10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2008

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from: _______ to _______

Commission File Number: 001-32288

NEPHROS, INC.

(Exact Name of Registrant as Specified in Its Charter)

DELAWARE	13-3971809
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
3960 Broadway New York, New York	10032
(Address of Principal Executive Offices)	(Zip Code)

(212) 781-5113

Registrant’s Telephone Number, Including Area Code

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days 

x YES ¨ NO

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

¨ YES x NO

As of November 14, 2008, 38,165,380shares of issuer’s common stock, with $0.001 par value per share, were outstanding.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨	Smaller reporting company x

(Do not check if a smaller reporting company)

Table of Contents

		Page No.
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Unaudited Condensed Consolidated Interim Financial Statements
	Condensed Consolidated Balance Sheets	3
	Unaudited Condensed Consolidated Statements of Operations	4
	Unaudited Condensed Consolidated Statements of Cash Flows	5
	Notes to Unaudited Condensed Consolidated Interim Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	21
Item 4T.	Controls and Procedures	21
PART II - OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders	23
Item 6.	Exhibits	23
	SIGNATURES	24

2

PART I -FINANCIAL INFORMATION

Item 1.Financial Statements.

NEPHROS, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

	September 30,			December 31,
	2008			2007
ASSETS
Current assets:
Cash and cash equivalents	$	3,745		$	3,449
Short-term investments		7			4,700
Accounts receivable, less allowances of $0 and $7, respectively		322			419
Inventory, less allowances of $28 and $30, respectively		337			336
Prepaid expenses and other current assets		336			392
Total current assets		4,747			9,296
Property and equipment, net		554			762
Other assets		27			27
Total assets	$	5,328		$	10,085
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	856		$	488
Accrued expenses		1,066			841
Total current liabilities		1,922			1,329
Stockholders’ equity:
Preferred stock, $.001 par value; 5,000,000 shares authorized at September 30, 2008 and December 31, 2007; no shares issued and outstanding at September 30, 2008 and December 31, 2007.
Common stock, $.001 par value; 60,000,000 shares authorized at September 30, 2008 and December 31, 2007; 38,165,380 shares issued and outstanding at September 30, 2008 and December 31, 2007.		38			38
Additional paid-in capital		90,317			90,220
Accumulated other comprehensive income		93			110
Accumulated deficit		(87,042	)		(81,612	)
Total stockholders’ equity		3,406			8,756
Total liabilities and stockholders’ equity	$	5,328		$	10,085

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements

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NEPHROS, INC. AND SUBSIDIARY

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Net product revenues	$	393		$	112		$	1,033		$	755
Cost of goods sold		254			131			654			581
Gross margin		139			(19	)		379			174
Operating expenses:
Research and development		191			298			2,072			1,102
Depreciation		84			86			255			253
Selling, general and administrative		1,242			1,408			3,830			3,697
Total operating expenses		1,517			1,792			6,157			5,052
Loss from operations		(1,378	)		(1,811	)		(5,778	)		(4,878	)
Interest income		27			2			185			35
Interest expense					(149	)					(317	)
Impairment of auction rate securities								(114	)
Unrealized holding gain - auction rate securities		(114	)
Gain on sale of investments		114						114
Gain on exchange of debt					330						330
Other income		5			166			163			167
Net loss		($1,346	)		($1,462	)		($5,430	)		($4,663	)
Net loss per common share, basic and diluted		($0.04	)		($0.12	)		($0.14	)		($0.38	)
Weighted average common shares outstanding, basic and diluted		38,165,380			12,317,992			38,165,380			12,317,992

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements

4

NEPHROS, INC. AND SUBSIDIARY

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Nine Months Ended September 30,
	2008			2007
Operating activities:
Net loss		($5,430	)		($4,663	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		255			253
Amortization of research & development assets		12			11
Loss on disposal of equipment		3			2
Impairment of auction rate securities		114
Gain on sale of investments		(114	)
Amortization of debt discount					32
Loss on change in valuation of derivative liability					7
Stock-based compensation		97			265
Gain on exchange of debt					(330	)
(Increase) decrease in operating assets:
Accounts receivable		93			124
Inventory		(1	)		(11	)
Deferred cost - insurance					(4	)
Prepaid expenses and other current assets		48			197
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses		594			(205	)
Accrued interest-convertible notes					277
Other liabilities					(192	)
Net cash used in operating activities		(4,329	)		(4,237	)
Investing activities:
Purchase of property and equipment		(63	)		(2	)
Purchase of short-term investments					(4,000	)
Proceeds from sale of short-term investments		4,100
Maturities of short-term investments		593			2,800
Net cash provided by (used in) investing activities		4,630			(1,202	)
Financing activities:
Deferred financing costs					(992	)
Proceeds from private placement of convertible securities					12,677
Net cash provided by financing activities					11,685
Effect of exchange rates on cash		(5	)		14
Net increase (decrease) in cash and cash equivalents		296			6,260
Cash and cash equivalents, beginning of period		3,449			253
Cash and cash equivalents, end of period	$	3,745		$	6,513

5

Supplemental disclosure of cash flow information:
Cash paid for taxes	$	8	$	3
Supplemental disclosure of noncash investing and financing activities:
Convertible note issued on debt exchange			$	5,300
Fair value of warrants issued as placement agent fees				1,047
			$	6,347

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements

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Notes to the Unaudited Condensed Consolidated Interim Financial Statements

1. Basis of Presentation and Liquidity

The accompanying unaudited condensed consolidated interim financial statements of Nephros, Inc. and its wholly owned subsidiary, Nephros International, Limited, (collectively, the “Company”) should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s 2007 Annual Report on Form 10-KSB filed with the Securities and Exchange Commission (the “SEC”) on March 31, 2008. The Company filed Amendment No. 1 to its 2007 Annual Report Form 10-KSB/A with the SEC on October 9, 2008. The amendment added certain language regarding internal control over financial reporting to paragraphs 4 and 4(b) of the certifications of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 8 and Article 10 of Regulation S-X. Accordingly, since they are interim statements, the accompanying financial statements do not include all of the information and notes required by GAAP for a complete financial statement presentation. The condensed consolidated balance sheet as of December 31, 2007 was derived from the Company’s audited financial statements but does not include all disclosures required by GAAP. In the opinion of management, the interim financial statements reflect all adjustments consisting of normal, recurring adjustments that are necessary for a fair presentation of the financial position, results of operations and cash flows for the condensed consolidated interim periods presented. Interim results are not necessarily indicative of results for a full year. All significant inter-company transactions and balances have been eliminated in consolidation.

The Company has incurred significant losses in its operations in each quarter since inception. For the three and nine months ended September 30, 2008, the Company incurred a net loss of approximately $1.3 million and $5.4 million, respectively. In addition, the Company has not generated positive cash flow from operations in any quarter since inception. The Company expects to continue to incur losses for at least the short-term. To become profitable, the Company must increase revenue substantially and achieve and maintain positive gross and operating margins. If the Company is not able to increase revenue and gross and operating margins sufficiently to achieve profitability, the Company’s results of operations and financial condition will be materially and adversely affected.

2. Concentration of Credit Risk

For the nine months ended September 30, 2008 and 2007, the following customers accounted for the following percentages of the Company’s sales, respectively.

Customer	2008	2007
A	84 %	92 %
B	10 %	0 %

As of September 30, 2008 and December 31, 2007, the following customers accounted for the following percentages of the Company’s accounts receivable, respectively. 

Customer	2008	2007
A	77 %	0 %
B	16 %	0 %

3. Revenue Recognition

The Company recognizes revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition” (“SAB 104”). SAB 104 requires that four basic criteria must be met before revenue can be recognized: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the fee is fixed and determinable and (iv) collectability is reasonably assured.

The Company recognizes revenue related to product sales when its external logistics provider confirms delivery and the other criteria of SAB 104 are met. All costs and duties relating to delivery are absorbed by the Company. All shipments are currently received directly by the Company’s customers. Sales made on a returned basis are recorded net of a provision for estimated returns. These estimates are revised as necessary, to reflect actual experience and market conditions. The returns provision is based on historical unit return levels and valued relative to debtors at the end of each quarter. There were no returns for the nine months ended September 30, 2008 and 2007.

7

4. Stock-Based Compensation

The Company complies with the accounting and reporting requirements of Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”), using a modified prospective transition method. For the three months ended September 30, 2008, stock-based compensation expense was approximately $33,000, as compared to approximately $30,000 of stock-based compensation for the comparable period in 2007. For the nine months ended September 30, 2008 and 2007, stock-based compensation expense was approximately $97,000 and $265,000, respectively.

There was no tax benefit related to expense recognized in the nine months ended September 30, 2008 and 2007, as the Company is in a net operating loss position. As of September 30, 2008, there was approximately $706,000, of total unrecognized compensation cost related to unvested share-based compensation awards granted under the equity compensation plans. Such amount does not include the effect of future grants of equity compensation, if any. Of this amount, approximately $706,000 will be amortized over the weighted-average remaining requisite service period of 3.4 years. Of the total $706,000, the Company expects to recognize approximately 8.3% in the remaining interim periods of 2008, approximately 35.2% in 2009, approximately 30.0% in 2010, approximately 15.0% in 2011 and approximately 11.6% in 2012.

5. Comprehensive Income

The Company accounts for comprehensive income in accordance with SFAS No. 130, “Reporting Comprehensive Income” (“SFAS 130”), which requires comprehensive income (loss) and its components to be reported when a company has items of other comprehensive income (loss). Comprehensive income (loss) includes net income plus other comprehensive income (loss) (i.e., certain revenues, expenses, gains and losses reported as separate components of stockholders’ equity (deficit) rather than in net income (loss)).

The Company accounts for certain transactions with a foreign affiliate in a currency other than U.S. dollars. For the purposes of presenting the condensed consolidated interim financial statements in conformity with GAAP, the transactions must be converted into U.S. dollars in accordance with SFAS No. 52, “Foreign Currency Translation”(“SFAS 52”). Since these transactions are of a long-term investment nature and settlement is not planned or anticipated in the foreseeable future, the offsetting foreign currency adjustment is accounted for as an other comprehensive income item in the unaudited condensed consolidated balance sheets.

6. Loss per Common Share

In accordance with SFAS No. 128, “Earnings Per Share” (“SFAS 128”), net loss per common share amounts (“basic EPS”) are computed by dividing net loss by the weighted-average number of common shares outstanding and excluding any potential dilution. Net loss per common share amounts assuming dilution (“diluted EPS”) are generally computed by reflecting potential dilution from conversion of convertible securities and the exercise of stock options and warrants. However, because their effect is antidilutive, the Company has excluded stock options and warrants aggregating 14,339,324 and 38,546,992 from the computation of diluted EPS for the three and nine month periods ended September 30, 2008 and 2007, respectively.

7. Recently Adopted Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements”(“SFAS 157”). This Standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. It applies to other accounting pronouncements where the FASB requires or permits fair value measurements but does not require any new fair value measurements. In February 2008, the FASB issued FASB Staff Position (FSP) No. 157-2, “Effective Date of FASB Statement No.157” (“FSP 157-2”), which delayed the effective date of SFAS 157 for certain non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Company adopted SFAS 157 for financial assets and liabilities on January 1, 2008. The disclosures required under SFAS 157 are set forth in Note 9. The Company is currently in the process of evaluating the effect, if any, that the adoption of FSP 157-2 will have on its results of operations or financial position.

8

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 155” (“SFAS 159”). This statement permits entities to choose to measure selected assets and liabilities at fair value. The Company adopted SFAS 159 on January 1, 2008 resulting in no material impact to the Company’s financial condition, results of operation or cash flows.

On October 10, 2008, the FASB issued FSP FAS No. 157-3, “Fair Value Measurements” (FSP FAS 157-3), which clarifies the application of SFAS No. 157 in an inactive market and provides an example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of this standard as of September 30, 2008 did not have a material impact on the Company’s results of operations, cash flows or financial positions.

8. New Accounting Pronouncements

 In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations”(“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirer in a business combination recognizes and measures in its financial statements the fair value of identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date. SFAS 141R determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting SFAS 141R on its consolidated results of operations and financial condition and plans to adopt it as required in the first quarter of fiscal 2009.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”), an amendment of Accounting Research Bulletin (“ARB”) No. 51, “Consolidated Financial Statements” (“ARB 51”). SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be recharacterized as noncontrolling interests and will be reported as a component of equity separate from the parent’s equity, and purchases or sales of equity interests that do not result in a change in control will be accounted for as equity transactions. In addition, net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement and upon a loss of control, the interest sold, as well as any interest retained, will be recorded at fair value with any gain or loss recognized in earnings. This pronouncement is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting SFAS 160 on its consolidated results of operations and financial condition and plans to adopt it as required in the first quarter of fiscal 2009.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. The objective of the guidance is to provide users of financial statements with an enhanced understanding of how and why an entity uses derivative instruments: how an entity accounts for derivative instruments and related hedged items and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years beginning after November 15, 2008. Management has evaluated SFAS 161 and has determined that it will have no impact on the Company’s consolidated financial statements.

In December 2007, the SEC issued SAB No. 110, “Share-Based Payment” (“SAB 110”). SAB 110 establishes the continued use of the simplified method for estimating the expected term of equity based compensation. The simplified method was intended to be eliminated for any equity based compensation arrangements granted after December 31, 2007. SAB 110 is being published to help companies that may not have adequate exercise history to estimate expected terms for future grants. The Company does not expect the adoption of SAB 110 to have a material effect on its consolidated financial statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”(“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The adoption of this statement is not expected to have a material effect on the Company’s financial statements.

9

In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts - An interpretation of FASB Statement No. 60” (“SFAS 163”). SFAS 163 requires that an insurance enterprise recognize a claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. It also clarifies how SFAS No. 60 “Accounting and Reporting by Insurance Enterprises” (“SFAS 60”) applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities, and requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, except for some disclosures about the insurance enterprise’s risk-management activities. SFAS 163 requires that disclosures about the risk-management activities of the insurance enterprise be effective for the first period beginning after issuance. Except for the disclosures identified above, earlier application is not permitted. The adoption of this statement is not expected to have a material effect on the Company’s financial statements.

9. Fair Value of Financial Instruments 

As described in Note 7, the provisions of SFAS 157 were adopted by the Company on January 1, 2008 for financial assets and liabilities, and will be adopted by the Company on January 1, 2009 for non-financial assets and liabilities.

SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).

The Company invested in auction rate securities (“ARS”), which are long-term debt instruments with interest rates reset through periodic short-term auctions. If there are insufficient buyers when such a periodic auction is held, then the auction “fails” and the holders of the ARS are unable to liquidate their investment through such auction. With the liquidity issues experienced in global credit and capital markets, the ARS held by the Company have experienced multiple failed auctions since February 2008, and as a result, the Company did not consider these affected ARS liquid in the first quarter of 2008. Accordingly, while the Company had classified its ARS as current assets at December 31, 2007, the Company reclassified them as noncurrent assets at March 31, 2008.

Based upon an analysis of other-than-temporary impairment factors, the Company wrote down ARS with an original par value of approximately $4.4 million to an estimated fair value of $4.3 million as of March 31, 2008. The Company reviewed impairments associated with the above in accordance with Emerging Issues Task Force (EITF) 03-1 and FSP SFAS 115-1/124-1, “The Meaning of Other-Than-Temporary-Impairment and Its Application to Certain Investments,” to determine the classification of the impairment as “temporary” or “other-than-temporary.”

The Company determined the ARS classification to be “other-than-temporary,” and charged an impairment loss of approximately $114,000 on the ARS to its results of operations for the three months ended March 31, 2008.

During the three months ended June 30, 2008 approximately $300,000 of principal on the Company’s ARS had been paid back by the debtor, resulting in the Company’s investment in ARS having decreased from $4.4 million to $4.1 million (par value) at June 30, 2008. The net book value of the Company’s ARS at June 30, 2008 was $3.986 million, due to the approximate $114,000 impairment recorded at March 31, 2008. On July 22, 2008 the Company sold its ARS to a third party at 100% of par value, for proceeds of $4.1 million. The Company reclassified the ARS from Available-for-Sale to Trading Securities due to the sale of the investments in July 2008.

In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS 115”) the ARS, classified as Trading Securities, were valued at their fair value of $4.1 million at June 30, 2008. The adjustment of the investment’s carrying value from $3.986 million net book value to $4.1 million fair value resulted in an Unrealized Holding Gain of approximately $114,000 which is included in the Company’s Statement of Operations for the three and six months ended June 30, 2008.

The Company sold its ARS to a third party at 100% of par value, for proceeds of $4.1 million on July 22, 2008. The Unrealized Holding Gain of approximately $114,000 which was included in the Company’s Statement of Operations for the three and six months ended June 30, 2008 was reversed and a realized Gain on Sale of Investments of approximately $114,000 is included in the Company’s Statement of Operations for the three and nine months ended September 30, 2008.

10

The underlying assets of the Company’s ARS were comprised primarily of student loans and their fair value at March 31, 2008 was measured using Level 3 inputs due to the failure of the auction market. Due to the subsequent sale of the investments at par, the fair value of the securities was measured using Level 1 inputs as the proceeds redeemed in July 2008 were placed in a money market account with observable market sources.

