Nephros Inc Q2 FY2020 Earnings Call

Good afternoon, and welcome to the Nephros, Inc. Second Quarter 2020 Financial Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Kirin Smith with PCG Advisory. Please go ahead.

Good afternoon, everyone. This is Kirin Smith with PCG Advisory Group. Thank you all for participating in Nephros' second 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, August 5th, 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 Daron Evans, Nephros' CEO. Daron, please go ahead.

Thanks, Kirin. Good afternoon, everybody. Welcome to Nephros' second quarter 2020 earnings call. I would like to start by once again thanking all of those providing essential services that are keeping our country moving while putting themselves at risk. No small feat that we're continuing to press on this during this pandemic. Today I'll provide a few highlights on our various business units and then pass to Andy Astor, our COO-FO, for a recap of the financials for the quarter. In the second quarter, we spent most of our efforts adapting to the new normal. We transitioned from in-person sales meetings to Zoom meetings. We modified our work practices in the laboratories and offices and warehouses. We juggled workloads when a few of our team members came down with the virus. All thankfully have recovered. We've redirected some of our research to focus on issues related to the pandemic. We have been guided by both state and local guidance to do our part to help bend the curve. This is a unique time in our collective histories that we'll all remember. Our medical and water business saw a steep sales decline, driven primarily by a dearth of new customer meetings and lower-than-projected outbreak business. We believe that our hospital customers and potential customers were focused on solving the myriad of new issues created by the pandemic. At the beginning of the third quarter, we started to see signs that make us optimistic. Things will not return to normal, but we believe that our business model will be effective in the new normal. Our commercial water business also saw a steep decline as hotel and food service customers effectively shut down for a few months. In this business, we are also seeing recent signs that make us optimistic going forward into the new normal. Additionally, we believe that we are on track to secure at least one large national customer this calendar year. In our pathogen division, we had to slow down our launch plans for PluraPath, our multi-pathogen qPCR testing platform. We've redirected our research efforts to accelerate SequaPath, our wide-band bacterial detection system that uses qPCR and DNA sequencing. A pre-print article is now available online highlighting the bacterial risks in unoccupied buildings and showing that simply testing for legionella may not be adequate to ensure water safety. We did delay our research on DialyPath, our qPCR-based endotoxin testing system. That launch is now expected to occur before the end of the third quarter this year. As with our other business units, we have seen recent positive signs in our pathogen division. We were able to resume PluraPath launch efforts albeit not in person. More and more potential customers are shifting to the new Zoom reality. In general, the new normal will include a heightened sense of awareness around microbes and their risks. Additionally, we no longer need to explain what PCR means anymore. In our Renal Products subsidiary, we have a few small delays attributed to the pandemic. In the next few weeks, when we complete the production of the HDF systems, tube sets for verification validation, we will likely be able to file the Special 510(K) in the fall, which is behind our original timeline, but is no longer the bottleneck in our path to commercial relaunch. We witnessed a rapid change in our traditional business model of the 20% dialysis clinic that became imperfect in the face of the pandemic that is devastating to people with underlying health conditions, requiring extreme social distancing and high levels of PPE. We also observed that many COVID-19 patients need acute kidney support. There was an acceleration of the trend to shift to home dialysis, which also increased the cost and complexity of treatment. We are monitoring the market to ensure that we find the smoothest path back to patients. Now, I'll turn the call over to Andy who will talk more in detail about the most recent analysis we are performing to better understand the landscape around us.

