Nephros, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. The filing is unaudited; balance-sheet comparisons are with December 31, 2010. Nephros develops hemodiafiltration products and water-filtration systems for medical, commercial, and military uses.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $637,000 | $809,000 | $1.318 million | $1.799 million |
| Gross profit | $203,000 | $282,000 | $402,000 | $672,000 |
| Gross margin | 31.9% | 34.9% | 30.5% | 37.4% |
| Operating expenses | $801,000 | $648,000 | $1.646 million | $1.564 million |
| Operating loss | $598,000 | $366,000 | $1.244 million | $892,000 |
| Net loss | $602,000 | $365,000 | $1.309 million | $893,000 |
| Basic and diluted loss per share | $0.06 | $0.18 | $0.19 | $0.43 |
Revenue declined 21% in Q2 and 27% for the first six months. Management attributed the six-month decline mainly to lower Office of Naval Research project revenue (down approximately $420,000) and lower European MD-filter sales (down approximately $148,000); higher DSU sales and STERIS project revenue partly offset the decreases. Q2 selling, general and administrative expense rose 22%, largely due to bonus and European severance costs. Six-month research and development expense increased 43%.
For the six months, operating cash use was $1.088 million, versus $719,000 in 2010. Financing provided $2.550 million, including $3.190 million from common-stock issuance, offset by $500,000 of debt repayment and $140,000 of financing costs. Cash increased by $1.473 million to $1.713 million. There was no investing cash flow in either comparable period.
Financial position and material changes
- At June 30, cash was $1.713 million, current assets $2.733 million, and current liabilities $566,000; working capital was approximately $2.167 million. Cash and current assets increased from year-end 2010.
- Short-term borrowings fell from $500,000 at year-end to zero after repayment in March. The Lambda Investors note carried 12% interest; the company also recorded $12,000 interest and $40,000 debt-issuance-cost amortization for the six months.
- Accumulated deficit was $93.217 million. Common shares outstanding increased from 2,090,552 at year-end to 10,065,118 at June 30, following the March financing and 1-for-20 reverse split. The rights offering and concurrent private placement generated approximately $3.2 million gross and approximately $2.3 million net proceeds after stated costs and debt repayment.
- Two customers accounted for 75% of six-month sales (56% and 19%); those customers represented 74% of accounts receivable at June 30. The OLpur MDHDF and Dual Stage Ultrafilter products share a manufacturer.
Outlook, risks, and notable developments
- Going concern: Recurring losses and operating cash outflows raise substantial doubt about the company’s ability to continue as a going concern. Management said available cash flows, including anticipated Bellco payments, were expected to support operations only into Q2 2013; additional financing is required, with no assurance it can be obtained on acceptable terms or at all.
- Bellco license: The agreement, effective July 1, 2011, grants Bellco manufacturing and sales rights for Nephros MD filters in specified territories. Fixed payments total €1.85 million, due in installments through January 2013; the first €500,000 payment was received in July 2011. Unit royalties are scheduled for 2015–2016, subject to sales terms. The agreement includes minimum sales targets and termination, exclusivity, and repayment provisions.
- Regulatory and commercial outlook: On July 21, 2011, the company announced FDA 510(k) clearance for its MSU and SSU ultrafilters in dialysis applications. On August 11, it submitted a new 510(k) application for its HDF system; approval is uncertain. Management expected sales growth in U.S. dialysis and initial DSU sales in non-U.S. dialysis markets, but results depend on adoption, production, and regulatory progress.
- Nephros reported approximately $249,000 of 2011 revenue through June from its U.S. Defense Department project. It also expected remaining STERIS development milestones, if achieved, to yield an aggregate $60,000.
- Other risks include reliance on a concentrated customer base and shared manufacturer, foreign-exchange exposure, uncertain market acceptance and product profitability, regulatory outcomes, and the need for further capital. The company reported no pending legal proceedings and no off-balance-sheet arrangements. Management concluded disclosure controls were effective as of period-end.
Important facts for investors to verify
- Whether Nephros can raise additional capital and sustain operations beyond the stated Q2 2013 estimate.
- Receipt and timing of remaining Bellco installments, currency-adjustment effects, and compliance with the license’s sales and other terms.
- Progress and outcome of the HDF 510(k) application, and commercial sales following MSU/SSU clearance.
- Revenue trends and gross margins by product and project, including customer concentration and dependence on the shared manufacturer.
- The financing’s dilution and warrant overhang; the filing excludes substantial options and warrants from diluted EPS as anti-dilutive.