the U.S. market to our OLpur(TM) MD190 disposable dialyzer. We estimate that there are over 60,000 dialysis machines in the United States alone that can accommodate the OLpur(TM) H(2)H(TM). We believe the OLpur(TM) H(2)H(TM) will also significantly expand our OLpur(TM) MD190 market opportunity in western Europe. After we have acclimated dialysis clinics and patients to improved HDF technology through our OLpur(TM) MD190 and OLpur(TM) H(2)H(TM) products, we intend to introduce our OLpur(TM) NS2000 stand-alone HDF system to provide an upgrade in treatment performance and efficiency. Company Background We were founded in 1997 by health professionals, scientists and engineers affiliated with Columbia University to develop cost-effective, improved products for ESRD therapy. Our goal is to develop and market technologies and products to improve the efficacy of HDF 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 HDF 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 _______ shares Common stock to be outstanding after this offering _______ shares. This does not include: o ___ shares reserved for issuance upon exercise of the underwriter's over-allotment option; o ___ shares reserved for issuance upon exercise of the underwriter's warrants; o ___ shares of common stock underlying stock options issued under our 2000 Equity Incentive Plan and outstanding as of the date of this prospectus; o ___ additional shares of common stock reserved for issuance under our 2000 Equity Incentive Plan; o ___ shares of common stock which may be issuable in connection with certain convertible notes - See "Important Assumptions in this Prospectus - Certain Convertible Notes Have Not Been Converted;" or o ___ shares reserved for issuance upon the exercise of certain warrants to purchase shares of our common stock. We currently intend to use the net proceeds of this offering for: o marketing and sales; o clinical trials; o regulatory approvals; o research and development; o payment of certain dividends on our convertible stock; o repayment of a loan to a related party; o working capital; and o general corporate purposes.
3 You should read the discussion under the heading "Use of Proceeds" for more information. Proposed American Stock Exchange Symbol: NEP
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 and the discussion under the heading "Underwriting" for more information regarding the underwriter's over-allotment option. 4 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 June 30, 2002 and for the six-month periods ended June 30, 2002 and 2001 and the balance sheet data as of June 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 a reverse stock split pursuant to which each share of our common stock then outstanding will be converted into 0.2253 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
Year ended Six months ended From December 31, December 31, June 30, June 30, Inception to 2000 2001 2001 2002 June 30, 2002 ------------ ------------ ------------ ------------ ------------- (Unaudited) (Unaudited) Revenue - other $ -- $ 300,000 $ -- $ -- $ 300,000 Operating Expenses: Research and development 4,781,708 737,858 457,298 276,215 9,274,244 General and administrative 854,315 652,828 424,432 291,148 3,553,806 ------------ ------------ ------------ ------------ ------------ Loss from operations (5,636,023) (1,090,686) (881,730) (567,363) (12,528,050) Other income, net 53,440 5,497 4,308 813,974 1,023,010 ------------ ------------ ------------ ------------ ------------ Net income (loss) (5,582,583) (1,085,189) (877,422) 246,611 (11,505,040) Cumulative preferred dividends and accretion (169,000) (314,000) (143,000) (180,000) (663,000) ------------ ------------ ------------ ------------ ------------ Net Income (loss) attributable to common stockholders (5,751,583) (1,399,189) (1,020,422) 66,611 (12,168,040) ============ ============ ============ ============ ============ Net Income (loss) per share: Basic $ (4.63) $ (1.11) $ (0.81) $ 0.05 ============ ============ ============ ============ Diluted $ (4.63) $ (1.11) $ (0.81) $ 0.03 ============ ============ ============ ============ Weighted average shares outstanding: Basic 1,241,116 1,262,404 1,261,052 1,263,643 ============ ============ ============ ============ Diluted 1,241,116 1,262,404 1,261,052 2,568,713 ============ ============ ============ ============ Pro forma per share data (unaudited): Pro forma net income (loss) per share Basic $ (2.01) $ (0.33) $ (0.27) $ 0.07 ============ ============ ============ ============ Diluted $ (2.01) $ (0.33) $ (0.27) $ 0.06 ============ ============ ============ ============ Pro forma weighted-average shares outstanding: Basic 2,783,929 3,315,130 3,221,982 3,507,284 ============ ============ ============ ============ Diluted 2,783,929 3,315,130 3,221,982 3,911,281 ============ ============ ============ ============
Balance Sheet Data
June 30, 2002 -------------------------------------------- December 31, Pro Forma 2001 Actual Pro Forma As Adjusted ------------ ------------ ------------ ------------ (Unaudited) (1) (2) Cash and cash equivalents $ 277,526 $ 59,526 $ 59,526 $ 13,999,526 Working capital (deficiency) (1,756,838) (1,042,485) (1,042,485) 11,747,515 Total assets 394,624 147,638 147,638 14,087,638 Short-term debt 105,000 350,000 350,000 1,500,000 Redeemable preferred stock 5,520,550 5,700,550 -- -- Stockholders' equity (deficit) $ (7,163,151) $ (6,656,540) $ (955,990) $ 11,834,010
(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. 5 (2) Gives effect to (i) the receipt of $1,500,000 in proceeds in accordance with the Lancer Subscription Agreement (see "Important assumptions in this Prospectus -- Certain Convertible Notes Have Not Been Converted") and proceeds from this initial public offering of 2,500,000 shares of our common stock, assuming an initial public offering price of $6.00 per share, less underwriting discounts and commissions and other expenses of this offering; (ii) the payment of a short-term loan to a related party; and (iii) the conversion of outstanding notes in the aggregate principal amount of $250,000. 6 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 June 30, 2002, we had an accumulated deficit of approximately $12.2 million. 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 which expresses 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. One of our lenders has defaulted on its agreement with us to provide funds and, pending resolution, that default may have a material adverse effect on our ability to obtain additional financing that may be required for our future operating expenses and production and marketing activities. 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 provided that Lancer Offshore, Inc. would purchase convertible notes in the aggregate principal amount of $3,000,000 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 (subject to antidilution adjustments). We refer to this as the "Lancer Investment." The Lancer Subscription Agreement contemplated that a convertible note in the principal amount of $1,500,000 and warrants to purchase an aggregate of 120,000 shares of common stock (subject to antidilution adjustments) would be issued in August 2002 and that the remaining convertible notes and warrants would be issued following the payment by Lancer of an aggregate of $1,500,000 in two equal installments, payable on September 15, 2002 and October 15, 2002, respectively. The Lancer Subscription Agreement also provided that the convertible notes would be secured by the assets of the company and would be convertible at the option of the holder into 1,200,000 shares of our common stock (subject to antidilution adjustments) and that the convertible notes would be mandatorily convertible 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 further required that immediately prior to the initial public offering, we have 50,000 shares of common stock reserved for issuance upon the exercise of warrants to a placement agent in connection with the financing. We expect that such placement agent warrants, if issued, would be exercisable at no more than $2.50 per share. As of the date of this prospectus, Lancer Offshore, Inc. has defaulted in its obligation to make payments totaling $1,500,000 on September 15, 2002 and October 15, 2002, at which time the Lancer Subscription Agreement contemplated the delivery of convertible notes in the aggregate principal amount of $1,500,000 and warrants to purchase an aggregate of 120,000 shares of our common stock (subject to antidilution adjustments). We intend to pursue vigorously all available legal remedies against Lancer Offshore, Inc., including seeking rescission of the securities issued in August 2002. However, 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 common stock to Lancer Offshore, Inc. pursuant to the terms of the Lancer Subscription Agreement. Pending resolution of our dispute, the uncertainty surrounding the Lancer Subscription Agreement is likely to have a material adverse effect on our ability to obtain financing on acceptable terms, both because of the possibility that Lancer Offshore, Inc. may retain a security interest in our assets and because of the number of shares of common stock we could be required to issue to Lancer Offshore, Inc., either in respect of a purported exercise of warrants or an attempted conversion of convertible notes, or both. The number of shares common stock we could be required to issue to Lancer Offshore, Inc., will 7 remain in doubt pending a judicial or negotiated resolution of the matter. The purported exercise of such warrants or conversion of such notes, or both, would also dilute the interests of our common stockholders. Our revenues for the foreseeable future will depend on products that are in various stages of research, development and clinical trial, none of which have been approved for sale. Since our inception, we have devoted significant efforts to the development of the OLpur(TM) MD190 and the OLpur(TM) H(2)H(TM). We expect to be dependent for revenues for the foreseeable future on sales of these products and their components. To date, these products have not been tested on human patients and we have not received regulatory approval to sell these products. We cannot assure you that these products will be safe or effective or that they will be cost-effective relative to other dialysis treatment alternatives. In addition we have devoted significant efforts to the development of our OLpur(TM) NS2000 system. The OLpur(TM) NS2000 system is currently in the research and development phase. If our pre-production unit of this system is not finalized in 2005, then we may not be able to launch our marketing efforts on the OLpur(TM) NS2000 system when planned in 2006, if at all. We cannot sell our products until we obtain the requisite regulatory approvals and clearances. 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 OLpur(TM) MD190 during the first quarter of 2003 and to launch our United States sales efforts for the OLpur(TM) MD190 and the OLpur(TM) H(2)H(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. 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. We may not be able to obtain the government clearances and/or approvals required to sell our products in countries outside of the European Union and the United States. We plan to market our products in several countries outside of western Europe and the United States. 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, in countries outside of western Europe and the United States. If we cannot sell our products outside of western Europe and the United States, then the size of our potential market could be reduced by more than half, which could significantly reduce our sales and revenues. Any modifications we make to our products may require additional approvals or clearances before the modified product may be marketed. 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. 8 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 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. 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. 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 in the dialyzer and/or the End Stage Renal Disease, or ESRD, therapy markets. Our future success depends in part on our ability to protect our intellectual property and maintain the proprietary nature of our technology through patents. We will only be able to protect our proprietary products and methods from unauthorized use by third parties to the extent that our proprietary products and methods are covered by valid and enforceable patents or are effectively maintained as trade secrets. 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, may not be upheld by the courts of any jurisdiction. Numerous publications have been disclosed by, and numerous patents 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 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 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 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 9 licenses, we could encounter delays in, or be prevented from, 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 intellectual property through enforcement of our confidentiality and non-competition agreements, we may not be able to compete effectively in the dialyzer and ESRD therapy markets. We attempt to protect our proprietary information, 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 proprietary information. If the employees or other parties breach our confidentiality agreements and non-competition agreements or if these agreements are not sufficient to protect our proprietary technology or are found to be unenforceable, our competitors could acquire and use information that we consider proprietary and we may not be able to compete effectively. We may not be able to build brand loyalty because our trademarks and trade names may not be protected. 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. We may not be able to successfully commercialize our products. Other than the units of our OLpur(TM) MD190 manufactured for our clinical trial and a small number of units for commercialization scale-up, we have produced only prototype units of our OLpur(TM) MD190 and OLpur(TM) H(2)H(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 may not be able to have our products mass-produced in a cost-effective manner. We expect to rely on a limited number of independent manufacturers to produce the OLpur(TM) 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 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. We may not be able to ensure the timely delivery of our products. All of our products and components will be manufactured by independent manufacturers of medical devices. 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 10 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 OLpur(TM) 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 some of the facilities and processes that we expect to use to manufacture our OLpur(TM) H(2)H(TM) and OLpur(TM) NS2000 have been inspected by the FDA, 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 us or the contractors 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. Once our products are commercialized, we expect to face significant challenges in obtaining market acceptance of our products. 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 which 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, the market for our products may be limited. 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. 11 If we cannot develop adequate distribution, customer service and technical support networks, we may not be able to market and distribute our products effectively. 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. 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. We may not be able to obtain adequate insurance or other protection against product liability risks associated with the production, marketing and sale of our products. 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. Our business is likely to be damaged if we are unable to keep our key management and scientific personnel. 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. 12 Our certificate of incorporation limits liability of our directors, which could discourage stockholders from bringing suits against our directors. 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 and we may not be able to compete with them effectively. 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. If we are not able to develop competitive products and take and hold sufficient market share from our competitors, we will not be profitable. Our potential customers are limited in number, which could prevent us from taking and holding sufficient market share from our competitors to be profitable. 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 products to these potential customers. 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. 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 (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. Pharmacological or technological advances in preventative and alternative treatments for ESRD could significantly reduce the size of the market for our products and our profitability. 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. 13 If the number of ESRD patients needing ongoing treatment for ESRD does not increase at the rate we estimate, our revenues could be adversely affected. 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, we may need to reduce the estimated prices of our products and 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. We expect to obtain a portion of our revenues from reimbursement provided by non-governmental programs in the United States. Although non-governmental programs generally pay higher reimbursement rates than governmental programs, of the non-governmental programs, managed care plans generally pay lower reimbursement rates than insurance plans. Reliance on managed care plans for dialysis treatment may increase if future changes to the Medicare program require non-governmental programs to assume a greater percentage of the total cost of care given to dialysis patients over the term of their illness, or if managed care plans otherwise significantly increase their enrollment of these patients. If the reliance on managed care plans for dialysis treatment increases, more patients join managed care plans or managed care plans reduce 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, 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, we may not be able to sell a sufficient quantity of our products to be profitable. Proposals to modify the health care system in the United States or other countries could decrease our revenues. 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 and impair our ability to 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 our profitability. 14 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; 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. 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 additional funds. 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 debt and equity securities, aggregating approximately $12.2 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 15 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 stockholders prior to the offering will still control a significant portion of our stock after the offering. Our stockholders prior to the offering will own approximately [____]% and our officers and directors (excluding those directors who are affiliated with institutional stockholders) will own approximately [____]% 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. 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 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. 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 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 $___ per share based on the initial public offering price of $___ per share. 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. 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. 16 IMPORTANT ASSUMPTIONS IN THIS PROSPECTUS References to Shares of Common Stock in this Prospectus Assume Completion of Reverse Stock Split Immediately prior to the effectiveness of the registration statement to which this prospectus relates, we intend to effect a reverse stock split pursuant to which each share of our common stock then outstanding will be converted into 0.2253 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 completion of our reverse stock split described above. 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 Pending resolution of the uncertainty surrounding the Lancer Investment, which is described in "Risk Factors -Risks Related to our Company - One of our lenders has defaulted on its agreement with us to provide funds and, pending resolution, that default may have a material adverse effect on our ability to obtain additional financing that may be required for our future operating expenses and production and marketing activities," 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"). Therefore, unless otherwise indicated, all information in this prospectus assumes that: (i) no additional convertible notes or warrants will be issued to Lancer Offshore, Inc.; (ii) none of the convertible notes has been converted; and (iii) none of the warrants is exercisable. 17 USE OF PROCEEDS At an assumed initial offering price of $6.00 per share and after deducting underwriting discounts and commissions and other expenses of this offering, we will receive net proceeds of approximately $12.5 million from the sale of 2.5 million shares of our common stock in this offering. We intend to use $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 $3.6 million 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 also intend to use approximately $6.5 million 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 approximately $2.3 million of the net proceeds 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 and 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 closing of this offering. In the event the underwriter's 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. 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 June 30, 2002: o on an actual basis giving effect to a reverse stock split pursuant to which each share of our common stock then outstanding will be converted into 0.2253 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 0.2253 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 2,284,431 shares of our common stock, simultaneously with the closing 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 0.2253 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 2,284,431 shares of our common stock, simultaneously with the closing of this offering (iii) the receipt of the net proceeds 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, (iv) the receipt of $1,500,000 in proceeds in accordance with the Lancer Subscription Agreement, (v) the payment of a short-term loan from a related party, and (vi) the conversion of outstanding notes in the aggregate principal amount of $250,000.
June 30, 2002 ------------------------------------------- Pro Forma Actual Pro Forma As Adjusted ------ --------- ----------- (Unaudited) Loan from related party .................................................. $ 110,000 110,000 -- Short-term convertible note payable, net of unamortized discount of $10,000 ............................................................... 240,000 240,000 -- Short-term bridge financing .............................................. -- 1,500,000 Series B Convertible Preferred Stock, par value $.001 per share: 2,333,333 shares authorized, 2,333,333 shares issued and outstanding; pro forma - _______shares authorized, none issued and outstanding; pro forma as adjusted - none authorized, none issued and outstanding ............... 2,259,000 -- -- Series C Convertible Preferred Stock, par value $.001 per share: 3,140,000 shares authorized, 3,137,550 shares issued and outstanding; pro forma -______ shares authorized, none issued and outstanding; pro forma as adjusted - none authorized, none issued and outstanding: .............. 3,441,550 -- -- Stockholders' equity (deficit): Series A Convertible Preferred Stock, par value $.001 per share: 4,000,000 shares authorized, 4,000,000 shares issued and outstanding; pro forma - ______ 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, 1,263,643 shares issued and outstanding; pro forma - ___ shares authorized, 3,548,074 shares issued and outstanding; pro forma as adjusted -30,000,000 shares authorized, 6,093,127 shares issued and outstanding(1) ............................................. 1,264 3,548 6,093 Additional paid-in capital ............................................... 5,506,236 11,208,502 24,005,957 Accumulated deficit from inception ....................................... (12,168,040) (12,168,040) (12,178,040) ------------ ------------ ------------ Total stockholders' equity (deficit) ..................................... (6,656,540) (955,990) 11,834,010 ------------ ------------ ------------ Total capitalization ..................................................... $ (605,990) $ (605,990) $ 13,334,010 ============ ============ ============
19 - ------------ (1) The number of shares of common stock to be outstanding after this offering is based on the number of shares outstanding as of June 30, 2002, and does not include the following: o ____ shares of common stock issuable upon exercise of the underwriter's over-allotment option; o ____ shares of common stock issuable upon the exercise of the underwriter's warrants; o 135,161 shares of common stock issuable upon exercise of warrants issued in June 2002 to a former supplier. See "Description of Securities - Other Warrants." o shares of common stock and warrants which may be issuable in connection with the Potential Lancer Share Issuance. See "Important Assumptions in this Prospectus - Certain Convertible Notes Have Not Been Converted;" o 1,013,708 shares of common stock reserved for issuance under our equity incentive plan; or o ___ 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. 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 June 30, 2002, our pro forma net tangible book value was $_____, or approximately $___ 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 June 30, 2002, our pro forma net tangible book value as adjusted for the sale of the ____ shares of our common stock offered in this offering and application of the net proceeds of $______ (at the assumed initial public offering price of $____ per share and after deducting the underwriting discounts and commissions and estimated offering expenses), would have been approximately $___ per share. This represents an immediate increase of $____ per share to existing stockholders and an immediate and substantial dilution of $___ 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 . $ Pro forma net tangible book value as of June 30, 2002 ......... $ Increase attributable to new investors ........................ Pro forma net tangible book value after this offering ........... --- Dilution of net tangible book value to investors in this offering $ === The following table summarizes on a pro forma basis, as of June 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 into shares of our common stock, and investors in this offering, assuming the sale of all ______ 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...... % $ % $ New Investors.............. --------- ----------- ----------- ------------ Total...................... % $ % ========= =========== =========== ============
The above discussion and tables exclude: o ____ shares of common stock issuable upon exercise of the underwriter's over-allotment option; o ____ shares of common stock issuable upon the exercise of the underwriter's warrants; o ____ shares of common stock issuable upon exercise of warrants issued in June 2002 to a former supplier (see "Description of Securities -- Other Warrants"); o shares of common stock and warrants which may be issuable in connection with the Potential Lancer Share Issuance - See "Important Assumptions in this Prospectus - Certain Convertible Notes Have Not Been Converted;" or o ____ shares of common stock reserved for issuance under our equity incentive plan. 21 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 June 30, 2002 and the six-month periods ended June 30, 2002 and 2001 and the balance sheet data as of June 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 a reverse stock split pursuant to which each share of our common stock then outstanding will be converted into 0.2253 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
Year ended Six months ended From December 31, December 31, June 30, June 30, Inception to 2000 2001 2001 2002 June 30, 2002 ------------ ------------ ------------ ------------ ------------- (Unaudited) (Unaudited) Revenue - other $ -- $ 300,000 $ -- $ -- $ 300,000 Operating Expenses: Research and development 4,781,708 737,858 457,298 276,215 9,274,244 General and administrative 854,315 652,828 424,432 291,148 3,553,806 ------------ ------------ ------------ ------------ ------------ Loss from operations (5,636,023) (1,090,686) (881,730) (567,363) (12,528,050) Other income, net 53,440 5,497 4,308 813,974 1,023,010 ------------ ------------ ------------ ------------ ------------ Net income (loss) (5,582,583) (1,085,189) (877,422) 246,611 (11,505,040) Cumulative preferred dividends and accretion (169,000) (314,000) (143,000) (180,000) (663,000) ------------ ------------ ------------ ------------ ------------ Net Income (loss) attributable to common stockholders (5,751,583) (1,399,189) (1,020,422) 66,611 (12,168,040) ============ ============ ============ ============ ============ Net Income (loss) per share: Basic $ (4.63) $ (1.11) $ (0.81) $ 0.05 ============ ============ ============ ============ Diluted $ (4.63) $ (1.11) $ (0.81) $ 0.03 ============ ============ ============ ============ Weighted average shares outstanding: Basic 1,241,116 1,262,404 1,261,052 1,263,643 ============ ============ ============ ============ Diluted 1,241,116 1,262,404 1,261,052 2,568,713 ============ ============ ============ ============ Pro forma per share data (unaudited): Pro forma net income (loss) per share Basic $ (2.01) $ (0.33) $ (0.27) $ 0.07 ============ ============ ============ ============ Diluted $ (2.01) $ (0.33) $ (0.27) $ 0.06 ============ ============ ============ ============ Pro forma weighted-average shares outstanding: Basic 2,783,929 3,315,130 3,221,982 3,507,284 ============ ============ ============ ============ Diluted 2,783,929 3,315,130 3,221,982 3,911,281 ============ ============ ============ ============
Balance Sheet Data
June 30, 2002 --------------------------------------------- December 31, Pro Forma 2001 Actual Pro Forma As Adjusted ------------ ------------ ------------ ------------ (Unaudited) (1) (2) Cash and cash equivalents $ 277,526 $ 59,526 $ 59,526 $ 13,999,526 Working capital (deficiency) (1,756,838) (1,042,485) (1,042,485) 11,747,515 Total assets 394,624 147,638 147,638 14,087,638 Short-term debt 105,000 350,000 350,000 1,500,000 Redeemable preferred stock 5,520,550 5,700,550 -- -- Stockholders' equity (deficit) $ (7,163,151) $ (6,656,540) $ (955,990) $ 11,834,010
22 (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) Gives effect to (i) the receipt of $1,500,000 in proceeds in accordance with the Lancer Subscription Agreement and proceeds from this initial public offering of 2,500,000 shares of our common stock, assuming an initial public offering price of $6.00 per share, less underwriting discounts and commissions and other expenses of this offering; (ii) the payment of a short-term loan to a related party; and (iii) the conversion of outstanding notes in the aggregate principal amount of $250,000. 23 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 proprietary hemodiafiltration products and technologies for treating patients with End Stage Renal Disease, or ESRD. Our products include the OLpur(TM) MD190, a proprietary dialyzer, OLpur(TM) H(2)H(TM), an add-on module designed for use with existing hemodialysis machines and controlled by advanced proprietary software with a simplified user interface, and the OLpur(TM) NS2000 system, a stand-alone HDF machine and associated proprietary 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 June 30, 2002, we had a deficit accumulated during the development stage of $12.2 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. Results of Operations Six Months Ended June 30, 2002 Compared to the Six Months Ended June 30, 2001 Revenues. There were no revenues for the six months ended June 30, 2002 and for the six months ended June 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 $276,215 for the six months ended June 30, 2002 compared to $457,298 for the six months ended June 30, 2001, a decrease of $181,083. The decrease was primarily due to capital constraints in the first half of 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 $291,148 for the six months ended June 30, 2002 compared to $424,432 for the six months ended June 30, 2001, a decrease of $133,284. The decrease was primarily due to lower staffing levels and bonuses and a reduction in non-cash compensation. Other Income (Expense), Net. Other income (expense), 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 six months of 2002, other income also included a gain that resulted from a settlement with a supplier. Other income (expense), net was income of $813,974 for the six months ended June 30, 2002 compared to income of $4,308 for the six months ended June 30, 2001, an increase of $809,666. The increase was primarily due to a gain that resulted from the forgiveness of indebtedness by a supplier in the six months ended 2002. 24 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 consulting agreement, outside of the planned principal operations, that was begun and completed in 2001. 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 lower levels of research in development in 2001 owing to capital constraints. 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 (Expense), Net. Other income (expense), net was income of $5,497 for the year ended December 31, 2001 compared to income of $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. Liquidity and Capital Resources We have incurred losses since our inception. At June 30, 2002, we had a deficit accumulated during the development stage of $12.2 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 securities. Through June 30, 2002, we had received net offering proceeds from private sales of equity securities of approximately $10.4 million. Since our inception in 1997 through June 30, 2002, we made $390,000 of net capital expenditures and used $10.0 million in cash to support our operations. At June 30, 2002, we had cash, cash equivalents and short-term investments of $59,526 and a working capital deficit of $1.0 million. In addition, subsequent to June 30, 2002, we issued a convertible note in the principal amount of $1,500,000 and may be obligated to issue to the holder of these notes additional convertible notes in the aggregate principal amount of $1,500,000, subject to our receipt of appropriate funds. All of these convertible notes may be converted into an aggregate of 1,200,000 shares of our common stock in certain circumstances. For a description of our sales of debt and equity securities, see "Certain Transactions." We expect to use the proceeds of this offering (1) to repay a short-term loan to a related party; (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 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 and 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 closing of this offering. In the event the underwriter's 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 the net proceeds of this offering will be sufficient to satisfy our contemplated funding requirements through 2003. 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 25 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. 26 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 process for ESRD patients. These are the OLpur(TM) MD190, a proprietary dialyzer, OLpur(TM) H(2)H(TM), an add-on module designed for use with existing hemodialysis machines and controlled by advanced proprietary software with a simplified user interface, and the OLpur(TM) NS2000 system, a stand-alone HDF machine and associated proprietary filter technology. We believe these products are significantly more effective than any products currently available for ESRD therapy. In our laboratory bench studies, our proprietary 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. 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 April 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 proprietary 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 OLpur(TM) MD190 and the OLpur(TM) H(2)H(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." 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. 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 27 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. According to the Merrill Report, the worldwide hemofiltration/HDF market segment was estimated to be growing at a rate of 23% per year, or approximately three times the annual rate of the overall hemodialysis market. We initially intend to compete in the HDF dialyzer market with our OLpur(TM) MD190 in western Europe. If we can obtain FDA approval of the OLpur(TM) MD190 and the OLpur(TM) H(2)H(TM), we will compete in the U.S. hemodialysis dialyzer market by combining our OLpur(TM) MD190 with an OLpur(TM) H(2)H(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 has not caught on 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. 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 28 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 Beta(2)Microglobulin, 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, is significantly reduced. 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 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. 29 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 Solution Our OLpur(TM) MD190 utilizes a proprietary design and a process we developed called Mid-Dilution Diafiltration, or MDF, which 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 which may be carried out in a single dialyzer cartridge. We believe that the MDF process will provide superior treatment efficacy in HDF treatments, with a resulting improvement in patient health. Our Products Our products, which are currently in the development stage or subject to our receipt of regulatory approval, include: OLpur(TM) MD190 OLpur(TM) MD190 is our proprietary 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 OLpur(TM) MD190 incorporates a unique blood-flow characteristic that enhances toxin removal with almost no cost increase over existing devices currently used for HDF therapy. In our laboratory bench studies, OLpur(TM) MD190 offered small molecule removal comparable to existing HDF standards and an improvement of over 80% in removing middle molecules. The OLpur(TM) MD190 will enter human clinical trials in Europe in November 2002. We will then work with TUV Rheinland of North America, Inc., a worldwide testing and certification agency that performs conformity assessments to European Union requirements for medical devices, to obtain the Conformite Europeenne, or CE, mark, a mark which demonstrates compliance with relevant European Union requirements. We anticipate initiating European sales of OLpur(TM) 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. OLpur(TM) H(2)H(TM) OLpur(TM) H(2)H(TM) is our add-on module that is designed to convert hemodialysis machines into HDF-capable machines that can then be used with the OLpur(TM) MD190. We estimate there are over 60,000 hemodialysis machines in the United States alone that can be converted to HDF with our OLpur(TM) H(2)H(TM) technology. We have completed our OLpur(TM) H(2)H(TM) design and laboratory bench testing; we plan to submit to the FDA for 510(k) approval of OLpur(TM) H(2)H(TM), as well as acquire the CE mark, and have targeted an introduction of the OLpur(TM) H(2)H(TM) in the United States and Europe by the end of 2003. OLpur(TM) NS2000 OLpur(TM) NS2000 is our standalone HDF machine and associated proprietary filter technology. In our laboratory bench studies and animal studies, 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. OLpur(TM) NS2000 is in the development stage. 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 proprietary 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 proprietary products and patented technology offer the ability to remove toxins more effectively than current dialysis therapy. Our objective is to capitalize on the 30 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 OLpur(TM) MD190 during the first quarter of 2003. We believe that there is an immediate opportunity for sales of the OLpur(TM) MD190 in western Europe because there is an established HDF machine base using disposable (rather than re-usable) dialyzers. According to the Merrill Report, the worldwide hemofiltration/HDF market segment was estimated to be growing at a rate of 23% per year, or approximately three times the annual rate of the overall dialysis market. 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 there is a substantial sales opportunity that will increase over time. We believe that our products and technology will develop strong support among leading physicians and others in the dialysis community, and that this support will prove invaluable to our product market penetration. 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 OLpur(TM) MD190, we will seek to complete comprehensive clinical trials to validate OLpur(TM) H(2)H(TM), to complete our regulatory approval processes in western Europe for OLpur(TM) H(2)H(TM) and to complete our regulatory approval processes in the United States for both OLpur(TM) MD190 and OLpur(TM) H(2)H(TM). Our goal is to initiate U.S. and European sales for the OLpur(TM) H(2)H(TM) and the OLpur(TM) MD190 in 2003. We seek to achieve market penetration by offering the OLpur(TM) H(2)H(TM) for use by the dialysis clinic at a very low price in concert with long-term dialyzer and other disposable products supply agreements, thus permitting the dialysis clinic to use the OLpur(TM) H(2)H(TM) without a large initial outlay of capital. We believe that this will allow the dialysis clinic to upgrade its performance profile at a very low cost increase on a per treatment basis, without replacing their existing machines. We believe that through the OLpur(TM) H(2)H(TM) we can introduce hemodiafiltration 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 OLpur(TM) 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 OLpur(TM) MD190. We are in the process of negotiating with additional independent manufacturers to ensure multiple sourcing for our products and supplies. See "Risk Factors -- We may not be able to have our products mass-produced in a cost-effective manner; We may not be able to ensure the timely delivery of our products; 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. We have marketing expertise in both these areas; prior to joining us, members of our staff were employed by the some of the largest dialysis providers and product manufacturers in the world. In addition, we have retained a marketing expert based in Paris on a contract basis to support the development of our European marketing arm. We intend to market our products 31 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 cannot develop adequate distribution...; and Once our products are commercialized...." 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 managed care entities would seek improved therapy for their patient constituents so as to reduce overall the per-patient care cost. We believe that this would provide us with a substantial advantage competitively, because we believe that our products offer the most effective avenue for improved ESRD therapy available to these managed care organizations for the foreseeable future. We are 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 million for the fiscal year ended December 31, 2000. Clinical Testing We intend to conduct clinical studies in Europe in 2002, under the supervision of Bernard Canaud, M.D., a prominent and widely published nephrologist associated with the Hospal Lapeyronie in Montepellier, France. Throughout 2003, we also intend to engage in additional clinical studies across western Europe to demonstrate additional safety and benefits of our products. Competition We expect to compete in the dialyzer and renal replacement therapy market 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 (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 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 -- Pharmacological or technological advances in preventative and alternative treatments for ESRD..." 32 Intellectual Property Patents We attempt to protect our proprietary rights in 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 Asia, 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 use. 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. 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 (one of which has been allowed) 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 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 Expiration Date ----- --------------- Method for Efficient Hemodiafiltration July 30, 2019 Two Stage Diafiltration Method and Apparatus July 30, 2019 Non-Isosmotic Diafiltration System October 29, 2019 Dual Stage Hemodiafiltration Cartridge 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 proprietary methods to enhance toxin removal. Trademarks As of the date of this prospectus, we do not have any registered trademarks. Centrapur,TM OLpur,TM and H(2)H(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 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 June 30, 2002, we had not met any of these milestones. We do not anticipate making any further payments under this license agreement as we have discontinued the development of any products covered by the licensed patents. 33 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. 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 34 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 OLpur(TM) MD190 and the OLpur(TM) H(2)H(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 OLpur(TM) MD190 and the OLpur(TM) H(2)H(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 market our products until we obtain the requisite 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. 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 35 facilities and processes that we expect to use to manufacture our OLpur(TM) 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 OLpur(TM) H(2)H(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 OLpur(TM) 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. 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. 36 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. 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 37 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" 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. 38 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 -- We may not be able to obtain adequate insurance or other protection against product liability risks..." Employees As of September 30, 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 hire additional sales staff, marketing management and administrative support for our European operations. 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 office and laboratory 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. We believe that our existing facilities are adequate to meet our current U.S. requirements and 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. However, we intend to initiate legal proceedings against Lancer Offshore, Inc. with respect to their failure to comply with the terms of the Lancer Subscription Agreement, which is described in "Risk Factors -Risks Related to our Company - One of our lenders has defaulted on its agreement with us to provide funds and, pending resolution, that default may have a material adverse effect on our ability to obtain additional financing that may be required for our future operating expenses and production and marketing activities." 39 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 45 President, Chief Executive Officer, Chief Financial Officer and Director (1) Lawrence J. Centella 61 Director Donald G. Drapkin 54 Director W. Townsend Ziebold, Jr. 41 Director - ------------ (1) We are currently conducting an executive search for a secretary and chief financial officer. 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 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 May 1999. 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). 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 since June 1998. From 1997 to 1998, Mr. Centella served as executive vice president and chief operating officer of Gambro Healthcare, Inc. 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. 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 chairman of MacAndrews & Forbes Holdings Inc. and various of its affiliates since 1987. 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. Mr. Drapkin is also 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; Panavision, Inc.; Playboy Enterprises, Inc.; Playboy.com, Inc.; Revlon Consumer Products Corporation; Revlon, 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. W. Townsend Ziebold, Jr. has served as a director of our company since 1999. 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.'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. 40 There are no family relationships among any of our directors and executive officers. Our board of directors currently consists of five 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 2000 to 2002, Mr. Crook owned and operated approximately 12 dialysis clinics throughout the United States. From 1996 to 2002, Mr. Crook worked as an independent marketing consultant for a variety of medical device companies. 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 We have a compensation committee and an audit committee. The compensation committee consists of two members, ________ and _________, each of whom is an independent director. The compensation committee is responsible for establishing executive officers' compensation and fringe benefits. It also administers our Nephros 2000 Stock Incentive Plan, as amended, and is authorized to grant options under this plan. The audit committee consists of two members, ________ and _________, each of whom is an independent director. The audit committee recommends the appointment of independent accountants and reviews and discusses 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 $_____ per meeting for board meetings attended in person or telephonically and will reimburse our directors for expenses incurred by them in connection with serving on our board of directors. Executive Compensation The following tables set forth in summary form information concerning the compensation paid by us during the fiscal years ended December 31, 2001, 2000 and 1999, 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, 2001. 41 SUMMARY COMPENSATION TABLE
Annual Compensation ------------------- Salary Bonus Name and Principal Position (1) Year (dollars) (dollars) ------------------------------- ---- --------- --------- Eric A. Rose, M.D., Chairman of the Board (2) 2001 0 0 2000 21,154 0 1999 48,077 0 Norman J. Barta 2001 130,000 250 President, Chief Executive Officer and 2000 130,000 30,349 Chief Financial Officer (3) 1999 99,385 6,500
- ----------- (1) Donald G. Drapkin served as our interim president, chief executive officer and treasurer during the fiscal year ended December 31, 1999. We did not pay any compensation to Mr. Drapkin for his services in such capacity. (2) Eric A. Rose, M.D. served as our president and our chief executive officer during the fiscal years ended December 31, 2001, 2000 and 1999. We paid Dr. Rose compensation for his services in such capacity. (3) Mr. Barta served as our chief operating officer from October 1999 until July 2002. We are currently conducting an executive search for a secretary and chief financial officer. For information about employment agreements to take effect upon the closing of this offering with some of our executive officers, see "-- Employment Agreements and Incentive Bonus Programs" below. 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 October 31, 2005. This agreement provides Mr. Barta with an annual base salary upon the closing 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 thereafter, 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 OLpur(TM) 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. Beginning in 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 equalling 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 not tied 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. We will grant to Mr. Barta an option, pursuant to our equity incentive plan, to purchase _______ shares of our common stock. 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 42 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 six month period ended June 30, 2002. Equity Incentive Plan We adopted the Nephros 2000 Equity Incentive Plan in January 2000. Under this plan 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 this plan in determining who shall receive awards, the amount of an award and the terms and conditions of an award, provided, that no individual or entity receive awards that together equal more than 20% of the total shares of our common stock subject to option grants under the plan. The plan provides 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 this plan 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 aggregate number of shares of our common stock subject to option grants under the plan is 1,013,708. As of December 31, 2001, we had granted incentive stock options and nonqualified stock options to purchase 462,363 shares of common stock at a weighted average price of $.40 per share under the provisions of the plan and of these stock options, of which stock options to purchase 432,853 shares of common stock were outstanding. As of the closing of this offering, none of the stock options will have been exercised and options for _____ shares were vested and eligible for exercise. Nephros 2000 Equity Incentive Plan Information
Nephros 2000 Equity Incentive Plan Information Number of Shares of Common Stock Number of Shares of Weighted-Average Remaining Available Common Stock to be Exercise Price of for Future Issuance Issued upon Exercise of Outstanding under Equity Outstanding Options Options Incentive Plan (1) Nephros 2000 Equity Incentive Plan Information
- ---------- (1) Excludes shares of our common stock to be issued upon exercise of outstanding options. 43 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. 44 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 participated. 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 participated in these private placements participated in them on substantially the same terms and conditions as the other participants. 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, and Ronald O. Perelman and WP Nephros Partners, LLC, holders of more than 5% of our common stock, participated in the issuance of such notes, as set forth below. Number of Shares of Series C Convertible Preferred Stock Issued/Issuable Principal Amount Upon Conversion of Name of Convertible Note Convertible Note ---- ------------------- ---------------- Eric A. Rose, M.D. $ 240.00 240,000 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. On _____, 2002 these notes were converted into an aggregate of 250,000 shares of our series A convertible preferred stock. We also 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 a price of $1.00 per share, which are exercisable through April 2004. Each of Eric A. Rose, M.D., Donald G. Drapkin and Ronald O. Perelman participated 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.
