Nephros, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; unaudited, consolidated results. Nephros develops and sells filtration products for healthcare, dialysis, commercial water filtration, and military/outdoor use.
Financial performance and position
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Total revenue | $544,000 | $473,000 |
| Product revenue | $527,000 | $219,000 |
| License revenue | $17,000 | $254,000 |
| Gross profit / margin | $282,000 / 51.8% | $367,000 / 77.6% |
| Operating expenses | $1.088 million | $929,000 |
| Operating loss | $806,000 | $562,000 |
| Net income (loss) | $243,000 | $(3.511) million |
| Operating cash flow | $(917,000) | $(622,000) |
Q1 2015 basic EPS was $0.01; diluted EPS was a loss of $0.02. The filing attributes reported net income largely to a $1.009 million noncash gain from the decrease in warrant liability fair value. Diluted EPS includes an adjustment for that warrant fair-value change.
At March 31, 2015, cash was $367,000, down from $1.284 million at December 31, 2014. Current assets were $991,000 and current liabilities $1.256 million, a $265,000 working-capital deficit. Total liabilities were $8.033 million, including a $6.377 million warrant liability; the filing reports no outstanding debt balance. Stockholders’ deficit was $5.411 million.
Material changes and operating developments
- Revenue rose 15%, driven by increased water-filter sales, including hospital sales following FDA clearance of DSU-H and SSU-H filters. Product revenue grew $308,000, while Bellco license revenue fell $237,000 as prior upfront payments were largely recognized in 2014.
- Gross profit declined $85,000 and gross margin fell to 51.8% from 77.6%, as cost of goods sold rose 147% to $262,000, reflecting higher sales volume and product-mix effects.
- Operating expenses increased 17% to $1.088 million. SG&A rose 19% to $843,000, with higher personnel, commissions, professional services, director compensation, and investor relations costs partly offset by lower stock compensation and legal expenses. R&D increased 18% to $192,000, primarily for the OLpūr H2H module.
- The company used $917,000 of cash in operations and received only $1,000 from financing activities in the quarter. The prior-year financing included $2.016 million from an equity issuance, offset by repayment of a $1.5 million secured note.
- Three customers accounted for 76% of Q1 sales (30%, 28%, and 18%). Three customers represented 68% of accounts receivable at quarter-end (35%, 17%, and 16%).
Outlook, risks, and significant items
- Going concern: Recurring operating losses and insufficient operating cash flow raise substantial doubt about the company’s ability to continue as a going concern. Management says additional financing is necessary; without it, Nephros may curtail activities or cease operations. It expects operating losses to continue until, if ever, sales or license revenue increase sufficiently.
- Funding outlook: A May 12, 2015 securities purchase agreement contemplated approximately $1.2 million gross proceeds from a share sale plus warrants, with closing expected around May 15 subject to customary conditions. Management expected proceeds and projected hospital-sales growth to fund operations into Q4 2015. This is a projection, not a guarantee.
- Commercial execution: DaVita required additional validation of the HDF system; the validation work was completed and submitted, but remained under review. The Renal Research Institute was also evaluating the system. The Army purchased 50 HydraGuard devices for testing after its earlier solicitation was cancelled.
- Post-quarter developments: Daron Evans became President and CEO and acting CFO effective April 15. On May 6, Nephros granted CamelBak an exclusive worldwide sublicense, except Italy, for HydraGuard products; compensation includes per-unit fees or a share of gross profit on specified military sales, subject to minimum annual fees and other terms.
- Commitments: The Medica agreement carries a 2015 minimum purchase amount of €1.0 million (approximately $1.085 million); the filing also reports approximately €243,000 of Q1 2015 aggregate purchase commitments. The company may owe Medica 12% annual interest on invoices unpaid under original terms. Medica royalties apply to product sales under the agreement. Bellco royalties are based on units sold under revised terms.
- Product and regulatory risks: Voluntary recalls of hospital point-of-use and DSU in-line filters were announced in 2013; the company had requested FDA termination of the recall and reported no further FDA communication. Market acceptance, regulatory compliance, product liability, supplier/distributor performance, financing availability, and clinical or commercial validation remain key risks.
- Accounting and controls: Prior-period financial statements were restated because certain 2007 warrants had been classified as equity rather than derivative liabilities. The related material weakness in internal control remained unremediated at March 31, 2015, and management concluded disclosure controls were ineffective.
- Other accounting volatility: The $6.377 million warrant liability is valued using Level 3 assumptions, including stock-price volatility and expected life. Its fair-value movements can materially affect reported earnings without corresponding operating cash flow.
Important facts for investors to verify
- Whether the May 2015 financing closed as expected, and the net proceeds and resulting dilution from the shares and warrants.
- Whether cash runway extended into Q4 2015 and whether subsequent cash burn or sales differed from management’s projection.
- Hospital-market sales growth, gross-margin trends, customer concentration, and collection of receivables.
- Progress and commercial outcomes of DaVita and Renal Research Institute HDF evaluations, and Army HydraGuard testing and any follow-on orders.
- Ability to meet Medica purchase obligations and supplier payment terms, and the status of FDA recall matters.
- Remediation of the warrant-accounting material weakness and the sensitivity of the warrant liability to valuation assumptions.