Nephros, Inc. (NEPH) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Nephros 2020 Annual Shareholder Meeting. [Operator Instructions] I would now like to hand the conference over to President and CEO, Daron Evans. Thank you. Please go ahead, sir.

Good morning, everyone. My name is Daron Evans, I'm the President and CEO of Nephros. It is a pleasure to welcome you to our virtual annual meeting. Today's meeting has been called specifically to vote on the proposals described in the notice of Annual Meeting of Stockholders. Following today's annual meeting, we will proceed directly into an informal shareholder briefing at which time, several company executives will provide a briefing on the Nephros business and conduct a Q&A session. With us today for the formal part of the meeting is Andrew Astor, Chief Operating Officer and Chief Financial Officer of Nephros. In addition, representatives of our independent accounting firm, Moody, Famiglietti & Andronico have joined us and will answer questions from stockholders later in the meeting. The Annual Meeting of Stockholders of Nephros is hereby called to order, pursuant to notice, given as provided by the company's bylaws. I will serve as Chairman of the meeting. And in that capacity, I appoint Andrew Astor to act as the secretary of the meeting and as inspector of election. I will now call on Andy as Secretary of the meeting to report on the proper giving of notice and the presence of quorum. Andy?

I am here. Thank you. I present an affidavit of mailing of notice, certifying that the notice of Annual Meeting of Stockholders of Nephros, Inc. was mailed on April 8, 2020, to all stockholders of record as of March 25, 2020. A tabulation indicates that 7,571,124 shares of the company's voting stock are represented at the meeting either in person or by proxy, out of a total of 9,016,550 shares of voting stock outstanding on the record date. As the majority of shares are required to be present to attain a quorum and a majority of shares are, in fact, present and since legal notice of the meeting has been given, the annual meeting is now regularly and lawfully convened and ready to transact business.

Thank you, Andy. We will now open the polls, and I'll give the overview on the matters to be voted on. The first item of business is the election of Daron Evans, Alisa Lask and Thomas Gwydir to serve 3-year terms on the Board expiring in 2023. The Board has recommended that each of these nominees be elected by the company's stockholders. The second item of business is the ratification of the appointment of Moody, Famiglietti & Andronico as the company's independent registered public accounting firm for its 2020 fiscal year. The Board has recommended that this item of business be approved by the company's stockholders. Is there any questions from stockholders for the representatives of MFA? The third item of business is the approval of a 327,062 share increase in the number of shares authorized under the company's 2015 equity incentive plan. The Board has recommended that the stockholders approve the increase in shares authorized under the plan. The fourth item of business is to vote on a nonbinding advisory resolution to approve the compensation of the company's named executive officers. The Board has recommended that the stockholders approve the advisory resolution. The fifth item of business is to vote to recommend the frequency of future advisory votes on the compensation of the company's named executive officers. The Board has recommended the stockholders to vote for the advisory votes on the executive compensation to be held every 1 year. If you are a stockholder who has not voted and wishes to vote during the meeting, please vote using the instructions on your stream. And we'll close the voting since there's nothing -- no activity. The polls for voting on the matters before this meeting are hereby closed. Andy, will you please announce the results of the vote by the company's stockholders who are present in person and by proxy.

I will. Based upon the submission of proxies prior to the meeting, the preliminary voting results as follows -- are as follows: number one. First, each of Daron Evans, Alisa Lask and Thomas Gwydir have been elected to serve a 3-year term on the company's Board expiring in 2023. Second, a majority of the shares present and entitled to vote at this meeting have voted for ratification of the appointment of Moody Famiglietti & Andronico LLP, and the appointment is hereby ratified. Third, a majority of the shares present and entitled to vote at this meeting have voted for the amendment to the company's 2015 equity incentive plan. Fourth, a majority of shares present and entitled to vote at this meeting have voted to approve the advisory resolution on executive compensation. And fifth, the alternative receiving the vote of the greatest number of shares present and entitled to vote at this meeting, which is deemed the recommendation of the stockholders is to hold the advisory vote on executive compensation every one year. Votes submitted at this meeting will need to be validated by our inspector of elections. As such, the final vote totals will be announced via a Form 8-K filing with the SEC within 4 business days. I will now pass the floor back to the Chairman of the meeting, Daron Evans.

