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

Good afternoon, and welcome to the Nephros, Inc. Second Quarter 2020 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 Group. Thank you all for participating in Nephros' Second 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 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, August 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 Daron Evans, Nephros' CEO. Daron, please go ahead.

Thanks, Kirin. Good afternoon, everybody. Welcome to Nephros' Second Quarter 2020 Earnings Call. I would like to start by, once again, thanking all of those providing essential services that are keeping our country moving while putting themselves at risk. It's no small feat that we're continuing to progress in this pandemic. Today, I'll provide a few highlights on our various business units and then pass Andy Astor, our CFO, for a recap of the financials for the quarter. In the second quarter, we spent most of our efforts adapting to the new norm. We transitioned from an in-person sales meetings to Zoom meetings. We modified our work practices in the laboratories and offices and warehouses. We juggled workloads when a few of our team members came down with the virus, all thankfully have recovered. We redirected some of our research to focus on issues related to pandemic. We as a group have followed the state and local guidelines to do our part to help bend the curve. This is an unique time in our collective histories that we'll all remember. Our Medical Water business saw a steep sales decline, driven primarily by a dearth of new customer meetings and lower-than-projected outbreak business. We believe that our hospital customers and potential customers were focused on solving the myriad of new issues created by the pandemic. At the beginning of the third quarter, we started to see signs that make us optimistic. Things will not return to normal, but we believe that our business model will be effective in the new normal. Our Commercial Water business also saw a steep decline as hotel and food service customers effectively shut down for a few months. In this business, we are also seeing recent signs that make us optimistic going forward into the new normal. Additionally, we believe that we are on track to secure at least 1 large national customer this calendar year. In our Pathogen division, we had to slow down on our launch plans of PluraPath, our multi-pathogen qPCR testing platform. We redirected our research efforts to accelerate SequaPath, our wideband bacterial detection system that uses QPCR and DNA sequencing. A pre-print article is now available online, highlighting the bacterial risks in unoccupied buildings and showing that simply testing for Legionella may not be adequate to ensure water safety. We did delay our research on DialyPath, our qPCR-based endotoxin testing system. That launch is now expected to occur before the end of the third quarter this year. As with our other business units, we have seen recent positive signs in our Pathogen division. We were able to resume PluraPath launch efforts, albeit not in person. More and more potential customers are shifting to the new Zoom reality. We are now able to provide SequaPath as a service through certain strategic partners. In general, the new normal will include a heightened sense of awareness around microbes and their risk. Additionally, we have no need to explain what PCR means anymore. In our renal products subsidiary, we have a few small delays related to the pandemic. In the next few weeks, we'll complete the production of the HDF systems, tube sets for verification and validation. We will likely be able to file the special 510(k) in the fall, which is behind our original time line, but no longer the bottleneck in our path to commercial relaunch. In dialysis, as a whole, we saw the whole industry change in a heartbeat. The traditional business model of the 20-person dialysis clinic became imperfect in the face of the pandemic that is devastating in people with underlying health conditions, requires extreme social distancing and uses high level of PPE. We also observed many COVID-19 patients need acute kidney support. There was an acceleration of trend to shift to home dialysis, which also increased the cost and complexity of treatment. We are monitoring the market to ensure that we find the smoothest path back to patients. Now I'll turn the call over to Andy, who will talk more in detail about the most recent analysis we are performing to better understand the microorganisms around us.

