Nephros Inc Q2 FY2022 Earnings Call

Good afternoon and welcome to the Nephros Incorporated Second Quarter 2022 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 Stephanie Prince from PCG Advisory. Please go ahead.

Thank you, Gary. And thank you all for participating in Nephros’ second quarter 2022 conference call. Before we begin, I would like to caution you 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 the impact of the COVID-19 pandemic, Nephros’ ability to successfully timely and cost-effectively market its product and service offerings, the rate of adoption of its products and services by hospitals and other health care providers, the success of its commercialization efforts and the effect of existing and new regulatory requirements on Nephros’ business and other economic and competitive factors. The contents of this conference call contain time-sensitive information that is accurate only as of the date of the live call today, August 10, 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’ President and Chief Executive Officer, Andy Astor. Andy?

Thank you, Stephanie, and good afternoon, everyone and welcome to the call. I am pleased to report our second quarter results, which were strong at the topline, net revenue was $2.9 million, an increase of 27% year-over-year and 32% over the previous quarter. Also active customer sites increased 21% year-over-year to a record 1,349, which were also 6% higher than the previous quarter. Customer retention rates remain comfortably over 90%. While topline growth remains our top priority we also recognize that Nephros needs to become profitable. As we announced last month, Nephros expects to be cash flow positive by midyear 2023. Of course we remain focused and optimistic about revenue growth, but we are also taking steps to tighten our belts. In the quarter ended June 30, these steps included a 15% headcount reduction, reduced use of professional services, and initial work towards production and inventory efficiencies. As of July 1, operating expenses have been reduced by more than $300,000 per quarter. We expect our ongoing actions to reduce expenses further in the coming quarters. I’ll now give a brief overview of some sales and marketing highlights. Wes Lobo, our Chief Commercial Officer, he would normally give this update but he is on vacation this week. As we announced on the previous earnings call, Nephros launched its new web presence at the beginning of Q2. In his remarks at that time, Wes said, quote, the launch of our new website provides the digital architecture to articulate our value proposition, provide easier discovery of product solutions and produce timely relevant materials for our customers. I am pleased to report that just four months later, the website is delivering benefits including lead generation that has led to new revenue in the tens of thousands of dollars so far. In addition, we continue to build our regional sales teams to provide dedicated support to our distributors and our end customers. We have coverage in most of our important markets and are actively recruiting for the rest. Our Medical Water Filtration businesses primarily hospital infection control and dialysis water purification were both strong this quarter, also ending with record numbers of active customer sites. In the Commercial Filtration business, I am pleased to report that we shipped over 3,000 filters this quarter for installation in Chipotle restaurants nationwide. The replacement cycle for these products is every six months. We expect the brand equity from this relationship to unlock additional opportunities in the food service and beverage space going forward. And in the Pathogen Detection business, we have completed agreements with two strategic testing partners and anticipate a steady build of sales over time. And finally, with the previously announced FDA 510(k) clearance of the HDF Assist product from our subsidiary Specialty Renal Products, we are now in discussions with dialysis clinics for a rollout to patients around the end of this year. I’ll now turn to a few details of our financial results. We reported second quarter net revenue of $2.9 million, a 27% increase over prior year. Factors impacting this growth included organic growth, the Chipotle shipment I discussed earlier, and also some pull ahead sales due to a price increase implemented on June 1. Net consolidated loss for the quarter was $1.1 million, approximately the same amount as the second quarter or Q2 of 2021. Consolidated adjusted EBITDA in the quarter was negative $0.7 million, compared with negative $0.8 million in Q2 of 2021. Consolidated gross margins in the quarter were 47%, compared to 57% in Q2 2021. This decrease is primarily due to global inflationary and supply chain trends, in addition to some inventory exploration. We expect the June 1 price increase to improve our margins and continue to target future gross margins of 55% to 60%. Consolidated research and development expenses in the quarter were $0.4 million, compared with $0.5 million in Q2 2021. Consolidated sales, general and admin or SG&A expenses in the quarter were $2.0 million, compared with $1.9 million in Q2 of 2021. And our cash balance on June 30, 2022, was $4.2 million. We reassert that our current cash balances are expected to suffice for the foreseeable future. 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 results, including our Water Filtration, Pathogen Detection and Renal Products business segments will be found in our filing on Form 10-Q, which we plan to file on Monday, August 15th. That concludes the financial discussion. And we’ll open the call to questions in just a minute. But first, I would like to thank each of our Nephros employees and our strategic partners for providing unsurpassed products and services to our customers, especially this year during some difficult times. And thanks also to our devoted investors for your continued confidence and patience. We know that these are challenging times for our investors and yet we believe that our ability to navigate the short-term results will be to our ultimate benefit, as we maintain our commitment to investments in scalable, commercial and operational infrastructures as a path towards long-term sustainable growth. This concludes our formal presentation remarks. We will now take questions from the audience. Gary, please open the call for questions.