And this concludes the formal portion of the meeting. The Annual Meeting of Stockholders is hereby adjourned, and we will now continue into the informal shareholder briefing and Q&A session. Given the unique nature of this shareholder meeting, we thought we would try to provide you, our stakeholders with an experience akin to our shareholder meetings in the past. Since we have moved our head -- to the new headquarters a few years ago, and hosted our shareholder meetings in our conference room, we have started a tradition of letting our team members interact with you directly. To that end, today, we will be providing a presentation in multiple parts delivered by several members of our senior team. Please note that you can ask questions by entering them in the question window on your screen. We will collect the questions throughout the presentation and address them as time permits at the end of the presentation. Before we get started, please let me point to you the safe harbor statement on our presentation and refer to you the risks more clearly outlined in our public filings. Our goal as a company is to provide a unique technological solution for water safety to our customers, while leaving them wowed by our reliability and service levels. We live and breathe this mission every day, and this is the attitude with which we go to market. A company is only as good as people. This is our senior team. We have 7 post graduate degrees, over 150 years of experience in the field of life science, software, finance and sales. Many of us have run successful companies. And just as importantly, many of us have learned life lessons in unsuccessful companies. We have all converged at Nephros because we believe we can make a real difference. You can read more about the leadership team on our website. Today, I will kick off the presentation, then I'll pass the baton to Andy Astor, our COO, CFO; then to Shane Sullivan, our VP of Sales, then to Greg Lucas, President of our Aether Filter Systems division; and then to Dr. Kimothy Smith, VP of our Pathogen Detection Product division; and then to Tony Robinson, VP of Operations of our Specialty Renal Products subsidiary. Andy and I will then take back the baton to answer questions. We hope that this will help you glean a little more insight into who we are. We have 3 primary business units: water filtration, which includes our hospital filters, dialysis water filters and our commercial water filters under the Aether brand. Today, water filtration has constituted 100% of our revenue. We strive to provide a portfolio of high-performance products to the market at price points that meet or beat our competitors. Pathogen detection is our newest business unit. Pathogen testing in a potable water currently primarily focused on legionella is a huge global market. Our goal is to use real-time portable technology to provide actionable pathogen data to water management teams. By the end of this year, we will have launched 3 different product lines in this business segment. Inside our specialty renal products subsidiary, we are completing the development work for the second-generation of our hemodiafiltration assist device or HDF. HDF was the original focus of Nephros and still represents a large opportunity of changing lives in dialysis patients. HDF is routinely performed in Europe. U.S. patients deserve to have the same opportunity for this enhanced form of dialysis. I'll now pass it baton to Andy for an overview of some key results and metrics.

