Nephros Inc Q4 FY2021 Earnings Call

Good day and welcome to the Nephros, Inc. Fourth Quarter 2021 Financial Results Conference Call. All participants will be in a 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. Thank you all for participating in Nephros's Fourth Quarter 2021 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's filings with the Securities and Exchange Commission, including, without limitation, the company's Forms 10-K and 10-Q to 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, the impact of the COVID-19 pandemic, Nephros's ability to successfully, timely, and cost-effectively develop, seek, and obtain regulatory clearance for its products and services offerings. The rate of adoption of its products and services by hospitals and other health care providers, success of its commercialization efforts, its effect on the 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, February 23rd, 2022. 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 Nephros's President and Chief Executive Officer, Andy Astor. Andy, please go ahead.

Thank you, Kirin. And good afternoon, everyone. With me on the call today is Wes Lobo, our Chief Commercial Officer. As you might recall, Wes joined Nephros a little over a year ago, and happy anniversary, Wes. I thought it would be beneficial for you all to hear what he and his team have been working on. I will begin the call with a summary of Nephros's recent progress toward its revenue guidance of 25% to 30% growth, or $13 million to $13.5 million. I am pleased to report that we've had a strong start to the first few weeks of 2022. For example, we are now shipping filters on a nationally recognized quick-service restaurant deal, which will add about $250,000 in revenues in 2022. We are also pursuing several other large opportunities in the food service and beverage industries. Secondly, we have become a strategic supplier for two major dialysis companies. We expect these deals to add at least $0.5 million in revenue over the next 12 months. Other significant dialysis customers are also in the pipeline. Thirdly, we are making excellent progress in our Pathogen Detection Systems group, including significant commercial discussions with at least three leading firms in the microbiological testing space. Also, as noted in our recent shareholder letter, our Pathogen Detection group has achieved the CDC's elite certification for our laboratories, which has helped establish Nephros as a leading developer and manufacturer of qPCR assays for both environmental and Research Use Only testing. Fourthly, with respect to Specialty Renal Products or SRP and the HDF Assist Module, we have completed our responses on ten of the 14 topics raised by the FDA and are on schedule to resubmit for 510(k) clearance by the end of this quarter, Q1. Based on our high level of confidence, we have just hired an SRP Director of Commercial Operations whose job will be to manage the commercial launch of the HDF Assist Module and all aspects of the sales, marketing, logistics, and training related to that launch. Fifthly, we plan to launch our new website and lead generation infrastructure in the next 45 to 60 days. Lastly, our core business in hospital filtration sales remains strong, with customer retention rates exceeding 90% and adding an average of more than one new customer each day. We believe all of these points are strong indicators of progress and reasons for optimism. To be clear though, not all of these will show significant results in Q1 or even Q2. Building scalability will bring bigger returns in the second half of 2022 and more importantly, sets us up for sustainable growth in the long run. The Nephros leadership team is working tirelessly to deliver tangible results in the coming months to return us to the growth performance you have come to expect from Nephros. We all believe that we can deliver. I'll now turn the call over to Wes Lobo for a closer look at some of our sales and marketing activities, and then I'll return to review our financial results. Wes, please go ahead.

