Nephros, Inc. (NEPH) Earnings Call Transcript & Summary

Good day, and welcome to the Nephros Inc. Fourth Quarter 2019 Financial Results Conference Call. [Operator Instructions] 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' Full Year 2019 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 services by hospitals and other health care providers, the success of its commercialization efforts, the effect of it -- on its business of existing and new regulatory requirements and other economic and competitive factors. The contents of this conference call contains time-sensitive information that is accurate only as of the date of the live call today, February 27, 2020. The company undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call, except as required by law. I would now like to turn the call over to Daron Evans, Nephros' CEO. Daron, please go ahead.

Thank you, Kirin, and good afternoon, everyone. Welcome to Nephros' 2019 Full Year Earnings Conference Call. I'll begin the call with a brief overview of our year and have provided a corporate update. Then I'll turn the call over to Andy, our COO and CFO, and he will give a deeper dive into the results. In 2019, the engine that we've built building over the last couple of years has started to run on all cylinders. Total revenues for 2019 were up approximately 82% versus 2018. We saw nice growth in our base business, and we're also fortunate to support a growing number of pathogen outbreaks in the back half of the year. We continue to work tirelessly to support our value-added resellers and end customers in our hospital business segment. We are seeing hospitals make great strides in their development of water management plans, which establishes the routine pathogen testing protocols, their proactive use of chemistry infiltration and their responsive plan in event of a pathogen outbreak. We are in the process of launching our PluraPath pathogen detection system through in-person demonstrations, webinars and with our hospital customers. Our early discussions are very encouraging. We've already received multiple purchase orders for systems that we believe that we will deliver before the end of the first quarter. We have opened a new office to focus on the development and high throughput manufacturing of the PluraPath assays. We currently offer our multipath strip with 15 different paths and test in a single assay delivered on-site in less than an hour. And we also offer monopath strips that enable the user to run 8 different water samples in 1 test, targeting a single pathogen of interest. We envision that users can use the multipass test to provide a broad pathogen screening. And once the pathogen of interest is identified, the monopath test can help to quickly isolate the source of pathogen contamination, which often stems from biofilm buildup in one or more segments of the building's water pipe system. We can support development of pathogen building heat map in real time, saving them valuable time in the process of isolating and treating and operating. We expect the PluraPath system to be used both as a tool for the routine testing prescribed by the water management plant as well as for the realtime support in outbreak situations. Near the end of this year, we expect to launch our SequaPath service, which will have the ability to provide full bacterial biomapping of a building's water system in as few as 4 hours. To provide this data, we will utilize both our portable PCR technology and portable gene sequencing technology to compare amplified bacterial DNA versus a database of over 20,000 different bacterial families and species. To our knowledge, this will be the most extensive, on-site, realtime bacterial testing available anywhere in the world. This will be truly cutting edge. In the dialysis segment, we continue to see our EndoPur footprint growing slowly as the customers realize the performance improvement possible with better filtration. We expect this segment to grow -- this segment continue to see slow but steady growth. In the second quarter this year, we expect to launch our biopath assay, which will focus on gram-negative bacteria and providing 1,000 clinics with a realtime estimation and detection levels. The infection test is a standard assay into the dialysis world to confirm the dialysis water is safe to use for patients. When clinics have tests that show higher-than-acceptable levels of endotoxin, they may need to shut down until they disinfect the water system and prove their levels have returned to those required for patient safety. A realtime antitoxin assay has the potential to save days to weeks depending on the level of contamination. Today, we're in the final stage of the validating the correlation of the DialyPath assay with standard introduction assays performed in centralized laboratories. We are excited about the potential to provide a realtime endotoxin measurement tool. We expect the DialyPath system to be used primarily in support of clinics that need to rapidly solve their contamination events. In our commercial segment, we continue to see steady demand for our products in the quick service restaurant, convenience store and hotel markets. We will soon be launching additional products that can provide replacement filters for more filter manifold types, opening up additional segments of the market for our filters. We continue to see to pursue large chain for long-term supply contracts to grow our base business. In regards to the second-generation hemodiafiltration product being developed in our SRP subsidiary, we have completed formative testing of the system and will hold formal design meeting soon. We then will manufacture our first batch with final 4 units and initiate our verification and validation testing. Currently, we are on path to complete and file our special 510(k) this summer. I'll now turn the call over to Andy for a financial review.