Thank you, Daron. I'll provide a look now at the financial results for the second quarter ended June 30th, 2020. As many of you know, we speak frequently about Nephros' consistent year-over-year revenue growth, which extended to 15 consecutive quarters in the first quarter of 2020. Unfortunately, we did not extend the streak to 16 this quarter due to the significant interruptions associated with the COVID-19 pandemic. Nephros reported net revenues in the second quarter of $1.6 million, a 32% decrease compared to $2.3 million in the same period last year. Virtually all of these revenues came from our water filtration business segment, and the revenue decrease came entirely from our hospital segment within the water filtration, primarily because of the hospital industry's singular focus on COVID-19. The net loss in the water filtration business segment was $0.9 million compared to $0.3 million in 2019. This increased loss was primarily due to the reduced revenue that I just mentioned and also slightly lower gross margins, which I will discuss in a moment. Adjusted EBITDA in the segment was negative $0.7 million compared to breakeven in 2019. Please refer to today's press release for more details about our calculation of adjusted EBITDA and its reconciliation to GAAP net income or loss. Additional information about our water filtration, pathogen detection, and Renal Products business segments and their operating results can be found in today's filing on Form 10-Q. On a consolidated basis, the net loss for the quarter was $1.7 million compared with $0.9 million in 2019, a 76% increase. Consolidated adjusted EBITDA in the quarter was negative $1.4 million compared with negative $0.5 million in 2019. The cost of goods sold in the second quarter was $0.7 million compared with $0.9 million in 2019, a decrease of 28%, and the gross margins in the second quarter were 57% compared with 59% in 2019. The margin reduction compared to a year ago was due to increased shipping rates during the pandemic as well as increased warehousing costs associated with our Aether and the pathogen detection business. 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%, which has been our consistent range for the last three years. Research and development expenses in the second quarter were $0.84 million compared with $0.80 million in 2019, a $0.05 million increase. Depreciation and amortization expenses in the second quarter were $47,000 compared with $48,000, a 2% decrease from 2019. Selling, general, and administrative expenses for the second quarter were $1.6 million compared to $1.4 million in 2019, an increase of 15%. Finally, our cash balance at the end of the quarter was about $7 million. In closing, we remain resolute about staying strong during this extraordinary time and are excited about our future growth prospects. We look forward to seeing many of you virtually at financial conferences this summer and fall, and in the meantime, please always feel free to contact Daron or me directly at info@nephros.com, which goes directly to the two of us. This concludes our formal presentation remarks. I would like to personally thank all of you and the rest of our stakeholders for your continued support and look forward to speaking with you again soon. We will take questions from the audience now and also answer any emailed questions as appropriate. Operator, please open the call for questions.

We will now begin the question-and-answer session. The first question comes from Howard Halpern with Taglich Brothers. Please go ahead.

Congratulations on handling a tough environment in the second quarter.

Thanks, Howard.

In terms of what you're seeing in the beginning of the third quarter, could we say that existing customers that were focused on other things in Q2 are they starting to come back and fulfill the requirements of updating the filters when due and are you seeing that activity sort of back up and be fulfilled in the third quarter?

Yes. As Daron said, it's not normal; it's the new normal, and so it's not like a switch got thrown and everybody is back to normal business, but I think — and it's only been 30 days since the quarter began. So with all of those caveats, I'll say that it's safe to say that we are seeing a stronger performance at the beginning of the third quarter than we saw at the end of the second quarter, and we certainly hope it continues and are doing everything we can to ensure that it does.

And are you seeing some new customers also in the mix?

Very few. It's really hard in this environment to establish new relationships. Our business is a relationship-based business. Normally, our sales organization spends a lot of time on planes and it's not just us, but our distributors who are the principal tip of the spear that sells to our customers. Just nobody can get into hospitals right now. And so it's just hard. We're seeing, instead of a third of our business coming from new business, we're seeing more like a sixth coming from new customers.

Okay. And could you describe a little bit what kind of reaction you've got, what feedback you've got from when you published the paper for the SequaPath?

Yes. I'll take this one, Andy. The primary goal of that paper was to start shifting the conversation around what makes a building safe. There have been two schools of thought in the professional circles and at the regulatory level. The majority of water treatment folks just test for legionella because that's what the regulations say to do. A few forward-thinking ones have been pushing for looking for a broader band, and we're more aligned with those folks because when we see hospital outbreaks, it's not legionella every time. There's pseudomonas, burkholderia, and a bunch of others that cause just as terrible of an outcome as legionella. So it doesn't make sense to just look for one. That was the whole premise of the PluraPath system. So when we looked at who read it, the right people in the right places read it. The New York Department of Health, who leads the nation in kind of thinking around buildings, and TVC, some members there. We're definitely in the early stages of this conversation shift, but what we can tell from the different groups who debate guidelines and regulations is that there has definitely been momentum for those advocating for a broader approach. So it's early days in this whole conversation, but we believe over time, the right answer is to look for everything that could possibly be harmful, narrow down to what you might have, and then figure out what you can fix. That's the thesis behind the whole cascade of the SequaPath, which has looked at everything. It's a complete biome of a building that can help figure out what you should worry about because it exists in your water and won't go away once it's there. You can then use the PCR to negatively exclude their existence with a solid water management plan managed by our distributors. I think that's the whole thesis behind this, and we're seeing that conversation start to shift.

