Nephros, Inc.

Good day and welcome to the NEPHRO's first quarter 2021 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Kieran Smith from PCG Advisory. Please go ahead.

Good afternoon, everyone. This is Kieran Smith with PCG Advisory. Thank you all for participating in NEFROS' first quarter 2021 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 NEFROS. I encourage you to review NEPHRO'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 and timely and cost-effectively developed, 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 health care providers, 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, May 6, 2021. 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 Nefros' Chief Executive Officer, Andy Oster. Andy, please go ahead.

Thank you, Karen, and good afternoon, everyone. Nefros had a great start to 2021, recording our highest first quarter revenue in company history and our third best quarter ever. I'm also pleased to report here that March was the single highest revenue month in our history. Overall, it appears to us that as more of the country is vaccinated and the spread of COVID-19 trends downward, our markets are reopening. Our core water filtration business, which was challenged in 2020 while the healthcare market was mostly closed to us, had a nice bounce back in Q1 of this year. Net filtration revenue was up 8% over the same period in the prior year and up 17% over the prior quarter in Q4 of 2020. Also, we saw good performance in all three revenue elements in this business, that is new customer acquisition, recurring revenue from existing customers, and our emergency response business. We believe the strength in these results is due to the healthcare facilities, two healthcare facilities, shifting from an extensive focus on COVID-19 to more normal operations, including planned water testing, evaluation, and remediation as part of their water management programs. While a single quarter of strong performance is not a trend, we do believe that market dynamics are becoming favorable to return us to pre-pandemic growth levels in the coming quarters. In addition to our Q1 results, a couple of additional data points are also worth mentioning. First, the COVID-19 pandemic raised public awareness on the topic of infectious diseases as evidenced by, among other things, the many articles in mass media regarding the importance of reopening buildings properly with respect to water safety. In the coming months and years, we believe we will see increasing focus from the market on water safety and water pathogen prevention and remediation. Second, in a somewhat more technical development, The Center for Medicare and Medicaid Services, or CMS, recently approved the Joint Commission's document New Requirements for Water Management in Healthcare Facilities, which will go into effect on January 1, 2022. These requirements strengthen water management regulations that were published in 2017. Notably, the new requirements emphasize the need to look for multiple pathogens in water and not to focus exclusively on Legionella. This approach is consistent with NEFROS' view. We expect these new regulations to expand market awareness of the need for effective water management planning and processes, which in our view will be beneficial to NEFROS in the future. So in summary, as our core markets show signs of reopening and as water management awareness and regulations increase, we are optimistic about our filtration segment returning to high growth levels. I will next briefly discuss our pathogen detection systems or PDS business segment, which we first launched at about this time last year. The challenge of launching a new business segment last year, while our core markets were close to us, did in fact carry over into Q1 of this year. We did not record any revenue in the first quarter. However, we did maintain our strategic and intentional focus on driving customer and distributor awareness, establishing beta customers, expanding our bioassay portfolio, and completing our level two biosafety laboratory and manufacturing capability. We expect the recent updates to water management program regulations, as stated earlier, will have a net positive impact on our PDS business, as well as filtration, as water testing is a vital part of a healthcare facility's water management practices. Also, as presented by the CDC, the Centers for Disease Control, at the March 2021 Legionella Conference Special Session, Quantitative polymerase chain reaction, or qPCR, is now an approved testing method for Legionella and other concerning water pathogens with the same level of endorsement as traditional spread plate culture techniques, which take many times longer to execute. Our PDS products use qPCR technology exclusively. providing customers the ability to conduct on-site measurement and detection of waterborne pathogens quickly and accurately. This allows for near real-time responses to potential disease outbreaks, and of course, we provide excellent remediation with our point-of-use filtration to mitigate outbreaks of Legionella, Pseudomonas, E. coli, and other pathogens. As market dynamics continue to improve, we are confident that PDS will show significant revenue growth in the coming quarters. And I'll turn now briefly to a quick update on the renal product business segment. As we've stated previously, we completed the development of our second-generation hemodiafiltration, or HDF, product earlier this quarter. We submitted that HDF product for an accelerated special 510K to the FDA, and the FDA determined that a traditional application was required. We were prepared for this result, and we are now working to complete this traditional 510 filing. We expect to announce formal submission acceptance and expected timelines in the near future. Once we receive clearance, we will work to identify a few dialysis clinics to take part in our soft launch, which we still expect to initiate sometime in the second half of 2021. I will now provide a few highlights of our first quarter 2021 financial performance. Nefros reported consolidated net revenues in the first quarter of $2.7 million, a 17% increase over the fourth quarter in 2020, and an 8% increase versus the first quarter of 2020. Net consolidated loss for the quarter was $0.5 million compared with $1.2 million in 2020, about $500,000 of the $700,000 improvement was due to the forgiveness of our PPP loan. Consolidated adjusted EBITDA in the quarter was negative $0.7 million compared with negative $0.8 million in 2020. Consolidated gross margins in the first quarter were 59% compared with 58% in 2020. We expect future gross margins to continue in the range of 55 to 60%. Consolidated research and development expenses in the first quarter were 0.6 million, on par with the same period last year. And consolidated sales general and administrative expenses in the first quarter were 2.0 million, also on par with the same period last year. And our cash balance at the end of the first quarter was 8.2 million. Please refer to today's press release for more details about the calculation of adjusted EBITDA and its reconciliation to gap net income or loss. Additional information about our results, including our water filtration, pathogen detection, and renal product business segments, can be found in today's filing on Form 10-Q. In closing, I would once again like to thank all our NEFROS team members and our strategic partners for staying focused on the customers and achieving a company milestone for first quarter revenue. Please be on the lookout for our participation in upcoming industry trade shows and financial conferences. I look forward to seeing many of you there either virtually or soon in person. Also, if you're not already subscribed to our occasional email alerts, you may do so at the bottom of our website homepage. And of course, please always feel free to contact me directly at Andy at nefros.com. 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, and I look forward to speaking with all of you again soon. We will take questions from the audience now and answer emailed questions as appropriate. Operator, please open the call for questions.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. The first question will come from Martin Roth with Barrett Capital Management. Please go ahead.

