Earnings Call Transcript - NEPH Q3 2020

Operator, Operator

Good afternoon and welcome to the Nephros Third Quarter 2020 Earnings 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, Investor Relations Officer. Please go ahead.

Kirin Smith, Investor Relations Officer

Good afternoon, everyone. This is Kirin Smith with PCG Advisory Group. Thank you all for participating in Nephros’ third quarter 2020 conference call. Before we begin, I would like to caution that comments made during this conference call by management will contain forward-looking statements regarding the operations and future results of Nephros. I encourage you to review Nephros’ filings with the Securities and Exchange Commission including, without limitation, the company’s Forms 10-K and 10-Q, which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements. Factors that may affect the company’s results include, but are not limited to, its ability to successfully, timely, and cost-effectively develop, seek, and obtain regulatory clearance for and commercialize its products and service offerings, the rate of adoption of its products and services by hospitals and other healthcare providers, success of its commercialization efforts, the effect on its business of existing and new regulatory requirements, and other economic and competitive factors. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live call, today, November 5, 2020. The company undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call except as required by law. I would now like to turn the call over to Andy Astor, Nephros’ CEO. Andy, please go ahead.

Andy Astor, CEO

Thanks, Kirin, and good afternoon, everyone. Welcome to Nephros’ third quarter 2020 earnings conference call. This is my first earnings call as CEO, and I’d like to start by expressing my gratitude to Daron Evans, who developed and led our turnaround strategy over the past five and a half years, growing revenues from about $1 million to over $10 million annually during that time. As many of you are aware, Daron continues to support our progress on a part-time basis, concentrating on building the pathogen detection business and also fulfilling the CEO role at our Specialty Renal Products subsidiary, where he is focused on submitting the second-generation FDA HDF product for clearance. I would also like to once again thank everyone providing essential services that keep our country running and our fellow citizens safe, often at great personal risk. I will now share a few highlights of our Q3 business performance and review our financial results for the quarter. I’m pleased to report that net revenues rose 34% compared to the previous quarter. Although they are still about 30% lower than a year ago, this increase from the prior quarter suggests some level of market stabilization following a difficult second quarter driven by the pandemic. Additionally, while net revenues declined year-over-year, I am happy to report that recurring install base revenues in Q3 returned to 2019 levels after contracting in Q2. We see this strong demand from existing customers as a key indicator of strength, further supported by our customer retention rate remaining above 90%. Our medical and water filter business continued to face declines in new customer acquisition and emergency response, which we mentioned last quarter. We’ve observed that, at this time, customers and potential customers are largely focused on pandemic-related issues and do not have the opportunity for proactive water testing and remediation or forming new vendor relationships. Anecdotal evidence from our network appears to confirm that this trend is present across the industry. I’m also happy to report that Q4 has started off relatively well, including our recurring and emergency response medical filtration businesses. Our commercial water business declined compared to last year as our hospitality and food service customers are still facing significant challenges due to the pandemic. Notably, we are optimistic about securing at least one large national contract soon, hopefully within this calendar year. In our pathogen detection business, we recently launched the DialyPath, our qPCR-based endotoxin testing system, aimed at dialysis clinics. Similar to our filtration business, we’re starting to see increased interest in our pathogen detection products like PluraPath, SequaPath, and now DialyPath. However, the commercial environment remains tough, and we have slightly slowed our marketing plans for the moment. We’re using this time to build the product and marketing infrastructure needed to support the anticipated growth in 2021 and beyond. In our Specialty Renal Products subsidiary, we are close to submitting the next-generation HDF product to the FDA, as I mentioned earlier. As reported last quarter, we experienced some delays in the manufacturing process for HDF, but we are nearing submission and hope to do so by the end of this year. Now, let me provide an overview of our financial results for the third quarter ending September 30, 2020. As many of you know, prior to the COVID-19 pandemic, Nephros experienced consistent year-over-year revenue growth for 15 consecutive quarters, averaging over 50% through the first quarter of 2020. The second and third quarters of 2020 posed challenges for the company. However, the fourth quarter has begun strongly, and we are hopeful that growth will continue quarter-over-quarter. Nephros reported net revenues of $2.1 million for the third quarter, a 31% decline from $3.1 million in the same period last year. This decrease of $1 million was due to factors related to COVID-19, including a downturn in our emergency response business and fewer new customer acquisitions. The net loss in the water filtration segment was $0.4 million, compared to $0.2 million in 2019. This increased loss was primarily a result of the reduced revenue I just mentioned. Adjusted EBITDA for this segment was negative $0.3 million, compared to negative $0.4 million in 2019. For more details about the adjusted EBITDA calculation and its reconciliation to GAAP net income or loss, please refer to today’s press release. Additional information regarding our water filtration, pathogen detection, and Retail Products segments and their operating results can be found in today’s Form 10-Q filing. On a consolidated basis, the net loss for the quarter was $1 million compared to $0.7 million in 2019, a 36% increase. The consolidated adjusted EBITDA for the quarter was negative $1 million compared to negative $0.2 million in 2019. The cost of goods sold in the third quarter was $0.9 million compared to $1.3 million in 2019, a 30% decrease. Gross margins for the third quarter were 58% compared to 59% in 2019. The 1% margin reduction compared to last year was mainly due to unfavorable inventory expiration and adjustments of $0.1 million during the three months ended September 30th. As mentioned previously, margin fluctuations are normal for a company of our size, and we expect future gross margins to remain within the range of 55% to 60%. Research and development expenses in the third quarter were $0.75 million, down from $0.78 million in 2019, a 3% decrease. Depreciation and amortization expenses were $49,000 in the third quarter compared to $44,000 in 2019, an 11% increase. Selling, general, and administrative expenses for the third quarter amounted to $1.5 million compared to $1.8 million in 2019, a decrease of approximately 14%, primarily due to reduced travel and marketing expenses because of the COVID-19 pandemic. Our cash balance at the end of the third quarter was about $5.2 million. Additionally, as announced on October 16th, Nephros raised an extra $5 million through a registered direct offering of 833,333 shares of common stock at a public price of $6 per share. In conclusion, I would like to introduce Dan D'Agostino, who is on the call with us today. Dan joined the team a few weeks ago and will officially take on the role of Chief Financial Officer starting tomorrow morning. He will lead our next discussion on financial results during our year-end earnings call, which we expect to occur in late February 2021. We will be participating in several financial conferences over the next few weeks, with details to be announced this Monday, November 9th. We look forward to engaging with many of you virtually at these events. In the meantime, please feel free to contact me directly at info@nephros.com. Dan and I will also be available at that email address. This concludes our formal presentation. I want to personally thank all our investors and stakeholders for their support over the years, especially during our recent CEO transition. I look forward to speaking with you all again soon. We will now take questions from the audience and also address emailed inquiries as appropriate. Operator, please open the call for questions.