Number of Shares of Series A Number of Shares of Series Convertible Preferred Stock A Convertible Preferred Principal Amount Issued Upon Conversion of Stock 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
In August 2002, we entered into the Lancer Subscription Agreement, which is described under the heading "Risk Factors -Risks Related to our Company. One of our lenders has defaulted on its agreement with us to provide funds and, pending 45 resolution, that default may have a material adverse effect on our ability to obtain additional financing that may be required for our future operating expenses and production and marketing activities." 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. 46 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 0.2253 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 at the closing of this offering into 2,284,431 shares of our common stock, immediately prior to the closing 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. In making our calculations for the following list of Principal Stockholders, we have excluded the Potential Lancer Share Issuance. See "Important assumptions in this Prospectus -- Certain Convertible Notes Have Not Been Converted." Accordingly, the list does not include any reference to Lancer Offshore, Inc., which may currently be the beneficial owner of 120,000 shares of our common stock issuable upon exercise of warrants to purchase shares of our common stock at an exercise price of $2.50 per share (subject to antidilution adjustments) and which currently holds a note in the principal amount of $1,500,000, which may be convertible under certain circumstances. The warrants and the convertible note were purchased pursuant to the terms of the Lancer Subscription Agreement, which also required Lancer Offshore, Inc. to provide the Company with an aggregate of $1,500,000 in additional funds, which it did not do. Accordingly, the Company currently considers Lancer Offshore, Inc. to be in default under the terms of the Lancer Subscription Agreement. Had Lancer provided the required funds in a timely manner, Lancer Offshore, Inc. would have been the beneficial owner of more than 5% of our common stock. Lancer Offshore, Inc.'s address is Kaya Flamboyan 9, Curacao, Netherlands Antilles. 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. 47
Percentage of Beneficial Ownership ---------------------------------- Number of After After Shares of Offering Offering 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) .......... 67,590 * * * Eric A. Rose, M.D. (2) ....... 458,674 13.7 Donald G. Drapkin (3) ....... 265,807 7.6 Lawrence J. Centella (4) ..... 631,591 * * * W. Townsend Ziebold, Jr. (5) . 0 * * * Ronald O. Perelman (6) ....... 292,552 8.4 Lindsay A. Rosenwald (7) .... 318,537 9.2 WP Nephros Partners, LLC (8) . 631,591 18.1
- --------- * 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 beneficially owned by Mr. Barta include 67,590 shares of our common stock issuable upon exercise of options to purchase shares of our common stock at an exercise price of $___ per share and excludes shares of our common stock issuable upon options exercisable only after the satisfaction of certain performance criteria. (2) Dr. Rose's address is c/o Nephros, Inc., 3960 Broadway New York, New York 10032. The shares beneficially owned by Dr. Rose include (i) 116,030 shares of our common stock issuable upon the automatic conversion of 515,000 shares of our series C convertible preferred stock upon the closing of this offering, (ii) 8,449 shares of our common stock issuable upon conversion of our series A convertible preferred stock which are themselves issuable upon exercise of warrants at an exercise price of $1.00 per share, and (iii) _____ shares of our common stock issuable upon exercise of options to purchase shares of our common stock at an exercise price of $___ per share. (3) Mr. Drapkin's address is c/o Nephros, Inc., 3960 Broadway New York, New York 10032. The shares beneficially owned by Mr. Drapkin include (i) 18,024 shares of our common stock issuable upon automatic conversion of 80,000 shares of our series A convertible preferred stock upon the closing of this offering, (ii) 25,008 shares of our common stock issuable upon automatic conversion of 111,100 shares of our series C convertible upon the closing of this offering, and (iii) 2,816 shares of our common stock issuable upon exercise of warrants to purchase shares of our series A convertible preferred stock at an exercise price of $1.00 per share. (4) Mr. Centella's address is c/o Nephros, Inc., 3960 Broadway New York, New York 10032. (5) Mr. Ziebold's address is c/o Nephros, Inc., 3960 Broadway New York, New York 10032. (6) Mr. Perelman's address is c/o Nephros, Inc., 3960 Broadway New York, New York 10032. The shares beneficially owned by Mr. Perelman include (i) 180,240 shares of our common stock issuable upon automatic conversion of 800,000 shares of our series A convertible preferred stock upon the closing of this offering, (ii) 2,816 shares of common stock issuable upon conversion of our series A convertible preferred stock, which are themselves issuable upon exercise of warrants at an exercise price of $1.00 per share and (iii) 109,496 shares of our common stock issuable upon conversion of 486,000 shares of our series C convertible preferred stock. (7) 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 beneficially owned by Mr. Rosenwald include (i) 400,000 shares of our common stock issuable upon automatic conversion of 800,000 shares of our series A convertible preferred stock upon the closing of this offering, and (ii) 40,554 shares of our common stock issuable upon automatic conversion of 180,500 shares of our series C convertible preferred stock upon the closing of this offering. (8) WP Nephros Partners, LLC's address is c/o Wasserstein & Co., L.P., 1301 Avenue of the Americas, 44th Floor, New York NY 10019. The shares beneficially owned by WP Nephros Partners, LLC include (i) 2,333,333 shares of our common stock issuable upon automatic conversion of 2,333,333 shares of our series B convertible preferred stock upon the closing of this offering, and (ii) 105,891 shares of our common stock issuable upon automatic conversion of 470,000 shares of our series C convertible preferred stock upon the closing of this offering. 48 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 1,263,643 shares of common stock outstanding and 9,470,883 shares of preferred stock outstanding, held by 44 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 0.2253 of one share of our common stock, as described below under the heading "-- Reverse Stock Split." Simultaneously with the closing 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 2,284,431 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 3,548,074 shares of common stock outstanding and no shares of preferred stock outstanding. After giving effect to the reverse stock split and the conversions and the sale of shares of our common stock pursuant to this offering, there will be a total of ________ 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 outstanding shares of our common stock are, and the shares offered in this offering will be, when issued and paid for, validly issued, duly authorized, fully paid and nonassesable. 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. 49 Although we currently have no plans to issue shares of blank check preferred stock, we may issue them in the future. Underwriter's Warrants Subject to the approval of the National Association of Securities Dealers, Inc., at the closing of this offering, we will sell to the underwriter or its designees, warrants to purchase up to an aggregate of _____ 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 120% 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 a former supplier of engineering services, we issued warrants to purchase 135,161 shares of our common stock at an exercise price of $13.32 per share, which are exercisable through June 2007. 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 (subject to antidilution adjustments), 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 "Risk Factors -Risks Related to our Company - One of our lenders has defaulted on its agreement with us to provide funds and, pending resolution, that default may have a material adverse effect on our ability to obtain additional financing that may be required for our future operating expenses and production and marketing activities." 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 0.2253 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 901,200 shares in the aggregate, for some of our current stockholders. 50 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, convertible notes and warrants. Pursuant to these registration rights agreements, we granted each of these holders (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 their respective shares of preferred stock, notes and warrants; and (2) piggy-back registration rights to include the shares of common stock underlying their respective shares of preferred stock, 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 1,288,915 shares in the aggregate, for some of our current stockholders. 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. 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 51 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 intend to apply 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. 52 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this offering, we will have __________ shares of common stock outstanding, assuming the underwriter's 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 __________ 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 ______ shares immediately after this offering, assuming no exercise of the underwriter's 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 901,200 shares in the aggregate, for some of our current stockholders. 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, convertible notes and warrants. Pursuant to these registration rights agreements, we granted each of these holders (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 their respective shares of preferred stock, notes and warrants; and (2) piggy-back registration rights to include the shares of common stock underlying their respective shares of preferred stock, 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 1,288,915 shares in the aggregate, for some of our current stockholders. 53 We have also entered into a registration rights agreement with our underwriter. Pursuant to this agreement, the holders of the underwriter's 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. 54 UNDERWRITING Subject to the terms and conditions of the underwriting agreement between us and GunnAllen Financial, Inc., the underwriter 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 underwriter, and the underwriter has agreed to purchase all ____ shares of our common stock offered. Underwriter Address Number of Shares ----------- ------- ---------------- GunnAllen Financial, Inc. 1715 North Westshore Blvd. Suite 700 Tampa, Florida 33607 The underwriter has advised us that it will offer the shares as set forth on the cover page of this prospectus, which includes the underwriting discount indicated there, and that it will initially allow concessions not in excess of $___ per share on sales to certain dealers. After the initial public offering, concessions to dealer terms may be changed by the underwriter. The underwriter has advised us that it does not intend to confirm sales of the shares to any account over which it exercises discretionary authority in an aggregate amount in excess of five (5%) percent of the total securities offered hereby. We have granted to the underwriter an option which expires 30 days after the date of this prospectus, exercisable as provided in the underwriting agreement, to purchase up to an additional ___ shares of our common stock at a net price of $__ per share which option may be exercised only for the purpose of covering over-allotments, if any. The underwriting agreement provides that we will reimburse the underwriter for its expenses on a non-accountable basis in the amount equal to 3% of the gross proceeds of this offering, of which $15,000 has been paid to date, $15,000 shall be paid upon completion and filing of the first draft of the registration statement to which this prospectus relates and the balance of which shall be paid on the closing of this offering. The underwriting agreement provides for reciprocal indemnification between us and the underwriter 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., our underwriter, 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., at the closing of this offering, we will sell to the underwriter or its designees at an aggregate purchase price of $100, warrants to purchase up to an aggregate of _____ 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 120% 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 underwriter and members of the selling group and/or their officers or partners. 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 underwriter's warrants may be deemed additional underwriting compensation. The exercise of the underwriter's over-allotment option will not result in an increase in the number of shares of common stock underlying the underwriter's warrants or in the granting of any additional warrants to the underwriter. 55 All of our officers, directors and one percent stockholders have agreed not to offer, pledge, sell, contract to sell, grant any option for the sale of, or otherwise dispose of, directly or indirectly, any of our securities they currently hold without the prior written consent of the underwriter, for a period of 365 days after the effective date of the registration statement of which this prospectus forms a part. The underwriter 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 underwriter 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 underwriter 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 underwriter 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 underwriter's over-allotment option to purchase additional shares in the offering. The underwriter may close out any covered short position by either exercising its over-allotment option or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriter will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which it may purchase shares through the over-allotment option. "Naked" short sales are sales in excess of the over-allotment option. The underwriter 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 underwriter is 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 underwriter's 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 public offering price of our common stock has been determined by negotiation between us and the underwriter. 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. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is _________. Its address is __________. 56 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 and at the SEC's Regional Offices located at 233 Broadway, New York, New York 10279, and 500 West Madison Street, Chicago, Illinois 60601. 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. 57 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. /S/ GRANT THORNTON LLP 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 June 30, June 30, December 31, ASSETS 2002 2002 2001 ----------- ------------ ------------ (unaudited) (unaudited) Current assets Cash and cash equivalents $ 59,526 $ 277,526 Prepaid expenses and other current assets 1,617 2,861 ------------ ------------ Total current assets 61,143 280,387 Property and equipment, at cost less accumulated depreciation of $314,582 and $285,573 in 2002 and 2001, respectively 76,223 102,783 Other assets 10,272 11,454 ------------ ------------ Total assets $ 147,638 $ 394,624 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities Accounts payable $ 692,960 $ 1,891,295 Accrued expenses 60,668 40,930 Loan from related party 110,000 105,000 Short-term convertible note payable, net of unamortized discount of $10,000 240,000 -- ------------ ------------ Total current liabilities 1,103,628 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 June 30, 2002 - liquidation preference of $2,295,666 and $2,227,666 in 2002 and 2001, respectively; none outstanding on a pro forma basis -- 2,259,000 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 June 30, 2002 - liquidation preference of $3,471,550 and $3,369,550 in 2002 and 2001, respectively; none outstanding on a pro forma basis -- 3,441,550 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 December 31, 2001 and June 30, 2002 - 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; 1,263,643 shares issued and outstanding at December 31, 2001 and June 30, 2002; 3,548,074 outstanding on a pro forma basis $ 3,548 1,264 1,264 Additional paid-in capital 11,208,502 5,506,236 5,066,236 Accumulated deficit from inception (12,168,040) (12,168,040) (12,234,651) ----------- ------------ ------------ Total stockholders' equity (deficit) (955,990) (6,656,540) (7,163,151) ----------- ------------ ------------ Total liabilities and stockholders' equity (deficit) $ 147,638 $ 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 Six months ended June 30, Year ended December 31, to June 30, ---------------------------- ---------------------------- 2002 2002 2001 2001 2000 ------------ ------------ ------------ ------------ ------------ (unaudited) (unaudited) (unaudited) Revenue - other $ 300,000 $ -- $ -- $ 300,000 $ -- Operating expenses Research and development 9,274,244 276,215 457,298 737,858 4,781,708 General and administrative 3,553,806 291,148 424,432 652,828 854,315 ------------ ------------ ------------ ------------ ------------ Total operating expenses 12,828,050 567,363 881,730 1,390,686 5,636,023 ------------ ------------ ------------ ------------ ------------ Loss from operations (12,528,050) (567,363) (881,730) (1,090,686) (5,636,023) ------------ ------------ ------------ ------------ ------------ Other income, net Interest expense (20,000) (20,000) -- -- -- Interest income 173,097 181 4,308 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 ------------ ------------ ------------ ------------ ------------ 1,023,010 813,974 4,308 5,497 53,440 ------------ ------------ ------------ ------------ ------------ NET INCOME (LOSS) (11,505,040) 246,611 (877,422) (1,085,189) (5,582,583) Cumulative preferred dividends and accretion (663,000) (180,000) (143,000) (314,000) (169,000) ------------ ------------ ------------ ------------ ------------ Net income (loss) attributable to common stockholders $(12,168,040) $ 66,611 $ (1,020,422) $ (1,399,189) $ (5,751,583) ============ ============ ============ ============ ============ Net income (loss) per share - Basic $ .05 $ (.81) $ (1.11) $ (4.63) ============ ============ ============ ============ Diluted $ .03 $ (.81) $ (1.11) $ (4.63) ============ ============ ============ ============ Weighted-average shares outstanding - Basic 1,263,643 1,261,052 1,262,404 1,241,116 ============ ============ ============ ============ Diluted 2,568,713 1,261,052 1,262,404 1,241,116 ============ ============ ============ ============ Pro forma per share data (unaudited): Pro forma net income (loss) per share Basic $ 0.07 $ (0.27) $ (0.33) $ (2.01) ============ ============ ============ ============ Diluted $ 0.06 $ (0.27) $ (0.33) $ (2.01) ============ ============ ============ ============ Pro forma weighted-average shares outstanding Basic 3,507,284 3,221,982 3,315,130 2,783,929 ============ ============ ============ ============ Diluted 3,911,281 3,221,982 3,315,130 2,783,929 ============ ============ ============ ============
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 Accumulated ------------------- ------------------- subscription Paid-in loss from Shares Amount Shares Amount receivable capital inception Total --------- ------- --------- ------- ------------ ----------- ------------ ----------- Issuance of common stock upon inception -- $ -- 1,238,976 $ 1,239 $ (5,500) $ 4,261 $ -- $ -- Issuance of preferred stock 4,000,000 4,000 -- -- (2,500,000) 4,996,000 -- 2,500,000 Net loss -- -- -- -- -- -- (453,001) (453,001) --------- ------- --------- ------- ------------ ----------- ------------ ----------- Balance, December 31, 1997 4,000,000 4,000 1,238,976 1,239 (2,505,500) 5,000,261 (453,001) 2,046,999 Net loss -- -- -- -- -- -- (1,146,061) (1,146,061) --------- ------- --------- ------- ------------ ----------- ------------ ----------- Balance, December 31, 1998 4,00,0000 4,000 1,238,976 1,239 (2,505,500) 5,000,261 (1,599,062) 900,938 Noncash stock-based compensation -- -- 2,140 2 -- 998 -- 1,000 Collection of stock subscription receivable -- -- -- -- 2,505,500 -- -- 2,505,500 Net loss -- -- -- -- -- (3,484,817) (3,484,817) --------- ------- --------- ------- ------------ ----------- ------------ ----------- Balance, December 31, 1999 4,000,000 4,000 1,241,116 1,241 -- 5,001,259 (5,083,879) (77,379) Noncash stock-based compensation -- -- -- -- -- 5,000 -- 5,000 Cumulative preferred dividend and accretion -- -- -- -- -- -- (169,000) (169,000) Net loss -- -- -- -- -- -- (5,582,583) (5,582,583) --------- ------- --------- ------- ------------ ----------- ------------ ----------- Balance, December 31, 2000 4,000,000 4,000 1,241,116 1,241 -- 5,006,259 (10,835,462) (5,823,962) Noncash stock-based compensation -- -- 22,527 23 -- 59,977 -- 60,000 Cumulative preferred dividend and accretion -- -- -- -- -- -- (314,000) (314,000) Net loss -- -- -- -- -- (1,085,189) (1,085,189) --------- ------- --------- ------- ------------ ----------- ------------ ----------- Balance, December 31, 2001 4,000,000 4,000 1,263,643 1,264 -- 5,066,236 (12,234,651) (7,163,151) Issuance of warrants -- -- -- -- -- 430,000 -- 430,000 Noncash stock-based compensation -- -- -- -- -- 10,000 -- 10,000 Cumulative preferred dividend and accretion -- -- -- -- -- -- (180,000) (180,000) Net income -- -- -- -- -- -- 246,611 246,611 --------- ------- --------- ------- ------------ ----------- ------------ ----------- Balance, June 30, 2002 (unaudited) 4,000,000 $ 4,000 1,263,643 $ 1,264 $ -- $ 5,506,236 $(12,168,040) $(6,656,540) ========= ======= ========= ======= ============ =========== ============ ===========
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 Six months ended June 30, Year ended December 31, to June 30, ---------------------------- ---------------------------- 2002 2002 2001 2001 2000 ------------ ------------ ------------ ------------ ------------ (unaudited) (unaudited) (unaudited) Cash flows from operating activities Net income (loss) $(11,505,040) $ 246,611 $ (877,422) $ (1,085,189) $ (5,582,583) Adjustments to reconcile net income (loss) to net cash used in operating activities Depreciation and amortization 344,589 29,009 35,232 70,466 86,545 Forgiveness of indebtedness (833,793) (833,793) -- -- -- Noncash stock-based compensation 76,000 10,000 55,000 60,000 5,000 Amortization of debt discount 20,000 20,000 -- -- -- Gain on disposal of assets (30,007) -- -- -- (30,007) (Increase) decrease in operating assets Prepaid expenses (1,617) 1,244 3,140 4,094 (3,808) Other assets (10,272) 1,182 568 1,690 2,173 Increase (decrease) in operating liabilities Accounts payable and accrued expenses 1,987,421 55,196 17,827 27,351 1,320,949 ------------ ------------ ------------ ------------ ------------ Net cash used in operating activities (9,952,719) (470,551) (765,655) (921,588) (4,201,731) ------------ ------------ ------------ ------------ ------------ Cash flows from investing activities Purchase of property and equipment (474,157) (2,449) (8,807) (8,807) (105,882) Proceeds from disposal of property and equipment 83,352 -- -- -- 83,352 ------------ ------------ ------------ ------------ ------------ Net cash used in investing activities (390,805) (2,449) (8,807) (8,807) (22,530) ------------ ------------ ------------ ------------ ------------
F-6 Nephros, Inc. (A Development Stage Company) STATEMENTS OF CASH FLOWS (continued)
Period from inception Six months ended June 30, Year ended December 31, to June 30, ---------------------------- --------------------------- 2002 2002 2001 2001 2000 ------------ ------------ ------------ ------------ ------------ (unaudited) (unaudited) (unaudited) Cash flows from financing activities Proceeds from issuance of preferred stock, net $ 10,037,550 $ -- $ 790,000 $ 940,000 $ 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 note payable 250,000 250,000 -- -- -- ------------ ------------ ------------ ------------ ------------ Net cash provided by financing activities 10,403,050 255,000 790,000 1,045,000 4,097,550 ------------ ------------ ------------ ------------ ------------ Net increase (decrease) in cash 59,526 (218,000) 15,538 114,605 (126,711) Cash, beginning of period -- 277,526 162,921 162,921 289,632 ------------ ------------ ------------ ------------ ------------ Cash, end of period $ 59,526 $ 59,526 $ 178,459 $ 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 -- -- -- Issuance of warrants in connection with issuance of short-term convertible notes 30,000 30,000 -- -- -- Cumulative preferred dividend and accretion 663,000 180,000 143,000 314,000 169,000
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 June 30, 2002 and for the six months ended June 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 OLpur(TM) MD190, a proprietary dialyzer, OLpur(TM) H(2)H(TM), an add-on module designed for use with existing hemodialysis machines and controlled by advanced proprietary software with a simplified user interface, and the OLpur(TM) NS2000 system, a stand-alone hemodiafiltration machine and associated proprietary 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 proprietary 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 (Note 9), will be sufficient to fund the Company's operations into the first quarter of 2003. 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 June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 1 (continued) Pro Forma Presentation The unaudited pro forma presentation at June 30, 2002 gives effect to the mandatory conversion of all of the convertible preferred stock 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 June 30, 2002 and for the six months ended June 30, 2002 and 2001 and for the period from inception to June 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 June 30, 2002 and the results of its operations and its cash flows for the six-month periods ended June 30, 2002 and 2001 and for the period from inception to June 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 six-month period ended June 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 June 30, 2002 and for the six months ended June 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: June 30, December 31, 2002 2001 ------------ ------------ (unaudited) Research equipment $ 337,447 $ 334,998 Computer equipment 53,358 53,358 ------------ ------------ 390,805 388,356 Less accumulated depreciation (314,582) (285,573) ------------ ------------ $ 76,223 $ 102,783 ============ ============ Depreciation expense for the six months ended June 30, 2002 and 2001 and for the years ended December 31, 2001 and 2000 was $29,009, $35,232, $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 June 30, 2002 and for the six months ended June 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 income (loss) per common share amounts ("basic EPS") were computed by dividing net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding and excluding any potential dilution. Net income (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 1,412,632, 2,562,064, 2,566,344 and 2,384,102 have been excluded from the computation of diluted EPS for the six months ended June 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 June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 1 (continued) Pro forma (unaudited) - Pro forma net income (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:
Six Months ended June 30, Year Ended December 31, 2002 2001 2001 2000 ---- ---- ---- ---- Numerator: Net income (loss) attributable to common stockholders $ 66,611 $(1,020,422) $(1,399,189) $(5,751,583) Preferred dividend and accretion 180,000 143,000 314,000 169,000 ---------- ----------- ----------- ----------- Pro forma net income (loss) $ 246,611 $ (877,422) $(1,085,189) $(5,582,583) ========== =========== =========== =========== Denominator: Weighted average basic shares outstanding 1,263,643 1,261,052 1,262,404 1,241,116 Assumed conversion of preferred stock and preferred dividend 2,243,641 1,960,930 2,052,726 1,542,813 ---------- ----------- ----------- ----------- Pro forma weighted average basic shares outstanding 3,507,284 3,221,982 3,315,130 2,783,929 ========== =========== =========== ===========
Diluted EPS - The following table reconciles the numerator and denominator for the calculation of the diluted EPS:
Six months ended June 30, 2002 Historical Proforma ---------- -------- (unaudited) (unaudited) Numerator: Net income attributable to common stockholders $ 66,611 $ 246,111 Preferred dividend and accretion -- -- ----------- ----------- $ 66,611 $ 246,111 =========== =========== Denominator: Weighted average basic shares outstanding 1,263,643 3,507,284 Assumed Convention of preferred stock 901,074 -- Incremental shares for assumed exercised of options 403,996 403,996 ----------- ----------- 2,568,713 3,911,281 =========== ===========
F-12 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 income (loss), which were not already in net income (loss) for the years ended December 31, 2001 and 2000 and for the six months ended June 30, 2002 and 2001. Accordingly, the Company's comprehensive income (loss) is the same as its net income (loss) for all periods presented. 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. F-13 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 1 (continued) 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. Cumulative preferred dividends on Series B preferred stock were $68,000, $64,000, $129,000 and $92,000 for the six months ended June 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 $4.44 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 $102,000, $69,000, $165,000 and $67,000 for the six months ended June 30, 2002 and 2001, and for the years ended December 31, 2001 and 2000, respectively. F-14 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 2 (continued) 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 $10,000, $10,000, $20,000 and $10,000 for the six months ended June 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 $5.55 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 1,013,708 shares of common stock have been authorized for issuance upon exercise of options granted by the Company. As of December 31, 2001, 419,900 options have been issued to employees. The options expire December 31, 2009, and vest as follows: - 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, 12,953 options have been issued to nonemployees. Such options expire December 31, 2006 and vest over four years. F-15 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 4 (continued) 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 462,363 .40 Options exercised -- -- Options canceled -- -- --------- --------- Outstanding at December 31, 2000 462,363 .40 Options granted -- -- Options exercised -- -- Options canceled (29,510) .40 --------- --------- Outstanding at December 31, 2001 432,853 $ .40 ========= ========= Exercisable at December 31, 2001 171,198 $ .40 ========= ========= At December 31, 2001, there were 580,855 shares available for future grant under the Plan. F-16 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 4 (continued) 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 June 30, 2002 is approximately $1,000,000. Options issued to non-employees were valued using the Black-Scholes options pricing model. The Company has recorded compensation in the amounts of $10,000, $5,000, $10,000 and $5,000 for the periods ended June 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 --------------- -------------- ------------ ----------- -------------- --------- $0.40-2.20 432,853 7.9 $.40 171,198 $.40
F-17 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 4 (continued) 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) $ (4.63) Pro forma (1.13) (4.66) 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 June 2001, the Company entered into a noncancelable operating lease for the rental of its office and research and development facility, which expires in June 2002. Rent expense for the six months ended June 30, 2002 and 2001 and for the years ended December 31, 2001 and 2000 totaled approximately $37,000, $36,000, $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. F-18 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 6 (continued) 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 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. F-19 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) 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-20 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 8 - RELATED PARTY TRANSACTION 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 June 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 Company is currently seeking the conversion of such Notes. In connection with such financing, the Company will also issue warrants to purchase 125,000 shares of its 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 the price of $1.00 per share. The warrants will be exercisable at any time through April 2004. The warrants were valued at $30,000 using the Black-Scholes model and are presented as a debt discount, which is being amortized over the term of the debt (four months). 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 135,161 shares of common stock of the Company for an exercise price of $13.32 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. F-21 Nephros, Inc. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS (continued) (Information as of June 30, 2002 and for the six months ended June 30, 2002 and 2001 is unaudited) NOTE 9 (continued) 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. The first installment of $1,500,000 was received in August 2002, with the remaining $1,500,000 to be received by October 2002. As of the date of these financial statements, the lender failed to fund the remaining $1,500,000 and is in default under the Subscription Agreement. The Company intends to pursue vigorously all available legal remedies against the lender, including seeking rescission of the securities issued 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 notes were 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). The Subscription Agreement also 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 0.2253 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. F-22 [INSIDE BACK COVER PAGE - DESCRIPTION OF ARTWORK] The middle of the inside back cover contains a computer-generated, three-dimensional, color picture of the OLpur(TM) NS2000, our standalone hemodiafiltration machine. 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. ___________SHARES NEPHROS, INC. COMMON STOCK PROSPECTUS _________, 2002 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) .......................................... $1,587 NASD filing fee......................................................... $2,225 Accounting fees and expenses ........................................... American Stock Exchange LLC listing fee................................. $5,000 Legal fees and expenses................................................. Printing and engraving expenses......................................... Blue Sky fees and expenses.............................................. Directors and officers' insurance....................................... Transfer agent and registrar fees....................................... Miscellaneous expenses.................................................. 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 not 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 9,500 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 WP Nephros Partners, LLC, a holder of more than 5% of Common Stock, 2,333,333 shares of its Series B Convertible Preferred Stock, par value $.001 per share, for an aggregate purchase price of $2,000,000. 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 certain of its 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 certain of its existing and new investors. In April 2002, the Registrant issued convertible promissory notes in the principal amount of $250,000 to certain of its existing and new investors. In connection with this issuance, the Registrant issued 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 a former supplier of engineering services, the Registrant issued warrants to purchase 135,161 shares of Common Stock at an exercise price of $13.32 per share, which warrants expire in June 2007. In August 2002, the Registrant issued a convertible note to Lancer Offshore, Inc., in the principal amount of $1,500,000. 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 240,000 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 principal amount. The Registrant intends to pursue vigorously all available legal remedies against Lancer Offshore, Inc., including seeking rescission of the securities issued 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. 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 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. II-2 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 Registrant's 2000 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 Intentionally Omitted. 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). 24.1 Power of Attorney (included as part of the signature page hereto). - -------------------- * 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 arising after the effective date of the Registration Statement(or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement; iii. To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement; provided, however, that clauses (i) and (ii) do not apply if the Registration Statement is on Form S-3, Form S-8 or Form F-3, and the information required to be included in a post-effective amendment by such II-3 clauses is contained in periodic reports file 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 October 22, 2002. By: /s/ Norman J. Barta ------------------------------------- Norman J. Barta President, Chief Executive Officer and Chief Financial Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Norman J. Barta his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to this registration statement, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully for all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. 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 Executive October 22, 2002 - ------------------------ Officer, Chief Financial Officer Norman J. Barta and Director /s/ Eric A. Rose, M.D. Chairman of the Board of October 22, 2002 - ------------------------ Directors and Director Eric A. Rose, M.D. /s/ Lawrence J. Centella Director October 22, 2002 - ------------------------ Lawrence J. Centella /s/ Donald G. Drapkin Director October 22, 2002 - ------------------------ Donald G. Drapkin Director - ---------------------------- W. Townsend Ziebold, Jr.