Yes. Andy, hello. This is our first visit with you, and we just took our initial look at the company. And I'm a bit confused. I thought initially that this company made products for the hemodialysis market and that you were going into commercial. And yet when I see your financial statements, it appears that you have it both water filtration and pathogens. That's the way you look at the business, correct?

Nice to meet you, Martin. Thank you. We are, thank you. The company was founded 24 years ago, primarily in the business of hemodialysis filtration and the hemodialysis market. But that, we changed that about six years ago while we still, and in fact, the last part of the business that I talked about is still that. Our primary and all of our revenue is from water filtration. There are three, and very briefly, there are three categories of water filtration. We have hospital infection control, we have the purification of dialysis water before it gets to patients, and we have commercial filtration. So all three of those together make up our filtration water business segment. Then there is the pathogen detection segment, which is essentially a water testing segment. And then the third area is the original business that the company was in when it was founded, which is the development of a new HDF treatment modality. And Mark and I would be more than happy to give you more of a briefing offline if that would be helpful to you. you can reach me at Andy at nefros.com. Okay, thank you. You're welcome. Thank you for the question.

The next question is from Robert Smith with Center for Performance Investing.

Hi, good afternoon, Andy. Thanks for taking my questions. Hi, Robert. Hi. So the change in regulations that you mentioned taking effect January 1st of 2022, do you anticipate perhaps any changes potential business getting a jump on that as far as orders go? We do. We do.

We believe that the fact that the new regulations will become official on July 1 of this year and they become effective on January 1 of next year is already having an impact on our customers and our prospects in terms of how they're thinking about what they need to do to get ready for that. So yes, I do think that that is the case.

And the comment you mentioned about the renal area and the formal... Yeah, so you said that you were going to file in the second half of this year and that you felt that you would have a soft launch also in the second half. So that's a relatively brief timeline. Can you kind of share with me your feelings about optimism in that respect?

Sure. We actually think that we will file So in the first half of this year, I expect to do so relatively soon. And then it's, you know, three or we think it'll be three months or so before we get the approval. And then that gives us a little bit of time to still be in this year, hopefully getting into clinics. I don't have a, I don't, I can't give you specific, you know, dates, but that's our target approximately.

And then there'll be a full go in 2022.

Well, we'll certainly be rolling out in 2022. Yeah. Yeah.

Okay. Thanks so much. Good luck to you.

Thank you, Robert. Nice to talk to you.

The next question is from Mark Weisenberger of B Riley FBR.

Thanks. Good afternoon. Really nice quarter, Andy. Congrats. I'd love to hear really what is driving the new customer growth and how is it compared to maybe some pre-COVID times that you can reflect on?

