EcoSynthetix Inc

TSX:ECO

Earnings Call Transcript 2019-Q2

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the EcoSynthetix 2019 Second 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, August 1, 2019, at 8:30 a.m. Eastern Standard Time.I would now like to turn the call over to Mr. Jeff MacDonald, Chief Executive Officer of EcoSynthetix. Please go ahead, sir.

[Jeffrey D. MacDonald, CEO & Director]

Thank you. Good morning, and thank you all for joining us today.Yesterday afternoon, we released our 2019 second 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.We made significant progress on a number of fronts during the quarter, which I'll outline in a moment. The business is positioned to begin harvesting the investments that we have made in wood composites. We're also encouraged by the early enthusiasm around some of the smaller bets we have made in new markets, such as the personal care space, which I will address shortly. However, the paper and paperboard business, where we generate the majority of our revenue today, continues to be impacted by a challenging macro environment. Paper manufacturers continue to endure softer demand. Coated freesheet paper demand worldwide was down 12% year-over-year in June 2019. And we felt the impact of that decline on our top line numbers. Our net sales were $5.1 million in Q2, which is down 12% on a quarterly basis and 15% on a year-to-date basis compared to the same period last year.Looking at the pricing dynamics for paper binders on Slide 4. The pricing of SB latex was down 15% from June 2018 to June 2019. As an alternative to SB latex, our EcoSphere binder maintains a cost-competitive profile, but the value proposition has narrowed during the past 12 months. We've been disciplined in our pricing strategy and managed to retain our overall pricing position on a relative basis despite these pressures.Our paper and paperboard customers recognized the benefits of EcoSphere. Our account base consists of some of the leading players in the industry. In our view, it's a stable core business with durable revenue. However, with the price of SB latex softening, new customer wins in the current environment are challenging. Despite these macro challenges on the paper side, we're very pleased with the progress we've made in the quarter, both from a financial perspective and on the wood composites front. The decisions we made to rightsize the business during the past 2 years are having a significant impact on our bottom line.As you can see on Slide 5, adjusted EBITDA was on the positive side of the ledger at $26,000 for Q2 compared to a loss of $479,000 last year. Cash from operations also improved to $220,000 in Q2 2019. On a year-to-date basis, cash from operations was $170,000 compared to cash used in operations of $2.2 million in the same period last year. And for the first time in our history, we recorded positive cash flow from operations on a trailing 12-month basis. As a result, we believe we are in a strong position to deliver on our commitment of profitability for fiscal 2019.Why are we confident? The progress we're seeing from the wood composites market is the primary reason. We attended the interzum furniture and LIGNA wood exhibitions in Europe in late May. As a backdrop to these exhibitions, Germany officially scheduled the implementation of the new regulations that I mentioned on our last call, for January 1, 2020, with a new E 0.5 requirement for all products sold in Germany. The industry expects that Europe will align with the German levels and move to a half step reduction in emission levels soon.One of the key points on the minds of visitors to LIGNA were these emission reductions, and it resulted in a level of urgency in the discussions during the show. When manufacturers consider the cost and productivity impact of moving to lower-emitting formaldehyde resins, they usually also consider whether the timing is right to move all the way to NAF. This dynamic is one of the reasons LIGNA was so well-timed from our perspective.At the interzum exhibition, the first NAF furniture was on display by an innovative European furniture manufacturer, using particleboard manufactured by SWISS KRONO, our customer and the top 10 particleboard manufacturer worldwide. This was an important milestone. A significant challenge to broad-based manufacturing of NAF panels, in our view, was the execution of potential panel suppliers. SWISS KRONO has eliminated that concern with their commitment and execution on successful industrial validation and strong marketing. SWISS KRONO continues to invest in marketing activities around the launch of its BE.YOND product line.It is positioning the BE.YOND furniture panel as the most environmentally friendly board of its kind on the market with an emission level equivalent to trees. This launch is enabled by our DuraBind resin. SWISS KRONO is leading the industry by offering a healthier particleboard alternative to conventional products that use formaldehyde-based resins It is a movement that started with IKEA and their desire to offer customers NAF furniture solutions. IKEA continues to be very engaged on their own no-added formaldehyde agenda.We had a very successful show at LIGNA with the momentum generated by the BE.YOND product launch and the NAF furniture on display. The LIGNA show and SWISS KRONO's activities represent the strongest proactive panel launch that I've seen in my time in the industry, and probably since Columbia Forest Products launched an NAF plywood some time ago. Pricing in the pMDI market remains favorable for further penetration in the particleboard market. pMDI and DuraBind work together as a binding solution to replace conventional formaldehyde-based resins. The outlook for pMDI pricing is expected to be stable and flat through the remainder of the year, which is positive for successful conversions.The momentum we are seeing from the LIGNA conference, the pull from retailers like IKEA, pMDI pricing dynamics and new legislation are generating a significant level of renewed interest in our DuraBind offering. We are engaged with new manufacturers as well as manufacturers that were qualified at the production stage, but did not move to the commercial stage due to the higher pMDI pricing levels experienced last year. These manufacturers recognize that retailers are asking for it, their competition is using it and the regulators continue to increase the emission level thresholds.Successfully penetrating the wood composites binder market remains our #1 priority. At the same time, we're vigilant in our efforts to support our existing paper and paperboard customers, which despite the current challenging market dynamics provide an established base business. We're also looking to the future by making small bets in other markets that use polymers like personal care. During Q2, our biopolymer products for the personal care space were launched together with a leading player in the personal care market under exclusive marketing and development agreements.The flexibility of our platform technology and its unique all-natural profile has benefits across a wide range of applications. It brings to mind the 3-legged stool analogy. We have one established, the challenged, leg in paper and paperboard, a second new leg planting itself in wood composites and a third important leg beginning to emerge in personal care.With that, I'll turn the call over to Rob to review the financial highlights. Rob?