Thank you, Daron. I'll provide a look now at the financial results for the second quarter ended June 30, 2020. As many of you know, we speak frequently about Nephros' consistent year-over-year revenue growth, which extended to 15 consecutive quarters in the first quarter of 2020. Unfortunately, we did not extend the streak to 16 this quarter, this past quarter, due to the significant interruptions associated with the COVID-19 pandemic. Nephros reported net revenues in the second quarter of $1.6 million, a 32% decrease compared to $2.3 million in the same period last year. Virtually all of these revenues came from our Water Filtration business segment, and the revenue decrease came entirely from our Hospital segment within the water filtration, primarily because of the hospital industry's singular focus on COVID-19. Net loss in the Water Filtration business segment was $0.9 million compared to $0.3 million in 2019. This increased loss was primarily due to the reduced revenue that I just mentioned and also to slightly lower gross margins, which I will discuss in just a moment. Adjusted EBITDA in the segment was negative $0.7 million compared to breakeven in 2019. Please refer to today's press release for more details about our calculation of adjusted EBITDA and its reconciliation to GAAP net income or loss. Additional information about our Water Filtration, Pathogen Detection and Renal Products business segments and their operating results can be found in today's filing on Form 10-Q. On a consolidated basis, net loss for the quarter was $1.7 million compared with $0.9 million in 2019, a 76% increase. Consolidated adjusted EBITDA in the quarter was negative $1.4 million compared with negative $0.5 million in 2019. Cost of goods sold in the second quarter was $0.7 million compared with $0.9 million in 2019, a decrease of 28%. And gross margins in the second quarter were 57% compared with 59% in 2019. The margin reduction compared to a year ago was due to increased shipping rates during the pandemic as well as increased warehousing costs that are associated with our Aether division and the Pathogen Detection business. As we've said before, margin fluctuations are normal for a company of our size, and we do expect future gross margins to remain in the range of 55% to 60%, which has been our consistent range for the last 3 years. Research and development expenses in the second quarter were $0.84 million compared to $0.80 million in 2019, a 5% increase. Depreciation and amortization expenses in the second quarter were $47,000 compared with $48,000, a 2% decrease from 2019. And selling, general and administrative expenses for the second quarter were $1.6 million compared to $1.4 million in 2019, an increase of 15%. Finally, our cash balance at the end of the quarter was about $7 million. In closing, we remain resolute about saying strong during this extraordinary time and excited about our future growth prospects. We look forward to seeing many of you virtually at conferences this -- financial conferences this summer and fall. And in the meantime, please always feel free to contact Daron or me directly at [email protected], which goes directly to the 2 of us. This concludes our formal presentation remarks. I would like to personally thank all of you and the rest of our stakeholders for your continued support and look forward to speaking with you again soon. We will take questions from the audience now and also answer any e-mailed questions as appropriate. Operator, please open the call for questions.

[Operator Instructions] The first question comes from Howard Halpern with Taglich Brothers.

Congratulations on handling that tough environment in the second quarter.

Thanks, Howard.

In terms of, I guess, what you're seeing in the beginning of the third quarter, could we say that existing customers that were focused on other things in Q2, are they starting to come back and fulfill the requirements of updating the filters when due? And are you seeing that activity sort of back up and be fulfilled in the third quarter?

Yes. As Daron said, it's not normal, it's the new normal. And so it's not like a switch got thrown and everybody is back to normal business. But I think -- and it's only been 30 days since the quarter began. So with all of those caveats, I'll say that it's safe to say that we are seeing a stronger performance in the beginning of the third quarter that we saw -- than we saw at the end of the second quarter, and we certainly hope it continues and are doing everything we can to ensure that it does.

And are you seeing some new customers also in the mix?

Very few. It's really hard in this environment to establish new relationships. Our business is a relationship-based business. We normally, our sales organization spends a lot of time on claims. And it's not just us, but our distributors who are the principal tip of the spear that sells to our customers, just nobody can get into hospitals right now. And so it's just -- it's hard. So we're seeing instead of 1/3 of our business coming from new business, we're seeing more like 1/6 of our business coming from new customers.

Okay. And could you describe a little bit what kind of reaction you got or feedback you got from -- when you published the paper for the SequaPath?