Okay. And is it not only office buildings that you see as potential customers? Do you see which is likely to open up first, school districts around the country? Are school buildings part of your plan too?

We haven't spent a lot of our own personal effort and time from a sales point of view to look at buildings outside of hospitals or wherever one of our distributors brought this into. But we're starting to see that; we see it in prisons, we see it in lots of other places where anywhere you have a building with water, there are people in the spaces that may have been sitting around for a little bit, so it's going to be an issue. Long term, I see every commercial facility on the planet having to take measures to ensure they're not causing risks to whoever is buying a Coke or drinking from a water fountain on the fourth floor. How long that will take, I have no idea. But we believe that what's happening in the hospitals, where they have the most acute, immune-sensitive patients, will eventually transition to the rest of the commercial world of water as long as it's easy, cheap, convenient, and doesn't create too much of a headache to execute, which is the goal of our systems.

Okay. Thanks. I'll hop off. And just keep up the good work, guys.

Thanks so much, Howard.

The next question comes from Anthony Vendetti with Maxim Group. Please go ahead.

Thanks. Daron, I was wondering if you could talk a little bit more about the large national account you have in the pipeline that you expect to close by the end of the year. Is that a QSR or a hotel chain? Can you give a little more color on that?

It's in the foodservice world.

Okay.

If you can imagine, upon closing something of that nature, we would request the ability to publicize who, what, when, where, why, and how. When and if we have permission for that, I'll obviously let you know, but in general, we'll be able to talk about the revenue shifts that occur as they arise.

Okay. And then, you were talking a little bit about how it's much more difficult to access new customers. Andy mentioned this quarter, one-sixth of the business is from new customers, down from one-third. In terms of Zoom calls, how are you getting even that one-sixth? Is it prospecting by phone, then setting up a Zoom call? How is the sales force building the new customer pipeline during this pandemic?

Yes. So nothing really happened in Q2 because our partners, the water treatment professionals in the field, weren't allowed in buildings for the most part either. So the ability for them to get in and have sample collections sometimes didn't happen. The way that we have conversations right now is, a majority of our distributors have not fully penetrated their footprint. One of them has 1,000 hospitals, but we're not in more than 15% to 20% of them. So the way we get new customers right now is the way we got them before; we just support via Zoom instead of coming in and doing a round of meetings in town with whoever is around. So it's a little more scattershot, but it is partnering with our water treatment professionals who then need to change a procedural update. That's how we're getting in. It's not necessarily proactively driven by, hey, we're going to be in town. Let's go meet everybody. It's more of we're having to hope they pull us in and proactively expand our reach. It's getting better day by day, but that's how we do it.

Okay, makes sense. And then lastly on the delay due to a shortage of PCR, obviously polymerase chain reaction is how some of the COVID-19 tests are done and the reagents associated with that. Are you confident that by the fall, you'll have enough PCR to go forward or is it hard to tell at this point?

Our PCR is ready to go. The PluraPath, we're making, we're selling, the — we're actually making mono-strips. So if someone has a particular bug that they're worried about, we could make strips of just that bug. So they can do eight tests at once. What was delayed with our DialyPath, which is the endotoxin testing, was planned for Q2; SequaPath was planned for sort of Q3, Q4, because it's a little more complicated. But given the opportunity we had to look at unoccupied buildings and examine the biome, that really is going to show the power of the system to do an initial assessment of problems, and through that, we can help solve it. We just accelerated that research. So, DialyPath is a gram-negative backbone that's consistent across all gram-negative bacteria, plus some specific tests of gram-negative bacteria consistent with dialysis units. That assay is just — we didn't validate it yet. We had the assay, but we didn't go through the work to validate it to sell it. We just accelerated SequaPath to get it out as soon as possible. It was more germane to the current environment, and then DialyPath would be ramping up really soon. But we did make some changes to our PluraPath based on COVID-19 because we had some virus testing there with norovirus and rotavirus, which are useful for cruise ships and other places. The reagents that work on breaking down the cell walls around RNA-based viruses like those spiked by 100% and the supply was zero because they were all being used for COVID. So, we removed the virus assays from our PluraPath, added a couple of other bacteria that we had listed out anyway, but otherwise, the reagents for bacteria are all available in plenty of stock. We can make whatever assay we need right now.

