Nephros, Inc. (NASDAQ:NEPH) Q3 2020 Results Earnings Conference Call November 5, 2020 4:30 PM ET

Company Participants

Kirin Smith – PCG Advisory Group, IR

Andy Astor – Chief Executive Officer

Dan D’Agostino – Chief Financial Officer

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Conference Call Participants

Howard Halpern – Taglich Brothers

Jeremy Pearlman – Maxim Group

Operator

Good afternoon. And welcome to the Nephros Third Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]

Please note, this event is being recorded. I would now like to turn the conference over to Kirin Smith, Investor Relations Officer. Please, sir — please go ahead.

Kirin Smith

Good afternoon, everyone. This is Kirin Smith with PCG Advisory Group. Thank you all for participating in Nephros’ third quarter 2020 conference call.

Before we begin, I would like to caution that comments made during this conference call by management will contain forward-looking statements regarding the operations and future results of Nephros.

I encourage you to review Nephros’ filings with the Securities and Exchange Commission including, without limitation, the company’s Forms 10-K and 10-Q, which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

Factors that may affect the company’s results include, but are not limited to, its ability to successfully, timely, and cost effectively develop, seek, and obtain regulatory clearance for and commercialize its products and service offerings, the rate of adoption of its products and services by hospitals and other healthcare providers, success of its commercialization efforts, the effect on its business of existing and new regulatory requirements, and other economic and competitive factors.

The content of this conference call contains time-sensitive information that is accurate only as of the date of the live call, today, November 5, 2020. The company undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call except as required by law.

I would now like to turn the call over to Andy Astor, Nephros’ CEO. Andy, please go ahead.

Andy Astor

Thanks, Kirin, and good afternoon, everybody. Welcome to Nephros’ third quarter 2020 earnings conference call. This is my first earnings call as CEO and I’d like to start by thanking Daron Evans, who developed and led our turnaround strategy over the past five and a half years, increasing revenues from about $1 million to more than $10 million annually during that time.

As most of you know, Daron is continuing to help drive our progress on a part-time basis, focused on building the pathogen detection business and also filling the CEO role at our Specialty Renal Products subsidiary, where he is laser focused on submitting the second generation FDA product, I’m sorry, HDF product for FDA clearance. And of course, I want to thank once again all the people providing essential services that keep our country moving and our fellow citizens safe, while putting themselves in harm’s way.

I will now provide a few highlights of our Q3 business performance and I will also review our financial results for the quarter. I’m pleased to report that net revenues increased 34% over the prior quarter. While they remain about 30% lower than a year ago, the quarter-over-quarter increase does seem to indicate some level of market stabilization after a challenging second quarter when the pandemic took hold.

Also, while net revenues were down year-over-year, I am pleased to note that recurring install base revenues in Q3 returned to their 2019 levels after these revenues had contracted somewhat in Q2. We believe this strong demand from our existing customers is an important sign of strength, further bolstered by our customer retention rate remaining over 90%.

Our medical and water filter business did continue to experience declines in new customer acquisitions and in emergency response business as we had reported last quarter. Our observation is that for the time being customers and potential customers are primarily focused on pandemic related issues and simply don’t have time for proactive water testing and remediation, nor for new vendor relationships. Anecdotal evidence from our network seems to confirm that this is a trend throughout the industry. I’m also pleased to report that Q4 has kicked off relatively strongly including both our recurring and our emergency response medical filtration businesses.

Our commercial water business declined versus last year as our hospitality and food service customers continue to be deeply impacted by the pandemic. Notably, we continue to believe that we are on track to secure at least one large national contract in the near future, hopefully within this calendar year.

In our pathogen detection business we recently released the DialyPath, our qPCR based endotoxin testing system, which will be marketed to dialysis clinics. As with our filtration business, we are beginning to see increased interest in our pathogen detection products, including PluraPath, SequaPath and now DialyPath.

But the commercial environment is still challenging and we have somewhat slowed our marketing plans for the moment. We are using this time to build product and marketing infrastructure to support the growth that we expect in 2021 and beyond.

In our subsidiary Specialty Renal Products, we are getting closer to FDA submission of the next-generation HDF product, as I mentioned briefly at the beginning of this call. As reported last quarter, we did experience a few delays in the manufacturing process for HDF, but we are indeed getting close and hope to submit before the end of this year.

