Nephros, Inc.

Good afternoon and welcome to the NEFROS Incorporated fourth quarter 2022 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 being recorded. I would now like to turn the conference over to Kieran Smith, Investor Relations. Please go ahead.

Thank you. Good afternoon, everyone. This is Kieran Smith with TCG Advisory. Thank you all for participating in NEPHRO's fourth quarter and fiscal year 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 Nefros. I encourage you to review Nefros' 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 statement. Factors that may affect the company's results include but are not limited to the impact of the COVID-19 pandemic, Nefros' ability to successfully, timely, and cost-effectively market and sell its products and service 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 new regulatory requirements on Nefros' business and other economic and competitive factors. The contents of this conference call contain time-sensitive information that is accurate only as of the date of the live call today, March 8, 2023. 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's President and Chief Executive Officer, Andy Oster. Andy, please go ahead.

Thank you, Kieran, and good afternoon, everyone, and welcome to the call. I'm very pleased to report and to comment on our fourth quarter and year-end results, which reflects continuing positive trends, both in leading growth indicators and in cash usage. 2022 was a year of refocusing and rebuilding for Nefros. After a very challenging first half of the year, we established a target of cash flow breakeven by mid-year 2023, coupled with significant revenue growth by that same time. As we noted in our press release today, I am pleased to say that we are making good progress on both fronts. I'll talk about each one. In our efforts to achieve cash flow breakeven, we took multiple actions. These included broad headcount and other expense reductions, the disposition of our pathogen detection systems or PDS business segment, and two price increases during the year which were intended to return us to target gross margins of 55 to 60 percent. I am pleased to report that our fourth quarter gross margins were 59 percent. Additionally, we reduced our net cash usage from 2.8 million in the first half of 2022 to 0.5 million in the second half of the year, an 80 percent improvement. Turning our attention to revenue growth, we took several actions including a restructuring of our sales organization, the doubling in size of our sales team, and the relaunch of our commercial filtration business, which included a rebrand of our commercial filter products from Ather to Nefros. Of further note, as we reported last week, we established a strategic partnership with Donestar Enterprises as the exclusive master distributor of our commercial filters in the food and beverage and hospitality markets. We anticipate realizing further cost savings in the second quarter of this year due to the planned cessation of operations by our majority-owned subsidiary, Specialty Renal Products, or SRP. In February 2023, SRP management unsuccessfully concluded its efforts to identify a strategic partner to support a commercial launch of SRP's second-generation HDF product and or to identify potential additional investment that would allow SRP to fund the launch itself. SRP's capital resources are now nearly exhausted. Accordingly, the SRP Board of Directors recently determined, subject to the approval of SRP stockholders, to wind down SRP's operations and liquidate its remaining assets. NEFROS expects to reevaluate opportunities for HDF in the future but has no immediate plans to do so. On that turn to our financial results for the quarter and year ended December 31, 2022. We reported fourth quarter net revenue of 2.6 million, a 6% decrease over prior year and full year revenue of 10 million or 10.0 million, a 2% decrease over prior year. Net consolidated loss for the quarter was 0.7 million, equivalent to that of the fourth quarter or Q4 of 2021. Net consolidated loss for the year was 4.3 million compared with 2.8 million in 2021. Consolidated adjusted EBITDA in the quarter was negative 0.5 million compared with 0.1 million negative in 2021. Consolidated adjusted EBITDA for the year was negative 2.4 million compared with negative 1.6 million in 2021. Consolidated gross margins in the quarter were 59% compared with 54% in 2021. Consolidated gross margins for the year were 47% compared with 55% in 2021. And as I said earlier, we do expect future gross margins to continue in the range of 55 to 60%. Consolidated research and development expenses in the quarter were 0.4 million compared to 0.3 million in 2021. Consolidated research and development expenses for the year were 1.3 million compared with 1.5 million in 2021. Consolidated sales general and administrative expenses in the quarter were $1.8 million, no change from Q4 2021. Consolidated sales general and administrative expenses for the year were $7.6 million compared with $7.2 million in 2021. Cash used in operating activities was $202,000. compared with $336,000 in Q4 of 2021. Our cash balance on December 31, 2022, was $3.6 million, and we reassert our belief that 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 will be found in our filing on Form 10-K, which we plan to file later this month. This concludes the financial discussion. As always, I would like to thank each of our Nefros 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 your patience. We believe our continued dedication to growth and expense management have well positioned the company for future long-term success. This concludes our formal presentation remarks. We will now take questions from the audience. Gary, will you please open the call for questions? Thank you.

