Nephros, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Amounts are in U.S. dollars; financial statement figures are generally in millions unless noted. Nephros sells water filtration products, is launching pathogen-detection products, and develops renal products through Specialty Renal Products, Inc. (SRP).
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net revenue | $1.577 | $2.309 | $4.106 | $4.078 |
| Gross margin | $0.895 (57%) | $1.367 (59%) | $2.386 (58%) | $2.365 (58%) |
| Operating loss | $(1.598) | $(0.868) | $(2.624) | $(2.169) |
| Net loss | $(1.657) | $(0.942) | $(2.755) | $(2.291) |
| Net loss attributable to Nephros shareholders | $(1.717) | $(1.003) | $(2.874) | $(2.411) |
- Q2 basic and diluted loss per share was $0.19, compared with $0.14; first-half loss per share was $0.33 in both years.
- First-half cash used in operating activities was $3.560, versus $2.026 in 2019. Investing activities used $0.226; financing activities provided $6.666. Cash increased by $2.880 to $7.046 at June 30.
- Current assets were $13.070 and current liabilities $2.765, giving working capital of $10.305. Total assets were $16.649 and total liabilities $4.373.
- Debt included a secured note with $0.711 principal outstanding, a $0.479 PPP loan, and $0.008 equipment financing. The company had terminated its revolving credit facility and had no balance outstanding on it at June 30. Lease liabilities totaled $1.223.
- Inventory rose to $4.769 from $2.562 at year-end, primarily reflecting precautionary purchases from the Italian supplier. Nephros raised $6.8 million net in a February share offering and received the PPP loan; shares outstanding increased to 9,039,673 at June 30 from 8,058,850 at December 31, 2019.
Material changes versus the prior comparable periods
- Q2 revenue fell 32%, primarily as COVID-19 reduced demand for hospital filtration and commercial products. First-half revenue was approximately flat: medical filtration growth earlier in the period was offset by a decline during Q2.
- Q2 gross margin declined two percentage points, with higher pandemic-related shipping costs and the absence of a favorable prior-year inventory adjustment partly offset by lower product costs. First-half gross margin remained 58%.
- Q2 operating loss widened to $1.598 million. SG&A rose 15% to $1.610 million, including increased headcount and pathogen-detection sales and marketing investment. First-half SG&A rose 23% to $3.560 million, while R&D declined 10% to $1.399 million, partly as the second-generation HDF product neared regulatory submission.
- Pathogen Detection generated $28,000 of first-half revenue and an operating loss of $402,000. Water Filtration revenue was $4.078 million, with a $1.401 million operating loss; Renal Products recorded an $821,000 operating loss and no revenue.
Outlook, management commentary and risks
- Management stated that available cash was expected to fund the current operating plan for at least 12 months from the financial statement issuance date, while cautioning that COVID-19 and economic uncertainty could shorten the runway. If demand remained depressed beyond Q3 2020 and revenue targets were missed, the company might cut costs; additional financing could be difficult or available only on unfavorable terms.
- Management reported operations and shipments continuing, with no material supply-chain disruption to date, but described lower hospital demand, delayed orders, restricted access to prospective customers, and reduced hotel and restaurant demand. It anticipated possible medium- to long-term demand benefits as buildings reopen and attention to waterborne pathogens increases; timing and extent were uncertain.
- Management expected to pursue FDA 510(k) clearance for SRP’s second-generation HDF system, with submission anticipated in Q3 and clearance expected before year-end 2020. It also accelerated the SequaPath launch, and planned a DialyPath launch in the second half of 2020. These are forward-looking plans, not assured outcomes.
- Nephros intends to use the $0.5 million PPP loan for qualifying costs; some or all may be forgivable if program requirements are met. The loan bears 1% interest and matures in 2022.
- Under its Medica supply agreement, the company had 2020 minimum purchases of approximately €3.2 million and aggregate purchase commitments of approximately €4.2 million (about $4.7 million) at June 30. The agreement also includes a 3% royalty on covered product sales.
- Revenue concentration is notable: four Water Filtration customers represented 47% of Q2 revenue, and three customers represented 45% of first-half revenue. The company also recorded a $187,000 contingent-consideration liability, measured using significant unobservable inputs.
- Management disclosed continuing operating losses, an accumulated deficit of $130.1 million, dependence on product acceptance and financing, regulatory and product-liability risks, and uncertainty from COVID-19. No off-balance-sheet arrangements were reported. Management concluded disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether post-Q2 demand recovered, particularly in hospitals, hospitality and food service, and whether the company met its revenue plan.
- Cash burn, inventory conversion, and the accuracy of the stated 12-month liquidity outlook in light of purchase commitments and continuing losses.
- Progress and timing of SRP’s HDF regulatory submission and clearance, and commercial uptake of PluraPath, SequaPath and DialyPath.
- PPP loan forgiveness eligibility and status, and the effect of the Medica minimum-purchase obligations on cash and margins.
- Customer concentration, potential dilution from equity awards and securities, and the assumptions underlying the contingent-consideration valuation.