Well, what drives new customer growth is our reputation and our outreach and our work on market awareness. And then in turn, new customer growth, which is very small, by the way, in terms of our actual dollars, is what drives the growth in future quarters. So I don't really think it's very different. And so my answer in terms of whether or not it's it's similar or different to pre-COVID times is it's quite similar. While I won't go into specific numbers, I would call our proportion of new customer and emergency response as well, by the way, to be in the normal range for pre-COVID times.

Got it. Would that answer your question? Sure, yep. And then can you kind of talk about the healthcare hospital activity versus some of the dialysis clinic market, and what are you seeing in the respective areas there?

They're both healthy. We are seeing some very nice growth on the dialysis side. And we think that will continue to be an important contributor to the higher growth levels that we're expecting as the year continues. But they're both healthy. You know, our retention on the hospital side, our recurring percent, I'm sorry, our new customer percentages are, as I said, normal. Our emergency response percentages are normal. And our recurring retention rates remain in the 90% range. And so that's a healthy business. And then on the dialysis side, we're actually seeing net growth, which is, well, we're seeing growth on the dialysis side as well. And so we've got two businesses that I think are ready to launch. I should say growth curves that are ready to launch.

Got it. And then turning to pathogen detection, you talked about QPCR as becoming an approved method for Legionella testing. How does that compare to some of the CDC's labs, and is there a potential that over time the QPCR could become the standard rather than ultimately some of those labs and And we'd love to hear also as well about the respective products and potential beta customers and where you're seeing interest for the respective products as well.

Yeah, it is way above my pay grade to speculate on the CDCs and on, you know, on surpassing the technologies used in the CDC labs, which are the gold standard today. I think that PCR, particularly coming out of the pandemic where all of the reliable tests for COVID were done using PCR technology or just about all of them. And I think we as a society will see PCR continue to take its rightful place, you know, right alongside a traditional culture, spread culture plates, sorry, spread plate cultures. But, you know, whether or not it takes over as the gold standard, I have no idea. And in terms of more color on the kinds of customers we're talking to, I won't say too much because... We don't have a lot to say in terms of results right now, but what I will say is that we're focused on the same distributors as we are in the filter business and having some great meetings, not just with them, but with them and end customers. And as I said in my talk, I think we're going to see some real growth in that area.

Great. And then one final one from me. The obligatory commercial filtration update would be helpful. Thanks a lot.

Sure. Thanks. Mark, as I think I've said a couple of times, we were premature, at this point it's close to a year ago, on thinking that we had a multimillion-dollar contract at the ready. And I hope by now I've made clear that that contract, while we're still pursuing it, is taking its sweet time, and it will happen if and when it happens. So the results will speak for themselves. We don't break out our individual market numbers, and so I can't comment on that because we don't break them out. but commercial is doing well, and we are moving forward.

The next question will be from Bob Wasserman of Benchmark.

Hey, thanks. Good afternoon. Congratulations, Andy, on a good quarter, and I guess getting through the last 12 months. A couple questions that are related, and it's... kind of related to new products, but maybe you could give us a little more color both on the expected beta sites for the new pathogen testing and also you mentioned a little bit about the 510K, the new dialysis and soft launch. How will you go about doing that at this point?

Well, on the When I said beta customers, we're really talking about relationships with distributors and cooperating with them on proving out our technology with them. And that's going well. And obviously, we don't have revenue to speak of for Q1, so I can't talk about specifics there. But we are working in beta. doing what I think is great work. And that's giving me great confidence. I can't really say a whole lot more than that at this point. In terms of the rollout to clinics, that really hasn't changed. Our plan always has been to roll it out to a few clinics once we have FDA clearance. And that is still true. And the good news is that it looks like by the fall, the pandemic will be cross your fingers behind us and the, uh, we hope that the clinics will be more open to, um, uh, to new solutions and technologies than they were able to be during COVID when frankly dialysis clinics just got, just got smashed by the pandemic because of the, uh, the death rates and the, uh, the, the, well, the morbidity rates, um, associated with dialysis patients and COVID.

Okay. Are you looking, in terms of clinics, are you looking for, to put it in clinics that you've been in before, are you looking for kind of, you know, big, you know, there's a lot of big national change. Are you looking for kind of unique situations that, you know, might be representative of where you want to go long term?

I'm not sure that we can learn anything The answer is both, Bob. We are, you know, I can imagine going to a very small clinic of one or two sites because it's easy to talk to the principals. It's easy to, you know, it's not a big deal. I can also imagine going in on a pilot with a very large organization which knows how to pilot and bring in technologies. And we'll pursue both. We have relationships in both the large and the small, and I think you'll see us pursuing both.

