NEPHROS, INC. The following discussion includes forward-looking statements about our business, financial condition and results of operations including discussions about management's expectations for our business. These statements represent projections, beliefs and expectations based on current circumstances and conditions and in light of recent events and trends, and these statements should not be construed either as assurances of performances or as promises of a given course of action. Instead, various known and unknown factors are likely to cause our actual performance and management's actions to vary, and the results of these variances may be both material and adverse. A list of the known material factors that may cause our results to vary, or may cause management to deviate from its current plans and expectations, is included in Item 1A, "Risk Factors," of this Annual Report on Form 10-K. The following discussion should also be read in conjunction with the consolidated financial statements and notes included in Item 8, "Financial Statements and Supplemental Data," of this Annual Report
on Form 10-K. Business Overview
We are a commercial-stage company that develops and sells high performance water solutions to the medical and commercial markets.
Our medical water filters, mostly classified as ultrafilters, are used primarily by hospitals for the prevention of infection from waterborne pathogens, such as legionella and pseudomonas, and in dialysis centers for the removal of biological contaminants from water and bicarbonate concentrate. Because our ultrafilters capture contaminants as small as 0.005 microns in size, they minimize exposure to a wide variety of bacteria, viruses, fungi, parasites,
and endotoxins.
Our commercial water filters improve the taste and odor of water and reduce biofilm, cysts, particulates, and scale build-up in downstream equipment. Our products are marketed primarily to the food service, hospitality, convenience store, and health care markets, and also sold into medical institutions to supplement. We also own a majority stake inSpecialty Renal Products, Inc. ("SRP"), a development-stage medical device company that is focused primarily on developing hemodiafiltration ("HDF") technology. OnMay 13, 2022 , the FDA gave 510(k) clearance to SRP's second-generation model of the OLp?rH2H Hemodiafiltration System, which enables nephrologists to provide HDF treatment to patients with end stage renal disease. InJanuary 2023 , SRP management began exploring strategic partnerships to support a commercial launch of the HDF product but was successful in identifying a partner. By lateFebruary 2023 , SRP had nearly exhausted its capital resources. Due to its limited capital and lack of prospects for securing a strategic partnership or additional financing, the board of directors of SRP adopted a plan onMarch 6, 2023 to wind down SRP operations, liquidate its remaining assets and dissolve the company. That plan was approved by SRP's stockholders onMarch 9, 2023 . We anticipate that SRP's cash resources will be sufficient to satisfy all of its outstanding liabilities other than its obligations to us under a loan with an outstanding balance of approximately$1.4 million . Accordingly, we expect that SRP will assign all of its remaining assets, including its intellectual property rights in the HDF2 device, to us in partial satisfaction of its outstanding loan balance. Although we have no current plans to do so, we may re-evaluate opportunities for HDF in the future. As a result of ourNovember 2022 sale of substantially all of the assets used in our PDS business, we completely exited the PDS business, which we had previously been reporting as a separate reportable operating segment for financial reporting purposes. As a result, we determined that our PDS business had met the criteria for discontinued operations as ofSeptember 30, 2022 . We no longer separately report the PDS business as a separate reportable segment in our financial statements including in this Annual Report on Form 10-K for any of the periods presented.
