Nephros, Inc. (NEPH) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Nephros Incorporated Second Quarter 2018 Financial Results Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Kirin Smith. Please go ahead.

Good afternoon, everyone. This is Kirin Smith with PCG Advisory Group. Thank you all for participating In Nephros's second quarter 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 identifies specific factors and 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 service by hospitals and other healthcare providers to 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 8, 2018. 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's CEO. Daron, please go ahead.

Thank you, Kirin, and good afternoon, everyone. Welcome to Nephros's second quarter earnings call, our first. I'll begin with the call with a brief overview of our second quarter results and discuss developments that occurred during the quarter. Then I'll turn the call over to Andy Astor, our Chief Financial Officer. Andy will do a deeper dive in the second quarter operating results, provide guidance and our near term plans for uplifting to the National Exchange. I'll then return to discuss some more new strategic initiatives before opening the call for your questions. From a high level, Nephros had a pretty good quarter. Product revenue is up 55% over the last year's second quarter. Our growth since 2015 is driven by sales in the Hospital Infection Control segment of our business. Based on all of general indications from the field, we're confident this growth trend will continue. Tragic events such as the 2014 flint water crisis have heightened awareness for water safety. In 2015, the American Society of Heating, Refrigerating and Air-Conditioning Engineers or ASHRAE, published Standard 188, to provide guidance for the industry on the prevention of Legionella. In 2016, the Centers for Disease Control and Prevention or the CDC, and its partners, developed a toolkit to help hospitals and other medical facilities implement the ASHRAE 188 Standard. And then in 2017, the Centers for Medicare & Medicaid Services or CMS, added water safety to its site survey, which now requires hospitals across the U.S. to increase their focus on water safety, and provides an economic penalty for failing to do so. Core to the guidance is the development of a water management program. These programs generally include an initial effort to identify the high risk areas, a proactive testing schedule, and an intervention plan when control limits are not met. Five years ago, based on Nephros's internal data, majority of the hospitals did not routinely test for waterborne pathogens. Today, 100% of hospitals are required to perform testing to validate their water management programs. Given that waterborne pathogens are everywhere, positive test are inevitable. Hospitals with a water management plan and proactive infection control teams will have a process to manage that risk by any positive test. Microbiological filters, Sartorius, are one of several control measures to manage these risks. However, filters are the best way and most instant way to control the risks. Nephros filters are used in two ways in hospitals. First, the filters can provide a long term control measure for high risk areas of the hospital. Second, the filters can provide an effective tool to support intervention efforts when bacterial limits exceed controls, commonly referred to as an outbreak. When choosing a microbiological filtration product, water management teams need to balance filter performance and overall cost of ownership. We strive to exceed on both. We're the first company to receive a 510(k) clearance for our ultrafilters, to be used as a medical device to aid infection control of bacteria, such as Legionella, Pseudomonas, viruses, adenovirus. As far as we know, we're the only 510(k) cleared product to provide up to 12 months protection, which lowers the cost of patient protection to less than $1 per day in certain locations. We see the hospital filtration market as very young, with a lot of wide space for us and others to grow as the industry shifts to full execution of water management plans. In our dialysis business, the filtration market is much more mature. The high standards for Water and Dialysis quality are such, the filtration has been part of the system since the beginning. Interestingly, the current guideline for Dialysis Water quality in the U.S., which have been adopted as a condition of coverage for payment by the CMS, are not as high as the guidelines in Europe. As an example, the CMS conditions for coverage require Endotoxin levels in Dialysis Water to be less than 2 units per mil. In Europe, the standard is ISO 13959, it specifies the limit of 0.25 units per mil, an 8 fold difference. We believe that as U.S. will eventually align with the international standards on Dialysis Water, Nephros ultrafilters will become the gold standard for dialysis, given our core size. We have two major growth initiatives underway in this space. First, we are in the process of rolling out the EndoPur cartridge ultrafilter. The only 0.005 micron cartridge filter available. We see increasing sales in this filter as we replace more and more clinics as the filter performs well in the field. Second, we have been working with equipment providers to make our DSU, SSU, and SSU-Mini ultrafilters, OEM products in their systems. In general, we expect strong growth in this segment as our initiatives gain traction. We also sell products in other market segments such as commercial, restaurants, and additionally some residential. In a short term now over, majority of our growth will be coming from the hospital and dialysis markets. I'll now turn the call over to Andy, for review.

