Nephros, Inc. (NEPH) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Nephros Second Quarter 2019 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kirin Smith, President of PCG Advisory. Please go ahead.

Good afternoon, everyone. This is Kirin Smith with PCG Advisory. Thank you all for participating in Nephros’ second quarter 2019 conference call. Before we begin, I would like to caution that comments made during the 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 services offerings, the rate of adoption of its products and services by hospitals and other healthcare providers, the success of its commercialization efforts, the efforts on its business of existing and new regulatory requirements and other economic 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 7, 2019. 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, everybody. Welcome to Nephros’s Q2, 2019 earnings conference call. I’ll begin the call with a brief overview of our second quarter results and provide a corporate update. Then I’ll turn the call over to Andy Astor, our Chief Operational and Financial Officer, and Andy will do a deeper dive into our second quarter operating results. Q2 was another good quarter. Total revenues were up almost 70% all of our business segments experience growth versus second quarter in 2018. Additionally, we supported a number of pathogen outbreaks in the second quarter. Pathogens tend to propagate in greater numbers in the warmer months and this year has been very consistent. Our land and expand strategy in cooperation with our strategic partners in the hospital segment continues to be an effective sales strategy. Hospitals have had two years to implement the water management plans to be compliant with the recent standards added by the CMS site survey. We are seeing more and more sites be proactive in our efforts to suppress the ever present bio burdens in their pipes. The dialysis segment, we are seeing our EndoPur footprint grow slowly but steadily. Our Portable RO business was consistent. We expect this segment to continue to see slow but steady growth in to more sites that can adopt the updated AAMI standards for the dialysis water and use additional EndoPurs in RO polished filters. In our commercial segment we are seeing steady growth and we're working with large format customers in the quick service restaurant or fast food market as well as partnering with some large beverage companies in that space. We also see continued growth in the convenience store chains. We continue to expand our manufacturing and R&D capabilities on this side of the business. We are seeing expansion of our commercial products into the hospital space as well one of the synergies that we’d would hope to would percolate following the acquisition. In the second quarter, we made great progress with our real-time multi-faceted diagnostic product. We introduced the product at two industry conferences to gather some initial feedback and short-listed the folks who would like to be part of the early customers. This month will perform usability testing in the field with a number of our strategic partners. Over the next few months, we’re working with our partners and other infection control experts to validate the test, draft white papers to highlight methods of use. We are on track to launch the product later in the year. In regards to the second-generation hemodiafiltration product under development in our specialty renal products subsidiary, we have almost finalized the design. We have been able to perform enough usability testing to be very comfortable to dialysis nurses and technicians treating the patients with the device will have a vastly improved experience versus our first-generation device. We are happy with the updated software, the look and feel of the device and the improved substitution line, installation setup and removal process. The whole system is much more intuitive and in line with a normal workflow of a dialysis technician and nurse. We did experience a short delay with a vendor who's manufacturing one of our components. The delay is over but it caused their timelines to shift. We now expect we'll be able to submit our 510(k) in the first part of 2020 instead of by the end of the year. We will be showing the new HDF device at the American Society of Nephrology Conference in November and meeting with prominent nephrologists in the back part of this year to start – to develop our short-list of sites who would like to be part of our initial launch of this next-generation product. I'll now turn the call over to Andy for the financial overview.

