Earnings Call Transcript - NEPH Q3 2021

Operator, Operator

Good day and welcome to Nephros, Inc. Third Quarter 2021 Financial Results conference call. I would now like to turn the conference over to Mr. Kirin Smith. Please proceed.

Kirin Smith, PCG Advisory

Thank you, Ian. Good afternoon everyone, this is Kirin Smith with PCG Advisory. Thank you all for participating in Nephros's third 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' 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 its products and services offerings; the rate of adoption of its products and services by hospitals and other health care providers; the 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 4th, 2021. 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' Chief Executive Officer Andy Astor. Please go ahead Andy.

Andy Astor, CEO

Thank you, Kirin, and good afternoon, everyone. I'll start with a brief overview of our consolidated results, followed by a brief discussion of each of our business segments. We were pleased with our third-quarter results, which were 24% ahead of last year. This was our third consecutive quarter of year-over-year growth, averaging about 25% and demonstrating our gradual emergence from the effect of the pandemic. Furthermore, and perhaps most importantly, year-to-date revenue in 2021 was $7.6 million, the highest nine months total in the company's history. Looking ahead, our outlook is strongly positive. And with that, let's take a closer look at each of our business segments. Our core Water Filtration business continued its growth in the third quarter. Net filtration revenue was up 22% over the same period last year. Our active customer count is near its all-time high, and customer retention rates were strong, comfortably exceeding 90%. Our emergency response business, which had been significantly impacted by the pandemic, was at normal levels during this quarter. As stated in our prior call, we expect an important driver of increased customer interest to be the new standards document, new requirements for water management in health care facilities by the Joint Commission, which was approved earlier this year by the Center for Medicare and Medicaid Services or CMS. The requirements in this document apply to all health care facilities receiving funding from CMS and stipulate increased scope and documentation for water management programs beginning January 1, 2022. As health care facilities develop, implement and update their water management programs to meet the deadline of these upcoming requirements, we are well positioned to work with our strategic partners and their customers to support health care facilities' needs for filtration and pathogen detection. Indeed, some of our most recent customer engagements and orders are a direct result of health care facilities and water management consultants implementing water screening and infection control filtration due to the upcoming Joint Commission standard. Moving on to Pathogen Detection Systems or PDS business segment, we delivered about $60,000 in revenue this quarter. While still an emerging business, we are pleased with recent revenue consistency and excited by several recent developments. For example, we recently completed the integration of GenArraytion, our previously announced acquisition into the PDS organization. GenArraytion was a recognized market leader in infectious disease monitoring and measurement. The acquisition gave us access to a wide variety of proprietary assays, multiplexing technology, and selection methods using PCR technology. These intellectual property assets are expected to accelerate new product development and time-to-market and to add new revenue streams to this business. We also recently signed partnership agreements with consulting organizations to promote PDS products into their customer bases. We are building a significant pipeline of opportunities within these new relationships, and we expect these will generate significant revenue growth in the coming months. For a brief update on our Renal Products business segment and our second-generation HDF product. We received promising news from the FDA recently that they have completed their acceptance review of our HDF application. This means that the FDA has all the information necessary to evaluate our second-generation HDF product, and we'll now move into their substantive review phase. This is expected to take approximately 60 to 90 days, assuming they have no further questions. We expect FDA clearance around the end of the year or early 2022, after which we will pursue a limited commercial launch in the dialysis clinic market. I'll now present a few highlights of our third-quarter 2021 financial performance. We reported consolidated net revenues in the quarter of $2.6 million, a 24% increase versus the same period of 2020. We also had a net consolidated loss for the quarter of $1.2 million compared with $1.0 million in 2020. Consolidated adjusted EBITDA in the quarter was negative $0.7 million compared with negative $1.0 million in 2020. Consolidated gross margins in the quarter were 54% compared with 58% in 2020. We continue to expect future gross margins to continue in the range of 55% to 60%, despite this quarter's fall to slightly under that range. Consolidated research and development expenses in the third quarter were $0.6 million compared with $0.8 million in 2020. Consolidated sales, general, and administrative expenses in the third quarter were $1.9 million compared to $1.5 million in 2020. Our cash balance at the end of the third quarter was $7.4 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. Additional information about our results, including our Water Filtration, Pathogen Detection, and Renal Products business segments can be found in today's filing on Form 10-Q. I'll now make a couple of closing comments. First, as I said earlier, we are pleased with our year-to-date revenue results, in that we have stabilized the business to more consistent quarter-over-quarter performance after a tough 2020. To be clear, we are pleased but we are not satisfied. We intend to accelerate our growth trajectory by investing in scalable commercial and operational infrastructures and balancing short-term results with long-term sustainable high rates of growth. Second, I'd like to speak briefly about the topic of revenue guidance. We believe it was prudent at the start of the pandemic to suspend our practice of giving annual guidance since so many of our business assumptions were upended. However, as vaccinations become ubiquitous and the pandemic begins to recede, we believe we can return to giving guidance and we expect to do so shortly after the turn of the New Year. And with that, I would like to thank each of our Nephros employees and our strategic partners for your unwavering focus on providing unsurpassed products and services to our customers, as well as for achieving record year-to-date revenues thus far in 2021. I would also like to thank our investors for your continued confidence and patience as we exit the pandemic and get back to higher growth rates. We look forward to seeing many of you at upcoming trade shows and financial conferences. And if you've not already subscribed to our occasional e-mail alerts, once again, I'll remind you that you can do so at the bottom of our website homepage. And of course, always, please feel free to contact me directly at andy@nephros.com. This concludes our formal presentation remarks and we will now take questions from the audience. Ian, please open the call for questions.