Thank you, Daron, and good afternoon, everyone. I will now provide a look at our financial results, our guidance for 2018, as well as our plan to uplift to a National Exchange. All numbers that I'm going to talk about are rounded to the nearest thousand dollars unless otherwise specified. I'm very pleased to report that this quarter represents our eighth consecutive quarter of year-over-year revenue growth, averaging 59%. We believe this consistent revenue growth is indicative of Nephros's strong product portfolio, increasing market awareness of our brand, our deep relationships with partner companies in the field, and the increasing regulations requiring water testing and remediation, as Daron just discussed. Our total revenues for the second quarter were $1.366 million, this compares to $858,000 in the same quarter last year, an increase of $508,000 or about 59%. Quarter-over-quarter total revenue growth was also quite strong, increasing by $381,000 or 27%. Product revenue for the quarter was $1.216 million, compared to $785,000 in the same quarter last year, an increase of $431,000 or 55%. Quarter-over-quarter product revenue growth was $258,000 or 27%. Cost of goods sold were right on target, with gross margin of 61%, compared to 60% in the same period last year. That cost of goods sold number was a big recovery from our 49% gross margin in the first quarter of this year, which was primarily caused by foreign exchange rates and the transition cost associated with operating our own warehouse, for the first time in the Company's history. Research and development or R&D expenses were approximately $352,000 in the second quarter, compared with $277,000 in the same quarter last year, a 27% increase. Quarter-over-quarter R&D growth was $63,000 or 21%. We have increased our R&D spend to begin funding the development of a second generation HDF machine, which Daron will discuss in more detail in the next part of this call. Selling, General and Administrative expenses or SG&A were $1.91 million in the second quarter, compared to $881,000 in the same quarter last year, representing an increase of $210,000 or about 24%. Our quarter-over-quarter spend on SG&A, decreased from $1.26 million, a reduction of $169,000 or 15%, again, quarter-over-quarter. It is worth noting that our year-over-year expense growth rate is about 25% overall, which is significantly slower than our revenue growth rate of 59%. Of course this has the effect of reducing our net losses and bringing us closer to profitability. We anticipate that our ultrafilter business will achieve profitability in less than a year. Our cash balance at the end of the second quarter was $3.484 million, a significant increase from our first quarter cash balance of $1.819 million, the increase was largely driven by $2.9 million private placement previously reported on April 10. We believe our cash balance is sufficient to fund operations till the time we achieve profitability, and we do not anticipate raising further capital for the Nephros water filtration business. We do however expect to raise funds for the HDF side of the business, also, which Daron will also discuss in a few minutes. Our net cash flow from operations was negative $1.343 million, while this is higher than normal, it includes significant non-expense items, including an inventory investment of $424,000, an increase in accounts receivable of $179,000 and a decrease in accounts payable of $381,000. Excluding these three investments, our operating net cash flow was negative $359,000. Turning to guidance, we continue to target full year 2018 revenue of about $6 million, an increase of 58% over 2017. We expect revenue to progressively accelerate through the year as we continue to expand within hospital and dialysis accounts, and as we add new accounts as well. As my final topic, I want to announce that we intend to uplift our shares to a National Exchange in the very near future. National Exchange Stocks have access to a wider set of investors and a greater access to capital to fuel additional growth. Furthermore, we believe that a market price of under $1 has a negative effect on the marketability of our shares. We therefore plan to reverse split Nephros common stock in about 30 days and to uplift onto a National Exchange as quickly as possible thereafter. We believe the reverse split and uplifting will make our stock more attractive to a broad range of institutional and private investors. I will now turn the call back over the Daron, who will describe some important strategic initiatives, and we'll then open the floor to your questions. Thank you.

