Nephros, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Financial statement amounts are in thousands of U.S. dollars, except per-share data. Nephros develops hemodiafiltration (HDF) products for end-stage renal disease and ultrafiltration products for water treatment.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $407 | $622 | $1,725 | $2,421 |
| Gross profit | $309 | $303 | $711 | $975 |
| Gross margin | 75.9% | 48.7% | 41.2% | 40.3% |
| Operating expenses | $734 | $696 | $2,380 | $2,260 |
| Operating loss | $(425) | $(393) | $(1,669) | $(1,285) |
| Net loss | $(413) | $(375) | $(1,722) | $(1,268) |
| Net loss per share | $(0.04) | $(0.18) | $(0.21) | $(0.61) |
| Operating cash flow | Not provided for the quarter | $(679) | $(641) |
At September 30, cash and cash equivalents were $2,117; current assets were $2,848 and current liabilities $1,032, for working capital of $1,816. Total assets were $2,885 and stockholders’ equity $1,853. Short-term borrowings were zero, following repayment of the $500 Lambda Investors note in March 2011. Nine-month financing cash flow was $2,550, including $3,190 from common stock issuance, offset by debt repayment and financing costs. Cash increased by $1,877 to $2,117.
Changes and business developments
- Nine-month revenue fell 29% year over year. Lower U.S. Naval Research contract revenue, reduced European MD-filter sales, and lower STERIS project revenue more than offset higher DSU sales and $187 of Bellco licensing revenue.
- Q3 revenue declined 35%. Direct European MD-filter sales were lower, partly offset by $187 of Bellco licensing revenue and increased Naval Research revenue. Q3 gross profit increased slightly despite lower revenue, principally as direct filter sales were replaced by licensing revenue with no associated cost of goods sold.
- For the nine months, R&D expense rose 29% to $335, and SG&A rose 4% to $1,974. SG&A included $78 of recruiting fees; stock-based compensation was $197 for the period.
- Nephros completed a March rights offering and private placement with approximately $3.2 million gross proceeds, issued shares and warrants, and effected a 1-for-20 reverse stock split. The balance sheet reported 10,065,118 shares outstanding at September 30; 10,473,134 were outstanding as of November 7.
Outlook, risks and unusual items
- 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 estimated available cash flows would support operations only into Q2 2013 and stated additional financing is required; failure to obtain funding could force curtailment or cessation of operations.
- Bellco license: Bellco agreed to fixed payments totaling €1.85 million through January 2013. The first €500,000 payment was received in July 2011; €750,000 and €600,000 installments were scheduled for January 2012 and January 2013. Nephros recognizes the fixed license revenue over 42 months, so cash receipts and reported revenue differ. Unit-based royalties are scheduled for 2015–2016 and depend on sales and minimum targets.
- Regulatory and sales outlook: Nephros submitted a new FDA 510(k) application for its HDF system in August 2011. Subsequent to quarter-end, FDA requested additional information; the company said it intended to respond within 30 days or request an extension. FDA clearance remained uncertain. Management expected accelerating U.S. dialysis sales of its cleared MSU and SSU filters and initial international DSU dialysis sales in 2012; these are expectations, not assured results.
- Other risks: Revenue is concentrated: two customers represented 74% of nine-month sales. The MDHDF and DSU products are manufactured by the same vendor. Management cited financing availability, regulatory approvals, market acceptance, product profitability, supplier/manufacturer issues, and intellectual-property protection as material risks.
- There were no pending legal proceedings reported and no off-balance-sheet arrangements. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Investor verification points
- Verify collection and timing of Bellco’s remaining installments, the related deferred-revenue balance, and the terms and performance conditions for future royalties.
- Assess the company’s funding needs against its stated Q2 2013 runway, operating cash burn, and ability to raise additional capital.
- Track FDA’s review of the HDF application, including the response to the information request and any resulting clearance or delay.
- Monitor the sources and durability of revenue growth, especially dialysis-filter sales, DSU/MSU/SSU adoption, and customer concentration.
- Review potential dilution from outstanding warrants and options; the filing reports 8,828,471 warrants exercised by November 7, resulting in 408,016 common shares.