Thank you, Daron. I'll now provide a look at our financial results for the fourth quarter and for the full year ended December 31, 2019. First off, as is my habit, I'm very pleased to report our 14th consecutive quarter of year-over-year net revenue growth with an average growth rate during those 14 quarters of 63%. Nephros reported net revenues in the fourth quarter of $3.2 million compared to $1.6 million in the same period last year, an increase of 96%. For the full year, net revenues were $10.3 million compared to $5.7 million in 2018, an 82% increase. All of these results exceeded our revenue guidance for the year. As a reminder, we recognized 2 distinct business segments, Water Filtration and Renal Products. The revenues I just described were all generated by the Water Filtration business segment, which has also hit an important milestone here in the fourth quarter, achieving positive net income for the first time, which was $135,000 compared with a net loss of $147,000 in 2018. For the full year, Water Filtration showed a net loss of $1.6 million, down 32% from $2.4 million in 2018. Adjusted EBITDA for the Water Filtration business segment was $648,000 in the fourth quarter compared with $136,000 in the same quarter 2018. Adjusted EBITDA in the Water Filtration segment for the full year was positive $281,000 compared with negative $861,000 in 2018. 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. On a consolidated basis, net loss for the quarter was negative -- I'm sorry, net loss for the quarter was $144,000 compared with $664,000 in 2018, a 78% improvement. And for the full year, net loss was $3.2 million, a small improvement from the $3.3 million net loss in 2018. Consolidated adjusted EBITDA in the quarter was positive $376,000 compared with negative $256,000 in 2018. For the full year, consolidated adjusted EBITDA was negative $1.2 million, a 30% improvement compared with negative $1.8 million in 2018. Cost of goods sold in the fourth quarter was $1.3 million compared with $0.7 million in 2018, an increase of 92%. Cost of goods sold for the year was $4.3 million compared with $2.5 million in 2018, a 71% increase. Gross margins in the fourth quarter were 60% compared with 59% in 2018. Gross margins for the year were 59% compared with 56% in 2018. And we expect future gross margins to continue in the range of 55% to 60%. Research and development or R&D expenses in the fourth quarter were $0.8 million compared with $0.5 million in 2018, a 40% increase. And R&D expenses for the year were $3.1 million compared with $1.5 million in 2018, an increase of 101%. Depreciation and amortization in the fourth quarter was $44,000 compared with $40,000 in 2018, a 10% increase. And for the year, depreciation and amortization expenses were $186,000 compared with $163,000 in 2018, a 14% increase. Selling, general and administrative, SG&A expenses for the fourth quarter were $1.4 million compared with $1.1 million in 2018, an increase of 30%. SG&A expenses for the year were $6.1 million compared with $4.5 million in 2018, a 35% increase. Our cash balance at the end of 2019 was about $4.2 million. As you may be aware, in late January, we also completed a common stock offering, which generated approximately $6.7 million of net cash proceeds. I'll wrap up my introductory comments today or my comments today with the subject of revenue guidance. We are anticipating revenue growth in the 40% to 50% range in 2020 with additional growth possible depending on the timing and growth slope of our pathogen detection products and on the potential for larger-scale contracts in the commercial sector. For the full year 2020 then, we are setting guidance at $14.5 million to $15.5 million. In closing, we remain excited with the momentum we've been experiencing and with our future growth prospects. We look forward to seeing many of you at financial conferences this spring and at our annual meeting, which is scheduled for May 21. That's May 21 at our offices. More details will be released soon. In the meantime, please feel free to contact Daron or me directly at info@nephros.com. This concludes our formal presentation remarks. I would again like to personally thank all of our stakeholders for your continued support, and I look forward to speaking with you all again soon. We'll take questions now and also answer e-mail questions as appropriate. Operator, please open the call for questions. Thank you.

