Nephros, Inc.

Good day, and welcome to the Nefros Incorporated First Quarter 2022 Financial Results 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. Please note, this event is being recorded. I'd now like to turn the conference over to Kieran Smith with PCG Advisory. Please go ahead.

Good afternoon, everyone. This is Kieran Smith with PCG Advisory. Thank you all for participating in NEPROS' first quarter 2022 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 NEPROS. I encourage you to review NEPROS' 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, NEPROS' ability to successfully, timely, and cost-effectively develop, seek, and obtain regulatory clearance for 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, and its effect on the 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 4, 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 Nefros' President and Chief Executive Officer, Andy Astor. Andy, please go ahead.

Thank you, Kieran. Good afternoon, everyone. I apologize for my voice. Just getting over a cold. With me on the call today also is Wes Lobo, our Chief Commercial Officer, who will also provide an update on our commercial progress. I'll begin the call with an acknowledgement that the first quarter financial results of 2022 were not strong. Net revenue decreased to 20% year over year and net losses increased significantly. I also want to remind you though, of my comments from our last earnings call on February 23rd. After listing our recent accomplishments during that call, I said, quote, I believe these are strong indicators of progress and cause for optimism. But not all of these accomplishments will show significant results in Q1 or even Q2. Building scalability will have a bigger return in the second half of 2022, and more importantly, sets us up for sustainable growth in the long run, unquote. My perspective on this topic has not changed. Leading indicators remain strong in each of our three business segments. In water filtration, for example, our active customer count increased 17% year over year to an all-time high of 1,276 customers with a retention rate well over 90%. Our pathogen detection systems group is actively pursuing agreements to provide products and services to two significant partners. And in our specialty renal product subsidiary, We completed our response to the FDA on schedule and are now waiting for the agency's response to our request for 510 clearance of our second generation HDF product. I'll turn the call over now to Wes Lobo, our chief commercial officer, for a closer look at our sales and marketing activities. And then I'll return to review our financial results and to provide some brief closing comments. Wes, please go ahead.

Thank you, Andy. Good afternoon, everyone. It's a privilege to be joining you on today's call. As Andy just mentioned, we are coming off of a tough quarter in terms of our financial results. And while it is true that we fell short of our financial expectations, it is also true that we've made great progress, particularly on the sales and marketing front that sets us up for success. First, as announced in our April 26 press release, we officially shared our new website and branding. In our February earnings call, I stated that the goal of this initiative was to make NEPROS easier to find, easier to contact, and to clearly communicate our value proposition in an easy to understand and measurable way. I'd like to thank our marketing department and wider NEPROS team who delivered on this commitment on time and on budget. The launch of our new website was an important milestone for NEPROS as we now have the digital architecture to better articulate our value proposition and provide easier discovery of product solutions as well as timely, relevant materials for our customers. In addition, the platform allows us to better leverage the power of SEO or search engine optimization and run targeted lead generation campaigns. To cite one example of such a campaign, we recently received market feedback that some of our peers in the industry were challenged by chain constraints, causing them to push out lead times for infection control filters to weeks or even months. NEPROS is in the deliberate and favorable position of having healthy inventory levels to support our customers, and so we've launched an awareness and lead generation campaign to capitalize on this opportunity. This type of campaign was not even possible three months ago. Now onto our filtration business segment. For the healthcare market, one of our main goals is to grow a programmatic or planned business to lower our reliance on unpredictable emergency response business. Of course, We will always be ready to support emergency customers with a sense of urgency and responsiveness they've come to trust with NEPROS. In support of the goal to grow our planned healthcare business, we are targeting new customer acquisition through a land and expand strategy. What does land and expand mean? Our initial transaction with a new customer or landing an account tends to be a small dollar value in the low thousands, taking the form of pilots and demonstrations of our filter systems. The results of these pilots and demonstrations often lead customers to expand their nephro-sulfate program to include additional touch points with patients, staff, visitors, such as ice machines, sinks, showers, or central sterile processing. Account values can grow from the low thousands to tens and even hundreds of thousands. The land and expand model hinges on getting new customers on the treadmill. Therefore, new customer sites and overall active customer sites are great leading indicators to sales growth. To that extent, we had healthy Q1 growth as we saw our overall active customer sites grow by the aforementioned 17% year over year. To further support our customers in anticipated growth, we recently strengthened our sales team to allow for more dedicated coverage in our defined regions and improve our ability to reach and connect with more customers. In dialysis water, sales were on plan and continue to serve as a steady growth business for Nefros. In commercial filtration, In February, we stated that we started shipping filters to a large quick service restaurant or QSR national chain. I'm happy to report that our supplier agreement is to provide beverage filters to over 2,500 Chipotle locations in the U.S. We will be shipping the majority of this opportunity in Q2. An expected replacement cycle on this opportunity is about every six months. As we prove our execution capability to the parties involved, we expect the brand equity from this relationship to unlock additional opportunities in the food service and beverage space going forward. Now onto our pathogen detection business. The team has been laser focused on closing agreements with two strategic testing partners. We anticipate these new relationships and other revenue generating opportunities in Q2 to yield a steady build of potential sales in upcoming quarters. Our 2022 goal for this business is to demonstrate sustainable growth, and we are confident that we're on the right trajectory. Looking ahead, with a new digital infrastructure, the complement of a full sales team, and a more structured approach to customer acquisition and customer retention, I'm confident that we're putting the right pieces in place to capture and close more opportunities and ultimately achieve our expected growth and profitability. Thank you, and I will now turn the call back over to Andy.