Our first question is from Marc Wiesenberger with B. Riley FBR. Please go ahead.

Yeah. Thank you. Good afternoon. Appreciate you taking the questions. And Andy, it’s nice to hear a more upbeat tone from you relative to the last quarter. So congrats on the efforts.

Yeah. Thank you, Marc. Nice to hear your voice.

I would like to start maybe with the gross margins. We did see some nice stabilization and sequential increase. How should we think about that ramping into the second half of the year and do you anticipate getting back into the target range by the end of this year?

In this economy, it’s difficult to provide a straightforward answer. I’m pleased to see stabilization. However, there will be additional pressure from product exploration. I have not observed continued increases in shipping. In fact, I heard recently that while we do not rely heavily on air shipments, the costs for air shipping have declined. Therefore, with prices not rising and a price increase implemented for most of our customers on June 1st, we should experience upward pressure on our gross margin. I anticipate modest increases over the next couple of quarters. While we may not reach our target range of 55% to 60% this year, or possibly early next year, we will trend toward that direction in the coming quarters as part of our plan to achieve positive cash flow.

Got it. Okay. Well, we’ll be looking for that continued progress. Moving down the P&L, how should we think about OpEx building off the 2Q levels? And I guess as growth ramps, is the current infrastructure sufficient for that expansion? And then I did hear you mention expanding the sales team a little bit in certain regions, is this kind of a shift in emphasis from distribution partners to maybe more of a direct salesforce or how do I interpret that comment there?

I think the answer to your first question is yes, our current level will support the growth that we are looking for. So we don’t need to significantly increase OpEx in order to grow. When I say modestly, I mean let’s say 20% or 30%. Sorry, could you remind me of your second question? I've lost my train of thought.

Sure. No problem. You talked about expanding, I think, this...

Oh! I am sorry.

... in certain geographies, is that a kind of an emphasis away from distribution partners to more direct salesforce?

Thank you. No, not at all. In fact, we have always had direct salespeople to support our partners. So there’s absolutely no change to that whatsoever. But what there is not a change but a continuation of is our intent to have geographical, regional sales managers, within a long drive or a short flight to everywhere in the continental U.S., and we’re making good progress on that.

Very helpful. And then...

And that’s, again, not a change from the plan.

Perfect. In terms of the Medical Filtration market, if you could kind of provide some more insights in terms of what you’re seeing there and kind of the different kinds of submarkets within there. That would be really helpful.

Sure. Regarding Q2, all three filtration markets, which include the two Medical markets and the Commercial market, showed normal distribution and experienced healthy growth. The Commercial segment saw even better growth, largely due to the Chipotle shipments. Overall, while solid healthy growth is not surprising, it aligned with our expectations. After a disappointing Q1, we have returned to the anticipated levels in all three markets for Q2. Does that answer your question?

It does. I think this quarter, though, does kind of have some lag or delay from the first quarter, is that right? Can you remind us kind of how much that was pushed in from the first quarter into this quarter?

There wasn't much to discuss. One of the two items we mentioned in the last call was completed while the other was postponed. So I wouldn’t spend too much time analyzing that. Q2 was just Q2. As I mentioned in my opening remarks, there were likely some sales pulled ahead due to our June 1st price increase, estimated to be in the low hundreds of thousands of dollars, around 250, which likely would have contributed to second quarter sales that might have been realized in Q3 if it weren't for the price increase.