Yes, I'll take this one, Andy. So the primary goal of that paper was really to start to kind of, I wouldn't say, chum the water, but begin to shift the conversation around what makes a building safe. There's been sort of 2 schools of thoughts in the professional circles in sort of at the regulatory level. A majority of water treatment folks just asked for Legionella because that's what the regulations say to do. A couple of forward-thinking ones have been pushing on looking for a broader band, and we're more aligned with those folks because when we see hospital outbreaks, it's not Legionella every time, there's Pseudomonas, Burkholderia, there's a bunch of others that cause just as terrible of an outcome as Legionella. So it's not -- it doesn't make sense to just look for one, and that was the whole premise of the PluraPath system. So when we looked at who read it, the right people in the right places read it. New York Department of Health, who leads the nation in kind of thinking around buildings; CDC, some members there. We're definitely early stages in this conversation shift. But what we can tell from the different groups who debate guidelines and debate regulations, there's definitely the people who have been pushing for the broader band have gotten more data to now then push for the broader band. So it's early days in this whole conversation, but we believe, over time, the right answer is to look for everything that could possibly kill you. And then narrow it down to what you might have in your pipes, and then narrow it down to what you could fix. And that's kind of the thesis that behind the whole cascade of the SequaPath, which looks at everything. It's a complete biome of a building to then figure out what are the ones that you have to worry about because that's what's in your water, and they won't go away once they're there. And so then you use the PCR to negatively exclude their existence, with a good water management plan that's managed by our distributors. So I think that's the whole thesis behind this. And we're seeing that conversations are going to shift.

Okay. And is it not only office buildings that you see as potential customers, do you see, which is likely to open up first, school districts around the country? Are school buildings part of your plan, too?

We haven't spent a lot of our own personal effort and time in sales point of view to look at buildings outside of hospitals or wherever one of our distributors sort of pulled us into, but we're starting to see that, like we see it in prisons. We see it in lots of other places, where -- anywhere you have a building with water, with people in the cramped spaces that might have been sitting around for a little bit, it's going to be an issue. So long term, I see every commercial facility on the planet having to do something to just make sure that they're not going to cause risk to whoever is buying a coke or drinking from the water fountain on the fourth floor. How long will that take? I have no idea. But -- and we do believe that what's happening in hospitals, where they have the most acute immune sensitive patients will eventually transition to the rest of the commercial world of water as long as it's easy, cheap, convenient and doesn't create too much of a headache to execute, which is kind of the goal of most of the systems we're working on.

[Operator Instructions] The next question comes from Anthony Vendetti with Maxim Group.

Daron, I was wondering if you could talk a little bit more about the large national account you have in the pipeline that you expect to close by the end of the year. Is that a QSR or a it's a whole of panel chain? Can you give a little more color on that?

It's in the food service world. Okay. But if you can imagine our -- upon closing something of that nature, we would request the ability to pull aside, who, what, when, where, why, how? If -- when and if we have permission for that, I'll absolutely let you know. But in general, we'll be able to talk about the revenue shifts that occur as they occur.

Okay. And then you were talking a little bit about how it's much more difficult to access new customers. Andy mentioned this quarter, 1/6 of the businesses from new customers down from 1/3. In terms of Zoom calls, how are you getting even that 1/6? Is it prospecting by phone and then setting up a Zoom call? How is the sales force building the new customer pipeline during this pandemic?

Yes. So nothing really happened in Q2 because our partners, the water treatment professionals in the field, they weren't allowed in the building for the most part either. So the ability for them to get in and have their conversations and do their work, do their sampling sometimes, so this didn't happen. The way that we had conversations right now is a majority of our distributors, they have -- we're not fully penetrated in their footprint. So 1 of them has 1,000 hospitals. Well, we're not in -- we're not in more than 15%, 20% of them. So the way we get new customers right now is the way we got them before, we just support via Zoom, is that coming in and doing a round of meetings in a town with whoever is around. So it's a little more scattershot, but it is partnering with our water treatment professionals who then need to change an -- update a performance procedure or update some other procedures around their water management plans. And that's what when they'll be brought in. So it's a similar path, leveraging relationships that our distributors have, just not necessarily proactively driven by, "Hey, we're going to be in town, let's go meet everybody you know." It's more of a, we're having to hope they pull us out and proud that we're able to pulled in. So it's getting better day by day, but that's how we do it.

