Nephros, Inc. — Q3 2016 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2016. Nephros develops and sells hemodiafiltration systems and ultrafiltration products for healthcare, dialysis, military, and commercial water-filtration markets.
Financial performance and liquidity
Amounts below are in thousands of dollars, except per-share data and percentages.
- Revenue: Q3 net revenue was $475, up 48% from $320; nine-month revenue was $1,575, up 10% from $1,433. Growth primarily reflected hospital-filter sales, partly offset by lower dialysis-filter and HDF revenue. Q3 product revenue was $407 and license, royalty, and other revenue was $68.
- Gross margin: Q3 gross profit was $316 (66.5% of revenue), versus $166 (51.9%) a year earlier. Nine-month gross profit was $908 (57.7%), versus $807 (56.3%).
- Operating results: Q3 operating loss narrowed to $637 from $1,087; nine-month operating loss narrowed to $2,260 from $2,485. Q3 SG&A fell 33% to $652; nine-month SG&A fell 12% to $2,234. R&D increased 7% in Q3 to $241 and 31% for nine months to $763.
- Net loss: Q3 net loss was $706, versus $581; nine-month net loss was $2,377, versus $2,153. The 2015 comparisons included noncash warrant-related income and expense: a $2,287 Q3 and $2,099 nine-month gain from warrant fair-value changes, partly offset by $1,761 of warrant modification expense. Excluding the net $338 benefit from those 2015 items, nine-month loss improved by approximately $114. Basic and diluted loss per share was $0.01 for Q3 and $0.05 for nine months, versus $0.02 and $0.07, respectively.
- Cash flow: Nine-month cash used in operations was $1,584, compared with $2,575 in 2015; investing used $45. Financing provided $1,188, primarily from the June note issuance. Cash declined $441 during the period to $807.
- Liquidity and debt: Current assets were $1,532 and current liabilities $684, for working capital of $848. Total assets were $3,010 and stockholders’ equity $1,217. The company received $1,187 gross proceeds from unsecured notes bearing 11% interest, due June 7, 2019; the balance sheet reports $814 net of debt discount and issuance costs. Cash interest payments were $39 for the nine months.
Material changes and management outlook
- Management stated that recurring losses and insufficient operating cash flow raise substantial doubt about the company’s ability to continue as a going concern. Based on projections, existing cash and anticipated product-sales increases were expected to fund operations at least into Q1 2017; this estimate depends on timing and market acceptance of new products and excludes future operating cash receipts. Additional financing may be needed, and management warned that failure to obtain it could force curtailment or cessation of operations.
- Product developments include the SSUmini launch in March 2016 and limited availability planned for NanoGuard-C and NanoGuard-E, with broader availability expected in 2017. Management planned to submit additional information for the HydraGuard 10-inch filter by late November 2016 and for EndoPur 10-inch by late November, with the 20-, 30-, and 40-inch EndoPur package expected by mid-December. These regulatory submissions and commercial timelines are forward-looking, not assured outcomes.
- The HDF evaluation with the Renal Research Institute concluded in June 2016 after more than 1,200 treatments; management expected a Vanderbilt-affiliated clinic to begin treatments before year-end 2016. Development of HDF System version 2.0 was underway. The filing says DaVita was not expected to restart its evaluation in the near term.
- Key execution risks include market acceptance, product economics, regulatory clearance, dependence on third-party manufacturers and distributors, and the ability to raise capital. Revenue and receivables are concentrated among a small number of customers; one customer represented 16% of Q3 revenue and 21% of receivables at quarter-end.
- Commitments include a 2016 Medica minimum purchase level of €1.2 million and a U.S. facility lease costing approximately $9,000 monthly through November 2018. The Medica agreement also carries a 3% royalty on specified product sales and a 12% interest understanding for overdue invoices. No off-balance-sheet arrangements were reported.
- Nephros reported that the FDA had completed its review of corrective actions related to a 2015 warning letter and that a February 2016 inspection had no observations. The warning letter did not restrict manufacturing or shipments.
Most important facts for investors to verify
- Whether cash runway and financing plans remain adequate, given $807 of cash, continued operating losses, and the stated going-concern uncertainty.
- Actual sales growth, gross margins, and customer concentration as newly launched filtration products gain or fail to gain market acceptance.
- Regulatory outcomes and timing for HydraGuard and EndoPur, and whether anticipated clinic evaluations and HDF development proceed as planned.
- Debt terms, interest burden, and the company’s capacity to meet the 2016 Medica purchase commitment and other obligations.
- Potential dilution: 49,216,086 common shares were outstanding at November 4, 2016; the filing also listed 3,291,149 shares underlying warrants and 4,418,160 underlying options at September 30, 2016.