Recent Accounting Pronouncements
We are subject to recently issued accounting standards, accounting guidance and disclosure requirements. For a description of these new accounting standards, see "Note 2 - Summary of Significant Accounting Policies," to our consolidated financial statements included in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K. 26
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States ("GAAP"). The preparation of financial statements in accordance with GAAP requires application of management's subjective judgments, often requiring estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Our actual results may differ substantially from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in "Note 2 - Summary of Significant Accounting Policies," to our consolidated financial statements included in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K, we believe that the following accounting policies require the application of significant judgments and estimates. Inventories Our inventory reserve requirements are based on various factors including product expiration date and estimates for the future sales of the product. Reserve assessments include inventory obsolescence based upon expiration date, damaged, or rejected product, slow-moving products, and other considerations. We continue to monitor our inventory reserves amounts and policies, and to update both as required by relevant circumstances. Results of Operations
Fluctuations in Operating Results
Our results of operations have fluctuated significantly from period to period in the past, including recently, and are likely to continue to do so in the future. We anticipate that our annual results of operations will be impacted for the foreseeable future by several factors, including market acceptance of our products, expense management, and progress in achieving positive operating cash flow. 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. 27
Fiscal Year Ended
The following table sets forth our summarized, consolidated results of operations for the years endedDecember 31, 2022 and 2021 (in thousands except percentages): $ % Years Ended December 31, Increase Increase 2022 2021 (Decrease) (Decrease) Total net revenues$ 9,975 $ 10,217 $ (242 ) (2 )% Cost of goods sold 5,244 4,584 660 14 % Gross margin 4,731 5,633 (902 ) (16 )% Gross margin % 47 % 55 % - (8 )%
Research and development expenses 1,255 1,498 (243 ) (16 )% Depreciation and amortization expenses 218 192 26 14 % Selling, general and administrative expenses 7,593 7,195 398 6 % Operating loss from continuing operations (4,335 ) (3,252 ) (1,083 ) 33 % Interest expense (20 ) (41 ) 21 (51 )% Interest income 14 10 4 40 %
Forgiveness of PPP Loan - 482 (482 ) (100 )% Other income, net 64 17 47 276 % Net loss from continuing operations (4,277 ) (2,784 )
(1,493 ) 54 %
Net loss from discontinued
operations (2,829 ) (1,083 ) (1,746 ) 161 %
Net Loss (7,106 ) (3,867 ) (3,239 ) 84 %
Less: undeclared deemed dividend
attributable to continuing
noncontrolling interest (276 ) (240 ) (36 ) 15 %
Net loss attributable to Nephros,
Inc. shareholders $ (7,382 ) $ (4,107 ) (3,275 ) 80 %
Net Revenues. Our business is reported in two reportable segments: Water
Filtration and Renal Products. Our net revenues in each of these segments for
the year ended December 31, 2022 and 2021 (in thousands, except percentages)
were as follows:
$ %
2022 2021 Increase Increase
Water Filtration $ 9,975 $ 10,217 $ (242 ) (2 )%
Renal Products - - - -
Total $ 9,975 $ 10,217 $ (242 ) (2 )%
Total net revenues in the Water Filtration segment decreased 2% in the year
ended December 31, 2022 .
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Gross Profit Margin
%
Increase
2022 2021 (Decrease)
Water Filtration 47 % 55 % (8 )%
Renal Products - % - % -
Total 47 % 55 % (8 )%
Consolidated gross profit margin was approximately 47% for the year ended
December 31, 2022 , compared to approximately 55% for the year ended December 31,
2021 . The decrease of approximately 8% was driven by increased shipping costs,
as well as inventory reserve increases charged to expense, for expirations,
certain product obsolescence and adjustments to inventory counts. Responding to
supply chain cost increases, we implemented a broad price increase beginning
June 1, 2022 , which helped to offset these expense increases. Our gross margins
returned to 59% in the quarter ended December 31, 2022 , well within our target
range of 55-60%.
Research and Development Expenses
Research and development expenses by segment for the year ended
$ %
2022 2021 Increase (Decrease) Increase (Decrease)
Water Filtration $ 879 $ 1,251 $ (372 ) (30 )%
Renal Products 376 247 129 52 %
Total $ 1,255 $ 1,498 $ (243 ) (16 )%
Consolidated research and development expenses decreased 16% primarily due to decreased R&D investment in the Water Filtration segment.
Depreciation and Amortization Expense
Depreciation and amortization expenses were
Selling, General and Administrative Expenses
Selling, general and administrative expenses by segment for the year endedDecember 31, 2022 and 2021 (in thousands, except percentages) were as follows: $ % 2022 2021 Increase (Decrease) Increase (Decrease) Water Filtration$ 7,328 $ 7,124 $ 204 3 % Renal Products 265 71 194 273 % Total$ 7,593 $ 7,195 $ 398 6 %
Consolidated selling, general and administrative expenses increased
29 Interest Expense Interest expense was approximately$20,000 for the year endedDecember 31, 2022 compared to$41,000 for the year endedDecember 31, 2021 . This reduction is primarily related to a lower principal balance of the company's secured note payable. Interest Income Interest income was approximately$14,000 for the year endedDecember 31, 2022 compared to approximately$10,000 for the endedDecember 31, 2021 . The increase in interest income is due to higher interest rates earned on invested cash
balances. Extinguishment of PPP loan
Our outstanding PPP loan was forgiven in
Other Income (Expense), net Other income was approximately$64,000 for the year endedDecember 31, 2022 , compared to$17,000 for the year endedDecember 31, 2021 . This increase is primarily related to the release of the cumulative translation adjustment from accumulated other comprehensive income (loss) on the liquidation of a foreign entity, related to the closure in the second quarter of 2022, ofNephros International , a wholly owned subsidiary ofNephros, Inc.