Thanks Daron. I will now provide a look at our consolidated financial results for the quarter ended June 30, 2019 as well as guidance about our expected revenues this year. I will also give an update on our plans to uplift to a national exchange. I'll begin with consolidated financial results. I’m very pleased to report our 12th consecutive quarter of year-over-year product revenue growth with an average growth rate of over 60%. As we have said consistently for three years now, we believe this steady revenue growth is indicative of Nephros’ strong product portfolio, our increasing market awareness of our brand, our deep relationships with partner companies in the field and the increasing number of regulations that require water testing and remediation. I'm also very pleased to report that in July, Nephros’ monthly revenue exceeded $1 million for the first time in the company's history. This result included both a strong performance in our prevention business as well as some significant outbreak response business. While the $1 million month is an important milestone, it is important to keep in mind that outbreak responses do not follow a predictable schedule, so future months will not necessarily equal or exceed the month of July. Nephros’ reported total net revenues of $2.3 million for the quarter. This compares with $1.4 million in the same quarter last year, an increase of about $900,000 or 69%, product revenues, which comprised 99% of total revenues this year, were up 88% for the year. Cost of goods sold in the quarter were $0.9 million compared with $0.5 million in the same quarter last year, an increase of 76%. Gross margins for the quarter were 59% compared to 61% in the same quarter last year. These results are in line with our previously announced expectations of gross margins in the range of 55% to 60%. Research and development or R&D expenses were approximately $0.8 million for the quarter compared with $0.4 million last year, an increase of 125%. This R&D increase over the past year is due to our investment both in the new water diagnostics product and the second-generation HDF machine, both of which Daron mentioned earlier in this call. Selling, general and administrative or SG&A expenses were $1.4 million this quarter compared with $1.1 million in 2018, a 29% increase largely due to new headcount to support our increased revenues. Our cash balance at the end of the first quarter was $4.3 million compared with $3.5 million at this time last year. Based on our results in the first quarter, I'm sorry, in the second quarter, and our strong sales pipeline, I'm pleased to reiterate guidance for 2019 revenues between $8.5 million and $9.5 million, which would be an increase of 50% to 65% over 2018. I'll now discuss our Water Filtration business segment. As a reminder, we recognize two distinct business segments, Water Filtration and Renal Products. Water Filtration is 100% of our current revenues, which have approximately tripled over the past three years. Our Renal Products business on the other hand is a development stage business. Net loss in the Water Filtration business was $0.5 million, a small improvement of 8% compared with a net loss of $0.6 million in the first – in the second quarter last year. Adjusted EBITDA for the Water Filtration business was negative $0.1 million this year compared to a negative $0.3 million in 2018, a 62% improvement. As we discussed in our previous earnings call, the Water Filtration business segment showed positive adjusted EBITDA in the fourth quarter of 2018, and we do anticipate a return to positive adjusted EBITDA during 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. I will now discuss our uplift process. As you all know, we executed a one for nine reverse stock split on July 10, 2019 just a few weeks ago. With that step, we believe we now meet all published required, I'm sorry, all published criteria for uplifting. We continued to work actively on completing this objective. We believe we are making headway and we expect to report progress in the near future. I'll just say off the cuffs that it is a process that takes time and is not fully controllable from our end. So we can’t really be more specific than that. Lastly, we continue to present the Nephros story to the investment community regularly and we plan to intend to attend a number of upcoming events throughout the next several months. This concludes our formal presentation remarks. I would like to personally thank all of our stakeholders for their continued support and I look forward to chatting with you again soon. We will now take questions from the audience and also answer emailed questions as appropriate. Operator, please open the call for questions.

Thank you, sir. [Operator Instructions] Our first question today will come from Howard Halpern of Taglich Brothers. Please go ahead.

Congratulations. Great quarter guys.

Thanks, Howard.

Could you talk a little bit about, I guess the sales cycle for the commercial customers that you hope to grow with over the next couple of years.

So there’s not any real theme that we can see. Some have an RFP process that they say is very clear to find and then take months and months to deliberate. Others will call up one day and say, hey, I have a 100 sites and I need to have filters there tomorrow. So the larger ones that we expect to have – if we get them, they’ll cause step changes and increases in the revenue. They just take time and we’re not going to be the ones to hurry them. But we’re happy to take their requests when they get them. We hope to have some news on some soon, but we wouldn’t be surprised if they came tomorrow and said, we’re good, let’s go. And we wouldn’t be surprised if they came, Q1 next year and said, okay, let’s go. Unfortunately, we’re definitely at the end of the tail on this one. But we’re in the running and we tend to be one or two in the list. Cross fingers and hope we get some of these big hits.

Okay. And what are you seeing, I think you mentioned a little bit, but what are you actually seeing in terms of your existing hospital customers sort of taking on some of the new products that you obtained in the acquisition?