I will now provide a look at our financial results for the third quarter ended September 30, 2020. As many of you know, up until the COVID-19 pandemic, Nephros delivered consistent year-over-year revenue growth for 15 consecutive quarters, averaging over 50% through the first quarter of 2020. The second and now the third quarter of 2020 were challenging for the company. Although, the fourth quarter has started strongly and we are optimistic that quarter-over-quarter growth will continue.

Nephros reported net revenues in the third quarter of $2.1 million, a 31% decrease, compared to $3.1 million in the same period last year. The decrease of $1 million was driven by changes due to COVID-19, including a downturn in the emergency response business, as well as fewer new customer acquisitions.

Net loss in the water filtration business segment was point $0.4 million, compared to $0.2 million in 2019. This increased loss was primarily due to the reduced revenue that I just mentioned.

Adjusted EBITDA in the segment was negative $0.3 million, compared to a negative $0.4 million in 2019. Please refer to today’s press release for more details about the calculation of adjusted EBITDA and its reconciliation to GAAP net income or loss. Additional information about our water filtration, pathogen detection and Retail Products business segments and their operating results can be found in today’s filing on Form 10-Q.

On a consolidated basis net loss for the quarter was $1 million, $1.0 million, compared with $0.7 million in 2019, a 36% increase. Consolidated adjusted EBITDA in the quarter was negative $1.0 — $1.0 million, compared with negative $0.2 million in 2019. Cost of goods sold in the third quarter was $0.9 million, compared to $1.3 million in 2019, a decrease of 30%.

Gross margins in the third quarter were 58%, compared to 59% in 2019. The 1% margin reduction compared to a year ago was primarily due to unfavorable inventory expiration and adjustments of 1 — of $0.1 million during the three months ended September 30th. As we’ve said before, margin fluctuations are normal for a company of our size and we expect future gross margins to remain in the range of 55% to 60%.

Research and development expenses in the third quarter were $0.75 million, compared with $0.78 million in 2019, a 3% decrease.

Depreciation and amortization expenses in the third quarter were $49,000, compared with $44,000 in 2019, an 11% increase.

Selling, general, excuse me, selling, general and administrative expenses for the third quarter were $1.5 million, compared with $1.8 million in 2019, a decrease of approximately 14%, primarily driven by a decrease in travel-related and marketing expenses due to the COVID-19 pandemic.

Our cash balance at the end of the third quarter was about $5.2 million, and also, as announced on October 16th, Nephros did raise an additional $5 million through a registered direct offering of 833,333 shares of common stock at a price to the public of $6 per share.

In closing, I would like to introduce you all to Dan D’Agostino, who is on the call with us today. Dan joined the team a few weeks ago and will be officially assuming the role of Chief Financial Officer beginning tomorrow morning. He will be leading our next discussion on financial results in our year-end earnings call, which we expect will take place in late February 2021.

We will be participating in several financial conferences in the coming weeks, details of which will be announced this Monday, November 9th and we look forward to seeing many of you virtually at the shows. In the meantime, of course, please always feel free to contact me directly at info@nephros.com. And Dan — and we’ll be on that email address as well.

This concludes our formal presentation remarks. I would like to personally thank all of our investors and other stakeholders for their support through the years, as well as during our recent CEO transition. I look forward to speaking with you all again soon. And we will take questions from the audience now and also answer emailed questions as appropriate.

Operator, please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Howard Halpern from Taglich Brothers. Please, sir, you may proceed.

Howard Halpern

Congratulations on navigating in a tough environment out there.

Andy Astor

Thank you, Howard.

Howard Halpern

Did I hear correctly, so far at the start or the fourth quarter, you’ve gotten some emergency response business, compared to the prior quarters, which there really wasn’t any?

Andy Astor

Yes. You did hear correctly.

Howard Halpern

Okay.

Andy Astor

October is one month out of a quarter. So I don’t want to set expectations. I don’t know what the quarter will look like.

Howard Halpern

Correct.

Andy Astor

But the first month was a very reasonable emergency response. For normal October, it felt pretty normal. So we’ll see if it keeps up.

Howard Halpern

Okay.

Andy Astor

This is an area of our business that we have almost no control over or — well, we have zero control over it, because it’s all inbound and so we’ll see how it goes.

Howard Halpern

And any indication for you new customers so far in the beginning of the quarter or is that still going to be a very single-digit percentage of the business?

Andy Astor

It’s not a single-digit percentage, it — it’s normally 30%-ish per quarter and in the last couple of quarters, it’s been between 10% and 20%.

Howard Halpern

Okay.

