NEPH - NASDAQ

Good afternoon. And welcome to the Nephros Incorporated Second Quarter 2022 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Stephanie Prince from PCG Advisory. Please go ahead.

Thank you, Gary. And thank you all for participating in Nephros’ second quarter 2022 conference call. Before we begin, I would like to caution you 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 the impact of the COVID-19 pandemic, Nephros’ ability to successfully timely and cost effectively market its product 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 and the effect of existing and new regulatory requirements on Nephros’ business and other economic and competitive factors. The contents of this conference call contain time sensitive information that is accurate only as of the date of the live call today, August 10, 2022. 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 Nephros’ President and Chief Executive Officer, Andy Astor. Andy?

Thank you, Stephanie, and good afternoon, everyone and welcome to the call. I am pleased to report our second quarter results, which were strong at the topline, net revenue was $2.9 million, an increase of 27% year-over-year and 32% over the previous quarter. Also active customer sites increased 21% year-over-year to a record 1,349, which were also 6% higher than the previous quarter. Customer retention rates remain comfortably over 90%. While topline growth remains our top priority we also recognize that Nephros needs to become profitable. As we announced last month, Nephros expects to be cash flow positive by midyear 2023. Of course we remain focused and optimistic about revenue growth, but we are also taking steps to tighten our belts. In the quarter ended June 30, these steps included a 15% headcount reduction, reduced use of professional services, and initial work towards production and inventory efficiencies. As of July 1, operating expenses have been reduced by more than $300,000 per quarter. We expect our ongoing actions to reduce expenses further in the coming quarters. I’ll now give a brief overview of some sales and marketing highlights. Wes Lobo, our Chief Commercial Officer, he would normally give this update but he is on vacation this week. As we announced on the previous earnings call, Nephros launched its new web presence at the beginning of Q2. In his remarks at that time, West said, the launch of that, quote, the launch of our new website provides the digital architecture to articulate our value proposition, provide easier discovery of product solutions and produce timely relevant materials for our customers. I am pleased to report that just four months later, the website is delivering benefits including lead generation that has led to new revenue in the tens of thousands of dollars so far. In addition, we continue to build our regional sales teams to provide dedicated support to our distributors and our end customers. We have coverage in most of our important markets and are actively recruiting for the rest. Our Medical Water Filtration businesses primarily hospital infection control and dialysis water purification were both strong this quarter, also ending with record numbers of active customer sites. In the Commercial Filtration business, I am pleased to report that we shipped over 3,000 filters this quarter for installation in Chipotle restaurants nationwide. The replacement cycle through these products is every six months. We expand -- we expect the brand equity from this relationship to unlock additional opportunities in the food service and beverage space going forward. And in the Pathogen Detection business, we have completed agreements with two strategic testing partners and anticipate a steady build of sales over time. And finally with the previously announced FDA 510(k) clearance of the HDF Assist product from our subsidiary Specialty Renal Products, we are now in discussions with dialysis clinics for a rollout to patients around the end of this year. I’ll now turn to a few details of our financial results. We reported second quarter net revenue of $2.9 million, a 27% increase over prior year. Factors impacting this growth included organic growth, the Chipotle shipment, I discussed earlier, and also some pull ahead sales due to a price increase implemented in June 1. Net consolidated loss for the quarter was $1.1 million, approximately the same amount as the second quarter or Q2 of 2021. Consolidated adjusted EBITDA in the quarter was negative $0.7 million, compared with negative $0.8 million in Q2 of 2021. Consolidated gross margins in the quarter were 47%, compared to 57% in Q2 2021. This decrease is primarily due to global inflationary and supply chain trends, in addition to some inventory exploration. We expect the June 1 price increase to improve our margins and continue to target future gross margins of 55% to 60%. Consolidated research and development expenses in the quarter was $0.4 million, compared with $0.5 million in Q2 2021. Consolidated sales, general and admin or SG&A expenses in the quarter were $2.0 million, compared with $1.9 million in Q2 of 2021. And our cash balance on June 30, 2022, was $4.2 million. We reassert that our current cash balances are expected to suffice for the foreseeable future. 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 our results, including our Water Filtration, Pathogen Detection and Renal Products businesses -- business segments will be found in our filing on Form 10-Q, which we plan to file on Monday, August 15th. That concludes the financial discussion. And we’ll open the call to questions in just a minute. But first, I would like to thank each of our Nephros employees and our strategic partners for providing unsurpassed products and services to our customers, especially this year during some difficult times. And thanks also to our devoted investors for your continued confidence and your patience. We know that these are challenging times for our investors and yet we believe that our ability to navigate the short-term results will be to our ultimate benefit, as we maintain our commitment to investments in scalable, commercial and operational infrastructures as a path towards long-term sustainable growth. This concludes our formal presentation remarks. We will now take questions from the audience. Gary, please open the call for questions.