10. Inventory, net

Inventory is stated at the lower of cost or market using the first-in first-out method. The Company’s inventory as of September 30, 2008 and December 31, 2007 was approximately as follows:

	Unaudited
	September 30, 2008		December 31, 2007
Raw Materials	$	25,000	$	62,000
Finished Goods		340,000		304,000
Total Gross Inventory	$	365,000	$	366,000
Less: Inventory reserve		28,000		30,000
Total Inventory	$	337,000	$	336,000

11. Commitments and Contingencies

As of September 15, 2008, Norman J. Barta resigned from the Company’s Board of Directors and as the Company’s Chairman of the Board, President, Chief Executive Officer, Secretary and Treasurer. Effective immediately upon Mr. Barta’s resignation, the Board of Directors appointed Ernest A. Elgin III as the Company’s President and Chief Executive Officer, appointed the Company’s Chief Financial Officer, Gerald Kochanski, to the additional offices of Secretary and Treasurer, and elected Mr. James Scibetta, an independent Director of the Company and the Chairman of Audit Committee, to serve as Chairman of the Board of Directors.

Separation Agreement

On September 15, 2008, the Company entered into a separation agreement and release with Mr. Barta, pursuant to which the employment agreement between the Company and Mr. Barta, dated as of July 1, 2007, was terminated.  Pursuant to the separation agreement, Mr. Barta agreed to remain employed by the Company and to consult with the Company's officers, directors and agents and otherwise provide assistance in the Company's transition to a new chief executive officer until October 10, 2008 (“Separation Date”).   The separation agreement provides, among other things, that: 

·   The Company will pay Mr. Barta his base salary and any accrued but unused vacation through the Separation Date;

·   Within five days following the Separation Date, the Company will pay Mr. Barta an $18,000 bonus in connection with certain operational milestones that had been met; and

·   Mr. Barta will continue to receive his base salary for a period of six months following the Separation Date.

The Separation Agreement also stated that, in accordance with their respective terms, the options granted to Mr. Barta on January 24, 2000, December 14, 2004 and November 8, 2007 - to the extent vested prior to the Separation Date - shall remain exercisable until three months after the Separation Date, and the options granted to Mr. Barta on January 30, 2003 shall remain exercisable until nine months after the Separation Date. A number of the options that were granted to Mr. Barta on November 8, 2007 remained unvested and were cancelled and forfeited by Mr. Barta as of the Separation Date. The separation agreement also contains mutual releases and other customary provisions.

11

Employment Agreement

The Company entered into an employment agreement with Mr. Elgin, dated as of September 15, 2008, having a term of three years. Pursuant to such employment agreement, Mr. Elgin’s initial annual base salary is $240,000. The employment agreement also provides that the Company shall establish a target discretionary bonus of 30% of Mr. Elgin’s base salary, the amount of which, if any, that Mr. Elgin is awarded will be determined by the Compensation Committee of the Company’s Board in its sole discretion, based in part on attainment of certain performance objectives to be identified by Mr. Elgin and the Compensation Committee. The Company agreed to provide Mr. Elgin with a guaranteed bonus of $35,000 for the period from September 15, 2008 through December 31, 2008. Pursuant to the employment agreement, on September 15, 2008, the Company’s Compensation Committee granted Mr. Elgin an option to purchase 750,000 shares of common stock under the Company’s 2004 Equity Incentive Plan. The option will vest in four equal annual installments of 187,500 shares on each of September 15, 2009, September 15, 2010, September 15, 2011 and September 15, 2012, provided that Mr. Elgin remains employed by the Company at such time, and provided further that all options shall vest and become exercisable in full immediately upon the occurrence of a Change of Control (as defined in the employment agreement).

Mr. Elgin’s employment agreement provides that, upon termination by the Company for Cause or Disability (as such terms are defined in the agreement) or by Mr. Elgin for any reason other than his exercise of the Change of Control Termination Option (as defined in the agreement), the Company shall pay him only his earned but unpaid base salary and bonuses for services rendered through the date of termination. If Mr. Elgin’s employment is terminated by his death or by his voluntary resignation or retirement other than upon his exercise of the Change of Control Termination Option, then the Company shall pay him only his earned but unpaid base salary for services rendered through the date of termination. If the Company terminates Mr. Elgin’s employment for any other reason or if he terminates his employment pursuant to his Change of Control Termination Option, then, provided he continues to abide by certain confidentiality and non-compete provisions of his agreement and executes a release, he shall be entitled to: (1) any accrued but unpaid base salary for services rendered through the date of termination; and (2) the continued payment of his base salary, in the amount as of the date of termination, for a period of either three months or, if he has been employed under the agreement for at least one year, six months subsequent to the termination date or until the end of the remaining term of the agreement if sooner, such payments to be made at the times such base salary would have beenpaid had his employment not been terminated. Upon termination of Mr. Elgin’s employment for any reason, his unvested options shall immediately be cancelled and forfeited and his vested options shall remain exercisable for 90 days after such termination.

Upon any Change of Control (as defined in the employment agreement), Mr. Elgin shall have a period of time in which to discuss, negotiate and confer with any successor entity regarding the terms and conditions of his continued employment. If Mr. Elgin, acting reasonably, is unable to timely reach an agreement through good faith negotiations with such successor, then he may elect (the “Change of Control Termination Option”) to terminate his employment with the Company and receive the payments and bonuses described above with respect to such a termination.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

The following discussion and analysis of our condensed consolidated interim financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated interim financial statements and related notes, as well as the other sections of this quarterly report on Form 10-Q (the “Quarterly Report”) and the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2007 included in our Annual Report on Form 10-KSB filed with the SEC on March 31, 2008 (the “Annual Report”) as well as the rest of such Annual Report, including the “Certain Risks and Uncertainties” and “Description of Business” sections thereof. Operating results are not necessarily indicative of results that may occur in future periods. This discussion contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this Quarterly Report and in our Annual Report. Our actual results may differ materially.

Financial Operations Overview

Revenue Recognition: Revenue is recognized in accordance with SAB 101, “Revenue Recognition in Financial Statements” (“SAB 101”), as amended by SAB 104. SAB 101 requires that four basic criteria must be met before revenue can be recognized: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the fee is fixed and determinable; and (iv) collectability is reasonably assured.

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Cost of Goods Sold: Cost of goods sold represents the acquisition cost for the products we purchase from our third party manufacturers as well as damaged and obsolete inventory written off.

Research and Development: Research and development expenses consist of costs incurred in identifying, developing and testing product candidates. These expenses consist primarily of salaries and related expenses for personnel, fees of our scientific and engineering consultants and subcontractors and related costs, clinical studies, machine and product parts and software and product testing. We expense research and development costs as incurred.

Selling, General and Administrative: Selling, general and administrative expenses consist primarily of sales and marketing expenses as well as personnel and related costs for general corporate functions, including finance, accounting, legal, human resources, facilities and information systems expense.

Business Overview

Since our inception in April 1997, we have been engaged primarily in the development of hemodiafiltration, or HDF, products and technologies for treating patients with End Stage Renal Disease, or ESRD. Our products include the OLpūr MD190 and MD220, which are dialyzers (our “OLpūr MDHDF Filter Series”), OLpūr H2H, an add-on module designed to enable HDF therapy using the most common types of hemodialysis machines, and the OLpūr NS2000 system, a stand-alone HDF machine with associated filter technology. We began selling our OLpūr MD190 dialyzer in some parts of our Target European Market (consisting of France, Germany, Ireland, Italy and the United Kingdom (U.K.), as well as Cyprus, Denmark, Greece, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland) in March 2004, and have developed units suitable for clinical evaluation for our OLpûr H2H product. We are developing our OLpûr NS2000 product in conjunction with an established machine manufacturer in Italy. We are working with this manufacturer to modify an existing HDF platform they currently offer for sale in parts of our Target European Market, incorporating our proprietary H2H technology.

To date, we have devoted most of our efforts to research, clinical development, seeking regulatory approval for our ESRD products, establishing manufacturing and marketing relationships and establishing our own marketing and sales support staff for the development, production and sale of our ESRD therapy products in our Target European Market and the United States upon their approval by appropriate regulatory authorities.

In the first quarter of 2007, we received approval from the U.S. Food and Drug Administration (the “FDA”) for our Investigational Device Exemption (“IDE”) application for the clinical evaluation of our OLpūr H2H module and OLpūr MD 220 filter. We have also received the approval from the Institutional Review Board (“IRB”) associated with the clinics at which the trials will take place. We obtained approval from Western IRB, Inc. to conduct a clinical trial. We completed the patient treatment phase of our clinical trial during the second quarter of 2008. We have submitted our data to the FDA with our 510(k) application on these products in November 2008.

We have also applied our filtration technologies to water filtration and in 2006 we introduced our new Dual Stage Ultrafilter (the “DSU”) water filtration system. Our DSU represents a new and complementary product line to our existing ESRD therapy business. The DSU incorporates our unique and proprietary dual stage filter architecture. The DSU is designed to remove a broad range of bacteria, viral agents and toxic substances, including salmonella, hepatitis, cholera, Ebola virus, ricin toxin, legionella, fungi and e-coli.

We currently have pilot installations of the DSU at several hospitals in the United States. We are actively qualifying distributors nationwide to sell the DSU and they are in the process of completing product evaluations.

In 2006, the U.S. Defense Department budget included an appropriation for the U.S. Marine Corps for development of a dual stage water ultra filter. In connection with this Federal appropriation of approximately $1 million, we are developing a personal potable water purification system for use by warfighters. Work on this project commenced in January 2008 and we have billed approximately $103,000 during the nine months ended September 30, 2008. In December 2007, the U.S. Department of Defense Appropriations Act appropriated an additional $2 million to continue the development of a dual stage ultra reliable personal water filtration system. Although it is our intention to execute an agreement with the U.S. Department of Defense to utilize this appropriation before it expires in September 2009, such an agreement has not been executed as of September 30, 2008.

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Since our inception, we have incurred annual net losses. As of September 30, 2008 we had an accumulated deficit of approximately $87,042,000, and we expect to incur additional losses in the foreseeable future. We recognized net losses of approximately $5,430,000 for the nine month period ended September 30, 2008, and approximately $4,663,000 for the nine-month period ended September 30, 2007.

Since our inception, we have financed our operations primarily through sales of our equity and debt securities. From inception through September 30, 2008, we received net-offering proceeds from private sales of equity and debt securities and from the initial public offering of our common stock (after deducting underwriters’ discounts, commissions and expenses, and our offering expenses) of approximately $52.0 million in the aggregate. An additional source of financing was our license agreement with Asahi, pursuant to which we received an up front license fee of $1.75 million in March 2005.

The following trends, events and uncertainties may have a material impact on our potential sales, revenue and income from operations:

(1) achieving regulatory approval for use of our ESRD therapy products in the United States;

(2)	the market acceptance of HDF therapy in the United States and of our technologies and products in each of our target markets;
(3)	our ability to effectively and efficiently manufacture, market and distribute our products;

(4) our ability to sell our products at competitive prices which exceed our per unit costs; and

(5) the consolidation of dialysis clinics into larger clinical groups.

To the extent we are unable to succeed in accomplishing (1) through (4), our sales could be lower than expected and dramatically impair our ability to generate income from operations. With respect to (5), the impact could either be positive, in the case where dialysis clinics consolidate into independent chains, or negative, in the case where competitors acquire these dialysis clinics and use their own products, as competitors have historically tended to use their own products in clinics they have acquired.

Compliance with the Listing Standards of the NYSE Amerinext U.S. (f/k/a the American Stock Exchange)

During 2006, we received notices from the American Stock Exchange (together with NYSE Amerinext U.S., following NYSE Euronext’s acquisition of the American Stock Exchange, the “AMEX”) that we were not in compliance with certain conditions of the continued listing standards of Section 1003 of the AMEX Company Guide. Specifically, AMEX noted our failure to comply with Section 1003(a)(i) of the AMEX Company Guide relating to shareholders’ equity of less than $2,000,000 and losses from continuing operations and/or net losses in two out of our three most recent fiscal years; Section 1003(a)(ii) of the AMEX Company Guide relating to shareholders’ equity of less than $4,000,000 and losses from continuing operations and/or net losses in three out of our four most recent fiscal years; and Section 1003(a)(iii) of the AMEX Company Guide relating to shareholders’ equity of less than $6,000,000 and losses from continuing operations and/or net losses in our five most recent fiscal years. We submitted a plan in August 2006 to advise AMEX of the steps we had taken, and proposed to take, to regain compliance with the applicable listing standards.

On November 14, 2006, we received notice that the AMEX staff had reviewed our plan of compliance to meet the AMEX’s continued listing standards and that AMEX would continue our listing while we sought to regain compliance with the continued listing standards during the period ending January 17, 2008. During the plan period, we were required to provide the AMEX staff with updates regarding initiatives set forth in our plan of compliance. On November 14, 2007, all of our Series A 10% Secured Convertible Notes Due 2008 and our Series B 10% Secured Convertible Notes due 2008 (collectively, the "Notes"), representing an aggregate principal amount of $18 million, were converted into shares of our common stock and warrants, resulting in an increase in our stockholders’ equity. As a result, and notwithstanding our loss during the fourth quarter of 2007, our stockholders’ equity at December 31, 2007 was approximately $8,756,000 and in excess of the $6,000,000 required by the AMEX rules.

On March 5, 2008, we received a letter from the AMEX acknowledging that we had resolved the continued listing deficiencies referenced in the AMEX’s letters dated July 17, 2006 and November 14, 2006.

At June 30, 2008, our stockholders’ equity was $4,814,000, which is less than the applicable AMEX continued listing standard.

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On September 12, 2008 we received notice from the AMEX that we were not in compliance with certain conditions of the continued listing standards of Part 10 of the AMEX Company Guide. Specifically, the AMEX noted our failure to comply with Section 1003(a)(iii) of the AMEX Company Guide relating to shareholders’ equity of less than $6,000,000 and losses from continuing operations and net losses in our five most recent fiscal years. We submitted a plan on October 13, 2008 to advise AMEX of the steps we had taken, and proposed to take, to regain compliance with the applicable listing standards. We have not yet received a response to the compliance plan that we submitted.

Management is considering various approaches to regaining compliance; however, there can be no assurance that we will be successful. In accordance with Section 1009(h) of the AMEX Company Guide, the AMEX may evaluate the relationship between our failures to meet its continued listing standards and truncate its evaluation process or immediately initiate delisting proceedings. If our plan of compliance to meet the AMEX continued listing standards is not accepted by the AMEX, or if we are unable to show progress consistent with our plan of compliance or otherwise unable to timely regain compliance with the AMEX listing standards, then we may be delisted from the AMEX. Furthermore, there can be no assurance that we will not fail to comply with the AMEX rules regarding minimum stockholders’ equity or other continued listing standards in the future. If we fail to meet any of these standards, then our common stock may be delisted from the AMEX.

Critical Accounting Policies

We adopted several changes to our critical accounting policies during the first nine months of 2008 as set forth below. The discussion and analysis of our consolidated financial condition and results of operations are based upon our condensed financial statements. These condensed financial statements have been prepared following the requirements of accounting principles generally accepted in the United States (“GAAP”) and Rule 8-03 of Regulation S-X for interim periods and require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to potential impairment of investments and share-based compensation expense. As these are unaudited condensed consolidated financial statements, one should also read expanded information about our critical accounting policies and estimates provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Form 10-KSB for the year ended December 31, 2007.

In September 2006, the FASB issued SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. It applies to other accounting pronouncements where the FASB requires or permits fair value measurements but does not require any new fair value measurements. In February 2008, the FASB issued FSP 157-2, which delayed the effective date of SFAS 157 for certain non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. We adopted SFAS 157 for financial assets and liabilities on January 1, 2008. The disclosures required under SFAS 157 are set forth in Note 9 to our condensed financial statements set forth in Item 1 of this quarterly report. We are currently in the process of evaluating the effect, if any, that the adoption of FSP 157-2 will have on our results of operations or financial position.

Results of Operations

Fluctuations in Operating Results

Our results of operations have fluctuated significantly from period to period in the past and are likely to continue to do so in the future. We anticipate that our quarterly results of operations will be impacted for the foreseeable future by several factors including the progress and timing of expenditures related to our research and development efforts, as well as marketing expenses related to product launches. Due to these fluctuations, we believe that the period to period comparisons of our operating results are not a good indication of our future performance.

Three Months Ended September 30, 2008 Compared to the Three Months Ended September 30, 2007

Net Product Revenues

Net product revenues were approximately $393,000 for the three months ended September 30, 2008 compared to approximately $112,000 for the three months ended September 30, 2007, an increase of 251%. The $281,000 increase in net product revenues is primarily due to an increase of approximately $231,000 or 206% in sales of the OLpūr MD190 and MD220 Dialyzers in Europe and approximately $50,000 in revenue generated from the U.S. Defense Department project in the United States which did not begin until 2008.

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Cost of Goods Sold

Cost of goods sold was approximately $254,000 for the three months ended September 30, 2008 compared to approximately $131,000 for the three months ended September 30, 2007. The increase of approximately $123,000 or 94% in cost of goods sold is primarily due to the 206% increase in sales of the OLpūr MD190 and MD220 Dialyzers in Europe for the 2008 period.