II-5 EX-10 4 kl10022_ex10-1.txt EXHIBIT 10.1 Exhibit 10.1 Nephros 2000 Equity Incentive Plan SECTION 1 PURPOSE The purpose of the Nephros 2000 Equity Incentive Plan is to provide a means whereby Nephros, Inc., a Delaware corporation (the "Corporation"), may attract able persons to remain in or to enter the employ of the Corporation, a Parent Corporation or a Subsidiary and to provide a means whereby those employees, directors, officers, and other individuals or entities upon whom the responsibilities of the successful administration, management, planning, and/or organization of the Corporation may rest, and whose present and potential contributions to the welfare of the Corporation, a Parent Corporation or a Subsidiary are of importance, can acquire and maintain stock ownership, thereby strengthening their concern for the long-term welfare of the Corporation. A further purpose of the Plan is to provide such employees and individuals or entities with additional incentive and reward opportunities designed to enhance the profitable growth of the Corporation over the long term. Accordingly, the Plan provides for granting Common Stock, Incentive Stock Options, options which do not constitute Incentive Stock Options, or any combination of the foregoing, as is best suited to the circumstances of the particular employees and individuals or entities as provided herein. SECTION 2 DEFINITIONS The following definitions shall be applicable during the term of the Plan unless specifically modified by any paragraph: (a) Award means, individually or collectively, any Option granted pursuant to the Plan. (b) Board means the board of directors of the Corporation. (c) Cause means, for the purposes of employment, any of the following: (i) the gross neglect or willful failure or refusal to perform duties (other than as a result of total or partial incapacity due to physical or mental illness); (ii) engaging in misconduct which is materially injurious to the Company, monetarily or otherwise; (iii) perpetration of an intentional and knowing fraud against or affecting the Company or any customer, client, agent, or employee thereof; or (iv) conviction (including conviction on a nolo contendere plea) of a felony or any crime involving, in the good faith judgment of the Company, fraud, dishonesty or moral turpitude. (d) Change of Control Value means the amount determined in Clause (i), (ii) or (iii), whichever is applicable, as follows: (i) the per share price offered to stockholders of the Corporation in any merger, consolidation, sale or assets or dissolution transaction, (ii) the price per share offered to stockholders of the corporation in any tender offer or exchange offer whereby a Corporate Change takes place or (iii) if a Corporate Change A-1 occurs other than as described in Clause (i) or Clause (ii), the fair market value per share determined by the Board as of the date determined by the Board to be the date of cancellation and surrender of an Option. If the consideration offered to stockholders of the Corporation in any transaction described in this Paragraph or Paragraphs (d) and (e) of Section 8 consists of anything other than cash, the Board shall determine the fair cash equivalent of the portion of the consideration offered which is other than cash. (e) Code means the Internal Revenue Code of 1986, as amended. Reference in the Plan to any Section of the Code shall be deemed to include any amendments or successor provisions to such Section and any regulations under such Section. (f) Committee means the committee, consisting of three officers of the Company or members of the Board of the Company, established by the Board to administer the Plan; provided, however, that one member of the Committee must be appointed by WP Nephros Partners, LLC, or any successor entity. (g) Common Stock means the common stock of the Corporation. (h) Corporation means Nephros, Inc. (i) Corporate Change means one of the following events: (i) the merger, consolidation or other reorganization of the Corporation in which the outstanding Common Stock is converted into or exchanged for a different class of securities of the Corporation, a class of securities of any other issuer (except a Subsidiary or Parent Corporation), cash or other property other than (a) a merger, consolidation or reorganization of the Corporation which would result in the voting stock of the Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of the Corporation, at least sixty percent (60%) of the combined voting power of the voting stock of the Corporation or such surviving entity outstanding immediately after such merger, consolidation or reorganization of the Corporation, or (b) merger, consolidation or reorganization of the Corporation effected to implement a recapitalization of the Corporation (or similar transaction) in which no person acquires more than forty-nine percent (49%) of the combined voting power of the Corporation's then outstanding stock; (ii) the sale, lease or exchange of all or substantially all of the assets of the Corporation to any other corporation or entity (except a Subsidiary or Parent Corporation); (iii) the adoption by the stockholders of the Corporation of a plan of liquidation and dissolution; (iv) the acquisition (other than acquisition pursuant to any other clause of this definition) by any person or entity, including without limitation a "group" as contemplated by Section 13(d)(3) of the Exchange Act, of beneficial ownership, as contemplated by such Section, of more than fifty percent (50%) (based on voting power) of the Corporation's outstanding capital stock or acquisition by a person or entity who currently has beneficial ownership which increases such person's or entity's beneficial ownership to fifty percent (50%) or more (based on voting power) of the Corporation's outstanding capital stock; or (v) as a result of or in connection with a contested election of directors, the persons who were directors of the Corporation before A-2 such election shall cease to constitute a majority of the Board. Notwithstanding the provisions of clause (iv) above, a Corporate Change shall not be considered to have occurred upon the acquisition (other than acquisition pursuant to any other clause of the preceding sentence) by any person or entity, including without limitation a "group" as contemplated by Section 13(d)(3) of the Exchange Act, of beneficial ownership, as contemplated by such Section, of more than twenty-five percent (25%) (based on voting power) of the Corporation's outstanding capital stock or the requisite percentage to increase their ownership to fifty percent (50%) resulting from a public offering of securities of the Corporation under the Securities Act of 1933, as amended. (j) Exchange Act means the Securities Exchange Act of 1934, as amended. (k) Fair Market Value means, as of any specified date, the closing price of the Common Stock on the NASDAQ (or, if the Common Stock is not listed on such exchange, such other national securities exchange on which the Common Stock is then listed) on that date, or if no prices are reported on that date, on the last preceding date on which such prices of the Common Stock are so reported. If the Common Stock is not then listed on any national securities exchange but is traded over the counter at the time determination of its Fair Market Value is required to be made hereunder, its Fair Market Value shall be deemed to be equal to the average between the reported high and low sales prices of Common Stock on the most recent date on which Common Stock was publicly traded. If the Common Stock is not publicly traded at the time a determination of its value is required to be made hereunder, the determination of its Fair Market Value shall be made by the Board in good-faith as required by Section 422(c)(1) of the Code and shall be based on the advice of an independent investment banker or appraiser recognized to be expert in making such valuation). (l) Good Reason means, for the purposes of employment, any of the following: (i) any material adverse alteration in the Optionee's title, position, status, duties or responsibilities with the Corporation; (ii) any reduction in the Optionee's annual base salary or annual or long term aggregate compensation and benefits; or (iii) any relocation of the Corporation's principal executive offices outside of the New York metropolitan area or requiring the Optionee to travel on business in unreasonable amounts in relation to the Optionee's duties with the Corporation. (m) Grant means individually or collectively, any Common Stock granted pursuant to the Plan. (n) Grantee means an employee, director, officer, other individual or entity who has been granted Common Stock pursuant to the Plan. (o) Holder means an individual or entity who has been granted an Award. (p) Incentive Stock Option means an Option intended to qualify and designated as an "incentive stock option" within the meaning of Section 422(b) of the Code. (q) Non-Qualified Stock Option means an Option not designated as an Incentive Stock Option. A-3 (r) Option means an Award granted under Section 7 of the Plan and includes both Incentive Stock Options to purchase Common Stock and Options which do not constitute Incentive Stock Options to purchase Common Stock. (s) Option Agreement means a written agreement between the Corporation and an employee with respect to an Option. (t) Optionee means an employee, director, officer, entity or individual who has been granted an Option. (u) Parent Corporation shall have the meaning set forth in Section 424(e) of the Code. (v) Plan means the Nephros 2000 Equity Incentive Plan. (w) Rule 16b-3 means Rule 16b-3 of the General Rules and Regulations of the Securities and Exchange Commission under the Exchange Act, as such rule is currently in effect or as hereafter modified or amended. (x) Subsidiary means a company (whether a corporation, partnership, joint venture or other form of entity) in which the Corporation, or a corporation in which the Corporation owns a majority of the shares of capital stock, directly or indirectly, owns an equity interest of fifty percent (50%) or more, except solely with respect to the issuance of Incentive Stock Options the term "Subsidiary" shall have the same meaning as the term "subsidiary corporation" as defined in Section 424(f) of the Code. SECTION 3 EFFECTIVE DATE AND DURATION OF THE PLAN The Plan shall be effective as of the date of its adoption by the Board. Following such adoption, the Board shall submit the Plan to the shareholders for approval in order to remain in compliance with requirements for Incentive Stock Option plans under the Code. If shareholders fail to approve the plan, all Awards of Incentive Stock Options hereunder shall then be deemed to be Awards of Non-Qualified Stock Options. Subject to the provisions of Section 9, the Plan shall remain in effect for ten years from the date of its adoption by the Board or, if earlier, until terminated by the Board. SECTION 4 ADMINISTRATION (a) Administration of Plan by Board. The Plan shall be administered by the Board in compliance with Rule 16b-3. Members of the Board shall abstain from participating in and deciding matters which directly affect their individual ownership interests under the Plan. A-4 (b) Powers. Subject to the terms of the Plan, the Board shall have sole authority, in its discretion, to determine which employees, officers, directors, individuals or entities shall receive an Award or Grant, the time or times when such Award or Grant shall be made, whether Common Stock, an Incentive Stock Option or non-qualified Option shall be granted and the number of shares of Common Stock which may be issued under each Option. In making such determinations, the Board may take into account the nature of the services rendered by these individuals, their present and potential contribution to the success of the Corporation, a Parent Corporation or a Subsidiary, and such other factors as the Board in its discretion shall deem relevant. (c) Additional Powers. The Board shall have such additional powers as are delegated to it by the other provisions of the Plan. Subject to the express provisions of the Plan, the Board is authorized to prescribe such rules and regulations relating to the Plan as it may deem advisable to carry out the Plan, and to determine the terms, restrictions and provisions of each Award or Grant, including such terms, restrictions and provisions as shall be requisite in the judgment of the Board to cause designated Options to qualify as Incentive Stock Options, and to make all other determinations necessary or advisable for administering the Plan. The Board may correct any defect or supply any omission or reconcile any inconsistency in any agreement relating to an Award or Grant in the manner and to the extent it shall deem expedient to carry it into effect. (d) Compliance With Code ss.162(m). In the event the Corporation, a Parent Corporation or a Subsidiary becomes a "publicly-held corporation" as defined in Section 162(m)(2) of the Code, the Corporation may establish a committee of outside directors meeting the requirements of Code ss. 162(m) to (i) approve the grant of Options which might reasonably be anticipated to result in the payment of employee remuneration that would otherwise exceed the limit on employee remuneration deductible for income tax purposes by the Corporation pursuant to Codess.162(m) and (ii) administer the Plan. In such event, the powers reserved to the Board in the Plan shall be exercised by such compensation committee. In addition, Options under the Plan shall be granted upon satisfaction of the conditions to such grants provided pursuant to Codess.162(m) and any Treasury Regulations promulgated thereunder. SECTION 5 GRANT OF OPTIONS AND STOCK SUBJECT TO THE PLAN (a) Award Limits. The Committee may from time to time grant Awards and/or make Grants to one or more employees, directors, officers, individuals or entities determined by him or her to be eligible for participation in the Plan in accordance with the provisions of Section 6 of the Plan. The aggregate number of shares of Common Stock that may be issued under the Plan shall not exceed 4,500,000 shares. The aggregate number of shares of Common Stock that may be issued to any Holder and/or granted to any Grantee under the Plan shall not exceed twenty percent (20%) of the aggregate number of shares referred to in the preceding sentence. Any of such shares which remain unissued and which are not subject to outstanding Options and/or Grants at the termination of the Plan shall cease to be subject to the Plan but, until termination of the Plan, the A-5 Corporation shall at all times reserve a sufficient number of shares to meet the requirements of the Plan. Shares shall be deemed to have been issued under the Plan only to the extent actually issued and delivered pursuant to an Award or Grant. To the extent that an Award or Grant lapses or the rights of its Holder or Grantee terminate, any shares of Common Stock subject to such Award or Grant shall again be available for the grant of an Award or making of a Grant. The aggregate number of shares which may be issued under the Plan shall be subject to adjustment in the same manner as provided in Section 8 of the Plan with respect to shares of Common Stock subject to Options then outstanding. Separate stock certificates shall be issued by the Corporation for those shares acquired pursuant to a Grant, the exercise of an Incentive Stock Option and for those shares acquired pursuant to the exercise of any Option which does not constitute an Incentive Stock Option. (b) Stock Offered. The stock to be offered pursuant to an Award or Grant may be authorized but unissued Common Stock or Common Stock previously issued and outstanding and reacquired by the Corporation. SECTION 6 ELIGIBILITY An Incentive Stock Option Award made pursuant to the Plan may be granted only to an individual who, at the time of grant, is an employee of the Corporation, a Parent Corporation or a Subsidiary. An Award of an Option which is not an Incentive Stock Option or a Grant of Common Stock may be made to an individual who, at the time of Award or Grant, is an employee of the Corporation, a Parent Corporation or a Subsidiary, or to an individual who has been identified by the Board or the Committee to receive an Award or Grant due to the individual's contribution or service to the Corporation, including members of the Board of Directors of the Corporation, a Parent Corporation or a Subsidiary. An Award or Grant made pursuant to the Plan may be made on more than one occasion to the same person, and such Award or Grant may include a Common Stock Grant, an Incentive Stock Option, an Option which is not an Incentive Stock Option, or any combination thereof. Each Award or Grant shall be evidenced by a written instrument duly executed by or on behalf of the Corporation. SECTION 7 STOCK OPTIONS/GRANTS (a) Stock Option Agreement. Each Option shall be evidenced by an Option Agreement between the Corporation and the Optionee which shall contain such terms and conditions as may be approved by the Board and agreed upon by the Holder. The terms and conditions of the respective Option Agreements need not be identical. Each Option Agreement shall designate the Option as an Incentive Stock Option (in the event its terms, and the individual to whom it is granted, satisfy the requirements for Incentive Stock Options under the Code) or a Non-Qualified Stock Option, specify the effect of termination of employment, total and permanent disability, retirement or death on the exercisability of the Option. Under each Option Agreement, a Holder shall have the right A-6 to appoint any individual or legal entity in writing as his or her beneficiary under the Plan in the event of his death. Such designation may be revoked in writing by the Holder at any time and a new beneficiary may be appointed in writing on the form provided by the Board for such purpose. In the absence of such appointment, the beneficiary shall be the legal representative of the Holder's estate. (b) Option Period. The term of each Option shall be as specified by the Board at the date of grant and shall be stated in the Option Agreement; provided, however, that an Incentive Stock Option may not be exercised more than one hundred twenty (120) months from the date it is granted. (c) Limitations on Exercise of Option. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Board and as shall be permissible under the terms of the Plan, which shall be specified in the Option Agreement evidencing the Option. (d) Special Limitations on Incentive Stock Options. To the extent that the aggregate Fair Market Value (determined at the time the respective Incentive Stock Option is granted) of Common Stock with respect to which Incentive Stock Options are exercisable for the first time by an individual during any calendar year under all incentive stock option plans of the Corporation (and any Parent Corporation or Subsidiary) exceeds One Hundred Thousand Dollars ($100,000) (within the meaning of Section 422 of the Code), such excess Incentive Stock Options shall be treated as Options which do not constitute Incentive Stock Options. The Board shall determine, in accordance with applicable provisions of the Code, Treasury Regulations and other administrative pronouncements, which of an Optionee's Incentive Stock Options will not constitute Incentive Stock Options because of such limitation and shall notify the Optionee of such determination as soon as practicable after such determination. No Incentive Stock Option shall be granted to an individual if, at the time the Option is granted, such individual owns stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Corporation or of its Parent Corporation or a Subsidiary, within the meaning of Section 422(b)(6) of the Code, unless (i) at the time such Option is granted the Option price is at least one hundred ten percent (110%) of the Fair Market Value of the Common Stock subject to the Option and (ii) such Option by its terms is not exercisable after the expiration of five years from the date of grant. (e) Exercise Price. The purchase price of Common Stock issued under each Option shall be determined by the Board and shall be stated in the Option Agreement, but such purchase price shall, in the case of Incentive Stock Options, not be less than the Fair Market Value of Common Stock subject to the Option on the date the Option is granted, except that the price of any Common Stock purchased pursuant to any Incentive Stock Option shall be at least one hundred ten percent (110%) of the fair value in the case of any person or entity who owns stock comprising more than ten percent (10%) of the total combined voting power of all classes of stock of the Corporation or its Parent Corporation or Subsidiary. Fair value in the case of options that do not constitute Incentive Stock Options shall be defined in accordance with applicable Delaware law. A-7 (f) Options and Rights in Substitution for Stock Options Made by Other Corporations. Options may be granted under the Plan from time to time in substitution for stock options held by employees of corporations who become, or who became prior to the effective date of the Plan, employees of the Corporation, of any Parent Corporation or of any Subsidiary as a result of a merger or consolidation of the employing corporation with the Corporation, such Parent Corporation or such Subsidiary, or the acquisition by the Corporation, a Parent Corporation or a Subsidiary of all or a portion of the assets of the employing corporation, or the acquisition by the Corporation, a Parent Corporation or a Subsidiary of stock of the employing corporation with the result that such employing corporation becomes a Subsidiary. SECTION 8 RECAPITALIZATION OR REORGANIZATION (a) Except as hereinafter otherwise provided, Awards or Grants shall be adjusted by the Board as to the number and price of shares of Common Stock in the event of changes in the outstanding Common Stock by reason of stock dividends, stock splits, reverse stock splits, reclassifications, recapitalizations, reorganizations, mergers, consolidations, combinations, exchanges or other similar changes in capitalization occurring after the date of the grant of any such Options or Common Stock. (b) The existence of the Plan and the Awards and/or Grants made hereunder shall not affect in any way the right or power of the Board or the stockholders of the Corporation to make or authorize any adjustment, recapitalization, reorganization or other change in the capital structure of the Corporation, a Parent Corporation or a Subsidiary or their business, any merger or consolidation of the Corporation, a Parent Corporation or a Subsidiary, any issue of debt or equity securities having any priority or preference with respect to or affecting Common Stock or the rights thereof, the dissolution or liquidation of the Corporation, a Parent Corporation or a Subsidiary, or any sale, lease, exchange or other disposition of all or any part of their assets or business or any other corporate act or proceeding. (c) The shares with respect to which Options may be granted are shares of Common Stock as presently constituted but if and whenever, prior to the expiration of an Option theretofore granted, the Corporation shall effect a subdivision or consolidation of shares of Common Stock or the payment of a stock dividend on Common Stock without receipt of consideration by the Corporation, the number of shares of Common Stock with respect to which such Option may thereafter be exercised (i) in the event of an increase in the number of outstanding shares shall be proportionately increased, and the purchase price per share shall be proportionately reduced, and (ii) in the event of a reduction in the number of outstanding shares shall be proportionately reduced, and the purchase price per share shall be proportionately increased. (d) If the Corporation recapitalizes or otherwise changes its capital structure, thereafter upon any exercise of an Option theretofore granted, the Optionee shall be entitled to purchase under such Option, in lieu of the number of shares of Common Stock as to A-8 which such Option shall then be exercisable, the number and class of shares of stock and securities, and the cash and other property to which the Optionee would have been entitled pursuant to the terms of the recapitalization if, immediately prior to such recapitalization, the Optionee had been the holder of such record of the number of shares of Common Stock then covered by such Option. (e) In the event of a Corporate Change, unless otherwise deemed to be impractical by the Board, then no later than (i) two business days prior to any Corporate Change referenced in Clause (i), (ii), or (iii) of the definition thereof or (ii) ten business days after any Corporate Change referenced in Clause (iv) or (v) of the definition thereof, the Board, acting in its sole discretion without the consent or approval of any Optionee or Grantee, shall act to effect the following alternatives with respect to outstanding Options which acts may vary among individual Optionees and, with respect to acts taken pursuant to Clause (i) above, may be contingent upon effectuation of the Corporate Change: (A) in the event of a Corporate Change referenced in Clauses (i) and (ii) acceleration of exercise for all Options then outstanding so that such Options may be exercised in full for a limited period of time on or before a specified date (before or after such Corporate Change) fixed by the Board, after which specified date all unexercised Options and all rights of Optionees thereunder shall terminate; (B) in the event of a Corporate Change referenced in Clauses (iii), (iv) and (v) require the mandatory surrender to the Corporation by selected Optionees of some or all of the outstanding Options held by such Optionees (irrespective of whether such Options are then exercisable under the provisions of the Plan) as of a date (before or after such Corporate Change) specified by the Board, in which event the Board shall thereupon cancel such Options and pay to each Optionee an amount of cash per share equal to the excess, if any, of the Change of Control Value of the shares subject to such Option over the exercise price(s) under such Options for such shares; (C) in the event of a Corporate Change referenced in Clauses (iii), (iv) and (v), make such adjustments to Options then outstanding as the Board deems appropriate to reflect such Corporate Change; or (D) in the event of a Corporate Change referenced in Clauses (iii), (iv) and (v), provide that thereafter upon any exercise of an Option theretofore granted the Optionee shall be entitled to purchase under such Option, in lieu of the number of shares of Common Stock as to which such Option shall then be exercisable, the number and class of shares of stock or other securities or property (including, without limitation, cash) to which the Optionee would have been entitled pursuant to the terms of the agreement of merger, consolidation or sale of assets or plan of liquidation and dissolution if, immediately prior to such merger, consolidation or sale of assets or any distribution in liquidation and dissolution of the Corporation, the Optionee had been the holder of record of the number of shares of Common Stock then covered by such Option. Notwithstanding the provisions of clauses (B), (C) and (D), above, in the event of a Corporate Change referenced in Clause (iv), the provisions of clauses (B), (C) and (D) shall only apply if, in connection with such a Corporate Change, there is a termination (the "Corporate Change Termination") of an Optionee's employment with the Corporation (x) by the Corporation without Cause, or (y) by the Optionee with Good Reason. (f) Except as hereinbefore expressly provided, issuance by the Corporation of shares of stock of any class or securities convertible into shares of stock of any class, for cash, A-9 property, labor or services, upon direct sale, upon the exercise of rights or warrants to subscribe therefore, or upon conversion of shares or obligations of the Corporation convertible into such shares or other securities, and in any case whether or not for fair value, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number of shares of Common Stock subject to Options theretofore granted, or the purchase price per share of Common Stock subject to Options. SECTION 9 AMENDMENT OR TERMINATION OF THE PLAN The Board in its discretion may terminate or alter or amend the Plan from time to time; provided that no change in any Award or Grant previously made may be made which would impair the rights of the Holder or Grantee without the consent of such Holder or Grantee, and provided further, that the Board may not, without approval of the stockholders, amend the Plan: (a) to increase the aggregate number of shares which may be issued pursuant to the provisions of the Plan on exercise or surrender of Options or upon Grants; (b) to change the minimum Option exercise price; (c) to change the class of employees eligible to receive Awards and/or Grants or increase materially the benefits accruing to employees under the Plan; (d) to extend the maximum period during which Awards may be granted or Grants may be made under the Plan; (e) to modify materially the requirements as to eligibility for participation in the Plan; or (f) to decrease any authority granted to the Board hereunder in contravention of Rule 16b-3. SECTION 10 OTHER (a) No Right to an Award or Grant. Neither the adoption of the Plan nor any action of the Board or Designated Officer shall be deemed to give an employee any right to be granted an Option to purchase Common Stock, to receive a Grant or to any other rights hereunder except as may be evidenced by an Option Agreement duly executed on behalf of the Corporation, and then only to the extent of and on the terms and conditions expressly set forth therein. (b) No Employment Rights Conferred. Nothing contained in the Plan or in any Award or Grant made hereunder shall (i) confer upon any employee any right with respect to continuation of employment with the Corporation or any Parent Corporation or Subsidiary, or (ii) interfere in any way with the right of the Corporation or any Parent Corporation or Subsidiary to terminate his or her employment at any time. A-10 (c) Other Laws; Withholding. The Corporation shall not be obligated to issue any Common Stock pursuant to any Award granted or any Grant made under the Plan at any time when the offering of the shares covered by such Award has not been registered (or exempted) under the Securities Act of 1933 and such other state and federal laws, rules or regulations as the Corporation or the Board deems applicable and, in the opinion of legal counsel for the Corporation, there is no exemption from the registration requirements of such laws, rules or regulations available for the issuance and sale of such shares. In the event no such exemption is available, the Corporation shall use its best efforts to obtain such an exemption or to register such shares. No fractional shares of Common Stock shall be delivered, nor shall any cash in lieu of fractional shares be paid. As a condition of issuing any Common Stock pursuant to any Award granted or any Grant made under the Plan, the Corporation shall have the right to deduct in connection with all Awards or Grants any taxes required by law to be withheld and to require any payments necessary to enable it to satisfy its withholding obligations. The Board in its sole discretion may permit the Holder of an Award or Grant to elect to surrender, or authorize the Corporation to withhold shares of Common Stock (valued at their Fair Market Value on the date of surrender or withholding of such shares) in satisfaction of the Corporation's withholding obligation, subject to such restrictions as the Board deems necessary to satisfy the requirements of Rule 16b-3. (d) No Restriction of Corporate Action. Nothing contained in the Plan shall be construed to prevent the Corporation or any Parent Corporation or Subsidiary from taking any corporate action which is deemed by the Corporation or such Parent Corporation or Subsidiary to be appropriate or in its best interest, whether or not such action would have an adverse effect on the Plan or any Award made under the Plan. No employee, beneficiary or other person shall have any claim against the Corporation or any Parent Corporation or Subsidiary as a result of such action. (e) Restrictions on Transfer. An Award shall not be transferable otherwise than by will or the laws of descent and distribution and shall be exercisable during the lifetime of the Holder only by such Holder or the Holder's guardian or legal representative. (f) Effect of Death, Disability or Termination of Employment. The Option Agreement or other written instrument evidencing an Award shall specify the effect of the death, disability or termination of employment of the Holder on the Award; provided, however that, with respect to an Award of an Incentive Stock Option, an Optionee or such Optionee's representative shall be entitled to exercise (i) within one (1) year from the date of termination of employment with the Corporation if such termination is caused by death or disability or (ii) within ninety (90) days from the date of termination of employment with the Corporation if such termination is caused by reasons other than death or disability. Pursuant to the Code, all outstanding Incentive Stock Options of a Holder will automatically be converted to a non-qualified stock option if the Optionee or its legal representative does not exercise the Incentive Stock Option (i) within ninety (90) days of the date of A-11 termination caused by reasons other than death or disability; or (ii) within one (1) year of the date of termination caused by death or disability. (g) Rule 16b-3. It is intended that the Plan and any grant of an Award made to a person subject to Section 16 of the Exchange Act meet all of the requirements of Rule 16b-3. If any provisions of the Plan or any such Award would disqualify the Plan or such Award hereunder, or would otherwise not comply with Rule 16b-3, such provision or Award shall be construed or deemed amended to conform to Rule 16b-3. (h) Governing Law. The Plan shall by construed in accordance with the laws of the State of Delaware and all applicable federal law. A-12 EX-10 5 kl10022_ex10-2.txt EXHIBIT 10.2 SUBSCRIPTION AGREEMENT Exhibit 10.2 SUBSCRIPTION AGREEMENT THIS SUBSCRIPTION AGREEMENT (the "Agreement") is made as of the date set forth on the signature page hereof between Nephros, Inc., a Delaware corporation (the "Company"), and the undersigned (the "Subscriber"). W I T N E S S E T H: WHEREAS, the Company desires to issue $5,500,000 of Series A Convertible Preferred Stock, par value $.001 per share, of the Company (the "Preferred Stock" and collectively with the common stock underlying the Preferred Stock hereinafter sometimes collectively referred to as the "Securities") in a private placement of the Company's securities (the "Offering"); WHEREAS, the Subscriber desires to purchase that number of shares of Preferred Stock set forth on the signature page hereof on the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the premises and the mutual representations and covenants hereinafter set forth, the parties hereto do hereby agree as follows: I SUBSCRIPTION FOR PREFERRED STOCK AND REPRESENTATIONS BY SUBSCRIBER 1 Subject to the terms and conditions hereinafter set forth, the Subscriber hereby subscribes for and agrees to purchase from the Company such number of shares of Preferred Stock (the "Shares") as set forth upon the signature page hereof at a price equal to $1.25 per Share and the Company agrees to sell such Shares to the Subscriber for said purchase price. Upon drawdown by the Company in accordance with Article III of this Agreement, the purchase price attributable to such drawdown will be payable by personal or business check, wire transfer of immediately available funds or money order made payable to "Nephros, Inc." The certificates representing the Securities will be delivered by the Company to the Subscriber within ten (10) business days following the receipt of Subscriber's payment of the applicable drawdown amount. 2 The Subscriber recognizes that the purchase of the Preferred Stock involves a high degree of risk in that, among other things, (i) the Company is a development stage business with no operating history and requires substantial funds in addition to the proceeds of the Offering; (ii) an investment in the Company is highly speculative, and only investors who can afford the loss of their entire investment should consider investing in the Company and the Preferred Stock; (iii) the Subscriber may not be able to liquidate the Subscriber's investment; (iv) transferability of the Securities is extremely limited and (v) in the event of a disposition, the Subscriber could sustain the loss of the Subscriber's entire investment. 3 The Subscriber represents that the Subscriber is an "accredited investor," as such term is defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933, as amended (the "Act"), as indicated by his responses to the questions contained in Article VI hereof, and that the Subscriber is able to bear the economic risk of an investment in the Preferred Stock. The Subscriber covenants to notify the Company at any time prior to the second drawdown (as defined in Article 3) if it is no longer an "accredited investor." 4 The Subscriber hereby acknowledges and represents that (i) the Subscriber has prior investment experience, including investment in non-listed and unregistered securities, or, to the extent necessary, the Subscriber has employed at its own expense and relied upon the services of an investment advisor, attorney and/or accountant to read all of the documents furnished or made available by the Company both to the Subscriber and to all other prospective investors in the Preferred Stock and to evaluate the investment, tax and legal merits and the consequences and risks of such an investment on the Subscriber's behalf; (ii) the Subscriber recognizes the highly speculative nature of this investment, and (iii) the Subscriber is able to bear the economic risk which the Subscriber hereby assumes. 5 The Subscriber hereby acknowledges receipt and careful review of the Confidential Term Sheet dated July 15, 1997 and the attachments and exhibits thereto, all of which constitute an integral part thereof (the "Term Sheet"). The Subscriber further represents that it has been furnished by the Company during the course of this transaction with all information regarding the Company which the Subscriber has requested or desired to know, has been afforded the opportunity to ask questions of and receive answers from duly authorized officers or other representatives of the Company concerning the terms and conditions of the Offering and has received any additional information which the Subscriber has requested. 6 (a) The Subscriber has relied solely upon the information provided by the Company in the Term Sheet in making the decision to invest in the Preferred Stock and the Subscriber covenants that no person other than the Company has supplied the Subscriber with any information relating to an investment in the Preferred Stock. (b) The Subscriber covenants that no Preferred Stock was offered or sold to it by means of any form of general solicitation or general advertising, and in connection therewith the Subscriber did not (A) receive or review any advertisement, article, notice or other communication published in a newspaper or magazine or similar media or broadcast over television or radio whether closed circuit or generally available, or (B) attend any seminar meeting or industry investor conference whose attendees were invited by any general solicitation or general advertising. 7 The Subscriber agrees that the Subscriber will not sell or otherwise transfer the Securities unless they are registered under the Act or unless an exemption from - 3 - such registration is available and until such Subscriber complies with the transfer restrictions set forth in herein. 8 The Subscriber understands that the Securities have not been registered under the Act by reason of a claimed exemption under the provisions of the Act which depends, in part, upon the Subscriber's investment intention. In connection herewith, the Subscriber hereby represents that the Subscriber is purchasing the Securities for the Subscriber's own account for investment and not with a view toward the resale or distribution to others. The Subscriber, if an entity, was not formed for the purpose of purchasing the Securities. The Subscriber understands that Rule 144 promulgated under the Act requires, among other conditions, a one (1) year holding period prior to the resale (in limited amounts) of securities acquired in a non-public offering without having to satisfy the registration requirements under the Act. 9 Other than as set forth in Article IV hereof, the Subscriber understands and hereby acknowledges that the Company is under no obligation to register the shares of common stock (the "Common Stock") underlying the Preferred Stock under the Act or any state securities or "blue sky" laws. The Subscriber consents that the Company may, if it desires, permit the transfer of the Securities out of the Subscriber's name only when the Subscriber's request for transfer is accompanied by an opinion of counsel reasonably satisfactory to the Company that neither the sale nor the proposed transfer results in a violation of the Act or any applicable state "blue sky" laws (collectively, the "Securities Laws"). 10 The Subscriber agrees to hold the Company and its directors, officers, employees, controlling persons and agents and each of their respective heirs, representatives, successors and assigns harmless and to indemnify them against all liabilities, costs and expenses incurred by them as a result of any misrepresentation made by the Subscriber contained in this Agreement (including the Confidential Investor Questionnaire contained in Article VI herein) or any sale or distribution by the Subscriber in violation of the Securities Laws. 11 The Subscriber consents to the placement of a legend on any certificate, or other document evidencing the Securities, that such Securities have not been registered under the Securities Laws and setting forth or referring to the restrictions on transferability and sale thereof contained in this Agreement. The Subscriber is aware that the Company will make a notation in its appropriate records with respect to the restrictions on the transferability of such Securities. 12 The Subscriber understands that the Company will review this Agreement and the Company is hereby given authority by the Subscriber to call the Subscriber's bank or place of employment or otherwise review the financial standing of the Subscriber; and it is further agreed that the Company reserves the unrestricted right, without further documentation or agreement on the part of the Subscriber, to reject all or a portion of any subscription, to accept subscriptions for lesser amounts than subscribed for and to close the Offering to the Subscriber at any - 4 - time. In addition, the Subscriber understands and agrees that the during the Drawdown Period (as hereinafter defined), the Subscriber shall have no rights in or to purchase Securities and the Company, in its sole discretion, shall have the right to drawdown in whole or in part or to cancel any subscription. 13 The Subscriber hereby represents that the address of the Subscriber furnished by the Subscriber on the signature page hereof is the Subscriber's principal residence if the Subscriber is an individual or its principal business address if it is a corporation or other entity. 14 The Subscriber represents that the Subscriber has full power and authority (corporate, statutory and otherwise) to execute and deliver this Agreement and to purchase the Preferred Stock. This Agreement constitutes the legal, valid and binding obligation of the Subscriber, enforceable against the Subscriber in accordance with its terms. 15 If the Subscriber is a corporation, company, trust, employee benefit plan, individual retirement account, Keogh Plan, or other tax-exempt entity, it is authorized and qualified to become an investor in the Company and the person signing this Agreement on behalf of such entity has been duly authorized by such entity to do so. 16 The Subscriber acknowledges that if the Subscriber is a Registered Representative of a National Association of Securities Dealers, Inc. ("NASD") member firm, the Subscriber must give such firm the notice required by the Rules of Fair Practice promulgated by the NASD, receipt of which must be acknowledged by such firm in Article 6.4 below. II REPRESENTATIONS BY AND COVENANTS OF THE COMPANY The Company hereby represents and warrants to the Subscriber that: 1 Organization, Good Standing and Qualification. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware and has full corporate power and authority to conduct its business as described in the Term Sheet. 2 Capitalization and Voting Rights. The authorized, issued and outstanding capital stock of the Company is as follows: 30,000,000 authorized shares of Common Stock, of which 5,500,000 shares are currently issued and outstanding and 5,000,000 authorized shares of Preferred Stock of which none are currently issued or outstanding. All issued and outstanding shares of capital stock of the Company are validly issued, fully paid and nonassessable. The Preferred Stock has been duly and validly authorized and, when issued and paid for pursuant to this Agreement, will be validly issued, fully paid and nonassessable. Except as set forth in the Term Sheet, there are no outstanding options, warrants, agreements, convertible securities, preemptive rights or other rights to subscribe for or to purchase any shares of capital stock of the Company. Except as set forth in this - 5 - Agreement and as otherwise required by law, there are no restrictions upon the voting or transfer of the Securities pursuant to the Company's Certificate of Incorporation, Bylaws or other governing documents or any agreement or other instruments to which the Company is a party or by which the Company is bound. 3 Authorization; Enforceability. This Agreement has been duly and validly authorized by the Company and is enforceable against the Company in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally and by general principles of equity (regardless of whether enforcement is sought in a proceeding in equity or at law). The Company has full power and lawful authority to authorize, issue and sell the Preferred Stock to be sold by it hereunder on the terns and conditions set forth herein. 4 Reservation of Common Stock Issuable Upon Conversion. The Company shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of the Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Preferred Stock and all shares of Preferred Stock that may be issued upon drawdown of subscriptions by the Company. 5 Certificate of Designations of Series A Preferred Stock. The Series A Preferred Stock has the rights, preferences and privileges substantially as set forth in the Form of Certificate of Designations attached as Exhibit B to the Term Sheet with the conversion ratio as set forth therein. 6 No Conflict; Governmental Consents. (a) The execution and delivery by the Company of this Agreement and the consummation of the transactions contemplated hereby will not result in the violation of any law, statute, rule, regulation, order, writ, injunction, judgment or decree of any court or governmental authority to or by which the Company is bound, or of any provision of the Certificate of Incorporation or Bylaws of the Company, and will not conflict with, or result in a breach or violation of, any of the terms or provisions of, or constitute (with due notice or lapse of time or both) a default under, any lease, loan agreement, mortgage, security agreement, trust indenture or other agreement or instrument to which the Company is a party or by which it is bound or to which any of its properties or assets is subject, nor result in the creation or imposition of any lien upon any of the properties or assets of the Company. (b) No consent, approval, authorization or other order of any governmental authority is required to be obtained by the Company in connection with the authorization, execution and delivery of this Agreement or with the - 6 - authorization, issue and sale of the Securities, except such filings as may be required to be made with, the Securities and Exchange Commission (the "SEC"), any state or foreign "blue sky" or securities regulatory authority. 7 Licenses. Except as set forth herein, the Company has sufficient licenses, permits and other governmental authorizations currently required for the conduct of its business or ownership of properties and is in all material respects complying therewith. 8 Litigation. The Company knows of no pending or threatened legal or governmental proceedings against the Company which could materially adversely affect the business, property, financial condition or operations of the Company. 9 Representations and Warranties Correct. The representations and warranties made by the Company in Article II hereof shall be true and correct in all material respects when made, and except for Article 2.2, shall be true and correct in all material respects on the date of each drawdown with the same force and effect as if they had been made on and as of such date. III TERMS OF SUBSCRIPTION 1 There will be no minimum commitment amount required for the closing of this Offering. Accordingly, the Company may drawdown on subscriptions, subject to Article 3.2, immediately following receipt of such subscriptions without regard to the aggregate number of shares of Preferred Stock subscribed for in the Offering. 