EcoSynthetix Inc

TSX:ECO

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the EcoSynthetix 2019 First Quarter Results Conference Call. [Operator Instructions] Listeners are reminded that portions of today's discussion may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.For more information on EcoSynthetix' risks and uncertainties related to these forward-looking statements, please refer to the company's annual information form dated March 4, 2019, posted on SEDAR. This morning's call is being recorded on Thursday, May 9, 2019, at 8:30 a.m. Eastern Time.I would now turn the call over to Mr. Jeff MacDonald, Chief Executive Officer of EcoSynthetix. Please go ahead, sir.

[Jeffrey D. MacDonald, CEO & Director]

Good morning and thank you for joining us today. Yesterday afternoon we released our 2019 first quarter results, which you can find on our website at ecosynthetix.com. You can also download a copy of the slides that accompany today's call from our website or alternatively access them on the webcast.From a top line perspective, it was a challenging quarter for us and certainly a setback relative to what we have achieved in the past few years, but we see it as temporary. Net sales were $4.5 million, down 18% based on lower volumes from lumpiness within our customer base and 1 European account that is no longer buying EcoSphere.However, despite this pressure, the actions that we've taken during the past few years, including rightsizing the business overhead and continuing to be disciplined in terms of costs, position us better than ever before to withstand short-term pressure on sales. Our adjusted EBITDA loss was $145,000, an improvement of 83% compared to the prior year period. And we used just $50,000 in cash for operations.We also continue to make progress with our key prospects conducting trials in wood composites and with our primary commercial account in that market. Based on the first quarter results, we remain committed to running the business profitability in 2019. One of the key drivers for success in the wood composites market is the pace of change for no added formaldehyde resins. That change is a function of demand or standards established among regulators and customers, retailers and manufacturers.We're seeing positive progress among regulators and manufacturers in Europe. In Germany, regulators are adopting more stringent standards for testing emission levels from wood composite panels. These changes will take effect in January 2020.While Germany is independently taking this step, given the overlap in markets in Europe, the rest of the market is expected to follow suit with at least a matching voluntary standard. These changes are indicative of the focus on formaldehyde emissions by regulators globally as they continue to ratchet up to standard on the allowable emission levels. As a result, some of the more progressive manufacturers are mobilizing their efforts. The change agenda is also supported by major retailers like IKEA that has consistently communicated to their supply chain partners a desire to use more sustainable and healthy solutions. We believe our DuraBind resin is the leading bio-based alternative for wood composites manufacturers to the conventional formaldehyde-based binders used today. DuraBind, together with pMDI, replaces formaldehyde-based resins.The price of pMDI continues to trade below normalized level, which is helping to enable a DuraBind and pMDI binder system to be competitive to formaldehyde resins. And it's driving renewed interest from manufacturers that have trialed with us in the past when pMDI prices were higher.That covers the economic perspectives. The second key element is the technical viability of our solution. We continue to make good progress on our trials with wood composites manufacturers. Our key prospects continue to see strong results in terms of runability of the line and final testing of the products.We are running trails in the normal mainstream production of our prospects. In short, our results are better than ever with our key prospects. Our trials are primarily focused on the particleboard segment of the wood composites market, with some activity in medium density fiberboards. The smaller segment of oriented strand board is less active today, given the attractive price of pMDI at this stage. Based on our trials, it is clear to us that DuraBind is the best performing, most economical bio-based solution for particleboard available today. In terms of our commercial relationship, SWISS KRONO continues to march ahead with the agenda that they announced last September. They are embarking on a series of market launches for their no-added formaldehyde product line. But beyond product launch is one of their 4 key themes that has anchored their recent market activity, which speaks to the prominence and importance they're facing on healthier solutions.SWISS KRONO is positioning the beyond furniture panel as the most environmentally friendly board of its kind on the market, with an emission level equivalent to trees. This technology is enabled by our DuraBind resin.SWISS KRONO is pleased with the initial response they're receiving at this stage of the rollout. They're building awareness within their B2B channel, but it's still early days in the overall program.In terms of our marketing activity, later this month, we will be participating at the LIGNA trade show for wood manufacturers held every 2 years in Germany. We're excited for the opportunity to engage and share our DuraBind progress with manufacturers. We will be featuring new aspects of our resin, which include increased tack and improve speed, as our R&D investment continues to enhance our offering. Given the favorable market dynamics for pMDI pricing and the heightened awareness for lower emission levels, it's a great time to be in front of the key manufacturers.Turning to paper and paperboard. The macro environment in the paper market continues to be challenging for manufacturers. The traditional coated paper market is experiencing lower demand. As evidence, during the quarter, one of the largest North American manufacturer shuttered a mill. This mill wasn't using our EcoSphere binder, but its closure is indicative of what manufacturers are facing. Among the broader paper manufacturing market, the pricing dynamics of oil and SB latex continues to play an important role as it relates to new customer wins for EcoSphere. With oil trading in the $40 range in late 2018 and early 2019, it created a drag on SB latex pricing. This constrained our ability to offer sufficient saving by switching to EcoSphere. With oil returning above $60 in April, the underlying fundamentals should improve. At these levels, we generally expect upward pressure in the near term for SB latex.As I mentioned earlier, we experienced lower volumes in the first quarter due in part to destocking of inventory in Asia-Pacific. We continue to view Asia-Pacific as an important long-term market for EcoSphere with robust future opportunities, and we have seen buying patterns normalize since the close of Q1In North America and Europe, our highest priority prospects are in the specialty paper segment where manufacturers are searching for sustainable alternatives to conventional petroleum-based binders. We believe paper remains an important foundational market for us. With the changes we've made in the cost structure of the business, our paper sales provide a critical mass from which to grow. We believe opportunities exist to expand our paper business, but our #1 priority is successfully penetrating the wood composites market with our DuraBind resin. To that end, last month we hosted the Minister of Agriculture and Agro-Food and the minister of the democratic institutions from the federal government at our Center of Innovation in Burlington. At the event, they announced new funding from the Canadian agricultural partnership to support renewable materials. Under the program, we've been awarded up to $2 million for additional development of our DuraBind resin. Research and development activities remain a core focus for our team. The versatility of our biopolymer platform from which we commercialize EcoSphere and DuraBind provides additional potential and new opportunities.Both kind of perspective of enhancing our existing products as well as expanding into new areas with focused opportunities alongside partners with expertise in the relevant end markets. While our priority will remain on our commercial products, we also recognize the importance of laying the groundwork for new opportunities.With that I'll turn the call over to Rob to review the financial highlights.

