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

Good afternoon, and welcome to the Nephros, Inc. Fourth 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, Investor Relations. Please go ahead.

Good afternoon, everyone. This is Kirin Smith of PCG Advisory. Thank you all for participating in Nephros's full year 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's 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. Contents of this conference call contains time-sensitive information that is accurate only as of the date of the live call today, March 1, 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 Andy Astor, Nephros's CEO. Andy, please go ahead.

Thank you, Kirin. Good afternoon, everyone. I'll spend a few minutes reviewing our business operations and then turn my attention to the company's financial performance. But first, as with all of our earnings calls in these pandemic times, I'd like to express my gratitude to all of the essential workers who continue to keep our country moving and our fellow citizens safe. As you are aware, our business takes us into these health care facilities where we provide products and services to keep health care workers and patients safe. And to that point, I would also like to extend a sincere thank you to all of our Nephros' employees and our partners and distributors for continuing to provide excellent service and support through an incredibly difficult 2020 and into 2021. Now onto our results. I will begin with our Water Filtration core business segment. And candidly, the water -- the Nephros Water Filtration business had a challenging year in 2020. After 15 consecutive quarters of revenue growth averaging 60%, sales in 2020 were down 17% compared to 2019, while cash burn and net losses increased. The 2020 revenue downturn was driven by the COVID-19 pandemic, and it manifested itself primarily in 3 ways. First was a reduction in our emergency response business. This is the business in which we respond with filtration solutions to outbreaks of water pathogens and associated diseases. The reduction of this business appears to have been an industry-wide pattern, driven by health care institutions being focused primarily on COVID-19 during the year. The second major contributor to the revenue downturn was the reduction in new business as access -- I'm sorry, as accessibility to facilities and new customers in our core markets were significantly restricted due to COVID-19. And the third and final trend contributing to revenue reduction was the downturn in the restaurant and hotel industries, which are, of course, the target markets of our commercial filtration solution. But these negative trends, however, were offset by very stable recurring revenue from our existing customer base, largely maintaining levels from prior years and limiting our overall downturn for the year. Accordingly, looking past the pandemic, I strongly believe the Nephros Water Filtration business is a promising one. From 2016 to 2019, this segment grew 345% and did so consistently quarter after quarter after quarter. Furthermore, the segment turned profitable in Q4 2019, the quarter before the pandemic hit. As the pandemic recedes over the coming few quarters, we believe this segment can return to the high-growth levels of the previous 4 years and do so profitably. And to reap the benefits of this opportunity, we will continue to invest in both our medical and commercial core business, most significantly in sales and marketing. One of our top priorities will be to drive market awareness of our filtration solutions and to generate demand. These will be a primary focus area for Wes Lobo, our new Chief Marketing Officer and his organization. And I'll introduce Wes in a moment for some brief introductory comments. Wes joined Nephros in mid-February after recently serving as Vice President of Marketing and New Product Development at Watts Water Technologies, a leader in plumbing, heating and water quality products and services for residential, commercial and general industrial markets. Wes brings more than 20 years of water industry experience and expertise in commercial roles of increasing responsibility, including sales, marketing, business development, strategy and customer service. He holds a Bachelor of Science in Chemical Engineering from Lafayette College and a Master of Business Administration from the Duke University Fuqua School of Business. Wes is a certified Lean Six Sigma Black Belt and a graduate of the Xylem Executive Development Program. So I would now like to pause for a moment and let Wes introduce himself. Wes?

Thank you, Andy. It is a pleasure to be here, and thank you for allowing me a moment to introduce myself to the investor community. First, I would like to echo how Andy kicked off this call. Amazingly, we have now been living in a pandemic-stricken world for over a year, and we look forward to returning to normalcy in the, hopefully, not-too-distant future. Over this past year, we have seen our nation's essential workers, our everyday heroes, continue to answer the bell day in and day out. We owe them a debt of gratitude and our continued support for what they have done, are doing and will continue to do post pandemic. So why did I join Nephros? I'm passionate about the water industry and have had the privilege to serve within this community for over 20 years. Through my early discussions with Andy and the management team, 2 things became clear: one, Nephros is a company founded on industry-leading science and technology for water safety through purification and pathogen detection: two, and more importantly, Nephros is a diverse and passionate team dedicated to helping people. The combination of these 2 attributes positions the company for accelerated growth as was demonstrated for 15 consecutive quarters prior to the COVID-19 pandemic. The pandemic has raised awareness on the topic of pathogens, be they airborne or waterborne. At Nephros, we have the opportunity and the obligation to partner with communities and facilities to educate, monitor and treat for waterborne pathogens. When your mission is to help people by advancing water safety, it is easy to have a common sense of purpose. I'm humbled and honored to be given the opportunity to tell the Nephros story, work with this incredible team and help unlock the Nephros growth potential to be a company that does well by doing good. Thank you.