Thanks, Daron. Some of you in today's audience will be familiar with this slide, which we've been updating quarterly now for over 4 years. It shows that Nephros' year-over-year revenue has increased for 15 consecutive quarters and that the average of those year-over-year increases is over 60%. This slide is the first metric our management team looks at each quarter. It communicates our commitment to ourselves and to our shareholders to focus on sustainable, continuous growth over the long term, not just quarter-to-quarter. And we believe our strategy is paying off. Over the past 4 years, our share price is up 390% while net revenue is up 432%, equating to compounded annual growth rates of 49% and 52%, respectively. And these numbers are supported by growth in new customer sites of 136%, which is a 54% compounded growth rate since 2017 when we began tracking that statistic. Our management team recognizes that share price is directly correlated with our revenue growth, and we want you, our shareholders, to know that we remain intensely focused on delivering great products, both existing and new that will continue to grow the top line revenue at these growth rates and at gross margins that enable us to build a profitable business. Another important metric along the bottom of this slide is the installed base revenue, which means revenue from existing customers. This metric represents customers' ongoing commitment to Nephros products, which is a critical driver of our high-growth rates over the past few years. As you can see on this slide, the proportion of installed base revenue has remained relatively constant since 2017 at about 2/3 of our sales in any given period, which means that about 1/3 of our sales generally come from new customers. We consider this combination of 2/3 installed base and 1/3 new customers to be a healthy mix for our company. But let's now take a look at how these numbers began to change in the first quarter of 2020 as the COVID-19 pandemic began to impact the U.S. as you can see, our revenues and our number of customers continue to grow in Q1 with 43% revenue growth, although more slowly than in the last couple of years. Most significantly though, our installed base revenue increased from about 2/3 to 92% of net revenue. And in other words, only 8% of our sales came from new customer sites. The major reasons for the decrease in the proportion of new customer revenues are well understood, including that most non-COVID decision-making has been postponed. Also our PluraPath pathogen detection system launch was interrupted after only 3 weeks in the market. Also all lead generation events and conferences were canceled and nearly all casinos and hotels were shut down. It's our view that all of these issues are temporary. As the pandemic response becomes less emergency driven in the coming months, we expect Nephros to return to the rapid growth levels that we've seen over the last 4 years. As health care and commercial facilities turn their attention back to testing for and protecting against waterborne pathogens and ensuring water quality for their patients and customers. In a nutshell, we think COVID-19 has caused the temporary interruption in some of our new -- in our new customer growth and some of our growth within an otherwise very strong business with a solid track record and a long-term focus. I will now hand the baton to Shane Sullivan, who will discuss our medical filter business.

Thanks, Andy. Nephros' ultra filters provide a critical barrier to protect patients and consumers in waterborne pathogens such as Legionella, pseudomonas, e-coli and nontuberculosis causing mycobacterium, which can cause illness or even death. This picture illustrates the debris we filtered from 2 hospital ice machines in Southern Texas. Nephros filters differ from conventional filtration in several important ways. Most obviously, our pore size of 5 nanometers. 0.005 microns is the smallest in the industry. Actually 40x smaller than conventional filters. Simply put, we provide superior biological retention, but our differences don't end there. Our filters tend to last longer than conventional filters, typically, 2 to 3x longer. They also clog or foul less easily due to a completely different design. You see conventional filters are mostly made of pleated paper. Nephros filters also have excellent flow rate properties due to much larger surface areas than conventional filters. As a result, has a lower cost per day than conventional filters since they generally need to be changed less frequently. As Andy presented earlier, we have seen strong and sustained growth over the past few years. This slide illustrates some of the drivers behind that growth. In 2015 ASHRAE, American Society of Heating, Refrigeration and Air Conditioning Engineers, established a standard of care for building management systems, known as ASHRAE 188. This standard of care was later adopted in 2017 by CMS, the Center for Medicare and Medicaid Services, which set regulatory requirements for all 20,000 health care facilities receiving their reimbursement to follow ASHRAE 188. While these standards do not require the use of filtration, our FDA-cleared filters are effectively used as an immediate barrier for patient safety as a corrective action or emergency response related to outbreaks as well as proactive prevention programs. Over the past 4 years, we have also developed a distribution network of some of the country's finest water safety professionals who represent our filters as an integral part of their business models. We are thankful to their dedication to patient safety and their loyalty to our products. The increases in water safety regulations, coupled with our strategic partnered model of marketing through water safety professionals have significantly increased the market awareness of Nephros, which has created a virtuous cycle of increased customer awareness and demand for our products, leading to the growth and numbers you see here. Together with our strategic partners, we have grown our business to serve over 1,000 health care accounts. We are actively engaged in providing continuous training to our distribution network and their clients educating them on the unique health economics of a multi barrier approach to mitigating risk. We are always on call and oftentimes in the trenches, turning wrenches to ensure our clients achieve the best service and outcome using our products today. I will now pass the baton to Greg Lucas, President of our Aether Filter Systems division.