Thank you, Wes. Excuse me. And I will now review our financial results. We reported fourth quarter net revenue of $2.2 million, a 20% decrease over prior year. We attribute the decrease to two primary factors. First, 2021 revenue included an unusually high emergency response component, while 2022 was more typical of first quarter results in prior years. Second, two large customer orders expected to close in the first quarter were delayed. Net consolidated loss for the quarter was 2.0 million compared with 0.5 million in 2021. Primary contributing factors to the increased loss were lower sales, lower gross margins, and investments in SG&A or sales general and admins. In addition, first quarter results from 2021 were favorably skewed by the forgiveness of our $500,000 PPP loan. Consolidated adjusted EBITDA in the quarter was negative 1.5 million compared with negative 0.7 million in 2021. Consolidated gross margins in the quarter were 47% compared with 58% in 2021. This decrease is primarily due to global inflationary and supply chain trends, in addition to some inventory expiration. We are implementing a price increase, our second in the last 10 months, which we expect will improve gross margins beginning in June. We continue to target future gross margins to be in the range of 55 to 60 percent. Consolidated research and development expenses in the quarter were $0.6 million, approximately unchanged from 2021. Consolidated sales general and administrative expenses in the quarter were $2.3 million compared to $2.0 million in 2021. And our cash balance on March 31, 2022, was $5.4 million. In light of our Q1 financial results and the volatility of our revenues, we believe it is prudent to withdraw our 2022 revenue guidance. Our optimism for the year remains high, and we reassert that our current cash balances are expected to suffice for this foreseeable future. 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, will be found in our filing on Form 10Q, which we expect to file this week, perhaps today. That concludes the financials. And now for just a couple of brief closing comments. Most importantly, we recognize that quarters such as this one are challenging for our co-investors. But as we have stated repeatedly, we decided about a year ago to invest in scalable commercial and operational infrastructures and to balance short-term results with long-term sustainable growth. We continue to believe these investments will pay off this year. As always, I would like to thank each of our NEPROS employees and our strategic partners for their unwavering focus on providing unsurpassed products and services to our customers. And thanks also to you, our devoted investors, for your continued confidence, especially during challenging quarters. Please continue to stay in touch. This concludes our formal presentation remarks. We will now take questions from the audience. Jason, please open the call for questions. Thank you.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Anthony Vendetti from Maxson Group. Please go ahead.

Thanks. Andy, if you could provide a little more color on the two large customers you said that you were hoping to close this quarter. Have those closed since the conclusion of the first quarter or are those still pending? And do you have an approximate value either of in total or of each one of those deals?