Andy Astor

We — it’s down, but it’s not down terribly. It’s not down as much as the emergency response businesses, that’s for sure.

Howard Halpern

Okay.

Andy Astor

It has been like that, has been.

Howard Halpern

And I am started looking forward with the pathogen detection division. If you could describe what you’re anticipating going forward in terms of what — which one of those three products that you have, do you think will be the gain the easiest traction, I guess, in terms of revenue? And then which one over time should be the biggest driver of revenue as the world eases in pandemic conditions?

Andy Astor

I wish I knew Howard. But one of the reasons we have three products is, because we can’t know for sure which one will catch on first. PluraPath is a very straightest line between infection control and infection control prevention. So it may be PluraPath. But dialy — by dialysis clinics tend to make decisions more centrally. So there may be some traction there.

And then SequaPath in answer to another part of your question that could be the biggest of them all by far, because it’s not — its applicability is not limited to a medical facility, it can be used in any kind of a building, commercial, residential, et cetera. So we will have to see.

Howard Halpern

And, lastly, I know we’ve been — you’ve been consistent on moving closer towards getting that commercial contract. Is it just — is it with the same or do you have a group of them that might come together or is it in the same potential customer or just moving — as you just moving forward?

Andy Astor

It’s not just one opportunity and…

Howard Halpern

Okay.

Andy Astor

… it has a couple of different forms, but it is the main opportunity that we have been talking about for a couple of quarters is the same main opportunity that we are still talking about.

Howard Halpern

Okay. And then, if and when that happens that will move the needle.

Andy Astor

We expect it to Yes.

Howard Halpern

Okay. Okay. Well, keep up the good work and I will — well, I guess, one more question, what — Dan, what…

Dan D’Agostino

Sure.

Howard Halpern

If you can answer, what drew you to Nephros and what do you — basically what drew you to Nephros?

Dan D’Agostino

Well, thanks for the question. I would say that, knowing that company for — which is, probably, five years now. Andy mentioned briefly, there really has been just an incredible sort of resurgence, Daron coming in, I think and doing some of the heavy lifting.

And then, Andy, the way that I perceived it from an outsider’s perspective, putting a lot of the processes in place to take, now some interesting products and a real strategy into kind of institutionalizing that. I just see tremendous value in the products that are really just starting to get traction.

Howard Halpern

Okay. I look forward to talking with you guys in the future. Thanks. Keep up the good work.

Andy Astor

Yeah. Good. Thank you, Howard.

Operator

Our next question comes from Todd Eiler [ph], private investor. Please sir, you may proceed.

Unidentified Analyst

Hi, Andy. It’s Todd Eiler. Good to speak to you again.

Andy Astor

You too, Todd. Nice to hear your voice.

Unidentified Analyst

Two short questions and then I’ll get off the call for others to ask there. One of the short companies I had when I first started following Nephros years ago with a thought, the HDF submittals was simply a paperwork exercise. So could you provide a little bit more color for some of the investors of what really goes into the submission to the FDA and why manufacturing is so critical to that submission? And then my second question is just based on the comment about the commercial contract that we’ve heard a lot about the coming commercial contract, the big one for many quarters now. Is there any further information you can provide about, are there multiple RFPs you guys respond to or is it multiple big customers or just some more information about why there’s been a delay and why there’s always seems to be one right around the corner?

Andy Astor

Thank you. Appreciate it. Sure, Todd. Good questions, both. So on the HDF side, the — what’s going on is we’re taking a product that was designed and approved eight years ago in 2012 and dramatically simplifying it. But when you dramatically simplify something, you — and you want to bring it to the FDA for approval, you then have to produce it and test it, and write a user manual for it and drop heavy balls on it and if something cracks, you’ve got to fix it, and you’ve got to have relationships with overseas manufacturers and packages get lost in Alaska. I kid you not, even though there had nothing to do with — it had nothing to do with an Alaska shipment. And so it’s a complex, many, many dimensional undertaking.

Once the FDA gets our submission, which we will be submitting for a, quote, special 510(k) clearance, unquote, they — one of two things will happen, either they will accept that it is a special 510(k), which means that they have 30 days to comment and if they don’t, we can go ahead and enter the marketplace. Or they will say, no, this has more change than you — we don’t accept that this is a special 510(k), and therefore, we will go through a normal 510(k) process, which could take 90 days and in a pandemic, perhaps, even more. So that’s why that’s where the complexity comes from. I hope that relatively brief answer gives you some idea of the — of what — what’s going on behind the scenes.