Thanks, Shane. Aether water systems was founded with the goal of producing cutting-edge water filtration systems while providing the highest level of customer service. Combined, the Aether team members have over 50 years of experience developing water technology assets for commercial customers. Aether water systems offers a variety of products for different markets and different applications. Our filtration units meet the highest standards of water purification, scale removal, e-coli retention and other issues impacting the taste and use of our water. We customize products to meet the exact needs of our customers in the food, service, hospitality and convenience store markets with the goal of providing solutions that are both high-performance and cost-effective. Our portfolio of products includes proprietary technology, enabling us to provide a superior performance to our customers. Our recent integration with Nephros has enabled us to further expand our portfolio, enhance our engineering capabilities and increase our manufacturing capacity. Our business includes both new filter manifold installations and plug-and-play compatible replacement filters for existing filter manifolds from competitive companies. Over the past 3 years, we have grown our sales largely based on the strategy of competitive replacement filters. With the closure of most of our customers over the last few months, we have seen a pause in our growth. However, we expect our growth will resume as the U.S. economy finds its new normal. We expect the primary growth driver for the foreseeable future to result from joint sales efforts with a major beverage equipment distribution partner with whom we have collaborated on a number of projects to date. Additionally, we are pursuing replacement filter opportunities with quick service restaurants and convenience store chains. In general, we believe the commercial marketplace will need to increase its awareness of water quality and water safety. Our current high-performance products and the product that can be quickly incorporated from the Nephros medical portfolio will enable us to have technology-led discussions with the major QSRs and c-store chains that can have major impacts on the water quality and their facilities. I will now pass the baton to Kimothy Smith, Vice President of our Pathogen Detection Systems Group.

Thanks, Greg. I will spend a little time talking about the pathogen detection system team's work and some of the issues we will face regarding pathogens in building plumbing as America gets back to work. The PDS line of pathogen detection products includes 3 products: PluraPath, DialyPath and SequaPath. I'll focus mainly on PluraPath, which we released to market in late January, as has been mentioned before. PluraPath is a mobile quantitative polymerase chain reaction based waterborne pathogen detection system that can provide on site, actionable data to infection control teams on up to 15 different pathogens all in under 1 hour. This capability is especially relevant in light of the June 2017 Center for Medicare & Medicaid services mandate that all health care facilities must have water management plans in place. The CMS regulation further states that the plan must include testing for waterborne pathogens and that action must be taken if pathogens are detected. PluraPath can be used to perform testing for waterborne pathogens on-site and provide actionable information within an hour to inform remediation decisions. Of course, remediation actions include filter installations. PluraPath rapid on-site testing is mostly offered through the same strategic partner network that markets our filters. Indeed, the business model for PluraPath is similar to the filter model, providing a largely recurring revenue stream. PluraPath allows our customers to understand the breadth of waterborne pathogens in their premise plumbing systems. Not just Legionella, but pseudomonas, nontuberculosis causing mycobacteria, Burkholderia and many others. These pathogens are a major concern for certain segments of the population and are associated with HAI's hospital-acquired infections. The capability of high-quality, rapid on-site waterborne pathogen detection offered by PluraPath is essential as America goes back to work in the post pandemic period. Now I'd like to show you a brief video on the PluraPath system to give you a greater understanding of how it works. The video moves pretty quickly, so don't blink or you'll miss something important. [Presentation]