Thanks Andy. So last year we wrote a letter to update you on our overall strategic vision for the Company. We told you that we intended to focus in the water business first, to build a sustainable business, and then to invest in the re-launch of the hemodiafiltration or HDF system, the technology in which the Company was founded. We are quite pleased with progress we've made in the water filter side of the business. Subtracting expenses associated with the HDF, we have a reasonable shot at achieving profitability in the water filter business as early as the end of this year. That's quite a change from almost – three years ago we were losing about $1 million a quarter. We are now at a point in the turnaround process where we're fiscally comfortable taking forward steps with HDF again. HDF is a treatment modality accessible to patients in Europe and other parts of the world, but is not yet become a mainstream option in the U.S. We have the opportunity to change that. Over the last few years, we have worked on HDF solution, in partnership with DaVita, Renal Research Institute, division of Fresenius and Vanderbilt University. We learned a great deal from these experiences and believe we can significantly improve our first generation device. Using feedback from our collaborators, we developed a concept for our next generation product at the end of last year. Earlier this year we engaged with Medical Devices line, an engineering company, to help build prototypes. First, a printer proto device that will spread across the pegboard, then a true working prototype in a 3D printed shell using OEM parts that could be used in the final product. We now have a few working prototypes that we'll use to gain additional feedback from potential customers and industry thought leaders over the next few months. Feedback early and often is the theme for this next iteration of our system. Currently we're working through a list of specific design changes needed to re-launch the product. Pending funding we believe we can be treating patients with this device within 18 months. We will of course announce the next steps if and when we're able to do so. We have positioned our HDF product line in a subsidiary company, Specialty Renal Products or SRP. The split of the two businesses enables Nephros to focus on the commercial state business of water purification, and allows SRP to seek funding and strategic partnerships with first development stage product. The sales channels are different. The water filter business targets engineers, infection control teams, an eventually into commercial and residential, while the HDF product Group will focus on nephrologists and clinical dialysis personnel. Ultimately, if either the water filtration business or the HDF business is to be acquired, it is highly unlikely that a single suitor would want to buy book businesses. Outside of HDF, we have been looking at additional products and companies that could fit into iodine infection control sales channel at Nephros or into the dialysis equipment market represented by SRP. We will announce any acquisitions or in-licensed products if and when we consummate any agreements. I'd like to end the call by thanking all of our investors, customers, partners, for the support, as the community gained momentum for Nephros and its products. This concludes the formal presentation and remarks, and we'll now open the door for questions.

[Operator Instructions].

In this pause, I will answer some questions we've received in e-mail earlier this week. From, David. We had a high hope for the royalty potentially from a Bellco agreement why has this potential not come to fruition? And is the mid-dilution dialyzer part of their Flexya system? So, David, Bellco was a small player of the dialysis group in market with large growth plans. But a small player is hard when companies like Fresenius and Nikkiso are out there. Bellco was purchased by Medtronic in 2016, we expect Medtronic will help them see a greater potential for their devices in time. In addition, to now being part of a larger company, we believe they could have increased interest in their devices and our dialyzer when data from the MILESTONE Study is released. So the MILESTONE Study is a 500 patients, randomized, open-label clinical study designed to determine whether the mid-dilution hemodiafiltration is effective in the reduction of crude mortality risk in patients who've been undergoing renal replacement treatment therapy for less than a year. The study was launched in 2012, and expected to conclude in September of this year. We, as well as many others in Dialysis Community are looking forward to the results from this study. And yes, the mid-dilution dialyzer is an option when using the Flexya system from Bellco.

Mr. Evans, are you ready for some of the telephonic questions?

Yes, we are.

The first question will come from Peter Koz with Windward Venture Partners. Please go ahead.

Was the breakdown in revenue between the water business and the hemodialysis business?

Basically the breakdown result is 100%. Today the breakdown is 100% water business and 0% HDF.

