Nephros Inc Q1 FY2024 Earnings Call

Good afternoon, and welcome to the Nephros, Inc. First Quarter 2024 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Kirin Smith, Investor Relations. Please go ahead.

Thank you. Good afternoon, everyone. Thank you all for participating in Nephros' First Quarter 2024 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 Nephros' 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, Nephros' ability to successfully market and sell its products and service offerings, the rate of adoption of its products and services, the success of its commercialization efforts, and the effect of existing and new regulatory requirements on Nephros' business 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 9, 2024. 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 Nephros' President and Chief Executive Officer, Robert Banks. Robert, please go ahead.

Thank you, Kirin, and good afternoon, everyone. Thank you for joining us to discuss the 2024 first quarter results, which we reported today. It has been an exciting start to the year. I want to start by thanking the Nephros team for a job well done as our programmatic business grew 12% over the same quarter last year despite the 5% drop in top line net revenue. This top line decrease is attributed to a record nonrecurring emergency order that was reported in Q1 of last year and an unusually low amount of emergency business in this past quarter. The collective result of these factors was a modest 8% overall growth over the prior quarter. Given the unpredictable nature of emergency orders, we remain focused on operational prudence and disciplined deployment of capital. These actions positively complement the growth of recurring sales and further support our steady advancement towards solid financial performance. With an established foundation of programmatic business and customer loyalty, we are investing in the development of new capabilities to extend our competitive advantages, addressing water quality and safety challenges. One example is the creation of an online filter tracker, which enhances the customers' experience in managing their Nephros filters. This tool offers automated replacement reminders and documentation of installations and inventory. These features are just the beginning as Nephros continues to explore ways of generating value in the digital space. Nephros is also exploring how to best support customers in need of nano and microplastics, as we seek to expand our future capabilities within our medical filtration lines. Our ability to retain microorganisms with the smallest pore size on the market uniquely positions us to address these challenges, particularly nanoplastics. Looking ahead, the future growth of Nephros will depend upon the continuous enhancement of sales strategies, leveraging changing regulatory guidance and the exploration of new products. Accordingly, our sales team is actively supporting our national partners and nurturing their success through increased training, expansion with existing accounts, and conversion of emergency response to programmatic business. Additionally, we have been participating in a record number of trade shows and regional industry events, generating significant brand awareness and visibility to our product capabilities. Nephros' presence also affords countless opportunities to educate key influencers and decision-makers on impending regulatory changes and recommended solutions. The stakeholder connections cultivated in these environments inform customer frameworks and often lead to future sales. The last area I'd like to highlight before turning the floor over to Judy is the need for solutions that mitigate human exposure to nano and microplastics. I read a new article almost weekly regarding the multiple health concerns related to these materials. The ability of nano and microplastics to penetrate biological barriers and leach toxic chemicals can lead to cellular toxicity, inflammation, and damaged DNA. Our hollow-fiber technology, which offers the smallest pore size on the market, enables us to provide filtration that may effectively retain these substances. I will now pass the mic to our CFO, Judy Krandel.

Thanks, Robert. I will now provide a closer look at Nephros' financial performance in the first quarter. We reported first quarter net revenue of $3.5 million, a 5% decrease over the corresponding period in 2023. This decrease was primarily driven by decreased revenue from emergency response orders, which were unusually large in the first quarter of 2023 and were not repeated in the comparable 2024 period. However, the decrease in emergency response orders was partially offset by increased revenue from programmatic or recurring sales, which were 12% more than the same period in 2023. Gross margins in the quarter were 62% compared with 57% in 2023, an increase of 5 percentage points year-over-year. The increase in gross margins was driven by reductions in shipping expenses and more favorable terms with our largest supplier. Research and development expenses were $200,000 for both the first quarter of 2024 and 2023. Sales, general and administrative expenses were $2.1 million for both the first quarters of 2024 and 2023. Net loss for the quarter was $169,000 compared to $306,000 in the same period last year. Adjusted EBITDA in the quarter was negative $95,000 compared with positive $147,000 during the same period in 2023. Net cash used in operating activities was $672,000 in the quarter compared to net cash provided by operating activities of $276,000 in the same quarter last year. The use of cash primarily reflects the operating loss, payment of 2023 annual bonuses, which always hits in the first quarter, and an investment in inventory to support future growth. Our cash balance on March 31, 2024, was $3.6 million compared to $4.3 million as of December 31, 2023. We continue to remain debt-free. 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 should be filed later today. I will now turn the call back to Robert for some closing remarks. Robert, please go ahead.

Thank you again for joining me and for your investment in this great organization that is uniquely positioned to solve the toughest problems associated with water consumption. Additional thanks to each of our Nephros employees, our partners, and our customers, without whom we would not be where we are today. I'd like to close by reiterating our enthusiasm for our future growth prospects as we continue to build on the momentum we have been experiencing. This concludes our formal presentation remarks. We will now take questions from the audience. Operator, please open the call for questions.

The first question comes from Thomas McGovern with Maxim Group.