[Operator Instructions] The first question is from Anthony Vendetti from Maxim Group.

I just wanted to talk a little bit the guidance. Andy, you said the $14.5 million to $15.5 million doesn't include potential commercial side of the business. So that would encompass QSRs, hotels, stuff of that nature, convenience stores, correct?

I'm not sure I'd put it quite that black and white, Anthony. I would just say that we are anticipating total revenue growth of 40% to 50%. And we think that if we get some breaks, we can -- it can be higher, particularly due step by success in the commercial sector and in -- potential growth in pathogen detection.

Okay. Maybe Daron, more for you, in terms of the color on the opportunity there. I know you mentioned on the last call, you've had some pretty extensive discussions. Is there -- is that still where it's at? Or any comment that you can make on what that opportunity is or where it's at today versus the last conference call?

Yes. Sure. We're still in the process of working with these large companies that they're big and they move pretty slowly. The range of opportunities is sort of in the $1 million range per year up to the [indiscernible] it was multi-million, more than $5 million a year. It's just -- the probability of success, we don't have a long history of chasing these big contracts. So we just can't really rightly include them in our risk weighting. But if we get them, it's a step change. They have multi-million dollar step change from the commercial side. And that's just -- if we get them, then it's -- we kind of see is upside bonus. And if we don't, we actually have a relatively nice growth path. They'll be more conservative, but not the step change capability. So we don't know more than the other bidders, the RFPs, but we think we've got a pretty good job to get 1 or 2 of these things.

Okay. Great. That's helpful. And then in terms of the dialysis business, the hemodiafiltration. I think you mentioned you're on track with the 510(k) there. Can you just talk about what that opportunity could be assuming clearance there and whether it's this year or next year? What's the opportunity in that space?

Yes. When we think about it, if you look at Europe as an example being 10, 15 years ahead on HDIA about -- a little more than 15% of the market uses HDIA. And so for the U.S., if you sort of apply our model, which is we're an assist device for a current footprint of HD machines that provide to the dialyzer in a tube set and a machine, if we had 15% of the U.S. dialysis market, that would be sort of the $60 million to $75 million opportunity for us. But I rely -- I would doubt that we're going to get there tomorrow. So our path is to get approved. We'll be back in the market, go back to some of the clinics that we were there before, work on making sure we fit in the procedures that are different between Fresenius and Davita and the rest of the dialysis community. And then create an easy button, which we didn't give last time. It wasn't easy to use our system. So we created an easy bottom that we're going to try to then get back in the market and then have some logical portion of patients who -- of whom this works better than normal dialysis. And so I can't really give any guidance on what we're trying to achieve. Every machine we place, if it's fully utilized, it's $17,000 to $20,000 of revenue. And right now, the HD market, there's over 200,000 machines in place and being utilized. So that's -- I give you a scope of what's possible. And it all depend on where DaVita and Fresenius and others decide to use the system and on which patients.

The next question comes from Howard Halpern from Taglich Brothers.

Congratulations on the quarter and the year, guys.

Thanks.

Thanks.

Talking about the commercial segment. How large now is your sales team as you head into 2020?

On just on the commercial side, it's really just a couple of people. It's a small operation.

Okay. And you talked a little bit about, I guess, the manufacturing of the strips and stuff. Is that in the U.S. or is that local?

That will be -- Go ahead, Andy.

Okay. It is in the U.S. It will be in Nevada, which, for a variety of reasons, makes sense. And so we're building it there. And yes, we'll we doing it ourselves. It will be a local U.S.-based operation.

Okay. And I'm may be jumping ahead, but is there a potential to consistently add to the number? I think now it's like 15, but could you add additional tests for different pathogens?

Absolutely. So if you think about what I talked about the SequaPath, ultimately, what we envisioned is going into a building and whether it's because of insurance company who's entering the building want to see what's there or if the building engineers want to see the full biome, which often is kind of scary to think about it if you can see what exactly lives in the pipes. But we can go in and do that. And then each system might have its own biome, might have its own problem books. And so if you can envision a few years out, we come in, do SequaPath, give a full heat map, full biome testing of the building, figure out what are the problem of that building and have a custom strip. And these are just DNA assays you could somewhere off the shelf, some or some of subgrade papers, but it wouldn't be hard to make any given assay once you have the bacteria identified because they're just DNA and they've all been sequenced. And so we can have custom strips per site so they can track their own progress on getting rid of their bad boy bugs.