2 The Company shall be permitted to drawdown up to fifty percent (50%) of each investors subscription immediately upon acceptance by the Company of such subscription and shall be permitted to drawdown the remaining fifty percent (50%) of each investors subscription on or after the date which is one (1) year from the date of acceptance of subscriptions pursuant to this Offering. The Company shall send a notice (the "Drawdown Notice") to each Subscriber specifying the drawdown amount. The Subscriber shall be required to fund the amount specified in the Drawdown Notice within ten (10) business days of receipt by the Subscriber of such notice. Any amount of this subscription not drawn down upon shall expire on the date which is three (3) years from the date of this Agreement (the "Drawdown Period"). IV REGISTRATION RIGHTS 1 Registration Rights. The Company covenants and agrees as follows: 2 Definitions. For purposes of this Article IV: (a) The term "Act" means the Securities Act of 1933, as amended. - 7 - (b) The term "Holder" means any person owning or having the right to acquire Registrable Securities or any assignee thereof. (c) The term "1934 Act" shall mean the Securities Exchange Act of 1934, as amended. (d) The terms "register", "registered" and "registration" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Act, and the declaration or order of effectiveness of such registration statement or document. (e) The term "Registrable Securities" shall mean (i) the shares of Common Stock issuable upon the conversion of the Preferred Stock, (ii) any shares of Common Stock issued as (or issuable upon the conversion or exercise of any warrant, right or other security which is issued as) a dividend or other distribution with respect to or in replacement of the Preferred Stock; provided, however, that securities shall only be treated as Registrable Securities if and only for so long as they (A) have not been disposed of pursuant to a registration statement declared effective by the Commission, (B) have not been sold in a transaction exempt from the registration and prospectus delivery requirements of the Act so that all transfer restrictions and restrictive legends with respect thereto are removed upon the consummation of such sale or (C) are held by a Holder or a permitted transferee of a Holder. 3 "Piggy-back" Registration Rights. If (but without any obligation to do so), at any time after the initial public offering (the "IPO") of the Company's Common Stock, the Company proposes to register any of its stock or other equity securities under the Act in connection with the public offering of such securities solely for cash (other than a registration relating solely to the sale of securities to participants in a Company stock plan, a registration on any form which does not include substantially the same information as would be required to be included in a registration statement covering the sale of the Registrable Securities or a registration in which the only Common Stock being registered is Common Stock issuable upon conversion of debt securities which are also being registered), the Company shall, at such time, promptly give each Holder written notice of such registration. Upon the written request of each Holder given within ten (10) days after mailing of such notice by the Company in accordance with Article 4.1, the Company shall, on up to two (2) occasions and subject to the limitations set forth in this Agreement (including the provisions of Article 4.8), include in the Company's registration statement under the Act all of the Registrable Securities that each such Holder has requested to be registered; provided, however, that nothing in this Article 4.3 shall prevent the Company from at any time abandoning or delaying any such registration without obligation to any Holder. - 8 - 4 Obligations of the Company. Whenever required under this Article IV to include Registrable Securities in a Company registration statement, the Company shall, as expeditiously as reasonably possible: (a) Use its reasonable best efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective for a period of up to one hundred twenty (120) days or until the distribution contemplated in the Registration Statement has been completed; provided, however, that such 120-day period shall be extended for a period of time equal to the period that the Holder refrains from selling any securities included in such registration at the request of an underwriter of Common Stock (or other securities) of the Company, and provided further that if applicable rules under the Act governing the obligation to file a post-effective amendment permits, in lieu of filing a post-effective amendment which (x) includes any prospectus required by Section 10(a)(3) of the Act or (y) reflects facts or events representing a material or fundamental change in the information set forth in the registration statement, the Company may incorporate by reference information required to be included in (x) and (y) above to the extent such information is contained in periodic reports filed pursuant to Section 13 or 15(d) of the 1934 Act in the registration statement. (b) Prepare and file with the SEC such amendments and supplements to such registration statement, and the prospectus used in connection with such registration statement, as may be necessary to comply with the provisions of the Act with respect to the disposition of all securities covered by such registration statement. (c) Furnish to the Holders such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registrable Securities owned by them. (d) Use its reasonable best efforts to register and qualify the securities covered by such registration statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions, unless the Company is already subject to service in such jurisdiction and except as may be required by the Act. (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering. Each Holder - 9 - participating in such underwriting shall also enter into and perform its obligations under such an agreement. (f) Notify each Holder of Registrable Securities covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Act of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. (g) Cause all such Registrable Securities registered hereunder to be listed on each securities exchange on which similar securities issued by the Company are then listed. (h) Provide a transfer agent and registrar for all Registrable Securities registered pursuant hereunder and CUSIP number for all such Registrable Securities, in each case not later than the effective date of such registration. 5 Furnish Information. It shall be a condition precedent to the obligation of the Company to take any action pursuant to this Article IV with respect to the Registrable Securities of any selling Holder that such Holder shall furnish to the Company such information regarding the Holder, the Registrable Securities held by the Holder, and the intended method of disposition of such securities as shall be required to effect the registration of such Holder's Registrable Securities. 6 Expenses of Company Registration. The Company shall bear and pay all expenses incurred in connection with any registration, filing or qualification of Registrable Securities with respect to the registrations pursuant to Article 4.3 for each Holder, including (without limitation) all registration, filing, and qualification fees, printers and accounting fees relating or apportionable thereto, but excluding underwriting discounts and commissions relating to Registrable Securities; provided, however, that the Company shall not bear the cost of any professional fees or costs of accounting, financial or legal advisors to any of the Holders. Notwithstanding the foregoing, each Holder shall pay all registration expenses which such Holder is required to pay under applicable law. 7 Underwriting Requirements. In connection with any offering involving an underwriting of shares of the Company's capital stock, the Company shall not be required under Article 4.3 to include any of the Holders' securities in such underwriting unless they accept the terms of the underwriting as agreed upon between the Company and the underwriters selected by it (or by other persons entitled to select the underwriters), and then only in such quantity as the underwriters determine in their sole discretion will not jeopardize the success of the offering by the Company. If the total amount of securities, including Registrable Securities, requested by stockholders to be included in such offering - 10 - exceeds the amount of securities sold other than by the Company that the underwriters determine in their sole discretion is compatible with the success of the offering, then the Company shall be required to include in the offering only that number of such securities, including Registrable Securities, which the underwriters determine in their sole discretion will not jeopardize the success of the offering (the securities so included to be apportioned pro rata among the selling stockholders according to the total amount of securities entitled to be included therein owned by each selling stockholder or in such other proportions as shall mutually be agreed to by such selling stockholders). For purposes of the preceding parenthetical concerning apportionment, for any selling stockholder that is a holder of Registrable Securities and that is a partnership or corporation, the partners, retired partners and stockholders of such holder, or the estates and family members of any such partners and retired partners and any trusts for the benefit of any of the foregoing persons shall be deemed to be a single "selling stockholder", and any pro-rata reduction with respect to such "selling stockholder" shall be based upon the aggregate amount of shares carrying registration rights owned by all entities and individuals included in such "selling stockholder", as defined in this sentence. 8 Delay of Registration. No Holder shall have any right to obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Article IV. 9 Indemnification. In the event any Registrable Securities are included in a registration statement under this Article IV: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Holder, any underwriter (as defined in the Act) for such Holder and each person, if any, who controls such Holder or underwriter within the meaning of the Act or the 1934 Act, against any losses, claims, damages, or liabilities (joint or several) to which they may become subject under the Act, or the 1934 Act, insofar as such losses, claims, damages, or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively a "Violation"): (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein not misleading, or (iii) any violation or alleged violation by the Company of the Act, the 1934 Act, or any rule or regulation promulgated under the Act, or the 1934 Act, and the Company will pay to each such Holder, underwriter or controlling person, as incurred, any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement - 11 - contained in this Article 4.9(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld), nor shall the Company be liable in any such case for any such loss, claim, damage, liability, or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information famished expressly for use in connection with such registration by any such Holder, underwriter or controlling person. (b) To the extent permitted by law, each selling Holder will indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the registration statement, each person, if any, who controls the Company within the meaning of the Act, any underwriter, any other Holder selling securities in such registration statement and any controlling person of any such underwriter or other Holder, against any losses, claims, damages, or liabilities (joint or several) to which any of the foregoing persons may become subject, under the Act, or the 1934 Act, insofar as such losses, claims, damages, or liabilities (or actions in respect thereto) arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Holder expressly for use in connection with such registration; and each such Holder will pay, as incurred, any legal or other expenses reasonably incurred by any person intended to be indemnified pursuant to this Article 4.9(b), in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Article 4.9(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Holder, which consent shall not be unreasonably withheld; provided, that, in no event shall any indemnity under this Article 4.9(b) exceed the gross proceeds from the offering received by such Holder. (c) Promptly after receipt by an indemnified party under this Article 4.9 of notice of the commencement of any action (including any governmental action), such indemnified party shall, if a claim in respect thereof is to be made against any indemnifying party under this Article 4.9, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly notified, to assume the defense thereof with counsel selected by the indemnifying party and approved by the indemnified party (whose approval shall not be unreasonably withheld); provided, however, that an indemnified party (together with all other indemnified parties which may be represented without conflict by one counsel) shall have the right to retain one separate counsel, with the fees and expenses to be paid - 12 - by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action, if prejudicial to its ability to defend such action, shall relieve such indemnifying party of any liability to the indemnified party under this Article 4.9, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this Article 4.9. (d) If the indemnification provided for in this Article 4.9 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage, or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such statement or omission. (e) Notwithstanding the foregoing, to the extent that the provisions on indemnification and contribution contained in the underwriting agreement entered into in connection with the underwritten public offering are in conflict with the foregoing provisions, the provisions in the underwriting agreement shall control. (f) The obligations of the Company and Holders under this Article 4.9 shall survive the completion of any offering of Registrable Securities in a registration statement under this Article IV, and otherwise. 10 Reports Under Securities Exchange Act of 1934. With a view to making available to the Holders the benefits of Rule 144 promulgated under the Act and any other rule or regulation of the SEC that may at any time permit a Holder to sell securities of the Company to the public without registration or pursuant to a registration on Form S-3, the Company agrees to: - 13 - (a) make and keep public information available, as those terms are understood and defined in SEC Rule 144, at all times after ninety (90) days after the effective date of the registration statement filed in connection with an IPO by the Company; (b) file with the SEC in a timely manner all reports and other documents required of the Company under the Act and the 1934 Act; and (c) furnish to any Holder, so long as the Holder owns any Registrable Securities, forthwith upon request (i) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company, and (ii) such other information as may be reasonably requested in availing any Holder of any rule or regulation of the SEC which permits the selling of any such securities without registration or pursuant to such form. 11 Lock-Up Provision. In connection with the IPO, the Holder hereby agrees to be subject to a lock-up for a period of one hundred eighty (180) days following the IPO or such longer period as may be required by the underwriter or underwriters of such IPO. In connection with any subsequent public offering of the Company's securities, the Holder hereby agrees to be subject to a lock-up for a period of sixty (60) days or such longer period following such public offering as required by the underwriter or underwriters of such public offering. During such periods, the Holder agrees not to directly or indirectly sell, offer to sell, contract to sell, including, without limitation, "short" or "short against the box" (as those terms are generally understood), grant any option to purchase or otherwise transfer or dispose of (other than to donees who agree to be similarly bound) any securities of the Company held by it at any time during such period. This Article 4.11 shall be binding upon any transferee of the Securities. In order to enforce the foregoing covenant, the Company may impose stock-transfer instructions with respect to the Registrable Securities of each Holder (and the shares or securities of every other person subject to the foregoing restriction) until the end of such period. Notwithstanding the foregoing, the obligation described in this Article 4.11 shall not apply to a registration relating solely to employee benefit plans on Form S-1 or Form S-8 or similar forms which may be promulgated in the future, or a registration relating solely to a Commission Rule 145 transaction on Form S-4 or similar forms which may be promulgated in the future. 12 Termination of Registration Rights. In addition, the right of any Holder to request inclusion in any registration pursuant to Article 4.3 shall terminate if all shares of Registrable Securities held by such Holder may immediately be sold under Rule 144 or Rule 701 during any 90-day period; provided, however, that the provisions of this Article 4.12 shall not apply to any Holder who owns more than two percent - 14 - (2%) of the Company's outstanding stock until such time as such Holder owns less than two percent (2%) of the outstanding stock of the Company. V MISCELLANEOUS 1 Any notice or other communication given hereunder shall be deemed sufficient if in writing and sent by (a) telecopy or facsimile at the address or number designated below (if delivered on a business day during normal business hours where such notice is to be received); or (b) registered or certified mail, return receipt requested, or delivered by hand against written receipt therefor, addressed to Nephros, Inc., c/o 787 Seventh Avenue, New York, New York, 10019, Attn: Michael S. Weiss, or such other office designated by the Corporation, and to the Subscriber at his address indicated on the signature page of this Agreement. Notices shall be deemed to have been given or delivered on the date of mailing, except notices of change of address, which shall be deemed to have been given or delivered when received. 2 This Agreement shall not be changed, modified or amended except by a writing signed by the parties to be charged, and this Agreement may not be discharged except by performance in accordance with its terms or by a writing signed by the party to be charged. 3 This Agreement shall be binding upon and inure to the benefit of the parties hereto and to their respective heirs, legal representatives, successors and assigns. This Agreement sets forth the entire agreement and understanding between the parties as to the subject matter hereof and merges and supersedes all prior discussions, agreements and understandings of any and every nature among them. 4 Upon the execution and delivery of this Agreement by the Subscriber, this Agreement shall become a binding obligation of the Subscriber with respect to the purchase of Preferred Stock as herein provided; subject, however, to the right hereby reserved to the Company to reject or decrease any subscription, enter into the same agreements with other subscribers and to add and/or delete other Persons as subscribers. 5 NOTWITHSTANDING THE PLACE WHERE THIS AGREEMENT MAY BE EXECUTED BY ANY OF THE PARTIES HERETO, THE PARTIES EXPRESSLY AGREE THAT ALL THE TERMS AND PROVISIONS HEREOF SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAW. 6 In order to discourage frivolous claims, the parties agree that unless a claimant in any proceeding arising out of this Agreement succeeds in establishing his claim and recovering a judgment against another party (regardless of whether such claimant succeeds against one of the other parties to the action), then the other party shall be entitled to recover from such claimant all of its/their reasonable - 15 - legal costs and expenses relating to such proceeding and/or incurred in preparation therefor. 7 The holding of any provision of this Agreement to be invalid or unenforceable by a court of competent jurisdiction shall not affect any other provision of this Agreement, which shall remain in full force and effect. If any provision of this Agreement shall be declared by a court of competent jurisdiction to be invalid, illegal or incapable of being enforced in whole or in part, such provision shall be interpreted so as to remain enforceable to the maximum extent permissible consistent with applicable law and the remaining conditions and provisions or portions thereof shall nevertheless remain in full force and effect and enforceable to the extent they are valid, legal and enforceable, and no provisions shall be deemed dependent upon any other covenant or provision unless so expressed herein. 8 It is agreed that a waiver by either party of a breach of any provision of this Agreement shall not operate, or be construed, as a waiver of any subsequent breach by that same party. 9 The parties agree to execute and deliver all such further documents, agreements and instruments and take such other and further action as may be necessary or appropriate to carry out the purposes and intent of this Agreement. 10 This Agreement may be executed in two or more counterparts each of which shall be deemed an original, but all of which shall together constitute one and the same instrument. 11 (a) The Subscriber agrees not to issue any public statement with respect to the Subscriber's investment or proposed investment in the Company or the terms of any agreement or covenant between it and the Company without the Company's prior written consent, except such disclosures as may be required under applicable law or under any applicable order, rule or regulation. (b) The Company agrees not to disclose the names, addresses or any other information about the Subscribers, except as required by law; provided, that the Company may use the name (but not the address) of the Subscriber in registration materials filed with the SEC. 12 The Subscriber represents and warrants that it has not engaged, consented to or authorized any broker, finder or intermediary to act on its behalf, directly or indirectly, as a broker, finder or intermediary in connection with the transactions contemplated by this Agreement. The Subscriber hereby agrees to indemnify and hold harmless the Company from and against all fees, commissions or other payments owing to any such person or firm acting on behalf of the Subscriber hereunder. - 16 - 13 Nothing in this Agreement shall create or be deemed to create any rights in any Person not a party to this Agreement, except for the holders of Registrable Securities. VI CONFIDENTIAL INVESTOR QUESTIONNAIRE 6.1 The Subscriber represents and warrants that the Subscriber comes within one category marked below, and that for any category marked, the Subscriber has truthfully set forth, where applicable, the factual basis or reason the Subscriber comes within that category. ALL INFORMATION IN RESPONSE TO THIS Article WILL BE KEPT STRICTLY CONFIDENTIAL. The Subscriber agrees to furnish any additional information which the Company deems necessary in order to verify the answers set forth below. Category A | | The Subscriber is an individual (not a partnership, corporation, etc.) whose individual net worth, or joint net worth with his or her spouse, presently exceeds $1,000,000. Explanation. In calculating net worth you may include equity in personal property and real estate, including your principal residence, cash, short-term investments, stock and securities. Equity in personal property and real estate should be based on the fair market value of such property less debt secured by such property. Category B | | The Subscriber is an individual (not a partnership, corporation, etc.) who had an income in excess of $200,000 in each of the two most recent years, or joint income with his or her spouse in excess of $300,000 in each of those years (in each case including foreign income, tax exempt income and full amount of capital gains and losses but excluding any income of other family members and any unrealized capital appreciation) and has a reasonable expectation of reaching the same income level in the current year. Category C |_| The Subscriber is a director or executive officer of the Company which is issuing and selling the Preferred Stock. - 17 - Category D |_| The Subscriber is a bank; a savings and loan association, insurance company, registered investment company; registered business development company; licensed small business investment company ("SBIC"); or employee benefit plan within the meaning of Title 1 of ERISA and (a) the investment decision is made by a plan fiduciary which is either a bank, savings and loan association, insurance company or registered investment advisor, or (b) the plan has total assets in excess of $5,000,000 or is a self directed plan with investment decisions made solely by persons that are accredited investors. -------------------------- -------------------------- (describe entity) Category E |_| The Subscriber is a private business development company as defined in Article 202(a)(22) of the Investment Advisors Act of 1940. -------------------------- -------------------------- (describe entity) Category F |_| The Subscriber is a corporation, partnership, Massachusetts business trust, or a non-profit organization within the meaning of Article 501(c)(3) of the Internal Revenue Code, in each case not formed for the specific purpose of acquiring the Preferred Stock and with total assets in excess of $5,000,000. -------------------------- -------------------------- (describe entity) Category G |_| The Subscriber is a trust with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the Preferred Stock, where the purchase is directed by a "sophisticated person" as defined in Regulation 506(b)(2)(ii). - 18 - Category H |_| The Subscriber is an entity all the equity owners of which are "accredited investors" within one or more of the above categories. If relying upon this Category alone, each equity owner must complete a separate copy of this Agreement. -------------------------- -------------------------- (describe entity) Category I |_| The Subscriber is not within any of the categories above and is therefore not an accredited investor. 6.2 SUITABILITY (please answer each question) (a) For an individual Subscriber, please describe your current employment, including the company by which you are employed and its principal business: - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (b) For an individual Subscriber, please describe any college or graduate degrees held by you. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (c) For all Subscribers, please list types of prior investments: - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (d) For all Subscribers, please state whether you have participated in other private placements before: YES | | NO |_| (e) For all Subscribers, please indicate frequency of such prior participation in private placements of: - 19 - Public Companies Companies Biotechnology Companies Frequently | | | | |X| Occasionally |_| |_| |_| Never |_| |_| |_| (f) For individual Subscribers, do you expect your current level of income to significantly decrease in the foreseeable future: YES |_| NO | | (g) For individual Subscribers, do you expect your total net worth to significantly decrease in the foreseeable future: YES |_| NO | | (h) For trust, corporate, partnership and other institutional Subscribers, do you expect your total assets to significantly decrease in the foreseeable future: YES |_| NO |_| (i) For all Subscribers, do you have any other investments or contingent liabilities which you reasonably anticipate could cause you to need sudden cash requirements in excess of cash readily available to you: YES |_| NO | | (j) For all Subscribers, are you familiar with the risk aspects and the non-liquidity of investments such as the securities for which you seek to subscribe? YES | | NO |_| (k) For all Subscribers, do you understand that there is no guarantee of financial return on this investment and that you run the risk of losing your entire investment? YES | | NO |_| - 20 - 6.3 MANNER IN WHICH TITLE TO BE HELD (circle one) (a) Individual Ownership (b) Community Property (c) Joint Tenant with Right of Survivorship (both parties must sign) (d) Partnership* (e) Tenants in Common (f) Corporation* (g) Trust* (h) Other *If Preferred Stock is being subscribed for by an entity, the attached Certificate of Signatory must also be completed. 6.4 NASD Affiliation Is the Subscriber affiliated or associated with an NASD member firm (please check one): YES | | NO |_| If Yes, please describe: - --------------------------------------------------------- - --------------------------------------------------------- - --------------------------------------------------------- *If Subscriber is a Registered Representative with an NASD member firm, have the following acknowledgment signed by the appropriate party: The Subscriber NASD member firm acknowledges receipt of the notice required by Article 3, Articles 28(a) and (b) of the Rules of Fair Practice. - ------------------------------------- Name of NASD Member Firm By: ---------------------------------- Authorized Officer Date: -------------------------------- - 21 - 6.5 REPRESENTATIONS AND WARRANTIES The Subscriber hereby represents and warrants to the Company as follows: The Subscriber has been informed of the significance to the Company of the foregoing representations and answers contained in this Confidential Investor Questionnaire and this Agreement. The answers to the foregoing questions are true, complete and correct and have been provided with the understanding that the Company will rely upon them for all purposes, including but not limited to the purpose of determining whether the offering in which the Subscriber proposes to participate is exempt from registration under federal and state securities laws. The Subscriber will notify the Company immediately, at any time on or prior to the Final Closing Date, in the event that the representations and warranties in this Agreement shall cease to be true, accurate and complete. The Subscriber is able to bear the economic risk of the investment and, at the present time, can afford a complete loss of such investment. - 22 - [Signature Page] NUMBER OF SHARES ________ X $1.25 = $_______ (the "Purchase Price") - ----------------------------------- ----------------------------------- Signature Signature (if purchasing jointly) - ----------------------------------- ----------------------------------- Name Typed or Printed Name Typed or Printed - ----------------------------------- ----------------------------------- Address Address - ----------------------------------- ----------------------------------- City, State and Zip Code City, State and Zip Code - ----------------------------------- ----------------------------------- Telephone -- Business Telephone -- Business - ----------------------------------- ----------------------------------- Telephone -- Residence Telephone -- Residence - ----------------------------------- ----------------------------------- Telephone -- Business Telephone -- Business - ----------------------------------- ----------------------------------- Telephone -- Residence Telephone -- Residence - ----------------------------------- ----------------------------------- Tax ID# or Social Security # Tax ID or Social Security # Name in which Securities should be issued : ------------------------------------- Dated: ___________________, 1997. This Subscription Agreement is agreed to and accepted as of __, 1997. NEPHROS, Inc. By: ----------------------------------- Name: Title: - 23 - CERTIFICATE OF SIGNATORY (To be completed if Preferred Stock is being subscribed for by an entity) I, _______________________________ , am the ____________________ of ________________________________________________________________ (the "Entity"). I certify that I am empowered and duly authorized by the Entity to execute and carry out the terms of the Subscription Agreement and to purchase and hold the Preferred Stock, and certify further that the Subscription Agreement has been duly and validly executed on behalf of the Entity and constitutes a legal and binding obligation of the Entity. IN WITNESS WHEREOF, I have set my hand this ___________________ day of ______, _____. --------------------------- (Signature) - 24 - EX-10 6 kl10022_ex10-3.txt EXHIBIT 10.3 Exhibit 10.3 REGISTRATION RIGHTS AGREEMENT DATED AS OF FEBRUARY 8, 2000 among NEPHROS, INC., the HOLDERS, and the INVESTORS IDENTIFIED HEREIN TABLE OF CONTENTS Page Section 1. Definitions........................................................1 Section 2. Required Registration..............................................3 Section 3. Piggyback Registration.............................................4 Section 4. Registrations on Form S-3..........................................5 Section 5. Holdback Agreement.................................................5 Section 6. Preparation and Filing.............................................6 Section 7. Expenses...........................................................9 Section 8. Indemnification....................................................9 Section 9. Underwriting Agreement............................................11 Section 10. Information.......................................................11 Section 11. Exchange Act Compliance...........................................12 Section 12. No Conflict of Rights.............................................12 Section 13. Termination.......................................................12 Section 14. Successors and Assigns............................................12 Section 15. Assignment........................................................12 Section 16. Entire Agreement..................................................12 Section 17. Notices...........................................................13 Section 18. Modifications; Amendments; Waivers................................14 Section 19. Counterparts; Facsimile Signatures................................14 Section 20. Headings..........................................................14 Section 21. Governing Law.....................................................14 i REGISTRATION RIGHTS AGREEMENT, dated as of February 8, 2000, between NEPHROS, INC., a Delaware corporation (the "Corporation"), and the INVESTORS (as herein defined). The Investors own or have the right to purchase or otherwise acquire shares of the Common Stock (as hereinafter defined) of the Corporation. The Corporation and the Investors deem it to be in their respective best interests to set forth the rights of the Investors in connection with public offerings and sales of the Common Stock. NOW, THEREFORE, in consideration of the premises and mutual covenants and obligations hereinafter set forth, the Corporation and the Investors hereby agree as follows: Section 1. Definitions. As used in this Agreement, the following terms shall have the following meanings: (a) "Commission" means the Securities and Exchange Commission or any other Federal agency at the time administering the Securities Act. (b) "Common Stock" means the common stock, $.001 par value per share, of the Corporation. (c) "Counsel" shall have the meaning ascribed to such term in Section 6(b). (d) "Exchange Act" means the Securities Exchange Act of 1934 or any successor Federal statute, and the rules and regulations of the Commission promulgated thereunder, all as the same shall be in effect from time to time. (e) "Information" shall have the meaning ascribed to such term in Section 6(i). (f) "Inspectors" shall have the meaning ascribed to such term in Section 6(i). (g) "Investors" means the Person set forth on Schedule I and each additional Person who shall execute a counterpart signature page hereto, and includes any successor to, or assignee or transferee of, any such Person who or which agrees in writing to be treated as an Investor hereunder and to be bound by the terms and comply with all applicable provisions hereof. (h) "Other Shares" means at any time those shares of Common Stock which do not constitute Primary Shares or Registrable Shares. (i) "Person" means any individual, partnership, corporation, group, trust, limited liability company or other legal entity. (j) "Primary Shares" means at any time the authorized but unissued shares of Common Stock and shares of Common Stock held by the Corporation in its treasury. (k) "Records" shall have the meaning ascribed to such term in Section 6(i). (l) "Registrable Shares" means Common Stock which constitutes Restricted Shares. (m) "Restricted Shares" means the Series B Restricted Shares. As to any particular Restricted Shares, once issued, such Restricted Shares shall cease to be Restricted Shares when (i) they have been registered under the Securities Act, the registration statement in connection therewith has been declared effective and they have been disposed of pursuant to such effective registration statement, (ii) they are eligible to be sold or distributed pursuant to Rule 144 within any consecutive three month period (including, without limitation, Rule 144(k)) without volume limitations, or (iii) they shall have ceased to be outstanding. (n) "Registration Date" means the date upon which the registration statement pursuant to which the Corporation shall have initially registered shares of Common Stock under the Securities Act for sale to the public shall have been declared effective. (o) "Rule 144" means Rule 144 promulgated under the Securities Act or any successor rule thereto or any complementary rule thereto (such as Rule 144A). (p) "Securities Act" means the Securities Act of 1933 or any successor Federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect from time to time. (q) "Securities Purchase Agreement" means the Securities Purchase Agreement dated the date hereof, among the Corporation and the Investor party thereto. (r) "Series B Preferred" means the Series B Convertible Preferred Stock, $.001 par value per share of the Corporation, issued to the Investor pursuant to the Securities Purchase Agreement. (s) "Series B Restricted Shares" means shares of Common Stock issued or issuable upon conversion of the Series B Preferred or any other securities of the Company issued from time to time to the Investors. -2- Section 2. Required Registration. (a) At any time after six months after the Registration Date, if holders of not less than 20% of the Series B Restricted Shares then outstanding shall in writing state that such holders desire to sell Registrable Shares in the public securities markets and request the Corporation to effect the registration under the Securities Act of Registrable Shares, the Corporation shall promptly use its best efforts to effect the registration under the Securities Act of the Registrable Shares which the Corporation has been so requested to register. (b) Anything contained in Section 2(a) to the contrary notwithstanding, the Corporation shall not be obligated to effect any registration under the Securities Act pursuant to Section 2(a) except in accordance with the following provisions: (i) The Corporation shall not be obligated to use its best efforts to file and cause to become effective (A) more than two registration statements initiated pursuant to this Section 2 on Form S-1 promulgated under the Securities Act or any successor forms thereto, (B) any registration statement with respect to which the reasonably anticipated proceeds shall not exceed $5,000,000 or (C) any registration statement during any period in which any other registration statement (other than on Form S-4 or Form S-8 promulgated under the Securities Act or any successor forms thereto) pursuant to which Primary Shares are to be or were sold has been filed and not withdrawn or has been declared effective within the prior 90 days. (ii) The Corporation may delay the filing or effectiveness of any registration statement for a period of up to 90 days after the date of a request for registration pursuant to this Section 2 if at the time of such request (A) the Corporation is engaged, or has fixed plans to engage within 90 days of the time of such request, in a firm commitment underwritten public offering of Primary Shares in which the holders of Registrable Shares may include Registrable Shares pursuant to Section 3 or (B) the Corporation reasonably determines that such registration and offering would interfere with any material transaction involving the Corporation, as approved by the Board of Directors. (iii) With respect to any registration pursuant to this Section 2, the Corporation shall give notice of such registration to any Investor who does not request registration hereunder and to the holders of all Other Shares which are entitled to piggy back registration rights and the Corporation may include in such registration any other Registrable Shares, Primary Shares or Other Shares; provided, however, that if the managing underwriter advises the Corporation that the inclusion of all Registrable Shares, Primary Shares and/or Other Shares proposed to be included in such registration would interfere with the successful marketing (including pricing) of the Registrable Shares proposed to be included in such registration, then the number of Registrable Shares, Primary Shares and/or Other Shares proposed to be included in such registration shall be included in the following order: -3- (A) first, the Registrable Shares requested to be included in such registration (or, if necessary, such Registrable Shares pro rata among the holders thereof based upon the number of Registrable Shares requested to be registered by each such holder); (B) second, the Primary Shares; and (C) third, the Other Shares which are entitled to piggy back registration rights. (c) At any time before the registration statement covering Registrable Shares becomes effective, the holders of a majority of the Series B Restricted Shares requested to be included in such registration may request the Corporation to withdraw or not to file the registration statement. In that event, if such request of withdrawal shall not have been caused by, or made in response to, the material adverse effect of an event on the business, properties, condition, financial or otherwise, or operations of the Corporation, the holders shall have used one of their demand registration rights under this Section 2 and the Corporation shall no longer be obligated to register Registrable Shares pursuant to the exercise of such one registration right pursuant to this Section 2 unless the remaining holders shall pay to the Corporation the expenses incurred by the Corporation through the date of such request. A registration will not count as a demand registration for purposes of Section 2 hereof unless the Investors requesting registration are able to register at least 85% of the Registrable Shares requested to be included in such registration. Section 3. Piggyback Registration. If the Corporation at any time proposes for any reason to register Primary Shares or Other Shares under the Securities Act (other than on Form S-4 or Form S-8 promulgated under the Securities Act or any successor forms thereto), it shall give written notice to the Investors of its intention to so register such Primary Shares or Other Shares at least 30 days before the initial filing of such registration statement and, upon the written request, delivered to the Corporation within 20 days after delivery of any such notice by the Corporation, of the Investors to include in such registration Registrable Shares (which request shall specify the number of Registrable Shares proposed to be included in such registration and shall state that such Investors desire to sell such Registrable Shares in the public securities markets), the Corporation shall use its best efforts to cause all such Registrable Shares to be included in such registration on the same terms and conditions as the securities otherwise being sold in such registration; provided, however, that if the managing underwriter advises the Corporation that the inclusion of all Registrable Shares requested to be included in such registration would interfere with the successful marketing (including pricing) of the Primary Shares or Other Shares proposed to be registered by the Corporation, then the number of Primary Shares, Registrable Shares and Other Shares proposed to be included in such registration shall be included in the following order: (a) if the Corporation proposes to register Primary Shares: -4- (i) first, the Primary Shares; (ii) second, the Registrable Shares requested by the Investors to be included in such registration (or, if necessary, such Registrable Shares pro rata among the holders thereof based upon the number of Registrable Shares requested to be registered by each such holder); (iii) third, the Other Shares held by the parties demanding such registration. (b) The number of requests permitted by the Investors pursuant to this Section 3 shall be unlimited. Section 4. Registrations on Form S-3. Anything contained in Section 2 to the contrary notwithstanding, at such time as the Corporation shall have qualified for the use of Form S-3 promulgated under the Securities Act or any successor form thereto, the Investors holding Registrable Shares then outstanding shall have the right to request in writing that the Corporation effect the registration of Registrable Shares on Form S-3 or such successor form, which request or requests shall (i) specify the number of Registrable Shares intended to be sold or disposed of and the holders thereof and (ii) state the intended method of disposition of such Registrable Shares. A requested registration on Form S-3 or any such successor form in compliance with this Section 4 shall not count as a registration statement initiated pursuant to Section 2 but the provisions of Section 2 shall otherwise apply to a registration initiated pursuant to this Section 4. The number of requests permitted pursuant to this Section 4 shall be unlimited; provided, however, that requests may only be made pursuant to this Section 4 if the reasonably anticipated proceeds therefrom shall be at least $500,000. Section 5. Holdback Agreement. (a) If the Corporation at any time shall register shares of Common Stock under the Securities Act (including any registration pursuant to Sections 2, 3 or 4 hereof) for sale to the public, the Investors shall not sell publicly, make any short sale of, grant any option for the purchase of, or otherwise dispose publicly of, any Registrable Shares (other than those shares of Common Stock included in such registration pursuant to Sections 2, 3 or 4 hereof) without the prior written consent of the Corporation, for a period as shall be determined by the relevant managing underwriters, which period shall begin not more than 10 days prior to the effectiveness of the registration statement pursuant to which such public offering shall be made and shall not last more than 180 days after the effective date of such registration statement. The Corporation shall obtain the agreement of any Person permitted to sell shares of stock in a registration to be bound by and to comply with this Section 5 as if such Person were an Investor hereunder. (b) If the Corporation at any time pursuant to Sections 2 or 3 of this Agreement shall register under the Securities Act Registrable Shares held by the Investors for sale to the public pursuant to an underwritten offering, the Corporation shall -5- not effect any public sale or distribution of securities similar to those being registered, or any securities convertible into or exercisable or exchangeable for such securities, for such period as shall be determined by the managing underwriters. Section 6. Preparation and Filing. If and whenever the Corporation is under an obligation pursuant to the provisions of this Agreement to use its best efforts to effect the registration of any Registrable Shares, the Corporation shall, as expeditiously as practicable: (a) use its best efforts to cause a registration statement that registers such Registrable Shares to become and remain effective for a period of 90 days or until all of such Registrable Shares have been disposed of (if earlier); (b) furnish, at least five business days before filing a registration statement that registers such Registrable Shares, a prospectus relating thereto or any amendments or supplements relating to such a registration statement or prospectus, to one counsel selected by the Investors ("Counsel") copies of all such documents proposed to be filed (it being understood that such five-business-day period need not apply to successive drafts of the same document proposed to be filed so long as such successive drafts are supplied to Counsel in advance of the proposed filing by a period of time that is customary and