Thank you, Andy. Good afternoon everyone. It is a pleasure to be joining you on today's earnings call. Over the past year, I have had the opportunity to meet our healthcare and commercial customers and partners, both virtually and in person. I've been in hospitals with their sales and service teams to see firsthand what we do and how we do it. My main learning is that we are a niche market player in infection control for healthcare, and what we do, we do extremely well. When we are in front of a potential customer, we have a very high rate of success. Our challenge has been the ability to broaden the reach of our value proposition to a wider audience. To use a sports analogy, we have a high batting average; we need more at-bats. We are addressing this opportunity through three lenses: brand and marketing, business development, and customer service. First, our brand and marketing team has been working diligently to overhaul and launch a new Nephros brand that better articulates who we are and how we help our customers. This includes a new website to update product and company collateral, lead generation initiatives, and more channels through which to connect with our customers. We will publicly launch our new brand and messaging at the Grainger show next week in Orlando, and we expect to launch the new website in the next 45 to 60 days. Our goal is to make Nephros easier to find, easier to contact, and to clearly communicate our value proposition in an easy-to-understand and measurable way. On the business development front, we've organized around our three primary filtration segments: healthcare, dialysis water, and commercial, as well as pathogen detection. While the pandemic has caused significant stress on the healthcare market over the past two years, the market opportunity and expected growth from favorable CMS guideline changes continue to make healthcare our primary focus. Between hospitals, long-term care, and skilled nursing facilities, there are over 50,000 locations in the U.S. alone. According to the AIA Consensus Construction Forecast, new construction and retrofit expansion spending in healthcare is expected to grow at mid-single digits in 2022 and 2023. We are continuing the expansion of healthcare facilities, adding more beds to the addressable market, and we have a lot of runway to accelerate growth and expand our share within healthcare networks through a targeted value proposition for their channel partners. For example, we can supplement our infection control filters by providing our healthcare customers with filtration solutions that include taste, odor, scale, and more. Over the past two years, we’ve had nice growth of commercial filters being sold as part of the solution with our infection control filters in healthcare. In fact, in one recent example, a California-based hospital that uses our inline infection control filters for their ice machines was unhappy with the taste of their water, so their patients and staff were using bottled water. They asked if we could help, and by supplementing their infection control filters with our carbon filters for taste, they now enjoy drinking water from their dispenser and have cut down on pallets of plastic bottled water. This is one of many examples of accomplishing our goal to be a resource for science, solutions, and services to our customers. In dialysis water, we have strong OEM relationships where our filters play a key role in dialysis machines, delivering safe dialysate water to patients by retaining bacteria and endotoxins. We are recently qualified as a strategic supplier by a high-growth dialysis company and are working on similar strategic relationships with several dialysis machine providers. We expect our dialysis water business to continue its strong growth trajectory as we solidify our OEM relationships. In commercial filtration, we are focused on the food service and beverage markets, especially quick-service restaurants. As Andy stated earlier, we recently started shipping filters for beverage machines to a large national QSR, a revenue opportunity of about $250,000, and we are working on similar opportunities with globally recognized partners and regional chains. This commercial opportunity is multi-tiered and more complex than healthcare, and therefore takes longer to develop. However, we believe we have a healthy pipeline and will continue to nurture and develop these opportunities. Moving to our pathogen detection business, last year we had some great wins across healthcare, multi-family housing, and recreation and hospitality. We grew from $30,000 in revenue in 2020 to $188,000 in 2021, and more importantly, we gained experience and feedback on our products and services from end customers, consultants, service providers, and agencies. Our industry-leading assortment of assays is applicable to many different markets and customer types. Our focus in the short term is to solidify our relationships with at least two potential testing partners as a supplier of qPCR test strips and kits. We anticipate our pathogen detection business to demonstrate sustainable growth in 2022 and build the foundation for accelerated growth going forward. Finally, regarding customer service, we are well known for our industry-leading service when it comes to emergency outbreak response business. We are working to supplement this service with a more structured approach throughout the customer journey to provide a terrific customer experience and improve our retention rate. While our current retention rate of over 90% is good, we know it can be better. Each extra percent of customer retention means an improved customer experience and higher revenue. As you can see, our team is working on many exciting growth opportunities which we believe will have measurable benefits in 2022 and beyond. A year ago, I stated my enthusiasm for joining the Nephros team and having the privilege to tell our story. We’ve been working on that and in the coming weeks, our team is excited to share how Nephros seeks to improve the human relationship with water by providing leading accessible technology and resources for advancing water safety and quality. Thank you, and I’ll turn the call back over to Andy now.

