EcoSynthetix Inc

TSX:ECO

Earnings Call Transcript 2020-Q1

[Operator]

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the EcoSynthetix 2020 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's risks and uncertainties related to these forward-looking statements, please refer to the company's annual information form dated March 2, 2020, posted on SEDAR, S-E-D-A-R. This morning's call is being recorded on Thursday, May 7, 2020, at 8:30 a.m. Eastern Time.I would now like to turn the call over to Mr. Jeff MacDonald, Chief Executive Officer of EcoSynthetix. Please go ahead, sir.

[Jeffrey Douglas MacDonald, CEO & Director]

Thank you. Good morning, and thanks, everyone, for joining us today. Firstly, I apologize for the delay in getting things started here. I think probably like many of you, we've been in queue on what is apparently a very high-volume day. So we'll get started.Yesterday afternoon, we released our 2020 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.The world has undergone a tremendous change since our last call on March 4. We'll begin today with an overview of our approach to dealing with the COVID-19 outbreak and then move into the progress since the Q4 call. Our priorities are making sure our employees are as safe as possible in the workplace and that our customers who rely on us for products continue to receive a high level of service. As in the case of most businesses, the employees that are able to work from home have been doing so since mid-March. A small number of employees that have essential responsibilities on the pilot line in Burlington or in our laboratories have been attending our workplace practicing physical distancing and hygiene in accordance with public health standards.The 2 commercial-scale toll manufacturing lines that we utilize in Tennessee and Holland continue to operate. They adhere to local regulations in their regions. However, we have not had any interruption in our ability to service accounts based on their uptime. So from an operational perspective, we're managing well.From a macro business perspective, our bio-based polymer technologies offer a more sustainable, healthier alternatives in the markets that we target. As consumers, retailers and manufacturers navigate the pandemic, we believe that sustainable and healthier options will draw even more focus once we are on the other side of the recovery. Our technologies and our existing relationships with commercial partners, accounts and prospects put us in a great position to compete and drive adoption. Despite the outbreak, we continue to have a great deal of confidence across each of our 3 primary markets. From a practical perspective, some of the projects underway will inevitably move to the right as development and trials are impacted by the shelter-in-place practices and the production capacity of lines at our prospects. However, we continue to have a high level of engagement with our key strategic relationships even in the face of this health crisis.On the wood composites front, current commodity pricing dynamics helped to support the conversion away from formaldehyde resins. Our DuraBind resin works with pMDI within the particleboard and medium-density fiberboard markets. The underlying supply of pMDI was already strong, pushing pMDI prices to near historic lows, and the recent crash of fossil fuel prices has pushed this even lower. The current pricing situation supports our value proposition as a no-added-formaldehyde binder to replace formaldehyde-based resins.Our primary customer in the wood composites front, SWISS KRONO, continues to produce its BE.YOND particleboard to seed the market as part of its product launch. They continue to invest resources in BE.YOND as a product that differentiates them in the market. They view driving the commercial success of their NAF particle board as a greenfield opportunity.In terms of broadening adoption and leading change in the market, our key strategic retail prospect continues to be highly engaged throughout a cross-functional team. Due to confidentiality, we cannot provide specific details of our progress. However, in addition to dealing with their development and production groups, we are also working with the regulatory, marketing and supply chain groups. I believe this demonstrates the breadth and depth of the relationship, and it is certainly a necessity for an organization that is preparing to take more significant steps with a new technology. We remain highly confident that we are engaged with the right strategic partners to drive the NAF agenda forward. Market leaders in pursuit of sustainable and healthier NAF alternatives for customers, retailers and manufacturers. As SWISS KRONO and our key strategic partner make progress, we continue to maintain contact with the other major manufacturers, where DuraBind has already qualified on their production lines as well as with new prospects. Once these producers see a meaningful step on the NAF agenda is taken in the market, we are poised to support additional growth. Our key priority for commercial success in wood composites is supporting the market launch of SWISS KRONO and converting the key strategic player to a commercial account. Moving the needle in these areas is the path to generating top line growth for the business.Today, the vast majority of our sales continue to come from the paper and paperboard markets with our EcoSphere binder. The paper market continues to come under pressure. It is difficult to unpack the broader paper demand challenges from the impact the virus may be having. The trend in coated free sheet demand was already falling in 2019 prior to the COVID-19 outbreak, and it is generally expected to further dampen demand for coated paper. What we can report is that all of our existing accounts remain in good standing. They continue to place orders, and many of them have been in contact with us through March and April to ensure we understood that our binder was an essential input as part of their supply chain to continue to service their customers.In the near-term, we expect demand pressures to continue in line with the overall direction of the economic downturn through the course of the pandemic. As an example, the delay in the Olympics will likely impact regional paper manufacturers in Japan, which remains an important market. From a pricing perspective, whereas the downward pressure in oil benefits our wood composites offering, in the paper and paperboard markets, it is a headwind. The price of the binder we replace, SB latex, is highly correlated to oil. It traded at historic lows in March. As a result, our ability to convert new accounts to EcoSphere through cost savings while still earning a reasonable margin is constrained. At present, we are focused on retaining our existing commercial accounts, and we anticipate some pressure on margins due to the falling price of SB latex.At the same time, we continue to pursue opportunities in the specialty paper and packaging markets, where interest is higher due to the health and sustainability benefits EcoSphere offers to manufacturers. These areas also appear to be seeing more steady demand during the pandemic as packaging remains a necessity.We continue to invest in developments where customers are using paper for sustainable packaging materials, and we do not expect a change on that front. Our prospects continued to run trials in April and into May. However, while these applications are important, they are in niche markets compared to the traditional graphic paper application where we drive higher volumes. Our newest market is personal care. Last year, we signed an exclusive development marketing and distribution agreement for our biopolymer with a leading global chemical company with a large presence in this space. Consumer demand for green ingredients is driving rapid change in the personal care market today, and our all-natural biopolymer plays directly into that shift. Formulations using our biopolymer replace existing chemistries at a competitive price with the same or better performance. Our partner is marketing our biopolymer and developing formulations for personal care brands across a range of applications with an initial focus on hair fixatives.The platform was launched mid last year, and it typically takes 12 to 18 months for a brand owner to launch a new SKU. The hair fixative applications targets an approximately $350 million addressable global market for our ingredient. Given the scale and brand of our partner, they enter markets where they believe they can compete to take a significant share. Our partner believes the chemistry could take a meaningful position in this space. Their objective is to be a market leader, which would make it a significant growth driver for our business. They are looking to expand the platform, both in terms of pipeline and geography. We are supporting them through the development of their pipeline and on regulatory activities in new geographies. We're also continuing with our development efforts on new products. They're interested in launching new grades this year. However, formulation development in their laboratories has temporarily stopped due to the outbreak. But they remain highly engaged and continue to demonstrate conviction in the potential for our green ingredient platform in the personal care space.In summary, our strategy remains intact despite the COVID-19 outbreak. We have confidence in our ability to penetrate the 3 markets we target. We possess strategic customers or partners in wood composites and personal care that have global reach. And our paper and paperboard applications represent a foundational business that covers our costs and is underpinned by sticky long-term customers. While no one has clarity today on the duration of the pandemic, our multiple shots on goal strategy offers consumers, retailers and manufacturers sustainable and healthier alternatives to conventional chemistries. We believe this puts us in a great position as we move forward. The economy recovers and those key stakeholders look at their health and lifestyle choices in a new perspective. And with that, I'll turn it over to Rob to review the financials. Rob?