Operator, Operator

Our first question comes from Howard Halpern from Taglich Brothers. Please proceed.

Howard Halpern, Analyst

Congratulations on navigating in a tough environment out there.

Andy Astor, CEO

Thank you, Howard.

Howard Halpern, Analyst

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

Andy Astor, CEO

Yes. You did hear correctly.

Howard Halpern, Analyst

Okay.

Andy Astor, CEO

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

Howard Halpern, Analyst

Correct.

Andy Astor, CEO

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

Howard Halpern, Analyst

Okay.

Andy Astor, CEO

This is an area of our business that we have no control over, as it's all inbound, so we'll see how it goes.

Howard Halpern, Analyst

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

Andy Astor, CEO

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

Howard Halpern, Analyst

Okay.

Andy Astor, CEO

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

Howard Halpern, Analyst

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

Andy Astor, CEO

I wish I knew Howard. But one of the reasons we have three products is that we can’t know for sure which one will catch on first. PluraPath is a very straightest line between infection control and infection control prevention. So it may be PluraPath. But DialyPath, by dialysis clinics, tends to make decisions more centrally. So there may be some traction there. And then SequaPath in answer to another part of your question that could be the biggest of them all by far, because its applicability is not limited to a medical facility; it can be used in any kind of a building, commercial, residential, etc. So we will have to see.

Howard Halpern, Analyst

And lastly, I know we’ve been consistent in progressing towards securing that commercial contract. Is it just with the same one, or do you have a group of them that might come together, or is it simply moving forward?

Andy Astor, CEO

It’s not just one opportunity and…

Howard Halpern, Analyst

Okay.

Andy Astor, CEO

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

Howard Halpern, Analyst

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

Andy Astor, CEO

We expect it to, yes.

Howard Halpern, Analyst

Okay. Well, keep up the good work and I have one more question. Dan, what…

Dan D'Agostino, CFO

Sure.