Loss from discontinued operations
Loss from discontinued operations was approximately$2.8 million for the year endedDecember 31, 2022 , compared to approximately$1.1 million for the year endedDecember 31, 2021 . The discontinued operations are related to the company's former PDS operating segment. The increased loss is primarily due to the impairment of the net assets of PDS that was sold, and reported in the third quarter of 2022 that totaled approximately$1.4 million .
Liquidity and Capital Resources
The following table summarizes our liquidity and capital resources as of
December 31,
Liquidity and Capital Resources 2022 2021
Cash and cash equivalents $ 3,634 $ 6,973
Other current assets 4,627 6,661
Working capital 6,849 11,244
Stockholders' equity 8,881 14,749
We operate under an Investment, Risk Management and Accounting Policy adopted by
our Board of Directors. Such policy limits the types of instruments or
securities in which we may invest our excess funds: U.S. Treasury Securities ;
Certificates of Deposit issued by money center banks; Money Funds by money
center banks; Repurchase Agreements; and Eurodollar Certificates of Deposit
issued by money center banks. This policy provides that our primary objectives
for investments are the preservation of principal and achieving sufficient
liquidity to meet our forecasted cash requirements. In addition, provided that
such primary objectives are met, we may seek to achieve the maximum yield
available under such constraints.
At December 31, 2022 , we had an accumulated deficit of $142.8 million and we
expect to incur additional operating losses from operations until such time, if
ever, that we are able to increase product sales and/or licensing revenue to
achieve profitability.
30
Based on cash that is available for our operations and projections of our future
operations, as well as our significantly reduced cash burn rates over the past 6
months, we believe that our existing cash resources together with our
anticipated revenue, will be sufficient to fund our current operating plan
through at least the next 12 months from the date of issuance of the
consolidated financial statements in this Annual Report on Form 10-K.
Additionally, our operating plans are designed to help control operating costs,
to increase revenue and to raise additional capital until such time as we
generate sufficient cash flows to fund operations. If there were a decrease in
the demand for our products due to either economic or competitive conditions, or
if we are otherwise unable to achieve our plan or achieve our anticipated
operating results, there could be a significant reduction in liquidity due to
our possible inability to cut costs sufficiently. In such event, the Company may
need to take further actions to reduce its discretionary expenditures, including
further reducing headcount, reducing spending on R&D projects and reducingother variable costs.
Our future liquidity sources and requirements will depend on many other factors, including:
? the market acceptance of our products, and our ability to effectively and
efficiently produce, market and sell our products;
? the costs involved in filing and enforcing patent claims and the status of
competitive products; and
? the cost of litigation, including potential patent litigation and any other
actual or threatened litigation.
We expect to put our current capital resources toward the development, marketing, and sales of our water filtration products and working capital purposes.
Net cash used in operating activities was$3.2 million for the year endedDecember 31, 2022 compared to$1.4 million for the year endedDecember 31, 2021 , an increase of$1.8 million . This increase of$1.8 million is due primarily to an increase in the net loss incurred of$3.2 million , partially offset by approximately$1.4 million in non-cash charges for impairment of assets held for sale.
Net cash used in investing activities was
Net cash provided by financing activities was approximately$43,000 for the year endedDecember 31, 2022 . This was primarily from proceeds from the exercise of warrants of$0.2 million and from the sale to Nephros of SRP preferred shares of$0.2 million , offset partially by payments of$0.3 million on our secured note, payments of employee taxes on restricted stock of approximately$31,000 , principal payments of approximately$3,000 on our finance lease obligation and principal payments of approximately$3,000 on our equipment financing debt. Net cash provided by financing activities of$0.2 million for the year endedDecember 31, 2021 resulted from proceeds from the exercise of warrants and stock options of$0.5 million partially offset by payments on our secured note payable of$0.3 million . Purchase Commitments In exchange for the rights granted under the License and Supply Agreement with Medica (see Note 10 - License and Supply Agreement, net), the Company agreed to make certain minimum annual aggregate purchases from Medica over the term of the License and Supply Agreement. For the year endedDecember 31, 2022 , the Company has agreed to make minimum annual aggregate purchases from Medica of €3.5 million (approximately$3.7 million ). For the year endedDecember 31, 2022 , aggregate purchase commitments totaled €3.2 million (approximately$3.4 million ). The company has agreed with Medica that it will make-up the €0.3 purchase shortfall based on anticipated future revenues. Future purchase commitments under the License and Supply Agreement with Medica are as follows: ? 2023: €3,625,000 ? 2024: €3,825,000 ? 2025: €4,000,000
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