Nephros, Inc.

Good day and welcome to the NEFROS Incorporated third 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 telephone keypad. To withdraw your question, please press star then two. Please note, this event is generally recorded. I now like to turn the conference over to Mr. Kieran Smith. Please proceed.

Thank you, Ian. Good afternoon, everyone. This is Kieran Smith with PCG Advisory. Thank you all for participating in NEPHROs' third 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 NEPHROs. I encourage you to review nephrosis filings with the Securities and Exchange Commission, including without limitation the company's forms 10-K and 10-Q, which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements. Factors that may affect the company's results include, but are not limited to, its ability to successfully, timely, and cost-effectively develop, seek, and obtain regulatory clearance for its products and service offerings, The rate of adoption of its products and services by hospitals and other healthcare providers, 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, November 4th, 2021. 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' Chief Executive Officer, Andy Astor. Please go ahead, Andy.

Thank you, Kieran, and good afternoon, everyone. I'll start with a brief overview of our consolidated results, followed by a brief discussion of each of our business segments. We were pleased with our third quarter results, which were 24% ahead of last year. This was our third consecutive quarter of year-over-year growth, averaging about 25%, and demonstrating our gradual emergence from the effect of the pandemic. Furthermore, and perhaps most importantly, year-to-date revenue in 2021 was $7.6 million, the highest nine-month total in the company's history. Looking ahead, our outlook is strongly positive. And with that, let's take a closer look at each of our business segments. Our core water filtration business continued its growth in the third quarter. Net filtration revenue was up 22% over the same period last year. Our active customer count is near its all-time high, and customer retention rates were strong, comfortably exceeding 90%. Our emergency response business, which had been significantly impacted by the pandemic, was at normal levels during this quarter. As stated in our prior call, we expect an important driver of increased customer interest to be the new standards document, New Requirements for Water Management in Healthcare Facilities by the Joint Commission, which was approved earlier this year by the Center for Medicare and Medicaid Services, or CMS. The requirements in this document apply to all healthcare facilities receiving funding from CMS and stipulate increased scope and documentation for water management programs beginning January 1, 2022. As healthcare facilities develop, implement, and update their water management programs to meet the deadline of these upcoming requirements, we are well-positioned to work with our strategic partners and their customers to support healthcare facilities' needs for filtration and pathogen detection. Indeed, some of our most recent Customer engagements and orders are a direct result of healthcare facilities and water management consultants implementing water screening and infection control filtration due to the upcoming Joint Commission standard. Moving on to pathogen detection systems, or PDS, business segment, we delivered about $60,000 in revenue this quarter. While still an emerging business, we are pleased with recent revenue consistency and excited by several recent developments. For example, we recently completed the integration of Generation, our previously announced acquisition, into the PDS organization. Generation was a recognized market leader in infectious disease monitoring and measurement, and the acquisition gave us access to a wide variety of proprietary assays, multiplexing technology and selection methods using PCR technology. These intellectual property assets are expected to accelerate new product development and time to market and to add new revenue streams to this business. We also recently signed partnership agreements with consulting organizations to promote PDS products into their customer bases. We are building a significant pipeline of opportunities within these new relationships and we expect These will generate significant revenue growth in the coming months. For a brief update on our renal products business segment and our second-generation HDF product, we received promising news from the FDA recently that they have completed their acceptance review of our HDF application. This means that the FDA has all the information necessary to evaluate our second-generation HDF product and will now move into their substantive review phase. This is expected to take approximately 60 to 90 days, assuming they have no further questions. We expect FDA clearance around the end of the year or early 2022, after which we will pursue a limited commercial launch in the dialysis clinic market. I'll now present a few highlights of our third quarter 2021 financial performance. We reported consolidated net revenues in the quarter of $2.6 million, a 24% increase versus the same period of 2020. We also had a net consolidated loss for the quarter of $1.2 million compared with $1.0 million in 2020. Consolidated adjusted EBITDA in the quarter was negative 0.7 million compared with negative 1.0 million in 2020. Consolidated gross margins in the quarter were 54% compared with 58% in 2020. We continue to expect future gross margins to continue in the range of 55% to 60% despite this quarter's fall to slightly under that range. Consolidated research and development expenses in the third quarter was $0.6 million compared with $0.8 million in 2020. Consolidated sales, general, and administrative expenses in the third quarter were 1.9 million compared to 1.5 million in 2020. And our cash balance at the end of the third quarter was $7.4 million. 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 business segments can be found in today's filing on Form 10-Q. I'll now make a couple of closing comments. First, as I said earlier, we are pleased with our year-to-date revenue results in that we have stabilized the business to more consistent quarter-to-over-quarter performance after a tough 2020. To be clear, we are pleased, but we are not satisfied. We intend to accelerate our growth trajectory by investing in scalable commercial and operational infrastructures and balancing short-term results with long-term sustainable high rates of growth. Second, I'd like to speak briefly about the topic of revenue guidance. We believe it was prudent at the start of the pandemic to suspend our practice of giving annual guidance since so many of our business assumptions were upended. However, as vaccinations become ubiquitous and the pandemic begins to recede, we believe we can return to giving guidance and we expect to do so shortly after the turn of the new year. And with that, I would like to thank each of our Nefros employees and our strategic partners for your unwavering focus on providing unsurpassed products and services to our customers, as well as for achieving record year-to-date revenues thus far in 2021. I would also like to thank our investors for your continued confidence and patience as we exit the pandemic and get back to higher growth rates. We look forward to seeing many of you at upcoming trade shows and financial conferences. And if you're not already subscribed to our occasional email alerts, once again, I'll remind you that you can do so at the bottom of our website homepage. And of course, always please feel free to contact me directly at andy.nefros.com This concludes our formal presentation remarks, and we will now take questions from the audience. Ian, 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 telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. Which are your questions, please press star, then 2. At this time, we will pause momentarily to assemble our roster. First question, Mark Weisenberg, B-Rally Securities. Please go ahead.