A couple of years ago, when we were first were pushing into the hospital space on an aggressive basis. What we found is that, less than 5% of hospitals had a microbiological filter on their ice machine, but they had a filter. And they usually had the filter that was there as recommended by the ice machine maker that was recommended to the same people they send in a McDonald's and to Subway’s and to other restaurants. So they had a restaurant filter on there. And so what we're seeing is when we – the right thing to do to have pure water in the hospital that's totally safe, is to not have a carbon filter, because carbon grows bugs and just to have a microbiological filter. That doesn't sit well with people who like the taste of the ice. And so some decide they want to maintain the protection of taste and odor in addition to the microbiological and for those customers, they generally have either Everpure or Cuno manifold in place and it's very easy to plug and play our product, right in the same manifold and then put our microbiological filter following that. And we given the option, we're happy to support them with a set instead of a single.

Okay. Can you talk I guess a little bit about the second generation product, the 510(k) submissions now going to get pushed just a little bit, you said, but how long once you submit all the documentation. Does it normally take to expect any the answer. So as again, a little bit of a timeframe on when you could actually launch – officially launched the product.

Yes. So the path we're going to start with is the special 510(k) path. Because we’re making a second generation of existing product, we're not changing the label, we're not changing the use, we're just changing features on the machine. The standard special 510(k) is the 30-day response. However, what we've learned from the FDA from the dialysis space, especially for HDF is that, they could dig in really deep or they could not. It just depends. We've heard some other companies come to them with HDF and get rejected. We've heard some companies go with an HDF program, try to use us as a predicate and get told, no, that's not going to work. So it's a great question. I'd like to say somewhere between 30 and I mean 80-day, just depends.

Okay. So to be conservative on a modeling basis, who would be the second half of next year would be an approximate launch for generating some meaningful revenue?

Yes. And even if we got a fast approval, let's say it was 30-day approval and we had – we were able to sell kind of in Q1 or Q2. We’re going to take a slow approach to market. We're going to pick a couple of sites of trusted nephrologists that we work with well. We've got an office in Nashville and some very relationships, so probably somewhere around there. And just we're not going to rush. This is a big market, great patients, great nephrologists out there. We want to make sure we do right.

And same goes for the diagnostic product. You're going to have – once you want it, you're going to have a core group that you're going to dig deep on and then expand more rapidly after those for lack of a better word, test subjects or test clients find the product very, very useful.

Yes. Similar strategy, but we’ll probably have a faster ramp once we do our soft launch. So I’d call it, so have some identified, some experts that we’re going work with to, go do an outbreak and go test and see how we utilize that and then write a white paper on it. We’re going to go do some, some basic building diagnosis, just thinking about the patient as building as a patient. Let’s do a building diagnosis and see what there. We’ll do set up some maintenance programs. We’ll do that. But once we have some comfort around those sort of three threats, we have over a 100 customers that we, U.S. trust us, use our filters who are spending money right now on testing. And there’s no reason why we can’t do a blast, we make – we can – the filter we use for consolidating the test sample. We can press print very quickly, the test strips we’re making. We can either make them in the lab or we can use a robot. We can scale very quickly. And we think there’s a large demand for the testing based on what’s being spent right now. And we think that our solution might have some value and convenience and data point of view. So, I don’t know how fast we launch, but we were very often that you get that there’s a place for this.

Okay. And one final one from me. Your distributor network has it grown over the last a quarter or so? Have you obtained new distributors?

I think we added one, maybe too small, what’s been happening is the momentum in the market for our product is accelerating. And if you think about a sales force in any given distributor, there’s 10% first movers, there’s sort of the bolts in the middle. And then there’s the people who will never ever sell our stuff because they don’t do that. We’re seeing movement in that 80% of the –we’ll watch and see what happens with the product before we really put some time and effort into it. And when we’re seeing emotion there. So, I’d say out of hundreds of boots on the ground that could sell the product we have by less than 100 that are really doing it well. I think that number is growing and growing pretty quickly.

And just to add a point to that, there aren’t, hundreds of distributors that we want. Right, we’ve got a dozen or so and that’s a good number. We can – we can focus on that. We can grow quickly with that number. We will add opportunistically, but we don’t want to go out and double our distributor base tomorrow. We are pretty encourage with the one we have.

Okay. Okay, well guys, keep up the great work.

Thanks very much, Howard.

[Operator Instructions] Our next question will come from Michael Brick of National Securities. Please go ahead please.