[Robert Martin Haire, CFO & Corporate Secretary]

Thanks, Jeff, and good morning. From a top line perspective, net sales were $4.5 million in Q1 2018 compared to $5.4 million in the same period in 2018. This 18% decrease was primarily due to lower sales volumes of $1.3 million or 23% due to unfavorable market conditions. Sales were impacted by $600,000 due to inventory destocking at a distributor in Asia-Pacific, which has since normalized.Sales were also impacted by $400,000 due to the loss of business at a European paperboard mill. These decreases were partially offset by higher average selling prices due to favorable customer mix, which improves sales by $300,000 or 5% in the quarter.Gross profit was $1 million in the quarter, down $60,000 compared to the same period in 2018. This change was primarily due to lower sales volume, partially offset by higher average selling prices.Net of manufacturing depreciation, gross profit as a percentage of sales is 25.5% in the quarter compared to 23.4% in the same period in 2018. The increase was primarily due to higher average selling prices due to favorable customer mix. Adjusted EBITDA loss was $145,000 for the quarter, an improvement of 83% compared to a loss of $875,000 in the same period in 2018. Improvement was due to lower operating expenses. We continue to be disciplined in our approach to cost management.SG&A expenses were $1.2 million in the quarter compared to $1.5 million in the same period in 2018. SG&A includes share-based compensation expense. Excluding this item, SG&A was $1 million in the quarter compared to $1.3 million in the same period in 2018.R&D expenses were $450,000 in the quarter compared to $750,000 in the same period in 2018. The changes were primarily due to lower people-related costs and discretionary spending as well as a $60,000 beneficial impact from the adoption of IFRS 16 for lease accounting in the current period. Our R&D efforts continue to focus on further enhancing value for our existing product lines and expanding our addressable opportunities.We are confident that our current investment level is appropriate to deliver significant growth. As of March 31, 2019, we had $44.3 million in cash in short-term investments compared to $44.8 million as of December 31, 2018.Since April 2018, the company acquired and canceled just over 2 million common shares for an average cost of $1.88 per share under our normal course issuer bid. We have announced the renewal of our NCIB yesterday and intend to be active for share buybacks in 2019. We have more than sufficient cash resource to execute our growth strategy, and we'll remain disciplined and manage our cash responsibly while continue to invest in our long-term growth strategy.With that, I'll turn it back to Jeff for closing comments.

[Jeffrey D. MacDonald, CEO & Director]

Thanks, Rob. We're committed to delivering profitable growth while investing in product development and our sales platform. The headwinds we encountered in the paper and paperboard market during the first quarter were frustrating, but it is clear from our bottom line results that the business is in a far better position to deal with short-term market dynamics than we were in years past.In my view, the challenges we faced in the first quarter are short term and not concerning in the bigger picture. The primary question is the pace of change in the wood composites market. It can be challenging to predict. So how are we managing that aspect of the equation? We've positioned the business in the best possible way to take advantage of change with the best available product that competes effectively, both economically and on technical viability.We're engaged with strategic accounts that have conviction like SWISS KRONO. These accounts and prospects are differentiated. They're investing resources both operationally and from a marketing perspective. And they have the necessary retail pull to deliver on an agenda of change.In the past few months, we've hosted a series of stakeholders at our Center for Innovation here in Burlington, including commercial customers, prospects, strategic partners, government officials and investors. These are long-term stakeholders that are each important in their own way to our commercial and overall success of the business. Each time we host one of these visits and share the progress we've made, the stakeholders depart emboldened in the potential our sustainable polymers offer.We appreciate the trust and the patience that our shareholders have shown, and I look forward to continuing to update you as we move forward. And with that, I'll turn it back to the operator and open the line for questions.