[Operator Instructions] Our first question is from Marc Wiesenberger with B. Riley FBR. Please go ahead.

Yeah. Thank you. Good afternoon. Appreciate you taking the questions. And Andy, it’s nice to hear a more upbeat tone from you relative to the last quarter. So congrats on the efforts.

Yeah. Thank you, Marc. Nice to hear your voice.

I would like to start maybe with the gross margins. We did see some nice stabilization and sequential increase. How should we think about that ramping into the second half of the year and do you anticipate getting back into the target range by the end of this year?

In this economy, it’s hard for me to say a simple yes or no. I’m glad they have stabilized. There will be some more pressure from product exploration. But I don’t think -- I have what we have not seen is continued increases in shipping. Indeed, I just heard yesterday that our air shipments, which we don’t do very much of, but air shipping costs have actually gone down. So the fact that prices are not going up and the fact that we have a price increase that, for most of our customers went into effect on June 1st, should give us upwards -- should be -- should positively impact our gross margin and so I do think we will see modest increases in it over the course of the next couple of quarters. We probably won’t be back at target range of 55% to 60% overall. I don’t know if it’ll be this year or if they’re -- or if it’ll be early next. But we’ll be moving. We intend to move in that direction in the next few quarters. That’ll be part of our plan, of course, of getting to cash flow -- positive cash flow.

Got it. Okay. Well, we’ll be looking for that continued progress.

Thank you.

Moving down the P&L, how should we think about OpEx building off the 2Q levels? And I guess as growth ramps, is the current infrastructure sufficient for that expansion? And then I did hear you mentioned expanding the sales team a little bit in certain regions, is this kind of a shift in emphasis from distribution partners to maybe more of a direct salesforce or how do I interpret that comment there?

I think you -- I think the answer to your first question is, yes, we are -- our current level will support the growth that we are looking for. So we don’t need to significantly increase OpEx in order to grow -- when I say modestly, I mean, make up the number 20%, 30%. The second question you asked, sorry, just remind me, I’ve lost my train of thought.

Sure. No problem. You talked about expanding, I think, this…

Oh! I am sorry.

…in certain geographies, is that a kind of an emphasis…

Yeah.

… away from distribution partners to more direct salesforce?

Thank you. No. Not at all. In fact, we have always had direct sales people to support our partners. So there’s absolutely no change to that whatsoever. But what we -- what there is not a change to but a continuation of is our intent to have geographical, regional sales managers, within a long drive or a short flight to everywhere in the continental U.S. and we’re making good progress on that.

Very helpful. And then…

And that’s, again, not a change from plan.

Perfect. In terms of the Medical Filtration market, if you could kind of provide some more insights in terms of what you’re seeing there and kind of the different kinds of submarkets within there. That would be really helpful.

Sure. What I would tell you about Q2 is for all three of the filtration markets, which are the two Medicals and the Commercial. The -- they were normally distributed. They grew -- all three grew nicely and Commercial grew a little extra nicely, because of the Chipotle shipments. So what I would tell you is that, there’s nothing -- I wouldn’t say that solid healthy growth is not noteworthy, but it is what we expected and it was what we were surprised. We had a negative surprise in Q1, but we’re right back where we thought we would be in all three markets in Q2. Does that answer your question?

It does. I think this quarter, though, does kind of have some lag or delayed from the first quarter, is that right? Can you remind us kind of how much that was pushed in from the first quarter into this quarter?

Yeah. Not a lot. One of the two that we mentioned in that last call did close and of that, the other one got kicked down the road. So I wouldn’t spend a lot of time trying to analyze that. I think Q2 was Q2 is Q2. And what I do -- what I did say in the -- my opening remarks and would remind you Marc is that there probably was some pull ahead sales, not probably, there was some pull ahead sales on our June 1st price increase, probably, to the tune of the low hundreds of thousands of dollars, like, let’s call it about 250 would likely have come into the second quarter sales that might have not come in until Q3 if not for the price increase.

Understood. Very helpful. And then just one more and I’ll get back in the queue.

Sure.

Looking at the at-home dialysis market, I believe a leading player previously had an FDA hold from shipping some units, which has now been lifted. Were you at all impacted by that in the first half of the year and now that that has been lifted, do you anticipate that accelerating some of your growth into the second half of the year?

