Business context and reporting period
Nephros, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. The company sells water-filtration products for healthcare and other markets and is developing renal-disease therapies, including a second-generation hemodiafiltration (HDF) system through its new subsidiary, Specialty Renal Products, Inc. (SRP). Unless otherwise noted, amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $1.724m | $0.916m | $4.075m | $2.509m |
| Gross margin | $0.952m; 55% | $0.532m; 58% | $2.249m; 55% | $1.504m; 60% |
| Operating loss | $0.511m | $0.518m | $2.287m | $1.823m |
| Net loss attributable to Nephros | $0.566m | $0.632m | $2.677m | $2.098m |
Q3 revenue growth was 88%, driven by new customers and expansion in existing accounts. Nine-month revenue rose 62%; product revenue was $3.822m, versus $2.316m. Gross margin declined year over year, partly reflecting a greater share of product revenue and higher product costs; the nine-month period also included inventory reserves and physical-count adjustments. Nine-month operating expenses increased to $4.536m from $3.327m, including higher SG&A and Renal Products investment. Q3 net loss attributable to Nephros narrowed, while the nine-month loss increased.
Cash was $5.322m at September 30, 2018, compared with $2.194m at year-end 2017. Working capital was $6.936m, and total assets were $9.404m. Operating activities used $3.134m in cash in the first nine months, versus $1.871m in 2017; financing provided $6.269m, and cash increased by $3.128m. Management said available cash was expected to fund the current operating plan for at least 12 months from issuance of the statements.
At quarter-end, debt included a $1.088m secured note and $0.163m outstanding on a secured revolving facility. The note bears 8% interest and matures in 2023; the revolving facility rate was 8.75% and its borrowing base depends on eligible receivables and inventory. The prior $1.187m unsecured note was repaid in March 2018, generating a $0.199m extinguishment loss. The balance sheet also reports $3.000m of redeemable noncontrolling interest in SRP as mezzanine equity.
Material changes versus the prior comparable period
- Water Filtration revenue growth improved operating performance in that segment: Q3 operating loss was $0.207m, compared with $0.502m; for nine months it was $1.770m, compared with $1.807m.
- Renal Products operating loss increased to $0.304m for Q3 and $0.517m for nine months, primarily reflecting development spending on the second-generation HDF product.
- Shares outstanding rose to 64.17m from 55.29m at December 31, 2017, following equity issuance and warrant exercises. Common-stock proceeds were $3.778m for the nine-month period.
- SRP raised $3.0m by selling preferred shares representing 37.5% of its fully diluted equity. The proceeds are restricted to SRP expenses, subject to limited reimbursement for SRP-attributable expenses.
- Adoption of ASC 606 accelerated recognition of approximately $278,000 of previously deferred Bellco license revenue through an opening accumulated-deficit adjustment. The filing reports $18,000 less revenue for Q3 and $53,000 less for the nine-month period than under the previous accounting guidance.
Outlook, commentary, risks and unusual items
Management expects operating losses to continue over the next several quarters. It intends to use capital for water-filter sales and marketing, HDF development, and working capital. The company has built a second-generation HDF prototype and says it may return to market in approximately 15 months, pending FDA clearance; this is a forward-looking estimate, not a guarantee. Prior post-market evaluations concluded in early 2018, and the company said it would work with Vanderbilt to publish observational findings when practical.
Risks highlighted include product acceptance, regulatory approvals, product safety and liability, supplier and manufacturer issues, competition and pricing, access to future funding, and the efficacy or economics of products under development. Revenue is concentrated: five customers represented 56% of Q3 revenue, and three represented 33% of nine-month revenue. The company also had approximately €2.706m of remaining aggregate purchase commitments as of September 30 under its 2018 minimum-purchase arrangement with Medica; the annual minimum was €2.5m. The filing states no off-balance-sheet arrangements. Management concluded disclosure controls and procedures were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether water-filtration revenue growth can continue and gross margins recover, given rising product costs, inventory reserves, and customer concentration.
- Cash burn and liquidity, including the restriction on SRP’s $3.0m financing proceeds and management’s 12-month cash-sufficiency assessment.
- HDF development milestones, FDA-clearance timing, expected costs, and the basis for the estimated 15-month return-to-market timeline.
- Terms and servicing capacity of the secured debt and revolving facility, and the company’s Medica purchase commitments.
- Potential dilution from outstanding options and warrants, and SRP preferred-stock rights, including cumulative dividends, liquidation preference, board representation, and approval rights.