Understood. Very helpful. And then just one more and I’ll get back in the queue.

Sure.

Looking at the at-home dialysis market, I believe a leading player previously had an FDA hold from shipping some units, which has now been lifted. Were you at all impacted by that in the first half of the year and now that that has been lifted, do you anticipate that accelerating some of your growth into the second half of the year?

Yes and yes. We were impacted by that FDA hold and there were some holds put on future orders that were planned by both parties. The lifting of the hold, we do anticipate, although, I can’t tell you that we have it in hand yet, but we do anticipate that will contribute to growth in Q3 and Q4.

Great. Let me ask a follow-up to that. Could you clarify what the drag was, first? Also, do you supply customers in clinic, or do you provide filters for customers in clinic in addition to their at-home needs?

No and no. I won’t quantify the impact and know the customer relationship there is for the home and portable dialysis product.

Great. I appreciate you taking all my questions. Thank you very much.

That’s okay. Good questions as always, Marc. Thank you.

Our next question is from Ralph Weil with R. Weil Investment Management. Please go ahead.

Hi, Andy.

Hi, Ralph.

Could you comment a little more about the expense cuts and the headcount cuts where they may have taken place and what parts of the business? And I assume you feel that these were done without hurting your business going forward? And a second question would be, do you envision in view of the fact that you’ve had this problem that and then even though you say you don’t need money that you get by and I hope you will, sincerely hope you will. Do you see any parts of the business being monetized so that you can concentrate more on any of the ones that are left?

Thanks, Ralph. Good to hear your voice, by the way. The cuts were made across most departments. They were a combination of layoffs and replacement and attrition and so forth. But the cuts were made carefully and I can’t say they weren’t painful, but I do think you’re correct that we are able to do 90% of what we need to do and I think we made the cuts prudently, and again, it was painful and it was tough for the organization. We haven’t had to do that before. But I think they were necessary and we did them and I think we’re firing on all cylinders. I’m sorry, your follow-on question was regarding the cash balances, is that right?

Yeah. Yeah. You say that you don’t need money, because cash is...

Oh! Oh! I’m sorry.

...gone quite low.

Yeah. Yeah. No. I…

And I’m just wondering, you do have a few different businesses, some of which are maybe more exciting than others, but they all could grow. But I’m just wondering whether there’s any thought on your part to focus more on growing some parts, and perhaps, monetizing one or two others?

I understand your point. I won’t comment on that since those are strategic questions that are quite material. I can't say we're ruling out any options, nor can I confirm that we are pursuing them. However, we are always aiming for cash flow breakeven and have multiple alternatives in front of us. We will proceed in a way that we believe is best for the overall business. So, we are considering all options.

Do you think the third quarter will continue positively, or could it be negatively impacted by the advance purchases in the second quarter due to the price increase? Additionally, do you see any significant factors that might counteract any potential decline caused by those advance purchases?

It’s difficult to predict; the buy ahead has essentially taken a $0.25 million hit, so we have to see what happens as we finish the quarter. I view each quarter independently and want to avoid explaining the results of one quarter based on another. Our goal is to grow the business, and we must do so despite any challenges that may arise, such as price increases or a company temporarily losing its FDA clearance. I don't have much more to add on that.

The next question is from… Andy Astor: Gary? Thomas McGovern was met Maxim Group. Please go ahead.

Hi, everyone. Thank you for addressing my question and congratulations on a strong quarter. I have a quick follow-up regarding Marc's earlier inquiry about operating expenses. You mentioned that the infrastructure is ready for moderate growth and suggested a figure of around 30%. Can you clarify if that's the anticipated increase in operating expenses, or do you believe you can sustain that level of growth with the existing infrastructure?

The latter is what I said. What I said was, I don’t think we need to substantially increase our OpEx. We just decreased our OpEx. And I don’t think we need to substantially increase it with the kind of growth that we’re planning. So we do not plan on increasing our OpEx going forward in the foreseeable future. Okay.

Great. Thanks. Thanks very much for clarifying my question.

You’re welcome, Thomas. Thank you.