Right. And how important -- I'm pretty sure it's important, but how important is the data once you actually building this out as to, for instance, you do with buildings in certain areas. You go to other buildings in those areas. Does that typically have similar pipes, I guess, or stuff in the pipes?

Well, you end up with a base water source that might be similar and might have a similar, equal levels of contaminants. But once it gets on the building, whether the backhoe from Fifth Avenue hit the -- hit the hospital in Fourth Avenue would be different dirt than the backhoe from the 27th Avenue. It really has a chance of sort of building its own on a home basis. So it's very likely that a single water supply supplying a bunch of hospitals might have a similar starting point. But once the source of contamination wouldn't just be from the water pipes, it could be from other more localized sources. So each building truly will have its own biome.

And we do think, Howard, that there is value to the data. It's early days, and we don't know exactly what that looks like. But if we've got data on 1,000 or 2,000 or whatever number of sites, there's information that should be extracted there.

Okay. In terms of outbreak business, is that -- was that in the fourth quarter? And so far in this year, has that been relatively steady based on the temperatures that we've been seeing?

It's an interesting question. We can't really talk about this quarter in terms of results. But last quarter was a strong quarter for outbreaks because it was warmer than usual. Without going into numbers, this quarter has not been as strong as outbreaks, and you wouldn't expect it to be because while the overall temperatures are a little bit warmer, it's still pretty cold outside. So we don't tend to get a lot of outbreaks.

Okay. And one final one. Based on the revenue guidance that you put out there, how you performed in the fourth quarter is getting to or getting to or close to a positive EBITDA probable in 2020?

I try really hard not to get ahead of our skis in terms of projections. What I would point you to is this. We have the Water Filtration business is 100% of our revenue. So that's the business that is our growth engine that exists today. That is not only EBITDA positive, not only adjusted EBITDA positive, but it is actually net income positive. So that business is on a solid footing to be profitable and to continue to increase its profitability. The other business is the PluraPath Pathogen Detection business. And the SRP HDS business are development space businesses, and they're going to take investments. And depending on how those investments go, the overall consolidated report is going to have to be -- is a little unpredictable. But we're only investing because we believe that those business was -- will be profitable in the future. So with all of that, I'm not going to answer your question.

Okay. And I'll say one final question, too. With the PluraPath and the other one that you're developing too, are we going to see a series of papers or consulting reports come out based on immediate results with some of the early customers that you engage with?

We would very likely not be producing any papers based on a specific customer site in regards to the PluraPath. You noticed that we don't publish who our customers are for the water filters because if we're there in emergency reasons and there's other stuff going on, they don't really want to call attention to that. There's a couple of press releases where we've been mentioned as the filter that came in and made it all work. But what we will be doing is publishing our comparisons of our own test internally to centralized labs to other sort of standards so that we can sort of show and prove to our customers that it works. So we've already got one white paper out there for Legionella. We'll be adding more to that over time. So for each different pathogen that we have on the strip, you'll see a validation test. And then for things like the introduction levels, that's one that's very easy to do where we just test water in the lab and then also send it off to a centralized lab and not call into question any particular clinic. So we will be publishing papers and things that customers could see the assays and how they work, probably not calling any particular customer out.

The next question comes from Michael Brcic from National Securities.

Congratulations. Actually, most of my questions were answered. But I just wanted to go a little bit deeper on a couple of things. On the commercial side, you said you had a couple of salespeople. Is that the type of business that you're going to have to grow by growing salespeople? Or are they more leveraged in the sense that they're signing up distributors and then they end up distributing and increasing your client base?