Wow, that was quick. Our second pathogen detection product, DialyPath, will be released later this quarter. DialyPath is designed to provide real-time endotoxin level estimates for dialysis clinics by detecting and quantifying endotoxin producing gram-negative bacteria. In simpler terms, this means that DialyPath can identify bacteria, which can cause inflammatory reactions before they impact patient health. The DialyPath system is extremely sensitive and specific. It can detect levels of gram-negative bacteria as low as 1 bacterium per 100 mils of dialysis water or about 1 trillionth of a gram of endotoxin per mil of water. And it can provide the specific identity of the predominant bacteria in a water sample. The third product in our pathogen detection roster is SequaPath. To be released soon, SequaPath will provide a window into the true microbial diversity in a building's plumbing system. SequaPath extends the technologies of PluraPath and DialyPath with the power of rapid targeted DNA sequencing. It will provide an opportunity to understand the microbial community dynamics of building biomes. We expect SequaPath technology to be particularly useful as America goes back to work from the COVID-19 shutdowns. There are risks associated with stagnant water in buildings that have had little or no occupancy over the last few months. Indeed, we are currently collecting water samples and performing PluraPath and SequaPath analysis to learn more about these risks. We expect to write a white paper in the coming weeks on this topic, comparing building bacterial signatures and unoccupied buildings with similar buildings that have been occupied during the pandemic. We'll have more to say about this on this topic soon. With that, I will now hand the baton to Tony Robinson, Vice President of Operations at Specialty Renal Products.

Thanks, Timothy. Over the course in the past 12 months, SRP been gaining momentum toward our primary goal of launching our HDF Gen 2 system. This stand-alone software-driven device is poised to fill in the gaps left by its predecessor, offering a far easier to use product at a much lower price point, all while maintaining a high level of safety and effectiveness expected by the industry. Recently, we have finalized the design of the new system, a major milestone in itself since the design takes into account all aspects of the product from usability to manufacturability. Having addressed and eliminated all major concerns with the Gen 1 system, SRP leadership is confident we are bringing a product to market fully capable of both acceptance by clinicians and implementation by the industry as a whole. Furthermore, SRP has formalized all key relationships necessary for validation and market launch of the product. With these critical aspects addressed, SRP is now able to focus on the documentation and testing necessary to support our special 510(k) submission to the FDA for clearance to sell the HDF system into the U.S. market. Based on the current status of the project and open items remaining, we are planning our FDA submission for late summer 2020. Once we receive clearance from the FDA, we'll work with national institutions, and key opinion leaders to communicate the clinical potential and ease of use to the industry, a critical element in building the framework of a successful sales platform. In parallel, we've been working on our second product offering, a dialysate regeneration device to be used with CBVT device in the acute patients. We expect to speak with the FDA in the coming months to help finalize our regulatory and developmental pathway. I will now turn the call back to Daron and Andy.

Thank you, Tony. Now we will answer some of the questions you have submitted. We will do our best to get through all of them, but we must try to stay within our allotted time.

Our first question, post COVID, QSRs, including MCD recommending the closure of their public soda fountains, MCD meaning McDonald's. Does this simply move Aether's QSR opportunity to the back of the house? Or is the revenue opportunity more severely impaired as long as public fountain stations remain closed? I'll let Greg comment on this. But most of our filtration systems in QSRs are in the back of the house already. Greg, can you talk more about that?

Sure. As Daron mentioned, the beverage stations and how they're accessed, they are back of the house, so when these QSRs and c-stores begin to come back online, we anticipate those will be back online as well.

Okay. And our next question for Kimothy. So the question is PluraPath setup seems complex. Are the on-site hospital operations personnel familiar with these kind of SOPs, quality, et cetera, such training that is not a high hurdle? What is the kind of recurrent training that is required?

Yes this is an excellent question. It may seem complex, but the training actually takes less than 2 days to complete and this is with some proficiency testing. It is our anticipation that hospital operations personnel would not likely be the type of people performing this. In fact, to this point, in our sales and operations, it has been the water -- net water management personnel who have been contracted to and put in place a water management plan that are familiar with taking water samples and performing testing, if not themselves, but through a centralized laboratory. They adapt to performing this very easily because of many of the efficiencies that we've built into the system. And they seem complex particularly when it's moving at super high-speed in a video. But I assure you, it's rather easy to do. We've designed it that way and performed it that way, not such a high hurdle and in terms of recurrent training, we are putting in place a proficiency testing program so that unknown sample is going to be sent out to those people who have purchased and contracted with the PluraPath system to ensure that they're meeting the mark, gives them reassurance, and provides as well their customers some level of reassurance.