Okay, great. Thanks, and congrats again. Okay, thanks very much, Bob. Appreciate that.

The next question is from Anthony Vendetti of Maxim Group.

Good afternoon. This is John. I'm speaking on behalf of Anthony. It's a pleasure. Hey, John. How are you doing? Thanks for having me. I guess just with the vaccines rolling out and there's focus away from COVID-19 slowly, along with the CMS water management guidance that you mentioned earlier, it seems like there's an opportunity for growth or significant growth that the pathogen detection product can take advantage of. I was just wondering if we can get more color, I guess your expectations or plan in order to, you know, leverage or capture the market that we're seeing right now? Or maybe there are trends that you've already observed this quarter. Just, I guess, your expectations or what you think about moving forward.

And, John, you're talking about specifically pathogen detection.

Yeah, specifically for, yeah.

Well, I think... Look, it's early days. The new regulations were only made public a couple of weeks ago. But what I can tell you is that we are seeing interest and movement from both our distributor slash strategic partner community and from our end customers to be responsive to the need to A, be responsive to the need for tighter regulation, or I'm sorry, to be responsive to the tighter regulations, and B, to take advantage of the fact that QPCR is now at the same level of recommendation as cultures have been for years. And, you know, we're seeing real interest in that in this very you know, in this, just this two or three week time period. And that gives us, you know, that that's why we are feeling optimistic about it. Right. Yeah. That makes sense. Does that answer your question? Yeah. Okay. Yeah. That was helpful. Thank you. You're welcome. Thanks for the question, John.

The next question is from Michael Burchett of national securities.

Hello, Michael. Hey, Andy. How are you? I was good. Long time.

No talk.

Yes. I was, uh, just looking at the stock chart and the price is a lot higher when we first started talking. And then I think it was like two or three bucks. It's done well. Congratulations on the first quarter. It's great. Thank you. I missed the first few minutes of this, so if you covered it, let me know. But obviously, the COVID pandemic has had a negative effect on the business. Is there... a pent-up demand, or do you just go back to the growth that you had before because your other customers weren't doing any business anyway, so it wasn't like they needed your filtration products?

Yeah, so I think your question is, would we expect to see, well, as you said, is there pent-up demand that might give us a big bump in the near future that would then smooth out over time. I don't, I'm not planning on that. There's, with one exception, I'm not seeing that. Generally speaking, most of our business, the great majority of our business is proactive in nature. And so customers come to us when they are planning their pathogen detection and their filtration solutions, and they put those programs in place, and then they stay in place forever, which is why we have a nice recurring revenue model. And so I don't think that business comes – I don't think that brings – sort of a big surge of demand for any structural reason. However, what we have seen is a little bit of a bump in the emergency response business, which is a reactive business as opposed to a proactive business. And my hypothesis on that is that hospitals are testing more aggressively for emergency outbreaks than they were able to during the pandemic. And so there may be some underlying problems that have been developing over the past year that are only now being discovered. And so that might give us a little bump, but that's a small but important part of our business. So I'm not sure that it will be a major contributor.

The other part that's sort of semi-related, not directly, is just in normal times, do you have a cyclicality to the business?

A little bit. Go ahead. A little bit. Q1, which we just finished, is usually our lowest quarter. And the reason, again, these are our hypotheses, is that it's cold in the first quarter. And bacteria don't grow as well in the cold seasons, and so our emergency outbreak business tends to be lower. And in Q2, Q3, and Q4, we see acceleration, and then usually a dip again in Q1. But it's not like retailers and Christmas, but it's a little bit of cyclicality.

Right, right. Got it. Thank you and congratulations. Keep it up. My pleasure. Thank you.

Again, if you have a question, you can press star then one. The next question is a follow-up from Martin Roth of Ferret Capital Management.

Andy, I'm back again. I don't want to sound like the skunk at your picnic, but there are a couple things I don't understand. One, you made clear that you have a stable base of operations and and they were affected by COVID, and they were affected by your inability to get salespeople to visit new prospects. But, excuse me, I see in comparison to other medical companies that we follow that you seem to be hit harder than others, even though you have the space. Why would that be the case?