reasonable under the circumstances); (c) prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective for at least a period of 90 days or until all of such Registrable Shares have been disposed of (if earlier) and to comply with the provisions of the Securities Act with respect to the sale or other disposition of such Registrable Shares; (d) promptly notify Counsel in writing (i) of the receipt by the Corporation of any notification with respect to any comments by the Commission with respect to such registration statement or prospectus or any amendment or supplement thereto or any request by the Commission for the amending or supplementing thereof or for additional information with respect thereto, (ii) of the receipt by the Corporation of any notification with respect to the issuance by the Commission of any stop order suspending the effectiveness of such registration statement or prospectus or any amendment or supplement thereto or the initiation or threatening of any proceeding for that purpose and (iii) of the receipt by the Corporation of any notification with respect to the suspension of the qualification of such Registrable Shares for sale in any jurisdiction or the initiation or threatening of any proceeding for such purposes; (e) use its best efforts to register or qualify such Registrable Shares under such other securities or blue sky laws of such jurisdictions as the holders of the Registrable Shares reasonably request and do any and all other acts and things which may be reasonably necessary or advisable to enable such holders to consummate the disposition in such jurisdictions of such holders' Registrable Shares; provided, however, -6- that the Corporation will not be required to qualify generally to do business, subject itself to general taxation or consent to general service of process in any jurisdiction where it would not otherwise be required to do so but for this paragraph (e) or to provide any material undertaking or make any changes in its by-laws or amended and restated certificate of incorporation which the Board of Directors determines to be contrary to the best interests of the Corporation or to modify any of its contractual relationships then existing; (f) furnish to the holders of such Registrable Shares such number of copies of a summary prospectus, if any, or other prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as such holders may reasonably request in order to facilitate the public sale or other disposition of such Registrable Shares; (g) without limiting subsection (e) above, use its best efforts to cause such Registrable Shares to be registered with or approved by such other governmental agencies or authorities as may be necessary by virtue of the business and operations of the Corporation to enable the holders of such Registrable Shares to consummate the disposition of such Registrable Shares; (h) notify the holders of such Registrable Shares on a timely basis at any time when a prospectus relating to such Registrable Shares is required to be delivered under the Securities Act within the appropriate period mentioned in subparagraph (a) of this Section 6, of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing and, at the request of such holders, prepare and furnish to such holders a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the offerees of such shares, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing; (i) subject to the execution of confidentiality agreements in form and substance satisfactory to the Corporation, make available upon reasonable notice and during normal business hours, for inspection by the holders of such Registrable Shares any underwriter participating in any disposition pursuant to such registration statement and any attorney, accountant or other agent retained by the Investors or underwriter (collectively, the "Inspectors"), all pertinent financial and other records, pertinent corporate documents and properties of the Corporation (collectively, the "Records"), as shall be reasonably necessary to enable them to exercise their due diligence responsibility, and cause the Corporation's officers, directors and employees to supply all information (together with the Records, the "Information") reasonably requested by any such Inspector in connection with such registration statement. Any of the Information which the Corporation determines in good faith to be confidential, and of which determination the Inspectors are so notified, shall not be disclosed by the Inspectors -7- unless (i) the disclosure of such Information is necessary to avoid or correct a misstatement or omission in the registration statement, (ii) the release of such Information is ordered pursuant to a subpoena or other order from a court of competent jurisdiction or (iii) such Information has been made generally available to the public; the Investors agree that they will, upon learning that disclosure of such Information is sought in a court of competent jurisdiction, give notice to the Corporation and allow the Corporation, at the Corporation's expense, to undertake appropriate action to prevent disclosure of the Information deemed confidential; (j) use its best efforts to obtain from its independent certified public accountants "cold comfort" letters in customary form and at customary times and covering matters of the type customarily covered by cold comfort letters; (k) use its best efforts to obtain from its counsel an opinion or opinions in customary form; (l) provide a transfer agent and registrar (which may be the same entity and which may be the Corporation) for such Registrable Shares; (m) issue to any underwriter to which the holders of such Registrable Shares may sell shares in such offering certificates evidencing such Registrable Shares; (n) list such Registrable Shares on any national securities exchange on which any shares of the Common Stock are listed or, if the Common Stock is not listed on a national securities exchange, use its best efforts to qualify such Registrable Shares for listing on the Nasdaq Stock Market, or such other national securities exchange as the holders of a majority of such Registrable Shares shall reasonably request; (o) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission and make available to its securityholders, as soon as reasonably practicable, earnings statements (which need not be audited) covering a period of 12 months beginning within three months after the effective date of the registration statement, which earnings statements shall satisfy the provisions of Section 11(a) of the Securities Act; and (p) subject to all the other provisions of this Agreement, use its best efforts to take all other steps necessary to effect the registration of such Registrable Shares contemplated hereby. Each holder of the Registrable Shares upon receipt of any notice from the Corporation of any event of the kind described in Section 6(h) hereof, shall forthwith discontinue disposition of the Registrable Shares pursuant to the registration statement covering such Registrable Shares until such holder's receipt of the copies of the supplemented or amended prospectus contemplated by Section 6(h) hereof, and, if so directed by the Corporation, such holder shall deliver to the Corporation all copies, other than permanent file copies then in such holder's possession, of the prospectus covering such Registrable Shares at the time of receipt of such notice. -8- Section 7. Expenses. All expenses (other than underwriting discounts and commissions relating to the Registrable Shares, as provided in the last sentence of this Section 7) incurred by the Corporation in complying with Section 6, including, without limitation, all registration and filing fees (including all expenses incident to filing with the National Association of Securities Dealers, Inc.), fees and expenses of complying with securities and blue sky laws, printing expenses, fees and expenses of the Corporation's counsel and accountants and reasonable fees and expenses of Counsel shall be paid by the Corporation; provided, however, that all underwriting discounts and selling commissions applicable to the Registrable Shares shall be borne by the holders selling such Registrable Shares, in proportion to the number of Registrable Shares sold by each such holder. Section 8. Indemnification. (a) In connection with any registration of any Registrable Shares under the Securities Act pursuant to this Agreement, the Corporation shall indemnify and hold harmless the holders of Registrable Shares, each underwriter, broker or any other Person acting on behalf of the holders of Registrable Shares and each other Person, if any, who controls any of the foregoing Persons within the meaning of the Securities Act against any losses, claims, damages or liabilities, joint or several (or actions in respect thereof), to which any of the foregoing Persons may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or allegedly untrue statement of a material fact contained in the registration statement under which such Registrable Shares were registered under the Securities Act, any preliminary prospectus or final prospectus contained therein or otherwise filed with the Commission, any amendment or supplement thereto or any document incident to registration or qualification of any Registrable Shares, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading or, with respect to any prospectus, necessary to make the statements therein in light of the circumstances under which they were made not misleading, or any violation by the Corporation of the Securities Act or state securities or blue sky laws applicable to the Corporation and relating to action or inaction required of the Corporation in connection with such registration or qualification under such state securities or blue sky laws; and shall reimburse the holders of Registrable Shares, such underwriter, such broker or such other Person acting on behalf of the holders of Registrable Shares and each such controlling Person for any legal or other expenses reasonably incurred by any of them in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the Corporation shall not be liable in any such case to the extent that any such loss, claim, damage, liability or action (including any legal or other expenses incurred) arises out of or is based upon an untrue statement or allegedly untrue statement or omission or alleged omission made in said registration statement, preliminary prospectus, final prospectus, amendment, supplement or document incident to registration or qualification of any Registrable Shares in reliance upon and in conformity with written information furnished to the -9- Corporation through an instrument duly executed by the holders of Registrable Shares specifically for use in the preparation thereof. (b) In connection with any registration of Registrable Shares under the Securities Act pursuant to this Agreement, each holder of Registrable Shares shall severally and not jointly indemnify and hold harmless (in the same manner and to the same extent as set forth in the preceding paragraph of this Section 8) the Corporation, each director of the Corporation, each officer of the Corporation who shall sign such registration statement, each underwriter, broker or other Person acting on behalf of the holders of Registrable Shares and each Person who controls any of the foregoing Persons within the meaning of the Securities Act with respect to any statement or omission from such registration statement, any preliminary prospectus or final prospectus contained therein or otherwise filed with the Commission, any amendment or supplement thereto or any document incident to registration or qualification of any Registrable Shares if such statement or omission was made in reliance upon and in conformity with written information furnished by such holder to the Corporation or such underwriter specifically for use in connection with the preparation of such registration statement, preliminary prospectus, final prospectus, amendment, supplement or document; provided, however, that the maximum amount of liability in respect of such indemnification shall be limited, in the case of each seller of Registrable Shares to an amount equal to the net proceeds actually received by such seller from the sale of Registrable Shares effected pursuant to such registration. (c) Promptly after receipt by an indemnified party of notice of the commencement of any action involving a claim referred to in the preceding paragraphs of this Section 8, such indemnified party will, if a claim in respect thereof is made against an indemnifying party, give written notice to the latter of the commencement of such action. The failure of any indemnified party to notify an indemnifying party of any such action shall not (unless such failure shall have a material adverse effect on the indemnifying party) relieve the indemnifying party from any liability in respect of such action that it may have to such indemnified party on account of this Section 8. In case any such action is brought against an indemnified party, the indemnifying party will be entitled to participate in and to assume the defense thereof, jointly with any other indemnifying party similarly notified to the extent that it may wish, with counsel reasonably satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be responsible for any legal or other expenses subsequently incurred by the indemnified party in connection with the defense thereof; provided, however, that if any indemnified party shall have reasonably concluded that there may be one or more legal or equitable defenses available to such indemnified party which are additional to or conflict with those available to the indemnifying party, or that such claim or litigation involves or could have an effect upon matters beyond the scope of the indemnity agreement provided in this Section 8, the indemnifying party shall not have the right to assume the defense of such action on behalf of such indemnified party (but shall have the right to participate therein with counsel of its choice) and such indemnifying party shall reimburse such indemnified party and any Person controlling such indemnified party for that portion of the fees and expenses of any counsel retained by the -10- indemnified party which is reasonably related to the matters covered by the indemnity agreement provided in this Section 8. If the indemnifying party is not entitled to, or elects not to, assume the defense of a claim, it will not be obligated to pay the fees and expenses of more than one counsel with respect to such claim. (d) If the indemnification provided for in this Section 8 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, claim, damage, liability or action referred to herein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amounts paid or payable by such indemnified party as a result of such loss, claim, damage, liability or action in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions which resulted in such loss, claim, damage, liability or action as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The parties agree that it would not be just and equitable if contribution pursuant hereto were determined by pro rata allocation or by any other method or allocation which does not take account of the equitable considerations referred to herein. No Person guilty of fraudulent misrepresentation shall be entitled to contribution from any Person. Section 9. Underwriting Agreement. Notwithstanding the provisions of Sections 5, 6, 7 and 8, to the extent that the Investors shall enter into an underwriting or similar agreement, which agreement contains provisions covering one or more issues addressed in such Sections, the provisions contained in such agreement addressing such issue or issues shall control. No holder may participate in any underwritten registration hereunder unless such holder (a) agrees to sell such holder's securities on the basis provided in any underwriting arrangements and (b) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents reasonably and customarily required under the terms of such underwriting arrangements. Section 10. Information. Each Investor shall furnish to the Corporation such written information regarding such Person and the distribution proposed by such Person as the Corporation may reasonably request in writing and as shall be reasonably required in connection with any registration, qualification or compliance referred to in this Agreement. -11- Section 11. Exchange Act Compliance. From the Registration Date or such earlier date as a registration statement filed by the Corporation pursuant to the Securities Act relating to any class of the Corporation's securities shall have become effective, the Corporation shall comply with all of the reporting requirements of the Exchange Act applicable to it (whether or not it shall be required to do so, but specifically excluding Section 14 of the Exchange Act if not then applicable to the Corporation) and shall comply with all other public information reporting requirements of the Commission which are conditions to the availability of Rule 144 for the sale of the Common Stock. The Corporation shall cooperate with the Investors in supplying such information as may be necessary for the Investors to complete and file any information reporting forms presently or hereafter required by the Commission as a condition to the availability of Rule 144. Section 12. No Conflict of Rights. The Corporation has not in the past, and shall not, after the date hereof, grant any registration rights which conflict with or impair the registration rights granted hereby. Section 13. Termination. This Agreement shall terminate and be of no further force or effect when there shall no longer be any Registrable Shares outstanding. Section 14. Successors and Assigns. This Agreement shall bind and inure to the benefit of the Corporation and the Investors and, subject to Section 15, the respective successors and assigns of the Corporation and the Investors. Section 15. Assignment. Each Investor may assign its rights hereunder to any purchaser or transferee of Registrable Shares; provided, however, that such purchaser or transferee shall, as a condition to the effectiveness of such assignment, be required to execute a counterpart to this Agreement agreeing to be treated as an Investor, whereupon such purchaser or transferee shall have the benefits of, and shall be subject to the restrictions contained in, this Agreement as if such purchaser or transferee was originally included in the definition of an Investor herein and had originally been a party hereto. Section 16. Entire Agreement. This Agreement, the Securities Purchase Agreement, and the Stockholders' Agreement (as defined in the Securities Purchase Agreement), each dated as of the date hereof, and the other writings referred to herein or therein or delivered pursuant hereto or thereto, contain the entire agreement among the Investors and the Corporation with respect to the subject matter hereof and supersede all prior and -12- contemporaneous arrangements or understandings with respect thereto, all of which are hereby automatically terminated in their entirety and of no further force or effect, without any action by the parties thereto. Section 17. Notices. All notices, requests, consents and other communications hereunder to any party shall be deemed to be sufficient if contained in a written instrument delivered in person or sent by telecopy, nationally-recognized overnight courier or first class registered or certified mail, return receipt requested, postage prepaid, addressed to such party at the address set forth below or such other address as may hereafter be designated in writing by such party to the other parties: (i) if to the Corporation, to: Nephros, Inc. 3960 Broadway New York, NY 10032 Telephone: (212) 781-5113 Telecopy: (212) 781-5166 Attention: Norman Barta with a copy to: Kramer Levin Naftalis & Frankel, LLP 919 Third Avenue New York, NY 10022 Telecopy: (212) 715-8000 Attention: Thomas Constance, Esq. Peter Smith, Esq. (ii) if to the Investors, to their respective addresses set forth on Schedule I hereto, with a copy to: O'Sullivan Graev & Karabell, LLP 30 Rockefeller Plaza New York, New York 10112 Telephone: (212) 408-2440 Facsimile: (212) 408-2420 Attention: William B. Kuesel All such notices, requests, consents and other communications shall be deemed to have been delivered (a) in the case of personal delivery or delivery by telecopy, on the date of such delivery, (b) in the case of dispatch by nationally-recognized overnight courier, on the next business day following such dispatch and (c) in the case of mailing, on the fifth business day after the posting thereof. -13- Section 18. Modifications; Amendments; Waivers. The terms and provisions of this Agreement may not be modified or amended, nor may any provision be waived, except pursuant to a writing signed by the Corporation and the holders of at least a majority of the Registrable Shares then outstanding. Section 19. Counterparts; Facsimile Signatures. This Agreement may be executed in any number of counterparts, and each such counterpart hereof shall be deemed to be an original instrument, but all such counterparts together shall constitute but one agreement. Facsimile counterpart signatures to this Agreement shall be acceptable at the Closing (as defined in the Securities Purchase Agreement) if the originally executed counterpart is delivered within a reasonable period thereafter. Section 20. Headings. The headings of the various sections of this Agreement have been inserted for convenience of reference only and shall not be deemed to be a part of this Agreement. Section 21. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to contracts made and to be performed wholly therein. -14- IN WITNESS WHEREOF, the parties hereto have executed this Registration Rights Agreement on the date first written above. NEPHROS, INC. By: ______________________________ Name: Title: NEP EMPLOYEE PARTNERS LLC By: ______________________________ Name: Title: WPPN, INC. By: ------------------------------ Name: Title: EX-10 7 kl10022_ex10-4.txt EXHIBIT 10.4 Exhibit 10.4 REGISTRATION RIGHTS AGREEMENT DATED AS OF MAY 17, 2000 among NEPHROS, INC., the HOLDERS, and the INVESTORS IDENTIFIED HEREIN TABLE OF CONTENTS Page Section 1. Definitions.......................................................1 Section 2. Required Registration.............................................3 Section 3. Piggyback Registration............................................4 Section 4. Registrations on Form S-3.........................................5 Section 5. Holdback Agreement................................................5 Section 6. Preparation and Filing............................................6 Section 7. Expenses..........................................................9 Section 8. Indemnification...................................................9 Section 9. Underwriting Agreement...........................................11 Section 10. Information......................................................12 Section 11. Exchange Act Compliance..........................................12 Section 12. No Conflict of Rights............................................12 Section 13. Termination......................................................12 Section 14. Successors and Assigns...........................................12 Section 15. Assignment.......................................................12 Section 16. Entire Agreement.................................................13 Section 17. Notices..........................................................13 Section 18. Modifications; Amendments; Waivers...............................14 Section 19. Counterparts; Facsimile Signatures...............................14 Section 20. Headings.........................................................14 Section 21. Governing Law....................................................14 i REGISTRATION RIGHTS AGREEMENT, dated as of May 17, 2000, between NEPHROS, INC., a Delaware corporation (the "Corporation"), and the INVESTORS (as herein defined). The Investors own or have the right to purchase or otherwise acquire shares of the Common Stock (as hereinafter defined) of the Corporation. The Corporation and the Investors deem it to be in their respective best interests to set forth the rights of the Investors in connection with public offerings and sales of the Common Stock. NOW, THEREFORE, in consideration of the premises and mutual covenants and obligations hereinafter set forth, the Corporation and the Investors hereby agree as follows: Section 1. Definitions. As used in this Agreement, the following terms shall have the following meanings: (a) "Commission" means the Securities and Exchange Commission or any other Federal agency at the time administering the Securities Act. (b) "Common Stock" means the common stock, $.001 par value per share, of the Corporation. (c) "Counsel" shall have the meaning ascribed to such term in Section 6(b). (d) "Exchange Act" means the Securities Exchange Act of 1934 or any successor Federal statute, and the rules and regulations of the Commission promulgated thereunder, all as the same shall be in effect from time to time. (e) "Information" shall have the meaning ascribed to such term in Section 6(i). (f) "Initial Public Offering" shall mean an initial public offering pursuant to a registration statement on Form S-1 under the Securities Act (or any equivalent successor form) pursuant to a bona fide firm commitment underwriting. (g) "Inspectors" shall have the meaning ascribed to such term in Section 6(i). (h) "Investors" means the Person set forth on Schedule I and each additional Person who shall execute a counterpart signature page hereto, and includes any successor to, or assignee or transferee of, any such Person who or which agrees in writing to be treated as an Investor hereunder and to be bound by the terms and comply with all applicable provisions hereof. (i) "Other Shares" means at any time those shares of Common Stock which do not constitute Primary Shares or Registrable Shares. (j) "Person" means any individual, partnership, corporation, group, trust, limited liability company or other legal entity. (k) "Primary Shares" means at any time the authorized but unissued shares of Common Stock and shares of Common Stock held by the Corporation in its treasury. (l) "Records" shall have the meaning ascribed to such term in Section 6(i). (m) "Registrable Shares" means Common Stock which constitutes Restricted Shares. (n) "Restricted Shares" means, in the aggregate, the Series B Restricted Shares and Series C Restricted Shares. As to any particular Restricted Shares, once issued, such Restricted Shares shall cease to be Restricted Shares when (i) they have been registered under the Securities Act, the registration statement in connection therewith has been declared effective and they have been disposed of pursuant to such effective registration statement, (ii) they are eligible to be sold or distributed pursuant to Rule 144 within any consecutive three month period (including, without limitation, Rule 144(k)) without volume limitations, or (iii) they shall have ceased to be outstanding. (o) "Registration Date" means the date upon which the registration statement pursuant to which the Corporation shall have initially registered shares of Common Stock under the Securities Act for sale to the public shall have been declared effective. (p) "Rule 144" means Rule 144 promulgated under the Securities Act or any successor rule thereto or any complementary rule thereto (such as Rule 144A). (q) "Securities Act" means the Securities Act of 1933 or any successor Federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect from time to time. (r) "Securities Purchase Agreement" means the Securities Purchase Agreement dated the date hereof, among the Corporation and the Investor party thereto. (s) "Series B Preferred" means the Series B Convertible Preferred Stock, $.001 per value per share of the Corporation, issued to the Investors pursuant to the Securities Purchase Agreement dated as of February 8, 2000. (t) "Series C Preferred" means the Series C Convertible Preferred Stock, $.001 par value per share of the Corporation, issued to the Investor pursuant to the Securities Purchase Agreement dated the date hereof. -2- (u) "Series B Restricted Shares" means shares of Common Stock issued or issuance upon conversion of the Series B Preferred or any other securities of the Company issued from time to time to the Investors. (v) "Series C Restricted Shares" means shares of Common Stock issued or issuable upon conversion of the Series C Preferred or any other securities of the Company issued from time to time to the Investors. Section 2. Required Registration. (a) At any time after six months after the Registration Date, if holders of not less than 20% of the Series B Restricted Shares and Series C Restricted Shares, in the aggregate, then outstanding shall, in writing, state that such holders desire to sell Registrable Shares in the public securities markets and request the Corporation to effect the registration under the Securities Act of Registrable Shares, the Corporation shall promptly use its best efforts to effect the registration under the Securities Act of the Registrable Shares which the Corporation has been so requested to register. (b) Anything contained in Section 2(a) to the contrary notwithstanding, the Corporation shall not be obligated to effect any registration under the Securities Act pursuant to Section 2(a) except in accordance with the following provisions: (i) The Corporation shall not be obligated to use its best efforts to file and cause to become effective (A) more than two registration statements initiated pursuant to this Section 2 on Form S-1 promulgated under the Securities Act or any successor forms thereto, (B) any registration statement with respect to which the reasonably anticipated proceeds shall not exceed $5,000,000 or (C) any registration statement during any period in which any other registration statement (other than on Form S-4 or Form S-8 promulgated under the Securities Act or any successor forms thereto) pursuant to which Primary Shares are to be or were sold has been filed and not withdrawn or has been declared effective within the prior 90 days. (ii) The Corporation may delay the filing or effectiveness of any registration statement for a period of up to 90 days after the date of a request for registration pursuant to this Section 2 if at the time of such request (A) the Corporation is engaged, or has fixed plans to engage within 90 days of the time of such request, in a firm commitment underwritten public offering of Primary Shares in which the holders of Registrable Shares may include Registrable Shares pursuant to Section 3 or (B) the Corporation reasonably determines that such registration and offering would interfere with any material transaction involving the Corporation, as approved by the Board of Directors. (iii) With respect to any registration pursuant to this Section 2, the Corporation shall give notice of such registration to any Investor who does not request registration hereunder and to the holders of all Other Shares which are entitled to piggy back registration rights and the Corporation may include in such registration any other Registrable Shares, Primary Shares or Other Shares; provided, however, that if the managing underwriter advises the Corporation that the inclusion of all Registrable Shares, Primary Shares and/or Other Shares proposed to be included in such -3- registration would interfere with the successful marketing (including pricing) of the Registrable Shares proposed to be included in such registration, then the number of Registrable Shares, Primary Shares and/or Other Shares proposed to be included in such registration shall be included in the following order: (A) first, the Registrable Shares requested to be included in such registration (or, if necessary, such Registrable Shares pro rata among the holders thereof based upon the number of Registrable Shares requested to be registered by each such holder); (B) second, the Primary Shares; and (C) third, the Other Shares which are entitled to piggy back registration rights. (c) At any time before the registration statement covering Registrable Shares becomes effective, the holders of a majority of the Series B Restricted Shares and Series C Restricted Shares, in the aggregate, requested to be included in such registration may request the Corporation to withdraw or not to file the registration statement. In that event, if such request of withdrawal shall not have been caused by, or made in response to, the material adverse effect of an event on the business, properties, condition, financial or otherwise, or operations of the Corporation, the holders shall have used one of their demand registration rights under this Section 2 and the Corporation shall no longer be obligated to register Registrable Shares pursuant to the exercise of such one registration right pursuant to this Section 2 unless the remaining holders shall pay to the Corporation the expenses incurred by the Corporation through the date of such request. A registration will not count as a demand registration for purposes of Section 2 hereof unless the Investors requesting registration are able to register at least 85% of the Registrable Shares requested to be included in such registration. Section 3. Piggyback Registration. If the Corporation at any time proposes for any reason to register Primary Shares or Other Shares under the Securities Act (other than on Form S-4 or Form S-8 promulgated under the Securities Act or any successor forms thereto), it shall give written notice to the Investors of its intention to so register such Primary Shares or Other Shares at least 30 days before the initial filing of such registration statement and, upon the written request, delivered to the Corporation within 20 days after delivery of any such notice by the Corporation, of the Investors to include in such registration Registrable Shares (which request shall specify the number of Registrable Shares proposed to be included in such registration and shall state that such Investors desire to sell such Registrable Shares in the public securities markets), the Corporation shall use its best efforts to cause all such Registrable Shares to be included in such registration on the -4- same terms and conditions as the securities otherwise being sold in such registration; provided, however, that if the managing underwriter advises the Corporation that the inclusion of all Registrable Shares requested to be included in such registration would interfere with the successful marketing (including pricing) of the Primary Shares or Other Shares proposed to be registered by the Corporation, then the number of Primary Shares, Registrable Shares and Other Shares proposed to be included in such registration shall be included in the following order: (a) if the Corporation proposes to register Primary Shares: (i) first, the Primary Shares; (ii) second, the Registrable Shares requested by the Investors to be included in such registration (or, if necessary, such Registrable Shares pro rata among the holders thereof based upon the number of Registrable Shares requested to be registered by each such holder); (iii) third, the Other Shares held by the parties demanding such registration. (b) The number of requests permitted by the Investors pursuant to this Section 3 shall be unlimited. Section 4. Registrations on Form S-3. Anything contained in Section 2 to the contrary notwithstanding, at such time as the Corporation shall have qualified for the use of Form S-3 promulgated under the Securities Act or any successor form thereto, the Investors holding Registrable Shares then outstanding shall have the right to request in writing that the Corporation effect the registration of Registrable Shares on Form S-3 or such successor form, which request or requests shall (i) specify the number of Registrable Shares intended to be sold or disposed of and the holders thereof and (ii) state the intended method of disposition of such Registrable Shares. A requested registration on Form S-3 or any such successor form in compliance with this Section 4 shall not count as a registration statement initiated pursuant to Section 2 but the provisions of Section 2 shall otherwise apply to a registration initiated pursuant to this Section 4. The number of requests permitted pursuant to this Section 4 shall be unlimited; provided, however, that requests may only be made pursuant to this Section 4 if the reasonably anticipated proceeds therefrom shall be at least $500,000. Section 5. Holdback Agreement. (a) If the Corporation at shall effect an Initial Public Offering or if at any time thereafter, the Corporation shall register its shares of Common Stock under the Securities Act for sale to the public on a registration statement under which the Investors are given the opportunity to have their Registrable Shares registered (including any such registration in accordance with Sections 2, 3 or 4 hereof), the Investors shall not sell publicly, make any short sale of, grant any option for the purchase of, or otherwise -5- dispose publicly of, any Registrable Shares (other than those shares of Common Stock included in such registration pursuant to such Initial Public Offering or in accordance with Sections 2, 3 or 4 hereof) without the prior written consent of the Corporation, for a period as shall be determined by the relevant managing underwriters, which period shall begin not more than 10 days prior to the effectiveness of the registration statement pursuant to which such public offering shall be made and shall not last more than 180 days after the effective date of such registration statement. The Corporation shall obtain the agreement of any Person permitted to sell shares of stock in a registration to be bound by and to comply with this Section 5 as if such Person were an Investor hereunder. (b) If the Corporation at any time pursuant to Sections 2 or 3 of this Agreement shall register under the Securities Act Registrable Shares held by the Investors for sale to the public pursuant to an underwritten offering, the Corporation shall not effect any public sale or distribution of securities similar to those being registered, or any securities convertible into or exercisable or exchangeable for such securities, for such period as shall be determined by the managing underwriters. Section 6. Preparation and Filing. If and whenever the Corporation is under an obligation pursuant to the provisions of this Agreement to use its best efforts to effect the registration of any Registrable Shares, the Corporation shall, as expeditiously as practicable: (a) use its best efforts to cause a registration statement that registers such Registrable Shares to become and remain effective until the earlier of 90 days after such registration statement becomes effective or such time as all of such Registrable Shares are eligible to be sold or distributed pursuant to Rule 144 (including, without limitation, Rule 144(k)) within any consecutive three-month period without volume limitations; (b) furnish, at least five business days before filing a registration statement that registers such Registrable Shares, a prospectus relating thereto or any amendments or supplements relating to such a registration statement or prospectus, to one counsel selected by the Investors ("Counsel") copies of all such documents proposed to be filed (it being understood that such five-business-day period need not apply to successive drafts of the same document proposed to be filed so long as such successive drafts are supplied to Counsel in advance of the proposed filing by a period of time that is customary and reasonable under the circumstances); (c) prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective for at least a period of 90 days or until all of such Registrable Shares have been disposed of (if earlier) and to comply with the provisions of the Securities Act with respect to the sale or other disposition of such Registrable Shares; (d) promptly notify Counsel in writing (i) of the receipt by the Corporation of any notification with respect to any comments by the Commission with respect to such -6- registration statement or prospectus or any amendment or supplement thereto or any request by the Commission for the amending or supplementing thereof or for additional information with respect thereto, (ii) of the receipt by the Corporation of any notification with respect to the issuance by the Commission of any stop order suspending the effectiveness of such registration statement or prospectus or any amendment or supplement thereto or the initiation or threatening of any proceeding for that purpose and (iii) of the receipt by the Corporation of any notification with respect to the suspension of the qualification of such Registrable Shares for sale in any jurisdiction or the initiation or threatening of any proceeding for such purposes; (e) use its best efforts to register or qualify such Registrable Shares under such other securities or blue sky laws of such jurisdictions as the holders of the Registrable Shares reasonably request and do any and all other acts and things which may be reasonably necessary or advisable to enable such holders to consummate the disposition in such jurisdictions of such holders' Registrable Shares; provided, however, that the Corporation will not be required to qualify generally to do business, subject itself to general taxation or consent to general service of process in any jurisdiction where it would not otherwise be required to do so but for this paragraph (e) or to provide any material undertaking or make any changes in its by-laws or amended and restated certificate of incorporation which the Board of Directors determines to be contrary to the best interests of the Corporation or to modify any of its contractual relationships then existing; (f) furnish to the holders of such Registrable Shares such number of copies of a summary prospectus, if any, or other prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as such holders may reasonably request in order to facilitate the public sale or other disposition of such Registrable Shares; (g) without limiting subsection (e) above, use its best efforts to cause such Registrable Shares to be registered with or approved by such other governmental agencies or authorities as may be necessary by virtue of the business and operations of the Corporation to enable the holders of such Registrable Shares to consummate the disposition of such Registrable Shares; (h) notify the holders of such Registrable Shares on a timely basis at any time when a prospectus relating to such Registrable Shares is required to be delivered under the Securities Act within the appropriate period mentioned in subparagraph (a) of this Section 6, of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing and, at the request of such holders, prepare and furnish to such holders a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the offerees of such shares, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to -7- be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing; (i) subject to the execution of confidentiality agreements in form and substance satisfactory to the Corporation, make available upon reasonable notice and during normal business hours, for inspection by the holders of such Registrable Shares any underwriter participating in any disposition pursuant to such registration statement and any attorney, accountant or other agent retained by the Investors or underwriter (collectively, the "Inspectors"), all pertinent financial and other records, pertinent corporate documents and properties of the Corporation (collectively, the "Records"), as shall be reasonably necessary to enable them to exercise their due diligence responsibility, and cause the Corporation's officers, directors and employees to supply all information (together with the Records, the "Information") reasonably requested by any such Inspector in connection with such registration statement. Any of the Information which the Corporation determines in good faith to be confidential, and of which determination the Inspectors are so notified, shall not be disclosed by the Inspectors unless (i) the disclosure of such Information is necessary to avoid or correct a misstatement or omission in the registration statement, (ii) the release of such Information is ordered pursuant to a subpoena or other order from a court of competent jurisdiction or (iii) such Information has been made generally available to the public; the Investors agree that they will, upon learning that disclosure of such Information is sought in a court of competent jurisdiction, give notice to the Corporation and allow the Corporation, at the Corporation's expense, to undertake appropriate action to prevent disclosure of the Information deemed confidential; (j) use its best efforts to obtain from its independent certified public accountants "cold comfort" letters in customary form and at customary times and covering matters of the type customarily covered by cold comfort letters; (k) use its best efforts to obtain from its counsel an opinion or opinions in customary form; (l) provide a transfer agent and registrar (which may be the same entity and which may be the Corporation) for such Registrable Shares; (m) issue to any underwriter to which the holders of such Registrable Shares may sell shares in such offering certificates evidencing such Registrable Shares; (n) list such Registrable Shares on any national securities exchange on which any shares of the Common Stock are listed or, if the Common Stock is not listed on a national securities exchange, use its best efforts to qualify such Registrable Shares for listing on the Nasdaq Stock Market, or such other national securities exchange as the holders of a majority of such Registrable Shares shall reasonably request; (o) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission and make available to its securityholders, as soon as reasonably practicable, earnings statements (which need not be audited) covering a period -8- of 12 months beginning within three months after the effective date of the registration statement, which earnings statements shall satisfy the provisions of Section 11(a) of the Securities Act; and (p) subject to all the other provisions of this Agreement, use its best efforts to take all other steps necessary to effect the registration of such Registrable Shares contemplated hereby. Each holder of the Registrable Shares upon receipt of any notice from the Corporation of any event of the kind described in Section 6(h) hereof, shall forthwith discontinue disposition of the Registrable Shares pursuant to the registration statement covering such Registrable Shares until such holder's receipt of the copies of the supplemented or amended prospectus contemplated by Section 6(h) hereof, and, if so directed by the Corporation, such holder shall deliver to the Corporation all copies, other than permanent file copies then in such holder's possession, of the prospectus covering such Registrable Shares at the time of receipt of such notice. Section 7. Expenses. All expenses (other than underwriting discounts and commissions relating to the Registrable Shares, as provided in the last sentence of this Section 7) incurred by the Corporation in complying with Section 6, including, without limitation, all registration and filing fees (including all expenses incident to filing with the National Association of Securities Dealers, Inc.), fees and expenses of complying with securities and blue sky laws, printing expenses, fees and expenses of the Corporation's counsel and accountants and reasonable fees and expenses of Counsel shall be paid by the Corporation; provided, however, that all underwriting discounts and selling commissions applicable to the Registrable Shares shall be borne by the holders selling such Registrable Shares, in proportion to the number of Registrable Shares sold by each such holder. Section 8. Indemnification. (a) In connection with any registration of any Registrable Shares under the Securities Act pursuant to this Agreement, the Corporation shall indemnify and hold harmless the holders of Registrable Shares, each underwriter, broker or any other Person acting on behalf of the holders of Registrable Shares and each other Person, if any, who controls any of the foregoing Persons within the meaning of the Securities Act against any losses, claims, damages or liabilities, joint or several (or actions in respect thereof), to which any of the foregoing Persons may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or allegedly untrue statement of a material fact contained in the registration statement under which such Registrable Shares were registered under the Securities Act, any preliminary prospectus or final prospectus contained therein or otherwise filed with the Commission, any amendment or supplement thereto or any document incident to registration or qualification of any Registrable Shares, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading or, with respect to any prospectus, necessary to make the -9- statements therein in light of the circumstances under which they were made not misleading, or any violation by the Corporation of the Securities Act or state securities or blue sky laws applicable to the Corporation and relating to action or inaction required of the Corporation in connection with such registration or