The next question is from Neil Cataldi with Blueprint Capital. Please go ahead.

Hey, Andy. Just one quick one.

Hey, Neil.

You mentioned you’re in discussions with dialysis clinics for rollout to patients by the end of this year. Just wondering if you could elaborate a little bit on that, does that mean that maybe you’d have to partner with one of these dialysis companies or what should expectations be going forward there?

We have been consistent on this, although it's taken longer than we expected. Our goal is to enter a few dialysis clinics, potentially one or three, to showcase our product by engaging with patients directly. This product was developed without requiring trials, so we aim to start commercialization in one or two clinics to gather patient experiences and demonstrate the machine's capabilities. This will help us determine if we can scale up from one clinic to more, or if there are strategic reasons to simply get into a clinic and operate in a real-world setting. We are currently in discussions to make this happen. Does that answer your question, Neil?

Yeah. I guess the company spent years and millions upon millions of dollars to get to this point, right? And the market hasn’t really given you guys any credit for getting the approval. So I am not sure that investors or the investor universe really appreciate what the magnitude of this might be or even the value that this may have to the company. So are you saying that you need to really prove that it works in the field first before you can then engage with a few of those bigger names that sort of dominate that market?

I believe that's part of the situation. It's important to remember that the initial version released and approved in 2012 was actually a machine that was not usable and faced significant challenges in the market. The current second generation is much easier to operate, yet we still carry the reputation of being a difficult machine that clinicians have turned away from. Our goal is to showcase that we have the machine we claim to have. I completely agree with your point that the market has not recognized our efforts, which is due to the tremendous investment of time and money—over two decades of work. We have a lot to demonstrate, and we are very enthusiastic about the opportunity to do so.

All right. Great. Thanks.

Yeah.

The next question is a follow-up from Marc Wiesenberger with B. Riley FBR. Please go ahead.

Yeah. Thank you. You have been seeing some nice steady increases in your active customer sites. I’m wondering if you could talk about what specifically has been driving that and is that dynamic kind of sustainable going forward?

We believe so. I like to describe our business as functioning similarly to a subscription model, even though we are not one. Customers are not obligated to purchase replacement filters; they have the option to extend the life of their filters or choose a different method if they find filters too costly. Essentially, we operate within a recurring revenue framework. We track the number of customers who have made purchases in the past four quarters, which we refer to as our active site count. This is, in my opinion, our key leading indicator. Our goal is to see that number increase, although it did dip somewhat during the pandemic when our revenue contracted in 2020. At one point, our count fell to just below 1,100. However, we have seen a significant recovery in 2022, reaching approximately 1,350. I am confident that this figure will continue to grow over time, and I believe it serves as a leading indicator for our revenue prospects.

Great. And then two more, I think, previously on the last call you were talking about the Pathogen Detection segment pursuing some two significant customers or opportunities. I’m wondering if you could update us on the progress on those developments?

I did mention that briefly. There are two companies that are heavily involved in water testing, and we have established partnerships with both. We expect to see revenue from these partnerships grow in the near future, although I'm not sure how quickly. I'm not anticipating massive growth, but both partnerships have been officially signed.

Very good. Generally shouldn’t have skipped or flew over those. That’s pretty important and hopefully we can see that build going forward. And then just finally...

Okay.

I have a question regarding your previous call where you mentioned competitors facing supply constraints. Have you managed to gain any market share as a result of that situation? Additionally, do you anticipate any supply issues for Nephros in the latter half of the year? Thank you.

You're welcome. We conducted a marketing campaign and achieved some sales from it, although I don't have a specific number to share. We benefited because our competitors were unable to fulfill orders. In response to your second question, I do not expect any significant supply chain issues for the remainder of the year. Our suppliers are in good health, and we consistently maintain that situation.

Great. Thank you.

Marc, thank you very much. Those were, as always, great questions. Thank you.

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. I’ll be super quick. I wanted to say thanks everybody for taking time out of your busy day and I look forward to seeing you or at least talking to you in three months on our next call. And in the meantime, please keep in touch, you can always reach me at andy@nephros.com and I look forward to talking to all of you again soon. Take care everybody and have a great night.

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