Thank you, Wes. We're excited to have you. One more thing regarding the Water Filtration business segment. I mentioned the medical side. On the commercial side, we continue to pursue large contracts with major brand names in the food service space. And while this process has taken, frankly, much longer than expected due to previously mentioned slowness in the space, we remain optimistic about these opportunities within our commercial filtration segment. I'll turn my attention to Pathogen Detection Systems, or PDS, our second business segment. 2020 was our first year recognizing this segment, and first year, revenues were quite small. Fundamentally, as was also true in the filtration business, development of new business relationships and sales of new products proved very challenging in 2020 due to the single-minded market focus on COVID-19-related topics within the health care community. While we're off to a slow start, we remain very optimistic about this business. We committed significant resources during 2020, building an infrastructure, including the initial release of 3 new products; implementation of a level 2 biosafety laboratory; installation of an automated manufacturing system; and the development of significant scientific papers and marketing materials. We expect PDS to be a vital part of the health care facilities -- I'm sorry, of health care facilities' water management practices, enabling them to conduct on-site measurement and detection of waterborne pathogens such as Legionella. With proactive monitoring and potentially leveraging point-of-use filtration as necessary, our aim is to mitigate potential waterborne pathogen outbreaks from Legionella and Pseudomonas, E. coli and many others. As markets reopen in the second half of 2021 and early '22, we expect to see significant revenue growth within this segment. Like Water Filtration, PDS will be a major focus for our new marketing organization as well as the rest of the Nephros team. I'll briefly give an update on HDF, our hemodiafiltration business segment, which is a majority-owned -- our majority-owned subsidiary, Specialty Renal Products, in which we are pleased to report that we have completed the development of the second-generation HDF product, and we have begun conversations with the FDA regarding the 510(k) clearance process. We expect to announce formal submission acceptance and expected timelines in the very near future. Once we receive FDA clearance, we will work to identify a few dialysis clinics to take part in our soft launch, which we expect to initiate in the second half of 2021. I'll now provide a few highlights of our Q4 and full year financial performance. Nephros reported net revenues in the fourth quarter of $2.3 million, a 10% increase over third quarter of 2020 and a 26% decrease versus fourth quarter of 2019. For the full year, net revenues were $8.6 million, a 17% decrement when compared to $10.3 million in 2019. While net revenues were down year-over-year, as I alluded to earlier, I'm pleased to note that fourth quarter revenues from our recurring installed base remained at 2019 levels. We believe that this strong demand from existing customers is an important sign of the underlying strength of our business, bolstered by our customer retention rate of about 90%. As a reminder, we recognized 3 distinct business segments: Water Filtration, Pathogen Detection and Renal Products, of course. And all of the revenues that I just described were generated by the Water Filtration business segment. Net loss in the Water Filtration business segment was $0.3 million compared with net income of $0.2 million in 2019. For the full year, Water Filtration showed a net loss of $2.2 million compared to $1.1 million in 2019. This increased loss was due primarily to the reduced revenue I discussed earlier. Adjusted EBITDA in the Water Filtration segment for the fourth quarter was approximately breakeven compared to positive $0.7 million in the same quarter 2019. Adjusted EBITDA in the Water Filtration segment for the full year was negative $1.4 million compared with positive $0.5 million in 2019. 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 the Water Filtration, Pathogen Detection and Renal Products business segments and their operating results can be found in today's filing on Form 10-K. On a consolidated basis, net loss for the quarter was $0.8 million compared with $0.1 million in 2019. The for the full year, net loss was $4.5 million compared with $3.2 million in 2019. And once again, the increased loss was almost entirely due to reduced revenues and the associated reduction in gross margin available to cover other costs. Consolidated adjusted EBITDA in the quarter was negative $0.5 million compared with positive $0.4 million in 2019. And for the full year, consolidated adjusted EBITDA was negative $3.6 million compared with negative $1.2 million in 2019. Cost of goods sold in the fourth quarter was $1.0 million compared with $1.3 million in 2019. Cost of goods sold for the year was $3.6 million compared with $4.3 million in 2019. Gross margin percentages for the fourth quarter were 56% compared with 60% in 2019. Gross margins for the year were 57% compared with 59% in 2019. And as we have said, almost every -- I think every quarter over the last few years, we expect our gross margins to continue in the range of 55% to 60%. Research and development or R&D expenses in the fourth quarter were $0.6 million compared with $0.8 million in 2019. And R&D expenses for the year were $2.8 million compared with $3.1 million in 2019. Depreciation and amortization expenses in the fourth quarter were $50,000 compared to $44,000 in 2019. And for the year, depreciation and amortization were $0.2 million, both in 2020 and in 2019. Selling, general and administrative or SG&A expenses for the fourth quarter were $1.4 million in both 2020 and 2019. And for the year, SG&A expenses were $6.5 million compared with $6.1 million in 2019. Our cash balance at the end of 2020 was about $8.2 million. And as you may be aware, in October 2020, we completed a common stock offering, which generated approximately $4.7 million of net cash proceeds. In closing, all of us at Nephros want to, once again, thank the health care and other frontline professionals providing essential services that keep our fellow citizens safe. Let me also mention that we will be at several financial conferences this spring, details of which will be released publicly as well as to our mailing list. I look forward to seeing many of you at these shows, virtually, in all likelihood. Also, if you're not already subscribed to our occasional e-mail alerts, you may do so at the bottom of our website homepage. And of course, please always feel free to contact me directly at [email protected]. This concludes our formal presentation remarks. I would like to personally thank all of our investors and other stakeholders for your support through the years. I look forward to speaking with you all again soon. And we'll take questions now from the audience and also answer e-mailed questions if there are any. Operator, please open the call for questions.