Operator, Operator

We will now begin the question-and-answer session. At this time, we will pause momentarily to assemble our roster. First question, Marc Wiesenberger of B Riley Securities, please go ahead.

Marc Wiesenberger, Analyst

Thanks. Good afternoon. Andy, in your prepared remarks, you talked about the Joint Commission's new guidelines and how that related to activity within the third quarter. I'm wondering if you've seen any acceleration in that activity in the fourth quarter. And is there an expectation that maybe there could be some sustained demand generation from that into the New Year? Or is this something that once the year turns and everyone's expected to have it in place that may be some of this related activity kind of tails off?

Andy Astor, CEO

First of all, hi, Marc. Good to talk to you again. And we have seen early signs of increased demand both in Q3 and in Q4, early increased demand. I think that the best way to project what will happen during the time as the Joint Commission requirements come into effect is to look back at 2017, the last time they revised their water management requirements. At that time, we saw significant growth, and it wasn't limited to just a quarter or two. It was really a rising tide over the next couple of years. That was reflected in our growth rates in 2017, '18, and '19. So I do expect this to be an important medium-term event. I also expect it to be subtle. In other words, we won't double overnight in a quarter. It'll be something that happens over the course of the next couple of years. But I do think it's a pretty meaningful event that's happening.

Marc Wiesenberger, Analyst

Very helpful. Since August 1, alone, we've heard that there have been 13 hospital construction projects worth at least $500 million or more. We know that renovation projects involve water shut-offs and potential disruptions of the existing biofilms. So I'm wondering what kind of proactive initiatives the company and its partners are undertaking to get in front of these hospital teams, so that if there is a problem, Nephros is ready and on speed dial?

Andy Astor, CEO

The short answer to that is it's all about having the relationship with the central offices that build those facilities. To the extent that we have that, we can have beneficial conversations. To the extent that they're happening at places where we don't have relationships, it's more challenging. But both the Filtration business and the Pathogen Detection business have potential opportunities in those facilities, and I can tell you with certainty that we're pursuing them.

Marc Wiesenberger, Analyst

Great. And kind of dovetailing on the back of your PDS comment right there. Where are you seeing traction thus far with the Pathogen Detection's sales? And where are you and your partners concentrating more efforts and targeting going forward?

Andy Astor, CEO

It's fair to say that we are learning. The Pathogen Detection business, although we've been talking about it for a year and a half or so, is really only now beginning to start to generate revenue. We are being a bit of a chameleon to see where the markets are that are attracted to us. They include on-site testing at hospitals and commercial buildings that we've talked about before. But they also include potential opportunities with centralized testing laboratories which may be interested in our assays, particularly since they're multi-pathogen assays. The new Joint Commission requirements require a focus on multi-pathogens. Many companies today really only have regional and related assays. So we're learning and we're finding out what is out there. As I mentioned during my talk, we're working with consultants, where we've established a couple of partnerships with consultants who are bringing us some good new opportunities as well. So we're doing multiple things simultaneously to see how the Pathogen Detection business may evolve.

Marc Wiesenberger, Analyst

Very good to hear, two more from me. When I'm flipping through the queue right now, it looks like your largest customer in the quarter generated sales on an absolute basis that was the highest going back to 2019. I'm wondering if you could provide some insight into their activity in the quarter.

