Nephros, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Nephros develops and sells medical and water-filtration products, including hemodiafiltration systems and ultrafilters. Amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net revenue | $0.320 | $0.491 | $1.433 | $1.406 |
| Product revenue | $0.274 | $0.298 | $1.323 | $0.765 |
| License and royalty revenue | $0.046 | $0.193 | $0.110 | $0.641 |
| Gross margin, as reported | $0.166 | $0.316 | $0.807 | $0.983 |
| Operating expenses | $1.253 | $0.997 | $3.292 | $2.862 |
| Operating loss | $(1.087) | $(0.681) | $(2.485) | $(1.879) |
| Net income (loss) | $(0.581) | $2.723 | $(2.153) | $(6.127) |
- Q3 revenue fell 35%, mainly because Bellco license revenue recognized was lower. Nine-month revenue was approximately flat: product growth of 73% largely offset an 83% decline in license and royalty revenue.
- Management reports product gross margin of 44% for Q3 versus 41% and 53% for the nine months versus 45%, citing favorable currency movements and distributor contract changes. These product-margin figures differ from the statement’s gross margin, which includes total revenue less cost of goods sold.
- Net results were substantially affected by noncash warrant accounting. Q3 2015 included $2.287 million of warrant revaluation income and $1.761 million of warrant modification expense; Q3 2014 included $3.428 million of revaluation income. The 2014 figures were previously restated for warrant accounting.
- Nine-month operating expenses rose 15%, including higher R&D ($0.582 million) and SG&A ($2.551 million). SG&A increases included personnel and severance, professional services related partly to the accounting restatement and control improvements, and sales and marketing.
Cash, liquidity and capitalization
- At September 30, cash was $1.813 million, current assets $2.779 million, current liabilities $1.148 million, working capital $1.631 million, and stockholders’ equity $2.792 million. The company had an accumulated deficit of $116.318 million.
- The balance sheet showed no outstanding debt and no warrant liability at quarter-end. The latter followed the September exercise of Lambda’s 2007 warrants; the company issued 11.742 million shares and received about $1.76 million after reducing the exercise price to $0.15.
- Cash used in operating activities was $2.575 million in the cash-flow statement; MD&A instead cites $2.601 million. The filing text does not reconcile this difference. Financing activities provided $3.102 million, including stock issuance and warrant exercises. Cash increased $0.529 million from year-end 2014.
- Shares outstanding rose from 30.392 million at year-end 2014 to 45.026 million at September 30, 2015, primarily reflecting warrant exercises and other equity issuances.
- The Lincoln Park agreement permits sales of up to $10 million of common stock over 36 months, subject to conditions and limits; the company sold $0.135 million of stock under it in September. A May private placement raised about $1.23 million gross. The company also planned discounted tender offers for remaining warrants, which could yield up to about $1.39 million if fully exercised.
Outlook, risks and notable developments
- Management stated that available resources, possible additional warrant proceeds, and projected sales growth were expected to fund operations through at least Q3 2016. This outlook was conditional: management warned that cash flow had not been sufficient to meet obligations and that additional financing might be needed; failure to obtain it or achieve sales projections could require curtailing operations or ceasing operations.
- The filing states that recurring losses and difficulty generating sufficient cash flow raise substantial doubt about the company’s ability to continue as a going concern.
- Management cited more than 1,000 HDF patient treatments and an ongoing evaluation by the Renal Research Institute. It did not expect DaVita to restart its evaluation in the near term. A software update and revised training were expected by year-end 2015; new hospital and commercial filter products were planned for 2016.
- Risk factors include market adoption, financing needs, reliance on suppliers and distributors, product liability and regulatory exposure, and customer concentration. Four customers represented 63% of nine-month revenue; one customer represented 44% of receivables at quarter-end.
- The company disclosed earlier voluntary recalls of certain hospital water filters and a May 2015 FDA warning letter alleging quality-system and medical-device-reporting deficiencies. The FDA subsequently acknowledged receipt of the company’s corrective-action response; the letter did not restrict manufacturing or sales.
- Disclosure controls were deemed ineffective at September 30, 2015 because a material weakness in accounting for warrants remained. The company reported steps to improve review procedures but said remediation was incomplete. The filing also notes prior-period financial-statement restatements related to warrant accounting.
- No pending legal proceedings were reported. The company reported no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether operating cash burn, sales trends, and financing availability support the stated runway through Q3 2016.
- The status, timing, pricing and actual proceeds of the planned warrant tender offers and any Lincoln Park equity sales, including resulting dilution.
- Product-level sales and margins, Bellco royalty receipts, and whether product growth can offset lower license revenue.
- Progress on HDF evaluations, planned product launches, and required regulatory clearances, including the S100 filter submission.
- Whether the warrant-accounting material weakness is remediated and disclosure controls become effective.
- The reported operating cash use differs between the cash-flow statement and MD&A; confirm the correct figure in the underlying filing or subsequent disclosures.