They have not closed as of today. We do expect them to close this quarter. There's no concern about that. Each has their own story, but they're just normal disconnects between suppliers and vendors in terms of timing. So I have no concern about that. In terms of size, we weren't specific. But roughly speaking, as I said, the... The shortfall was roughly 50-50 between delayed large customers and lower emergency response than last year, which was uncharacteristically high in Q1 last year.

Okay, so the emergency response was uncharacteristically high last year, but just lower than expected this year, or at least past the shortfall, is related to that.

It was actually pretty normal. In four of the last five years, Q1 is quite low on an emergency response basis due to the colder weather months. We've talked about that. And last year, it was uncharacteristically high, which yields a... which yields a challenging comparable.

Okay, that's helpful. And then the QSR customer that you signed up last quarter, any updates on how that's progressing?

Yeah, Wes updated during his chat. We did say that it is Chipotle and that we'll be in 2,500 locations. and we expect the bulk of those to ship this quarter.

The bulk this quarter, okay.

And it will be on a six-month replacement basis.

Every six months, okay. Any other update on the pathogen detection business? Is that starting to ramp up, or is it still very early?

Both. It is an early stage venture, and it is, as Wes described, we're in negotiations with two significant testing organizations that we're quite optimistic about.

Now that you've announced the actual QSR, obviously Chipotle is very well known. Have you seen or do you expect to see an increased interest from other QSRs? Because obviously the first contract is the most difficult, right? And so have you seen or do you expect to see increased interest from other QSRs at this point?

I certainly do. Wes, would you like to answer the question?

Sure, Andy. Thanks, Anthony. Yes, as you know, and I did say that really for us it's about executing on the current order and as we improve our execution capability to the different parties involved with this specific Chipotle opportunity, the brand equity from this relationship is absolutely something that we're looking to unlock additional opportunities in the food service and beverage space going forward. Okay, great. The short answer is yes.

Yes, okay. All right, guys, thanks so much. I'll hop back in the queue. Thanks, Anthony.

Thank you. Our next question comes from Mark Wisenberger, B Riley Securities. Please go ahead.

Hey, good afternoon. This is Sahil Kazmian for Mark. Thanks for the comprehensive update. At a high level, I've got the pricing strategy question. I believe, you know, NEPRIS instituted about an 8% price increase in the third quarter of last year. Just wondering if you can talk about plans for any additional price increases in the near term, and maybe just in general, how you think about your pricing strategy in the near and long term.

Yeah, I did just mention that we are implementing a price increase strategy in the last couple of weeks are second in 10 months. And it is a more significant price increase that is necessary to pass along the costs, which is largely why our gross margin was depressed this quarter from 58 in the first quarter of last year to 47 this year. So we will have price increases two price increases, as I said, over the past 10 months. And we will try to keep our prices as low as we can for our customers. And we will also simultaneously target a 55% to 60% gross margin, as we've stated.

Excellent. Thank you. And then I believe you've also talked about leveraging your capabilities across both medical and commercial filtration to healthcare customers. And I'm wondering if you could frame your current penetration of bundled sales and your expectations of how that can evolve both in the near and maybe median term.

I'm sorry, could you repeat the, I understand the premise of bundling medical and commercial, but I'm not quite sure I understood the fine points of your question.

Just how you're thinking about leveraging the capabilities to healthcare customers across both medical and commercial filtration.

I see. So our medical filters are designed to focus on the removal of bacteria, of viruses, of endotoxins, but they do not address taste and odor the way our commercial filters do. That's just the nature of the kinds of filters. And they also have very different pricing profiles. So we combine the two of them to not only give ultra-pure water, but also ultra-good tasting water to our customers. And the cross-sell opportunity is significant. I wouldn't say that it's earth-shattering, but we cross-sell quite often. And we also believe that there will be, over time, as water quality issues continue to be more and more important in this changing world, we believe that cross-selling will also take place in the other direction, where commercial operations will be purchasing medical filters to keep their drinking water safer, not just better tasting.

Excellent. Thanks. Appreciate you addressing the questions, and congrats on the quarter.