Andy Astor, CEO

We did have a significant concentration in the quarter with one of our distributors. There's a normal ebb and flow there. It is a distributor that's been doing quite well with us, and they had a good quarter. It's really that simple. I wouldn't say that we have - it's not indicative of a circumstance that I would consider abnormal in any way. They had a good quarter. And they've been growing nicely over the last couple of years.

Marc Wiesenberger, Analyst

Great, good to hear. And then the final one for me, as I continue to flip through the queue, I did see some discussion about some change in the Executive Team. It looks like at Specialty Renal Products. Can you elaborate on what's going on there?

Andy Astor, CEO

Sure. We've made a subtle change to the management of Specialty Renal Products. Darren Evans, who many of you know and who was the former CEO of Nephros, before I took that seat a little over a year ago, was the CEO of Specialty Renal Products. Darren is, again, an extraordinary executive, but he's not a dialysis expert. Now that we are getting close to approval by the FDA for the 510(k) of the HDF product, Darren is rolling into Chairman of the Board of Specialty Renal Products. His time commitment will be slightly lowered. I will take the CEO role, because it's now about the strategic decisions that have to be made about Specialty Renal Products. We will hire a Launch Manager/COO candidate to help lead the rollout into dialysis clinics. As I said, it's a subtle change; nobody is leaving who was involved. It's just a matter of how we organize the work. So Darren will be Chair of Specialty Renal Products, and I will take on the CEO role, as well as keep the CFO position that I've maintained.

Marc Wiesenberger, Analyst

Understood, but I appreciate the color. And thank you.

Andy Astor, CEO

Sure.

Marc Wiesenberger, Analyst

And that's all from me. Thank you.

Andy Astor, CEO

Okay, great questions. Thanks, Marc.

Operator, Operator

Our next question comes from Neil Kadoorie at Blue Firm Capital. Please go ahead.

Unidentified Analyst, Analyst

Hi, thanks. I was going to ask some of those questions that were just asked. So I'll come up with another one or two here. When do you think the water Pathogen Detection will be a material revenue driver, 10% or more of overall revenue, maybe?

Andy Astor, CEO

I don't know that I can answer that question. We don't have enough information to make that statement. It could happen; I would certainly think it will happen in the next couple of years. It may not happen in 12 months, but I would guess that it's 10% in a couple of years, except that if the Filter business grows the way we think it could, it may not be. So, could it be $1 million or $2 million in a couple of years? I think it absolutely could. I hope that answers your question, Neil.

Unidentified Analyst, Analyst

Yeah, no, that's good, thanks. And then on the dialysis side, could you - I've been an investor here for over a year. I think I understand it, but a lot of people are probably new to the story. Don't understand what will come post-510(k) approval? Can you just kind of explain the opportunity there a little bit and walk us through what might happen next year?

Andy Astor, CEO

Sure, so the HDF - indulge me and I'll tell you the background. Nephros was founded 25 years ago as a spinoff from Columbia University to develop an HDF product. HDF is a different kind of dialysis than traditional HD or hemodialysis that adds a pressure gradient, a convection element to the dialysis process. Many patients report feeling better after an HDF treatment. HDF is popular and represents roughly 15% to 20% of dialysis performed in many countries in Europe and Asia. Nephros created an HDF product that received 510(k) clearance back in 2012, but it was commercially unsuccessful due to clinician hesitance. After filtration grew and reached the $5 million to $7 million level, we turned our attention back to HDF and created a second-generation product that is now undergoing evaluation by the FDA for 510(k) clearance. The new product is vastly simplified and is believed to be a much more attractive clinical device. Once we get the 510(k) clearance, the next step will be to get the product into a couple of dialysis clinics and prove how it works in the real world. Many have been waiting a long time for this. It is also under a subsidiary of Nephros called Specialty Renal Products or SRP. Once SRP has a cleared 510(k) product, it raises interesting questions about how to fund a rollout or other strategic opportunities for that business. The potential opportunity is significant, as there are hundreds of thousands of dialysis patients, and even if just 1% to 3% are candidates for HDF, this could be substantial for Nephros shareholders. Neil, did that provide the background you were hoping to get?

Unidentified Analyst, Analyst

Yeah, that's great, thanks. And just one point I wanted to clarify, it's an attachment to the current standard of care, right, in dialysis today in the United States, is that correct?