Thanks. Good afternoon. Andy, in your prepared remarks, you talked about the Joint Commission's new guidelines and how that related to activity within the third quarter. I'm wondering if you've seen any acceleration in that activity in the fourth quarter, and is there an expectation that maybe there could be some sustained demand generation from that into the new year, or is this something that once the year turns and everyone's expected to have it in place, that maybe some of this related activity kind of tails off?

First of all, hi, Mark. Good to talk to you again. And we have seen early signs of increased demand, both in Q3 and in Q4, early increased demand. And I think that the best way to project what will happen during the uh you know as the joint commission requirements become uh go into effect is to look back at 2017 the last time they did exactly this thing they they revised their water management requirements and in that time we saw significant growth happen and it wasn't limited to just a quarter or two it was really a rising tide over the next couple of years that was reflected in, frankly, in our growth rates in 2017, 18, and 19. So I do expect this to be an important sort of medium-term event, and I also expect it to be subtle. In other words, we won't double, you know, overnight in a quarter. It'll be something that happens over the course of the next couple of years. But I do think it's a pretty meaningful event that's happening.

Very helpful. Since August 1st alone, we've heard that there have been 13 hospital construction projects worth at least $500 million or more. And we know that renovation projects involve water shutoffs and potential disruptions of the existing biofilms. So I'm wondering what kind of proactive initiatives the company and its partners are undertaking to kind of get in front of these hospital teams so that if there is a problem, Nefros is ready and on the speed dial?

Yeah. Thank you for the insightful question. The short answer to that is it's all about having the relationships with the central offices that build those facilities. And to the extent that we have relationships with those customers, those conversations can be very beneficial. To the extent that they're happening at places where we don't have relationships, it's more challenging. But both the filtration business and the pathogen detection business has potential opportunities in those facilities, and I can tell you with certainty that we're pursuing them.

Great. And kind of dovetailing on the back of your PDS comment right there, where are you seeing the traction thus far with pathogen detection sales, and where are you and your partners maybe concentrating more efforts and targeting going forward?

Well, you know, I think that it's fair to say, I'll answer your question in a second, but I think it is fair to say that we are learning. The pathogen detection business, while we've been talking about it for a year and a half or so, is really only now beginning to start to have a flywheel going, to have revenues going. And so we're We are being a little bit of a chameleon to see where the markets are that are attracted to us. They include the on-site testing at hospitals and commercial buildings that we've talked about before, but they also include potential opportunities with centralized testing laboratories with... who may be interested in our assays, particularly since they're multi-pathogen assays and the new Joint Commission requirements require a focus on multi-pathogens and many companies today really only have Legionella and related assays. So we're learning and we're finding out what is out there. And we're also, as I mentioned during my talk, working with consultants where we have established a couple of partnerships with consultants who are bringing us into new opportunities as well. So we're doing multiple things simultaneously to see how the pathogen detection business may evolve.

