Nephros, Inc. — Q2 2015 Form 10-Q
Business and period: Nephros is a commercial-stage medical-device company selling water-filtration products and hemodiafiltration products for dialysis. This filing covers the quarter and six months ended June 30, 2015; financial amounts below are in thousands unless otherwise noted.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $567 | $441 | $1,112 | $915 |
| Operating loss | $(594) | $(636) | $(1,398) | $(1,198) |
| Net loss | $(1,815) | $(5,339) | $(1,572) | $(8,850) |
| Net loss per share | $(0.06) | $(0.21) | $(0.05) | $(0.40) |
- Q2 revenue grew 29%; six-month revenue grew 22%. Product revenue was $521 in Q2 and $1,049 for the half, versus $248 and $467, respectively, in 2014. License and royalty revenue was $46 and $63, compared with $193 and $448.
- Management attributed product-sales growth primarily to hospital-market sales following the October 2014 FDA clearance of the DSU-H and SSU-H filters. Bellco license revenue declined as previously received upfront payments had been recognized by year-end 2014.
- Q2 gross profit was $358; six-month gross profit was $641. Management separately reported product gross margins of 60% for Q2 and 55% for the half, compared with 43% and 47%, respectively, in the prior-year periods. It attributed the improvement to a greater direct-sales mix and changes to distributor pricing.
- Six-month operating expenses were $2,039, up from $1,865, including SG&A of $1,578 versus $1,412. Research and development was $355 versus $343.
- Six-month operating cash use was $1,451, compared with $867 in 2014. Financing provided $1,206, principally from the May stock-and-warrant placement. Cash declined $247 during the half, to $1,037 at June 30.
- At June 30, current assets were $1,812 and current liabilities $1,364, for reported working capital of $448. Total liabilities were $9,320, including a $7,574 warrant liability; stockholders’ deficit was $5,929. The company reported no outstanding debt at period-end.
Material changes and unusual items
- The substantially smaller net loss versus 2014 mainly reflects a much smaller noncash warrant revaluation expense: $188 for the first half of 2015 versus $7,436 in 2014. The warrant liability is valued using a Level 3 model and is not conventional borrowing.
- May financing raised $1.23 million gross ($1.205 million net) through 1,834,299 units, each comprising one common share and a warrant for half a share, exercisable at $0.85. Shares outstanding were 32,227,939 as of August 6, 2015.
- As a subsequent event, the company entered into a July 24 agreement giving it the option to sell up to $10 million of stock to Lincoln Park over 36 months, subject to conditions and price and ownership limits. The facility is not committed cash available irrespective of market conditions; the company stated a $0.35 floor price could prevent access.
- Comparative 2014 financial information reflects a prior restatement for accounting for certain 2007 warrants as derivative liabilities rather than equity.
Outlook, risks and contingencies
- Going concern: Management disclosed substantial doubt about the company’s ability to continue as a going concern, citing recurring losses and insufficient operating cash flow. It expected the May proceeds, potential Lincoln Park sales and projected hospital-product growth to fund operations through fiscal 2016, but warned that this depended on sales and access to financing. No assurance was given.
- Management expects continuing operating losses at least until sales or license revenue increase sufficiently. It identified sales and marketing, business development for the dialysis system, and working capital as uses of capital. No formal revenue or earnings guidance was provided.
- In May 2015, the FDA issued a warning letter alleging quality-system and medical-device-reporting deficiencies. Nephros said it had responded and was working to address the concerns; the letter did not restrict manufacturing, shipping, or require product withdrawal. The filing also discusses 2013 voluntary recalls of certain hospital water filters.
- Commercialization risks include market acceptance, product performance and regulatory compliance, supplier and distributor dependence, and the need for additional financing. Q2 sales growth was concentrated in a small number of customers: four customers accounted for 70% of first-half revenue, and one customer represented 52% of receivables at June 30.
- Commitments include Medica product-purchase requirements; the filing reports approximately €567,000 of aggregate purchases in the first half and a €1 million minimum for 2015. The company also disclosed 12% interest on Medica invoices not paid under original terms. Bellco royalties and license obligations continue under an agreement extended through 2021.
- DaVita’s additional validation of the HDF system was completed and its data report was under review; continuation of the evaluation remained subject to confirmatory review. Nephros also reported an ongoing evaluation by the Renal Research Institute.
- Disclosure controls were deemed ineffective at June 30 due to a material weakness in accounting for complex warrants. Management said remediation efforts were underway, but the weakness continued to exist.
Important facts for investors to verify
- Whether product-sales growth, particularly in the hospital market, continued and translated into improved operating cash flow and margins.
- Actual cash runway and access to Lincoln Park funding, including registration effectiveness, stock-price floor restrictions, sales made, and resulting dilution.
- Progress on going-concern risks, the FDA warning-letter response, and remediation of the internal-control material weakness.
- Terms and performance of the Medica and Bellco arrangements, including purchase commitments, royalties, and any overdue supplier invoices.
- Warrant-liability valuation assumptions and resulting noncash earnings volatility; confirm that comparisons use the restated 2014 figures.