Research and Development

Research and development expenses were approximately $191,000 for the three months ended September 30, 2008 compared to approximately $298,000 for the three months ended September 30, 2007, a decrease of 36%. This $107,000 decrease is primarily due to a decrease of approximately $213,000 in Clinical Trial Expense, which was caused by a reduction during the three months ended September 30, 2008 in a previously accrued related expenditure. This reduction in Clinical Trial Expense was offset by increases of $43,000 in Salaries, $59,000 in Supplies, and $4,000 in Product Development/Testing.

Depreciation Expense

Depreciation expense was approximately $84,000 for the three months ended September 30, 2008 compared to approximately $86,000 for the three months ended September 30, 2007, a decrease of approximately $2,000.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were approximately $1,242,000 for the three months ended September 30, 2008 compared to approximately $1,408,000 for the three months ended September 30, 2007, a decrease of approximately $166,000 or 12%. The decrease is due primarily to reduced Legal Expenses of approximately $321,000. Legal Expenses were higher in the 2007 period due to the exchange of New Notes for Old Notes and the private placement of additional New Notes that took place in September 2007. The savings in Legal Expenses were partially offset by increases of $100,000 in Marketing Expenses and $55,000 in Recruiting Expenses.

Interest Income

Interest income was approximately $27,000 for the three months ended September 30, 2008, compared to approximately $2,000 for the three months ended September 30, 2007. The increase of approximately $25,000 is a result of our having in excess of $3 million in a savings account generating interest income during the three months ended September 30, 2008, compared to none during the comparable period in 2007.

Interest Expense

We incurred no interest expense for the three months ended September 30, 2008 because we had no debt during this period. Interest expense totaled approximately $149,000 for the three months ended September 30, 2007. The prior period interest expense primarily represents approximately $72,000 for accrued interest liability associated with our 6% Secured Convertible Notes due 2012 (the “Old Notes”), approximately $50,000 for the accrued interest liability associated with the our 10% Secured Convertible Notes due 2008 (the “New Notes”), approximately $24,000 associated with the amortization of the debt discount on the New Notes that we issued in exchange for Old Notes on September 19, 2007, and approximately $3,000 associated with amortization of debt discount on the Old Notes through September 18, 2007. In the fourth quarter of 2007, all of our debt securities, including the New Notes, were converted into equity. For further information regarding the conversion of these debt securities, please refer to Note 7 to our Consolidated Financial Statements in our Annual Report on Form 10-KSB for the year ended December 31, 2007.

Unrealized Holding Gain - Auction Rate Securities(ARS) and Gain on Sale of Investments

On July 22, 2008 the Company sold its ARS to a third party at 100% of par value, for proceeds of $4.1 million. The Company, at June 30, 2008, reclassified the ARS from Available-for-Sale to Trading Securities due to the sale of the investments in July 2008.

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In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS 115”), the ARS, classified as Trading Securities, were valued at their fair value of $4.1 million at June 30, 2008. The adjustment of the investment’s carrying value from $3.986 million net book value to $4.1 million fair value resulted in an Unrealized Holding Gain of approximately $114,000 which is included in the Company’s Statement of Operations for the three and six months ended June 30, 2008.

The Company sold its ARS to a third party at 100% of par value, for proceeds of $4.1 million on July 22, 2008. The Unrealized Holding Gain of approximately $114,000 which was included in the Company’s Statement of Operations for the three and six months ended June 30, 2008 was reversed and a realized Gain on Sale of Investments of approximately $114,000 is included in the Company’s Statement of Operations for the three and nine months ended September 30, 2008.

Gain on Exchange of Debt

For the three months ended September 30, 2007, the gain on exchange of debt in the amount of approximately $330,000 resulted from a gain of approximately $254,000 on exchange of the Old Notes and a gain of approximately $76,000 on the cancellation of the warrants that could have been issued upon certain prepayments of the Old Notes by the Company. There was no gain or loss on exchange of debt in the three months ended September 30, 2008.

Other Income and Expenses

Other income was approximately $5,000 for the three months ended September 30, 2008 compared to approximately $166,000 of other income for the three months ended September 30, 2007. The $166,000 is the net result of approximately $261,000 for refunds received from New York State for Qualified Emerging Technology Credits (“QETC”) and other expenses of approximately $95,000 for the three months ended September 30, 2007. The prior year other expenses are comprised of the impact of the change in valuation of the derivative liability of approximately $8,000 and approximately $87,000 in expenses associated with the collection of the QETC tax refund reported in other income.

Nine Months Ended September 30, 2008 Compared to the Nine Months Ended September 30, 2007

Net Product Revenues

Total net product revenues for the nine months ended September 30, 2008 were approximately $1,033,000 compared to approximately $755,000 for the nine months ended September 30, 2007, an increase of 37%. The $278,000 or 37% increase is primarily due to an increase of approximately $165,000 or 22% in sales of the OLpūr MD190 and MD220 Dialyzers in Europe and revenues in the Unites States of $9,000 from the sale of the Dual Stage Ultrafilter (the “DSU”) water filtration system. Our DSU represents a new and complementary product line and the Company had no revenues generated from it during the comparable time period in 2007. Approximately $103,000 in revenue was generated from the U.S. Defense Department project in the United States which did not begin until 2008.

Cost of Goods Sold

Cost of goods sold was approximately $654,000 for the nine months ended September 30, 2008 compared to approximately $581,000 for the nine months ended September 30, 2007. The $73,000 or 13% increase in cost of goods sold is primarily due to the $165,000 increase in sales of the OLpūr MD190 and MD220 Dialyzers in Europe for the 2008 period.

Research and Development

Research and development expenses were approximately $2,072,000 for the nine months ended September 30, 2008 compared to approximately $1,102,000 for the nine months ended September 30, 2007, an increase of $970,000 or 88%. This $970,000 increase is primarilydue to the cost of the clinical trial that took place during the nine months ended September 30, 2008. There was no similar clinical trial in 2007.

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Depreciation Expense

Depreciation expense was approximately $255,000, for the nine months ended September 30, 2008 compared to approximately $253,000 for the nine months ended September 30, 2007.. The $2,000 increase is primarily due to an increase in purchases of long-term assets in the amount of $63,000 during the nine months ended September 30, 2008.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were approximately $3,830,000 for the nine months ended September 30, 2008 compared to approximately $3,697,000 for the nine months ended September 30, 2007, an increase of $133,000 or 4%. The increase of $133,000 reflects the Company’s investment in Marketing during the 2008 period in order to establish corporate identity, improve the company’s website, and advertise the merits of the Dual Stage Ultrafilter (the “DSU”) water filtration system. The Company also hired a Vice President of Marketing during the 2008 period and will hire a Vice President of Sales in 2008.

Interest Income

Interest income was approximately $185,000 for the nine months ended September 30, 2008 compared to approximately $35,000 for the nine months ended September 30, 2007. The increase of approximately $150,000 resulted from our having cash on hand during the 2008 period that we invested in interest generating investments. We had no excess cash during the comparable period in 2007.

Interest Expense

We incurred no interest expense for the nine months ended September 30, 2008 because we had no debt during this period. The interest expense of approximately $317,000 for the nine months ended September 30, 2007 primarily represents approximately $228,000 for the accrued interest liability associated with our Old Notes, approximately $50,000 for the accrued interest liability associated with the New Notes, approximately $24,000 associated with the amortization of the debt discount on the New Notes that we issued in exchange for New Notes, approximately $8,000 associated with the amortization of the debt discount on the Old Notes and approximately $6,000 for the interest portion of the present value of payments we made to the Receiver for Lancer Offshore, Inc. pursuant to certain settlement arrangements. In the fourth quarter of 2007, all of our debt securities, including the New Notes, were converted into equity. We made the final payment under our settlement with the Receiver for Lancer Offshore, Inc. in October 2007.

Impairment of Auction Rate Securities and Gain on Sale of Investments

At December 31, 2007 we held $4.1 million in ARS as a short-term investment. We sold our ARS to a third party on July 22, 2008 for $4.1 million. We recorded an Unrealized Holding Gain through earnings for the three months ended June 30, 2008 of approximately $114,000 (the difference between fair value and book value) when we adjusted such investment to fair value, as a result of our reclassification of such investment from Available-for-Sale to Trading Securities. We subsequently reversed the Unrealized Holding Gain and recorded a Realized Gain on Sale of Investments of approximately $114,000 in July 2008 when the sale transaction was executed.

Gain on Exchange of Debt

There was no gain or loss on exchange of debt in the nine months ended September 30, 2008. For the nine months ended September 30, 2007, the gain on exchange of debt includes approximately $330,000 for the gain realized on debt extinguishment which includes a gain on exchange of the Old Notes of approximately $254,000 and a gain of approximately $76,000 on the cancellation of the warrants that could have been issued upon certain prepayments of the Old Notes by us.

Other Income and Expenses

Other income in the amount of approximately $163,000 for the nine months ended September 30, 2008 resulted from our receipt of QETC tax refunds. This amount was approximately $4,000, or 2%, less than other income of approximately $167,000 for the nine months ended September 30, 2007, which also includes the impact of refunds received from New York State for QETC.

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Liquidity and Capital Resources

We have incurred losses in our operations in each quarter since inception. We expect to continue to incur losses for at least the short-term. To become profitable, we must increase revenue substantially and achieve and maintain positive gross and operating margins. If we are not able to increase revenue and gross and operating margins sufficiently to achieve profitability, our results of operations and financial condition will be materially and adversely affected.

As of September 30, 2008, we had approximately $3.7 million in cash and cash equivalents and approximately $7,000 in short term investments. We do not currently generate enough revenue through the sale of our products or licensing revenues to meet our expenditure needs on an ongoing basis. There can be no assurance that our future cash flow will be sufficient to meet our obligations and commitments. If we are unable to generate sufficient cash flow from operations in the future to service our indebtedness and to meet our other commitments, then we may be required to adopt alternatives, such as seeking to raise additional debt or equity capital, curtailing our planned activities or ceasing our operations. There can be no assurance that any such actions could be effected on a timely basis or on satisfactory terms or at all, or that these actions would enable us to continue to satisfy our capital requirements.

Net cash used in operating activities was approximately $4.3 million for the nine months ended September 30, 2008 compared to approximately $4.2 million for the nine months ended September 30, 2007. Approximately $92,000 more cash was used in operating activities during the nine months ended September 30, 2008 than in the nine months ended September 30, 2007. This was primarily due to:

· During the 2008 period, our net loss increased by approximately $767,000;

· During the 2008 period, adjustments to net loss were approximately $127,000 higher than during the 2007 period;

· During the 2008 period, our decrease in current assets was approximately $166,000 lower than during the 2007 period; and

· During the 2008 period, our increase in current liabilities was approximately $714,000 higher than during the 2007 period due to higher operating expenses in the 2008 period as compared to the 2007 period.

Net cash provided by investing activities was approximately $4,630,000 for the nine months ended September 30, 2008, compared to net cash used in investing activities of approximately $1,202,000 for the nine months ended September 30, 2007. Our net cash provided by investing activities for the nine months ended September 30, 2008 reflects the proceeds from the sales of auction rate securities of approximately $4,100,000 plus maturities of short-term investments net of purchases in the amount of approximately $593,000 partially offset by approximately $63,000 for purchases of computer equipment. For the nine months ended September 30, 2007, our $1,202,000 net cash used in investing activities reflects purchases of $4,000,000 of auction rate securities and purchases of $2,000 of equipment, partially offset by the maturities of short-term investments in the amount of approximately $2,800,000.

Certain Risks and Uncertainties

Our Annual Report on Form 10-KSB for the year ended December 31, 2007 includes a detailed discussion of our risk factors under the heading “Certain Risks and Uncertainties.” The information presented below updates and should be read in conjunction with the risk factors and information disclosed in such Form 10-KSB.

We may not be able to meet the continued listing standards of the NYSE Amerinext U.S. (f/k/a the American Stock Exchange) and as a result, our Common Stock may be delisted from such exchange.

During 2006, we received notices from the American Stock Exchange (together with NYSE Amerinext U.S., following NYSE Euronext’s acquisition of the American Stock Exchange, the “AMEX”) that we are not in compliance with certain conditions of the continued listing standards of Section 1003 of the AMEX Company Guide. Specifically, AMEX noted our failure to comply with Section 1003(a)(i) of the AMEX Company Guide relating to minimum shareholders’ equity requirements. We submitted a plan in August 2006 to advise AMEX of the steps we had taken, and would take, to regain compliance with the applicable listing standards. On November 14, 2006, we received notice that the AMEX staff had reviewed our plan of compliance to meet the AMEX’s continued listing standards and that AMEX will continue our listing while we seek to regain compliance with the continued listing standards during the period ending January 17, 2008.

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On November 14, 2007, all of our Series A 10% Secured Convertible Notes Due 2008 and our Series B 10% Secured Convertible Notes due 2008 (collectively, the "Notes"), representing an aggregate principal amount of $18 million, were converted into shares of our common stock and warrants, resulting in an increase in our stockholders’ equity. As a result, and notwithstanding our loss during the fourth quarter of 2007, our stockholders’ equity at December 31, 2007 was approximately $8,756,000 and in excess of the $6,000,000 required by the AMEX rules. On March 5, 2008, we received a letter from the AMEX acknowledging that we had resolved the continued listing deficiencies referenced in the AMEX’s letters dated July 17, 2006 and November 14, 2006.

At June 30, 2008, our stockholders’ equity was $4,814,000, which is less than the applicable AMEX continued listing standard. On September 12, 2008 we received notice from the AMEX that we were not in compliance with certain conditions of the continued listing standards of Part 10 of the AMEX Company Guide. Specifically, AMEX noted our failure to comply with Section 1003(a)(iii) of the AMEX Company Guide relating to shareholders’ equity of less than $6,000,000 and losses from continuing operations and net losses in our five most recent fiscal years. We submitted a plan on October 13, 2008 to advise AMEX of the steps we had taken, and proposed to take, to regain compliance with the applicable listing standards. We have not yet received a response to the submitted plan.

In accordance with Section 1009(h) of the AMEX Company Guide, the AMEX may evaluate the relationship between our failures to meet its continued listing standards and truncate its evaluation process or immediately initiate delisting proceedings. Furthermore, there can be no assurance that we will not fail to comply with the AMEX rules regarding minimum stockholders’ equity or other continued listing standards in the future. If we fail to meet any of these standards, then our common stock may be delisted from the AMEX.

If our plan of compliance to meet the AMEX continued listing standards is not accepted by the AMEX, or if we are unable to show progress consistent with our plan of compliance or otherwise unable to timely regain compliance with the AMEX listing standards, then we may be delisted from the AMEX. If our Common Stock is delisted by the AMEX, then the market liquidity for our Common Stock would likely be negatively affected, which may make it more difficult for holders of our Common Stock to sell their securities in the open market and we could face difficulty raising capital necessary for our continued operation. Investors may find it more difficult to dispose of or obtain accurate quotations as to the market value of our securities.

In addition, our Common Stock, if delisted by the AMEX, may constitute “penny stock” (as defined in Rule 3a51-1 promulgated under the Securities Exchange Act of 1934, as amended) if we fail to meet certain criteria set forth in such Rule. Various practice requirements are imposed on broker-dealers who sell “penny stocks” to persons other than established customers and accredited investors. For these types of transactions, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transactions prior to sale. Consequently, if our Common Stock were to become “penny stock,” then the Rule may deter broker-dealers from recommending or selling our Common Stock, which could further negatively affect the liquidity of our Common Stock.

Safe Harbor for Forward-Looking Statements

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Such statements include statements regarding the efficacy and intended use of our technologies under development, the timelines for bringing such products to market and the availability of funding sources for continued development of such products and other statements that are not historical facts, including statements which may be preceded by the words “intends,” “may,” “will,” “plans,” “expects,” “anticipates,” “projects,” “predicts,” “estimates,” “aims,” “believes,” “hopes,” “potential” or similar words. For such statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance are based on certain assumptions and are subject to various known and unknown risks and uncertainties, many of which are beyond our control. Actual results may differ materially from the expectations contained in the forward-looking statements. Factors that may cause such differences include the risks that:

· we may not be able to obtain funding if and when needed or on terms favorable to us in order to continue operations;

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· we may not be able to continue as a going concern;

· we may be unable to maintain compliance with the AMEX's continued listing standards and, as a result, we may be delisted from the AMEX;

· products that appeared promising to us in research or clinical trials may not demonstrate anticipated efficacy, safety or cost savings in subsequent pre-clinical or clinical trials;

· we may not obtain appropriate or necessary regulatory approvals to achieve our business plan or effectively market our products;

· we may encounter unanticipated internal control deficiencies or weaknesses or ineffective disclosure controls and procedures;

· HDF therapy may not be accepted in the United States and/or our technology and products may not be accepted in current or future target markets, which could lead to failure to achieve market penetration of our products;

· we may not be able to sell our ESRD therapy or water filtration products at competitive prices or profitably;

· we may not be able to secure or enforce adequate legal protection, including patent protection, for our products; and

· we may not be able to achieve sales growth in Europe or expand into other key geographic markets.

More detailed information about us and the risk factors that may affect the realization of forward-looking statements, including the forward-looking statements in this Quarterly Report, is set forth in our filings with the SEC, including our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007 and in this Quarterly Report on Form 10-Q. We urge investors and security holders to read those documents free of charge at the SEC’s web site at www.sec.gov. We do not undertake to publicly update or revise our forward-looking statements as a result of new information, future events or otherwise.