Thank you very much. The next question comes from Henry Link, a private investor. Please go ahead. Hi, Andy.

Hey, Henry. Nice to hear from you.

Yeah. What's the status of the Reno Products Company?

So SRP, the Specialty Renal Products, is the subsidiary, just for the benefit of everybody else, is the subsidiary that has built our second generation HDF dialysis assist machine. And that, as many of you know, was submitted to the FDA for approval last June. We received 14 questions from the FDA, clarifications for the most part. And we promised to deliver those by the end of Q1, which we did. And we are now waiting for what we hope will be positive news from the FDA. And, you know, we hope to have that as soon as the middle of the year. But the FDA obviously operates on its own schedule. but that's when we are looking for further news from the FDA.

By June?

Well, we are hoping that by the middle of the year we will hear from the FDA, but obviously that's not something that we control.

Sure.

But I don't expect it to be significantly before that. Okay.

Now, do you have any inventory or do you have to build it up after they approve it?

Well, we'll have a small inventory. As we've said for a couple of years now, our goal is not to roll this out on a wide basis too quickly. FDA clearance is great, and then you need operational experience, and so our plan is to roll it out to just a couple of clinics in the second half of this year to demonstrate its efficacy and its convenience and make any tweaks that are necessary so that we can do a rollout in 2023. That's been our hope and plan for this year.

Well, great. Thanks a lot, Andy.

You're welcome, Henry. Thanks for the question.

Again, if you have a question, please press star, then 1. Our next question comes from Robert Smith from Center for Performance Investments. Please go ahead.

Hi, Andy.

Hi, Robert.

Thanks for taking my question. So this was kind of a real surprise to me. I can imagine that your comments in late February, I just didn't connect that with the possible performance that you, you showed for the first quarter. So my question is that, uh, it's also difficult for me to circle and connect the enthusiasm for the second half. And then you withdrawing your, uh, your revenue targets or how the year looks as a whole. So maybe you could, uh, uh, yeah, I usually am not that particularly interested in the next quarter. I'm not a longterm investor, but, uh, I am interested in, uh, trying to get some more clarity to this as the year unfolds. What can you share with me in that respect?

Well, what I can share with you is that we have built and are building an infrastructure that we believe will drive greater volumes of customers, which we have some indication of with the 17% increase in the customer count. We know that we have excellent products and excellent customers that come back and buy our stuff again and again. And we know that quarters can be fickle and that individual quarters Sometimes, as it did happen this quarter, many factors sort of pile up on each other. When you take the snapshot, particularly when you're in a small company, when you take the snapshot, things aren't optimal. What I can tell you about the year is that we, and I can't tell you how Q2 or Q3 or Q4 will behave, But because the things are taking the time they're taking, we just didn't think it was prudent to leave a 25 to 30% growth number out there when we don't have the reasonable certainty to say that. It's still very, very possible. But I'm not really sure how better to answer the question because we give guidance when we have a high level of certainty and if something changes and certainly the results in this quarter were a change, we want to make sure that we communicate openly and honestly with our shareholders and our investors.

And with the first month in, so to speak, in the second quarter, do you have any additional feel for this?

We are not in the... We don't have a practice of reporting quarters, you know, four weeks in. I will tell you that, like many companies, Nefros' quarterly revenue patterns tend to be... back-loaded, and so it doesn't make sense to really evaluate quarterly results. Okay.

Yeah, I surely accept that. So with the price increase coming, you said in June, right? So that will be fully implemented for the second half? Yes, it will. So your enthusiasm for the second half would seem to be quite palpable. I concur. All right. And as far as Chipotle goes, I don't have the fingertips what their actual units are. Is that the quarter of their units?

I believe it's just about all of them.

Okay, great. Yeah, well, that's certainly a feather in your cap, and it's a great name. Thank you, sir. So I wish you well, and I'm on board, but this took me aback a little, but I'm a long-term investor, and I see the promise of the company. I hope you can execute and implement it. Thanks again. Thank you. Thank you. Take care, Robert.

Again, if you have a question, please press star, then 1. There are no more questions in the queue. This concludes our question and answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.