Howard Halpern, Analyst

If you can answer, what attracted you to Nephros?

Dan D'Agostino, CFO

Thank you for the question. I have known the company for about five years now. Andy briefly mentioned that there has been an incredible resurgence with Daron coming in and doing some of the heavy lifting. From my perspective as an outsider, Andy has put many processes in place to develop interesting products and a solid strategy for institutionalizing them. I see a lot of value in the products that are just beginning to gain traction.

Howard Halpern, Analyst

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

Andy Astor, CEO

Yeah. Good. Thank you, Howard.

Operator, Operator

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

Unidentified Analyst, Analyst

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

Andy Astor, CEO

You too, Todd. Nice to hear your voice.

Unidentified Analyst, Analyst

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

Andy Astor, CEO

Thank you. I appreciate your questions. Regarding the HDF side, we are simplifying a product that was designed and approved eight years ago in 2012. This simplification involves producing, testing, and creating a user manual for the product. We also need to conduct various tests, including stress tests, and if any issues arise, we must address them. Additionally, we need to coordinate with overseas manufacturers, which can be complicated. For example, we had shipping issues unrelated to the Alaska situation. It’s a complex undertaking. When we submit to the FDA for a special 510(k) clearance, there are two possible outcomes. They may accept it as a special 510(k), allowing us to move forward if they don’t comment within 30 days, or they may determine that it requires a standard 510(k) process, which could take up to 90 days or longer, especially in the context of the pandemic. I hope this gives you some insight into the challenges we face. Regarding the commercial contract, we have several possibilities but have been close to one particular contract for a few quarters now. We thought we were close two quarters ago and even closer last quarter, and I can say we feel closer now. However, these national contracts with major companies are generally slow-moving. We can apply pressure, but there are limits. This is a new area for us, and the timing will depend on how it develops, not on our push. I am optimistic that this will happen this year, and I believe there is a good chance, though it’s not fully within our control. As Howard mentioned, this will significantly impact our division, which currently generates less than $1 million, while the contract in question should be worth at least $2 million or more.

Unidentified Analyst, Analyst

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

Andy Astor, CEO

No. We send documentation.

Unidentified Analyst, Analyst

Thank you.

Andy Astor, CEO

You’re welcome. Thank you.

Operator, Operator

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

Jeremy Pearlman, Analyst

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

Andy Astor, CEO

Hi, Jeremy.

Jeremy Pearlman, Analyst

I have a couple of questions. How’s it going? In the past, you mentioned that the COVID situation essentially prevented outside vendors from interacting with hospitals. Have hospitals started to allow outside vendors again? Have you managed to establish any face-to-face commercial contact regarding picture filters?

Andy Astor, CEO

Yeah. Absolutely. I would say that Q2 was, I call it a ghost quarter. It’s a quarter that almost didn’t happen, right? In the April to June timeframe, the world was very surprised by what was happening and there wasn’t anything going on in terms of face-to-face contact. That’s changed. It’s normalized into a time where I think we all know how to operate in a pandemic, but it’s still difficult. And so, yes, it’s changing, but it’s changing slowly and it’s going to continue to change slowly over time, in my opinion.

Jeremy Pearlman, Analyst

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

Andy Astor, CEO

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

Jeremy Pearlman, Analyst

What has the reception been like from your customers for DialyPath and its most recently released product?

Andy Astor, CEO

Okay.

Jeremy Pearlman, Analyst

Are you marketing DialyPath to the same customers you interact with for your filters, or is it a different customer base, and have you been attempting to cross-sell at all?

Andy Astor, CEO

We are definitely engaging in cross selling. In our filtered business, we have three main customer segments: infection control in hospitals, dialysis clinics for water purification, and commercial and other. Our three pathogen detection products fit well with these categories. DialyPath is primarily aimed at infection control teams and hospitals, while PluraPath targets dialysis clinics. SequaPath is mainly a commercial product but can be used in all types of building management, both medical and non-medical. We are certainly cross selling and have an overlapping customer base. I hope that clarifies your question.

Jeremy Pearlman, Analyst

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

Andy Astor, CEO

Yes. Yes.

Jeremy Pearlman, Analyst

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

Andy Astor, CEO

You’re welcome, Jeremy. Thank you.

Operator, Operator

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

Kirin Smith, Investor Relations Officer

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

Andy Astor, CEO

Thanks, everybody. Take care. See you soon.

Operator, Operator

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