Off-Balance Sheet Arrangements

We did not engage in any off-balance sheet arrangements during the three and nine month periods ended September 30, 2008 and 2007.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Due to our status as a smaller reporting company, this Item is not required.

Item 4T. Controls and Procedures.

Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures have not been operating effectively as of the end of the period covered by this report.

In connection with the preparation of our Annual Report of Form 10-KSB, management identified a material weakness, due to an insufficient number of resources in the accounting and finance department, resulting in (i) an ineffective review, monitoring and analysis of schedules, reconciliations and financial statement disclosures and (ii) the misapplication of U.S. GAAP and SEC reporting requirements. Due to the pervasive effect of the lack of resources, including a lack of resources that are appropriately qualified in the areas of U.S. GAAP and SEC reporting, and the potential impact on the financial statements and disclosures and the importance of the annual and interim financial closing and reporting process, in the aggregate, there is more than a remote likelihood that a material misstatement of the annual financial statements would not have been prevented or detected.

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Remediation Plans

Management is in the process of remediating the above-mentioned weakness in our internal control over financial reporting and is implementing the following steps:

• Develop procedures to implement a formal monthly closing process and hold monthly meetings to address the monthly closing process;

• Establish a detailed timeline for review and completion of financial reports to be included in our Forms 10-Q and 10-K;

• Enhance the level of service provided by outside accounting service providers to further support and supplement our internal staff in accounting and related areas; and

• Employ the use of appropriate supplemental SEC and U.S. GAAP checklists in connection with our closing process and the preparation of our Forms 10-Q and 10-K.

The implementation of these remediation plans has been initiated and will continue during the remainder of fiscal 2008. The material weakness will not be considered remediated until the applicable remedial procedures are tested and management has concluded that the procedures are operating effectively. Management recognizes that use of our financial resources will be required not only for implementation of these measures, but also for testing their effectiveness.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II -OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders.

There were no matters submitted to a vote of security holders during the three months ended September 30, 2008.

Item 6.Exhibits.

EXHIBIT INDEX

10.1 Separation Agreement and Release, dated as of September 15, 2008, between Nephros, Inc. and Norman J. Barta.

10.2 Employment Agreement, dated as of September 15, 2008, between Nephros, Inc. and Ernest A. Elgin III.

31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certifications by the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	NEPHROS, INC.
Date: November 14, 2008	By:	/s/ Ernest A. Elgin III
	Name:	Ernest A. Elgin III
	Title:	President and Chief Executive Officer (Principal Executive Officer)
Date: November 14, 2008	By:	/s/ Gerald J. Kochanski
	Name:	Gerald J. Kochanski
		Chief Financial Officer (Principal Financial and Accounting Officer)

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Exhibit Index

10.1 Separation Agreement and Release, dated as of September 15, 2008, between Nephros, Inc. and Norman J. Barta.

10.2 Employment Agreement, dated as of September 15, 2008, between Nephros, Inc. and Ernest A. Elgin III.

31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certifications by the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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EX-10.1

SEPARATION AGREEMENT AND RELEASE

This Separation Agreement and Release (“Agreement”) is entered into by and between Nephros, Inc., and its affiliates and subsidiaries (the “Company”), and Norman J. Barta (“Barta”), as of September 15, 2008 (the “Effective Date”). The Company and Barta are referred to herein as the “Parties.”

WHEREAS, Barta is employed as Chairman, President and Chief Executive Officer of the Company pursuant to an Employment Agreement, dated as of July 1, 2007 (the“Employment Agreement”), under which the Parties agreed to certain terms and conditions relating to Barta’s employment with the Company;

WHEREAS, because of his employment as an executive of the Company, Barta has obtained intimate and unique knowledge of all aspects of the Company’s business operations, current and future plans, financial plans and other confidential and proprietary information;

WHEREAS, Barta and the Company mutually desire to terminate their employment relationship and Barta desires to resign as a member of the Company’s Board of Directors and to resign his positions as Chairman, President, Chief Executive Officer, Secretary and Treasurer of the Company, and all other director, officer and employee positions (other than the Transition Role, as defined below), if any, held by Barta in the Company or any of its subsidiaries or affiliates effective as of the Effective Date;

WHEREAS, Barta and the Company mutually desire that, Barta shall be employed by the Company in the Transition Role after his termination as an officer, subject the terms and conditions set forth herein;

WHEREAS, the Parties desire to finally, fully and completely resolve all disputes that now or may exist between them, including, but not limited to those concerning Barta’s job performance and activities while employed by the Company and his hiring, employment and termination from the Company, and all disputes over benefits and compensation connected with such employment, and specifically, but not limited to, any disputes arising from the terms of Barta’s employment as set forth in the Employment Agreement.

NOW, THEREFORE, in consideration of the premises and mutual covenants and agreements hereinafter set forth, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Company and Barta agree as follows:

1.Termination; Transition.

(a) Termination. The Parties agree that the Employment Agreement shall terminate on the Effective Date. Effective as of the Effective Date, Barta hereby resigns his positions as Chairman of the Board, President, Chief Executive Officer, Secretary and Treasurer and all other director, officer, and employee positions with the Company and any of the Company’s subsidiaries or affiliates, other than the Transition Role (as defined below). On the Effective Date, Barta will execute a resignation letter in the form attached hereto as Exhibit A, and provide any other documents, if necessary, to effect his resignation(s).

(b) Transition. The Parties hereby agree that for a period of up to 26 days following the Effective Date (the “Transition Period”), Barta shall consult as reasonably needed and not necessarily on a full time basis with officers, directors and agents of the Company and otherwise provide assistance in the Company’s transition to a new chief executive officer as reasonably requested by the Company (the “Transition Role”); provided, however, that the Company may choose to terminate the Transition Period at any time in the event that Barta does not render the services required by this Section in the Transition Role. During the Transition Period, Barta shall be paid an amount equal to his current pre-Transition Period salary, which shall be paid in the same manner as prior to the Transition Period, and shall be provided with the same benefits as his current pre-Transition Period benefits for the Transition Period. Transition Period payments shall be by wire transfer or direct deposit through the Company’s payroll system to Barta’s account shown therein. Upon at least seven (7) days prior written notice, Barta may elect a different account for the wire transfer or direct deposit. Barta’s last day of employment with the Company in any capacity will not be later than October 10, 2008 (the “Separation Date”).

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2.Certain Payments and Benefits.

(a)Accrued Obligations. On or prior to the third day following the Separation Date, Barta shall submit expense requests and supporting documentationfor any unpaid reimbursable company-related expenses, and within five (5) days following the Separation Date, the Company shall pay Barta for reimbursement for unpaid reimbursable company-related expenses for which Barta has timely submitted expense requests and supporting documentation, and for all unpaid salary, other earned but unpaid benefits relating to Barta’s employment with the Company, and any accrued but unused vacation through the Separation Date (the “Accrued Obligations”). Except as stated in this Agreement or as required by law, all other compensation and benefits which relate to Barta’s employment with the Company, including any benefits set forth in the Employment Agreement or in any other employee benefit plan, policy or program, except as memorialized in this Agreement, shall cease as of the Separation Date.

(b) Milestone Bonus payment. Within five (5) days following the Separation Date, the Company shall pay Barta $18,000 in fulfillment of the contractual Milestone Bonus stipulated upon successful completion of the clinical trial of the OLpur^TM H2H^TM Hemodiafiltration Module and OLpur^TM MD220 Hemodiafilter in the United States.

(c)Separation Payments. The Company will pay Barta his current pre-Transition Period base salary for a period of six months following the Separation Date (the “Severance Period”), minus normal payroll withholdings and taxes, if applicable (“Separation Payments”), payable in accordance with the Company’s normal payroll practices beginning with the first payroll period following the Separation Date. Separation Payments shall be by wire transfer or direct deposit through the Company’s payroll system to Barta’s account shown therein. Upon at least seven (7) days prior written notice, Barta may elect a different account for the wire transfer or direct deposit. Barta shall be entitled to submit a revised and restated IRS Form W-4 and/or New York Form IT-2104 to Company with regard to income tax withholding amounts. The Separation Payments will not be treated as compensation under the Company’s 401(k) Plan or any other retirement plan.

(d) Benefits. For a period of six (6) months after the Separation Date, Barta shall continue to participate in all employee benefit plans, programs, and arrangements providing health, medical, disability and life insurance benefits in which Barta (or as applicable, his spouse or estate) may be entitled pursuant to the plans and programs of the Company in which Barta was participating prior to the Transition and Severance Periods, the terms of which allow Barta’s continued participation, as if Barta had continued in employment with Company during the Severance Period. Alternatively, if such plans, programs, or arrangements do not allow Barta’s continued participation for the six (6) month period following the Separation Date, if Barta timely elects COBRA continuation coverage or similar continuation coverage provided for under New York or New Jersey law, Company will pay the monthly insurance premiums of such coverage for the levels and types of coverage Barta maintained for Barta’s benefit prior to the Transition and Severance Periods. In any case, at the end of the six (6) month period, Barta may pursue alternative continuation insurance coverage at his own expense. The Company will provide Barta with any notification as required by law with respect to such alternative coverage and reasonable assistance in completing any documents relating to such alternative continuing insurance coverage.

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(e)Options. The parties acknowledge that Barta has been granted certain options (collectively, the “Options”) under equity incentive plans of the Company, including the Amended and Restated Nephros 2000 Equity Incentive Plan and the Nephros, Inc. 2004 Stock Incentive Plan, which are represented by certain Option Agreements (the “Option Agreements”) that will survive the termination of Barta’s employment. Pursuant to the terms of such Option Agreements, 347,221 of shares subject to the Options granted on November 8, 2007 remain unvested as of the Effective Date and shall automatically be cancelled and forfeited by Barta as of the Separation Date. The shares subject to the Options granted on January 24, 2000, December 14, 2004, and November 8, 2007 that vested prior to the Separation Date shall remain exercisable until three months after the Separation Date, in accordance with the terms of the respective Option Agreements. The Option granted on January 30, 2003 shall remain exercisable until nine months after the Separation Date, in accordance with the terms of such Option Agreement.

(f)Waiver of Additional Compensation or Benefits. Other than the Separation Payments and other obligations provided for in this Agreement, Barta shall not be entitled to any additional compensation, benefits, payments or grants under any benefit plan, severance plan or bonus or incentive program established by the Company or any of the Company’s affiliates. Any vested interest held by Barta in the Company’s 401(k) Plan, retirement plan and any other plans in which Barta participates, including the 401(k) matching payments for contributions made up to and including the Separation Date, shall be maintained and/or distributed at Barta’s direction, e.g., rolled over or otherwise, in accordance with the terms of the plan and applicable law. Barta agrees that the release in Paragraph 4 covers any claims he might have regarding his compensation, bonuses, stock options or grants and any other benefits he may or may not have received during his employment with the Company.

(g)No Duty to Mitigate. Barta shall be under no duty to mitigate any losses or damage to Company with respect to any amounts payable pursuant to Section 2 of this Agreement, by seeking other employment or otherwise, nor shall the amount of any payments provided under this Section 2 be reduced by any compensation earned by Barta as the result if employment by another employer after the termination of Barta’s employment or otherwise.

(h)Life InsuranceTransfer. Company shall cooperate with Barta regarding the transfer of ownership to Barta, named beneficiaries, payee addresses, and otherwise under any life insurance policies, more particularly, without limitation, policy number 16-957-587, Plan 75, with ISA Number 97-430-81; provided that Barta assumes all of the Company’s obligations with respect to such policies and the relevant insurer provides the Company with an acknowledgement and/or consent to such assignment and assumption (which may include a release of the Company) in form and substance satisfactory to the Company.

3.Press Release. In connection with the termination of Barta’s employment with the Company, Barta hereby agrees to the Company’s issuance of a press release, and internal communications and external communications regarding his separation from his employment; provided that the Parties shall mutually approve the language of any press release; provided further that Barta shall not unreasonably withhold his approval or that Company shall not unreasonably propose and impose language for the press release and other communications on Barta. Any such announcements or statements shall not contain any disparaging statements about Barta. The Company agrees to include a favorable quote from the lead director of the Board of Directors concerning Barta in any press release and other communications issued relating to Barta’s resignation.

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4.Mutual Release and Waiver.

(a)By Barta. In consideration of the payments and other consideration provided for in this Agreement, that being good and valuable consideration, the receipt, adequacy and sufficiency of which are acknowledged by Barta, Barta, on his own behalf and on behalf of his agents, administrators, representatives, executors, successors, heirs, devisees and assigns (collectively, the “Releasing Parties”) hereby fully releases, remises, acquits and forever discharges the Company and all of its affiliates, and each of their respective past, present and future officers, directors, shareholders, equity holders, members, partners, agents, employees, consultants, independent contractors, attorneys, advisers, successors and assigns (collectively, the “Released Parties”), jointly and severally, from any and all claims, rights, demands, debts, obligations, losses, causes of action, suits, controversies, setoffs, affirmative defenses, counterclaims, third party actions, damages, penalties, costs, expenses, attorneys’ fees, liabilities and indemnities of any kind or nature whatsoever, whether known or unknown, suspected or unsuspected, accrued or unaccrued, whether at law, equity, administrative, statutory or otherwise, and whether for injunctive relief, back pay, fringe benefits, reinstatement, reemployment, or compensatory, punitive or any other kind of damages, which any of the Releasing Parties ever have had in the past or presently have against the Released Parties, and each of them, arising from or relating to Barta’s employment with the Company or its affiliates or the termination of that employment or any circumstances related thereto, or any other matter, cause or thing whatsoever, including without limitation all claims arising under or relating to employment, employment contracts (including the Employment Agreement), employee benefits or purported employment discrimination or violations of civil rights of whatever kind or nature, including without limitation all claims arising under the Age Discrimination in Employment Act (“ADEA”), the Americans with Disabilities Act of 1990, the Family and Medical Leave Act of 1993, the Equal Pay Act of 1963, the Rehabilitation Act of 1973, Title VII of the United States Civil Rights Act of 1964, 42 U.S.C. § 1981, the Civil Rights Act of 1991, the Civil Rights Acts of 1866 and/or 1871, the Sarbanes-Oxley Act, the New York State Labor Laws or any other applicable federal, state or local employment discrimination statute, law or ordinance, including, without limitation, any workers’ compensation or disability claims under any such laws, claims for wrongful discharge, breach of express or implied contract or implied covenant of good faith and fair dealing, and any other claims arising under state or federal law, as well as any expenses, costs or attorneys’ fees. Barta further agrees that Barta will not file or permit to be filed on Barta’s behalf any such claim. Notwithstanding the preceding sentence or any other provision of this Agreement, this release is not intended to interfere with Barta’s right to file a charge with the Equal Employment Opportunity Commission (the “EEOC”) in connection with any claim he believes he may have against the Company or its affiliates. However, by executing this Agreement, Barta hereby waives the right to recover in any proceeding Barta may bring before the EEOC or any state human rights commission or in any proceeding brought by the EEOC or any state human rights commission on Barta’s behalf. This release shall not apply to any of the Company’s obligations under this Agreement, or any vested 401(k), retirement plan, health, medical or dental insurance or continuing benefits or perquisites to which Barta is entitled under this Agreement or any tax qualified pension plan of the Company or its affiliates, COBRA continuation coverage benefits or any other similar benefits required to be provided by statute. Barta does not release his right to enforce the terms of this Agreement. Barta acknowledges that certain of the payments and benefits provided for in Section 2 of this Agreement constitute good and valuable consideration for the release contained in this Section 4.

(b)By the Company. In consideration of the mutual promises contained in this Agreement, that being good and valuable consideration, the receipt, adequacy, and sufficiency which are acknowledged by the Company, on behalf of itself and all of its subsidiaries, and their present and former representatives, agents, employees, officers, directors, attorneys, stockholders, plan fiduciaries, successors and assigns, irrevocably and unconditionally releases, waives, and forever discharges, Barta and his heirs, executors, successors and assigns (the “Barta Released Parties”), jointly and severally, from any and all claims, rights, demands, debts, obligations, losses, causes of action, suits, controversies, setoffs, affirmative defenses, counterclaims, third party actions, damages, penalties, costs, expenses, attorneys’ fees, liabilities and indemnities of any kind or nature whatsoever, whether known or unknown, suspected or unsuspected, accrued or unaccrued, whether at law, equity, administrative, statutory or otherwise, and whether for injunctive relief, or compensatory, punitive or any other kind of damages, which any of the Released Parties ever have had in the past or presently have against the Barta Released Parties, and each of them, arising from or relating to Barta’s employment with the Company or its affiliates or the termination of that employment or any circumstances related thereto, or any other matter, cause or thing whatsoever, including without limitation all claims arising under or relating to employment, employment contracts (including the Employment Agreement), that do not relate to or arise out of Barta’s gross negligence or intentional misconduct. This Agreement includes, without limitation, claims at law or equity or sounding in contract (express or implied) or tort, claims arising under any federal, state or local laws, or any other statutory or common law claims related to Barta’s employment or retirement as Chairman, Chief Executive Officer, Secretary, and Treasurer of the Company.