Andy Astor, CEO

That is correct. It is not a standalone dialysis machine; it is a bolt-on or an attachment that allows a traditional hemodialysis machine to be converted into HDF. That conversion happens in a minute. We think it'll be pretty attractive to dialysis centers that have traditional machines they've invested tens of thousands of dollars in, as it provides an important feature for a fraction of the cost of the machine.

Unidentified Analyst, Analyst

Right. Well, Andy, thanks. Looking forward to seeing how the next 12 months play out.

Andy Astor, CEO

Me too. Thanks, Neil. Appreciate your patience and your confidence.

Operator, Operator

Our next question comes from Larry Cassie, a private investor. Please go ahead.

Unidentified Analyst, Analyst

I was wondering - how is your supply chain holding up as far as inventory levels and given the state of business right now, shipments coming over to you?

Andy Astor, CEO

Great question, Larry, thanks for asking. If you've been following us, you may remember that in early 2020, when the pandemic hit, we actually bumped up our inventory tremendously by 20% to 30%, even though our sales were declining, to avoid any supply chain interruptions. That turned out to be a good idea. We've been able to maintain that inventory, and we've had absolutely no issues, even with additional orders happening today. We've got a great partner in Medica, which does our manufacturing for us. We have a very reliable supply chain. However, I will tell you that shipping costs are exceedingly high. International shipping in particular is extraordinarily expensive, and that primarily drove our gross margin down a bit this quarter, as it's costing more than double to ship our filters to the U.S., but we are receiving them with no problems from our supply chain.

Unidentified Analyst, Analyst

Okay, thanks. And secondly, can you comment on October sales? What they look like?

Andy Astor, CEO

We don't usually do that. We don't usually comment on individual monthly sales. We've made a couple of exceptions where we've made a public statement, but I'll say this: October sales were fine. Since we're not going to release publicly about that, I can't say a whole lot more.

Unidentified Analyst, Analyst

Okay, thank you.

Andy Astor, CEO

You're welcome. Thank you, appreciate your questions.

Operator, Operator

Our next question comes from Ralph Weil of R. Weil Investment Management. Please go ahead.

Ralph Weil, Analyst

Hello, Andy.

Andy Astor, CEO

Good to see you. Thank you.

Ralph Weil, Analyst

I recently read that a company that perhaps you're familiar with called Outset Medical said that the Center for Medicare and Medicaid Services has approved the company's Tablo hemodialysis system for a transitional add-on payment, adjusted for new and innovative equipment and supplies, which is an add-on. Are we with the Specialty Renal Products product assuming that it will be approved? Will this be something that we can also pursue with this add-on payment?

Andy Astor, CEO

I will tell you, Ralph, I'm sorry to say that I'm not familiar with that. It sounds very interesting, and I want to look into it. I will be happy to get back to you about it, but I'm not currently aware of the add-on payment. It's not my area of expertise. I will find out.

Ralph Weil, Analyst

Well, this was announced by them this past week, November 1.

Andy Astor, CEO

I understand.

Ralph Weil, Analyst

I mean, from what I've heard in the past your product, the Specialty Renal Products product, will make it better for the patients etc., etc. But the question was, to some who was going to pay for this extra amount of money that it may cost? And even if it's a little bit more, doctors usually do what they can do to maximize profit or what dialysis clinics will do. But here, here's a scenario that might seem to me the Center for Medicare and Medicaid Services, if this really is better, may be inclined to cover some of it. So I do look forward to your answer. Okay?

Andy Astor, CEO

I look forward to the research because I missed that. It rang a bell in my head the same way it did in yours. So let me come back to you.

Ralph Weil, Analyst

Okay, all right. Very good.

Andy Astor, CEO

Thank you, Ralph.

Operator, Operator

At this time, we have no further questions. I'll now turn it back over to Mr. Andy Astor for any closing remarks.

Andy Astor, CEO

Okay, well, if you do have any further questions, I'll stall for another 20 seconds or so, and you can press the proper buttons on your phone. Otherwise, I'll say thank you for attending. We're excited for what '22 - well for the rest of the year, but in particular, what 2022 looks like. I'm excited to get back to revenue guidance. Please stay in touch and always feel free to reach out to me directly at andy@nephros.com. Thanks very much, everybody. Appreciate you taking the time out of your busy days, and you have a great rest of your evening. Bye-bye now.

Operator, Operator

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