It's a combination, Michael. It's good to hear you voice. And it's a combination. The core strategy that we have is to go after large national contracts as Daron referred to earlier. And that is a very -- that's a very senior, low number of persons like 1, to focus on the industry and get the big accounts. We also are more than dipping our toes in going after local operations and then sort of working up from there. And that's the second one of those, which is less developed than the first would over time be one that you'd show people at. That would be more regional. But I don't think that the investment mix -- I don't want to overinvest too quickly there because we don't have the reputation yet. We're starting to bring in regional people on the hospital side because we're #2 in the industry, and we're pretty well-known at this point. I don't want to spend -- I don't want to throw good money after bad. It's not really the right point. But I don't want to spend too heavily in a market where we're not that well-known yet.

Right. Right. Just as a side, if we talk about manufacturing, my understanding was stuff was manufactured in Italy. Is that going to be moving to the states? Are we talking about 2 different things?

Two different things. The medical filters that we sell are manufactured in Italy. The commercial filters that we sell, we actually manufacture here in Nevada, in Las Vegas. And the PluraPath, the pathogen detection materials that we were talking about, the assays themselves will be manufactured in Reno.

Got it. And I assume the guidance for the year is all filtration, right? You're not counting anything else in the guidance?

Well, we're hoping to have some positive numbers from pathogen detection, not counting on anything significant from -- we're not really counting on a great deal of revenue from either one, but we'd like both of those numbers to be somewhat positive.

Right. The -- you were talking about the tests and the outbreaks, and it was warmer in the quarter before and now, is there any, I don't know if seasonality is the right word. But obviously, does the change in weather, where it's going from warner to cold or cold to warm, does that have any sort of effect on those?

Well, we don't have scientific answers to that. But I can tell you that looking at the data for the last 3 years, Q1 is always a slower rise or, even in some cases, a slight fall from the previous quarter even though it's a great deal higher than the Q1 before that. Q1 is just -- and so it does appear that there's some seasonality to the cold winter months. It's not a great deal of seasonality like Christmas for retail. But it's -- there does appear to be some, well, some...

Lull.

Some lull. Exactly.

Congratulations again.

Thanks, Michael.

The next question comes from Bob Wasserman from Benchmark Company.

Congratulations on a big year. Just real briefly, I know that you've guided revenue growth guidance in 2020. Can you give us a little color on the core business, the filter business? Are you looking for new sites, new facilities? Are you looking to sell more filters for each facility? Maybe a little bit more color on how that breaks down.

Yes. The short answer is yes and yes. We monitor closely, although we don't publish, but we monitor closely our sales from existing customers or increases to our existing customers and also the addition of new customer sites. We're adding new customer sites at more than 1 -- throughout 2019, we added more than 1 per day on average, 1 per business day, which is pretty great. And at the same time, our customer retention rate was 94% measured quarterly, which tells you that we're keeping our customers. And indeed, over the course of the year, they accounted -- our existing customers accounted for 62% of our revenues, which I think is a really healthy number. It's not 98%, which would tell you that we're not getting enough new customers, nor is it 10%, which means that we're losing customers. It's a good, healthy sort of 2/3 of our revenue is coming from existing customers. The other color I would give you, which isn't -- is a little bit different than what you asked about is that we postulate that the reason is that we're becoming more known in the industry. But our response to outbreak business increased 142% over 2018. So that's another area. And by the way, some of those are existing customers, but more of them are new ones. So that tells you that the reputation is out there and bringing new customers into the fore as well through the outbreak response. Is that helpful?

Yes. That's great. And maybe just a little bit on the trend. Are you seeing, in terms of new customers, are you seeing kind of growth in certain geographical areas? Are you seeing growth in the sort of types of facilities? Or is it all across the board?

Well, it's all across the board. I would tell you that we're strong in the New York metropolitan area. We're strong in California. We're strong in the Midwest. I think we could -- and when I say strong, there's plenty of room for growth. But I think we've got a pretty good base in those 3 areas. I think the Southeast and the Deep and the South like Texas area, frankly, the whole Southern Belt could be stronger. And we're going to work on that this year. But we have sold product over the last 3 years to all 50 states plus Puerto Rico. So we're everywhere, at least to some degree.

Okay. Great. Congrats on a good quarter.

Thanks, Bob.