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5.Exclusive Employment; Noncompetition.

(a)No Conflict; No Other Employment. Until the Separation Date, Barta shall not: (i) engage in any activity which conflicts or interferes with or derogates from the performance of Barta’s duties hereunder nor shall Barta engage in any other business activity, whether or not such business activity is pursued for gain or profit, except as approved in advance in writing by the Board of Directors of the Company; provided, however, that Barta shall be entitled to manage his personal investments and otherwise attend to personal affairs, including charitable activities, in a manner that does not unreasonably interfere with his responsibilities hereunder, or (ii) accept any other employment, whether as an executive or consultant or in any other capacity, and whether or not compensated therefor, unless Barta receives the prior written approval of the Board of Directors of the Company.

(b)No Competition. Barta acknowledges and recognizes the highly competitive nature of the Company’s business and that access to the Company’s confidential records and proprietary information renders him special and unique within the Company’s industry. In consideration of the termination of the Employment Agreement (which includes restrictions substantially similar to those provided by this Section 5) and the payment by the Company to Barta of amounts that may hereafter be paid to Barta pursuant to this Agreement and other obligations undertaken by the Company hereunder, Barta agrees that during (i) his employment with the Company and (ii) the period beginning on the Separation Date and ending on the last day of the Severance Period, Barta shall not, directly or indirectly, engage (as owner, investor, partner, stockholder, employer, employee, consultant, advisor, director or otherwise) in any Competing Business, provided that the provisions of this Section 5(b) will not be deemed breached merely because Barta owns less than 1% of the outstanding common stock of a publicly-traded company. Additionally, the Company, upon sixty (60) days written notice to Barta shall have the option subject to Barta’s mutual approval, which shall not be unreasonably withheld, to extend the No Competition Period for an additional six months in return for a six (6) month extension of the Severance Period in consideration for continued Separation Payments under Section 2(c) hereof and continued welfare coverage under Section 2(d) hereof during such extended Severance Period. For purposes of this Agreement, “Competing Business” shall mean (i) any business in which the Company is engaged as of the Effective Date in the geographic locations set forth on Schedule A hereto, including without limitation with regard to the businesses of (A) the development of medical equipment in the hemodiafiltration realm for use in ESRD chronic therapy, and (B) the development of cold water purification systems.

(c)Non-Solicitation. In further consideration of the termination of the Employment Agreement (which includes restrictions substantially similar to those provided by this Section 5) and the payment by the Company to Barta of amounts that may hereafter be paid to Barta pursuant to this Agreement and other obligations undertaken by the Company hereunder, Barta agrees that until the end of the Severance Period, he shall not, directly or indirectly, (i) solicit, encourage or attempt to solicit or encourage any of the employees, agents, consultants or representatives of the Company or any of its affiliates to terminate his, her, or its relationship with the Company or such affiliate; (ii) solicit, encourage or attempt to solicit or encourage any of the employees of the Company or any of its affiliates to become employees or consultants of any other person or entity; (iii) solicit, encourage or attempt to solicit or encourage any of the consultants of the Company or any of its affiliates to become employees or consultants of any other person or entity, provided that the restriction in this clause (iii) shall not apply if (A) such solicitation, encouragement or attempt to solicit or encourage is in connection with a business which is not a Competing Business and (B) the consultant’s rendering of services for the other person or entity will not interfere with the consultant’s rendering of services to the Company; (iv) solicit or attempt to solicit any customer, vendor or distributor of the Company or any of its affiliates with respect to any product or service being furnished, made, sold or leased by the Company or such affiliate, provided that the restriction in this clause (iv) shall not apply if such solicitation or attempt to solicit is (A) in connection with a business which is not a Competing Business and (B) does not interfere with, or conflict with, the interests of the Company or any of its affiliates; or (v) persuade or seek to persuade any customer of the Company or any affiliate to cease to do business or to reduce the amount of business which any customer has customarily done or contemplates doing with the Company or such affiliate, whether or not the relationship between the Company or its affiliate and such customer was originally established in whole or in part through Barta’s efforts. For purposes of this Section 5(c) only, the terms “customer,” “vendor” and “distributor” shall mean a customer, vendor or distributor who has done business with the Company or any of its affiliates within twelve months preceding the Separation Date.

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(d)Until the end of the Severance Period, Barta agrees that upon the earlier of Barta’s (i) negotiating with any Competitor (as defined below) concerning the possible employment of Barta by the Competitor, (ii) receiving an offer of employment from a Competitor, or (iii) becoming employed by a Competitor, Barta will (A) immediately provide written notice to the Company (the “Competition Notice”) of such circumstances and (B) provide copies of Section 5 of this Agreement to the Competitor and, at Barta’s discretion, any other Sections and/or subsections of this Agreement. Barta further agrees that should the Company reasonably consider Barta’s proposed employment to be in violation of the terms of this Agreement, the Company may provide notice to a Competitor of Barta’s obligations under this Agreement, including without limitation Barta’s obligations pursuant to Section 5 hereof, subject to Barta first receiving five (5) days prior written notice of Company’s intent to notify any such Competitor and the basis for asserting such a violation hereof. Barta shall not accept employment with a Competitor until at least ten (10) days after the Company receives the Competition Notice with respect thereto. For purposes of this Agreement, “Competitor” shall mean any entity (other than the Company or any of its affiliates) that engages, directly or indirectly, in any Competing Business.

(e)Barta understands that the provisions of this Section 5 may limit his ability to earn a livelihood in a business similar to the business of the Company or its affiliates but nevertheless agrees and hereby acknowledges that the consideration provided under this Agreement, including without limitation the termination of the Employment Agreement, which includes restrictions substantially similar to those provided by this Section 5, and the other obligations undertaken by the Company hereunder, is sufficient to justify the restrictions contained in such provisions. In consideration thereof and in light of Barta’s education, skills and abilities, Barta agrees that he will not assert in any forum that such provisions prevent him from earning a living or otherwise are void or unenforceable or should be held void or unenforceable.

(f)Barta shall, prior to the end of the Severance Period and Subsequent thereto, if necessary, direct all requests for references from prospective employers to Company’s Chief Financial Officer, who shall provide in response to any such inquiry only the dates of his employment and the position he occupied at the time of the separation of employment from Company and state that Company policy precludes the disclosure of additional information.

6.Invention and Proprietary Property.

(a)Definition of Proprietary Property. For purposes of this Agreement, “Proprietary Property” shall mean designs, specifications, ideas, formulas, discoveries, inventions, improvements, innovations, concepts and other developments, trade secrets, techniques, methods, know-how, technical and non-technical data, works of authorship, computer programs, computer algorithms, computer architecture, mathematical models, drawings, trademarks, copyrights, customer lists, marketing plans, and all other matters which are legally protectable or recognized as forms of property, whether or not patentable or reduced to practice or to a writing.

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(b)Assignment of Proprietary Property to the Company or its Subsidiaries. Barta hereby agrees to assign, transfer and set over, and Barta does hereby assign, transfer and set over, to the Company (or, as applicable, a subsidiary of the Company), without further compensation, all of Barta’s rights, title and interest in and to any and all Proprietary Property which Barta, either solely or jointly with others, has conceived, made or suggested or may hereafter conceive, make or suggest, in the course of Barta’s employment with the Company.

The assignment of Proprietary Property hereunder includes without limitation all rights of paternity, integrity, disclosure and withdrawal and any other rights that may be known as or referred to as moral rights (“Moral Rights”). To the extent that such Moral Rights cannot be assigned under applicable law and to the extent the following is allowed by the laws in the various countries where Moral Rights exist, Barta hereby waives such Moral Rights and consents to any action of the Company or any subsidiary of the Company that would violate such Moral Rights in the absence of such consent. Barta also will endeavor to facilitate such use of any such Moral Rights as the Company, or, as applicable, a subsidiary of the Company, shall reasonably instruct, including confirming any such waivers and consents from time to time as requested by the Company (or, as applicable, a subsidiary of the Company).

(c)Works for Hire. Barta acknowledges that all original works of authorship or other creative works made by Barta (solely or jointly with others) within the scope of the employment of Barta by the Company and which are protectable by copyright are “works made for hire,” pursuant to United States Copyright Act (17 U.S.C., Section 101). To the extent such original work of authorship or other creative works are not works made for hire, Barta hereby assigns to the Company (or, as directed by the Company, to a subsidiary of the Company) all of the rights comprised in the copyright of such works.

(d)Disclosure of Proprietary Property and Execution of Documents. Barta further agrees to promptly disclose to the Company any and all Proprietary Property which Barta has assigned, transferred and set over or will assign, transfer and set over as provided in Section 6(b) above, and Barta agrees to execute, acknowledge and deliver to the Company (or, as applicable, to a subsidiary of the Company), without additional compensation and without expense to Barta, any and all instruments reasonably requested, and to do any and all lawful acts which, in the reasonable judgment of the Company or its attorneys (or, as applicable, a subsidiary of the Company or its attorneys) may be required or desirable in order to vest in the Company or such subsidiary all property rights with respect to such Proprietary Property.

(e)Enforcement of Proprietary Rights. Barta will assist the Company (or, as applicable, a subsidiary of the Company) in every proper way to obtain, assign to the Company (or, as directed by the Company, to a subsidiary), confirm and from time to time enforce, United States and foreign patent trade secret, trademark, copyright, mask work, and other intellectual property rights relating to Proprietary Property in any and all countries. To that end Barta will execute, verify and deliver such documents and perform such other acts (including appearances as a witness) as the Company, or, as applicable, a subsidiary of the Company, may reasonably request for use in applying for, obtaining, perfecting, evidencing, sustaining and enforcing such proprietary rights and the assignment of such Proprietary Property. In addition, Barta will execute, verify and deliver assignments of such Proprietary Property and all rights therein to the Company, its subsidiary or its or their designee. The obligation of Barta to assist the Company, or, as applicable, a subsidiary of the Company, with respect to proprietary rights relating to such Proprietary Property in any and all countries shall continue beyond the termination of employment, but the Company, or as applicable, a subsidiary of the Company, shall compensate Barta at a mutually agreed upon fee, in addition to any expenses, after such termination.

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In the event the Company, or, as applicable, a subsidiary of the Company, is unable for any reason, after reasonable effort, to secure the signature of Barta on any document needed in connection with the actions specified in the preceding paragraph, Barta hereby irrevocably designates and appoints the Company and its duly authorized officers and agents as agent and attorney in fact, which appointment is coupled with an interest, to act for and on behalf of Barta, to execute, verify and file any such documents and to do all other lawfully permitted acts to further the purposes of the preceding paragraph with the same legal force and effect as if executed by Barta. Barta hereby waives and quitclaims to the Company or, as applicable, a subsidiary of the Company, any and all claims, of any nature whatsoever, which Barta now or may hereafter have for infringement of any proprietary rights assigned hereunder to the Company or such subsidiary.

(f)Third Party Information. To the extent Barta has or possesses any Confidential Information (as hereinafter defined) belonging to Barta or to others, Barta shall not use or disclose to the Company or its subsidiaries or induce the Company or its subsidiaries to use any such Confidential Information unless the Company or its subsidiaries have a legal rights to use such Confidential Information. Barta will promptly advise the Company in writing if any of Barta’s involvement with the Company or any subsidiary of the Company might result in the possible violation of Barta’s undertakings to others or the use of any Confidential Information of Barta or of others.

7.Confidential Information.

(a)Existence of Confidential Information. The Company and its subsidiaries own and have developed and compiled, and the Company and its subsidiaries will develop and compile during the Transition Period, certain proprietary techniques and confidential information, which have and will have great value to their businesses (referred to in this Agreement, collectively, as “Confidential Information”). Confidential Information includes not only information disclosed by the Company (or, as applicable, a subsidiary of the Company) to Barta, but also information developed or learned by Barta during the course or as a result of employment with the Company, which information shall be the property of the Company or, as applicable, such subsidiary. Confidential Information includes all information that has or could have commercial value or other utility in the business in which the Company or any of its subsidiaries is engaged or contemplates engaging, and all information of which the unauthorized disclosure could be detrimental to the interests of the Company or its subsidiary, whether or not such information is specifically labeled as Confidential Information by the Company or such subsidiary. By way of example and without limitation, Confidential Information includes any and all information developed, obtained, licensed by or owned by the Company or any of its subsidiaries concerning trade secrets, techniques, know-how (including designs, plans, procedures, merchandising, marketing, distribution and warehousing know-how, processes, and research records), software, computer programs and designs, development tools, all Proprietary Property, and any other intellectual property created, used or sold (through a license or otherwise) by the Company or any of its subsidiaries, electronic data information know-how and processes, innovations, discoveries, improvements, research, development, test results, reports, specifications, data, formats, marketing data and plans, business plans, strategies, forecasts, unpublished financial information, orders, agreements and other forms of documents, price and cost information, merchandising opportunities, expansion plans, budgets, projections, customer, supplier, licensee, licensor and subcontractor identities, characteristics, agreements and operating procedures, and salary, staffing and employment information. Confidential Information shall not include any information once it has been disclosed to the public or becomes part of the public domain other than as a result of any breach hereof by Barta.

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(b)Protection of Confidential Information. Barta acknowledges and agrees that in the performance of Barta’s duties under the Employment Agreement as well as his continuing duties hereunder, the Company or a subsidiary of the Company may have disclosed to and entrusted, or during the Transition Period may disclose to and entrust, Barta with Confidential Information which is the exclusive property of the Company or such subsidiary and which Barta may possess or use only in the performance of Barta’s duties to the Company. Barta also acknowledges that Barta is aware that the unauthorized disclosure of Confidential Information, among other things, may be prejudicial to the Company’s or its subsidiaries’ interests, an invasion of privacy and an improper disclosure of trade secrets. Barta shall not, directly or indirectly, use, make available, sell, disclose or otherwise communicate to any corporation, partnership or other entity, individual or other third party, other than in the course of Barta’s assigned duties and for the benefit of the Company, any Confidential Information, either before the Separation Date or thereafter.

8.Return of the Company Property. Within seven (7) days of the Separation Date, Barta shall, to the extent not previously returned or delivered: (a) return all equipment, records, files, programs or other materials and property in his possession which belongs to the Company or any one or more of its affiliates, including, without limitation, all, computer access codes, Blackberries, credit cards, keys and access cards, except as otherwise stated in this Section; and (b) deliver all original and copies of notes, materials, records, plans, technical data or other documents, files or programs (whether stored in paper form, computer form, digital form, electronically or otherwise), other than this Agreement and copies of this Agreement, that relate or refer to (1) the Company or any one or more of its affiliates, or (2) the Company or any one or more of the Company’s affiliates’ financial statements, business contacts, and sales. By signing this Agreement, Barta represents and warrants that he has not retained and has or will timely return and deliver all the items described or referenced in subsections (a) or (b) above; and, that should he later discover additional items described or referenced in subsections (a) or (b) above, he will promptly notify the Company and return/deliver such items to the Company. Before Barta returns any computers, Blackberry, personal digital assistant or other electronic storage device, Barta may delete any personal information. The desktop and laptop computers used by and in the possession of Barta (the “Barta Computers”) shall remain the property of Barta. With respect to Company information contained in the Barta Computers, Barta shall delete any such Company information, after first providing the Company with a copy of such Company information, while retaining his personal information. The desk created by Barta and maintained in his office at the Company is Barta’s property and may be removed by him.

9.Material Breach of Agreement.

(a) In the event Barta knowingly fails to materially fulfill any of his obligations in this Agreement during the Severance Period, or Barta or anyone acting on his behalf brings suit against the Company seeking to declare any term of this Agreement void or unenforceable and if one or more material terms of this Agreement are ruled by a court or arbitrator to be void or unenforceable or subject to reduction or modification, then the Company shall be entitled to (i) terminate the Agreement, (ii) terminate any remaining Separation Payments set forth in Section 2, and Barta will not be entitled to receive any remaining Separation Payments, (iii) recover attorneys’ fees, expenses and costs the Company incurs in any such action, and/or (iv) recover any and all other relief and damages to which the Company may be entitled at law or in equity as a result of a breach of this Agreement. Among other things, any breach of Sections 5, 6 or 7 of this Agreement shall be deemed a Material Breach of this Agreement immediately, if not susceptible to cure, or if uncured for seven (7) days after notice thereof has been delivered to Barta

(b) In the event Company knowingly fails to materially fulfill any of its obligations in this Agreement during the Transition Period and/or Severance Period, or Company or anyone acting on its behalf brings suit against Barta seeking to declare any term of this Agreement void or unenforceable and if one or more material terms of this Agreement are ruled by a court or arbitrator to be void or unenforceable or subject to reduction or modification, then Barta shall be entitled to (i) terminate the Agreement, (ii) continue to receive any remaining Transition Payments, Separation Payments and other benefits to which he is entitled pursuant to Section 2 of this Agreement, (iii) terminate the exclusive employment and noncompetition provisions of Section 5 of this Agreement, (iv) recover attorneys’ fees, expenses and costs Barta incurs in any such action, and/or (v) recover any and all other relief and damages to which the Barta may be entitled at law or in equity as a result of a breach of this Agreement. Nonpayment of Transition Payments, Separation Payments, and/or any other benefits to be paid to Barta under Section 2 shall be deemed a Material Breach of this Agreement if uncured for seven (7) days after notice thereof has been delivered to the Company.