Okay, excellent. All right, thanks. I'll hop back in the queue. Thanks. Appreciate it.

The next question comes from Wayne Cadwallader with Elkhorn Partners. Please go ahead.

Hi, there. How are you?

Very good. How are you, Wayne?

Good. Quickly — I unfortunately got on the call a little bit late, what's the balance sheet in terms of cash that's on there? How much do you think you might end the year with? First question.

Cash is $7.0 million at the end of Q2. And I don't have a projection in front of us, but we plan on being in very good shape cash-wise for the foreseeable future. We don't foresee any capital needs.

Because of this pandemic, is it opening up opportunities that you might not have had more public forums like in stadiums and other places where people might want to — and the cruise ships, I heard mention there, opportunities to sell products now into other areas that you wouldn't have had six months or eight months ago? And if so, what steps are you taking or actions to try and open up those sales channels?

Six months ago, not many people knew what PCR meant when I mentioned it was a very useful tool.

Yes.

Now it is. And so while on the water filter side, I don't think the pandemic changes the model or the opportunities in the near term, on the pathogen detection side, everyone now believes the PCR is the gold standard. So we're seeing requests for quotes for office building complexes that have been vacated to conduct SequaPath tests or other forms of examination of cooling towers. I think the pathogen side, if you look at our projected growth slope prior to the pandemic and post-pandemic, the slope has probably gotten a little steeper because the buy-in time and soak time for the problems will likely be abbreviated for people facing the issues. We haven't been able to get out there and fully press the market with the tool. We've been working with our distributors to make sure they know it exists and now they have Zoom training videos and they're out there quoting. But we're still very early days for that product. We've made a sale to a customer with a kit and a system; that's not in our core business unit — not in hospitals, and I can foresee that happening more and more soon than we've expected. That was going to be more of a year, two years, three years in other markets, and I think that may be accelerated. But I can't tell you how fast or where this will develop going forward.

Okay, next question. Based on that, what I've just heard, it sounds like it's a very difficult process unless you're physically there to demonstrate the product to get that sale. So until such time that you can get into front of people and demonstrate and go through a beta test, whatever, it's really going to slow the sales channel down significantly or to some degree until such time that when we get into sites more and can meet face to face. Would that be a correct statement?

I'm not sure I would concur with that.

Okay.

Getting the meeting is sort of the hurdle because there's a bigger fire in the room in most places. Once they say, 'Hey, I need this,' then we've actually been pretty effective setting up webinars to walk them through it. We've had them send some water samples, so we can include their test results in the webinars. The acceptance of PCR and its effectiveness is now inherent. So we're not spending time discussing that. Once the contact is made and the need is identified, then the path to sale is likely faster.

Have you looked at ways to get more into some of the major news media outlets as to what you can bring to help with this whole pandemic issue and everything else? Are there opportunities just to create some noise?

We've —

We are looking at that. We're in the early stages with media relations, but we are looking at it. We actually completed our results just a couple of weeks after the New York Times published a significant article on the topic of unoccupied buildings. So we're in the early stages of that process, but we are knocking on doors and hopefully we'll get some coverage in the non-investor media space in the future.

Okay, terrific. I really appreciate that. Thank you.

You're welcome. Thank you.

Hi, Daron and Andy.

How are you?

Is there any type of patents or other protection on the testing protocols for the SequaPath?

We do have patents filed for the process that we undertake to do our pathogen detection analysis because we utilize a small filter in a different way and we have a process of concentration and other techniques. So we filed for it. The real secret sauce in this space is, A, it's concentration — sample concentrating, and then B, it's the actual assay, so the DNA chain link that you are testing for and its specificity versus other crossovers. So people can probably copy this and they will. What they'll find is that we have a pretty good filter, and we've even offered our filter to others who are working in this field because the concentration step is a key component to this. We filed a provisional for the PluraPath more than a year ago and there's a couple we followed with DialyPath. The SequaPath one, we're debating which piece of that puzzle we can lock up or if it's a continuation of the PluraPath.

Okay, great. So it might take a couple of years to actually get the patent.

Yes. This is — with these kinds of patents, it's a two or three-year process.

Sure. Thank you very much.

You're welcome.

Thanks, Henry.

At this time, we have no further questions. So this concludes our question-and-answer session. It also concludes the conference. Thank you for attending today's presentation. You may now disconnect.

Thanks, everybody.