[Robert Martin Haire, CFO & Corporate Secretary]

Thanks, Jeff, and good morning. From a top line perspective, net sales were $4.2 million in Q1 2020 compared to $4.5 million in the same period in 2019. This 5% decrease was primarily due to lower average selling prices, which impacted sales by $500,000 or 11%. The pricing pressure was due to a change in customer mix and the impact from the unfavorable pricing dynamics of SB latex, which Jeff mentioned earlier. This impact was partially offset by higher volumes of $300,000 or 6% in the quarter. Gross profit was $1.1 million in the quarter, up 11% compared to the same period in 2019. This improvement was primarily due to higher volumes and lower manufacturing costs partially offset by the lower average selling prices. Net of manufacturing depreciation, gross profit as a percentage of sales was 29.8% in the quarter compared to 25.5% in the same period in 2019.SG&A expenses were $1.4 million in the quarter compared to $1.2 million in the same period in 2019. The change was primarily due to unrealized foreign exchange losses due to the movement of the Canadian dollar to the U.S. dollar at quarter end. During the quarter, we had a foreign exchange loss of just over $100,000 compared to a gain of $100,000 in the same period in 2019. R&D expenses were $380,000 in the quarter compared to $450,000 in the same period in 2019. R&D expense as a percentage of sales was 9% for the quarter, compared to 10% in the same period last year. Our R&D efforts continue to focus on further enhancing value for our existing product lines and expanding our addressable opportunities.Adjusted EBITDA loss was $190,000 for the quarter, which is in line with the loss of $145,000 in the same period in 2019. As of March 31, 2020, we had $43 million in cash and short-term investments compared to $43.7 million at year-end. During the quarter, we invested $500,000 in the normal course issuer bid. We have acquired and canceled approximately 350,000 common shares at an average cost of CAD 1.79 per share in Q1 and remain active on a daily basis. We intend to renew the normal course issuer bid for another year upon its expiry, subject to regulatory approval. We will continue to be disciplined in our approach to cost management, and we are confident that our current investment level is sufficient to deliver significant growth.With that, I'll turn it back to Jeff for closing comments.