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10.Mutual Non-Disparagement.

(a)Barta agrees that he will not, directly or indirectly, disclose, communicate, or publish any disparaging information concerning the Company, its affiliates, its officers and directors, its customers or clients, operations, technology, proprietary or technical information, or software whatsoever, or cause others to disclose, communicate, or publish any disparaging information concerning the same. Barta further agrees that he will not disclose, directly or indirectly, communicate, or publish any disparaging information concerning the terms of his employment with the Company, any other circumstance that arose from his employment with the Company or separation from employment, or any action or event that occurred during his employment with the Company, or cause others to disclose, communicate, or publish any disparaging information concerning the same;

(b)The Company, including its officers and directors, agrees that it will not, directly or indirectly, disclose, communicate, or publish any disparaging information concerning Barta, or cause others to disclose, communicate, or publish any disparaging information concerning the same. The Company further agrees that it will not disclose, directly or indirectly, communicate, or publish any disparaging information concerning the terms of Barta’s employment with the Company or separation from employment, any other circumstance that arose from Barta’s employment with the Company, or any action or event that occurred during Barta’s employment with the Company, or cause others to disclose, communicate, or publish any disparaging information concerning the same.

11.Not An Admission of Wrongdoing. This Agreement shall not in any way be construed as an admission by any party of any acts of wrongdoing, violation of any statute, law or legal or contractual right.

12.Entire Agreement. This Agreement (including all exhibits hereto) contains the entire agreement and understanding between the Parties in respect of Barta’s employment, termination and related issues and supersedes, cancels and annuls any prior or contemporaneous written or oral agreements, understandings, commitments and practices between them respecting Barta’s employment, termination and related issues, including the Employment Agreement and all similar agreements, if any, between the Company and Barta, which agreements are hereby terminated and shall be of no further force or effect.

13. Voluntary Execution of the Agreement. Barta and the Company represent and agree that they have had an opportunity to review all aspects of this Agreement, and that they fully understand all the provisions of the Agreement and are voluntarily entering into this Separation Agreement and the General Release. Barta further represents that he has not transferred or assigned to any person or entity any claim involving the Company or any portion thereof or interest therein.

14.Binding Effect. This Agreement shall be binding upon the Company and upon Barta and his heirs, administrators, representatives, executors, successors and assigns. In the event of Barta’s death, this Agreement shall operate in favor of his estate and all payments, obligations and consideration will continue to be performed in favor of his estate.

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15.Severability. Should any provision of this Agreement be declared or determined to be illegal or invalid by any government agency or court of competent jurisdiction, the validity of the remaining parts, terms or provisions of this Agreement shall not be affected and such provisions shall remain in full force and effect.

16.Entire Agreement. This Agreement sets forth the entire agreement between the parties, and fully supersedes any and all prior agreements, understandings, or representations (written or oral) between the parties pertaining to Barta’s employment with the Company, the subject matter of this Agreement or any other term or condition of the relationship between the Company and Barta including the Employment Agreement. Barta represents and acknowledges that in executing this Agreement, he does not rely, and has not relied, upon any representation(s) by the Company or its agents except as expressly contained in this Agreement.

17.Knowing and Voluntary Waiver. Barta, by Barta’s free and voluntary act of signing below, (i) acknowledges that he was provided with an initial draft of this Agreement on September 5, 2008 and has been given a period of twenty-one (21) days to consider whether to agree to the terms contained herein, (ii) acknowledges that he has been advised to consult with an attorney prior to executing this Agreement, (iii) acknowledges that he understands that this Agreement specifically releases and waives all rights and claims he may have under the Age Discrimination in Employment Act, as amended, prior to the date on which he signs this Agreement, and (iv) agrees to all of the terms of this Agreement and intends to be legally bound thereby. The parties hereto acknowledge and agree that each party has reviewed and negotiated the terms and provisions of this Agreement and has contributed to its preparation (with advice of counsel). Accordingly, the rule of construction to the effect that ambiguities are resolved against the drafting party shall not be employed in the interpretation of this Agreement. Rather, the terms of this Agreement shall be construed fairly as to both parties hereto and not in favor of or against either party, regardless of which party generally was responsible for the preparation of this Agreement.

Barta understands and acknowledges that he has seven (7) days after he executes this Agreement to revoke the release of his claims under the ADEA. During this seven-day revocation period, Barta may revoke his agreement to release claims under the ADEA by indicating in writing to the Company his intention to revoke. If Barta exercises his right to revoke such release, he shall forfeit his right to receive any of the payments or benefits provided for herein, and to the extent such payments or benefits have already been made, Barta agrees that he will immediately reimburse the Company for the amounts of such payments and benefits.

18.Notices. Any notice, request, consent or approval required or permitted to be given under this Agreement or pursuant to law shall be sufficient if in writing, and if and when sent by certified or registered mail, return receipt requested, with postage prepaid, or by overnight courier: if to Barta, to Barta’s at 48 Essex Drive, Mendham, New Jersey 07945, or as otherwise designated by Barta, with a copy (which shall not constitute notice) to Bernstein & Manahan, LLC, 2633 Main Street, Suite 102, Lawrenceville, New Jersey 08648, attention: Edward M. Bernstein, Esq.; or, if to the Company, to the Company’s principal executive office, attention: Chairman of the Compensation Committee of the Board of Directors, with a copy (which shall not constitute notice) to Haynes and Boone, LLP, 1221 Avenue of the Americas, New York, NY 10020, attention: David M. Zlotchew, Esq. All such notices, requests, consents and approvals shall be effective upon being deposited in the United States mail or with the overnight courier service, as applicable. However, the time period in which a response thereto must be given shall commence to run from the date of receipt on the return receipt of the notice, request, consent or approval by the addressee thereof. Intentional rejection or other refusal to accept, or the inability to deliver because of changed address of which no notice was given as provided herein, shall be deemed to be receipt of the notice, request, consent or approval sent. Any party may change the address to which notices and other communications are to be delivered by giving the other party notice in accordance with this Section 18.

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19.Governing Law. This Agreement shall in all respects be interpreted, enforced, and governed under the laws of the State of New York. The Company and Barta agree that the language on this Agreement shall, in all cases, be construed as a whole, according to its fair meaning, and not strictly for, or against, any of the parties.

20.Consent to Jurisdiction; Waiver of Jury Trial. Each of the parties hereby irrevocably and unconditionally consents to the exclusive jurisdiction of any federal or state court of New York sitting in New York County and irrevocably agrees that all actions or proceedings arising out of or relating to this Agreement or the transactions contemplated hereby shall be litigated exclusively in such Courts. Each of the parties agrees not to commence any legal proceeding related hereto except in such Courts. Each of the parties irrevocably waives any objection which it may now or hereafter have to the laying of the venue of any such proceeding in any such Court and hereby further irrevocably and unconditionally waives and agrees not to plead or claim in any such Court that any such action, suit or proceeding brought in any such court has been brought in an inconvenient forum. Each of the parties irrevocably waives any right it may have to a trial by jury in any such action, suit or proceeding. Each of the parties agrees that the prevailing party in any action or proceeding arising out of or relating to this Agreement or the transactions contemplated hereby shall be entitled to recover its reasonable fees and expenses in connection therewith, including legal fees.

21.Counterparts. This Agreement may be executed in counterparts, each of which when executed and delivered (which deliveries may be by facsimile) shall be deemed an original and all of which together shall constitute one and the same instrument.

22.No Assignment Of Claims. Each of the Company and Barta represents to the other that it has not transferred or assigned, to any person or entity, any claim involving the other party, the Employment Agreement or Barta’s employment by the Company, or any portion thereof or interest therein.

23.Assignment and Transfer.

(a)Company. This Agreement shall inure to the benefit of and be enforceable by, and may be assigned by the Company to, any purchaser of all or substantially all of the Company’s business or assets, any successor to the Company or any assignee thereof (whether direct or indirect, by purchase, merger, consolidation or otherwise) and shall thereafter become binding upon such purchasers, successors and/or assignees of the Company.

(b)Barta. Barta’s rights and obligations under this Agreement shall not be transferable by Barta by assignment or otherwise, and any purported assignment, transfer or delegation thereof shall be void; provided, however, that if Barta shall die, all amounts then payable to Barta hereunder shall be paid in accordance with the terms of this Agreement to Barta’s devisee, legatee or other designee or, if there be no such designee, to Barta’s estate.

24.Cooperation. Following the Effective Date (including during the Transition Period), the parties hereto shall cooperate with each other, as reasonably requested by the other party , to effect a transition of Barta’s responsibilities and to ensure that the Company is aware of all matters being handled by Barta and to effectuate the consideration being paid to Barta during the Transition Period and the Severance Period.

25.No Amendment/Waiver. This Agreement may not be amended or modified in any manner nor may any of its provisions be waived except by written amendment executed by the parties. A waiver, modification or amendment by a party shall only be effective if (a) it is in writing and signed by the parties, (b) it specifically refers to this Agreement and (c) it specifically states that the party, as the case may be, is waiving, modifying or amending its rights hereunder. Any such amendment, modification or waiver shall be effective only in the specific instance and for the specific purpose for which it was given.

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26.Remedies for Breach. The parties hereto agree that Barta is obligated under this Agreement to render personal services during the Transition Period and the Severance Period of a special, unique, unusual, extraordinary and intellectual character, thereby giving this Agreement special value, and, in the event of a breach or threatened breach of any covenant of Barta herein, the injury or imminent injury to the value and the goodwill of the Company’s and its subsidiaries’ businesses could not be reasonably or adequately compensated in damages in an action at law. Accordingly, Barta acknowledges that the Company (and as applicable, one or more of its subsidiaries) shall be entitled to seek injunctive relief or any other equitable remedy against Barta in the event of a breach or threatened breach of Sections 5, 6 or 7 of this Agreement. The rights and remedies of Barta and the Company are cumulative and shall not be exclusive, and each of Barta and the Company shall be entitled to pursue all legal and equitable rights and remedies and to secure performance of the obligations and duties of the other under this Agreement, and the enforcement of one or more of such rights and remedies by Barta or the Company shall in no way preclude such party from pursuing, at the same time or subsequently, any and all other rights and remedies available to it.

27.Survival. Cessation or termination of Barta’s employment with the Company upon the Separation Date or otherwise shall not result in termination of this Agreement. The respective obligations, rights and benefits of Barta and the Company, as provided in this Agreement, including, without limitation, Sections 5, 6 and 7 hereof, shall survive cessation or termination of Barta’s employment hereunder or termination of this Agreement; provided, however, that Section 5 hereof may be terminated under certain circumstances in accordance with Section 9(b) hereof.

28.Acknowledgments by the Company. The Company acknowledges that (i) this Agreement is not a fraudulent transfer as described in 11 U.S.C. § 548; (ii) the Company and Barta are entering into this Agreement in good faith and in the ordinary course of business; (iii) by entering into this Agreement, the Company does not intend to hinder, delay, or defraud any creditors of either the Company or both; and, (iv) the Company received at least a reasonably equivalent value in exchange for its obligations hereunder.

[Remainder of Page Intentionally Left Blank]

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I ACKNOWLEDGE THAT I HAVE CAREFULLY READ THE FOREGOING AGREEMENT,
THAT I UNDERSTAND ALL OF ITS TERMS AND THAT I AM RELEASING CLAIMS AND
THAT I AM ENTERING INTO IT VOLUNTARILY.

AGREED TO BY:

/s/ Norman J. Barta	9-16-2008
Norman J. Barta	Date

STATE OF NEW JERSEY

COUNTY OF MORRIS

Before me, a Notary Public, on this day personally appeared NORMAN J. BARTA, known to me to be the person whose name is subscribed to the foregoing instrument, and acknowledges to me that he has executed this Agreement on behalf of himself and his heirs, for the purposes and consideration therein expressed.

Given under my hand and seal of office this 16th day of September, 2008.

/s/

Notary Public in and for the State of New Jersey

(PERSONALIZED SEAL)

NEPHROS, INC.

By:	/s/ Gerald J. Kochanski	9-15-2008
	Name: Gerald J. Kochanski	Date
	Title: V.P. & CFO

STATE OF NEW YORK

COUNTY OF NEW YORK

Before me, a Notary Public, on this day personally appeared Gerald J. Kochanski, known to me to be the person and officer whose name is subscribed to the foregoing instrument and acknowledged to me that the same was the act of NEPHROS, INC., and that he has executed the same on behalf of said corporation for the purposes and consideration therein expressed, and in the capacity therein stated.

Given under my hand and seal of office this 15th day of September, 2008.

/s/

Notary Public in and for the State of New York

(PERSONALIZED SEAL)

EXHIBIT A

__________________, 2008

Nephros, Inc.

ATTN:

EX-10.2

EMPLOYMENT AGREEMENT

This EMPLOYMENT AGREEMENT (this “Agreement”), made in New York, New York as of the 15th day of September 2008 (the “Effective Date”), between Nephros, Inc., a Delaware corporation having its executive offices and principal place of business at 3960 Broadway, New York, New York 10032 (the “Company”), and Ernest A. Elgin III (“Executive”).

RECITALS

WHEREAS, the Company desires to employ Executive, and Executive desires to accept such employment on the terms and conditions hereinafter set forth:

NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter set forth, the Company and Executive agree as follows:

1.Term. The term of this Agreement shall be the period commencing on the Effective Date and ending on September 14, 2011 (the “Expiration Date,” and collectively, the “Term”).

2.Employment.

2.1Employment by the Company; Duties. Executive agrees to be employed by the Company during the Term upon the terms and subject to the conditions set forth in this Agreement. Executive shall serve as President and Chief Executive Officer (“CEO”), reporting to the Board of Directors of the Company (the "Board”), and shall have such duties as may be prescribed by the Board from time to time and which are commonly performed by presidents and chief executive officer’s of similar sized companies conducting similar business, such as, but not limited to, corporate planning and oversight of the financial, marketing, research and other functions of the organization.

2.2Performance of Duties. Throughout the Term, Executive shall faithfully and diligently perform Executive's duties in conformity with the directions of the Board and serve the Company to the best of Executive's ability. Executive shall devote Executive's entire working time to the business and affairs of the Company, subject to vacations and sick leave in accordance with Company policy and as otherwise permitted herein and will not engage in any other employment, occupation or consulting for any direct or indirect remuneration, nor engage in any other activities that conflict with his obligations to the Company without the prior written approval of the Board.

2.3Place of Performance. During his employment with the Company, Executive will work at the Company's offices in New York, New York, as necessary or appropriate, or at such other location in the greater New York City area as the Company may determine. Throughout the Term, Executive agrees to maintain Executive's personal residence within reasonable access to Executive's place of employment. Executive recognizes that his duties will require, from time to time and at the Company's expense (subject to Section 3.6 below), travel to domestic and international locations.

2.4At-Will Employment. The parties agree that Executive’s employment shall be on an “at-will” basis, subject to the terms of this Agreement, and may be terminated at any time, with or without good cause or for any or no cause, at the option of either the Company or Executive with or without notice. Executive understands and agrees that neither his job performance nor promotions, commendations, bonuses or the like from the Company give rise to or in any way serve as the basis for modification, amendment, or extension, by implication or otherwise, of his employment with the Company.

3.Compensation and Benefits.

3.1Base Salary. The Company agrees to pay to Executive a base salary ("Base Salary") at the annual rate of $240,000, payable in equal installments consistent with the Company's payroll practices.

3.2Performance Bonus. The Company shall establish for Executive a target discretionary bonus of30% of annual base salary. The bonus amount, if any, will be determined by the Compensation Committee of the Board (or the independent members of the Board, if there is no Compensation Committee) (the “Compensation Committee”) in its sole discretion, based in part on attainment of personal objectives as determined by Executive and Compensation Committee, and based in part on the Company achieving overall corporate targets. The Company will provide a guaranteed bonus of $35,000 for the period beginning on Executive’s start date and ending on December 31, 2008.

3.3Grant of Options and Terms Thereof. Upon execution of this Agreement, the Company shall grant to Executive options to purchase 750,000 shares of the Company's common stock ("Options") pursuant to the Company’s 2004 Stock Incentive Plan or successor plans, if applicable, subject to exercise price, vesting and forfeiture as described in the Schedule A.

3.4Change of Control. In the event of a Change of Control (as defined below), all unvested Options shall vest and become exercisable immediately and, unless all such options are cashed-out in the Change of Control transaction, shall remain exercisable for a period of not less than 360 days, regardless of whether Executive’s employment is terminated.

(i) For purposes of this Agreement, a “Change of Control” shall mean (A) the acquisition, directly or indirectly, following the date hereof by any person (as such term is defined in Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended), in one transaction or a series of related transactions, of securities of the Company representing fifty percent (50%) or more of the combined voting power of the Company’s then outstanding securities if such person or his or its affiliate(s) do not own in excess of 50% of such voting power on the date of this Agreement, or (B) the disposition by the Company (whether direct or indirect, by sale of assets or stock, merger, consolidation or otherwise) of all or substantially all of its business and/or assets in one transaction or series of related transactions (other than a merger effected exclusively for the purpose of changing the domicile of the Company).