Thank you, Wes. That was great. I will now review our financial results. We reported fourth quarter net revenue of $2.8 million, an 18% increase over the prior year and full-year revenue of $10.4 million, a 22% increase over the prior year. The $10.4 million represents a record revenue year for Nephros, albeit by a small margin. Furthermore, we have now delivered four consecutive quarters of year-over-year growth, averaging 19%. The net consolidated loss for the quarter was $1 million, compared with $0.8 million in 2020, and the net consolidated loss for the year was $3.9 million compared with $4.5 million in 2020. Consolidated adjusted EBITDA in the quarter was negative $0.4 million compared with negative $0.5 million in 2020, and consolidated adjusted EBITDA for the year was negative $2.6 million compared with negative $3.6 million in 2020. Consolidated gross margins in the quarter were 53% compared with 56% in 2020. Consolidated gross margins for the year were 55% compared with 57% in 2020. We do continue to expect future gross margins to be in the range of 55% to 60% despite this quarter's fall to slightly under that range. Consolidated R&D expenses in the quarter were $0.5 million compared to $0.6 million in 2020, and consolidated R&D expenses for the year were $2.2 million compared with $2.8 million in 2020. Consolidated SG&A expenses in the quarter were $2 million compared to $1.4 million in 2020, and consolidated SG&A expenses for the year were $7.7 million compared with $6.5 million in 2020. Our cash balance on December 31, 2021, was $7 million. 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, and additional information about our results including our water filtration, pathogen detection, and renal products business segments will be found in our filing on Forms 10-K, which we plan to file on or about March 2, 2022. That concludes the financials. I'll now make a couple of closing comments. In our last earnings call in early November, I stated we were pleased with the results, but that we were not satisfied. In that call, I stated our intention to accelerate our growth trajectory by investing in scalable commercial and operational infrastructures while balancing short-term results with long-term sustainable growth. We are staying true to those objectives, and the results are beginning to show, as evidenced by the examples I listed early in this call, as well as by Wes's comments. As always, I would like to thank each of our Nephros employees and our strategic partners for their unwavering focus on providing unsurpassed products and services to our customers. Thanks also to our devoted investors represented on this call for your continued confidence and patience. Please continue to stay in touch. You can always reach out to me at andy.astor@nephros.com. This concludes our formal presentation remarks. We will now take questions from the audience. Operator or Chad, please open the call for questions. Thanks very much.

We will now begin our question-and-answer session. If you were using your speakerphone, please pick up your handset before pressing the keys. At this time, we will pause momentarily to assemble our roster. Thank you. And our first question will come from Marc Wiesenberger with B. Riley Securities. Please go ahead.

Yes. Thank you. Good afternoon. I appreciate the insight into the commercial. I'm wondering if you could rehash those details again and additionally, what percent of the overall footprint does what you're currently servicing represent for this customer in aggregate? Is this an initial pilot that maybe as we move through the year should expand from the stats that you talked about earlier?

Sure. Hi, Marc. What I mentioned was that we will add about a quarter of a million dollars in revenue in 2022. We don't have the exact figures yet, and it is not a pilot program. The testing has concluded, and this is a nationwide rollout. However, as I've mentioned before in private discussions and also on these calls, the market in food service and hospitality typically has a unit value that is significantly lower than healthcare. It's usually in the hundreds of dollars at most. This is a large contract involving thousands of locations, and the expected annual revenue is approximately a quarter of a million dollars, give or take.

Great. Appreciate that additional insight. You talked about scalability is setting up for a bigger second half of the year. The last few years in the second half represented about 52% of overall sales. Should we expect a deviation for that this year based on your scalability comments?

It's hard to set specific numbers for what the second half of the year looks like. I don't think that what you just said was the case. If I look back at 2019, for example, I think it was more like 60% in the back half of the year. So first of all, I'm not sure if it’s evenly spread as your observation. But more importantly, Marc, the difference this year is not that we're saying the second half of the year will be larger because of market trends, but rather because of the scalable infrastructure and the work that we're building in are expected to build over time. I think it is our expectation that we'll see increased acceleration through the year and also into next year.

Regarding your 2022 guidance, could you discuss the level of emergency response factored in and how it compares to 2019? It seems that emergency response has been below the trend in both 2020 and possibly 2021. I'd like to hear your thoughts on this, and when do you anticipate returning to normalized levels in the emergency response segment of the business?