[Robert Martin Haire, CFO & Corporate Secretary]

Thanks, Jeff, and good morning. From a top line perspective, net sales were $5.1 million in Q2 2019 compared to $5.8 million in the same period in 2018. This 12% decrease was primarily due to lower sales volume of $500,000 or 9% as well as lower average selling prices, which impacted sales by $200,000 or 3%.Volumes were impacted by $400,000 due to the loss of business at a paper mill, which was announced in Q1. Gross profit was $1 million in the quarter, down 14% compared to the same period in 2018. This change was primarily due to the lower sales volumes.Net of manufacturing depreciation, gross profit as a percentage of sales was 24.8% in the quarter compared to 23.9% in the same period of 2018. The increase is primarily due to lower manufacturing costs, which were partially offset by lower average selling prices. Adjusted EBITDA was $26,000 for the quarter, an improvement of 105% compared to a loss of $479,000 in the same period in 2018. The improvement was primarily due to lower operating expenses.We will continue to be disciplined in our approach to cost management. SG&A expenses were $1.1 million in the quarter compared to $1.6 million in the same period in 2018, a decrease of $500,000. The decrease was primarily due to lower people-related costs, lower foreign exchange losses and lower discretionary spending. SG&A includes share-based compensation expense. Excluding this item, SG&A was $1 million in the quarter compared to $1.5 million in the same period in 2018.R&D expenses were $385,000 in the quarter compared to $526,000 in the same period in 2018. The changes were primarily due to higher government grants and lower rent expense. 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 June 30, 2019, we had $44.6 million in cash and short-term investments compared to $44.8 million as of December 31, 2018. We have more than sufficient cash reserves to execute our growth strategy, and we'll remain disciplined and manage our cash responsibly while continuing 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 profitability in 2019. We have demonstrated an ability over the past 12 months to manage the headwinds in the paper and paperboard market and still generate improvements in our bottom line results.In the past, we have highlighted the opportunities that exist on the wood composites front. Today, we have reached a stage where customers and our customers' customers are delivering NAF panels and NAF furniture to end consumers. The transition is real. The change agenda is underway. We have never been in a stronger position as we're in today.We're engaged with the right strategic accounts, accounts that are differentiated and are investing resources because they have conviction in what NAF products can mean to their bottom line.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.

[Operator]

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

[Raveel Afzaal, Analyst]

Congrats on the positive EBITDA quarter. Just starting off with the personal care line. Can you speak to the economics in the personal care line? And how that might weigh compared to the economics that you guys are already realizing on the paper and the wood vertical?

[Jeffrey D. MacDonald, CEO & Director]

Raveel, thanks for the positive words, and specifically on the personal care front. I'll just start by saying, we're really, really excited about this space and the partner that we're working with there. We've been working extremely well together. But it's still very early days for both of us. So really projecting an outcome from it, I think, would be premature for both our partner and for us. What we can say though is that the dynamic on the margin side is quite attractive. This is a high-value space. We have a polymer that fits in to deliver high value within a high-value space. The performance attributes that our partner is seeing are very, very encouraging. And so while an expectation on demand and uptake of the product at this point is still premature, if and when that does happen, it's a really attractive product for us from a margin perspective.