Another question is, wasn't SRP FDA submission expected to be earlier this year? Is this a COVID issue? No. Today, we actually had not -- have not had a COVID delay -- COVID-based delay. There might be some with the testing, depending on if the labs that we're going to use are up to date. Really, the delay is because we want to get this right. The last system had a lot of different issues in the marketplace with the PCTs and nurses using the machine that we wanted to make sure we avoid it. And so one of -- part of our process was for every step we took on a design change, we made sure that we had a chance to test with a novice nurse to make sure that what we did was good for them and made it easier for them to use and understand. And so the delay is because we get 1 more shot, and we don't want to be wrong. And so we're taking a very precise and using our user feedback in as many cycles as possible to make sure we're right. And we believe now we have a device that is very easy to use from the nurses that have experienced it and meets all of the needs that we have in the marketplace so that we can relaunch in a way that may will make a much different bang in the market. The next question is for Kimothy. It says, I realize you only had a few weeks of experience launching PluraPath, but can you tell us anything about it in the market and how it's been received?

You bet. And this was another great question. It's almost like a follow-on to the previous question. For those water treatment teams that have contracted with us, they purchased the PluraPath system. We found a tremendous amount of excitement. And in fact, the ease of use is astonishing. The quality and value-add of being able to provide actionable data within an hour on-site at their customer sites for more than 1 pathogen, in fact, up to 15 pathogens not just for Legionella, is truly exciting. Many of these people are technically trained. While they may not have run a PCR before, they know what PCR is, and they know how to interpret it. And they're excited to have a system that allows them to perform the test easily on-site and rapidly.

And one thing I'll add to that is one of the effects of COVID is that everyone now knows what PCR is, what it does and how it can provide answers quickly. In the beginning of our launch, there was discussions about PCR, and we would spend time discussing the technology itself. We've been doing webinars recently with potential new customers, and there's not a question at all about what PCR is anymore. So it's -- that's 1 bright part of this process. The next question is for Andy. It says, is there any data you can share that gives your confidence in the temporary nature of COVID issues.

It's a tricky question because it's really a question of what's not there. What's not there are things that happen with new customers. New sales meetings, new conference encounters, new training sessions, things like that and exactly what we were just talking about with PluraPath. The customers that we expect to reorder are generally reordering. So we don't have quantitative data, but we have pretty compelling anecdotal data that says, this is behaving as you would expect to behave when COVID is really the only thing that people are thinking about right now. I hope that's helpful.

Okay. Next question is we have been speaking about commercial opportunities for some time. What more can you tell us? I'll do a quick little statement, and then I'll pass to Greg. In general, when we started working with Aether 5 years ago, one of the things we understood is that the commercial filter market is very much like the medical market that we play in now, and that there's 1 or 2 big gorillas that own the market and not a lot of opportunity for little folks who don't have the technology, the ability to be able to kind of play with the big boys. One of the things that we do know now is that we can play with the big boys. And we've gone head-to-head in a couple of different opportunities. And it's been very close. So we've gained confidence that our product is -- meets or exceeds the competitive products and that are -- it's only a matter of time before we are able to sort of start picking away some of the very large customers. So I'll move past to Greg to add more color.

Sure. Thanks, Daron. And to pick up where Daron left off, it is a long runway, but that runway is shrinking week-by-week and month-by-month. Obviously, we've all had a set back here recently. But working with large capacity beverage distribution centers, and some of our larger core customers, we've seen progress. And we hope, once we all get back online in the next quarter or the next few weeks that, that will continue, and that's what we expect.

Okay. That's the extent of the questions. So with that, we'll say thank you for everyone who joined us on the web or on phone. And please feel free at any time to ask questions or get -- reach out in touch. If you want to understand more about our business, [email protected]. Go straight to Andy and myself so you could ask questions any time, and we look forward to -- we will come back to normal and Nephros back on the rocket ship. Thank you very much.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.