Nephros, Inc. — Form 10-Q Summary
Business and reporting period: Nephros develops and sells liquid-purification ultrafilters, primarily for dialysis centers and healthcare facilities, and also serves military and other markets. This unaudited filing covers the quarter and nine months ended September 30, 2013; comparisons are with the corresponding 2012 periods. Dollar amounts below are in thousands unless stated otherwise.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Product revenue | $242 | $438 | $979 | $930 |
| License revenue | $176 | $166 | $535 | $509 |
| Total revenue | $418 | $604 | $1,514 | $1,439 |
| Gross profit / margin | $229 / 54.8% | $413 / 68.4% | $904 / 59.7% | $991 / 68.9% |
| Operating expenses | $837 | $1,266 | $3,353 | $3,212 |
| Operating loss | $(608) | $(853) | $(2,449) | $(2,221) |
| Net loss | $(611) | $(853) | $(2,523) | $(2,164) |
| Basic and diluted loss per share | $(0.03) | $(0.07) | $(0.17) | $(0.20) |
Cash flow: Net cash used in operating activities was $2,900 for the first nine months of 2013, versus $1,089 in 2012. Investing activities provided $3, compared with $666 used in 2012. Financing activities provided $3,019, including rights-offering proceeds, warrant exercises and a short-term secured note that was repaid. Cash increased by $121 from $47 at year-end 2012 to $168 at September 30, 2013.
Liquidity and balance sheet: At September 30, cash was $168, current assets $600 and current liabilities $1,950. Total assets were $2,556, total liabilities $2,126 and stockholders’ equity $430, compared with a $595 deficit at December 31, 2012. The balance sheet listed no senior secured note at quarter-end; the $1.3 million note issued in February was repaid from rights-offering proceeds. Accounts payable were $1,065. Deferred revenue totaled approximately $878, primarily under the Bellco license agreement. The company reported an accumulated deficit of $100,053.
Changes and operating results
- Third-quarter revenue fell 31% year over year. Product revenue declined $196, partly offset by $10 higher license revenue. Management attributed the product decline in part to no military sales in the quarter, versus $114 in Q3 2012, and recorded estimated recall-related sales credits of $127.
- For the nine months, revenue rose 5%, reflecting growth in water-filter sales and Bellco licensing revenue. Product costs increased, including higher costs associated with water-filter sales; gross profit declined $87 and gross margin contracted by about 9 percentage points.
- Q3 SG&A fell 43% to $578, mainly due to lower professional fees and personnel and travel costs, including an open CFO position and a reduction in the sales force from four people to one. Nine-month SG&A declined 3% to $2,497. R&D rose 24% for the nine months, and depreciation and amortization increased as Medica license-related assets were amortized.
- Q3 net loss narrowed to $611 from $853, but the nine-month loss widened to $2,523 from $2,164. The nine-month period included $52 of interest expense, largely related to the February secured note.
- Three customers represented 83% of nine-month sales (36%, 31% and 16%). Two customers accounted for 88% of accounts receivable at September 30 (57% and 31%).
Outlook, risks and unusual items
- Going concern: Management stated that recurring losses and insufficient operating cash flow raise substantial doubt about the company’s ability to continue as a going concern. It expects further losses and says additional financing is needed; failure to obtain capital could force it to curtail operations or cease them.
- Subsequent financing: On November 12, 2013, Nephros issued Lambda Investors a new $1.5 million senior secured note at 12%, due May 12, 2014; the rate increases to 16% if unpaid at maturity. The company also undertook to conduct a $2.75 million rights offering, expected at $0.30 per share. Transaction and legal fees are specified in the filing. The offering price is below the $0.40 exercise price of certain Lambda warrants and triggers their full-ratchet anti-dilution protection, creating potential dilution.
- Product recall: On October 30, 2013, the company announced voluntary recalls of all production lots of its point-of-use filters used in hospital water treatment and requests to remove certain labeling/promotional materials for those products and DSU in-line ultrafilters. The recalls do not affect dialysis products. The September statements include estimated adjustments of $127 to product revenue and $27 to cost of goods sold. Further business, financial, reputational or regulatory effects were uncertain; potential FDA action was not ruled out.
- Commercial prospects: The U.S. Army had not completed its technical evaluation of the individual water purification device solicitation as of November 5, 2013; any award remained uncertain. Nephros reported a small Marine Corps-related award and was pursuing military distribution. It planned a Q4 placement of its mid-HDF system in a U.S. dialysis clinic and was seeking a U.S. commercialization partner; broad marketing had not begun.
- Other commitments: Medica minimum purchase commitments were approximately €477,000 for 2013 through the reported date; the agreement also provides for a 3% royalty on specified product sales from April 2014 through 2022. Bellco license payments had been received, with unit-based royalties scheduled to begin in 2015. Management cited financing availability, market acceptance, recall costs, supplier/distributor issues, regulatory matters and litigation as risks. No pending legal proceedings were reported.
- Controls: Management concluded disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether the planned rights offering closes, its net proceeds and dilution effects, including warrant anti-dilution adjustments.
- Cash runway, near-term obligations and the company’s ability to meet the going-concern financing need.
- The scope, costs and commercial or regulatory consequences of the hospital water-filter recalls.
- Whether revenue growth can be sustained while restoring gross margins, and whether customer concentration declines.
- Outcomes and timing of the Army solicitation and mid-HDF commercialization plans.