Well, emergency response was deeply depressed, close to zero in 2020, but that was not the case last year. Emergency response last year was in the normal range. We usually say that if you zoom out, it's about 15%, although it varies tremendously because it is by definition unpredictable, it is an emergency. We expect similar levels of 15% as we continue to grow. We will learn, frankly, whether or not emergency response will scale up at the same rate, faster, or slower as we grow because we've never been there before, so we'll have to see. But as a starting point, 15% or so is about right.

Great. Appreciate it. And then just a final one for me. If you could talk about the demand resulting from recent CMS and Joint Commission guidelines, how that progresses at the end of the year, how it's progressing thus far in 2022. And how close of an analog is the 2017 time period turning out to be thus far and going forward? Thank you.

Thank you, Marc. It's a hard thing to measure. Back in 2017, 2018, and even 2019, there was a lot of talk about the new CMS guidelines. For those on the call who may not be familiar with these, these are guidelines on water management plans that every healthcare institution in the country is required to follow. They started in June of 2017 with a set of guidelines that have been tightened starting on January 1, 2022.

I would say that we're seeing the same thing. It's a big issue. Hospitals or healthcare institutions are dealing with it differently. It's more of a rising tide. You don't really notice the impact on a day-by-day basis even though it's a hot topic, but it has very much influenced our growth from 2017 to 2019, and frankly, I expect it to continue to influence in 2022 to '24. Thanks, Marc. I appreciate it.

Great. Thank you.

And the next question will come from Anthony Vendetti with Maxim Group. Please go ahead.

Yes, thanks. There was some static there so I don't know if you answered this, Andy, but the new water management standard went into effect 1-1-2022. Did that new standard increase interest in your products and services? And if so, is there a way to quantify to what level, in terms of either the pipeline or the growth that you can attribute to that new standard?

I apologize for the poor connection. I cannot provide a quantification of that. From my experience between 2017 and 2019, there was a general increase in interest from healthcare institutions in water management plans, which we don't carry out directly, but we offer the remediation services tied to those plans. This had a positive effect, but I’m unable to quantify the specific impact of the guidelines on current market trends. Wes, do you have a different viewpoint? You have more field experience, right?

Yeah, it's a good question. I think from what I've seen so far, it’s too early. I know that it's going into effect on 1-1-2022. What I've seen and what I've heard is that there’s a mix of healthcare facilities that, prior to this going into effect, were already stressed in terms of manpower, coverage, maintenance, facility upkeep, etc. So there's a combination of education that is still ongoing. You see a lot of consulting agencies out there doing education as they work with the healthcare community. What I can say is that we have seen facilities that previously contracted with us, now new healthcare facilities are seeking out our product as a result of implementing the water management plans. So we are seeing interest as a result of it. But there are still many questions about what it means, and there's a lot of education still happening. My view is that it will take some time to ramp up.

Okay, that's helpful. You provided good information on the restaurant contract, Andy, but regarding the Specialty Renal Products, you've completed 10 of the 14 questions, and you anticipate resubmitting to the FDA for the 510k by the end of Q1 2022. Does the 90-day clock start once you resubmit? That's one part of my question. The second part is that you mentioned in your prepared remarks that you have $500,000 in orders or backlog from two HDF customers. Is that dependent on this product being approved, or is that related to a different contract?

I wish that was the case, Anthony, but that's not. First of all, it is a 90-day clock that restarts when we resubmit. We're planning on resubmitting at the end of March, and we have found that the FDA is unpredictable and can be quite slow in its responses, but we are making headway with them. I do believe that we will resubmit at the end of March, and I do believe that roughly 90 days later, we should be getting a response from them. The $0.5 million I mentioned was for a couple of dialysis water purification contracts. In other words, we have three filtration business segments: hospitals and infection control, dialysis water purification, and hospitality and food service. The $0.5 million I mentioned was in the dialysis water purification, completely different from the HDF business which I discussed later.

That clarifies it. That's very helpful. Those are my questions. Thanks very much. I'll hop back in the queue.

