Nephros, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; financial statements are unaudited. Amounts below are in thousands of dollars, except per-share and share data.
Financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Product revenue | $248 | $391 | $467 | $737 |
| License revenue | $193 | $184 | $448 | $359 |
| Total revenue | $441 | $575 | $915 | $1,096 |
| Gross profit | $299 | $349 | $667 | $675 |
| Operating expenses | $935 | $977 | $1,865 | $2,311 |
| Operating loss | $(636) | $(628) | $(1,198) | $(1,636) |
| Net loss | $(654) | $(671) | $(1,414) | $(1,912) |
| Basic and diluted loss per share | $(0.03) | $(0.05) | $(0.06) | $(0.14) |
- Reported gross profit as a share of total revenue was approximately 68% in Q2 2014 and 73% for the first half; these figures include license revenue, which has no related cost of goods sold. Management reported water-filter gross margins of 43% in Q2 (42% in 2013) and 47% for the first half (43% in 2013).
- Six-month operating cash use was $867, versus $2,558 in 2013. Investing cash flow was zero. Financing provided $515, including rights-offering proceeds partly offset by repayment of the secured note. Cash fell to $225 from $579 at year-end.
- At June 30, total assets were $2,352, total liabilities $2,136, and stockholders’ equity $216, versus a $610 deficit at December 31, 2013. Current assets were $560 and current liabilities $1,684. Deferred revenue totaled approximately $873, of which $452 was classified long-term.
- No senior secured note remained outstanding at June 30. The $1.5 million Lambda Investors note, bearing 12% interest, was repaid in March with rights-offering proceeds. The company reported $70 of six-month interest expense, including interest on vendor payables.
Changes and significant developments
- First-half revenue declined 17%, mainly because product sales fell approximately $270; Bellco license revenue increased approximately $89. Q2 revenue declined 23%, with product sales down approximately $143 and license revenue up approximately $9.
- Operating expenses fell in the first half, primarily due to lower SG&A and R&D. R&D decreased $140, mainly because H2H module development costs incurred in 2013 did not recur. SG&A decreased $302, including lower personnel and legal costs. Despite lower operating costs, Q2 operating loss widened slightly.
- A March 2014 rights offering raised $2.1 million gross and issued 7,140,823 shares. Net proceeds after specified note repayment, fees and offering costs were approximately $581. Shares outstanding increased from 18.1 million at year-end to 25.2 million at June 30; 25,247,120 were outstanding August 12.
- The February Bellco amendment extended the license through 2021, expanded its territory and set minimum sales targets; failure to meet them may allow Nephros to make the license non-exclusive. Nephros received €450,000 (approximately $612) in upfront fees, recognized license revenue over the agreement period, and agreed to lower per-unit royalties beginning in 2015.
Outlook, risks and unusual items
- Going concern: Management stated that recurring losses and inadequate cash generation raise substantial doubt about the company’s ability to continue as a going concern. The filing says rights-offering proceeds and Bellco fees were expected to fund operations into Q3 2014, excluding future operating cash receipts. The company said it must obtain additional financing; failure could force it to curtail operations or cease them.
- No formal revenue or earnings guidance is provided. Management expects continued losses until product sales or license revenue increase and identifies financing, product acceptance, commercialization costs and R&D as key factors affecting liquidity.
- The voluntary recalls of POU and DSU hospital-water products announced in October 2013 remained a material uncertainty. The company requested termination of the recall from the FDA on March 20, 2014, but could not predict FDA action, potential claims or business impact. During the first half, it wrote off approximately $216 of POU recall inventory and $66 of DSU inventory near expiration or replaced by newer versions.
- Commercialization milestones included a DaVita six-month evaluation of the HDF system, begun in Colorado Springs; a U.S. Army procurement process still under consideration, with no assurance of an award; and FDA acceptance for review in July of the DSU-H and SSU-H 510(k) submission. The company also reported receiving a Canadian license for its SSU in July.
- Customer concentration was significant: three customers represented 59%, 20% and 4% of first-half sales. The filing reports no pending legal proceedings. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Key facts for investors to verify
- Whether Nephros obtained financing or cash receipts after the reporting date sufficient to meet near-term obligations, given the stated runway into Q3 2014.
- The status and financial or regulatory consequences of the POU/DSU recalls and the FDA’s response to the termination request.
- Whether the Bellco agreement’s minimum sales targets and reduced future royalty terms support sustainable license revenue and cash flow.
- Whether product sales recover, customer concentration changes, and the DaVita HDF evaluation, Army procurement process and FDA review lead to commercial revenue.
- Potential dilution from outstanding warrants and options: the filing lists approximately 16.8 million warrant shares and 2.4 million option shares, excluded from diluted EPS as anti-dilutive. Rights-offering terms also triggered revised Lambda warrant coverage and exercise price.