Business context and reporting period
Nephros, Inc. filed this Form 10-K for the fiscal year ended December 31, 2018; it reports annual results, not standalone fourth-quarter results. The company sells medical and commercial water-filtration products and is developing a second-generation hemodiafiltration (HDF) system through Specialty Renal Products (SRP). On December 31, 2018, Nephros acquired Biocon and Aether, expanding its commercial filtration business.
Financial performance and liquidity
| Metric | 2018 | 2017 |
|---|---|---|
| Revenue | $5.687 million | $3.809 million |
| Gross profit / margin | $3.203 million / 56% | $2.292 million / 60% |
| Operating loss | $3.016 million | $2.226 million |
| Net loss attributable to Nephros | $3.402 million | $0.809 million |
| Net cash used in operating activities | $3.662 million | $0.077 million |
Product revenue was $5.457 million; license, royalty and other revenue was $0.230 million. Revenue growth of 49% reflected new customers and increased sales to existing accounts. Gross margin declined four percentage points, primarily due to manufacturing and distribution inefficiencies and inventory adjustments. SG&A increased 37% to $4.517 million and R&D rose 54% to $1.539 million, including increased HDF development spending.
At year-end, cash was $4.581 million, working capital $5.519 million, total assets $10.558 million and stockholders’ equity $6.798 million. Total liabilities were $3.760 million. Debt included a $0.991 million secured revolving facility and a $1.038 million secured note; the prior unsecured note was repaid in 2018. Financing activities provided $7.047 million, including $3.778 million from common-stock issuance and $3.000 million from SRP preferred stock, whose proceeds are restricted to SRP-related expenses. The company reported an accumulated deficit of $124.153 million.
Material changes and unusual items
- Biocon/Aether acquisition consideration was reported as $1.621 million, including contingent consideration; preliminary purchase accounting recorded $0.748 million of goodwill and $0.590 million of intangible assets. The acquisition closed on the final day of 2018, so its contribution to reported 2018 revenue was limited. Unaudited pro forma revenue, assuming acquisition from January 1, was $6.412 million for 2018 and $4.236 million for 2017.
- Nephros formed SRP and sold a 37.5% interest for $3.0 million. SRP’s 2018 operating loss was $0.908 million, primarily reflecting increased second-generation HDF development costs.
- A $1.789 million 2017 income-tax benefit from selling New Jersey tax-credit carryforwards materially reduced that year’s reported net loss; the corresponding 2018 benefit was $0.093 million. Deferred tax assets remain fully offset by a valuation allowance.
- Repayment of the unsecured notes resulted in a $0.199 million debt-extinguishment loss. Adoption of ASC 606 accelerated approximately $0.278 million of deferred Bellco license revenue into opening accumulated deficit; 2018 reported revenue was $0.070 million lower than under the prior guidance.
Outlook, commitments and risks
Management expected available cash and projected sales growth to fund the current operating plan for at least 12 months from the financial-statement issuance date. It also described planned reductions to discretionary spending and personnel if sales underperform. Management expected to return the HDF system to market in late 2019 or early 2020, subject to FDA clearance. These are forward-looking expectations, not assurances.
Key risks include continued losses and cash burn, dependence on sales growth and possible additional financing, market acceptance and regulatory clearance, reliance on third-party manufacturers and distributors, and integration and performance of Biocon/Aether. Three customers represented 32% of 2018 revenue; customer concentration in receivables was 39% at year-end. Contractual obligations totaled approximately $29.513 million, including $28.700 million in minimum purchase commitments under the Medica supply agreement, substantially exceeding year-end cash. The revolving facility is secured by company assets and its renewal is not guaranteed. The company reported no pending legal proceedings, and its independent auditor issued an unqualified opinion on the financial statements.
Important facts for investors to verify
- Whether revenue growth converts into improved gross margin and reduced operating cash burn.
- Cash availability and financing needs, including the restricted use of SRP’s $3.0 million proceeds and the status of the secured credit facility.
- Timing, regulatory requirements, funding and commercial prospects for the second-generation HDF system.
- Acquisition performance, integration costs, contingent consideration and the assumptions supporting recorded goodwill and intangible assets.
- Ability to meet Medica minimum purchase commitments and the terms, timing and expected use of those purchases.
- Potential dilution: common shares outstanding increased during 2018, and outstanding options and warrants were 7.435 million and 6.642 million, respectively, at year-end.