Nephros, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Unaudited results; amounts below are in U.S. dollars. Nephros sells water-filtration products for medical and commercial markets. Its Specialty Renal Products subsidiary is developing hemodiafiltration (HDF) technology.
Financial results and liquidity
- Q3 revenue: $3.095 million, up 80% from $1.724 million in Q3 2018. Product revenue was $3.054 million; royalty and other revenue was $41,000. Nine-month revenue was $7.173 million, up 76% from $4.075 million.
- Profitability: Q3 gross profit was $1.819 million, with a 59% gross margin versus 55% a year earlier. Nine-month gross profit was $4.184 million and margin was 58%, versus $2.249 million and 55%. Q3 operating loss was $695,000 and net loss was $744,000; net loss attributable to Nephros shareholders was $804,000, or $0.10 per share. Nine-month net loss attributable to shareholders was $3.215 million, or $0.43 per share, versus $2.677 million, or $0.40 per share, in 2018.
- Costs: Q3 operating expenses were $2.514 million, including R&D of $777,000 and SG&A of $1.787 million. Nine-month operating expenses were $7.048 million. The nine-month increase in R&D reflected investment in the water-pathogen detection tool and second-generation HDF development; higher SG&A included headcount, stock compensation, marketing, and facility costs.
- Cash flow: Operations used $2.640 million in the first nine months, compared with $3.134 million in 2018; investing used $151,000 and financing provided $2.072 million. Cash declined $726,000 from year-end 2018 to $3.855 million at September 30, 2019. The company raised $1.992 million net in a May private placement.
- Liquidity and obligations: Working capital was $5.001 million. Current assets were $8.117 million and current liabilities $3.116 million. Debt included a $982,000 revolving facility, $879,000 secured note, and $10,000 equipment financing balance. Operating lease liabilities totaled $1.207 million; contingent consideration was $349,000. The revolving facility, secured by company assets, carried an 8.5% rate at quarter-end and automatically renewed in August 2019.
Changes versus prior period and notable items
- Revenue growth was attributed to increased medical-device sales to new and existing customers and expansion into commercial markets following the December 2018 Biocon/Aether acquisition. All reported revenue was in Water Filtration; Renal Products reported no revenue.
- Gross margin improved, partly due to a $67,000 manufacturer volume discount. Management also cited lower inventory adjustments and reserves in the nine-month comparison; it characterized these items as nonrecurring.
- Despite higher revenue, Q3 operating loss increased to $695,000 from $511,000, and nine-month operating loss increased to $2.864 million from $2.287 million, reflecting higher operating investment. A $94,000 Q3 and $113,000 nine-month gain from reduced contingent consideration fair value partially offset expenses, following lower-than-expected Biocon performance.
- The company effected a 1-for-9 reverse stock split in July 2019. Q3 SG&A included a $20,000 lease-termination loss. The company adopted lease accounting requirements in 2019, recognizing right-of-use assets and lease liabilities.
Outlook, risks, and contingencies
- Management expects continued operating losses over the next several quarters. It stated available cash was expected to fund the current operating plan for at least 12 months from the filing date, while warning that underperformance could require cuts to discretionary spending or additional capital. It cautioned that financing may not be available on acceptable terms or in time and referred to alleviating substantial doubt about going concern.
- Management expected to offer the water-pathogen detection system initially as a service in late 2019 and work with distribution partners on a 2020 rollout. It expected a return to the HDF market in the first half of 2020, subject to FDA clearance. These are forward-looking targets, not guarantees.
- Risks include ongoing cash burn and reliance on financing; product acceptance, regulatory approval, safety and liability; supplier, manufacturer and distributor dependence; and execution of product-development plans. Revenue and receivables were concentrated: the largest customer represented 31% of Q3 revenue and 33% of receivables at quarter-end; the top six customers represented 67% of Q3 revenue.
- Medica purchase commitments were approximately €4.32 million at September 30, 2019, including a 2019 minimum purchase commitment of approximately €3.7 million. The filing reports no off-balance-sheet arrangements.
Investor verification priorities
- Whether revenue growth and improved margins persist without the cited manufacturer discount and inventory-reserve benefits.
- Cash runway, operating cash burn, financing needs, and the terms and availability of the revolving facility.
- Customer concentration, collection of receivables, and the impact of Medica purchase commitments on working capital and margins.
- Progress, regulatory status, funding, and commercialization timelines for the detection system and second-generation HDF product.
- Biocon/Aether performance and assumptions underlying contingent consideration and goodwill valuations.