In terms of the commercial contract, we have several opportunities, but we have been pretty close on one particular one for a couple of quarters now and that is the one that we keep talking about being very close to, and frankly, it hasn’t changed. And we are — we thought we were very close two quarters ago, we thought we were much closer a quarter ago and I will tell you that we’re much closer now.

But when you’re dealing with national contracts of large companies that all of us have heard of, they proceed at a pace that is defined by the customer and you can push, but you can only push so hard. And this is a new area for us and we’re — it will develop at its — we — it will drive its timing, we will not.

And I do hope that it will happen this year. I believe there’s a good possibility that it will, but it’s not something that we control and but it will, as Howard point put it, we definitely will move the needle. We’re talking about a division that sub-$1 million today and we’re talking about a contract that should be at least $2 million, if not more.

Unidentified Analyst

Thank you, Andy. Just one follow-up. Do you send the fully packaged machine the HDF 2.0 machine to the FDA as part of the submission?

Andy Astor

No. We send documentation.

Unidentified Analyst

Thank you.

Andy Astor

You’re welcome. Thank you.

Operator

Our next question comes from Jeremy Pearlman from Maxim Group. Please, sir, you may proceed.

Jeremy Pearlman

Hi, Andy. This is Jeremy Pearlman. I’m on the line for Anthony Vendetti. He had another call.

Andy Astor

Hi, Jeremy.

Jeremy Pearlman

A couple questions. Hi. How’s it going? So, I know, in the past, you’ve mentioned the COVID environment really pretty much shutdown outside vendors to engage with hospitals. Have — is there any — has hospitals opened up at all to outside vendors? Have you been able to get any face-to-face commercial contact to picture filters?

Andy Astor

Yeah. Absolutely. We have — I would say that Q2 was, I call it a ghost quarter. It’s a quarter that that almost didn’t happen, right? In the April to June timeframe, the world was very surprised by what was happening and there wasn’t anything going on in terms of face-to-face contact.

That’s changed. It’s normalized into a time where I think we all know how to operate in a pandemic, but it’s still difficult. And so, yes, it’s changing, but it’s changing slowly and it’s going to continue to change slowly over time, in my opinion.

Jeremy Pearlman

Okay. And just a follow up, if you think that, we’re hearing a lot of uptick resurgence of COVID throughout the country. If stricter lockdowns go into place, do you think you’ll be able to still interact with hospitals maybe through digital means or it would sort of pull you back to like the second quarter like you just mentioned?

Andy Astor

Oh! No. I don’t think. Well, I think, face — I think, yes, there are lockdowns and if there are full emergency rooms at ICUs and lots of ventilators and so forth. Then I think it will be more difficult, of course, because people will be even busier than they are today. But I don’t think we’re going to go back to Q2. I think, as I said, I think that, the world kind of knows how to operate with a pandemic going on, which was not the case in Q2.

Jeremy Pearlman

Okay. And then just to switch past one last question. So what is the reception been like from your customers for DialyPath and it’s — the most recently released product?

Andy Astor

Okay.

Jeremy Pearlman

And then is it the same customers that you had — that you are marketing DialyPath or you’re interacting with as your filters or is it a separate customer base and have you been trying to cross sell at all?

Andy Astor

We definitely are cross selling. And in our filtered business, there are three main customer bases, there’s infection control for hospitals, there’s dialysis clinic for water purification, well, there’s dialysis clinics and then there’s commercial and other. And the three pathogen detection products align perfectly with those three or they align with those three categories.

DialyPath is largely targeted at infection control teams and hospitals. The Dia — I’m sorry, that’s PluraPath. DialyPath is targeted primarily at dialysis clinics and SequaPath is primarily a commercial product, although, it’s really applicable to all potential — all building management, both medical and non-medical. So definitely cross selling and definitely overlapping customer base. I hope that answers your question.

Jeremy Pearlman

Okay. And then the reception has been positive so far?

Andy Astor

Yes. Yes.

Jeremy Pearlman

Okay. All right. Great. Thank you so much for your time.

Andy Astor

You’re welcome, Jeremy. Thank you.

Operator

[Operator Instructions] This concludes our question-and-answer session. I’d like to turn the conference back over to Kirin Smith for any closing remarks.

Kirin Smith

Great. Thank you, everyone, and have a wonderful day.

Andy Astor

Thanks, everybody. Take care. See you soon.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.