Congrats on the quarter. So yes, let's start off with looking at the growth in recurring revenue. I'm just curious, how much of this growth in the programmatic sales is reflective of expansion within those key partners that you discussed in the last couple of calls versus acquiring new clients?

Thank you for that question, Thomas. It looks like it's about a good mix of new customers and growth in existing customers. We've been adding a record number of new sites this past quarter, and that felt really good. So the programmatic business continues to expand. The strategy we've been quite effective with has been this land and expand approach. We go in, and we acquire a business in one part of the facility. As we get comfortable and know the players, we expand to other parts. That strategy has been pretty effective in two of the regions, whereas regions where we haven't typically had a lot of sales exposure are experiencing significant growth with new customers as we build those relationships and trust while we work with local partners and directly. What we have noticed is that the existing business has not always been maintained and grown at the rate we expected. However, the new digital tool that I mentioned will let us track if they've got 10 units we're treating; then we have changed that filter 10 times in the prescribed period. We're finding that probably 40% to 25% of the time, depending on the region, they're not changing them when required. It's not intentional—they just forget that the filter is installed and miss their preventive maintenance activities. Our goal is to make sure we're not reading anything on the business we've already won, keeping that recurring programmatic business going while also adding new customers and expanding into areas we haven't penetrated before. The exact split between growth in new business versus existing customers is difficult to track based on the deficiencies in maintaining the programmatic business. But it's going to get much easier with the digital tools we mentioned. Hope that answers your question, and look for more updates on that business in the future.

Absolutely. No, that's very helpful. So just kind of on the online filter tracker, I'm curious when you guys exactly launched that. Have you started to see it reflect in people ordering these filters on time versus your earlier comments about how they might not have been ordering them as promptly? So have you begun to see a shift, or is it too early to tell?

It's too early to tell. We are just in the beta phase, signing up a few customers to work out the kinks. What we're finding is, 'Oh, there's another feature we'd like to add. It would be good if we could do this.' So we’ll probably need to say it's done and move on at one point, but it's proving exciting with different capabilities and enhancements. So we're happy that it’s finally ready to start rolling out to customers, and we're beginning to gather results but still early in the phases.

Got you. I appreciate that. And then my final question is regarding the NMPs you discussed in your prepared remarks. Are you currently servicing any customers specifically for filtering microplastics? Are you seeing industry demand for this, and are you looking to enter this space more aggressively?

Yes. This has surfaced fairly recently. I read an article stating the average person consumes plastic equivalent to a credit card every week. I began to think about how we can address that as a filtration company. There are no regulations stating the acceptable limits in certain areas. There's not a strong driver other than people's desire to do the right thing considering the potential human impact. Obviously, this is still under research. We're trying to get ahead of that by evaluating our technology, which uses size exclusion. We can easily remove NMPs as they are a larger particle size. While they pass right through regular filters, our technology allows us to address them effectively. We're currently building up information to determine holding capacity and where to recommend this solution. We’ll target areas like healthcare and hospitality markets, where regulations help guide water quality standards. We're preparing to provide products once we settle those details, and we’re excited about these opportunities for Nephros.

The next question comes from Mike Costides, a private investor.

My question is about Nephros selling to hospitals and health centers. You also mentioned schools and municipalities, but do you see the trend of increasing your total addressable market (TAM) continuing?

Yes, it's a great question. Good to hear from you, Mike. Nephros has been selling to those entities since our beginnings in the dialysis space, expanding our technology into patient care facilities. When we consider the TAM for places like schools, municipalities, senior centers, and government buildings, these sectors do not always have the same drivers present in healthcare facilities. For example, while there are regulations prompting requirements in healthcare, there's not the same mandate for schools. However, we're seeing increasing documentation of incidents where individuals have faced health issues, resulting in lawsuits. This presents opportunities for us. I believe this trend will continue, and I look forward to a shift where demand pulls rather than pushes us into the market. While we are focusing on our infection control products, we are providing great solutions for facilities facing challenges from contaminated water.

Could you elaborate on the OEM agreements involving Nephros filters, dialysis or otherwise?

Certainly. I will need to be a bit general and not mention names, out of respect for our OEM partners and competitors. When dealing with dialysis, our devices are FDA-cleared Class II. They’re integrated within the clearance required for those products. Often, we must work in conjunction for months or years before launching. We have several OEM agreements, and it's a significant part of our business. We continuously look to improve our performance and value delivery so that these OEMs choose us for their next product revisions and launches. They may have requirements that our filters cannot meet today, such as size or capacity constraints. We can redesign our products to accommodate those specifications, making us a favorable partner for OEMs.

I was going to ask about the nanoplastics opportunity, but you covered that already. Congratulations.

The next question comes from Ankur Sagar, a private investor.

Yes, sorry about that. A good quarter with growth in programmatic revenue. Robert, you laid out several initiatives for recurring revenue, including the filter and renegotiated contracts with distributors to track filter placement. Can you share any early insights on how this might help accelerate programmatic revenue even further?