[Jeffrey Douglas MacDonald, CEO & Director]

Thanks, Rob. Our key priority for 2020 is driving our commercial strategies forward in wood composites and personal care by supporting our customers and partners. We are engaged with the right players in both markets. Our technology offers a more sustainable and healthier alternative to existing chemistries. As the market comes through the other side of this pandemic, we believe that customers and retailers will increasingly demand greater focus on these attributes. We are looking to deliver strategic wins in the NAF market and the all-natural personal care market that will deliver meaningful growth in the long-term. We do not expect to drive outsized growth in our top line in 2020, given the state of the paper and paperboard market. However, we fully expect 2020 to be the start of a transition, where our sales and bottom line performance increasingly shift from paper applications to wood composites and personal care applications. We appreciate the trust and the patience that our shareholders have shown, and I look forward to updating you further on our progress.And with that, I'll turn it back to the operator to open up the call for questions. Thank you.

[Operator]

[Operator Instructions] Your first question comes from the line of Raveel Afzaal.

[Raveel Afzaal, Former Analyst]

Just starting off with the no-added-formaldehyde market, can you guys give us some color on how the adoption of no-added-formaldehyde products is coming along right now generally in the marketplace? And if customers are choosing these products, why they are choosing them? And if they're saying -- if they're not choosing these products now, what are some of the key reasons that's driving that?

[Jeffrey Douglas MacDonald, CEO & Director]

Raveel, thanks for joining us. I would say not a lot has changed on that front through the course of the last few months. But just generally, we do know, if we take it to the most basic level that retailers like IKEA get regular -- regularly are getting phone calls from consumers asking about formaldehyde in their products. And so it is an issue that consumers are sensitive to, and I would say there's a growing sensitivity to it. The availability of no-added-formaldehyde products has definitely been an issue. And I think with SWISS KRONO's moves, in particular, it's brought a product to the forefront that consumers can look at through their retailers or kitchen manufacturers or whoever they're looking to for safer products. And they can actually see something now. And we've actually seen through some of the furniture shows last year that there were furniture manufacturers that were picking up on that opportunity and trying to market healthier alternatives. I would say it's still early days in conversion. But I think the issue is one with growing interest from consumers, and I think retailers and manufacturers are starting to see it as a differentiation opportunity. SWISS KRONO's launch has definitely woken a lot of people up that there may be something more here that they should be focused on.

[Raveel Afzaal, Former Analyst]

Can you speak more specifically to SWISS KRONO's, like are they seeing any growing adoption of their no-added-formaldehyde products right now? Or is it still...

[Jeffrey Douglas MacDonald, CEO & Director]

I would say they're seeing steady interest from furniture manufacturers and kitchen manufacturers in taking their no-added-formaldehyde product and beginning to put it into their products and then those companies beginning to offer their products to consumers. So it is kind of a multi-level value chain that they need to work through. But what we have seen is that every month they're continuing to do a production run in order to do just that. So there's kind of a fairly steady demand for that initial seeding, but it hasn't gone to be something mainstream and significant yet. There hasn't been a big furniture manufacturer that's adopted this in a big way yet.

[Raveel Afzaal, Former Analyst]

Perfect. And just from early indication, how is the pricing of no-added-formaldehyde products versus the regular product?

[Jeffrey Douglas MacDonald, CEO & Director]

I think, as they are first, and they do see it as a greenfield opportunity, our understanding -- and we're not in the lead on this, but our understanding is that they're putting this out there as a premium product. And I would say, in early days, they should. A kitchen manufacturer, for example, could market this as a premium product and certainly get a premium for it. And their contribution to that through the particleboard panels they provide would be a small cost increase for a furniture manufacturer to offer something significantly different. So I think they want to take advantage of that to the extent they're able to. You never know, they may have to adjust prices and look at it differently, but I think they've started with it as a premium product.

[Raveel Afzaal, Former Analyst]

Perfect. And then just thinking about the strategic partner, I mean, given that SWISS KRONO has commercialized with you and their revenues coming from them are still -- I mean, this is -- these are early days. I mean so the revenues coming from them are relatively small. Could we expect like a similar order value or revenues from your new strategic partner once you go commercial with them? Or would you expect the initial order volume to be higher with the strategic partner?