[Raveel Afzaal, Analyst]

Got it. Yes. I completely understand, it's early to seek too much about the margin profile. But can you tell us like what type of steps are needed over the next, maybe, say, 6 to 9 months, in order for you to see how the adoption rate of your product could potentially work in this market? What are some of the next steps that you or your blue-chip partner needs to do to figure out what the adoption rates would look like?

[Jeffrey D. MacDonald, CEO & Director]

So a lot of that's in their hands now. There's not a whole lot more that we need to do, although we're encouraged enough that we're already working on some next-generation products with them, and that was the reason for the development agreement that I mentioned. But the things that do need to happen, they've done their diligence over a significant period of time to prove the performance attributes, and they've developed some fantastic marketing materials around that. The sample kits that they've generated are in the hands of their customers now. The uptake from customers and the interest in the product has apparently been very, very strong. It's really a matter now of those end customers pulling the product into their formulations and having it get to the shelves. I may be making that sound a little bit too simplistic, but you can imagine that you're introducing a new ingredient to an existing product or a new product, proving that product out at a formulator, let's say, like a P&G who then needs to put that product on the shelf, that's probably a 12-month process from when they get started with the new ingredient. So we don't expect any meaningful results through the balance of this year. But I think we should -- if this is going well, we should start to see some results from early adopters sometime early to mid next year.

[Raveel Afzaal, Analyst]

Perfect. And then just with respect to IKEA, to the extent possible, can you tell us if there are any more tests that IKEA needs to do before they can make a decision on whether to go commercial with you guys or not?

[Jeffrey D. MacDonald, CEO & Director]

So a lot of that is in their hands to decide, but we believe that we've demonstrated together all the proof points needed. And I think that's further validated by SWISS KRONO being in the market today with a very similar product. We don't think there are any further industrial validation steps needed to make decisions to move forward. I will say that, since making those industrial validation steps, we've remained very engaged in discussions on where we go from here. So we hope that turns into something real in the fairly near term.

[Raveel Afzaal, Analyst]

Perfect. And then just with respect to the demand for no-added formaldehyde furniture, are there any data points that you can share with us on how the demand is coming along for these products? Or is it still too early to say?

[Jeffrey D. MacDonald, CEO & Director]

Yes. I would say, the data points I can share are anecdotal data points. So what we've seen is the first furniture to hit the market. I mean there's not really any tracking to say how much of that is -- how much of the furniture that's being sold, in this case, in the European market, is showing up as NAF. I would say it's still early days. We're working with SWISS KRONO to put product out there in the hands of their customers, and we saw the first -- the very first furniture to come of that from a customer that even got ahead of their market launch, so they get some panels and get a product to market at the interzum show. But it's encouraging that they're continuing to produce panels and get them in more customers' hands. And I think the agenda for change and the search for greener, healthier products, I would say, in particular, in Europe, has never been stronger.

[Raveel Afzaal, Analyst]

Got it. And are you guys seeing any new wood panel manufacturers working with you or ramping up the efforts with you guys as a result of SWISS KRONO and IKEA?

[Jeffrey D. MacDonald, CEO & Director]

Yes. I think in particular, SWISS KRONO, given that it is real, there are products out there, they're making such a strong marketing effort, I do believe that was a wake-up call for others. I think the legislation is also an important motivator. But we -- as I mentioned in the script, we have some customers that went pretty far with us previously that have come back alive and they're satisfying some early customer orders. We don't consider that commercial yet. But we've also had some new customers, some of which are also connected directly to furniture manufacturing that have begun to look at our products. So there's definitely several factors that are leading to us getting some renewed interest.

[Raveel Afzaal, Analyst]

Is it possible to quantify how many pilot projects you guys have going on at the moment in the wood vertical outside of IKEA and SWISS KRONO?

[Jeffrey D. MacDonald, CEO & Director]

No. We have -- we really have stopped short of identifying how many and which ones. So I'm not in a position really to talk about number of prospects in the pipeline.

[Operator]

[Operator Instructions] There are no further questions at this time. I turn the call back over to the presenters.

[Jeffrey D. MacDonald, CEO & Director]

Okay. Many thanks for joining us this morning, and look forward to updating you again very soon.

[Operator]

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