Yes and yes. We were impacted by that FDA hold and there was -- there were some holes put on future orders that were planned by both parties. And the lifting of the hold, we do anticipate, although, I can’t tell you that we have it in hand yet, but we do anticipate that that will bring, that will contribute to growth in Q3, Q4.

Great. Let me just sneak in follow-up to that -- to those pretty helpful. I guess, could you quantify potentially what that drag was, number one? And then number two, do you also supply that customers in clinic or do supply filters for that customer in clinic, as well as their at-home?

No and no.

Okay. Thank you.

No. I won’t quantify the impact and know the customer relationship there is for the home and portable dialysis product.

Great. I appreciate you taking all my questions. Thank you very much.

That’s okay. Good questions as always, Marc. Thank you.

[Operator Instructions]

I will offer if there are no further questions, Marc, if you have other follow ups, you’re more than welcome to ask.

Our next question is from Ralph Weil with R. Weil Investment Management. Please go ahead.

Hi, Andy.

Hi, Ralph.

Could you comment a little more about the expense cuts and the headcount cuts where they may have taken place and what parts of the business? And I assume you feel that these were done without hurting your business going forward? And a second question would be, do you envision in view of, the fact that you’ve had this problem that and then even though you say you don’t need money that you get by and I hope you will, sincerely hope you will. Do you see any parts of the business being monetized so that you can concentrate more on any of the ones that are left?

Thanks, Ralph. Good to hear your voice, by the way. The cuts were made across most departments. They were a combination of layoffs and replacement and attrition and so forth. But the cuts were made across. And they were made carefully and I can’t say they weren’t painful, but I do think you’re correct that, I would say that they, that we are able to do 90% of what we need to do and I think we made the cuts prudently, and again, it was painful and it was tough for the organization. We haven’t had to do that before. But it is -- I think, they were necessary and we did them and we’re -- I think we’re firing on all cylinders. I’m sorry, your follow on question was regarding the cash balances, is that right?

Yeah. Yeah. You say that you don’t need money, because cash is...

Oh! Oh! I’m sorry.

…gone a quite low.

Yeah. Yeah. No. I…

And I’m just wondering, you do have a few different businesses, some of which are maybe more exciting than others, but they all could grow. But I’m just wondering whether there’s any thought on your part to focus more on growing some parts, and perhaps, monetizing one or two others?

I understand. I understand. And I won’t comment on that, because those are strategic questions that would be quite material. If I discussed them, I won’t -- I can’t say we’re ruling them out nor can I say that we are doing them. But I understand what you’re saying and we are, of course, looking at always to get ourselves to cash flow breakeven with multiple alternatives in front of us. But we’ll do something. Well, what we do, we’ll do in a way that I know this is not a direct answer to your question, Ralph, but we’ll do what we think is best for the overall business. But, yes, those -- that kind of thing is we’re looking at all options.

Okay. Do you feel that the third quarter, which hopefully will be a continuation, a positive continuation, but do you feel that it may be negatively affected by the buy ahead in the second quarter because of the price increase? And do you -- and to offset that, do you see any important things, which will, I guess, offset that potential decrease due to the buy ahead?

It’s hard to know, I mean, the buy ahead is essentially $0.25 million hit, so do we expect less, do we expect more? I mean, we have to see when we come out of the quarter. I -- the way I look at this is a quarter and a quarter, and not go -- I really want to get away from trying to explain away what happened in one quarter by what happened in another. We intend to grow the business and we have to do that in the face of all occurrences, whether there would be price increases or a company losing its FDA clearance temporarily or whatever it may be. So I don’t know what else I can say to that.

The next question is from…

Gary?

…Thomas McGovern [ph] was met Maxim Group. Please go ahead.

Hi, guys. Thanks for taking the time to take my question and congrats on the quarter. I just have a quick question following up on one of Marc’s earlier questions on OpEx. You mentioned that the infrastructure was ready or there was sufficient for moderate growth and you threw out a number, approximately 30%, just to clarify, is that roughly what you say -- you would say, you would expect an increase in OpEx or is that something that you think you can support, unless you can support a growth of 30% with the current infrastructure?

The latter is, what I said. The -- what I said was, I don’t think we need to substantially increase our OpEx. We just decreased our OpEx. And I don’t think we need to substantially increase -- significantly increase it with the kind of growth that we’re planning. So we do not plan on increasing our OpEx going -- in the foreseeable future. Okay.

Great. Thanks. Thanks very much for clarifying my question.

You’re welcome, Thomas. Thank you.

The next question is from Neil Cataldi with Blueprint Capital. Please go ahead.

Hey, Andy. Just one quick one.

Hey, Neil.