Sure. We've noticed that the team is working hard and closing new business. Our active customer sites remain high, but we weren't seeing the expected recurring revenue growth. We began investigating accounts and realized that nursing homes often lack budgets and can leave filters unchanged for years instead of the recommended three or six months. Many times it's neglect rather than deliberate. By having reminders for customers when it's time to change a filter, we should be able to drive more timely replacements. We have an offline tool to track installations, but using QR codes will give us real-time data on when filters should be replaced, which should help us avoid significant lapses in replacements. So yes, I'm optimistic this will boost growth in our programmatic business reflecting new sales.

That's great to hear. In the presentation at the Planet MicroCap conference, you discussed several growth initiatives, including microplastics and commercial opportunities. Could you summarize the top three initiatives that you think will impact this year's top line?

The top three initiatives that will impact this year include our digital tool, which won't necessarily bring in new customers but will help maintain and grow existing programmatic business. Our cross-selling opportunities are important as we often enter as a provider for one application but can expand to others. Finally, we are nurturing our partners and distributors by participating in conferences and events. These are key opportunities to educate stakeholders on new technologies and guidelines coming from regulatory bodies. So these will be our focus areas for this year.

Regarding the gross margin, there was a noticeable improvement. Do you expect that to continue?

Yes, I'm going to let Judy handle that question. She’s detailed the financials and will provide you with the best insight.

Yes. Thank you for the question. We were pleased with the margins we achieved. We have been carefully managing our shipping expenses, which were unusually high during the COVID period. We feel good about managing those costs without a significant economic increase. Our supplier negotiations have been beneficial, and we anticipate maintaining relatively strong margins, though there may be fluctuations from quarter to quarter.

Could you elaborate on the aspects of improved terms from your supplier? Did currency have any impact on your income statement or balance sheet?

Currency has had a negligible effect. Our recent contract renewal with our largest supplier allowed us to negotiate more favorable terms due to our growing volumes.

Given the 12% growth in the base business, do you believe this reflects a softer economy or merely a short-term fluctuation?

It's an important question, and I've been focusing on this prior to closing out the quarter. First, the number of hospital beds is stagnant, which affects support services. The healthcare industry only grows at about 2-3%. So while 12% growth seems modest, it still outpaces industry growth. Our expectations were high, and I believe we are taking market share while retaining customers. I look forward to achieving continued double-digit growth moving forward.

What is the mix between direct sales and those through distributors, and does that impact gross profit margins?

We have significantly reduced our number of distribution partners to those aligned with our values and sales approach. The few remaining partners have strong relationships that are essential to reaching numerous targets. While there might be slight differences in margin between direct sales and distributor sales, the positivity in gross margin is largely from other factors we've discussed.

Has headcount changed dramatically over the last year?

No dramatic changes have occurred, but we are selectively adding resources to support sales growth. There is a saturation point where additional personnel are necessary to maintain quality service. We're cautious with hiring while ensuring capital returns align with performance.

Has the recent move to a new facility reflected in improved gross margins?

Good point, and the new facility has allowed us to cease using a couple of other sites. While we are still organizing everything, the benefits from cost and efficiency improvements will likely be seen more in future quarters.

The next question comes from Thomas McGovern with Maxim Group.

I thought I would follow up. Regarding the headcount increases, you mentioned selectively adding where needed, but will you maintain a similar total headcount as in 2023? And have you considered specialized salespeople for niche opportunities?

These are great thoughts, Thomas. The app needs specialized expertise, so we are partnering with a firm that already developed this software. This saved us time and resources. For NMPs and upcoming technologies, we are adding engineers with the right skillsets. Everything is tied to our budget and profitability goals, so each hiring decision is analyzed for ROI. We're cautious yet proactive in headcount addition.

Thank you for that response. One last question on your warehouse. Are you using any third-party warehouses? And can you maintain your storage needs with your new facility?

Currently, we don’t use third-party storage; the goal was to eliminate those costs. We have partners that stock inventory. We monitor our milestones for when to expand again. Currently, we are using about 50% of the space available, and we will adjust as sales require.

What percentage of customers have been retained versus new customers? Have you experienced any price pressures, and are there any significant new accounts you've taken on?

Our retention rates are in the mid-90s percentage range, which indicates strong satisfaction despite our higher pricing than competitors. Yes, we do face price pressure as a premium product provider, but customers recognize the value of what we offer. We continue to leverage that value and ensure we don’t leave too much on the table.

As you've been at Nephros for nearly a year now, what has exceeded your expectations and what challenges have you faced?

The team’s commitment to customer satisfaction has been inspiring; their willingness to resolve problems has truly impressed me. However, one challenge has been customer complacency, particularly if there aren't regulatory requirements. We’re addressing this through education, highlighting the long-term cost benefits our solutions provide.

Do you see any other areas requiring pure water? How do you plan to access and serve those areas while balancing current reliance on hospitals and nursing homes?

Yes, we are pivoting to look at markets outside traditional healthcare, such as schools and government agencies, promoting water quality standards. We're also focusing on sterile processing, where our technology meets well-defined needs. We’re excited about expanding our footprint beyond our current base and we expect increasing inquiries for our solution in the near future.

This concludes our question-and-answer session for the Nephros, Inc. First Quarter 2024 Financial Results Conference Call. Thank you for attending today's presentation. You may now disconnect.