Very good to hear. Two more from me. When I'm flipping through the queue right now, it looks like your largest customer in the quarter generated sales on an absolute basis. That was the highest going back to 2019. I'm wondering if you could provide some insight into their activity in the quarter.

Yeah. We did have a significant concentration in the quarter. It was one of our distributors. And there's a normal ebb and flow there. It is a distributor that's been doing quite well with us, and they had a good quarter. It's really that simple. I wouldn't say that we have, you know, it's not indicative of a circumstance that I would consider abnormal in any way. They had a good quarter, and they've been growing nicely over the last couple of years.

Great. Good to hear. And then the final one for me, as I continue to flip through the queue, I did see some discussion about some change in the executive team, it looks like, at Specialty Reno Products. Can you elaborate on what's going on there?

Sure, sure. I'm glad that was a good catch to turn all the way to part two in the 20 minutes or so that you had with the queue. We've made a subtle change to the management of SRP. Darren Evans, who many of you know and who was the former CEO of before I took that seat a little over a year ago. Darren was the CEO of SRP. Darren is, again, as many of you know, an extraordinary executive, but he's not a dialysis expert. And so what we've done is now that we are getting, we hope, close to approval by the FDA for the 510K of the HDF product. Darren is rolling into chairman of the board of SRP. His time commitment will be slightly lowered. I will take the CEO role because it's really now about the strategic decisions that have to be made about SRP. And we will hire a a launch manager slash COO candidate or person to help lead the rollout into dialysis clinics. So as I said, it's a subtle change. Nobody is leaving who was involved. It's just a matter of how we organize the work. So Darren will be chair of SRP and I will take on the CEO role. as well as keep the CFO, which I've maintained.

Understood. Does that help? I appreciate the color. Yeah, it does. Thank you. Sure. And that's all from me. Thank you.

Okay. Great questions. Thanks, Mark. Our next question comes from Neil Cadorey of Blueprint Capital. Please go ahead.

Hi. Thanks. I was going to ask some of those questions that were just asked, so I'll come up with another one or two here. When do you think the water pathogen detection will be a material revenue driver, you know, 10% or more of overall revenue maybe?

I don't know that I can answer that question. We don't have a – I don't think we have enough information to make that statement. It could happen – I would certainly – I think it's got to happen in the next couple of years. It may not happen in 12 months, but I would guess that it's 10%. Well, I would say that it's 10% in a couple of years, except that if the filter business grows the way we think it could, it may not be. But, you know, could it be a million or $2 million in a couple of years? I think it absolutely could. I hope that answers your question, Neil. Okay.

Yeah, no, that's good. Thanks. And then on the dialysis side, could you, you know, I've been an investor here for over a year. I think I understand it, but a lot of people probably new to the story don't understand what will come post 510K approval. Could you just kind of, you know, explain the opportunity there a little bit and walk us through what might happen next year?

Sure. So the HDF process... I'll indulge me and I'll tell a three or four minute story. Nefros was founded 25 years ago as a spinoff from Columbia University to develop an HDF product. HDF is a different kind of dialysis than traditional HD or hemodialysis that adds a pressure gradient, a convection gradient, a convection element to the dialysis process and patients often report that they feel better after, or many patients often report that they feel better after an HDF treatment. HDF is popular and it's roughly 15 to 20% of the dialysis done in many countries in Europe and in Asia. Nephros created an HDF product that was released, or I'm sorry, that was cleared on a 510K back in 2012, and it was commercially unsuccessful. That's a long story, but fundamentally, the clinicians were not comfortable with how it worked, and it took too much time, and it was a commercially unsuccessful product. Nephros then pivoted into its filter and pathogen detection businesses, but then after particularly filtration grew and got up into the five, six, seven million dollar a year level, we turned our attention back to HDF and created a second generation product for that, which is now undergoing evaluation by the FDA for 510 clearance. The new product is vastly simplified and we believe will be a much more interesting clinical device. Once we get the 510 clearance, the next step is to take that product and get it out into a couple of dialysis clinics and prove how it works in the real world. And we want to do that as quickly as we can once we get the 510K clearance. A lot of people have been waiting a long time for this. It also, by the way, this business is in a subsidiary of Nephros called Specialty Renal Products, or SRP. And once SRP has a cleared 510K product, then it becomes an interesting question of, you know, how do we fund a rollout or are there other strategic opportunities for that business? And, you know, we'll cross that bridge when we come to it. But the opportunity here is potentially very large because obviously there are hundreds of thousands of dialysis patients. And if, you know, even never mind 15% or 20%, but even if 1% or 2% or 3%, are candidates for HDF, this could be, on its own, a very significant opportunity for nephro shareholders. Neil, did that give the background you were hoping to get?