qualification under such state securities or blue sky laws; and shall reimburse the holders of Registrable Shares, such underwriter, such broker or such other Person acting on behalf of the holders of Registrable Shares and each such controlling Person for any legal or other expenses reasonably incurred by any of them in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the Corporation shall not be liable in any such case to the extent that any such loss, claim, damage, liability or action (including any legal or other expenses incurred) arises out of or is based upon an untrue statement or allegedly untrue statement or omission or alleged omission made in said registration statement, preliminary prospectus, final prospectus, amendment, supplement or document incident to registration or qualification of any Registrable Shares in reliance upon and in conformity with written information furnished to the Corporation through an instrument duly executed by the holders of Registrable Shares specifically for use in the preparation thereof. (b) In connection with any registration of Registrable Shares under the Securities Act pursuant to this Agreement, each holder of Registrable Shares shall severally and not jointly indemnify and hold harmless (in the same manner and to the same extent as set forth in the preceding paragraph of this Section 8) the Corporation, each director of the Corporation, each officer of the Corporation who shall sign such registration statement, each underwriter, broker or other Person acting on behalf of the holders of Registrable Shares and each Person who controls any of the foregoing Persons within the meaning of the Securities Act with respect to any statement or omission from such registration statement, any preliminary prospectus or final prospectus contained therein or otherwise filed with the Commission, any amendment or supplement thereto or any document incident to registration or qualification of any Registrable Shares if such statement or omission was made in reliance upon and in conformity with written information furnished by such holder to the Corporation or such underwriter specifically for use in connection with the preparation of such registration statement, preliminary prospectus, final prospectus, amendment, supplement or document; provided, however, that the maximum amount of liability in respect of such indemnification shall be limited, in the case of each seller of Registrable Shares to an amount equal to the net proceeds actually received by such seller from the sale of Registrable Shares effected pursuant to such registration. (c) Promptly after receipt by an indemnified party of notice of the commencement of any action involving a claim referred to in the preceding paragraphs of this Section 8, such indemnified party will, if a claim in respect thereof is made against an indemnifying party, give written notice to the latter of the commencement of such action. The failure of any indemnified party to notify an indemnifying party of any such action shall not (unless such failure shall have a material adverse effect on the indemnifying party) relieve the indemnifying party from any liability in respect of such action that it may have to such indemnified party on account of this Section 8. In case -10- any such action is brought against an indemnified party, the indemnifying party will be entitled to participate in and to assume the defense thereof, jointly with any other indemnifying party similarly notified to the extent that it may wish, with counsel reasonably satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be responsible for any legal or other expenses subsequently incurred by the indemnified party in connection with the defense thereof; provided, however, that if any indemnified party shall have reasonably concluded that there may be one or more legal or equitable defenses available to such indemnified party which are additional to or conflict with those available to the indemnifying party, or that such claim or litigation involves or could have an effect upon matters beyond the scope of the indemnity agreement provided in this Section 8, the indemnifying party shall not have the right to assume the defense of such action on behalf of such indemnified party (but shall have the right to participate therein with counsel of its choice) and such indemnifying party shall reimburse such indemnified party and any Person controlling such indemnified party for that portion of the fees and expenses of any counsel retained by the indemnified party which is reasonably related to the matters covered by the indemnity agreement provided in this Section 8. If the indemnifying party is not entitled to, or elects not to, assume the defense of a claim, it will not be obligated to pay the fees and expenses of more than one counsel with respect to such claim. (d) If the indemnification provided for in this Section 8 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, claim, damage, liability or action referred to herein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amounts paid or payable by such indemnified party as a result of such loss, claim, damage, liability or action in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions which resulted in such loss, claim, damage, liability or action as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The parties agree that it would not be just and equitable if contribution pursuant hereto were determined by pro rata allocation or by any other method or allocation which does not take account of the equitable considerations referred to herein. No Person guilty of fraudulent misrepresentation shall be entitled to contribution from any Person. Section 9. Underwriting Agreement. Notwithstanding the provisions of Sections 5, 6, 7 and 8, to the extent that the Investors shall enter into an underwriting or similar agreement, which agreement contains provisions covering one or more issues addressed in such Sections, the provisions contained in such agreement addressing such issue or issues shall control. No -11- holder may participate in any underwritten registration hereunder unless such holder (a) agrees to sell such holder's securities on the basis provided in any underwriting arrangements and (b) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents reasonably and customarily required under the terms of such underwriting arrangements. Section 10. Information. Each Investor shall furnish to the Corporation such written information regarding such Person and the distribution proposed by such Person as the Corporation may reasonably request in writing and as shall be reasonably required in connection with any registration, qualification or compliance referred to in this Agreement. Section 11. Exchange Act Compliance. From the Registration Date or such earlier date as a registration statement filed by the Corporation pursuant to the Securities Act relating to any class of the Corporation's securities shall have become effective, the Corporation shall comply with all of the reporting requirements of the Exchange Act applicable to it (whether or not it shall be required to do so, but specifically excluding Section 14 of the Exchange Act if not then applicable to the Corporation) and shall comply with all other public information reporting requirements of the Commission which are conditions to the availability of Rule 144 for the sale of the Common Stock. The Corporation shall cooperate with the Investors in supplying such information as may be necessary for the Investors to complete and file any information reporting forms presently or hereafter required by the Commission as a condition to the availability of Rule 144. Section 12. No Conflict of Rights. The Corporation has not in the past, and shall not, after the date hereof, grant any registration rights which conflict with or impair the registration rights granted hereby. Section 13. Termination. This Agreement shall terminate and be of no further force or effect when there shall no longer be any Registrable Shares outstanding. Section 14. Successors and Assigns. This Agreement shall bind and inure to the benefit of the Corporation and the Investors and, subject to Section 15, the respective successors and assigns of the Corporation and the Investors. Section 15. Assignment. Each Investor may assign its rights hereunder to any purchaser or transferee of Registrable Shares; provided, however, that such purchaser or transferee -12- shall, as a condition to the effectiveness of such assignment, be required to execute a counterpart to this Agreement agreeing to be treated as an Investor, whereupon such purchaser or transferee shall have the benefits of, and shall be subject to the restrictions contained in, this Agreement as if such purchaser or transferee was originally included in the definition of an Investor herein and had originally been a party hereto. Section 16. Entire Agreement. This Agreement, the Securities Purchase Agreement, and the Stockholders' Agreement (as defined in the Securities Purchase Agreement), each dated as of the date hereof, and the other writings referred to herein or therein or delivered pursuant hereto or thereto, contain the entire agreement among the Investors and the Corporation with respect to the subject matter hereof and supersede all prior and contemporaneous arrangements or understandings with respect thereto, all of which are hereby automatically terminated in their entirety and of no further force or effect, without any action by the parties thereto. Section 17. Notices. All notices, requests, consents and other communications hereunder to any party shall be deemed to be sufficient if contained in a written instrument delivered in person or sent by telecopy, nationally-recognized overnight courier or first class registered or certified mail, return receipt requested, postage prepaid, addressed to such party at the address set forth below or such other address as may hereafter be designated in writing by such party to the other parties: (i) if to the Corporation, to: Nephros, Inc. 3960 Broadway New York, NY 10032 Telephone: (212) 781-5113 Telecopy: (212) 781-5166 Attention: Norman Barta with a copy to: Kramer Levin Naftalis & Frankel, LLP 919 Third Avenue New York, NY 10022 Telecopy: (212) 715-8000 Attention: Thomas Constance, Esq. Peter Smith, Esq. (ii) if to the Investors, to their respective addresses set forth on Schedule I hereto. -13- All such notices, requests, consents and other communications shall be deemed to have been delivered (a) in the case of personal delivery or delivery by telecopy, on the date of such delivery, (b) in the case of dispatch by nationally-recognized overnight courier, on the next business day following such dispatch and (c) in the case of mailing, on the fifth business day after the posting thereof. Section 18. Modifications; Amendments; Waivers. The terms and provisions of this Agreement may not be modified or amended, nor may any provision be waived, except pursuant to a writing signed by the Corporation and the holders of at least a majority of the Registrable Shares then outstanding. Section 19. Counterparts; Facsimile Signatures. This Agreement may be executed in any number of counterparts, and each such counterpart hereof shall be deemed to be an original instrument, but all such counterparts together shall constitute but one agreement. Facsimile counterpart signatures to this Agreement shall be acceptable at the Closing (as defined in the Securities Purchase Agreement) if the originally executed counterpart is delivered within a reasonable period thereafter. Section 20. Headings. The headings of the various sections of this Agreement have been inserted for convenience of reference only and shall not be deemed to be a part of this Agreement. Section 21. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to contracts made and to be performed wholly therein. -14- IN WITNESS WHEREOF, the parties hereto have executed this Registration Rights Agreement on the date first written above. NEPHROS, INC. By: ______________________________ Name: Title: IN WITNESS WHEREOF, the parties hereto have executed this Registration Rights Agreement on the date first written above. INVESTOR ------------------------------ Todd Slotkin IN WITNESS WHEREOF, the parties hereto have executed this Registration Rights Agreement on the date first written above. PANETTA PARTNERS, LTD By: ______________________________ Name: Title: PANETTA PARTNERS, LTD By: ______________________________ Name: Title: SCHEDULE I Investors EX-10 8 kl10022_ex10-6.txt EXHIBIT 10.6 Exhibit 10.6 SUBSCRIPTION AGREEMENT SUBSCRIPTION AGREEMENT (this "Agreement"), dated as of August 5, 2002 by and among NEPHROS, INC., a Delaware corporation (the "Company"), and the Person or Persons listed on the signature pages hereof (the "Purchasers"). The Company desires to issue and sell to Purchasers, and Purchasers desire to purchase from the Company, Notes due 2003 in substantially the form attached hereto as Exhibit A (the "Notes") and class A warrants to purchase shares of the Company's Common Stock (the "Warrants" and, together with the Notes, the "Securities") in substantially the form attached hereto as Exhibit B, upon the terms hereinafter set forth. As used herein, the term "Offering" shall mean the sale of Securities by the Company referred to in this Agreement. Certain defined terms used herein are defined in Section 7 hereof. Accordingly, in consideration of the premises and the mutual agreements contained herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Purchasers and the Company hereby agree as follows: 1. Purchase and Sale of the Securities. Pursuant to this Agreement, the Company shall issue and sell to Purchasers, and Purchasers, severally and not jointly, shall purchase from the Company, the Securities set forth beneath such Purchasers' names on the signature page hereto. The aggregate purchase price for the Securities sold to each Purchaser pursuant to this Agreement is one hundred percent (100%) of the aggregate principal amount of such Notes included in such Securities (the "Purchase Price"). 2. Delivery of Notes. 2.1. Delivery of Notes. (a) Prior to, or contemporaneously with, the execution and delivery of this Agreement by the Purchasers, the Purchasers shall remit $1,500,000 of the Purchase Price (including the $250,000 paid by Purchasers on July 8, 2002), in immediately available funds, to the Company by wire transfer for the account of the Company in accordance with the following wire transfer instructions: =========================================== Wire Transfer Instructions: =========================================== Bank: Fleet Bank 1185 Avenue of the Americas New York, NY 10036 - ------------------------------------------- ABA #: 021200339 - ------------------------------------------- Account Name: Nephros, Inc. - ------------------------------------------- Account #: 9403538578 =========================================== The Company acknowledges receipt of $250,000 towards the Purchase Price from the Purchasers on July 8, 2002. (b) On or prior to September 15, 2002, the Purchasers shall remit an additional $750,000 of the Purchase Price, in immediately available funds, to the Company by wire transfer for the account of the Company in accordance with the wire transfer instructions set forth in Subsection 2.1(a). (c) On or prior to October 15, 2002, the Purchasers shall remit the remaining $750,000 of the Purchase Price, in immediately available funds, to the Company by wire transfer for the account of the Company in accordance with the wire transfer instructions set forth in Subsection 2.1(a). (d) Upon receipt of the first $1,500,000 of the Purchase Price, the Company will immediately deliver to Purchasers one half of the Securities referred to in Article 1 hereof, and, upon each subsequent receipt of the additional Purchase Price amounts specified in Subsections 2.1(b) and (c), respectively, the Company will immediately deliver to Purchasers the one quarter of the Securities referred to in Article 1 hereof. The Securities shall be registered in the Purchasers' respective names. Interest on each Note sold hereunder shall accrue only from the date of issuance of such Note. 2.2. Default Warrants. If the Company fails to pay the interest and principal on the Notes on or before March 15, 2003 then, on March 16, 2003, and, unless all interest and principal on the Notes has been paid by such date, on each June 16, September 16, December 16 and March 16 thereafter, the Company shall issue to each Purchaser (or its designee reasonably acceptable to the Company) class A warrants ("Default Warrants") to purchase a number of shares of Common Stock equal to the quotient of (i) the outstanding principal amount of Notes held by such Purchaser, divided by (ii) thirty (30), at an exercise price of $2.50 per share of Common Stock, subject to adjustment for stock splits, reverse stock splits and similar recapitalizations. 3. Creation of Security Interest. 3.1. Grant of Security Interest. The Company hereby grants and pledges to Lancer Offshore, Inc. (the "Secured Party") a continuing security interest in all presently existing and hereafter acquired or arising assets and property of the Company (the "Collateral") in order to secure prompt payment of the principal sum and interest evidenced by the Notes, and the performance by the Company of each of its obligations under this Agreement and the Notes. Such security interest shall automatically terminate upon the earlier of (i) the payment of principal and interest on the Notes and (ii) such time as the Notes are no longer outstanding (the "Security Interest Termination Date"). 3.2. Designation of Secured Party as Agent. Purchasers, by their acceptance of the benefits of this Agreement and the Securities, hereby irrevocably designate the Secured Party to act as Secured Party on their behalf. Each Purchaser hereby irrevocably authorizes, and each holder of any Securities, by such holder's acceptance of such Securities, shall be deemed irrevocably to authorize, the Secured Party to take such action on their behalf under the provisions of this Agreement and any other instruments and agreements referred to herein or therein and to exercise such powers and to perform such duties hereunder and thereunder as are -2- specifically delegated to, or required of, the Secured Party by the terms hereof or thereof and such other powers as are reasonably incidental thereto. Each Purchaser, on behalf of itself and future holders of the Securities issued to such Purchaser, hereby authorizes and directs the Secured Party, from time to time in the Secured Party's discretion, to take any action and promptly to execute and deliver on such Purchaser's behalf any document or instrument that the Company may reasonably request to effect, confirm or evidence the provisions of this Article 3, the occurrence of the Security Interest Termination Date, any subordination agreement, or otherwise. Pursuant to Section 9-509(d) of the Uniform Commercial Code as in effect on the date hereof in the State of New York, the Secured Party hereby authorizes the Company to file a termination statement upon the occurrence of the Security Interest Termination Date; the Secured Party agrees to provide any further authorizations of such filing if requested by the Company. 3.3. Delivery of Additional Documentation Required. The Company shall from time to time execute and deliver to Secured Party, at the request of Secured Party and within 30 days of such request, all financing statements and other documents that Secured Party may reasonably request to perfect and continue perfected Secured Party's security interests in the Collateral, it being understood and agreed by the Purchasers and the Secured Party that the Company need not deliver possession or control of any Collateral to the Secured Party or take any action to perfect the security interest granted hereby other than the filing of financing statements under the Uniform Commercial Code. 4. Representations and Warranties of Purchasers. Purchasers hereby severally represent and warrant to the Company as follows: 4.1. Investment Intent. Each Purchaser recognizes that the purchase of the Securities involves a high degree of risk including, but not limited to, the following: (i) the Company remains a development stage business with limited operating history and requires substantial funds in addition to the proceeds of the Offering; (ii) an investment in the Company is highly speculative, and only investors who can afford the loss of their entire investment should consider investing in the Company, the Notes, the Warrants, or the shares of Securities-Underlying Common Stock, (iii) such Purchaser may not be able to liquidate his investment; (iv) transferability of the Notes, the Warrants and the Securities-Underlying Common Stock is extremely limited; (v) in the event of a disposition of the Notes, the Warrants and the Securities-Underlying Common Stock, such Purchaser could sustain the loss of its entire investment and (vi) the Company has not paid any dividends since inception and does not anticipate the payment of dividends on the Common Stock in the foreseeable future. 4.2. Lack of Liquidity. Each Purchaser confirms that it is able (i) to bear the economic risk of this investment, (ii) to hold the Notes, the Warrants and any shares of Securities-Underlying Common Stock for an indefinite period of time, and (iii) presently to afford a complete loss of its investment; and represents that it has sufficient liquid assets so that the illiquidity associated with this investment will not cause any undue financial difficulties or affect such Purchaser's ability to provide for his or its current needs and possible financial contingencies, and that his or its commitment to all speculative investments is reasonable in relation to his or its net worth and annual income. -3- 4.3. Knowledge and Experience. Each Purchaser hereby acknowledges and represents that such Purchaser has prior investment experience, including investment in securities that are non-listed, unregistered and are not traded on the Nasdaq National or SmallCap Market, nor on the National Association of Securities Dealers, Inc.'s (the "NASD") automated quotation system. 4.4. Purchaser Capacity. Each Purchaser hereby represents that such Purchaser has the capacity to protect such Purchaser's own interests in connection with the transaction contemplated hereby. 4.5. Receipt of Information. Each Purchaser hereby acknowledges that such Purchaser has carefully reviewed this Agreement and all attachments to it, and hereby represents that such Purchaser has been furnished by the Company with all information regarding the Company which such Purchaser has requested or desired to know, has been afforded the opportunity to ask questions of, and to receive answers from, duly authorized officers or other representatives of the Company concerning the terms and conditions of the Offering, the Notes, the Warrants and the Securities-Underlying Common Stock and the affairs of the Company and has received any additional information which such Purchaser or its representative has requested. 4.6. Reliance on Information. Each Purchaser has relied solely upon the information provided by the Company in this Agreement in making the decision to invest in the Securities. To the extent necessary, each Purchaser has retained, at the sole expense of such Purchaser, and relied upon, appropriate professional advice regarding the investment, tax and legal merits and consequences of this Agreement and its purchase of the Securities, and the conversion of the Notes into, or exercise of the Warrants for, Securities-Underlying Common Stock. 4.7. No Solicitation. Each Purchaser represents that (i) such Purchaser was contacted regarding the sale of the Securities by the Company (or an authorized agent or representative thereof) with whom such Purchaser had a prior substantial pre-existing relationship and (ii) no Securities were offered or sold to such Purchaser by means of any form of general solicitation or general advertising, and in connection therewith no Purchaser (A) received or reviewed any advertisement, article, notice or other communication published in a newspaper or magazine or similar media or broadcast over television or radio whether closed circuit, or generally available; or (B) attended any seminar meeting or industry investor conference whose attendees were invited by any general solicitation or general advertising. 4.8. Registration. Each Purchaser hereby acknowledges that the Offering has not been reviewed by the Securities and Exchange Commission or any state regulatory authority, since the Offering is intended to be exempt from the registration requirements of Section 5 of the Securities Act pursuant to Regulation D. No Purchaser shall sell or otherwise transfer the Securities or any Securities-Underlying Common Stock unless such securities are registered under the Securities Act or unless an exemption from such registration is available. 4.9. Purchase for own Account. Each Purchaser understands that neither the Securities nor the shares of Securities-Underlying Common Stock have been registered under the Securities Act by reason of a claimed exemption under the provisions of the Securities Act which -4- depends, in part, upon such Purchaser's investment intention. In this connection, each Purchaser hereby represents that such Purchaser is purchasing Securities for such Purchaser's own account for investment and not with a view toward the resale or distribution to others or for resale in connection with, any distribution or public offering (within the meaning of the Securities Act), nor with any present intention of distributing or selling the same and such Purchaser has no present or contemplated agreement, undertaking, arrangement, obligation or commitment providing for the disposition thereof. No Purchaser, if an entity, was formed for the purpose of purchasing the Securities. 4.10. Holding Period. Each Purchaser understands that there is no public market for the Securities or the Securities-Underlying Common Stock and that no market may ever develop for any such Securities or the Securities-Underlying Common Stock. Each Purchaser understands and hereby acknowledges that the Company is under no obligation to register any of the Securities under the Securities Act or any applicable non-United States, state securities or "blue sky" laws. Each Purchaser shall hold the Company and its directors, officers, employees, controlling persons and agents and their respective heirs, representatives, successors and assigns harmless from, and shall indemnify them against, all liabilities, costs and expenses incurred by them as a result of (i) any misrepresentation made by such Purchaser contained in this Agreement (including in Article 10 hereof), (ii) any sale or distribution by such Purchaser in violation of the Securities Act or any applicable non-United States, state securities or "blue sky" laws or (iii) any untrue statement made by such Purchaser. 4.11. Legends. Each Purchaser consents to the placement of the legend set forth below on any certificate or other document evidencing the Notes: THE TERMS OF THIS NOTE ARE SUBJECT TO THE TERMS OF A SUBSCRIPTION AGREEMENT, COPIES OF WHICH ARE AVAILABLE FROM NEPHROS, INC. NEITHER THIS NOTE NOR THE SECURITIES ISSUABLE UPON CONVERSION HEREOF HAVE BEEN REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED OR OTHERWISE TRANSFERRED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO SUCH SECURITIES UNDER THE SECURITIES ACT OR AN EXEMPTION FROM THE SECURITIES ACT. ANY SUCH TRANSFER MAY ALSO BE SUBJECT TO COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS AND THE LAWS OF OTHER APPLICABLE JURISDICTIONS. Each Purchaser consents to the placement of the legend set forth below on any certificate or other document evidencing the Warrants or Default Warrants: THE TERMS OF THIS WARRANT ARE SUBJECT TO THE TERMS OF A SUBSCRIPTION AGREEMENT, COPIES OF WHICH ARE AVAILABLE FROM NEPHROS INC. NEITHER THIS WARRANT NOR THE SECURITIES FOR WHICH IT IS EXERCISABLE HAVE BEEN REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD, OFFERED -5- FOR SALE, PLEDGED OR HYPOTHECATED OR OTHERWISE TRANSFERRED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO SUCH SECURITIES UNDER THE SECURITIES ACT OR AN EXEMPTION FROM THE SECURITIES ACT. ANY SUCH TRANSFER MAY ALSO BE SUBJECT TO COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS AND THE LAWS OF OTHER APPLICABLE JURISDICTIONS. Each Purchaser further consents to the placement of one or more restrictive legends on the Warrants, any Default Warrants and the Securities-Underlying Common Stock as required by applicable securities laws. Each Purchaser is aware that the Company will make a notation in its appropriate records with respect to the restrictions on the transferability of the Notes, the Warrants, any Default Warrants and the Securities-Underlying Common Stock. 4.12. Financial Review. Each Purchaser understands that the Company will review this Agreement and is hereby given authority by each Purchaser to call such Purchaser's bank or place of employment or otherwise review the financial standing of such Purchaser; and it is further agreed that the Company, at its sole discretion, reserves the unrestricted right, without further documentation or agreement on the part of such Purchaser, to reject or limit any purchase, and to close the Offering to such Purchaser at any time. 4.13. Address of Purchaser. Each Purchaser hereby represents that the address of such Purchaser furnished by such Purchaser on the signature page hereof is such Purchaser's principal residence if such Purchaser is an individual or its principal business address if it is a corporation or other entity. 4.14. Power and Authority. Each Purchaser represents that such Purchaser has full power and authority (corporate, statutory and otherwise) to execute and deliver this Agreement and to purchase the Securities and any shares of Securities-Underlying Common Stock. This Agreement constitutes the legal, valid and binding obligation of each Purchaser, enforceable against such Purchaser in accordance with its terms. 4.15. Plans. If a Purchaser is a corporation, partnership, limited liability company, trust, employee benefit plan, individual retirement account or other entity, then subject to the terms contained in this Agreement (a) it is authorized and qualified to become an investor in the Company and the person signing this Agreement on behalf of such entity has been duly authorized by such entity to do so, and (b) it is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization. 4.16. NASD. Each Purchaser acknowledges that if he or she is a registered representative of an NASD member firm, he or she must give such firm the notice required by the NASD's Rules of Fair Practice, receipt of which must be acknowledged by such firm in Section 10.3 below. 4.17. Securities Laws. Each Purchaser acknowledges that at such time, if ever, as the Securities or Securities-Underlying Common Stock are registered, sales of the Securities and Securities-Underlying Common Stock will be subject to applicable non-United States and state securities laws. -6- 4.18. Brokers. Each Purchaser represents and warrants that it has not engaged, consented to nor authorized any broker, finder or intermediary to act on its behalf, directly or indirectly, as a broker, finder or intermediary in connection with the transactions contemplated by this Agreement. Each Purchaser shall indemnify and hold harmless the Company from and against all fees, commissions or other payments owing to any such person or firm acting on behalf of such Purchaser hereunder. 4.19. Beneficial Owner. Each Purchaser, whose name appears on the signature line below, will be the beneficial owner of the Securities that such Purchaser acquires. 4.20. Accredited Investor. Each Purchaser represents and warrants that it is either a corporation, partnership, Massachusetts business trust, or non-profit organization within the meaning of Section 501(c)(3) of the Internal Revenue Code, in each case not formed for the specific purpose of acquiring the Securities and with total assets in excess of $5,000,000 or an entity in which all the equity owners are "accredited investor", as such term is defined in Rule 501 of the Securities Act. 4.21. Reliance on Representation and Warranties. Each Purchaser understands that the Notes are being offered and sold to the undersigned in reliance on specific exemptions from the registration requirements of United States Federal and state securities laws and that the Company is relying upon the truth and accuracy of the representations, warranties, agreements, acknowledgments and understandings of the undersigned set forth herein in order to determine the applicability of such exemptions and the suitability of the undersigned to acquire the Notes, the Warrants, any Default Warrants and the Securities-Underlying Common Stock. 5. Certain Covenants. 5.1. Within 30 days after each month end, financial statements with a brief monthly update regarding the business activities will be provided by the Company to the Purchasers. 5.2. Within 60 days after each year end, a budget and business plan for the next fiscal year, prepared monthly, will be provided by the Company to the Purchasers; the Company shall additionally provide the Purchasers with any other budgets developed or revised by the Company as soon as prepared by the Company. 5.3. Within 90 days after the conclusion of the Company's fiscal year end, the Company will provide the Purchasers with audited financial statements of the Company. 5.4. Subject to the execution of any confidentiality agreements determined to be necessary or appropriate by the Company, such determination to be made by the Company in its sole discretion, the Company shall provide to the Purchasers such other information relating to the financial condition, business, prospects or corporate affairs of the Company as the Purchasers shall reasonably request from time to time. 5.5. Subject to the execution of any confidentiality agreement determined to be necessary or appropriate by the Company, such determination to be made by the Company in its sole discretion, the Company shall afford one designee of Lancer Offshore, Inc. reasonably -7- acceptable to the Company with visitation rights at all regular meetings of the Company's Board of Directors unless the Company is advised by counsel that allowing such visitation rights would adversely affect the ability of the Company to withhold such information in a discovery request or similar or related proceeding. 5.6. The proceeds of the offering shall be used for working capital purposes, including, without limitation, marketing expenses; provided, however, that no more than $650,000 of such proceeds shall be utilized for the satisfaction of existing accounts payable of the Company. 5.7. Prior to the payment of the Purchase Price, the Company shall have caused all convertible promissory notes of the Company that are outstanding on the date hereof to have been converted into, or discharged for, capital stock of the Company. The Company's obligations under Subsections 5.5 and 5.6 shall expire upon the consummation of a Qualified IPO. 6. Capitalization. Immediately prior to the initial Qualified IPO, the capital stock, excluding the Securities-Underlying Common Stock, of the Company, shall consist of (i) 4,800,000 shares of Common Stock issued and/or reserved for issuance (other than as set forth in clauses (ii), (iii) and (iv) below), (ii) 1,200,000 shares of Common Stock reserved for issuance upon conversion of the Notes, (iii) 240,000 shares of Common Stock issued or reserved for issuance upon exercise of Warrants (subject to increase to the extent the Company issues any Default Warrants pursuant to Section 2.2 hereof), and (iv) 50,000 shares of Common Stock reserved for issuance upon exercise of placement agent warrants issued to Hermitage Capital, Incorporated in connection with the transactions contemplated by this Agreement. 7. Certain Definitions. For the purposes of this Agreement the following terms have the respective meanings set forth below: 7.1. "Business Day" means a Monday through Friday on which banks are generally open for business in New York. 7.2. "Common Stock" means the Company's common stock, par value $.001 per share. 7.3. "Offering" shall have the meaning ascribed to such term in the first paragraph of this Agreement. 7.4. "Person" means any individual, sole proprietorship, partnership, limited liability company, joint venture, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or governmental agency. 7.5. "Existing Registration Rights Agreement" means the Registration Rights Agreement, dated as of May 17, 2000, between the Company and the Investors (as defined therein). -8- 7.6. "Regulation D" means Regulation D promulgated under the Securities Act. 7.7. "Securities Act" means, as of any given time, the Securities Act of 1933, as amended, or any similar federal law then in force. 7.8. "Securities and Exchange Commission" includes any governmental body or agency succeeding to the functions thereof. 7.9. "Securities-Underlying Common Stock" shall mean the Common Stock issuable upon conversion of the Notes and the Common Stock issuable upon exercise of the Warrants or any Default Warrants. 7.10. "Preferred Stock Stockholders' Agreement " means the Stockholders' Agreement dated as of May 17, 2000 among the Company and the Stockholders identified therein, as it may be amended from time. 7.11. "Transfer Restricted Securities" means each Warrant, any Default Warrants, each Note and, if any Note has been converted or any Warrant or Default Warrant has been exercised, the Securities-Underlying Common Stock issued upon such conversion or exercise, until the earlier of (a) the date on which such Note, Warrant, Default Warrant or Securities-Underlying Common Stock, as applicable, has been effectively registered under the Securities Act and disposed of pursuant to, and in accordance with, an effective registration statement under the Securities Act, (b) the date on which such Note, Warrant, Default Warrant or Securities-Underlying Common Stock, as applicable, is distributed to the public pursuant to Rule 144 or any other applicable exemption under the Securities Act or (c) at such time as such Note, Warrant, Default Warrant or Securities-Underlying Common Stock, as applicable, may be sold under Rule 144(k). 7.12. "Preferred Stockholders' Voting Rights Agreement means the Voting Rights Agreement dated as of May 17, 2000 among the Company and the Stockholders identified therein, as it may be amended from time to time. 7.13. "Qualified IPO" shall mean a public offering of the securities of the Company yielding gross proceeds to the Company of not less than $10,000,000 and at an offering price per share of Common Stock equal to or greater than the quotient of $45,000,000 divided by the number of shares of Common Stock outstanding on a fully diluted basis immediately preceding such public offering. 8. Registration Rights. 8.1. As used in this Article 8, the following terms shall have the following meanings: (a) "Affiliate" shall mean, with respect to any Person (as defined below), any other Person controlling, controlled by, or under direct or indirect common control with, such Person (for the purposes of this definition "control," when used with respect to any specified Person, shall mean the power to direct the management and policies of such person, directly or -9- indirectly, whether through ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" shall have meanings correlative to the foregoing). (b) "Business Day" shall mean a day Monday through Friday on which banks are generally open for business in New York. (c) "Holders" shall mean the Purchasers and any person holding Registrable Securities or any person to whom the rights under Article 8 have been transferred in accordance with Section 8.10 hereof. (d) "Other Shares" means at any time those shares of Common Stock which do not constitute Registrable Securities or Primary Shares. (e) "Person" shall mean any person, individual, corporation, limited liability company, partnership, trust or other non-governmental entity or any governmental agency, court, authority or other body. (f) "Primary Shares" means at any time the authorized but unissued shares of Common Stock and shares of Common Stock held by the Company in its treasury. (g) The terms "register," "registered" and "registration" refer to the registration effected by preparing and filing a registration statement by the Company (a "Registration Statement") in compliance with the Securities Act, and the declaration or ordering of the effectiveness of such registration statement. (h) "Registrable Securities" shall mean the shares of Securities-Underlying Common Stock; provided, however, that securities shall only be treated as Registrable Securities if and only for so long as they (A) have not been disposed of pursuant to a registration statement declared effective by the Securities and Exchange Commission, (B) have not been sold in a transaction exempt from the registration and prospectus delivery requirements of the Securities Act and (C) are held by a Holder or a permitted transferee pursuant to Section 8.10. (i) "Registration Date" means the date upon which the registration statement pursuant to which the Company shall have initially registered shares of Common Stock under the Securities Act for sale to the public shall have been declared effective. (j) "Registration Expenses" shall mean all expenses incurred by the Company in complying with Section 8.2 hereof, including, without limitation, all registration, qualification and filing fees, printing expenses, escrow fees, fees and expenses of counsel for the Company, blue sky fees and expenses (but excluding the fees of legal counsel for any Holder). (k) "Registration Statement" shall have the meaning set forth in Subsection 8.1(g). -10- (l) "Registration Period" shall have the meaning ascribed to such term in Section 8.4. (m) "Selling Expenses" shall mean all underwriting discounts and selling commissions applicable to the sale of Registrable Securities and all fees and expenses of legal counsel for any Holder. 8.2. (a) Demand Registration. On one occasion at any time after six months after the Registration Date, if Holders of a majority of the Registrable Securities shall, in writing, state that such Holders desire to sell Registrable Shares in the public securities markets and request the Company to effect the registration under the Securities Act of Registrable Securities, the Company shall promptly use its reasonable best efforts to effect the registration under the Securities Act of the Registrable Securities which the Company has been so requested to register; provided, however, that if the managing underwriter advises the Company that the inclusion of all the securities requested to be included in such registration would interfere with the successful marketing (including pricing) of the Registrable Securities proposed to be registered by the Company, then the number of Primary Shares, Registrable Securities and Other Shares proposed to be included in such registration shall be included in the following order: (i) First, the Registrable Securities requested by the Holders to be included in such registration (or, if necessary, such Registrable Securities pro rata among the holders thereof based upon the number of Registrable Securities requested to be registered by each such holders); and (ii) second, the Other Shares held by the parties requesting inclusion in such registration; and (ii) third, the Primary Shares. (b) Piggyback Registration If the Company at any time after the Registration Date proposes for any reason to register Primary Shares or Other Shares under the Securities Act (other than on Form S-4 or Form S-8 promulgated under the Securities Act or any successor forms thereto), it shall give written notice to the Holders of its intention to so register such Primary Shares or Other Shares at least 30 days before the initial filing of such registration statement and, upon the written request, delivered to the Company within 20 days after delivery of any such notice by the Company, of the Holders to include in such registration Registrable Securities (which request shall specify the number of Registrable Securities proposed to be included in such registration and shall state that such Holders desire to sell such Registrable Securities in the public securities markets), the Company shall use its reasonable best efforts to cause all such Registrable Securities to be included in such registration on the same terms and conditions as the securities otherwise being sold in such registration; provided, however, that if the managing underwriter advises the Company that the inclusion of all the securities requested to be included in such registration would interfere with the successful marketing (including pricing) of the Primary Shares or Other Shares proposed to be registered by the Company, then the number of Primary Shares, Registrable Securities and Other Shares proposed to be included in such registration shall be included in the following order: (i) if the Company has initiated the registration: -11- (A) first, the Primary Shares; and (B) second, the Registrable Securities requested by the Holders to be included in such registration and the Other Shares held by the parties requesting inclusion in such registration (or, if necessary, such Registrable Securities and Other Shares pro rata among the holders thereof based upon the number of Registrable Securities and Other Shares requested to be registered by each such holder). (ii) if the holders of Other Shares have initiated the registration by exercising a registration demand right; (A) first, the Other Shares held by such initiating holders ("Other Demand Holders"); (B) second, the Other Shares held by persons entitled to registration rights as set forth in the Existing Registration Rights Agreement (the "Existing Holders"); (C) third, the Registrable Securities requested by the Holders to be included in such registration and any Other Shares held by parties requesting inclusion in such registration other than the Other Demand Holders and the Existing Holders ("Other Piggy-Back Holders") (or, if necessary, such Registrable Securities and Other Shares held by other Piggy-Back Holders pro rata among the holders thereof based upon the number of Registrable Securities and Other Shares requested to be registered by each such holder); and (D) fourth, the Primary Shares. Notwithstanding the foregoing Subsections 8.2(a) and 8.2(b), the Company shall not be obligated to enter into an underwriting agreement for the sale of the Registrable Securities. 8.3. All Registration Expenses incurred in connection with any registration, qualification or compliance pursuant to Section 8.2 shall be borne by the Company. All Selling Expenses relating to the sale of securities registered by or on behalf of Holders shall be borne by such Holders pro rata on the basis of the number of securities so registered; provided that if a Holder uses its own legal counsel in addition to one counsel for all of the Holders of securities registered on behalf of the Holders, such Holder shall bear the cost of such counsel. 