My pleasure, Anthony. Good to hear from you.

Thank you. And the next question will come from Neil Cataldi with Blueprint Capital. Please go ahead.

Hi, guys. Thanks for the color tonight. A few of mine were already asked but I'll just follow-up on two. Regarding the QSR opportunity, could you tell how long you were working on this? And has anything changed that might mean more of these start to hit, or does this win effectively open the door, validating your ability to capture others?

It's a great question, Neil. And good to hear your voice. If I said we’ve been working on it forever, would you believe me? We've been working on this for some time, probably over a year and maybe a little longer than that. I don’t think it represents a change in the industry that caused it to happen. I think that our persistence, integrity, and relationship building has paid off. We’re not starting from zero in the other opportunities that we are pursuing. As word gets around about our filters in several thousand locations and our ability to deliver and perform, our reputation will grow, and I do think it will help us win additional business.

Okay. I remember two years ago you were talking about a big opportunity and it sounds like this is a different one and maybe that one is still out there. Could you help us understand why they chose to switch? Was it a cost comparison or was it some other feature?

They had reasons, which I won't discuss, that they wanted to switch from their provider. They went looking for products through one particular channel and that company went searching for providers, found us, selected us, tested us, partnered with us, and we were selected. It was a cold selection process.

Got it. So there’s a middleman partner that you’ve a relationship with?

There was barely a relationship there. The middleman partner knew of us, but they also knew of everyone else, and we were evaluated alongside others.

Got it. Great. One other question I have on the pathogen side: I think you mentioned some partners that you're working on there. Anything you can elaborate on? I imagine they're distributors of some sort. And if so, what type of hospital reach might they have?

What I mentioned was three leading firms in the microbiological testing space. I'm not going to comment further on what or who they are, but they’re not the traditional hospital distributors that we've been working with on the filtration side. There are also opportunities growing in that area.

Hi, Andy. Hi, Wes. How are you guys doing today?

Doing great, Jason. Nice to hear your voice.

It's great to hear from you as well. You've mentioned the batting averages and the importance of getting more at-bats. Continuing with that baseball analogy, I’d like to discuss the possibility of bundling solutions. You mentioned packaging for just one hospital, but is there potential to bundle for other hospitals or even package detection solutions for a single customer? Do you see this becoming a larger part of your business or a greater opportunity moving forward?

It’s a great question, Jason. The answer is yes. Wes, would you like to talk about the cross-selling opportunities?

Yes. Thank you for the question, Jason. There's a natural adjacency between our Pathogen Detection business and our healthcare business, and as I mentioned earlier, our assortment of assays can go into many different vertical markets, specifically the healthcare business where we play mostly. There's that adjacency, and we've already seen success in joint calls where we go in to talk about one aspect and the other comes up as well. That part of our business development is ongoing. You bring up a valid point about our margin; even though it wouldn’t necessarily grow our deal dollar value significantly, it could help improve customer retention, and I appreciate the insight.

The next question will come from Jason Hirschman with Hudson 2-15 Capital. Please go ahead.

Great quarter, and looking forward to you hitting your guidance this year. And we'll keep our fingers crossed that we're done with the pandemic's part of the pandemic at least.

Marc, go ahead.

And thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Andy Astor for any closing remarks.

Thanks very much, Chad, and thanks Kirin and Wes for being on the call with me today and sharing the mic. Thanks to everybody for dialing in; we had a really good showing today. It's been a tough few months. We've grown out of the pandemic impacts of 2020, but it took us a whole year to do that. The stock price took a hit along with many others over the last couple of months, and it has been a challenging time. I'm here to tell you that we've never stopped believing. We have never stopped working, and we think we're beginning to see the benefits of not panicking, not changing our business model, and not trying to fix it with one blow. We're putting one foot in front of the other. We have a strategy in place and we are executing on that strategy. We've got a great team, and I hope you all stick with it because I think there are great times ahead. Thanks again for coming, everybody. Take care, and I look forward to seeing you all soon.

And thank you sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.