[Operator Instructions] Our first question comes from Marc Wiesenberger with B. Riley FBR.

Can you talk about what you're hearing from your distribution partners on the ground? And what's their ability to get access to hospitals and health care facilities? And how has that evolved from the end of last year into 2021 so far?

Marc, first of all, thanks for the question. It's good to hear from you. I would say that the comparison between Q1 of '21 and Q4 of 2020 is analogous to the comparison of Q4 2020 to Q3 2020. In other words, it's a steady, slow reopening. If I had to project, I think you're going to see a pretty steady slope of that line, and this is also what I'm hearing from our partners that we're going to see a pretty steady slope of that line, Q4, Q1, Q2, and then we would expect the slope of the line to increase in the second half of the year when most of the population -- when the vaccine is more widely distributed. But I would call -- if I were to put a finer point on it, a quarter ago, if you would ask me, I would say the market was about 90% closed, and I would say it's still about 80% closed.

Understood. I know the outbreak response business has some seasonality with usually higher activity in the warmer months. But are you at least seeing customers and facility managers starting to at least refocus their priorities and undertake maybe more normalized levels of testing and monitoring, which could bode well for kind of a bounce-back in that business?

A little. We are definitely seeing some emergency response events and servicing them, of course. But I would say that, that bounce-back is slow, but it does appear to be beginning.

Okay. Understood. Also, as schools are starting to return to more in-person learning, you've had districts in Michigan, Ohio, Pennsylvania, New York report elevated levels of Legionella in their drinking water following the closures. And then even recently, the governor of Wisconsin in her budget proposal put $55 million in there to install water filters in schools state-wide across Wisconsin. How should we think about Nephros potentially expanding its opportunities into schools and maybe other markets that it has not traditionally served?

Great question. Thank you. The -- what I would say is Nephros is 90% an indirect selling company that sells through the water service treatment professionals that are our strategic partners. And so it is really a matter of making sure that we partner with as many of the best of those that we can. Now we've already serviced multiple school systems, including some locally in New Jersey. But it really is a matter of working through our partners, our distributors, who have those relationships. The Nephros sales model is not to hire a sales force of 100 people but rather to go -- to support with expert sales and product capabilities the distributors that we are partnered with. And so I would expect that not to change fundamentally.

Understood. And last one for me. Where do we stand on some of the commercial RFPs that have been in the pipeline? And maybe if you could just give kind of an update on some of the give and takes on what's going on with the negotiations and maybe when we could expect to hear some good news there?

Thank you, Marc. I'd be happy to tell you all about the give and take except that it's mostly give. And what I mean by that is that we are dealing with extremely large organizations, and they move at their own pace. And while, as I said in my prepared remarks, we are -- we remain optimistic on those opportunities, we were premature, obviously, to talk about them probably at this point 9 months ago. They are still developing. They are still developing in a helpful way. And I cannot give you more specific guidance as to when they will close, but they are larger opportunities and will make a difference when they do.

The next question is from Anthony Vendetti with Maxim Group.

Thanks, Andy, and welcome aboard, Wes. Just -- Andy, just a quick follow-up on that. And I know the QSR has been discussed for a while, and I'm sure COVID had a lot to do with it, but would you say that pipeline, though, is it the same? Or even though it hasn't -- one hasn't closed, has the pipeline started to increase? In other words, the opportunities, have they expanded or is it about the same still?