8.4. In the case of the registration, qualification or compliance effected by the Company pursuant to this Agreement, the Company shall, upon reasonable request, inform each Holder as to the status of such registration, qualification and compliance. At its expense the Company shall: (a) use its reasonable best efforts to keep such registration, and any qualification, exemption or compliance under state securities laws which the Company -12- determines to obtain, continuously effective until the earlier of (i) such time as the Holders have completed the distribution described in the Registration Statement relating thereto and (ii) 90 days from the date of initial effectiveness of such registration. The period of time during which the Company is required hereunder to keep the Registration Statement effective is referred to herein as the "Registration Period." Notwithstanding the foregoing, at the Company's election, the Company may cease to keep such registration, qualification or compliance effective with respect to any Registrable Securities, and the registration rights of a Holder shall expire, at such time as the Holder may sell under Rule 144 under the Securities Act (or other exemption from registration acceptable to the Company) in a three-month period all Registrable Securities then desired to be sold by such Holder; and (b) advise the Holders: (i) when the Registration Statement or any amendment thereto has been filed with the Securities and Exchange Commission and when the Registration Statement or any post-effective amendment thereto has become effective; (ii) of any request by the Securities and Exchange Commission for amendments or supplements to the Registration Statement or the prospectus included therein or for additional information; (iii) of the issuance by the Securities and Exchange Commission of any stop order suspending the effectiveness of the Registration Statement or the initiation of any proceedings for such purpose; (iv) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Registrable Securities included therein for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose; and (v) of the happening of any event that requires the making of any changes in the Registration Statement or the prospectus included therein so that, as of such date, the statements therein are not misleading and do not omit to state a material fact required to be stated therein or necessary to make the statements therein (in the case of the prospectus, in the light of the circumstances under which they were made) not misleading; (vi) make every reasonable effort to obtain the withdrawal of any order suspending the effectiveness of any Registration Statement; (vii) furnish to each Holder, without charge, at least one copy of such Registration Statement and any post-effective amendment thereto, including financial statements and schedules, and, if the Holder so requests in writing, all exhibits (including those incorporated by reference) in the form filed with the Securities and Exchange Commission; (viii) during the Registration Period, deliver to each Holder, without charge, as many copies of the prospectus included in such Registration Statement and any amendment or supplement thereto as such Holder may reasonably request; and the Company consents to the use, consistent with the provisions hereof, of the prospectus or any amendment or supplement thereto by each of the selling Holders of Registrable Securities in connection with the offering -13- and sale of the Registrable Securities covered by the prospectus and any amendment or supplement thereto; (ix) subject to the execution of confidentiality agreements in form and substance satisfactory to the Company, make available upon reasonable notice and during normal business hours, for inspection by the holders of Registrable Securities, any underwriter participating in any disposition pursuant to Registration Statement and any attorney, accountant or other agent retained by the Holders or underwriter (collectively, the "Inspectors"), all pertinent financial and other records, pertinent corporate documents and properties of the Company (collectively, the "Records"), as shall be reasonably necessary to enable them to exercise their due diligence responsibility, and cause the Company's officers, directors and employees to supply all information (together with the Records, the "Information") reasonably requested by any such Inspector in connection with a Registration Statement. Any of the Information which the Company determines in good faith to be confidential, and of which determination the Inspectors are so notified, shall not be disclosed by the Inspectors unless (i) the disclosure of such Information is necessary to avoid or correct a misstatement or omission in a Registration Statement, (ii) the release of such Information is ordered pursuant to a subpoena or other order from a court of competent jurisdiction or (iii) such Information has been made generally available to the public; the Investors agree that they will, upon learning that disclosure of such Information is sought in a court of competent jurisdiction, give notice to the Company and allow the Company, at the Company's expense, to undertake appropriate action to prevent disclosure of the Information deemed confidential; (x) prior to any public offering of Registrable Securities pursuant to any Registration Statement, register or qualify for offer and sale under the securities or blue sky laws of such jurisdictions as any such Holders reasonably request in writing, provided that the Company shall not for any such purpose be required to qualify generally to transact business as a foreign corporation in any jurisdiction where it is not so qualified or to consent to general service of process in any such jurisdiction, and do any and all other acts or things reasonably necessary to enable the offer and sale in such jurisdictions of the Registrable Securities covered by such Registration Statement; (xi) upon the occurrence of any event contemplated by Section 8.4(b)(v) above, the Company shall promptly prepare a post-effective amendment to the Registration Statement or a supplement to the related prospectus, or file any other required document so that, as thereafter delivered to purchasers of the Registrable Securities included therein, the prospectus will not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and (xii) use its reasonable best efforts to comply with all applicable rules and regulations of the Securities and Exchange Commission, and will make generally available to the Holders not later than 45 days (or 90 days if the fiscal quarter is the fourth fiscal quarter) after the end of its fiscal quarter in which the first anniversary date of the effective date of the Registration Statement occurs, an earnings statement satisfying the provisions of Section 11(a) of the Securities Act. -14- 8.5. Material Development Condition. With respect to any Registration Statement, if the Company determines that, in its good faith judgment, it would (because of the existence of, or in anticipation of, any acquisition or corporate reorganization or other transaction, financing activity, stock repurchase or development involving the Company or any subsidiary, or the unavailability for reasons substantially beyond the Company's control of any required financial statements, or because of the presence of material undisclosed circumstances or developments with respect to which the disclosure that would be required in such a prospectus is premature, would have an adverse effect on the Company or is otherwise inadvisable or any other event or condition of similar significance to the Company or any subsidiary) be disadvantageous (a "Material Development Condition") to the Company or any subsidiary or its stockholders for such a Registration Statement to become effective or to be maintained effective or for sales of Registrable Securities to continue pursuant to the Registration Statement, the Company shall, notwithstanding any other provisions of this Agreement, be entitled, upon the giving of a written notice to such effect to any Holder of Registrable Securities included or to be included in such Registration Statement, (i) to cause sales of Registrable Securities by such Holder pursuant to such Registration Statement to cease, (ii) to cause such Registration Statement to be withdrawn and the effectiveness of such Registration Statement terminated, or (iii) in the event no such Registration Statement has yet been filed, to delay filing any such Registration Statement, until the Company determines that, in its good faith judgment, such Material Development Condition no longer exists (notice of which the Company shall promptly deliver to any Holder of Registrable Securities with respect to which any such Registration Statement has been filed). In the event the Company elects not to withdraw or terminate the effectiveness of any such Registration Statement but to cause a Holder or Holders to refrain from selling Registrable Securities for any period during the registration period, the Registration Period with respect to such Holders shall be extended by the number of days during the Registration Period that such Holders are required to refrain from selling Registrable Securities. 8.6. The Holders shall have no right to take any action to restrain, enjoin or otherwise delay any registration pursuant to Section 8.2 hereof as a result of any controversy that may arise with respect to the interpretation or implementation of this Agreement. 8.7. To the extent permitted by law, the Company shall indemnify each Holder, each underwriter of the Registrable Securities and each person controlling such Holder within the meaning of Section 15 of the Securities Act, with respect to which any registration, qualification or compliance has been effected pursuant to this Agreement, against all claims, losses, damages and liabilities (or action in respect thereof), including any of the foregoing incurred in settlement of any litigation, commenced or threatened (subject to Subsection 8.7(c) below), arising out of or based on any untrue statement of a material fact contained in any registration statement, prospectus or offering circular, or any amendment or supplement thereof, incident to any such registration, qualification or compliance, or based on any omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in light of the circumstances in which they were made, and shall reimburse each Holder, each underwriter of the Registrable Securities and each person controlling such Holder, for legal and other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action as incurred; provided that the Company shall not be liable in any such case to the extent that any untrue statement or omission is made in reliance -15- upon and in conformity with information furnished to the Company by or on behalf of such Holder and stated to be specifically for use in preparation of such registration statement, prospectus or offering circular; provided that the Company shall not be liable in any such case where the claim, loss, damage or liability arises out of or is related to the failure of the Holder to comply with the covenants and agreements contained in this Agreement respecting sales of Registrable Securities, and except that the foregoing indemnity agreement is subject to the condition that, insofar as it relates to any such untrue statement or omission made in the preliminary prospectus but eliminated or remedied in the amended prospectus on file with the Securities and Exchange Commission at the time the registration statement becomes effective or in the amended prospectus filed with the Securities and Exchange Commission pursuant to Rule 424(b) of the Securities Act or in the prospectus subject to completion and term sheet under Rule 434 of the Securities Act, which together meet the requirements of Section 10(a) of the Securities Act (the "Final Prospectus"), such indemnity agreement shall not inure to the benefit of any such Holder, any such underwriter or any such controlling person, if a copy of the Final Prospectus furnished by the Company to the Holder for delivery was not furnished to the person or entity asserting the loss, liability, claim or damage at or prior to the time such furnishing is required by the Securities Act and the Final Prospectus would have cured the defect giving rise to such loss, liability, claim or damage. (a) Each Holder will severally, if Registrable Securities held by such Holder are included in the securities as to which such registration, qualification or compliance is being effected, indemnify the Company, each of its directors and officers, each underwriter of the Registrable Securities and each person who controls the Company within the meaning of Section 15 of the Securities Act, against all claims, losses, damages and liabilities (or actions in respect thereof), including any of the foregoing incurred in settlement of any litigation, commenced or threatened (subject to Subsection 8.7(c) below), arising out of or based on any untrue statement of a material fact contained in any registration statement, prospectus or offering circular, or any amendment or supplement thereof, incident to any such registration, qualification or compliance, or based on any omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in light of the circumstances in which they were made, and will reimburse the Company, such directors and officers, each underwriter of the Registrable Securities and each person controlling the Company for reasonable legal and any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action as incurred, in each case to the extent, but only to the extent, that such untrue statement or omission is made in reliance upon and in conformity with written information furnished to the Company by or on behalf of the Holder and stated to be specifically for use in preparation of such registration statement, prospectus or offering circular; provided that the indemnity shall not apply to the extent that such claim, loss, damage or liability results from the fact that a current copy of the prospectus was not made available to the Holder and such current copy of the prospectus would have cured the defect giving rise to such loss, claim, damage or liability. Notwithstanding the foregoing, in no event shall a Holder be liable for any such claims, losses, damages or liabilities in excess of the proceeds received by such Holder in the offering, except in the event of fraud by such Holder. (b) Each party entitled to indemnification under this Section 8.7 (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim -16- as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom, provided that counsel for the Indemnifying Party, who shall conduct the defense of such claim or litigation, shall be approved by the Indemnified Party (whose approval shall not unreasonably be withheld or delayed), and the Indemnified Party may participate in such defense at such Indemnified Party's expense, and provided further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Agreement, unless such failure is materially prejudicial to the Indemnifying Party in defending such claim or litigation. An Indemnifying Party shall not be liable for any settlement of an action or claim effected without its written consent. 8.8. If the indemnification provided for in this Section 8 is held by a court of competent jurisdiction to be unavailable to an Indemnified Party with respect to any loss, claim, damage, liability or action referred to herein, then the Indemnifying Party, in lieu of indemnifying such Indemnified Party hereunder, shall contribute to the amounts paid or payable by such Indemnified Party as a result of such loss, claim, damage, liability or action in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party on the one hand and of the Indemnified Party on the other in connection with the statements or omissions which resulted in such loss, claim, damage, liability or action as well as any other relevant equitable considerations. The relative fault of the Indemnifying Party and of the Indemnified Party shall be determined by reference to, among other things, whether the untrue statement of a material fact or the omission to state a material fact relates to information supplied by the Indemnifying Party or by the Indemnified Party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. No person guilty of fraudulent misrepresentation shall be entitled to contribution from any person. 8.9. Each Holder agrees that, upon receipt of any notice from the Company of the happening of any event requiring the preparation of a supplement or amendment to a prospectus relating to Registrable Securities so that, as thereafter delivered to the Holders, such prospectus will not contain an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, each Holder will forthwith discontinue disposition of Registrable Securities pursuant to the registration statement contemplated by Section 8.2 until its receipt of copies of the supplemented or amended prospectus from the Company and, if so directed by the Company, each Holder shall deliver to the Company all copies, other than permanent file copies then in such Holder's possession, of the prospectus covering such Registrable Securities current at the time of receipt of such notice. (a) As a condition to the inclusion of its Registrable Securities, each Holder shall furnish to the Company such information regarding such Holder and the distribution proposed by such Holder as the Company may request in writing or as shall be required in connection with any registration, qualification or compliance referred to in this Article 8. (b) Each Holder hereby covenants with the Company (i) not to make any sale of the Registrable Securities without effectively causing the prospectus delivery requirements under the Securities Act to be satisfied, and (ii) if such Registrable Securities are to be sold by any method or in any transaction other than on a national securities exchange, the Nasdaq -17- National Market, Nasdaq SmallCap Market or in the over-the-counter market, in privately negotiated transactions, or in a combination of such methods, to notify the Company at least five (5) business days prior to the date on which the Holder first offers to sell any such Registrable Securities. (c) Each Holder acknowledges and agrees that the Registrable Securities sold pursuant to the Registration Statement described in this Article 8 are not transferable on the books of the Company unless the stock certificate submitted to the transfer agent evidencing such Registrable Securities is accompanied by a certificate reasonably satisfactory to the Company to the effect that (i) the Registrable Securities have been sold in accordance with such Registration Statement and (ii) the requirement of delivering a current prospectus has been satisfied. (d) Each Holder shall not take any action with respect to any distribution deemed to be made pursuant to such registration statement, which would constitute a violation of Regulation M under the Securities Exchange Act of 1934, as amended (the "Exchange Act") or any other applicable rule, regulation or law. (e) At the end of the period during which the Company is obligated to keep the Registration Statement current and effective as described above, the Holders of Registrable Securities included in the Registration Statement shall discontinue sales of shares pursuant to such Registration Statement. Upon receipt of notice from the Company of its intention to remove from registration the shares covered by such Registration Statement which remain unsold such Holders shall notify the Company of the number of shares registered which remain unsold immediately upon receipt of such notice from the Company. 8.10. With a view to making available to the Holders the benefits of certain rules and regulations of the Securities and Exchange Commission which at any time permit the sale of the Registrable Securities to the public without registration, the Company shall use its reasonable best efforts following the initial public offering of securities of the Company pursuant to an effective Registration Statement: (a) to make and keep public information available, as those terms are understood and defined in Rule 144 under the Securities Act, at all times; (b) to file with the Securities and Exchange Commission in a timely manner all reports and other documents required of the Company under the Exchange Act; and 8.11. The rights to cause the Company to register Registrable Securities granted to the Holders by the Company under Section 8.2 may be assigned in full by a Holder in connection with a transfer by such Holder of its Registrable Securities, provided that (i) such transfer may otherwise be effected in accordance with applicable securities laws; (ii) such transfer involves not fewer than the fewer than a majority of the Registrable Securities held by such Holder, (iii) such Holder gives prior written notice to the Company; and (iv) such transferee agrees to comply with the terms and provisions of this Agreement, and such transfer is otherwise in compliance with this Agreement. Except as specifically permitted by this Section 8.10, the rights of a Holder with respect to Registrable Securities as set out herein shall not be transferable -18- to any other Person, and any attempted transfer shall cause all rights of such Holder therein to be forfeited. 8.12. Lock-Up Period. If the Company shall effect a primary or a secondary public offering of its securities or if at any time, the Company shall register its shares of Common Stock under the Securities Act for sale to the public on a registration statement under which the Holders are given the opportunity to have their Registrable Securities registered (including any such registration in accordance with this Agreement), the Holders shall not sell publicly, make any short sale of, grant any option for the purchase of, or otherwise dispose publicly of, any Registrable Securities (other than those shares of Common Stock included in such registration in accordance with this Agreement) without the prior written consent of the Company, during the period beginning ten (10) days prior to the effectiveness of the registration statement pursuant to which such public offering shall be made and ending on the date 180 days after the effective date of such registration statement. 9. Miscellaneous. 9.1. Amendments and Waivers. This Agreement and all exhibits and schedules hereto set forth the entire agreement and understanding among the parties as to the subject matter hereof and merges and supersedes all prior discussions, agreements and understandings of any and every nature among them. This Agreement may be amended only by mutual written agreement of the Company and the Purchaser or Purchasers holding a majority of the Securities-Underlying Common Stock on a fully-diluted basis (the "Purchaser Majority"), and the Company may take any action herein prohibited or omit to take any action herein required to be performed by it, and any breach of any covenant, agreement, warranty or representation may be waived, only if the Company has obtained the written consent or waiver of the Purchaser Majority. (a) After an amendment or waiver becomes effective it shall bind every holder of Securities regardless of whether such holder held such Securities at the time such amendment or waiver became effective, or subsequently acquired such Securities. 9.2. Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the Company and its successors and assigns and Purchasers and their successors and registered assigns. 9.3. Notices. All notices, demands and other communications to be given or delivered under or by reason of the provisions of this Agreement shall be in writing and shall be deemed to have been given personally or when mailed by certified or registered mail, return receipt requested and postage prepaid, or by a nationally recognized overnight courier service and addressed to the addresses of the respective parties set forth below or to such changed addresses as such parties may have fixed by notice; provided, however, that any notice of change of address shall be effective only upon receipt: If to the Company: Nephros, Inc. 3960 Broadway -19- New York, NY 10032 Telephone: (212) 781-5113 Telecopy: (212) 781-5166 Attn: President If to Purchasers: as set forth on the signature page hereto. ; provided further that notices sent by courier or mail shall be deemed received on the date of receipt indicated by the return verification provided by the U.S. postal service or the records of the courier service. 9.4. Governing Law. The validity, performance, construction and effect of this Agreement shall be governed by the internal laws of the State of New York without giving effect to such State's principles of conflict of laws. 9.5. Counterparts. This Agreement may be executed in any number of counterparts and, notwithstanding that any of the parties did not execute the same counterpart, each of such counterparts shall, for all purposes, be deemed an original, and all such counterparts shall constitute one and the same instrument binding on all of the parties hereto. Delivery of an executed counterpart of a signature page to this Agreement by telecopier shall be as effective as delivery of a manually executed counterpart of a signature page of this Agreement. 9.6. Headings. The headings of the Sections hereof are inserted as a matter of convenience and for reference only and in no way define, limit or describe the scope of this Agreement or the meaning of any provision hereof. 9.7. Severability. In the event that any provision of this Agreement or the application of any provision hereof is declared to be illegal, invalid or otherwise unenforceable by a court of competent jurisdiction, the remainder of this Agreement shall not be affected except to the extent necessary to delete such illegal, invalid or unenforceable provision unless the provision held invalid shall substantially impair the benefit of the remaining portion of this Agreement. 9.8. Exculpation Among Purchasers. Each Purchaser acknowledges and agrees that it is not relying upon any other Purchaser, or any officer, director, employee partner or affiliate of any such other Purchaser, in making its investment or decision to invest in the Company or in monitoring such investment. Each Purchaser agrees that no Purchaser nor any controlling person, officer, director, stockholder, partner, agent or employee of any Purchaser shall be liable for any action heretofore or hereafter taken or omitted to be taken by any of them relating to or in connection with the Company or the securities, or both. 10. NASD Affiliation. Are you affiliated or associated with an NASD member firm (please check one): Yes _________ No __________ If Yes, please describe: - --------------------------------------------------------- -20- *If Purchaser is a Registered Representative with an NASD member firm, have the following acknowledgment signed by the appropriate party: The undersigned NASD member firm acknowledges receipt of the notice required by Article 3, Sections 28(a) and (b) of the Rules of Fair Practice. - --------------------------------- Name of NASD Member Firm By: ______________________________ Authorized Officer Date: ____________________________ -21- IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year indicated. LANCER OFFSHORE, INC. By: __________________________ Name: Michael Lauer Title: Investment Manager Address: Kaya Flamboyan 9, Curacao, Netherlands Antilles Principal Amount of Notes: $3,000,000 Number of Warrants: 240,000 NEPHROS, INC. By: __________________________ Name: Title: For Purposes of Article 3: ACCEPTED AND AGREED: LANCER OFFSHORE, INC., as Secured Party By: __________________________ Name: Michael Lauer Title: Investment Manager -22- CERTIFICATE OF SIGNATORY (To be completed if Notes are being subscribed for by an entity) I, _____________________________, am the _________________________ (the "Entity"). I certify that I am empowered and duly authorized by the Entity to execute and carry out the terms of the Subscription Agreement, dated as of , and to purchase and hold the Notes, and certify further that the Subscription Agreement has been duly and validly executed on behalf of the Entity and constitutes a legal and binding obligation of the Entity. IN WITNESS WHEREOF, I have set my hand this ____ day of _________________, - ----. ------------------------------ (Signature) -23- EXHIBIT A [Form of Note] THE TERMS OF THIS NOTE ARE SUBJECT TO THE TERMS OF A SUBSCRIPTION AGREEMENT, COPIES OF WHICH ARE AVAILABLE FROM NEPHROS, INC. THIS NOTE AND THE SECURITIES ISSUABLE UPON EXERCISE OF THIS NOTE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OR ANY APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED OR OTHERWISE TRANSFERRED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO SUCH SECURITIES UNDER THE SECURITIES ACT OR AN EXEMPTION FROM THE SECURITIES ACT. ANY SUCH TRANSFER MAY ALSO BE SUBJECT TO COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS AND THE LAWS OF OTHER APPLICABLE JURISDICTIONS. THE SALE, TRANSFER, ASSIGNMENT, PLEDGE, OR ENCUMBRANCE OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE AND THE RIGHTS OF THE HOLDER OF SUCH SECURITIES IN RESPECT OF THE ELECTION OF DIRECTORS ARE SUBJECT TO THE TERMS AND CONDITIONS OF A STOCKHOLDERS' AGREEMENT DATED AS OF MAY 17, 2000 AMONG NEPHROS, INC. AND THE HOLDERS OF OUTSTANDING CAPITAL STOCK OF SUCH COMPANY. COPIES OF SUCH AGREEMENT MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS CERTIFICATE TO THE SECRETARY OF NEPHROS, INC. NEPHROS, INC. No. 1 Note due 2003 $1,500,000 August 5, 2002 Nephros, Inc., a Delaware Company, (the "Company"), for value received, hereby promises to pay to Lancer Offshore, Inc. (the "Holder"), or registered assigns, the principal sum set forth above, with accrued but unpaid interest thereon at a rate equal to eight percent (8%) per annum, on the Maturity Date. Payment shall be made at such place as designated by the Company upon surrender of this Note (as defined below), and shall be in such coin or currency of the United States of America as at the time of payment shall be legal tender for the payment of public and private debts. This Note is one of a duly authorized issue of Nephros, Inc. Notes due 2003 (individually a "Note" and collectively the "Notes") issued pursuant to the Subscription Agreement. Certain capitalized terms used herein are defined in Section 8. Capitalized terms used herein without definition have the respective meanings specified therefor in the Subscription Agreement. The Notes are secured by the Collateral pursuant to the Subscription Agreement. SECTION 1. Interest. The Company will pay interest in arrears on the Maturity Date. Interest on this Note will accrue from the date of its issuance set forth above. SECTION 2. Prepayment. Upon 30 days prior written notice to the Holder, this Note (including interest accrued on the principal hereof) may be prepaid by the Company, at any time, in whole or in part, without penalty or premium. SECTION 3. Conversion (a) Conversion. The Holder may elect, at any time prior to the Maturity Date, to convert this Note and all accrued interest hereon into a number of shares of Common Stock equal to the principal amount of Note being converted divided by the then current Conversion Price. (b) Conversion Procedures. (i) Any Holder of a Note desiring to convert such Note into Common Stock shall surrender such Note at the Company's principal executive office, accompanied by proper instruments of transfer to the Company or in blank, accompanied by irrevocable written notice to the Company that the Holder elects so to convert such Note (the "Notice of Conversion") and specifying the name or names (with address) in which a certificate or certificates evidencing shares of Common Stock are to be issued; provided, however, in the event that the Holder or Holders submit a Notice of Conversion with respect to a principal amount outstanding of Notes equal to all the then-outstanding principal amount of Notes, the Company shall not be required to honor such Notice of Conversion unless the Secured Party shall have provided the Company with any authorizations requested by the Company to file a termination statement with respect to the Secured Party's security interest in the Collateral, as set forth in subsection 2.2 of the Subscription Agreement. (ii) The Company need not deem a Notice of Conversion to be received unless the Holder complies with all the provisions hereof. The Company will make a notation of the date that a Notice of Conversion is received, which date of receipt shall be deemed to be the date of receipt for purposes hereof. (iii) The Company shall, as soon as practicable after such deposit of any Note accompanied by a Notice of Conversion and compliance with any other conditions herein contained, deliver to the person for whose account such Note was so surrendered certificates evidencing the number of full shares of Common Stock to which such person shall be entitled as aforesaid, subject to Section 4. (iv) Subject to the following provisions of this paragraph 3(b)(iv), such conversion shall be deemed to have been made as of the date of such surrender of the Note to be converted, and the person or persons entitled to receive the Common Stock deliverable upon conversion of such Note shall be treated for all purposes as the record holder or holders of such Common Stock on such date and the Note shall no longer be deemed outstanding and all rights whatsoever in respect thereof (including the right to receive interest thereon) shall terminate except the right to receive the number of full shares of Common Stock to which such person -2- shall be entitled hereunder; provided, however, that the Company shall not be required to convert any Note while the stock transfer books of the Company are closed for any purpose, but the surrender of a Note for conversion during any period while such books are so closed shall become effective for conversion immediately upon the reopening of such books as if the surrender had been made on the date of such reopening, and the conversion shall be at the Conversion Rate in effect on such date applied to the principal amount of Note to be converted. (c) Adjustments to Conversion Price. (i) In case the Company shall hereafter (A) pay a dividend or make a distribution on its Common Stock in shares of Common Stock, (B) subdivide its outstanding shares of Common Stock into a greater number of shares or (C) combine its outstanding shares of Common Stock into a smaller number of shares (each of (A) through (C) an "Action"), the Conversion Price shall be adjusted to equal the product of the Conversion Price in effect immediately prior to such Action multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such Action and the denominator of which shall be the number of shares of Common Stock outstanding immediately following such Action. An adjustment made pursuant to this subsection 3(c) shall become effective immediately after the record date in the case of a dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or reclassification. (ii) In case the Company shall hereafter issue by reclassification of its Common Stock any shares of capital stock of the Company (a "Reclassification"), provision shall be made so that, immediately following such Reclassification, the Notes shall be convertible into the kind and quantity of securities to which the Holders of such Notes would have been entitled pursuant to such Reclassification, had such Holders converted such Notes immediately prior to such Reclassification. (iii) In case the Company shall hereafter issue any shares of Common Stock other than Excluded Stock without consideration or for a consideration per share less than the Conversion Price in effect immediately prior to the issuance of such Common Stock, then such Conversion Price, as in effect immediately prior to each such issuance, shall forthwith be lowered to a price equal to the quotient obtained by dividing: (A) an amount equal to the sum of (x) the total number of shares of Common Stock outstanding on a fully-diluted basis immediately prior to such issuance, multiplied by the Conversion Price in effect immediately prior to such issuance, and (y) the consideration received by the Company upon such issuance; by (B) the total number of shares of Common Stock outstanding on a fully-diluted basis immediately after the issuance of such Common Stock. (iv) For the purposes of any adjustment of a Conversion Price pursuant to clause 3(c)(iii) above, the following provisions shall be applicable: (A) In the case of the issuance of Common Stock for cash in a public offering or private placement, the consideration shall be deemed to be the amount of cash paid therefor after deducting therefrom any discounts, -3- commissions or placement fees payable by the Company to any underwriter or placement agent in connection with the issuance and sale thereof. (B) In the case of the issuance of Common Stock for a consideration in whole or in part other than cash, the consideration other than cash shall be deemed to be the fair market value thereof as determined in good faith by the Board of Directors of the Company, irrespective of any accounting treatment. (C) In the case of the issuance of options to purchase or rights to subscribe for Common Stock, securities by their terms convertible into or exchangeable for Common Stock, or options to purchase or rights to subscribe for such convertible or exchangeable securities except for options to acquire Excluded Stock: (1) the aggregate maximum number of shares of Common Stock deliverable upon exercise of such options to purchase or rights to subscribe for Common Stock shall be deemed to have been issued at the time such options or rights were issued and for a consideration equal to the consideration (determined in the manner provided in subdivisions (A) and (B) above), if any, received by the Company upon the issuance of such options or rights plus the minimum purchase price provided in such options or rights for the Common Stock covered thereby; (2) the aggregate maximum number of shares of Common Stock deliverable upon conversion of or in exchange for any such convertible or exchangeable securities or upon the exercise of options to purchase or rights to subscribe for such convertible or exchangeable securities and subsequent conversion or exchange thereof shall be deemed to have been issued at the time such securities, options, or rights were issued and for a consideration equal to the consideration received by the Company for any such securities and related options or rights (excluding any cash received on account of accrued interest or accrued dividends), plus the additional consideration, if any, to be received by the Company upon the conversion or exchange of such securities or the exercise of any related options or rights (the consideration in each case to be determined in the manner provided in subdivisions (A) and (B) above); (3) on any change in the number of shares or exercise price of Common Stock deliverable upon exercise of any such options or rights or conversions of or exchanges for such securities, other than a change resulting from the antidilution provisions thereof, the Conversion Price shall forthwith be readjusted to such Conversion Price as would have been obtained had the adjustment made upon the issuance of such options, rights or securities not converted prior to such change, or options or rights related to such securities not converted prior to such change, been made upon the basis of such change; -4- (4) on the expiration of any such options or rights, the termination of any such rights to convert or exchange or the expiration of any options or rights related to such convertible or exchangeable securities, the Conversion Price shall forthwith be readjusted to such Conversion Price as would have been obtained had the adjustment made upon the issuance of such options, rights, securities or options or rights related to such securities been made upon the basis of the issuance of only the number of shares of Common Stock actually issued upon the exercise of such options or rights, upon the conversion or exchange of such securities, or upon the exercise of the options or rights related to such securities and subsequent conversion or exchange thereof; and (5) No further adjustment of the Conversion Price adjusted upon the issuance of any such options, rights, convertible securities or exchangeable securities shall be made as a result of the actual issuance of Common Stock on the exercise of any such rights or options or any conversion or exchange of any such securities. (v) No adjustment in any Conversion Price shall be required unless such adjustment would require an increase or decrease of at least $0.01 in such Conversion Price; provided, that any adjustments not required to be made by virtue of this sentence shall be carried forward and taken into account in any subsequent adjustment. All calculations under this paragraph 3(c)(v) shall be made to the nearest one hundredth (1/100) of a cent or the nearest one tenth (1/10) of a share, as the case may be. (vi) In any case in which the provisions of this subsection 3(c) shall require that an adjustment shall become effective immediately after a record date of an event, the Company may defer until the occurrence of such event (1) issuing to the Holder of any Notes converted after such record date and before the occurrence of such event the shares of capital stock issuable upon such conversion by reason of the adjustment required by such event in addition to the shares of capital stock issuable upon such conversion before giving effect to such adjustments, and (2) paying to such Holder any amount in cash in lieu of a fractional share of capital stock pursuant to Section 4 below; provided, however, that the Company shall deliver to such Holder an appropriate instrument evidencing such Holder's right to receive such additional shares and such cash. (vii) Whenever a Conversion Price shall be adjusted as provided in subsection 3(c), the Company shall make available for inspection during regular business hours, at its principal executive offices or at such other place as may be designated by the Company, a statement, signed by its chief executive officer, showing in reasonable detail the facts requiring such adjustment and the Conversion Price that shall be in effect after such adjustment. The Company shall also cause a copy of such statement to be sent by first class certified mail, return receipt requested and postage prepaid, to each Holder of Notes at such Holder's address appearing on the Company's records. Where appropriate, such copy may be given in advance and may be included as part of any notice required to be mailed under the provisions of paragraph (viii) below. -5- (viii) If the Company shall propose to take any action of the types described in paragraphs 3(c)(i) and 3(c)(ii), the Company shall give notice to each Holder, in the manner set forth in paragraph (vii) above, which notice shall specify the record date, if any, with respect to any such action and the date on which such action is to take place. Such notice shall also set forth such facts with respect thereto as shall be reasonably necessary to indicate the effect of such action (to the extent such effect may be known at the date of such notice) on the Conversion Price and the number, kind or class of shares or other securities or property which shall be deliverable or purchasable upon the occurrence of such action or deliverable upon conversion of such Holder's Note. In the case of any action which would require the fixing of a record date, such notice shall be given at least 20 days prior to the date so fixed, and in case of all other action, such notice shall be given at least 30 days prior to the taking of such proposed action. Failure to give such notice, or any defect therein, shall not affect the legality or validity of any such action. (d) Reservation of Shares; Transfer Taxes; Etc. The Company shall at all times reserve and keep available, out of its authorized and unissued shares of Common Stock, solely for the purpose of effecting the conversion of the Notes, such number of shares of its Common Stock free of preemptive rights as shall be sufficient to effect the conversion of all Notes from time to time outstanding. The Company shall use its best efforts from time to time, in accordance with the laws of the State of Delaware, to increase the authorized number of shares of Common Stock if at any time the number of shares of Common Stock not outstanding shall not be sufficient to permit the conversion of all the then-outstanding Notes. The Company shall pay any and all issue or other taxes (other than income taxes) that may be payable in respect of any issue or delivery of shares of Common Stock on conversion of the Notes. The Company shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issue or delivery of Common Stock (or other securities or assets) in a name other than that in which the Notes so converted were registered, and no such issue or delivery shall be made unless and until the person requesting such issue has paid to the Company the amount of such tax or has established, to the satisfaction of the Company, that such tax has been paid. (e) Automatic Conversion. This Note shall automatically convert into shares of Common Stock at the then-current Conversion Rate upon the occurrence of a Qualified IPO. (f) Other Changes in Conversion Rate. The Company from time to time may increase the Conversion Rate by any amount for any period of time if the period is at least 20 days and if the increase is irrevocable during the period. Whenever the Conversion Rate is so increased, the Company shall mail to the Holder of record of this Note a notice of the increase at least 15 days before the date the increased Conversion Rate takes effect, and such notice shall state the increased Conversion Rate and the period it will be in effect. The Company may make such increases in the Conversion Rate, in addition to those required or allowed by this Section 3, as shall be determined by it, as evidenced by a resolution of the Board of Directors of the Company, to be advisable in order to avoid or diminish any income tax to holders of Common Stock resulting from any dividend or distribution of stock or issuance of rights or warrants to purchase or subscribe for stock or from any event treated as such for income tax purposes. -6- SECTION 4. Fractional Shares. No fractional shares or scrip representing fractional shares of Common Stock shall be issued upon conversion of this Note. If more than one certificate evidencing Notes shall be surrendered for conversion at one time by the same Holder, the number of full shares issuable upon conversion thereof shall be computed on the basis of the aggregate principal amount of the Notes so surrendered. Instead of any fractional share of Common Stock which would otherwise be issuable upon conversion of this Note (or of such aggregate number of Notes), the Company may elect, in its sole discretion, independently for each Holder, whether such number of shares of Common Stock will be rounded to the nearest whole share (with a .5 of a share rounded upward) or whether such Holder will be given cash, in lieu of any fractional share, in an amount equal to the same fraction of the Conversion Price as of the close of business on the day of conversion. SECTION 5. Events of Default Defined. The following shall each constitute an "Event of Default" hereunder: (a) the failure of the Company to make any payment of principal of or interest on this Note; (b) the Company, pursuant to or within the meaning of any Bankruptcy Law: (i) commences a voluntary case, (ii) consents to the entry of an order for relief against it in an involuntary case, (iii) consents to the appointment of a Custodian of it or for all or substantially all of its property, and such Custodian is not discharged within 30 days, or (iv) makes a general assignment for the benefit of its creditors; (c) a court of competent jurisdiction enters an order or decree under any Bankruptcy Law that remains unstayed and in effect for 60 consecutive days and that: (i) is for relief in any involuntary case against the Company, (ii) appoints a Custodian of the Company or for all or substantially all of the property of the Company, or (iii) orders the liquidation of the Company; the Company fails to deliver any Default Warrants (as defined in the Subscription Agreement) in accordance with Section 2.2 of the Subscription Agreement. The term "Bankruptcy Law" means Title 11 of the U.S. Code or any similar federal, foreign or state law for the relief of debtors. The term "Custodian" means any receiver, trustee, assignee, liquidator, examiner or similar official under any Bankruptcy Law. -7- SECTION 6. Remedies upon Event of Default. (a) If an Event of Default occurs and is continuing for a period of 15 or more consecutive days, the holder or holders of Notes constituting a majority of the principal amount of Notes then outstanding (the "Majority Noteholders"), by notice to the Company, may declare the unpaid principal of and accrued interest on all the Notes then outstanding to be due and payable (an "Acceleration"). Upon any such declaration, such principal and accrued interest shall be due and payable immediately. Majority Noteholders may rescind an Acceleration and its consequences; provided, however, that no such rescission shall effect any subsequent Default or impair any right consequent thereto. (b) Majority Noteholders may waive an existing Default or Event of Default and its consequences. Upon any such waiver, such Default shall cease to exist and any Event of Default arising therefrom shall be deemed to have been cured for every purpose of this Note; but no such waiver shall extend to any subsequent or other Default or impair any right consequent thereon. (c) In addition to any rights the Holders may have as set forth in the Subscription Agreement, if the Company defaults in a payment of interest on the Notes, then, during the continuance of such default, in lieu of this Note's ordinary 8% interest, the Company shall pay defaulted interest at a rate equal to the lesser of 18% or the maximum rate allowed by applicable law. (d) Upon the occurrence and during the continuance of an Event of Default, Majority Noteholders may, at their election, without notice of its election and without demand, take any action permitted by law, including the exercise of any rights accorded a secured creditor under the Uniform Commercial Code as in effect in New York. (e) To the extent permitted by law, the remedies provided herein shall be exclusive of any other remedies now or hereafter existing at law or in equity or by statute or otherwise. (f) In any suit for the enforcement of any right or remedy under this Note or the Subscription Agreement, a court in its discretion may require the filing by any party litigant in the suit of an undertaking to pay the costs of the suit, and the court in its discretion may assess reasonable costs, including reasonable attorneys' fees, against any party litigant in the suit, having due regard to the merits and good faith of the claims or defenses made by the party litigant. -8- SECTION 7. Lost, Mutilated, etc. Note. Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Note and of indemnity or bond reasonably satisfactory to it, and upon reimbursement to the Company of all reasonable expenses incidental thereto, and upon surrender and cancellation of this Note (in case of mutilation) the Company will make and deliver in lieu of this Note a new Note of like tenor and unpaid principal amount and dated as of the date to which interest has been paid on the unpaid principal amount of this Note in lieu of which such new Note is made and delivered. SECTION 8. Certain Definitions. (a) "Collateral" means all presently existing and hereafter acquired or arising assets and property of the Company. (b) The "Conversion Price" shall initially be $2.50 per share of Common Stock, subject to adjustment as provided below, representing an initial conversion rate (subject to adjustment) of 400 shares of Common Stock per $1,000 of principal amount of Note being converted (the "Conversion Rate"). (c) "Conversion Rate" is defined in subsection 8(b). (d) "Default" means an event which, with notice or the passage of time, or both, would become an Event of Default. (e) "Excluded Stock" means (1) shares of Common Stock issuable upon exercise of stock options granted to directors, officers, employees and consultants of the Company or its subsidiaries pursuant to any stock option plan approved by the Board of Directors and stockholders of the Company and (2) shares of Common Stock issued upon conversion of shares of the Series A Convertible Preferred Stock of the Company, the Series B Convertible Preferred Stock of the Company, the Series C Convertible Preferred Stock of the Company, upon conversion of the Company's Notes due 2003 or upon exercise of warrants issued pursuant to the Subscription Agreement. (f) "Maturity Date" means March 15, 2003. (g) "Qualified IPO" means the filing of a registration statement by the Company relating to a public offering of the securities of the Company yielding gross proceeds to the Company of not less than $10,000,000 and at an offering price per share of Common Stock equal to or greater than the quotient of $45,000,0000 divided by the number of shares of Common Stock outstanding on a fully diluted basis immediately preceding such public offering. (h) "Subscription Agreement" means the subscription agreement of even date herewith entered into by the Company and the Holder. (i) "Secured Party" means Lancer Offshore, Inc. (j) "Securities Act" means the United Stated Securities Act of 1933, as amended. -9- SECTION 9. Miscellaneous. (a) This Note may be amended only by mutual written agreement of the Company and the Majority Noteholders, and the Company may take any action herein prohibited or omit to take any action herein required to be performed by it, and any breach of any covenant, agreement, warranty or representation may be waived, only if the Company has obtained the written consent or waiver of the Holder or Majority Noteholders. Any amendments approved in compliance with this Section 9 shall bind the Holder's successors and assigns. (b) Forbearance from Suit. No holder of Notes shall institute any suit or proceeding for the enforcement of the payment of principal or interest unless the Secured Party joins in such suit or proceeding. (c) Governing Law. This Note shall be governed by, and construed in accordance with, the laws of the State of New York, excluding the body of law relating to conflict of laws. Notwithstanding anything to the contrary contained herein, in no event may the effective rate of interest collected or received by the Holder exceed that which may be charged, collected or received by the Holder under applicable law. (d) Interpretation. If any term or provision of this Note shall be held invalid, illegal or unenforceable, the validity of all other terms and provisions hereof shall in no way be affected thereby. (e) Successors and Assigns. This Note shall be binding upon the Company and its successors and assigns and shall inure to the benefit of the Holder and its successors and registered assigns. (f) Saturdays, Sundays, Holidays. If any date that may at any time be specified in this Note as a date for the making of any payment of principal or interest under this Note shall fall on Saturday, Sunday or on a day which in New York shall be a legal holiday, then the date for the making of that payment shall be the next subsequent day which is not a Saturday, Sunday or legal holiday. (g) Subscription Agreement. This Note is subject to the terms contained in the Subscription Agreement and the registered Holder of this Note is entitled to the benefits of such Subscription Agreement to the extent provided therein. -10- IN WITNESS WHEREOF, this Note due 2003 has been executed and delivered on the date first above written by the duly authorized representative of the Company. NEPHROS, INC. By: --------------------------------- Name: Title: -11- EXHIBIT B [Form of Warrant] THE TERMS OF THIS WARRANT ARE SUBJECT TO THE TERMS OF A SUBSCRIPTION AGREEMENT, COPIES OF WHICH ARE AVAILABLE FROM NEPHROS, INC. NEITHER THIS WARRANT NOR THE SECURITIES FOR WHICH IT IS EXERCISABLE HAVE BEEN REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS, AND MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED OR OTHERWISE TRANSFERRED IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO SUCH SECURITIES UNDER THE SECURITIES ACT OR AN EXEMPTION FROM THE SECURITIES ACT. ANY SUCH TRANSFER MAY ALSO BE SUBJECT TO COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS AND THE LAWS OF OTHER APPLICABLE JURISDICTIONS. THE SALE, TRANSFER, ASSIGNMENT, PLEDGE, OR ENCUMBRANCE OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE AND THE RIGHTS OF THE HOLDER OF SUCH SECURITIES IN RESPECT OF THE ELECTION OF DIRECTORS ARE SUBJECT TO THE TERMS AND CONDITIONS OF A STOCKHOLDERS' AGREEMENT DATED AS OF MAY 17, 2000 AMONG NEPHROS, INC. AND THE HOLDERS OF OUTSTANDING CAPITAL STOCK OF SUCH COMPANY. COPIES OF SUCH AGREEMENT MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS CERTIFICATE TO THE SECRETARY OF NEPHROS, INC. NEPHROS, INC. Class A Warrant for the Purchase of Shares of Common Stock No. A-1 August 5, 2002 FOR VALUE RECEIVED, NEPHROS, INC., a Delaware corporation (the "Company"), hereby certifies that Lancer Offshore, Inc. or its registered assigns (the "Holder") is entitled to purchase from the Company, subject to the provisions of this Warrant (the "Warrant"), at any time on or after the date hereof (the "Initial Exercise Date"), and prior to 12:01 A.M., New York City time, on December 1, 2007 (the "Termination Date"), 120,000 fully paid and non-assessable shares of the Common Stock, $.001 par value, of the Company ("Common Stock"), at an exercise price of $2.50 per share of Common Stock for an aggregate exercise price of three hundred thousand dollars ($300,000) (the aggregate purchase price payable for the Warrant Shares hereunder is hereinafter sometimes referred to as the "Aggregate Exercise Price"). The number of shares of Common Stock to be received upon exercise of this Warrant and the price to be paid for each share of Common Stock are subject to possible adjustment from time to time as hereinafter set forth. The shares of Common Stock or other securities or property deliverable upon such exercise as adjusted from time to time is hereinafter sometimes referred to as the "Warrant Shares." The exercise price of a share of Common Stock in effect at any time and as adjusted from time to time is hereinafter sometimes referred to as the "Per Share Exercise Price." The Per Share Exercise Price is subject to adjustment as hereinafter provided; in the event of any such adjustment, the number of Warrant Shares shall also be adjusted, by dividing the Aggregate Exercise Price by the Per Share Exercise Price in effect immediately after such adjustment. The Aggregate Exercise Price is not subject to adjustment except to the extent of any partial exercise of this Warrant. This Warrant constitutes one in a series of warrants (the "Class A Warrants") which includes this Warrant and any other Class A Warrants issued pursuant to Section 1 and/or Section 2.2 of the Subscription Agreement dated as of even date herewith (the "Subscription Agreement") by and among the Company and the Purchasers (as defined in the Subscription Agreement). 1. Exercise of Warrant. (a) This Warrant may be exercised in whole or in part, at any time by its holder commencing on the Initial Exercise Date and prior to the Termination Date by presentation and surrender of this Warrant, together with the duly executed subscription form attached at the end hereof, at the address set forth in Subsection 8(a) hereof, together with payment, by certified or official bank check or wire transfer payable to the order of the Company, of the Aggregate Exercise Price or the proportionate part thereof if exercised in part. (b) If this Warrant is exercised in part only, the Company shall, upon presentation of this Warrant upon such exercise, execute and deliver (along with the certificate for the Warrant Shares purchased) a new Warrant evidencing the rights of the Holder hereof to purchase the balance of the Warrant Shares purchasable hereunder upon the same terms and conditions as herein set forth. Upon proper exercise of this Warrant, the Company promptly shall deliver certificates for the Warrant Shares to the Holder duly legended as authorized by the subscription form. No fractional shares or scrip representing fractional shares shall be issued upon exercise of this Warrant; provided that the Company shall pay to the Holder of the Warrant cash in lieu of such fractional shares. 2. Reservation of Warrant Shares; Fully Paid Shares; Taxes. The Company hereby represents that it has, and until expiration of this Warrant agrees that it shall, reserve for issuance or delivery upon exercise of this Warrant, such number of shares of the Common Stock as shall be required for issuance and/or delivery upon exercise of this Warrant in full, and agrees that all Warrant Shares so issued and/or delivered will be validly issued, fully paid and non-assessable, and further agrees to pay all taxes (other than income taxes) and charges that may be imposed upon such issuance and/or delivery. The Company shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issue or delivery of Common Stock (or other securities or assets) in a name other than that in which the Warrants so exercised were registered, and no such issue or delivery shall be made unless and until the person requesting such issue has paid to the Company the amount of such tax or has established, to the satisfaction of the Company, that such tax has been paid. -2- 3. Protection Against Dilution. (a) In case the Company shall hereafter (i) pay a dividend or make a distribution on its capital stock in shares of Common Stock, (ii) subdivide its outstanding shares of Common Stock into a greater number of shares, (iii) combine its outstanding shares of Common Stock into a smaller number of shares or (iv) issue by reclassification of its Common Stock any shares of capital stock of the Company (each of (i) through (iv) an "Action"), the Per Share Exercise Price shall be adjusted to be equal to a fraction, the numerator of which shall be the Aggregate Exercise Price and the denominator of which shall be the number of shares of Common Stock or other capital stock of the Company that the Holder would have held (solely as a result of the exercise of this Warrant and the operation of such Action) immediately following such Action if this Warrant had been exercised immediately prior to such Action. An adjustment made pursuant to this Subsection 3(b) shall become effective immediately after the record date in the case of a dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or reclassification. (b) In the event of any capital reorganization or reclassification, or any consolidation or merger to which the Company is a party other than a merger or consolidation in which the Company is the continuing corporation, or in case of any sale or conveyance to another entity of the property of the Company as an entirety or substantially as an entirety, or in the case of any statutory exchange of securities with another corporation (including any exchange effected in connection with a merger of a third corporation into the Company), the Holder of this Warrant shall have the right thereafter to receive on the exercise of this Warrant the kind and amount of securities, cash or other property which the Holder would have owned or have been entitled to receive immediately after such reorganization, reclassification, consolidation, merger, statutory exchange, sale or conveyance had this Warrant been exercised immediately prior to the effective date of such reorganization, reclassification, consolidation, merger, statutory exchange, sale or conveyance and in any such case, if necessary, appropriate adjustment shall be made in the application of the provisions set forth in this Section 3 with respect to the rights and interests thereafter of the Holder of this Warrant to the end that the provisions set forth in this Section 3 shall thereafter correspondingly be made applicable, as nearly as may reasonably be, in relation to any shares of stock or other securities or property thereafter deliverable on the exercise of this Warrant. The above provisions of this Subsection 3(b) shall similarly apply to successive reorganizations, reclassifications, consolidations, mergers, statutory exchanges, sales or conveyances. (c) Whenever the Per Share Exercise Price payable upon exercise of this Warrant is adjusted pursuant to this Section 3, the number of shares of Common Stock underlying this Warrant shall simultaneously be adjusted to equal the number obtained by dividing the Aggregate Exercise Price (as the same shall be reduced to the extent of any partial exercise of this Warrant) by the adjusted Per Share Exercise Price. (d) If, as a result of an adjustment made pursuant to this Section 3, the Holder shall become entitled to receive, upon exercise of the Warrant, shares of two or more classes of capital stock or shares of Common Stock and other capital stock of the Company, the Board of Directors (whose determination shall be conclusive) shall determine the allocation of the -3- adjusted Per Share Exercise Price between or among shares or such classes of capital stock or shares of Common Stock and other capital stock. 4. Limited Transferability. This Warrant may not be sold, transferred, assigned or hypothecated by the Holder except in compliance with the provisions of the Act and the applicable state securities "blue sky" laws, and is so transferable only upon the books of the Company which it shall cause to be maintained for such purpose. The Company may treat the registered Holder of this Warrant as he or it appears on the Company's books at any time as the Holder for all purposes. 5. Loss, etc., of Warrant. Upon receipt of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant, and of indemnity reasonably satisfactory to the Company (which may include a bond), if lost, stolen or destroyed, and upon surrender and cancellation of this Warrant, if mutilated, the Company shall execute and deliver to the Holder a new Warrant of like date, tenor and denomination. 6. Investment Intent. (a) The Holder represents, by accepting this Warrant, that it understands that this Warrant and any securities obtainable upon exercise of this Warrant have not been registered for sale under Federal or state securities laws and are being offered and sold to the Holder pursuant to one or more exemptions from the registration requirements of such securities laws. The Holder is an "accredited investor" within the meaning of Regulation D under the Securities Act of 1933, as amended (the "Act"). In the absence of an effective registration of such securities or an exemption therefrom, any certificates for such securities shall bear the legend set forth on the first page hereof. The Holder understands that it must bear the economic risk of its investment in this Warrant and any securities obtainable upon exercise of this Warrant for an indefinite period of time, as this Warrant and such securities have not been registered under Federal or state securities laws and therefore cannot be sold unless subsequently registered under such laws, unless as exemption from such registration is available. (b) The Holder, by its acceptance of its Warrant, represents to the Company that it is acquiring this Warrant and will acquire any securities obtainable upon exercise of this Warrant for its own account for investment and not with a view to, or for sale in connection with, any distribution thereof in violation of the Act. The Holder agrees that this Warrant and any such securities will not be sold or otherwise transferred unless (i) a registration statement with respect to such transfer is effective under the Act and any applicable state securities laws or (ii) such sale or transfer is made pursuant to one or more exemptions from the Act. 7. Status of Holder. This Warrant does not confer upon the Holder any right to vote or to consent to or receive notice as a stockholder of the Company, as such, in respect of any matters whatsoever, or any other rights or liabilities as a stockholder, prior to the exercise hereof. 8. Notices. No notice or other communication under this Warrant shall be effective unless, but any notice or other communication shall be effective and shall be deemed to have been given if, the same is in writing and is mailed by first-class mail, postage prepaid, addressed to: -4- (a) the Company c/o Audubon Business and Technology Center, Columbia-Presbyterian Medical Center, 3960 Broadway, 4th Floor, New York, NY 10032, Attention: President, or such other address as the Company has designated in writing to the Holder; or (b) the Holder at Kaya Flamboyan 9, Curacao, Netherlands, Antilles, Attention: Investment Manager, or such other address as the Holder has designated in writing to the Company. 9. Headings. The headings of this Warrant have been inserted as a matter of convenience and shall not affect the construction hereof. 10. Applicable Law. This Warrant shall be governed by and construed in accordance with the law of the State of New York without giving effect to principles of conflicts of law thereof. 11. Amendments. This Warrant may be amended only by mutual written agreement of the Company and the holder or holders holding Class A Warrants exercisable for a majority of the shares of Common Stock issuable upon exercise of all then-outstanding Class A Warrants (the "Majority Holders"), and the Company may take any action herein prohibited or omit to take any action herein required to be performed by it, and any breach of any covenant, agreement, warranty or representation may be waived, only if the Company has obtained the written consent or waiver of the Majority Holders. -5- IN WITNESS WHEREOF, the undersigned, acting for and on behalf of the Company, has executed this Warrant as of the date first written above. NEPHROS, INC. By: _________________________ Name: Norma Barta Title: President and Chief Executive Officer -6- SUBSCRIPTION The undersigned, ____________________________, pursuant to the provisions of the foregoing Warrant, hereby elects to exercise the within Warrant to the extent of purchasing _____________________ shares of Common Stock thereunder and hereby makes payment of $_______________ by certified or official bank check in payment of the exercise price therefor. Dated:_______________ Signature:_____________________________ Address:_______________________________ -7- ASSIGNMENT FOR VALUE RECEIVED _______________________________________ hereby sells, assigns and transfers unto _____________________________________ the foregoing Warrant and all rights evidenced thereby, and does irrevocably constitute and appoint _____________________________, attorney, to transfer said Warrant on the books of Nephros, Inc. Dated:_______________ Signature:_____________________________ Address:______________________________ PARTIAL ASSIGNMENT FOR VALUE RECEIVED __________________________ hereby assigns and transfers unto _________________________ the right to purchase __________ shares of the Common Stock, no par value per share, of Nephros, Inc. covered by the foregoing Warrant, and a proportionate part of said Warrant and the rights evidenced thereby, and does irrevocably constitute and appoint __________________________, attorney, to transfer that part of said Warrant on the books of Nephros, Inc. Dated:_______________ Signature:___________________________ Address:_____________________________ -8- EX-10 9 kl10022_ex10-9.txt EXHIBIT 10.9 CONFIDENTIAL INFORMATION AGREEMENT Exhibit 10.9 EMPLOYEE PATENT AND CONFIDENTIAL INFORMATION AGREEMENT THIS AGREEMENT ("Agreement") is made by and between NEPHROS, INC. ("Employer") and _____________ ("Employee"). 1. Definitions. a. "Company" - The Employer and any corporation or other business enterprise directly or indirectly controlling, controlled by or under common control with Nephros, Inc. or otherwise related by equity ownership to (whether or not controlling, controlled by, or under common control with) Nephros, Inc. from time to time, whether before or after the execution of this Agreement. b. "Customer" - Customers, clients, licensors, licensees, agents, consultants, suppliers and contractors of the Company. c. "Confidential Information" - All information, whether or not reduced to writing, possessed by the Company or relating to the business of any actual or demonstrably anticipated research and development of the Company or its Customers and which gives the Company or any of its Customers an advantage over competitors who do not know or use it or is otherwise not generally known in the trade, including, but not limited to, trade secrets, proprietary information, customer lists and computer programs and software, and including information conceived, originated or developed by Employee. d. "Inventions" - All discoveries, inventions, improvements, innovations, ideas, concepts and other developments, including, but not limited to, computer programs and software, relating to the business or any actual or demonstrably anticipated research or development of the Company made or conceived by Employee in whole or in part during any period of employment with the Company, whether alone or with others, and whether or not patentable or reduced to practice. [It is understood and acknowledged by the Company and Employee that for purposes of this Agreement, in accordance with California Labor Code Sections 2870-2872, "Inventions" shall not be deemed to include an invention for which no equipment, supplies, facility, or trade secret information of the Company was used and which was developed entirely on the Employee's own time, and (a) which does not related (1) to the business of the Company or (2) to the company's actual or demonstrably anticipated research or development, or (b) which does not result from any work performed by the Employee for the Company]. 2. Consideration. This Agreement is entered in consideration of the hiring or continued employment of the Employee by the Company. 3. Purpose. The purpose of this Agreement is to protect the trade secrets and other proprietary and confidential information of the Company and the Company's right to certain inventions by Employee, in order to assure the Company's ability to continue its business and furnish employment to its employees and to preserve and protect the secrets of the United States Government, Customers and others which are entrusted to the Company. 4. Confidentiality. The Employee agrees to maintain the confidentiality of all Confidential Information, both during and subsequent to any periods of employment with the Company, and Employee will not, without express written authorization by the Company, directly or indirectly reveal or cause to be revealed any such Confidential Information to any person other than to Company employees who are authorized to receive such Confidential Information in order to perform their duties for the Company, nor will Employee use any such Confidential Information to the detriment of the Company or its Customers or other than in the course of his employment with the Company. 5. Return of Confidential Material. In the event of the Employees termination of employment with the Company for any reason whatsoever, the Employee agrees promptly to deliver to the Company all Confidential Information and Employee will not take or keep any Confidential Information, whether in its original form or as copies, upon the termination of his employment. 6. Return of Documents. All memoranda notes, notebooks, reports, drawings, photographs, plans, papers, recordings, tapes, computer discs or other forms of records made or compiled by or made available to Employee during the course of his employment, and any abstracts thereof, whether or not they contain Confidential Information, are and shall be the property of the Company and shall immediately be delivered by Employee to Company at its request or upon termination of his employment. 7. Assignment of Inventions. a. The Employee hereby assigns and transfers to the Company without further consideration his entire right, title and interest in and to all Inventions (as defined in this Agreement). b. Employee shall disclose any Invention during the period of employment promptly and fully in writing to Employee's immediate supervisor at the Company, with a copy to the President of Employer, to enable the Company to determine whether the Invention is subject to this Agreement, regardless of whether Employee believes the Invention belongs to him [or is protected by California Labor Code Section 2870.] To the extent that such Invention may belong to the Employee, the Company shall protect such disclosures to the same extent that it protects its own like proprietary information. The Company, however, shall have no such obligations to the extent such Invention is owned by the Company. c. Employee will, at the Company's request, promptly execute a written assignment of title to the Company for any Invention required to be assigned by this Agreement and will preserve any such Invention as Confidential Information of the Company. d. Employee shall, upon request by the Company, assist the Company or its nominee (at Company's expense) in every reasonable way during and at any time after Employee's employment to patent and defend the Company's or its nominee's title to any Inventions in any and all countries, which patents shall be and remain the sole and exclusive property of the Company or its nominee. -2- 8. Prior Inventions. It is understood that all inventions, if any patented or unpatented, which Employee made prior to employment by the Company are excluded from the scope of this Agreement. The Employee warrants that Employee has inserted in Schedule A attached hereby and made a part hereof a complete list of all prior inventions of Employee, if any, including numbers of all patents, and patent applications, and, in the case of unpatented inventions, a brief description of all such inventions which are not the property of a previous employer. Employee further warrants that, if no items are on the list, Employee has had no such prior inventions. IF NO INVENTIONS, SO INDICATE BY YOUR INITIALS: ____. 9. Extension of Obligations and Agreement to Previous and Future Employment. The Employee understands and agrees that the provisions of this Agreement extend also to all previous and future periods of Employee's employment by the Company and this Agreement shall continue to be in full force and effect without re-execution in the event Employee transfers between different employers within the Company, whether or not there are periods between such transfers during which the Employee is not employed by any employer within the Company. 10. Other Obligations. Employee hereby acknowledges that the Company from time to time may have agreements with other persons or with the United States Government which impose obligations or restrictions on the Company regarding inventions made during the course of work thereunder or regarding the confidential nature of such work. Employee hereby agrees to be bound by all such obligations and restrictions and to take all actions necessary to discharge the obligations of the Company thereunder. 11. Trade Secrets and Confidential Information of Others. The Employee represents and warrants that Employee's performance of all the terms of this Agreement and as an Employee of the Company does not and shall not breach any agreement to keep in confidence proprietary or confidential information acquired by the Employee during a period in which Employee was not employed by the Company, and Employee further represents and warrants that Employee shall not disclose to the Company, or induce the Company to use, any proprietary or confidential information belonging to any previous employer or to others. 12. Non-limitation of Rights. This Agreement shall not be construed to limit in any way any "shop rights" or other common law or contractual right of the Company by virtue of any previous relationship with the Employee. 13. Modification. This Agreement may only be modified or terminated by an instrument in writing, signed by the Employee and the Company. 14. Remedies. Employee and Company acknowledge and stipulate that the covenants and agreements contained in this Agreement are of a special nature and that any breach, violation or evasion by Employee of the terms of this Agreement will result in immediate and irreparable injury and harm to the Company, and will cause damage to the Company in amounts difficult to ascertain. Accordingly, the Company shall be entitled to the remedies of injunction and specific performance, or either of such remedies, as well as to all other legal or equitable remedies to which the Company may be entitled, including, without limitation, termination of the employment of Employee. -3- 15. Entire Agreement. The Employee hereby acknowledges receipt of a signed counterpart of this Agreement and acknowledges that it is Employee's entire Agreement with the Company with respect to the subject matter hereof, thereby superseding any previous oral or written understanding or agreements with the Company or any officer or representative of the Company. Nothing in this Agreement shall be deemed to be a contract of employment for a definite period of time or limit the right of the Company to terminate the employment of the Employee, with or without cause. 16. Severability. In the event that any paragraph or provision of this Agreement shall be held to be illegal or unenforceable, such paragraph or provisions shall be severed or otherwise modified as may best preserve the intention of the parties hereto, and the Agreement as so modified shall remain in full force and effect. 17. Successors and Assigns. This Agreement shall be binding upon Employee's heirs, executors, administrators and other legal representatives, and is for the benefit of the Company, it successors and assigns. 18. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York. IN WITNESS WHEREOF, the parties hereby set their hands as of this ____ day of _________, ______, and the Employee has completed Schedule A which is set forth below. NEPHROS, INC. ________________________________ Employer Employee Address: By:_______________________________ ________________________________ (Type or Print) __________ Street ________________________________ Title: ______ City, State or Province, Country -4- SCHEDULE A Following is a complete list of all prior inventions of Employee, if any, including numbers of all patents, and patent applications, and, in the case of unpatented inventions, a brief description of all such inventions which are not the property of a previous employer. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- -5- EX-10 10 kl10022_ex10-10.txt EXHIBIT 10.10 CONFIDENTIALITY AGREEMENT Exhibit 10.10 CONFIDENTIALITY AGREEMENT CONFIDENTIALITY AGREEMENT (this "Agreement") dated as of _________ between NEPHROS, INC., a Delaware corporation ("Nephros"), and ___________________ (the "Recipient") (each a "Party", and collectively, the "Parties"). WHEREAS Nephros expects to disclose to the Recipient confidential information about Nephros' business and technology, the Recipient agrees as follows: 1. "Nephros Confidential Information" means, individually and collectively, any and all information, including, without limitation, information relating to the dialysis related equipment being developed by Nephros. 2. Nephros shall disclose to Recipient only such Nephros Confidential Information as Nephros, at its sole discretion, considers necessary for Recipient to function in its defined role. 3. The Recipient shall maintain Nephros Confidential Information received pursuant to this Agreement in confidence and not disclose the same to any third party. Recipient shall use Nephros Confidential Information exclusively for the purpose of its role at Nephros as defined, and for no other purpose. The foregoing obligation of confidentiality by Recipient shall not apply to any information with respect to which the Recipient can demonstrate by written records that: (1) such information was already in the Recipient's possession or control prior to the earlier of the date of (a) disclosure or (b) first interaction with Nephros (provided that such information is not subject to another contractual, legal or fiduciary obligation to Nephros or a third party); or (2) such information was on the date of its disclosure to Recipient in or thereafter enters the public domain other than as a result of disclosure by Recipient in breach of this Agreement; or (3) becomes available to the Recipient on a non-confidential basis from a source other than Nephros, provided that such source has the right to disclose such information and is not prohibited by a confidentiality agreement with or other contractual, legal or fiduciary obligation of nondisclosure to Nephros or to another third party. 4. It is understood and agreed that any and all proprietary rights, including, but not limited to, patent rights, trademarks and other intellectual property or proprietary rights, in and to the Nephros Confidential Information disclosed by Nephros to the Recipient shall be and remain the exclusive property of Nephros. The Nephros Confidential Information will be disclosed to Recipient with the express understanding that neither Party will be obligated to enter into any further transaction or other agreement with the other party. In addition, nothing in this Agreement shall be construed as the granting of a license by Nephros to the Recipient. 5. The Agreement set forth herein may be modified, amended or waived only by separate written agreement of each of the Parties expressly so modifying, amending or waiving such Agreement. The waiver by either Party of compliance with any provision of this Agreement by the other Party shall not operate or be construed as a waiver of such Party of a provision of this Agreement. 6. The Recipient may not assign his rights or obligations hereunder. Nothing in this Agreement shall interfere with Nephros' ability to transfer or assign its rights under this Agreement. 7. All obligations of the Parties under this Agreement shall terminate upon the fifth anniversary of the termination of business relationships between the Parties. 8. This letter shall be governed by, and construed in accordance with, the laws of the State of New York, without reference to the conflict of law principles of such State to the extent that the laws of any other jurisdiction would be applicable in lieu thereof. The Parties irrevocably and unconditionally agree that the exclusive place of jurisdiction for any action, suit or proceeding ("Actions") relating to this Agreement shall be in the courts of the United States of America sitting in the City of New York. If such courts shall not have jurisdiction over the subject matter thereof, in the courts of the State of New York sitting therein, and each such party hereby irrevocably and unconditionally agrees to submit to the jurisdiction of such courts for purposes of any such Actions. Each Party irrevocably and unconditionally waives any objection it may have to the venue of any Action brought in such courts or to the convenience of the forum. Final judgment in any such Action shall be conclusive and may be enforced in other jurisdictions by suit on the judgment, a certified or true copy of which shall be conclusive evidence of the fact and the amount of any indebtedness or liability of any party therein described. 9. In the event that any provision of this Agreement shall be held invalid or unenforceable by any court of competent jurisdiction, such holding shall not invalidate or render unenforceable any other provision hereof. IN WITNESS WHEREOF, the Recipient executes this Agreement as of the date first set forth above. RECIPIENT: _____________________________ FOR NEPHROS: _____________________________ Norman J. Barta Chief Financial Officer -2- EX-10 11 kl10022_ex10-11.txt EXHIBIT 10.11 Exhibit 10.11 SETTLEMENT AGREEMENT AND MUTUAL RELEASE This Settlement Agreement and Mutual Release ("Agreement") is made and entered into as of the 19th day of June, 2002, by and among Plexus Services Corp., of 55 Jewelers Park Drive, Neenah, Wisconsin 54957 ("Claimant"), and Nephros, Inc., of 3960 Broadway, 4th Floor, New York, New York 10032 ("Nephros"). As used throughout this Agreement, the term "Parties" refers to the Claimant and Nephros and the term "Party" refers to any one of the same. RECITALS A. WHEREAS, Claimant and Nephros were engaged in a business relationship under the terms of that certain Navaho Project Plan Agreement, dated April 20, 1999, between Nephros and SeaMED Corporation, predecessor in interest to Claimant (the project contemplated thereby being called herein the "Navaho Project"); B. WHEREAS, Claimant has asserted a claim against Nephros in the amount of $1,832,496.87 (the "Claim"); C. WHEREAS, Nephros does not dispute the amount of the Claim. D. WHEREAS, the Parties have agreed to a manner in which the Claim will be paid and satisfied by Nephros. NOW, THEREFORE, in consideration of the following mutual terms, covenants and conditions, the Parties, and each of them, do hereby agree as follows: 1. Payment. Nephros shall pay the Claimant the sum of $650,000 by wire transfer in accordance with the schedule set forth below: Payment Due Date $300,000 Upon consummation of the first infusion of any capital into Nephros after the date of this Agreement, in whatever form, which results in net cash proceeds to Nephros exceeding $500,000 (the "First Infusion"). $100,000 No later than six (6) months after the First Infusion. $250,000 Upon the consummation of an infusion of capital into Nephros occurring after the First Infusion and on terms materially different from the First Infusion, or characterized by Nephros as a subsequent offering from the First Infusion, in whatever form, which results in net cash proceeds to Nephros of at least $1,250,000 (the "Second Infusion"). In the event the capital raised by Nephros after the date hereof is less than the relevant thresholds set forth above, the payment obligation of Nephros to Claimant shall be to make payment to Claimant in the amount of 20% of the gross proceeds of any such capital infusion. 2. Warrant. Simultaneously with its execution and delivery of this Agreement, Nephros is executing and delivering to Claimant a warrant granting Claimant the right to purchase 600,000 shares of common stock of Nephros (the "Stock Purchase Warrant"). 3. Satisfaction of Claim. Upon the execution and delivery of this Agreement by the Parties, the execution and delivery of the Stock Purchase Warrant by Nephros, and Nephros's compliance with its payment obligation under Section 1 hereof, the Claim shall be fully paid and satisfied and Nephros and all of its successors in interest, and all its agents, officers, directors, associates, affiliates, employees, representatives, attorneys, heirs, assigns, and/or their successors in interest, shall be forever released and discharged from any and all claims, causes of action, liabilities, damages, costs or demands of whatever character relating to the Claim, the Navaho Project or the Navaho Project Plan Agreement. Upon Nephros' payment to Claimant of the $300,000 payment referenced above, all right, title and interest to all materials and other assets, whether tangible or intangible, related to or prepared in connection with the Navaho Project (including but not limited to molds, computer and machine hardware and product documentation), and all intellectual property related thereto, shall automatically, without the necessity of any action by any Party, be conveyed and transferred to Nephros and Claimant shall, -2- promptly upon such payment, cause Nephros, to have sole access to such materials and other assets, at no additional cost to Nephros. Claimant shall execute any documentation reasonably requested by Nephros to evidence such conveyance, transfer and sole access. Releases. Except for any and all obligations and/or duties arising out of this Agreement, each Party does hereby and forever release and discharge the other Party, and all of its respective successors in interest, and all its agents, officers, directors, associates, affiliates, employees, representatives, attorneys, heirs, assigns, and/or their successors in interest, from any and all claims, causes of action, liabilities, damages or demands of whatever character which such Party now has, whether known or unknown, against the other Party. 5. Representations. (a) Nephros hereby represents and warrants that (i) Nephros has all requisite power and authority to execute and deliver this Agreement and the Stock Purchase Warrant and to perform its obligations hereunder and thereunder, (ii) this Agreement and the Stock Purchase Warrant have been duly and validly executed and delivered by Nephros and constitute valid and binding obligations of Nephros, enforceable against Nephros in accordance with their respective terms, and (iii) neither the execution and delivery of this Agreement or the Stock Purchase Warrant by Nephros, nor the consummation by Nephros of the transactions contemplated hereby or thereby, will (a) conflict with or violate any provision of the Charter, By-laws or other governing documents of Nephros, (b) require on the part of Nephros any filing with, or approval of, any governmental entity or (c) violate in any material respect any order, writ, injunction, decree, statute, rule or regulation applicable to Nephros, or any of its properties or assets. (b) Claimant hereby represents and warrants that (i) Claimant has the requisite power and authority to execute and deliver this Agreement, (ii) this Agreement has been duly -3- and validly executed and delivered by Claimant and constitutes the valid and binding obligation of Claimant, enforceable against Claimant in accordance with its terms, (iii) neither the execution and delivery of this Agreement, nor the consummation by Claimant of the transactions contemplated hereby, will (a) conflict with or violate any provision of the Charter, By-laws or other governing documents of Claimant, (b) require on the part of Claimant any filing with, or approval of, any governmental entity or (c) violate in any material respect any order, writ, injunction, decree, statute, rule or regulation applicable to Claimant, or any of its properties or assets, (iv) Claimant owns the Claim free from any lien or other encumbrance and has not assigned to any person or entity, in whole or in part, any rights in, or arising out of, the Claim, the Navaho Project or the Navaho Project Plan Agreement, (v) the Claim is the only obligation of Nephros or any of its affiliates arising out of the Navaho Project, and (vi) Claimant is the successor in interest to SeaMED Corporation as a result of a merger of SeaMED Corporation with and into Claimant. 6. Covenants. Each Party covenants to the other that it will use commercially reasonable efforts to take all actions and to do all things necessary, proper or advisable to consummate the transactions contemplated by this Agreement. Nephros agrees to provide to Claimant information with respect to the business and affairs of Nephros similar to that provided to equity investors in Nephros with investment interests in Nephros comparable to Claimant's interest (assuming the exercise by Claimant of the Stock Purchase Warrant). Nephros agrees to use its commercially reasonable best efforts to obtain the consent of the investor providing the "bridge" financing to permit Nephros to continue to conduct its operations pending its initial public offering to permit Claimant to have the right to register the common stock underlying the Stock Purchase Warrant in a Nephros registration statement (other than for -4- its initial public offering or on Form S-8 or S-4 or similar or successor form), under customary terms and conditions. 7. Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the Parties and their respective agents, employees, heirs, successors and assigns. 8. Waiver, Modification and Amendment. No provision hereof may be waived unless in writing and signed by the Party whose rights are thereby waived. Waiver of any one provision herein shall not be deemed to be a waiver of any other provision herein (whether similar or not), nor shall such waiver constitute a continuing waiver unless otherwise expressly so provided. 9. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of New York, without giving effect to any choice of law or conflict of law provision or rule that would cause the application of the laws of any jurisdictions other than the State of New York.. 10. Severability. In the event that any term or provision of this Agreement contradicts any term or provision of any other document, instrument or agreement between the Parties, the terms of this Agreement shall control. If any provision of this Agreement shall be invalid, illegal or otherwise unenforceable, such provision shall be severable from all other provisions of this Agreement, and the validity, legality and enforceability of the remaining provisions of this Agreement shall not be adversely affected or impaired, and shall thereby remain in full force and effect. 11. Entire Agreement. It is expressly understood and agreed that this Agreement constitutes the entire understanding and agreement between the Parties hereto, and supersedes and replaces all prior negotiations, agreements or understandings between the Parties, -5- whether written or oral, in each case relating to the subject matter hereof. This Agreement may not be modified by the Parties except by written instrument executed by an authorized officer of each Party. Each of the Parties acknowledges and represents that no other Party or agent or attorney of any other Party has made a promise, representation, or warranty whatsoever, express or implied, not contained herein concerning the subject matter of this Agreement. Each Party acknowledges and represents that it has not executed this Agreement in reliance upon any promise, representation or warranty whatsoever not expressly set forth in this Agreement. 12. Representations of Authority. The persons signing below each represent and warrant that they have the authority to enter into this Agreement on behalf of the Party on whose behalf they so sign. 13. Rights and Remedies Cumulative. The rights and remedies provided for in this Agreement or by law shall, to the extent permitted by law, be cumulative. 14. Reliance on Own Judgment. The Parties hereto acknowledge and agree, that in deciding to execute this Agreement, they have relied entirely upon their own respective judgment and have had adequate time to consider its terms and effects and to ask questions that they may have of anyone, including legal counsel of their own choosing. By signing this Agreement, the Parties hereto further acknowledge that they have been afforded a reasonable and sufficient period of time to review, for deliberation thereon and or the negotiations of the terms of this Agreement. 15. Counterparts. This Agreement may be signed in multiple counterpart copies, each of which shall constitute an original, with the same force and effect as if each of the Parties hereto has signed a single instrument. -6- 16. Notices. All notices under this Agreement shall be in writing, and may be delivered by hand, sent by overnight delivery by a nationally recognized overnight courier service or by registered mail, return receipt requested. Notices delivered by hand shall be effective upon receipt. Notices sent by courier or mail shall be deemed received on the date of receipt indicated by the return verification provided by the U.S. postal service or the records of the courier service. Notices shall be given or sent to the parties at the addresses set forth on the first page of this letter agreement, or to such other address as either party may designate in writing in a notice complying with this Section 16. Notices sent to Claimant shall be addressed to the General Counsel of Claimant. IN WITNESS THEREOF, the undersigned Parties have executed this Agreement effective as of the date first set forth above. DATED: June ___, 2002 Nephros, Inc. ---------------------------- By: Title: DATED: June ___, 2002 Plexus Services Corp. ---------------------------- By: Title: -7- EX-23 12 kl10022_ex23-1.txt EXHIBIT 23.1 CONSENT EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated October 15, 2002 accompanying the financial statements of Nephros, Inc. as of December 31, 2001 and for the years ended December 31, 2001 and 2000, contained in the Registration Statement and Prospectus. We consent to the use of the aforementioned report in the Registration Statement and Prospectus, and to the use of our name as it appears under the caption "Experts." /S/ GRANT THORNTON LLP October 15, 2002 New York, New York -----END PRIVACY-ENHANCED MESSAGE-----