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are 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 will pause momentarily to assemble our roster. Our first question is from Anthony Vendetti with Maxim Group. Please go ahead.

Thanks, Andy. So on the... On the Donna Star Enterprises Agreement as your exclusive distributor outside of healthcare, were there any companies or clients you were speaking with that you now are handing over to them, or is there a pipeline that they have or funnel that they're already looking at And then how does that agreement work, and how do they get paid going forward? And then any update on Chipotle? Does this have any impact on that, or is that just the go-forward business?

Okay. Thanks, Anthony. Good to hear your voice, and congratulations on your news at Maxim. Thanks. Let's see. First of all, it is not exclusive outside of healthcare. I just want to make sure that we're clear. It's exclusive within the food and beverage and hospitality space. There are other non-medical spaces that they do not have an exclusive with, although we will be partnering very, very closely together as close partners. In terms of The pipeline, the answer to your question is both. They both are bringing their own pipeline and their own network and their own relationships into the partnership, and they are also taking over all of the management from a sales and service perspective of our existing customers as well. So it's really both. Um, Chipotle, uh, as you said, uh, is one of our customers and, um, Donna star is deeply involved with them and that will continue and that's going very well. Um, but I expect that we'll be adding other, uh, companies, customers to the, to the roster, uh, in the, in the near future. Um, we've got a lot of energy going into the, uh, the Donna star relationship as well as, um, The relaunch that I mentioned, because we really did not just change our marketing and distribution strategy, we really relaunched the whole offering of commercial filtration to focus in on a tighter set of products that use our highest quality products that are that are all certified, that have a clear and standardized way of communicating their benefit and so forth. So it's been quite an effort. We've been quiet about it, but that effort is now rolling out in states. Did that answer your question, Anthony?

Yes, thank you. And even with this agreement, it sounds like you're still targeting 55% to 60% gross margins. It seems like a win-win for you in terms of the relationship with Donestop.

Yeah, I think so. Thankfully, they will be, and you asked how they get compensated. They really get compensated in two ways. One, they get a discount just like any other distributor on our filters, although they have the exclusives. in these markets. And then the second way, of course, is that they are a company with tremendous reach, over a thousand service people in the field around the country. And so they get, by adding the exclusive filter relationship with Nefros, they have a product that helps them sell not only filters, but the services that go with them. And so it's a win-win for everybody.

Okay, great, great. And then just switching gears, how many, at the end of the fourth quarter, how many active customer sites do you have now? Excellent. Okay, good. Let me hop back into the queue. Thanks so much, Andy. Appreciate it. Okay, you bet. Thanks, Anthony.

Again, if you have a question, please press star, then 1. Please stand by as we poll for questions. The next question is from Robert Smith from the Center of Performance Investing. Please go ahead.

Hi, Andy. Hey, Robert. Could you kind of discuss the growth drivers as you see it going forward?

I can. Thanks for asking. There really are a few. There's really just a very concentrated number of them. Number one, the growth driver is we have... We have had too few people in the field to respond properly to all of the opportunity that's in front of us. We have now doubled the size of our sales force. We're still a small company, a small sales force, but we have additional feet on the street and the ability to pound the pavement and to not only respond to incoming customers, but also to develop more on our own. We have the relationship with Donestar, which will bring us into the food and beverage space and the hospitality space, which is what they do, and I think that will drive. I think we will also have drivers environmentally in the increasingly stringent and strict regulations that are prevalent in the medical field, which we've talked about before and we are seeing some lift there. And while we're not releasing numbers for the first two months of the year, I am very optimistic that we are on the right track based on what I'm seeing internally. That helpful?

Yeah. Andy, was it a surprise to you, the inability to get funding for that operation and the shutting down? Okay, give us more color on that.

Yeah. It was certainly a disappointment. I'm not sure that it was a surprise based on what I've seen over the last year or so. It's a tough time to be... A, a microcap, B, in the dialysis field, and, well, I don't have a C right now, but it's a tough time to be looking for investment. And frankly, there is just a structural problem with the way that we reimburse for dialysis treatment in this country where all dialysis treatments are treated equally, even if some of them are A, more expensive, and B, have different or perhaps better outcomes. While HDF is only increasing in popularity in Europe, it's going nowhere right now in the US. We just hit a wall in this environment of being able to find either funding or a partner for the rollout. And so while I'm, as I say, very disappointed, I've been with the company now for six years, and I came because of the HDF opportunity. I think that at some point you've got to say, okay, We're succeeding in the filter business and we're just spending money again and again and again on SRP through a loan and I think it's just time to take a pause. So I do hope that Nefros will rekindle that technology in the future, but for right now When we've promised all of you that we will get the cash flow break even around the middle of the year, I just don't think it's the time to be spending $150,000 or more a quarter. And if we want to do the rollout without funding it from the outside, it would be double or triple that. We just don't have the resources.