[Jeffrey Douglas MacDonald, CEO & Director]

Yes. Without getting into detail on the details of their launch, I would expect it to be higher. It's a different kind of launch. It's really all I can say. And then, the -- I guess, the other reminder that I'd just like to throw in because I don't think we mentioned it in the script, is that we do have a meaningful volume of ongoing business with SWISS KRONO from another operation. So again, that has proven the viability of our product and that is commercially successful for us when it's adopted.

[Operator]

[Operator Instructions] We have a followup question from Raveel Azfaal.

[Raveel Afzaal, Former Analyst]

Just a couple more questions. Then on the personal care line, once a customer decides to want to go commercial with you, how much time before that would they start ordering volumes from you because initially we said that with the personal care line, it was launched in mid-2019, it takes 12 to 18 months to get that product line out, commercialized? We are getting close to the 12-month mark. If someone wants to get -- go commercial right now, would they start ordering volumes from you now, excluding COVID-19? Or how should we be thinking about that?

[Jeffrey Douglas MacDonald, CEO & Director]

We don't have a lot of insight into how the personal care brands are being affected in terms of product launches due to COVID-19. It's a few steps removed from us in the value chain. So we rely on our partner, and they've continued in earnest with their commercial activities in the geographies where they've already launched. Where they've been hampered a bit is where new formulation work is needed to convert new customers because their laboratories have simply been closed for 6 weeks now. But to your question, what we would expect is that when a brand owner has decided to use our partners' ingredient, that they would begin placing orders to that partner for volume commitments. What we're seeing so far is, I guess, very similar to what we would see from SWISS KRONO on the particleboard side. They continue to place regular orders in order to seed the market, and that's continued right through to this month. Actually, we've had another good signal from them in that regard.

[Raveel Afzaal, Former Analyst]

Got it. Perfect. And then just finally, your product -- your manufacturing costs on the paper side were down. Was that just a function of the input cost?

[Jeffrey Douglas MacDonald, CEO & Director]

Yes. It was the input cost, but also input costs related to product mix. So we were successful in putting out a lower cost grade of our product towards the end of last year, which was picked up and adopted by one customer early in the year, so that has a part of impact on it. Rob, do you want to touch on the corn impact?

[Robert Martin Haire, CFO & Corporate Secretary]

Yes. The only thing I would add Raveel is with lower, obviously, crude oil environment we are also seeing that impact on the -- on -- that impact move over to the corn market. So over the last month or so here, we have seen a significant drop of around 20% on the per-bushel cost of corn, moving from what we saw last year, the average around $4 to recently the lowest $3 per bushel. So we are also starting to see some lower input costs there that we should see it -- being able to use those savings to quite frankly negate some of the impact of the pricing pressure from having lower SB latex pricing and resulting in lower average selling prices for our product to some of our paper accounts.

[Raveel Afzaal, Former Analyst]

Perfect. And you wouldn't have seen any major issues on your supply chains. Or if you did, I'm guessing they are probably getting normalized now. Any comments on how your supply chain is looking?

[Jeffrey Douglas MacDonald, CEO & Director]

We haven't seen any significant impacts in our supply chain. There've been -- there's been some schedule management by our manufacturing partners, but we've been able to manage that well to be able to support our customers. I guess one phenomenon that many industries are probably seeing is just the container traffic volume that would normally be flowing from the Far East to Western Europe and North America and then back again has put some constraint on containers. We've had to scramble a little bit to get the right shipping tools in place to get our product to where it needs to be. But again, we've been able to do that without a hiccup to our customers.

[Raveel Afzaal, Former Analyst]

Perfect. And finally, just on acquisitions. Given your sizable balance sheet and COVID 19, I'm wondering whether there are more opportunities now to acquire some of your smaller competitors in different niches. Any view on your acquisition pipeline will be helpful.

[Jeffrey Douglas MacDonald, CEO & Director]

It's fun to think about at these depressed prices, and we do think about it every week, and we are looking as we have been. But I would say that the availability of companies to actually be purchased at these low prices is questionable, and then the ability to get in and do any kind of due diligence would be kind of difficult as well. But I think more importantly, we're focused on these 3 pillars that we have to make good on. Keeping the business moving in a tough time and then advancing these strategic agendas is taking up our time today. And we'll continue to keep an eye on those strategic opportunities, but I'm not sure that we could actually capture the value that you might see in the stock price numbers today very effectively.

[Operator]

And there are no further questions at this time.

[Jeffrey Douglas MacDonald, CEO & Director]

Okay. We'd like to thank everyone for joining us today, and we look forward to updating you again quite soon.

[Operator]

Thank you for participating in today's conference. This concludes today's call. You may disconnect at this time.