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(ii) Notwithstanding Section 3.4(i) above, no transaction shall be considered a Change of Control under this Agreement, and no Options shall vest, pursuant to this Section 3.4:

a. if the Company’s stockholders existing prior to such transaction(s) hold in the aggregate more than fifty percent (50%) of the securities or assets of the surviving or resulting company; or

b. in connection with a private placement of equity securities of the Company in connection with a financing of the Company’s on-going operations; or

c. for any transaction ascribing a valuation to the Company of less than Seventy Five Million Dollars ($75,000,000); provided, however, that such a transaction may be considered as part of a series of transactions that gives rise to a Change of Control pursuant to Section 3.4.

3.5Benefits and Perquisites. Executive shall be entitled to participate in, to the extent Executive is otherwise eligible under the terms thereof, the benefit plans and programs, and receive the benefits and perquisites, generally provided to the Company’s eligible employees. Executive shall be entitled to receive four weeks of annual paid vacation in accordance with the Company’s vacation policy, with the timing and duration of specific vacations mutually and reasonably agreed to by the parties hereto. The Company reserves the right to cancel or change the benefit plans and programs it offers to its employees at any time.

3.6Travel and Business Expenses. Upon submission of itemized expense statements in the manner specified by the Company, Executive shall be entitled to reimbursement for reasonable travel and other reasonable business expenses duly incurred by Executive in the performance of Executive's duties under this Agreement in accordance with the policies and procedures established by the Company from time to time for executives of the same level and responsibility as Executive.

3.7No Other Compensation or Benefits; Payment. The compensation and benefits specified in this Section 3 and in Section 4 of this Agreement shall be in lieu of any and all other compensation and benefits. Payment of all compensation and benefits to Executive hereunder shall be made in accordance with the relevant Company policies in effect from time to time to the extent the same are consistently applied, including normal payroll practices, and shall be subject to all applicable employment and withholding taxes and other withholdings.

3.8Cessation of Employment. In the event Executive shall cease to be employed by the Company for any reason, then Executive's compensation and benefits shall cease on the date of such event, except as otherwise provided herein or in any applicable employee benefit plan or program.

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4.Termination of Employment.

4.1Termination. The Company may terminate Executive's employment for Cause (as defined below), in which case the provisions of Section 4.2 of this Agreement shall apply. The Company may also terminate Executive's employment in the event of Executive's Disability (as defined below), in which case the provisions of Section 4.4 of this Agreement shall apply. The Company may also terminate Executive's employment for any other reason by written notice to Executive, in which case the provisions of Section 4.5 of this Agreement shall apply. If Executive's employment is terminated by reason of Executive's death, retirement or voluntary resignation, the provisions of Section 4.3 of this Agreement shall apply.

4.2Termination for Cause. In the event that Executive's employment hereunder is terminated during the Term by the Company for Cause (as defined below), then the Company shall pay to Executive only the earned but unpaid Base Salary for services rendered through the date of termination, and any and all unvested Options shall automatically be cancelled and forfeited by Executive as of the date of termination. Executive shall have the right to exercise any and all vested Options within the period commencing on the date of termination and ending ninety days after the date of such termination (the “Options Exercise Period”). Any Options not exercised by Executive within the Options Exercise Period shall be cancelled. In all other respects, all such Options shall be governed by the plans, programs, agreements, and other documents pursuant to which such Options were granted. For purposes of this Agreement, "Cause" shall mean (i) an indictment, conviction, or plea of nolo contendere to, any felony or a misdemeanor involving fraud or dishonesty (whether or not involving the Company); (ii) engaging in any act which, in each case, subjects, or if generally known would subject, the Company to public ridicule or embarrassment; (iii) gross neglect or misconduct in the performance of Executive's duties hereunder; or (iv) material breach of any provision of this Agreement by Executive; provided, however, that with respect to clauses (iii) or (iv), Executive shall have received written notice from the Company setting forth the alleged act or failure to act constituting "Cause" hereunder, and Executive shall not have cured such act or refusal to act within 10 business days of his actual receipt of notice.

4.3Termination by Reason of Death or Retirement or Voluntary Resignation. In the event that Executive's employment hereunder is terminated during the Term (x) by reason of Executive's death, or (y) by reason of Executive's voluntary resignation or retirement, then the Company shall pay to Executive only the earned but unpaid Base Salary for services rendered through the date of termination. Any and all unvested Options shall automatically be cancelled and forfeited by Executive as of the date of Executive's death or Executive's voluntary resignation or retirement, except upon exercise of Executive’s Change of Control Termination Option (as defined in Section 4.6). Executive or Executive’s estate shall have the right to exercise any and all vested Options within the Options Exercise Period. Any Options not exercised by Executive within the Options Exercise Period shall be cancelled. In all other respects, all such Options shall be governed by the plans, programs, agreements, and other documents pursuant to which such Options were granted.

4.4Disability. If, as a result of Executive's incapacity due to physical or mental illness, the Company determines that Executive has failed to perform Executive's duties hereunder on a full time basis for either (i) ninety (90) days within any three hundred sixty-five (365) day period, or (ii) sixty (60) consecutive days, the Company may terminate Executive's employment hereunder for "Disability". In that event, the Company shall pay to Executive only the earned but unpaid, Base Salary for services rendered through such date of termination. Any and all unvested Options shall be cancelled as of the date of termination. During any period that Executive fails to perform Executive's duties hereunder as a result of incapacity due to physical or mental illness (a "Disability Period"), Executive shall continue to receive the compensation and benefits provided by Section 3 of this Agreement until Executive's employment hereunder is terminated; provided, however, that the amount of compensation and benefits received by Executive during the Disability Period shall be reduced by the aggregate amounts, if any, payable to Executive under disability benefit plans and programs of the Company or under the Social Security disability insurance program. Additionally, the vesting of Executive’s Options shall be tolled during the Disability Period and in the event of a termination of this Agreement as a result of Executive’s Disability, any and all unvested Options shall automatically be cancelled and forfeited by Executive as of the date of such termination. Executive (or as applicable, his spouse or estate) shall have the right to exercise any and all vested Options within the Options Exercise Period. Any Options not exercised by Executive within the Options Exercise Period shall be cancelled. In all other respects, all such Options shall be governed by the plans, programs, agreements, and other documents pursuant to which such Options were granted.

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4.5Termination by Company for Any Other Reason. In the event that Executive's employment hereunder is terminated by the Company prior to the expiration of the Term for any reason other than as provided in Sections 4.2, 4.3 or 4.4 of this Agreement, any and all unvested Options shall automatically be cancelled and forfeited by Executive as of the date of such termination and the Company shall pay to Executive:

(i) any earned but unpaid Base Salary for services rendered through such date of termination; and

(ii) continuing payments of severance pay (less applicable withholding taxes) at a rate equal to his Base Salary rate, as then in effect, for a period equal to the lesser of (i) Maximum Severance Period (as defined below), and (ii) the remaining Term from the date of such termination (herein after the “Severance Term”), to be paid periodically in accordance with the Company's normal payroll policies); provided that if Executive continues to be employed in any capacity by a successor entity following a Change of Control, the severance pay that would otherwise be payable under this Section 4.5 shall be reduced by the amount of base compensation and guaranteed bonus (if any) Executive receives in such capacity during or attributable to the Severance Term.

As used herein, the “Maximum Severance Period” shall mean three months, until Executive has been employed hereunder for at least one year, and, thereafter, shall mean six months.

Notwithstanding anything to the contrary contained herein, in the event that Executive shall breach Sections 5, 6 or 7 of this Agreement at any time, in addition to any other remedies the Company may have in the event Executive breaches this Agreement, the Company's obligation under clauses (i) and (ii) of this Section 4.5 shall cease and Executive's rights thereto shall terminate and shall be forfeited.

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4.6Change of Control Termination. As soon as reasonable prior any event constituting a Change of Control, but no later than thirty one (31) days prior thereto, the Company shall advise Executive of this pending occurrence (the “Change of Control Notice”). Executive shall then have thirty one (31) days from the date of the Change of Control Notice to discuss, negotiate and confer with any successor entity regarding the terms and conditions of Executive's continued employment with the successor Company following a Change of Control. If Executive, acting reasonably, is unable to reach an agreement through good faith negotiations with any successor to the Company during such 31 day period, then Executive may elect (the “Change of Control Termination Option”) to terminate his employment with the Company and receive the payments outlined in Section 4.5 hereof.

4.7Release. Except for any accrued obligations, the severance payments described in Section 4.5 will be provided to Executive only if the following conditions are satisfied: (i) Executive agrees to continue to be bound by and complies with all surviving provisions of the confidentiality and/or non-compete provisions of this Agreement; and (ii) Executive executes and delivers to the Company, and does not revoke, a full general release, in a form acceptable to the Company, releasing all claims, known or unknown, that Executive may have against the Company, and any subsidiary or related entity, their officers, directors, employees and agents, arising out of or any way related to Executive’s employment or termination of employment with the Company.

4.8Section 409A. Notwithstanding the due date of any post-employment payments, if at the time of the termination of employment Executive is a “specified employee” (as defined in Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”)) as determined by the Compensation Committee of the Board, Executive will not be entitled to any payments upon termination of employment until the earlier of (i) the date which is six (6) months after the termination of employment for any reason other than death or (ii) the date of Executive’s death. The provisions of this paragraph will only apply if and to the extent required to avoid any “additional tax” under Section 409A.

5.Exclusive Employment; Noncompetition.

5.1No Conflict; No Other Employment. During the period of Executive's employment with the Company, Executive shall not: (i) engage in any activity which conflicts or interferes with or derogates from the performance of Executive's duties hereunder nor shall Executive engage in any other business activity, whether or not such business activity is pursued for gain or profit, except as approved in advance in writing by the Board; provided, however, that Executive shall be entitled to manage his personal investments and otherwise attend to personal affairs, including charitable activities, in a manner that does not unreasonably interfere with his responsibilities hereunder, or (ii) accept any other employment, whether as an executive or consultant or in any other capacity, and whether or not compensated therefor, unless Executive receives the prior written approval of the Board.

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5.2No Competition.

(a)Executive acknowledges and recognizes the highly competitive nature of the Company’s business and that access to the Company’s confidential records and proprietary information renders him special and unique within the Company’s industry. In consideration of the payment by the Company to Executive of amounts that may hereafter be paid to Executive pursuant to this Agreement (including, without limitation, pursuant to Sections 3 and 4 hereof) and other obligations undertaken by the Company hereunder, Executive agrees that during (i) his employment with the Company and (ii) the period beginning on the date of termination of employment for any reason and ending on the last day of the Severance Term as defined in Section 4.5(ii) (the “Post-Employment Period”), Executive shall not, directly or indirectly, for himself or any third party, engage without the prior consent of the Company as owner, investor, financier, partner, stockholder, employer, employee, consultant, advisor, director, officer or otherwise in any firm, partnership, corporation, entity, or business that engages or participates in a business that offers any product or service that competes in any material respect with a product or service (i) provided by the Company to customers or (ii) that the Company is developing, during the period of Executive’s employment with the Company (a “Competing Business”) anywhere in the world where the Company conducts its business, including but not limited to (A) the development of medical equipment in the hemodiafiltration realm for use in ESRD chronic therapy, and (B) the development of cold water or air purification systems.

(b)The provisions of Section 5.2(a) will not be deemed breached merely because Executive owns less than 1% of the outstanding common stock of a publicly-traded company.

(c)The Company shall have the option to extend the No Competition Period for an additional six months in return for a six-month extension of the Severance Term and any such extension shall extend the Post-Employment Period.

(d)The covenants contained in Section 5.2(a) shall be construed as a series of separate covenants, one for each county, city, state, or any similar subdivision in any geographic area. Except for geographic coverage, each such separate covenant shall be deemed identical in terms to the covenant contained in Section 5.2(a). If, in any judicial proceeding, a court refuses to enforce any of such separate covenants (or any part thereof), then such unenforceable covenant (or such part) shall be eliminated from this Agreement to the extent permitted by law and necessary to permit the remaining separate covenants (or portions thereof) to be enforced. In the event that the provisions of this section are deemed to exceed the time, geographic or scope limitations permitted by applicable law, then such provisions shall be, to the extent permitted by law, reformed to the maximum time, geographic or scope limitations, as the case may be, permitted by applicable laws.

(e)Executive acknowledges that the limitations of time, geography and scope of activity agreed to in this no competition provision are reasonable because, among other things, (i) the Company is engaged in a highly competitive industry, (ii) he will have access to trade secrets and know-how of the Company, (iii) he will be able to obtain suitable and satisfactory employment without violation of this agreement, and (iv) these limitations are necessary to protect the trade secrets, confidential information and goodwill of the Company.

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5.3Non-Solicitation. In further consideration of the payment by the Company to Executive of amounts that may hereafter be paid to Executive pursuant to this Agreement (including, without limitation, pursuant to Sections 3 and 4 hereof) and other obligations undertaken by the Company hereunder, Executive agrees that during his employment and the Post-Employment Period, he shall not, directly or indirectly, (i) solicit, encourage or attempt to solicit or encourage any of the employees, agents, consultants or representatives of the Company or any of its affiliates to terminate his, her, or its relationship with the Company or such affiliate; (ii) solicit, encourage or attempt to solicit or encourage any of the employees of the Company or any of its affiliates to become employees or consultants of any other person or entity; (iii) solicit, encourage or attempt to solicit or encourage any of the consultants of the Company or any of its affiliates to become employees or consultants of any other person or entity, provided that the restriction in this clause (iii) shall not apply if (A) such solicitation, encouragement or attempt to solicit or encourage is in connection with a business which is not a Competing Business and (B) the consultant’s rendering of services for the other person or entity will not interfere with the consultant’s rendering of services to the Company; (iv) solicit or attempt to solicit any customer, vendor or distributor of the Company or any of its affiliates with respect to any product or service being furnished, made, sold or leased by the Company or such affiliate, provided that the restriction in this clause (iv) shall not apply if such solicitation or attempt to solicit is (A) in connection with a business which is not a Competing Business and (B) does not interfere with, or conflict with, the interests of the Company or any of its affiliates; or (v) persuade or seek to persuade any customer of the Company or any affiliate to cease to do business or to reduce the amount of business which any customer has customarily done or contemplates doing with the Company or such affiliate, whether or not the relationship between the Company or its affiliate and such customer was originally established in whole or in part through Executive’s efforts. For purposes of this Section 5.3 only, the terms “customer,” “vendor” and “distributor” shall mean a customer, vendor or distributor who has done business with the Company or any of its affiliates within twelve months preceding the termination of Executive’s employment.

5.4Notifications. During Executive’s employment with the Company and during the Severance Term, Executive agrees that upon the earlier of Executive’s (i) negotiating with any Competitor (as defined below) concerning the possible employment of Executive by the Competitor, (ii) receiving an offer of employment from a Competitor, or (iii) becoming employed by a Competitor, Executive will (A) immediately provide written notice to the Company of such circumstances and (B) provide copies of Section 5 of this Agreement to the Competitor. Executive further agrees that the Company may provide notice to a Competitor of Executive’s obligations under this Agreement, including without limitation Executive’s obligations pursuant to Section 5 hereof. For purposes of this Agreement, “Competitor” shall mean any entity (other than the Company or any of its affiliates) that engages, directly or indirectly, in any Competing Business.

5.5Sufficient Consideration. Executive understands that the provisions of this Section 5 may limit his ability to earn a livelihood in a business similar to the business of the Company or its affiliates but nevertheless agrees and hereby acknowledges that the consideration provided under this Agreement, including any amounts or benefits provided under Sections 3 and 4 hereof and other obligations undertaken by the Company hereunder, is sufficient to justify the restrictions contained in such provisions. In consideration thereof and in light of Executive’s education, skills and abilities, Executive agrees that he will not assert in any forum that such provisions prevent him from earning a living or otherwise are void or unenforceable or should be held void or unenforceable.

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6.Inventions and Proprietary Property.

6.1Definition of Proprietary Property. For purposes of this Agreement, "Proprietary Property" shall mean non-public information that relates to the actual or anticipated business or research and development of the Company, designs, specifications, ideas, formulas, discoveries, inventions, improvements, innovations, concepts and other developments, trade secrets, techniques, methods, know-how, technical and non-technical data, works of authorship, computer programs, computer algorithms, computer architecture, mathematical models, drawings, trademarks, copyrights, customer lists and customers (including, but not limited to, customers of the Company on whom Executive called or with whom Executive became acquainted during the term of his employment), marketing plans, and all other matters which are legally protectable or recognized as forms of property, whether or not patentable or reduced to practice or to a writing.

6.2Assignment of Proprietary Property to the Company or its Subsidiaries.

(a)Executive hereby agrees to assign, transfer and set over, and Executive does hereby assign, transfer and set over, to the Company (or, as applicable, a subsidiary or designee of the Company), without further compensation, all of Executive's rights, title and interest in and to any and all Proprietary Property which Executive, either solely or jointly with others, has conceived, made or suggested or may hereafter conceive, make or suggest, in the course of Executive's employment with the Company, whether or not patentable or registrable under copyright or similar laws, which Executive may solely or jointly conceive or develop or reduce to practice, or cause to be conceived or developed or reduced to practice, during the period of time Executive is in the employ of the Company (collectively referred to as “Inventions”).