Thank you. Hi. The numbers compared to last year are very impressive. I’m looking at the guidance for the rest of the year and it would seem to me that you’re sort of guiding flat compared to this quarter, and first of all am I sort of under wrong correct with that? Is it otherwise, is it sort of like plateauing until the next generation product comes in? What are you –what are you seeing that gives you, that makes you give that guidance?

Michael, I knew, first of all am I get back over to Andy.

Hey Andy.

Hey good to talk to you again. And I knew someone was asked the question – has been asked that question. I didn’t know who would be. We do our guidance right at the end of the quarter, and if you think about where we were at the end of the quarter, we were at about $4 million. And so to guide to 8.5% to 9.5% on top of the $4 million base halfway through seems prudent to me, and it seems appropriate. Then we had $1 million month in July and if we reviewed our guidance monthly, this might be a different conversation, but we don’t. We review it quarterly, and let’s see how Q3 goes. And at the end of Q3, we’ll give you an update.

Got it. Is there any seasonality in your business?

There is. When it’s cold, bugs grow more slowly. It’s pretty – so Q1 particularly, what I would say is, there’s not so much seasonality in the prevention side of our business, but there’s definitely seasonality in the outbreak side of the business. And so where we will see few – we saw quite a bit of outbreak business in the last few months. And I would expect that to reduce as the temperatures go down, but, not dramatic seasonality, but some.

Got it.

If you look at our Q1 growth over the last three years over Q4 as opposed to over the year before you’ll get a feel for that.

Got it. Do you guys have any international business and or plans for?

Very little, And I answered this question a lot. There’s a huge market out there, but we’re a small company and frankly part of the – part of the way succeed as a small company is you say noting is you say no to far more things. And you say, yes too, and we are focusing on the U.S. as our primary outbound marketing and sales activity and opportunistically if and up – if something comes in internationally, we’ll certainly look at it. But for the next – for the next few quarters, certainly our focus remains U.S.

Got it. My final question is, how scalable is the business?

Quite scalable. We are – we don’t know precisely what our market share or the market share or the size of our major competitor, but it’s quite scalable. We can pretty much triple our current size without any significant change in our supply chain. And we’re maybe 10% market share in a market that is growing by, I don’t know, some number around 20% per year probably. And so there’s – the foreseeable future, the next three years in a company of our size, that’s a long time. The foreseeable future, we don’t really see a change in the opportunity.

Got it. Thank you very much guys.

Good to talk to you, Michael. Thanks.

Yes. Cheers.

And our next question will come from Art Winston of Pilot Advisors. Please go ahead.

Congratulations on a great quarter. And it’s good to know that we’re a player in global warming.

Thanks, Art.

I have two related questions on the expenses. Could you give some additional color on which of the new products and new products are getting the bulk of this increase in research, SG&A and added manpower and as a follow-on, we’re going to ramp up the expense – these operating expenses from where they were in the second quarter or are they going to plateau out? Are they going to go up with the increased sales that we expect and anticipate having?

Well, I don’t have it in front of me, but I think the G&A only went up 29% on a year-over growth went up 90%. So, I think you’re seeing the – particularly the G&A as opposed to the SG&A flattened out nicely. in terms of the investment in the new product, they’re not too far apart. I guess I would tell you that the HDF business is probably costing about twice as much per quarter in R&D as the diagnostic products give or take. That’s a rationale way to think about it. And it kind of makes sense, because HDF is a much more product with a lot more subtleties and a lot more regulation around it and so forth in the water testing product. Did I miss any part of your question?

Are we guys continue to add manpower do you think or for the – in the near future?

Marginal, manpower would go up just a little bit this year, I’d be surprised if it went up 10% in the next six – or six to nine months. Opportunistically, we’re always looking to – for people to help us increase our top line. We’re not going to go out and double our sales force or anything like that. but we had a great opportunity with a water safety expert, who joined our team in May. And frankly in April, like I didn’t know that was going to become an option for us and we grabbed it when it became available. So, we’ll – at this point, I think we’re growing what I would say incrementally and quite carefully.

Right. Congratulations and thank you.

Thanks Art.

And ladies and gentlemen, this will conclude the question-and-answer session and this will also conclude the Nephros’ second quarter 2019 financial results conference call. Thank you for attending today’s presentation and you may now disconnect your lines.