So what do you have to see, Andy, to regulatory to get this back? Well,

I don't think, well, we would have to see a better opportunity to properly reimburse a higher cost dialysis modality. Right now, it doesn't exist, and since the treatment costs more, nobody's doing it, so we have no market to go into. That's the problem. We think that will change, but I said that to you all three, four years ago, and we haven't seen it change yet. We'd rather not spend money while we wait for the market to change.

I guess on the run-up to this, looking back a year or so, I didn't have an inkling that this was going to unfold.

It's a surprise to me. Well, I hear what you're saying.

I'm sorry that you say it's a surprise. It is a company that the SRP effort has been, while we've been throwing our best efforts after it, it has also been true that we have seen many delays and had to report significant delays until last May when we got the clearance, and now we're, you know, since that time, or right about that time, we've seen the market in the medical microcap space really tank, and the availability of capital all but dry up. So, you know, as I said, I'm disappointed, but I'm not terribly surprised that we are where we are right now.

Is there any way to capitalize upon this in the European market?

Perhaps, but we're a small company and I think that the most important thing that we can do is focus on what we know and get ourselves to profitability and to cash flow break-even or positive cash flow and then make decisions based on what we can afford because right now we're in a situation where we need to get ourselves to profitability um and and meet the commitment that we've made so that's what we're working on yeah i hear you all right thanks and wish you good luck thank you robert the next question is from joseph schuler with jas investors please go ahead hello there um question two questions but one is srp just thinking on a cash flow basis

Was there expense to NEFROS in the last couple of years? Obviously the initial investment, but was there an expense in addition to that where that might be eliminated going forward?

Absolutely. SRP exhausted its funds Nefros agreed to lend it up to $1.3 million. That loan balance is now close to 1.5. And we've been funding SRP at a rate of about $150,000 a quarter, $150,000 to $200,000 a quarter. And so that will now come right out of our expenses. And I expect that Q2 Just like with PDS, we were able to remove $300,000 or so of costs. I expect to remove about $150,000 or so of costs in Q2 and forward.

Thank you. Just since you mentioned that, the $1.5 million or whatever that number is, what is NEPHRO's standing average? list of creditors to the degree there is anything left or do you feel there's nothing left on that? In other words, is it a loss or do you think funds can come back in?

No, it's a loss. There are virtually no assets except, of course, the technology, the IP, the machines, which And so all of that, Nefros is the sole creditor of SRP, and so what is almost certainly going to happen is that SRP will wind down and cease to exist as a separate company, and all of its assets, including those I just mentioned, will roll into Nefros. Okay.

One other question.

But there won't be any cash. Sorry. I understand.

Revenues have been around $10 million a year for a few years. Where do we get out of that? Do you see that as wherever it might come from? Do you see that as a possibility in the coming year?

Do I see growth from that $10 million a possibility? Yes.

Yes.

Absolutely. Absolutely. We are... We are focused on only two things. One is watching our cash burn, and two is growing that number. And so the only place that we're investing right now is in our sales team and our sales capability. And as I said, we're not discussing our results in Q1 yet. But the first few weeks of the year have been promising to me, and so I do expect to see that number growing this year.

Good luck going forward. We're rooting for you.

Thank you, John.

Okay.

All right. Take care.

The next question is a follow-up from Robert Smith with the Center for Performance Investing. Please go ahead.

Yeah, Andy, so can you share with us – The R&D budget, which is around, what, a million and a half or so, I mean, how is that being spent?

I don't think, well, it's a million and a half, including SRP, and that part will go away. It's probably, and I don't have it in front of me, but I think it's under a million dollars right now on the filtration side, and the It's being spent on product development and making sure that we're staying current with technology and offering the best current products to our customers. I think it's a pretty modest budget. It's pretty much cut as much as we can, or it certainly will be at the end of this quarter when SRP goes away.

All right. Would you say it's basically refinements? Are you working on anything that might be interesting? Not speaking about the immediate near term, but for the future?

Yeah, I think we are. I do, and I can't really say very much more about it than that.

All right. I'll be on the lookout. Okay. Thanks. Thanks, Robert. Yep, you bet.

This concludes our question and answer session, and the conference is also now concluded. Thank you for attending today's presentation. You may now disconnect.