Well, first of all, Martin, I don't think of you as a skunk at the picnic. I think of you asking good questions. Okay, thank you. You know, we're a small company. And my experience in the four years that I've been here is that, you know, if you try to relate our results to the larger organizations, you fail. you tend to come up against head scratchers all the time because we don't have the power of large numbers for working for us. In fact, quite the opposite. We have the laws of small numbers working for us, which means that we have more randomness. I don't honestly know why COVID hit us in certain ways. differently than the rest of the industry. What I can tell you, though, is what it looks like from inside the business. And where we really got hit, about 75% of our downturn last year was in the emergency response part of our business, in the non-proactive, in the reactive side of our business. And our understanding of the cause of that is that is that when that business depends on hospitals looking for waterborne pathogen problems with pathogens such as Legionella and Pseudomonas and E. coli and so forth. And frankly, last year, they were just too busy, and I think they didn't look that much, and that's why our business went It didn't go to zero, but it went pretty close to it in the emergency response space. So that may explain, that may be an explanation to the answer to your question, but again, I'll caution you taking any one piece of data too strongly when we're a small firm and sometimes, you know, numbers, there's a little bit more randomness than there are in companies that are 100 times our size.

Let me throw out what may sound like another stink bomb, which is what is your position versus the competition? And if you look at it in terms of filtration versus pathogens, who are the biggest competitors in those two areas?

Well, our biggest competitor on the medical filtration side is Paul Medical, which is part of Danaher. And they are at least 100 times our size. Well, they're much more than that. They're probably 1,000 times our size. And on the commercial side, our major competitors are also 1,000 or more times our size. They are 3M under the Kuno brand and Pentair under the Everpure brand. On the pathogen detection side, we compete against a big and fragmented market largely of microbiological laboratories that do bacteria cultures. But we are also riding a new wave of PCR technology, which is, as I said earlier, a... You know, at least it is completely different, so I don't want to say one's better than the other, but it is fast, accurate, and competitively priced. And we're riding a wave of a new technology where there are no major, there is no large leader in PCR, in mass market PCR pathogen detection. And so we are actually competing for that slot.

Now, PCR has been around for probably two decades, I would say, and no one has gotten into using that technology until recent years?

That's more or less true. It's gotten cheaper. It's gotten easier to do. And while PCR has been around for a long time, There have not been a lot. There is no single large successful leader in the field of real-time testing in the field for hospitals looking for waterborne pathogens.

Now, is it useful in all segments of your business or only for the hospital testings?

Oh, it's useful in all of them. Okay. But that's our main focus in the early days.

Right. Do you think the switch over to PCR testing should result in higher margins or is there going to be a lot of competition?

We are planning our PCR business to have similar margins to our filtration business. which gross margin run around 55% to 60%. And we think we can hold that. We're new, we're young, we're small. We'll see. We all have a lot to learn on that. Can they be better than that?

We'll see. To compete against the giants in the industry, there are two methods in which you could grow taking away market share by either a better product, more reliability, or better service, and most of all, new products. How do you think the company will grow in the future? Will it be from taking market share or from new technology?

Well, both. And in fact, our two main... product areas that are in the market reflect those two strategies, right? The water filtration market in both medical centers and in the commercial space is well penetrated and in that area we have to take market share and or get customers that are not currently filtering to filter. On the other hand, in the pathogen detection space, it's a completely new product that we invented and started bringing to market less than or just about 12 months ago. So a little bit of both.

Well, thank you. I'm going to put away the air wick now.

Okay.

Thank you very much, Martin.

Again, if you have a question, you can press star then one. The next question is of another follow-up from Mark Weisenberger of B. Reilly FBR.

Yep. Thanks for taking the follow-up. Looking through the queue, it looks like there's some shuffling in terms of your top customers. The number one seems like it stayed the same, but you've got some new number two and three customers there. Is this potentially sustainable? And the customers that had kind of dropped off this quarter, is there an expectation that they will come back to some more normalized levels?

Mark, I don't have that memorized off the top of my head, but I can tell you I know one of them had dropped off over the past few quarters and has come back in because it had a lot to do with emergency response. So that would explain part of it. But what I would tell you more broadly is we have not had any fall-off of our largest customers. And so there's going to be a little shuffling back and forth, and somebody will be a number one that will be a number two later, maybe number five, and then come back into number one. So that's normal shuffling. But as somebody who lives it day in and day out, I can tell you that there's new blood coming in, but there's no old blood going out.

Great. And so some of these new customers coming in and the shuffling presumably leads to the confidence that you talked about earlier in your prepared remarks in terms of potentially getting back to pre-COVID levels and some new record quarterly numbers? Yes. Excellent. Great. Thank you again.

My pleasure. Thank you, Mark.

And this concludes our question and answer session, and it also concludes our conference call for today. We want to thank everybody for joining the presentation. You may now disconnect your lines. Have a great day.