Nephros, Inc.

Good day, everyone, and welcome to the NEPROS Incorporated's third quarter 2022 financial results conference call. All participants will be in a listen-only mode should you need assistance. Please email 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 and then one using a touchtone telephone. To withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Kieran Smith with PCG Advisory, so please go ahead.

Thank you, Jamie. Good afternoon, everyone. This is Kieran Smith with PCG Advisory. Thank you all for participating in NEPROS' third 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'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 effects of different materially than those described in the forward-looking statement. Factors that may affect the company's results include, but are not limited to, the impact of the COVID-19 pandemic, Necrosis' ability to successfully, timely, and cost-effectively market 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 the effect of existing and new regulatory requirements on Necrosis' business and other economic and competitive factors. The content of this conference call contains time-spent information that is accurate only as of the date of the live call today, November 2nd, 2022. The company undertakes no obligation to revise or update any statements to reflect the best of circumstances after the date of this conference call, except as required by law. I would now like to turn the call over to NEPOS's President and Chief Executive Officer, Andy Astor. Andy, please go ahead.

Thank You Karen and good afternoon everyone welcome to the call I'm very pleased to be here to report and to comment on our third quarter results which reflect positive trends in leading growth indicators and in cash usage before reviewing our results though I will first highlight two events that significantly influenced third quarter financial results first on October 4 we agreed to sell our pathogen detection systems business, also known as PDS. Based on relevant accounting standards, we are reporting PDS as a discontinued operation, and all asset values have been written down to zero. PDS has also been removed from our results of continuing operations, as well as comparisons to prior periods. PDS results are consolidated into summary line items titled discontinued operations. The impact of this accounting treatment was an increase in net loss of approximately $1.4 million. The second event is the implementation of a new slow-moving inventory reserve policy for items without expiration dates. As a result of the company's adoption of this new policy, slow-moving inventory is now reserved more aggressively, resulting in an increase in inventory reserves and net losses of approximately $600,000. The combination of these two events culminated in a total charge of approximately $2 million. It is important to note, however, that neither of these events impacted cash usage at all. I will now turn to reporting our detailed results. First net revenue was $2.4 million, a decrease of 7% year-over-year and 16% over the previous quarter. Active customer sites, or ACS, increased 18% year-over-year to a record 1,391 sites, which is also 3% higher than the previous quarter. Customer retention rates remained steady at over 90%. At 2.4 million, top line growth was a bit disappointing. However, there are two mitigating factors to consider. First, certain customers pulled ahead approximately $300,000 of their third quarter purchases into the second quarter to avoid a price increase that took effect on June 1, 2022. This increased second quarter revenue and decreased third quarter revenue. The second mitigating factor was a revenue reduction of approximately 200,000 from a large customer navigating regulatory issues that were unrelated to Nefros products. These issues have since been resolved and the customer's orders are now back to normal levels. If not for these two unusual circumstances, we believe revenue would have been approximately 2.9 million in the quarter. While revenue growth remains our top priority, We are also driving hard to achieve profitability with particular focus on establishing positive cash flow by mid-year 2023. To this end, we remain committed to cost savings measures as evidenced by an 8% quarter over quarter decrease in total operating expense from continuing operations for the period ended September 30th. This is an additional reduction following the 15% quarter-over-quarter decrease in operating expense from continuing operations during the period ended June 30. We expect that the sale of PDS will further reduce our expenses by more than $300,000 per quarter. To summarize our business performance, Medical water filtration, or more specifically, hospital infection control and dialysis water purification, was relatively strong this quarter, ending with record numbers of active customer sites. In addition, new customer sites were very strong, as were sales of filter evaluation kits. Our evaluation kits provide customers with tangible evidence of nephro filter performance, evidence that often makes a compelling case for continued use of our infection control filters. We believe these collected metrics are leading indicators for future growth in medical filtration revenue. In the commercial filtration space, we have significantly improved our operations with improved manufacturing methodologies and a new sales and marketing partnership, which we expect to discuss in more detail on our next earnings call. Finally, in our specialty renal product segment, or SRP, the development of a commercial launch is ongoing with an anticipated rollout in at least one dialysis clinic around the end of 2022. I will now review our detailed financial results. We reported third quarter net revenue of $2.4 million, a 7% decrease over prior year. Loss from continuing operations for the quarter was $1.3 million compared with $0.8 million in the third quarter or Q3 of 2021. This increase in loss from continuing operations was driven entirely by the previously mentioned change to our slow-moving inventory reserve policy and once again had no impact on cash. Loss from discontinued operations or PDS was 1.9 million compared to approximately 360,000 in Q3 of 2021. This increase was driven by the write-down of assets associated with the sale of the PDF business. Consolidated adjusted EBITDA in the quarter was negative $304,000 compared with negative $394,000 in Q3 of 2021. This significant improvement was driven by the cost reduction efforts described earlier. Consolidated gross margins in the quarter was 32% compared with 53% in Q3 of 2021. This decrease reflects the impact of the aforementioned slow moving inventory reserve policy implementation. Without this event, gross margins would have been in our target range of 55 to 60%. Consolidated research and development expenses or R&D in the quarter were $252,000 compared with $394,000 in Q3 of 2021. Consolidated sales general and administrative expenses or SG&A in the quarter were $1.7 million, no change compared with Q3 2021. Net cash used in operating activities was negative $172,000 compared to $910,000 in Q3 2021, reflecting our focus on achieving cash flow breakeven by mid-2023. Our cash balance on September 30, 2022, was $3.9 million. and we reassert our belief that our current cash balances will suffice for the foreseeable future. Please refer to today's press release for more details about the calculation of adjusted EBITDA and its reconciliation to GAAP net income or loss. Additional information about our results including our water filtration and specialty renewal products business segments will be found in our filing on form 10Q which we plan to file on or before November 15th. That concludes the financial discussion. We will open the call to questions in just a minute. But first, as always, I would like to thank each of our Nafros employees and our strategic partners for providing unsurpassed products and services to our customers, especially this year during some difficult times. And thanks also to our devoted investors for your continued confidence and patience and support. We know these are challenging times for shareholders, and we believe that our ability to navigate short-term results will be to our ultimate benefit as we maintain our commitment to investments in scalable commercial and operational infrastructures as a path toward long-term sustainable growth. This concludes our formal presentation remarks. We will now take questions from the audience. Operator, please open the call for questions.