Okay. Makes sense. And then lastly, on the delay due to a shortage of PCR. Obviously, polymerase chain reaction is how some of the COVID-19 tests are done and the reagents associated with that. Are you confident that by the fall, you'll have enough PCR to go forward or its' hard to tell at this point?

So the -- our PCR is ready to go. Like the PluraPath we're making, we're selling -- we actually make mono strips. So if someone has a particular bug they're worried about, we could make strips of just that bug, so they can do 8 tests at once. What was delayed with our DialyPath, which is the endotoxin testing, that was planned for Q2. SequaPath was planned for sort of Q3, Q4 because it's a little more complicated, but given the opportunity we had to look at unoccupied buildings and look at the biome, that really is going to show the power of the system to do an initial assessment of what do you have? What's your problem? Let's figure what's your problem is so I can be able to solve it. We just accelerated that work. So the DialyPath is it's a Gram-negative backbone that's consistent across all Gram-negative bacteria plus some specific test of Gram-negative bacteria that are consistent with dialysis units. That assay is just -- we didn't validate it yet. We had the assay, but we didn't go through the work to validate it to be able to go sell it. We just accelerated the SequaPath to get it out ASAP because it's more germane to the current environment. And then DialyPath will be ramping up pretty soon. But we did make some changes to our PluraPath based on COVID-19 because we had some virus tests in there, with norovirus and rotavirus, which are useful for cruise ships and other places. The reagents that work on breaking down the cell walls around the RNA-based virus like those, those, obviously, like the price spike by 100%, and the supply was 0 because they're all being used for COVID. So we remove the virus assays from our PluraPath, added a couple of other bacteria that we hadn't list out anyway. But otherwise, the reagent for bacteria are all available and plenty in stock and we can make whatever assay we need to right now.

Okay. So the only real shortage is, obviously, for the virus assays, and temporarily remove that from PluraPath or some of them anyway, focus on some of the others. And then when, A, the prices get -- become more normalized and there's -- those particular assays are easier to re-implement and then you'll do that at that point?

And we actually have -- we had a stock of reagent prior to this pandemic having breaking out, and we're running through the validation. So we can actually make the assay now. We just -- we couldn't make 10,000 of them. We can make probably couple of thousand. We, obviously, want to have it as a core product that we don't know when we're going to be able to replace it. So if someone has a rotavirus problem, we can go make an assay and help them solve that.

The next question comes from Wayne Cadwallader with Elkhorn Partners.

Quick one. Unfortunately, I got into the call a little bit late. What's the balance sheet in terms of cash that's on there? And how much do you think you might end the year with? First question.

Cash is $7 million at the end of Q2. And I don't have a projection in front of us, but we plan on being in very good shape cash wise for the foreseeable future. We don't have any -- we don't foresee any capital needs.

Because of this pandemic, is it opening up opportunities that you might not have had in more public forums, like in stadiums and other places, where people might want to -- and the cruise ships I heard mention there, opportunities to sell products now into other areas that you wouldn't have had 6 months or 8 months ago? And if so, what steps you're taking or actions to try and open up those sales channels?