(b)The assignment of Proprietary Property hereunder includes without limitation all rights of paternity, integrity, disclosure and withdrawal and any other rights that may be known as or referred to as moral rights ("Moral Rights"). To the extent that such Moral Rights cannot be assigned under applicable law and to the extent the following is allowed by the laws in the various countries where Moral Rights exist, Executive hereby waives such Moral Rights and consents to any action of the Company or any subsidiary of the Company that would violate such Moral Rights in the absence of such consent. Executive also will endeavor to facilitate such use of any such Moral Rights as the Company, or, as applicable, a subsidiary of the Company, shall reasonably instruct, including confirming any such waivers and consents from time to time as requested by the Company (or, as applicable, a subsidiary of the Company).

6.3Works for Hire. Executive acknowledges that all original works of authorship or other creative works which are made by Executive (solely or jointly with others) within the scope of the employment of Executive by the Company and which are protectable by copyright are "works made for hire," pursuant to United States Copyright Act (17 U.S.C., Section 101). To the extent such original work of authorship or other creative works are not works made for hire, Executive hereby assigns to the Company (or, as directed by the Company, to a subsidiary of the Company) all of the rights comprised in the copyright of such works.

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6.4Disclosure of Proprietary Property and Execution of Documents. Executive further agrees to promptly disclose to the Company any and all Proprietary Property which Executive has assigned, transferred and set over or will assign, transfer and set over as provided in Section 6.2 above, and Executive agrees to execute, acknowledge and deliver to the Company (or, as applicable, to a subsidiary of the Company), without additional compensation and without expense to Executive, any and all instruments reasonably requested, and to do any and all lawful acts which, in the reasonable judgment of the Company or its attorneys (or, as applicable, a subsidiary of the Company or its attorneys) may be required or desirable in order to vest in the Company or such subsidiary all property rights with respect to such Proprietary Property.

6.5Enforcement of Proprietary Rights.

(a)Executive will assist the Company (or, as applicable, a subsidiary of the Company) in every proper way to obtain, assign to the Company (or, as directed by the Company, to a subsidiary), confirm and from time to time enforce, United States and foreign patent trade secret, trademark, copyright, mask work, and other intellectual property rights relating to Proprietary Property in any and all countries. To that end Executive will execute, verify and deliver such documents and perform such other acts (including appearances as a witness) as the Company, or, as applicable, a subsidiary of the Company, may reasonably request for use in applying for, obtaining, perfecting, evidencing, sustaining and enforcing such proprietary rights and the assignment of such Proprietary Property. In addition, Executive will execute, verify and deliver assignments of such Proprietary Property and all rights therein to the Company, its subsidiary or its or their designee. The obligation of Executive to assist the Company, or, as applicable, a subsidiary of the Company, with respect to proprietary rights relating to such Proprietary Property in any and all countries shall continue beyond the termination of employment, but the Company, or as applicable, a subsidiary of the Company, shall compensate Executive at a mutually agreed upon fee, in addition to any expenses, after such termination.

(b)In the event the Company, or, as applicable, a subsidiary of the Company, is unable for any reason, after reasonable effort, to secure the signature of Executive on any document needed in connection with the actions specified in the preceding paragraph, Executive hereby irrevocably designates and appoints the Company and its duly authorized officers and agents as agent and attorney in fact, which appointment is coupled with an interest, to act for and on behalf of Executive, to execute, verify and file any such documents and to do all other lawfully permitted acts to further the purposes of the preceding paragraph with the same legal force and effect as if executed by Executive. Executive hereby waives and quitclaims to the Company or, as applicable, a subsidiary of the Company, any and all claims, of any nature whatsoever, which Executive now or may hereafter have for infringement of any proprietary rights assigned hereunder to the Company or such subsidiary.

6.6Third Party Information. To the extent Executive has or possesses any Confidential Information (as hereinafter defined) belonging to Executive or to others, Executive shall not use or disclose to the Company or its subsidiaries or induce the Company or its subsidiaries to use any such Confidential Information unless the Company or its subsidiaries have a legal rights to use such Confidential Information. Executive will promptly advise the Company in writing if any of Executive's involvement with the Company or any subsidiary of the Company might result in the possible violation of Executive's undertakings to others or the use of any Confidential Information of Executive or of others.

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7.Confidential Information.

7.1Existence of Confidential Information. The Company owns and has developed and compiled, and the Company and its subsidiaries will develop and compile, certain proprietary techniques and confidential information, which have and will have great value to their businesses (referred to in this Agreement, collectively, as "Confidential Information"). Confidential Information includes not only information disclosed by the Company (or, as applicable, a subsidiary of the Company) to Executive, but also information developed or learned by Executive during the course or as a result of employment with the Company, which information shall be the property of the Company or, as applicable, such subsidiary. Confidential Information includes all information that has or could have commercial value or other utility in the business in which the Company or any of its subsidiaries is engaged or contemplates engaging, and all information of which the unauthorized disclosure could be detrimental to the interests of the Company or its subsidiary, whether or not such information is specifically labeled as Confidential Information by the Company or such subsidiary. By way of example and without limitation, Confidential Information includes any and all information developed, obtained, licensed by or to or owned by the Company or any of its subsidiaries concerning trade secrets, techniques, know-how (including designs, plans, procedures, merchandising, marketing, distribution and warehousing know-how, processes, and research records), software, computer programs and designs, development tools, all Proprietary Property, and any other intellectual property created, used or sold (through a license or otherwise) by the Company or any of its subsidiaries, electronic data information know-how and processes, innovations, discoveries, improvements, research, development, test results, reports, specifications, data, formats, marketing data and plans, business plans, strategies, forecasts, unpublished financial information, orders, agreements and other forms of documents, price and cost information, merchandising opportunities, expansion plans, budgets, projections, customer, supplier, licensee, licensor and subcontractor identities, characteristics, agreements and operating procedures, and salary, staffing and employment information.

7.2Protection of Confidential Information. Executive acknowledges and agrees that in the performance of Executive's duties hereunder, the Company or a subsidiary of the Company may disclose to and entrust Executive with Confidential Information which is the exclusive property of the Company or such subsidiary and which Executive may possess or use only in the performance of Executive's duties to the Company. Executive also acknowledges that Executive is aware that the unauthorized disclosure of Confidential Information, among other things, may be prejudicial to the Company's or its subsidiaries’ interests, an invasion of privacy and an improper disclosure of trade secrets. Executive shall not, directly or indirectly, use, make available, sell, disclose or otherwise communicate to any corporation, partnership or other entity, individual or other third party, other than in the course of Executive's assigned duties and for the benefit of the Company, any Confidential Information, either during the Term or thereafter. In the event Executive desires to publish the results of Executive's work for or experiences with the Company or its subsidiaries through literature, interviews or speeches, Executive will submit requests for such interviews or such literature or speeches to the Board at least fourteen (14) days before any anticipated dissemination of such information for a determination of whether such disclosure is in the best interests of the Company and its subsidiaries, including whether such disclosure may impair trade secret status or constitute an invasion of privacy. Executive agrees not to publish, disclose or otherwise disseminate such information without the prior written approval of the Board.

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7.3Delivery of Records. In the event Executive's employment with the Company ceases for any reason, Executive will not remove from the Company's premises without its prior written consent any records (written or electronic), files, drawings, documents, equipment, materials and writings received from, created for or belonging to the Company or its subsidiaries, including those which relate to or contain Confidential Information, or any copies thereof. Upon request or when employment with the Company terminates, Executive will immediately deliver the same to the Company.

8.Assignment and Transfer.

8.1Company. This Agreement shall inure to the benefit of and be enforceable by, and may be assigned by the Company to, any purchaser of all or substantially all of the Company's business or assets, any successor to the Company or any assignee thereof (whether direct or indirect, by purchase, merger, consolidation or otherwise).

8.2Executive. Executive's rights and obligations under this Agreement shall not be transferable by Executive by assignment or otherwise, and any purported assignment, transfer or delegation thereof shall be void; provided, however, that if Executive shall die, all amounts then payable to Executive hereunder shall be paid in accordance with the terms of this Agreement to Executive's devisee, legatee or other designee or, if there be no such designee, to Executive's estate.

9.Miscellaneous.

9.1Other Obligations. Executive represents and warrants that neither Executive's employment with the Company or Executive's performance of Executive's obligations hereunder will conflict with or violate or otherwise are inconsistent with any other obligations, legal or otherwise, which Executive may have. Executive covenants that he shall perform his duties hereunder in a professional manner and not in conflict or violation, or otherwise inconsistent with other obligations legal or otherwise, which Executive may have.

9.2Nondisclosure; Other Employers. Executive will not disclose to the Company or any of its subsidiaries, or use, or induce the Company or any of its subsidiaries to use, any proprietary information, trade secrets or confidential business information of others. Executive represents and warrants that Executive does not possess any property, proprietary information, trade secrets and confidential business information belonging to prior employers.

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9.3Cooperation. Following termination of employment with the Company for any reason, Executive shall cooperate with the Company, as requested by the Company, to effect a transition of Executive's responsibilities and to ensure that the Company is aware of all matters being handled by Executive.

9.4Protection of Reputation. During the Term and thereafter, Executive agrees that he will take no action which is intended, or would reasonably be expected, to harm the Company or any of its subsidiaries or its or their reputations or which would reasonably be expected to lead to unwanted or unfavorable publicity to the Company or any of its subsidiaries, other than those required in order to permit Executive to comply with applicable law or those made in connection with legal or arbitral process. During the Term and thereafter, the Company agrees that it will take no actions which are intended, or would reasonably be expected, to harm Executive or his reputation or which would reasonably be expected to lead to unwanted or unfavorable publicity to Executive, other than those required in order to permit the Company to comply with applicable law or those made in connection with legal or arbitral process. Notwithstanding the foregoing, this paragraph shall not prevent the Company or Executive from exercising any of their respective rights under this Agreement.

9.5Governing Law. This Agreement shall be governed by and construed (both as to validity and performance) and enforced in accordance with the internal laws of the State of New York applicable to agreements made and to be performed wholly with such jurisdiction, without regard to principles of the conflict of laws thereof or where the parties are located at the time a dispute arises.

9.6Consent to Jurisdiction, Waiver of Jury Trial. Each of the parties hereby irrevocably and unconditionally consents to the exclusive jurisdiction of any federal or state court of New York sitting in New York County and irrevocably agrees that all actions or proceedings arising out of or relating to this Agreement or the transactions contemplated hereby shall be litigated exclusively in such Courts. Each of the parties agrees not to commence any legal proceeding related hereto except in such Courts. Each of the parties irrevocably waives any objection which it may now or hereafter have to the laying of the venue of any such proceeding in any such Court and hereby further irrevocably and unconditionally waives and agrees not to plead or claim in any such Court that any such action, suit or proceeding brought in any such court has been brought in an inconvenient forum. Each of the parties irrevocably waives any right it may have to a trial by jury in any such action, suit or proceeding. Each of the parties agrees that the prevailing party in any action or proceeding arising out of or relating to this Agreement or the transactions contemplated hereby shall be entitled to recover its reasonable fees and expenses in connection therewith, including legal fees.

9.7Entire Agreement. This Agreement (including all exhibits hereto) contains the entire agreement and understanding between the parties hereto in respect of Executive's employment and supersedes, cancels and annuls any prior or contemporaneous written or oral agreements, understandings, commitments and practices between them respecting Executive's employment, including all prior employment agreements, if any, between the Company and Executive, which agreement(s) hereby are terminated and shall be of no further force or effect.

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9.8No Amendment/Waiver. This Agreement may not be amended or modified in any manner nor may any of its provisions be waived except by written amendment executed by the parties. A waiver, modification or amendment by a party shall only be effective if (a) it is in writing and signed by the parties, (b) it specifically refers to this Agreement and (c) it specifically states that the party, as the case may be, is waiving, modifying or amending its rights hereunder. Any such amendment, modification or waiver shall be effective only in the specific instance and for the specific purpose for which it was given.

9.9Severability. If any term, provision, covenant or condition of this Agreement or part thereof, or the application thereof to any person, place or circumstance, shall be held to be invalid, unenforceable or void by a court of competent jurisdiction, the remainder of this Agreement and such term, provision, covenant or condition shall remain in full force and effect, and any such invalid, unenforceable or void term, provision, covenant or condition shall be deemed, without further action on the part of the parties hereto, modified, amended and limited, and the court shall have the power to modify, to the extent necessary to render the same and the remainder of this Agreement valid, enforceable and lawful. In this regard, Executive acknowledges that the provisions of Sections 5, 6 and 7 of this Agreement are reasonable and necessary for the protection of the Company.

9.10Construction. The headings and captions of this Agreement are provided for convenience only and are intended to have no effect in construing or interpreting this Agreement. The language in all parts of this Agreement shall be in all cases construed according to its fair meaning and not strictly for or against the Company or Executive. The use herein of the word "including," when following any general provision, sentence, clause, statement, term or matter, shall be deemed to mean "including, without limitation." As used herein, "Company" shall mean the Company and its subsidiaries and any purchaser of, successor to or assignee (whether direct or indirect, by purchase, merger, consolidation or otherwise) of all or substantially all of the Company's business or assets which is obligated to perform this Agreement by operation of law, agreement or otherwise. As used herein, the words "day" or "days" shall mean a calendar day or days. As used herein, "Compensation Committee" means the Compensation Committee of the Board or, if no such committee is then serving, at least two members of the Board as selected by the Board.

9.11Remedies for Breach. The parties hereto agree that Executive is obligated under this Agreement to render personal services during the Term of a special, unique, unusual, extraordinary and intellectual character, thereby giving this Agreement special value, and, in the event of a breach or threatened breach of any covenant of Executive herein, the injury or imminent injury to the value and the goodwill of the Company's and its subsidiaries' businesses could not be reasonably or adequately compensated in damages in an action at law. Accordingly, Executive acknowledges that the Company (and as applicable, one or more of its subsidiaries) shall be entitled to seek injunctive relief or any other equitable remedy against Executive in the event of a breach or threatened breach of Sections 5, 6 or 7 of this Agreement. The rights and remedies of Executive and Company are cumulative and shall not be exclusive, and Executive and Company shall be entitled to pursue all legal and equitable rights and remedies and to secure performance of the obligations and duties of the other under this Agreement, and the enforcement of one or more of such rights and remedies by Executive or Company shall in no way preclude Executive or Company from pursuing, at the same time or subsequently, any and all other rights and remedies available to Executive or Company.

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9.12Notices. Any notice, request, consent or approval required or permitted to be given under this Agreement or pursuant to law shall be sufficient if in writing, and if and when sent by certified or registered mail, return receipt requested, with postage prepaid, or by overnight courier, to Executive's residence, as reflected in the Company's records or as otherwise designated by Executive, or to the Company's principal executive office, attention: Chairman of the Compensation Committee of the Board of Directors with a copy (which shall not constitute notice) to: David M. Zlotchew, Esq., Haynes and Boone, LLP, 153 East 53d Street, New York, NY 10022, as the case may be. All such notices, requests, consents and approvals shall be effective upon being deposited in the United States mail. However, the time period in which a response thereto must be given shall commence to run from the date of receipt on the return receipt of the notice, request, consent or approval by the addressee thereof. Rejection or other refusal to accept, or the inability to deliver because of changed address of which no notice was given as provided herein, shall be deemed to be receipt of the notice, request, consent or approval sent

9.13Assistance in Proceedings, Etc. Executive shall, without additional compensation during the Term and with complete reimbursement of expenses after the expiration of the Term, upon reasonable notice, furnish such information and proper assistance to the Company as may reasonably be required by the Company in connection with any legal or quasi-legal proceeding, including any external or internal investigation, involving the Company or any of its subsidiaries or in which any of them is, or may become, a party.

9.14Survival. Cessation or termination of Executive's employment with the Company shall not result in termination of this Agreement. To the extent that any of the obligations of this Agreement constitute continuing obligations, they shall survive any termination or expiration of this Agreement or of Executive’s employment hereunder.

[Signature page follows]

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IN WITNESS WHEREOF, each of the parties hereto has duly executed this Agreement as of September 15, 2008, to be deemed effective as of the date first written above.

EMPLOYER

NEPHROS, INC.

By:  /s/ Gerald J. Kochanski

Name: Gerald J. Kochanski

Title: V.P. & CFO

EXECUTIVE

/s/ Ernest A. Elgin III

Ernest A. Elgin III

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SCHEDULE A

Options

Options: Options to purchase 750,000 shares of Common Stock. The Options shall vest in four equal installments on each of September 15, 2009, September 15, 2010, September 15, 2011 and September 15, 2012; provided that Executive remains employed by the Company at such time. The Options shall be exercisable at an exercise price equal to the Common Stock’s closing price on the American Stock Exchange on the date of grant.

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EX-32.1

Exhibit 32.1

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report of Nephros, Inc. (the “Company”) on Form 10-Q for the period ended September 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Ernest A. Elgin III, the President & Chief Executive Officer of Nephros, Inc. and Gerald J. Kochanski, the Chief Financial Officer of Nephros, Inc., each certifies that:

1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

By:	/s/ Ernest A. Elgin III
Name: Ernest A. Elgin III
Title: President & Chief Executive Officer (Principal Executive Officer)
Dated: November 14, 2008
By:	/s/ Gerald J. Kochanski
Name: Gerald J. Kochanski
Title: Chief Financial Officer (Principal Financial and Accounting Officer)
Dated: November 14, 2008