Good to hear from you, Anthony. And what I would say is they have increased. These are larger opportunities. Having a conversation with one organization within a large company often brings additional conversations, and we are seeing that. So I think it's fair to say that the opportunities are increasing, and it's just a matter of when they fall.

Sure. Sure. Understood. And then just on -- I know the Pathogen Detection is new, and this was, obviously, a difficult year to launch it. How do you -- how should we look at that in 2021 with, as you mentioned, 80% of hospitals still difficult to access? Is that, you think, pushed out more towards the second half of this year? How should we look at it?

Well, the way I look at -- the way I think about the year is that the first half of the year is likely to look a lot more like 2020 than 2019. And what I mean by that is that 2020 was the peak of the pandemic and even though the vaccines came out in November, December, the distribution and the time associated with it, I think, gets us to at least July 1 until the system fundamentally changes. And so I'm hopeful that Q3, Q4 look more like 2019 than 2020 when we were growing 60% on average, but some quarters were closer to 100% year-on-year. And I'm hopeful that -- to see the growth curves coming back then. And when they do, I would think that pathogen detection will be part of that growth curve. So long -- a slightly long answer to say that I do think that you'll start to see acceleration in the second half of the year, although there could be some blue birds in the first half as well.

Okay. No, that color is helpful. Just lastly then, you mentioned that you completed the second-generation hemodiafiltration system, the HDF device. In terms of actual submission of that 510(k), is that on target for end of '21 or could that be sooner?

I'm sorry, when you say the -- on target for '21, do you mean the approval?

Yes. What do you think -- what's the time frame in your best guess?

Well, we -- as we've talked about before, we have filed the package under the special 510(k) pathway. And if -- assuming that the FDA accepts it, it's 30 -- the official timeline is 30 days once they accept it for that review. So even if it takes time, a little extra time for whatever reason, I think that unless there's a surprise and they don't accept it on the special 510(k) pathway, I would think it would be approved by the middle of the year. Now if the FDA turns around and says, "No, we think this is more of a traditional 510(k) pathway," then it will take longer, but end of year would be a surprise for me. I think it will be long before that.

Right. Okay. Makes sense. So special 510(k), if it's accepted, you'll find out soon, I guess. And if not, then it would go the normal 510(k) route, which would give them 90 days to respond. Once you -- you'd have to resubmit, right, for a regular 510(k)?

We would. But we've completed all the testing and documentation required for that. So it's a large paperwork exercise, but it's only a paperwork exercise. So it would be -- if we had to go the traditional route, it would be measured in weeks, not months or years.

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

Wes, welcome aboard. I'm glad to hear you're there.

Thank you.

Anyway, I was just wondering, do you have projections for the pathogen detection and testing portion to go out? Or how are they going relative to projections?

Well, we're not public with guidance on any of our businesses right now, Henry. But I would say that the work that's going on is going great. And by that, I mean, the development of the technology and the validation of it and the products that we've published -- that we've released, I'm sorry, as well as the construction of, as I said, a level 2 biosafety lab and an automated production facility. These are all things that we've built at relatively low capital costs, by the way, and are getting ready for that business to really grow. But until the health care markets open up again, it's just hard to project specific revenue levels. But I'm anxious to do so as soon as we see the markets open up.

Have you released the testing analysis as white papers or anything like that?

We have, we have. We actually produced a prepublication white paper -- actually, it was an academic paper, I guess, probably 4 or 5 months ago, talking about our SequaPath product, and we've got other papers in the works as well. So yes.

[Operator Instructions] The next question is from [ Joseph Shuler ] with JAS Investors.

Andy, HDF, maybe you could give us -- maybe you can elaborate a little more. You did mention that you've completed a second generation product. You also mentioned, if I've heard correctly, that you're proceeding with FDA paperwork. And I think you're hoping to pretest or early market the product possibly in the second half of 2021. I don't know if I got that all right, but maybe you could elaborate a little bit.

Well, the short answer, Joe, is you got it exactly right. The product is done. The paperwork for submission is done. The FDA has received it. We have a case number. We are in discussions with them over whether it's a special 510(k) or a traditional. And over the course of the next one to few months, we expect to get that product approved. That's our goal. That -- and we'll have more to say -- more specifics about the submission pathway as soon as we have it from the FDA.

Let me just proceed with that. If assuming your best hope, and it may not, happens and you get the FDA approval in 3 months, when after that do you think you'd have a marketable product -- or product on the market, let's say?

Well, we'd go immediately to dialysis clinics and roll it out in a controlled number of them so that we could get real world experience, but it would be -- officially, it's on the market as soon as the FDA clears it.

This concludes our question-and-answer session, and the conference has also now concluded. Thank you for attending today's presentation. You may now disconnect. .