You know 6 months ago not many people knew what PCR meant, and that it was a very useful tool, and now it is. And so while on the water filter side, I don't think that the pandemic changes the model or the opportunities in the near term, the -- on the path detection side, everyone now believes that PCR is a gold standard, so why wouldn't use it. So we're seeing some quotes to be put out there for office building complexes that have been vacated to go do a SequaPath test or a different way of working cooling towers. And there's -- I think the pathogen side, if you look at the -- our projected slope of growth of that business, prior to pandemic, post-pandemic, probably the slope got a little steeper because the buy end time and the soak time and the think time is going to be shortened for people who have the issues. We haven't been able to get out there and fully press the market with the tool. We've been working with our distributors to make sure they know it exists. And they've had Zoom videos on training and they're out there starting to quote, but we're still in very early days of that product. We've had a sale to a customer with a kit and a bunch of -- sorry, a system and a bunch of kits for testing, and we could -- and that's not in our core business unit, not in the hospitals, and we can see that -- I can foresee that happening more and more sooner than we had expected. That was going to be more with year 2, year 3, I think the person is in some of these different markets, and I think that may be accelerated. But I can't tell you how fast or where the place it will be come from.

Okay. Next question. Based on that, what I just heard, it sounds like it's a very difficult process unless you're physically there to demonstrate the product to get that sales. So until such time that you can become -- get into front of people and demonstrate it and go through a beta test or whatever, it's really going to slow the sales channel down significantly or to some degree until such time that you're able to get into sites more and to meet with people face to face. Would that a complete statement?

I'm not sure I would concur with that. So getting the meeting is sort of the hurdle because there's a bigger fire in the room in most places. Once they say, "Hey, I need this," then we've actually been pretty effective at setting up webinars to walk them through it. We have them send some water samples, so we can have the webinar include their test, their example, water sample. And the belief about PCR and its effectiveness is now inherent. And so we're not having to spend time discussing that. So once the contact is made and the need has been determined, then the path to sale is actually probably faster.

Have you looked at ways of getting more into some of the major news media outlets as to what you can bring to help with this whole pandemic thing and everything like other opportunities just to create some noise?

We've -- go ahead, Andy. No, you go ahead.

We do. Go ahead, Daron. Okay. We're are looking at that. We're early stages with media relations, but we are looking at it. And we actually completed our results just a couple of weeks after the New York Times published a pretty significant article on the topic of unoccupied buildings. So we're early stage in that process. But we are knocking on doors, and hopefully, we'll get some coverage in the non-investor media space in the future.

The next question is from Henry Link, a private investor.

Is there any type of patents or other protection on the testing protocols for the SequaPath?

The pathogen.

Patents, patents, patents.

Okay. We have filed some patents on the process that we undertake to do our pathogen detection analysis because we use a small filter in a different way, and we have a process of concentration, lysing and other things. So we filed for it. The real secret sauce in this space is: A, it's concentration, so sample concentration; and then B, it's the actual assay, so the DNA chain, the link of the chain that you decide that you're going to test for and its specificity versus other prospective crossovers. And so people could probably copy this and they can, they will. What they'll find is that we have a pretty good filter, and we've actually offered our filter to others who are doing this space because the concentration step is a key component to this. And then that's one that we kind of have a lock on from a who can do a liter in a minute versus the small disk filters that take a very long time to concentrate. And they're not as small, and poor size. And then the assays themselves, anybody can go make an assay, it takes a long time. And so we've got a head start on those who haven't been thinking about things like Legionella from that point of view, and those who really can't patent it. Mayo's failed patent on some of the breast stuff a couple of years ago, made sure that you can't patent nature. So we're -- we have a patent in the process. Will it block everybody? Probably not. Will it allow us to have a conversation with anybody and get closed? Yes.

How long ago did you file?

We filed the provisional for the PluraPath more than a year ago, so we've actually filed the official. And the DialyPath, we filed provisional, but we're to file the full one in about 2 months, I think. And then the SequaPath one, we're debating what pieces of that puzzle we can lock up or which is the continuation of the PluraPath.

Okay. Great. So it may take a couple of years yet to actually get the patent.

Yes. This is -- with these kinds of patents, it's a 2-or 3-year process.

At this time, we have no further questions. So this concludes our question-and-answer session. It also concludes the conference. Thank you for attending today's presentation. You may now disconnect.