All right, thank you.

We ceased selling our HDF system or operating our HDF system earlier this year, to focus on the filtration products.

The next question will come from Arthur Winston with Pilot Advisors. Please go ahead.

How are the sales through W. W. Grainger proceeding?

We don't breakout sales from individual distributors but we are very encouraged by the growth with that Group, as well as many others. We're - in our business, as we talked about before, we sell dilation kits to hospitals, to help them understand the performance of our filters and the test results they can get from those dilations. What that group has done is, they planted lot of seeds. And so in 2015 we started the dilation kit process and probably sold a couple of 100 in total. This year - I can't give you numbers but let's just say that there's exponential growth in our seeding of our dilation kits and especially driven by the CMS guideline change. Q – Arthur Winston: Sales at Grainger are increasing or they're stable?

They are quickly increasing.

And a second question. In his speech, Andy, said that - I heard him actually look forward to sales growth both in water treatment and dialysis, and I thought we had no dialysis sales?

I know what you are referring to. We have – our revenue split between the water filter business and the HDF business is 100:0, which is, as I said a few minutes ago. But within the water filter business, we have about an 80:20 split between water filters placed in hospitals for infection control, and about 20% in dialysis clinics used to further purify the water after it comes out of the RO system. So, it's very common that we get confused with when we're talking to people because we have a dialysis part of our water filter business, which is about 20% of our sales, and then we also have the HDF dialysis, which is 0%. Does that clear things up for you?

So, the sales at the Water Dialysis Center are increasing little bit, is what you're saying?

Yes, both the hospital and the dialysis side of the water filter business are increasing and have been averaging year-on-year about 50% to 60% growth.

The next question will be from Gary Sacks with RHK Capital. Please go ahead.

Roughly how much will you need to raise - you mentioned the dedicated funding for the specialty renal products, how much are you going to need to raise to get that up and running?

We haven't kind of disclosed the overall needs but it's not a lot in the grand scheme of things. The Company spent about $100 million getting the product to Stage 1, I think it's just going to be a couple to get to the next stage.

[Operator Instructions] The next question will be from [Henry Link] a Private Investor. Please go ahead.

You mentioned the standards in Europe are 8x more stringent than the U.S. I was just wondering are you going to be focusing on selling in Europe also?

We haven't really pushed a lot in Europe. Our manufacturing partner America has some direct sales in Europe. One thing that's different there is the RO systems used for dialysis clinics are - they're better than what we have here, to just kind of make it easy. They have some direct line RO systems that have either double pass or direct feed but no loops. So they're kind of at a later stage where the filtration is just a different role. So, we don't really have an intention to migrate to Europe at this point.

I think, I'll just add that - I've spoken to some of the people on this call about this topic before. We want to do a few things really well rather than put our resources into too many places at once. So, we're very focused for the time being on the U.S. market, that will certainly change over time but for the time being and for the foreseeable future we're very U.S. focused.

This concludes our question-and-answer session. I would like to turn the conference back over to Daron Evans for any closing remarks.

I actually have two more questions from e-mails. One is from David about the chemo bag. We're not really able to comment on the timing of the launch of the map system or the full launch. We do know it's been at tradeshows but we're optimistic they have a good chance if they access with their product. And then from Mike, he asked a question about the timing of revenue for the HDF version 2. I mentioned in the previous press release, I believe that we think that we can get this system back into the patients in about 18 months, pending funding, and that would suggest that if we're able to get funding in the near term that we could probably have revenue in that business in 2020. So, with that - that's all the questions we have. And I really appreciate everyone for spending some time this afternoon to hear our update. I look forward to providing additional updates in the future.

Sorry, before we jump off, I just got a note on e-mail that I'll address real quick, to clarify the raise that we are doing for - that we hope to do for the HDF side of our business will be into the new private entity SRP and not into Nephros. So, it will not be a dilutive event to our Nephros shareholders. Just as a clarification point. Sorry to interrupt you there, Daron. Thanks everybody for being on the call.

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