[Operator]

[Operator Instructions]

[Jeffrey D. MacDonald, CEO & Director]

Raveel, I do see that you're in the queue. If you want to go ahead, we'll pause for a couple more seconds here.

[Operator]

Raveel Afzaal, your line is open.

[Raveel Afzaal, Analyst]

Can you guys hear me?

[Jeffrey D. MacDonald, CEO & Director]

Yes. We can hear you now. Not sure what happened there.

[Raveel Afzaal, Analyst]

Yes, no worries. So I'll just start off with the average selling price. My understanding was that when SB latex prices come down or pMDI prices come down, you might lower your price as well, just to remain more competitive. So how come we saw an improvement in average selling price?

[Jeffrey D. MacDonald, CEO & Director]

Yes, it is a bit of an enigma. So we do expect and we have seen downward pressure where we're tied to SB latex monomers and we would normally expect that in a lower oil price environment. And we've definitely seen that. What was bigger in terms of impact was the mix of our customer business. So we had some products that were at the higher end of our margin range where we had good volumes in the quarter. And geographically, we were overweighed in markets where our margin and pricing is stronger than in markets where we had some weaker sales. So the micro stuff kind of outweighed the macro that we would normally expect to see. But you're right on in your assumption that as oil goes down, SB latex goes down with it and that puts our products under pricing pressure. And where we've had formulated pricing, that has been the case. But those micro factors of geography and product mix overshadowed that in the quarter, which is kind of a strange view on it, but that's what happened.

[Raveel Afzaal, Analyst]

No. That make sense. And can you remind us what are your higher-end products versus the lower-end products?

[Jeffrey D. MacDonald, CEO & Director]

Yes. Where we're participating in specialty paper applications, some of our products for adhesives, for example. And in some of our, I'd say, very new offerings for the personal care space, for example, those would be at the higher end of our range, whereas coated paper is the part of the market that is affected most by oil prices and tends to be, especially in this environment, at the lower end of our margin range.

[Raveel Afzaal, Analyst]

Got it. And then just moving on to IKEA, is it possible for you guys to comment on if you guys did any testing for IKEA in the quarter?

[Jeffrey D. MacDonald, CEO & Director]

We can't comment specifically on testing. I can say that we made progress in the quarter, progress that we're excited about. We are not in a position, we're not able to disclose details on what we've done together with IKEA, but we're pleased with progress that we've been making.

[Raveel Afzaal, Analyst]

Perfect. Yes. Finally, just on the personal care products, can you give us some update on what's going on in that vertical?

[Jeffrey D. MacDonald, CEO & Director]

So we're going to right pass the wood and paper and towards…

[Raveel Afzaal, Analyst]

Exactly.

[Jeffrey D. MacDonald, CEO & Director]

It's a fun one to talk about. So I guess the interest for those I guess that have been to our Center of Innovation here in Burlington, you've seen some of the products, the Aveta product that contains our ingredients as an important part of those products. Very -- it's been very small for us. We're excited that there is a very large global chemical player that's taken our product under their wing and has formulated us into things that they're offering to the market. We're really excited about it; it's very early days. But I think the appeal of it may be part of why you asked us. You can see how it makes its way on to the shelves and products that we're familiar with.

[Raveel Afzaal, Analyst]

Absolutely. And is there still a free revenue opportunity or are you guys already recognizing revenues from it?

[Jeffrey D. MacDonald, CEO & Director]

Well, we've had -- I mean, you've seen the Aveta products here. So we've had, I'll say, drops of revenue for that product over the past couple of years. We don't consider the impact of this new venture together with the large chemical supplier to be material at this point. We're excited and hopeful for it, but it's not meaningful enough for us at this point.

[Operator]

[Operator Instructions] We have a question from Geoff Gilbert with Inukshuk.

[Geoff Gilbert]

Congratulations on discipline. My question has been asked on other products. So I will get back in queue as well.

[Operator]

[Operator Instructions] We have a question from Kenan Lucas with Harbert Management.

[Kenan H. Lucas, Managing Director]

So I'm just a little confused because you said this product was positively impacting the margins because of the pricing but it's also not significant. So I wonder if you could clarify.

[Jeffrey D. MacDonald, CEO & Director]

Yes. Thanks. I really confused things there. Raveel asked for examples of things that would be at the higher end of our margin range and so I was listing examples. And I'll just say, were the personal care product to be material, then it would have a material impact on margins. But it's not.

[Kenan H. Lucas, Managing Director]

Okay. So it's other personal care with, I guess, presumably, the Aveta that's impacting the margins positively, not with this large chemical partner.

[Jeffrey D. MacDonald, CEO & Director]

No. That did not have a material impact in the quarter. Not at all. It's really related only to customer mix and underlying product mix within those customers.

[Operator]

[Operator Instructions] And we do not have any telephone questions at this time. I will turn the call over to the presenters.

[Jeffrey D. MacDonald, CEO & Director]

Okay. Thanks, everyone, for joining us today. And we look forward to updating you again soon.

[Operator]

This concludes today's conference call. You may now disconnect.