Nephros, Inc. — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; filed March 22, 2012. The filing reports annual results, not a standalone fourth-quarter financial summary. Dollar amounts below are in U.S. dollars.
Business context
Nephros develops and markets filtration products for end-stage renal disease (ESRD) therapy and water purification. Its portfolio includes mid-dilution HDF filters sold in parts of Europe, water-filtration products cleared for specified dialysis uses, and HDF products awaiting U.S. clearance. The company had seven employees and two ongoing consultants at year-end.
Financial results and liquidity
| Metric | FY 2011 | FY 2010 |
|---|---|---|
| Revenue | $2.214 million | $2.938 million |
| Gross profit / margin | $0.868 million / 39.2% | $1.122 million / 38.2% |
| Operating loss | $2.310 million | $1.889 million |
| Net loss | $2.360 million | $1.933 million |
| Net loss per share, basic and diluted | $0.27 | $0.93 |
| Cash used in operating activities | $1.296 million | $1.292 million |
- Revenue fell approximately 25%. Product revenue was $1.849 million, down from $2.938 million; 2011 also included $365,000 of Bellco license revenue.
- Gross margin improved to about 39.2% from 38.2%, but operating expenses increased to $3.178 million from $3.011 million, and the operating loss widened.
- Year-end cash and cash equivalents were $1.669 million, compared with $240,000 a year earlier. Current assets were $3.199 million and current liabilities $2.573 million; liabilities included $2.094 million of deferred Bellco revenue. No short-term borrowings remained at year-end.
- Financing activities provided $2.723 million, principally from the March 2011 rights offering and private placement. The company repaid its $500,000 secured note to Lambda Investors.
- Accumulated deficit was $94.268 million. The filing says projected cash flows would fund operations only into the second quarter of 2013 and that additional financing is required.
Material changes and unusual items
- Lower Office of Naval Research revenue, reduced direct MD-filter sales in Europe, and lower STERIS project revenue drove the decline; increased DSU sales and Bellco license revenue partly offset it.
- Cost of goods sold included a $200,000 obsolete-inventory write-down, compared with $18,000 in 2010.
- Research and development expense rose 25% to $451,000. Selling, general and administrative expense rose 5% to $2.636 million, including higher bonus, stock-compensation and recruiting costs.
- The Bellco agreement provides fixed installments of €500,000, €750,000 and €600,000. The company reported the first two payments received by the filing date; the final installment was due in January 2013. Revenue from the agreement is deferred and recognized over the obligation period through 2014. Unit-based royalties are scheduled for 2015–2016.
- A 1-for-20 reverse stock split became effective March 11, 2011. The rights offering and related private placement issued substantial common stock and warrants.
Outlook, risks and contingencies
- Going concern: The independent auditor’s report includes an explanatory paragraph citing substantial doubt about the company’s ability to continue as a going concern. The statements assume continued operations and contain no adjustments for the outcome of this uncertainty. Management says the company must obtain additional financing or curtail activities, and there is no assurance financing will be available on acceptable terms.
- Regulatory outlook: FDA did not find the earlier HDF submission substantially equivalent. For the new 510(k) application, filed August 2011, FDA requested additional information in November; Nephros submitted its response in early February 2012 and awaited further communication. Management hoped for U.S. approval in 2012, but approval and timing were uncertain.
- Commercial outlook: Management expected DSU sales to accelerate in the U.S. dialysis market and anticipated initial sales to dialysis markets outside the U.S. in 2012. These are expectations, not guaranteed results. The Army had validated the UF-40 against a military water-purifier standard, but had not issued a request for proposals.
- Concentration and execution risks: Two customers represented 71% of 2011 sales and 85% of year-end receivables. The company relies on outside manufacturers and distributors and faces market-acceptance, reimbursement, competition, currency, intellectual-property and regulatory risks.
- Governance and control: Paul A. Mieyal remained acting CEO; Lambda Investors and affiliated holders beneficially owned approximately 56% of outstanding stock. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not attest to internal-control effectiveness.
- No pending legal proceedings were reported. Contractual obligations totaled approximately $562,000, including leases and employment contracts.
Important facts for investors to verify
- Current cash runway, financing needs and whether additional capital was raised after the filing date.
- FDA status and any decision on the HDF 510(k) application, including any further data or clinical requirements.
- Bellco installment collection, deferred-revenue recognition, currency effects and any subsequent royalty or sales performance.
- Whether product revenue, customer concentration and receivable collections improved, particularly given the two customers’ share of sales and receivables.
- Inventory quality and the basis for the $200,000 write-down, as well as gross margins and cash consumption in subsequent periods.