Nephros, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Financial statement amounts are in thousands of dollars, except per-share data and share counts. Nephros develops and sells liquid-purification filters, including products for dialysis, hospitals, and other markets.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $491 | $418 | $1,406 | $1,514 |
| Gross margin dollars | $316 | $229 | $983 | $904 |
| Operating expenses | $997 | $837 | $2,862 | $3,149 |
| Operating loss | ($681) | ($608) | ($1,879) | ($2,245) |
| Net loss | ($706) | ($611) | ($2,120) | ($2,523) |
| Net loss per share, diluted | ($0.03) | ($0.03) | ($0.09) | ($0.17) |
- Q3 revenue rose 17%, reflecting higher water-filter sales and Bellco license revenue. Nine-month revenue fell 7%: lower water-filter sales were partly offset by higher Bellco license revenue.
- Water-filter gross margin was 41% in Q3 and 45% for the nine-month period, versus 22% and 38%, respectively, in 2013. Management attributed improvement partly to product mix and higher average selling prices; prior-year comparisons were affected by recall-related costs.
- Q3 net loss widened by $95; nine-month net loss narrowed by $403. Nine-month operating expenses declined, but Q3 SG&A increased 32%, including regulatory/quality costs and expenses tied to the planned rights offering.
- Cash was $1,047 at September 30, versus $579 at December 31, 2013. Nine-month operating cash use was $1,664, compared with $2,696 in 2013. Financing activities provided $2,134, including rights-offering proceeds and a new secured note.
- Current assets were $1,367 and current liabilities $3,057, implying a $1,690 working-capital deficit. Total liabilities were $3,491, exceeding total assets of $3,105; stockholders’ deficit was $386. The secured note had $1,750 principal, carried 12% interest, and was due February 28, 2015; its balance-sheet carrying value, net of debt discount, was $1,604.
Material developments, outlook, and risks
- Funding and going concern: Management said recurring losses and inadequate operating cash flow raise substantial doubt about the Company’s ability to continue as a going concern. It expected the August 2014 note and anticipated fourth-quarter $3 million rights offering to fund operations into Q3 2015, excluding future operating receipts. The offering was intended to repay the note; completion and sufficiency of financing were not assured.
- Rights offerings and dilution: The March 2014 rights offering raised $2.1 million gross and issued 7.14 million shares. Outstanding common shares rose to 25.25 million from 18.08 million at year-end 2013. A later $3 million offering at an anticipated $0.60 per share was registered and declared effective in November 2014. Warrants for 16.76 million shares were outstanding at September 30; potential shares were excluded from diluted EPS as anti-dilutive.
- Bellco agreement: The license was extended through 2021, territories expanded, and Nephros received €450,000 (about $612,000) in upfront fees. The agreement also revised future royalties and includes minimum sales targets that can permit conversion to non-exclusive status.
- Regulatory and product developments: FDA 510(k) clearance for DSU-H and SSU-H hospital ultrafilters was announced October 28, 2014. The 2013 voluntary recalls of POU and DSU hospital-water products remained unresolved with the FDA; Nephros had requested termination of the recall and reported no subsequent FDA communication as of the filing. The recall did not affect dialysis products. Recall-related inventory write-offs during the nine months included approximately $216 in POU inventory.
- Commercial and execution risks: DaVita began evaluating the HDF system at a clinic; Nephros was seeking a U.S. commercialization partner. The U.S. Army cancelled its IWPD solicitation in August and indicated it planned to revisit requirements. Three customers accounted for 80% of nine-month sales, creating customer concentration risk.
- Other key risks include dependence on additional financing, note default and lender remedies against substantially all assets, product acceptance, regulatory or product-liability actions, suppliers, and the ability to commercialize products profitably. No pending legal proceedings were reported. Management concluded disclosure controls were effective and reported no material change in internal control during the quarter.
Investor verification points
- Confirm whether the planned $3 million rights offering closed, its net proceeds, participation, and whether proceeds repaid the Lambda note.
- Review subsequent cash burn, financing needs, and the basis for the stated runway into Q3 2015 given the going-concern disclosure and working-capital deficit.
- Track FDA follow-up on the hospital-water product recall, any related claims or costs, and commercial uptake following DSU-H and SSU-H clearance.
- Verify Bellco sales against minimum targets and the timing and sustainability of license revenue; assess reliance on concentrated customers.
- Assess potential dilution from outstanding warrants and options and the effect of the March rights offering on warrant terms.