Yeah, that's great. Thanks. And just one point I wanted to clarify. It's an attachment to the current standard of care, right, in dialysis today in the United States. Is that correct?

That is correct. That's a really good point. It is not a standalone dialysis machine. It is a bolt-on or an attachment that allows an HD or hemodialysis machine, a traditional machine, to be converted in HDF, and that conversion happens in a minute. And so we think it'll be pretty attractive to dialysis centers that have that have traditional dialysis machines that they paid tens of thousands of dollars for because it provides basically an important feature for a fraction of the cost of the machine.

Great. Well, Andy, thanks. Looking forward to seeing how the next 12 months play out.

Me too. Thanks, Neil. Appreciate your patience and your confidence.

As a final reminder, if you have a question, please press store. Our next question comes from Larry Cassidy of a private investor.

Please go ahead. I was wondering, how is your supply chain holding up?

As far as inventory levels and given the state of business right now, shipment's coming over to you. Great question, Larry. Thanks for asking. If you've been following us, you may remember that in early 2020, when the pandemic hit, we actually bumped up our inventory tremendously by 20% or 30%, even though our sales were going down. so that we would avoid any supply chain interruptions. That turned out to be a good idea, and we bulked up. And we've had absolutely no issues, even with additional orders now that are happening today. They're coming through just fine. We've got a great partner in Medica, which does our manufacturing for us, and we've got a... a very reliable supply chain. I will tell you, however, that the shipping is through the roof. And I'm sure everybody is talking about how shipping in general and international shipping in particular is just extraordinarily expensive. And frankly, that is the lion's share of what drove our gross margin down a little bit this quarter. because it's costing more than double to ship filters to the U.S., but we are getting them, and we've got no problems with the supply chain. Okay, thanks. Secondly, can you comment on what October sales, what they look like? We don't usually do that. We don't usually comment on on individual monthly sales. We've made a couple of exceptions where we've made a public statement. But I guess what I'll say is October sales were fine. And since I'm not going to be, since we're not going to make a public release about that, I can't say a whole lot more. Okay. Thank you. You're welcome. Thank you. Appreciate your questions.

Our next question comes from Ralph Weil of our Weil Investment Management. Please go ahead.

Hello, Andy. Hello, Ralph. I recently read that a company that perhaps you're familiar with called Outset Medical said that the Center for Medicare and Medicaid Services has approved the company's tableau hemodialysis system for a transitional add-on payment adjusted for new and innovative equipment and supplies, which is an add-on, you're probably familiar with it, an add-on payment scheme designed to increase patient access to new technologies for end-stage renal disease. I'll Are we, with the SRP product, assuming that it will be approved, will this be something that we can also go for this add-on payment?

I will tell you, Ralph, that I'm sorry to say that I'm not familiar with that. It's very interesting, and I want to look into it, and I'll be happy to get back to you about it. But I'm not aware about the add-on payment. It's not my area of expertise, and I will find out.

Well, this was announced by them this past week, November 1st.

I understand.

In the past, your product, the SRP product, will make it better for the patients, et cetera, et cetera. But the question was to some, who's going to pay for this extra amount of money that it may cost? And even if it's a little bit more, doctors normally just do what they can do to... make the most money or dialysis clinics but here's a something that would seem to me to add the center for Medicare and Medicaid services if this really is better to pay for some of it so I do look forward to your answer okay I look forward to the research because I missed that and it

It rang a bell in my head the same way it did in yours, so let me come back to you.

Okay.

All right. Very good.

Thank you, Ralph.

At this time, we have no further questions. I'll now turn it back over to Mr. Andy Astor for any closing remarks.

Okay, well, if you do have any further questions, I'll stall for another 20 seconds or so, and you can press the proper buttons on your phone. Otherwise, I'll say thank you for attending. We're excited for what 22, well, for the rest of the year, but in particular, what 2022 looks like. I'm excited to get back to revenue guidance. Please stay in touch, and always feel free to reach out to me directly at andy.netfirst.com. Thanks very much, everybody. I appreciate you taking the time out of your busy days, and you have a great rest of your evening. Bye-bye now.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.