You mentioned you’re in discussions with dialysis clinics for rollout to patients by the end of this year. Just wondering if you could elaborate a little bit on that, does that mean that maybe you’d have to partner with one of these dialysis companies or what should expectations be going forward there?

Well, I think, we’ve been pretty consistent on this, although, it’s taken longer than we thought, certainly. And that is that our intent is to get into a couple of dialysis clinics that might be one, it might be three, but it’s a small number of dialysis clinics where we can demonstrate for the first time touching patients, since this was a product that we’ve developed without the need for trials, we want to we want to get out in commercialization into one or two dialysis clinics just to get the patient experience and demonstrate the machines capabilities and whether that is so that we can go from one to two to four to eight to 16 or it’s for strategic reasons, where we just need to get out into a clinic or get real, if you will. We are -- yeah, I mean, that -- and that’s what -- that is just what we have to do and we are in those discussions now. Does that answer your question, Neil?

Yeah. I guess, the company spent years and millions upon millions of dollars to get to this point, right? And the market hasn’t really given you guys any credit for getting the approval. So I am not sure that, that investors or the investor universe really appreciate what the magnitude of this might be or even the value that this may have to the company. So are you saying that you need to really prove that it works in the field first, before you can then engage with a few of those bigger names that that sort of dominate that market?

Well, it is -- I think that’s part of it. Remember that the first version, which came out and was approved in 2012 was, frankly, an unusable machine and had a lot of difficulty in the marketplace. And that this is a -- this is the second generation vastly easier to use and we currently have a reputation as a difficult to use machine, that clinic -- that clinicians rejected. So what we want to do is get out there to demonstrate that we that we have the machine that we are saying that we do. I certainly agree with your premise that the market did not give us any credit and we think that the reason for that is, as you said, untold millions of dollars, and frankly, two decades have gone by on, on the work on this and we’ve got a lot to prove and we’re really excited about getting the chance to prove it.

All right. Great. Thanks.

Yeah.

The next question is a follow-up from Marc Wiesenberger with B. Riley FBR. Please go ahead.

Yeah. Thank you. You have been seeing some nice steady increases in your active customer sites. I’m wondering if you could talk about what specifically has been driving that and is that dynamic kind of sustainable going forward?

We think so. The way our -- I like to say that we act like a subscription business, but we’re not a subscription business, right? We -- nobody has to buy a replacement filter, they can try to make their filters last longer or they can decide that filters are too expensive and they’re going to a different approach. But fundamentally, we’re in a recurring revenue model business. And so what we measure is the number of customers that we have who have bought within the last four quarters. That’s our active site count. And if we are -- and I consider that our primary leading indicator, right, the number of customers that are actively buying our product, we want that number to go up, and frankly, it went down a little bit during the pandemic, when we contracted revenue wise in 2020. If I look -- I am just looking at the numbers now, we were down as low as slightly below 1,100. But we have come up nicely in 2022, up to essentially 1,350, 1,349 and so that’s…

So yeah.

I do believe that this number will increase over time on a continuing basis and I think it’s a leading indicator of where our revenues will go.

Great. And then two more, I think, previously on the last call you were talking about the Pathogen Detection segment pursuing some two significant customers or opportunities. I’m wondering if you could update us on the progress on those developments?

Yeah. I did cover that. But I sort of flew over it. There are -- there were two companies that are deeply involved in the testing of water and both of those partnerships are signed, and revenue will start to grow out of them in the near future. I don’t know at what pace. I am not talking about gigantic growth, but I am talking about those -- both of those have been signed.

Very good. Generally shouldn’t have skipped or flew over those. That’s pretty important and hopefully we can see that build going forward. And then just finally…

Okay.

…last one from me. I think you -- on the last call you did previously talked about competitors being supply constrained. I’m wondering, have you been able to take any share as a result of that dynamic? And do you foresee any supply constraints for you -- for Nephros in the back half of the year? Thank you.

You’re welcome. We have -- we did do a marketing campaign on that and did get some sales. I don’t have a number for you. But we did get some sales as a result of our competitors not being able to fulfill orders. And no and answer your second question, I do not anticipate any supply chain issues of note with us for the rest of the year in fact our suppliers healthy and always have them. We keep it that way.

Great. Thank you.

Marc, thank you very much. Those were as always great questions. Thank you.

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

Thanks very much. I’ll be super quick. I wanted to say thanks everybody for taking time out of your busy day and I look forward to seeing you or at least talking to you in three months on our next call. And in the meantime, please keep in touch, you can always reach me at [email protected] and I look forward to talking to all of you again soon. Take care everybody and have a great night.