EcoSynthetix Inc

TSX:ECO

Earnings Call Transcript 2020-Q2

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the EcoSynthetix 2020 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 2, 2020, posted on SEDAR. This morning's call is being recorded on Thursday, July 30, 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]

Good morning and thank you for joining us today. Yesterday afternoon, we released our 2020 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.The macroeconomic changes in the paper market are reflected in our sales in the second quarter. The majority of our sales continue to be derived from our EcoSphere binder in the paper and paperboard markets. Coated freesheet paper, used for graphic and writing paper, experienced North American shipment declines of 43% in the quarter compared to the same period last year. That result is in line with our reported sales of $3.1 million, down 39% compared to the same period last year.The level of resiliency in the paper market remains uncertain. Industry reports are mixed on how demand will return once the recovery takes hold and whether the pandemic has set the stage for a structural change in the market. In the interim, paper producers took action with no closures and consolidation of production. The price of the binder we replaced, SB latex, is trading at historic lows.We are focused on retaining our existing commercial accounts and maintaining margins as best possible in the current environment. We saw some pressure on margins in the quarter, but this was partially offset by lower costs of manufacturing, including lower costs from the price of corn. As it relates to our customers, none of the mills where we are active have closed. All of the mills that were buying from us at this time last year continue to do so, albeit at lower volumes in line with demand.We've been preparing for this structural decline in paper with a diversification strategy beyond graphic paper. The pandemic has simply accelerated the need for change. We have projects underway in paper packaging and barrier applications where the demand for green ingredients shapes up well for our EcoSphere binder.These projects address niche markets relative to the broader paper market and development work is still required. But paperboard applications will remain a part of our product portfolio. Our prospects in these areas are engaged and providing production time on their lines to further development. These specialty applications are growth markets for manufacturers and they're hungry for healthier alternatives, like our EcoSphere.Beyond the paperboard market, the wood composites and personal care applications are the key drivers of our diversification strategy. On the wood composites front our first major customer, SWISS KRONO, continues to invest in the marketing of their BE.YOND particleboard as a key priority for their business. They view driving the commercial success of their [ non- ] added formaldehyde particleboard as a greenfield opportunity. As a first mover in the market, they are approximately 1 year into the launch of the product and sales are limited. But the team at SWISS KRONO is highly engaged. They have positioned the business to address demand with the healthiest particleboard on the market.Our other key strategic prospect in the wood composites market continues to make progress with us. Due to confidentiality, we cannot provide specific updates on our progress to date. As a leader in their industry for bringing new products to market, we could not be happier with how the relationship has evolved and the opportunity in front of us at this stage. It represents a 5-year relationship, which demonstrates the level of commitment on the part of the prospect. They are a great partner that has remained engaged across multiple contacts within their organization. There is a strong desire to bring a new solution to market and they've continued along that path, even in this difficult period during the pandemic. Anything that can be done has been done, with a great deal of commitment from their side.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.On the personal care front, we signed an exclusive development, marketing and distribution agreement last year for our biopolymer with a leading global chemical company with a large presence in this space. 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 ingredient and the formulation work have recently been recognized on a global basis, with an award win for green ingredients in the Asia market. 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. The hair fixative application targets an approximately $350 million addressable global market for our ingredient. Given the scale and the 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 the space. Their objective is to be a market leader, which would make it a significant growth driver for our business.The personal care application is another example of the flexibility of our biopolymer technology. Our multiple-shots-on-goal product strategy addresses large markets. Our approach and our story have not changed. Paper demand was expected to decline. It has simply happened faster than anticipated with the onset of the pandemic. We've been preparing to diversify beyond paper for more than 5 years. The relationships we have established with our key customers, like SWISS KRONO, and the key strategic prospect in wood composites as well as the global chemical company in the personal care market, put us in a strong position to manage the pressures in the paper market.Despite the headwinds in the paper market, we remain essentially breakeven on cash from operations. One new account win would push us across to profitability on a consistent basis. This fact demonstrates the discipline in how we have approached our cost structure, rightsizing the business over the course of the past 2 years.From an operational perspective, I'm incredibly proud of how the team has performed through the most challenging period of our professional careers. We've managed to continue the key aspects of our development work in the lab. We have maintained a high level of service with our customer support group. And we have retained a high level of engagement with our key prospects and partners.The pandemic has shone a light on the health and lifestyle choices we make as a society. As a green ingredients company we are positioned to benefit from the long-term trends in consumer behavior as manufacturers adapt their products and processes to meet demand for healthier alternatives.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 $3.1 million in Q2 2020 compared to $5.1 million in the same period in 2019. This 39% decrease was primarily due to lower volumes, which impacted sales by $1.7 million, or 34%. Lower average selling price also impacted sales by $300,000, or 5%. The decrease is primarily due to the unfavorable market conditions brought on by the COVID-19 pandemic, which reduced the global demand for paper products and created adverse market pricing dynamics.Gross profit was $500,000 in the quarter, down 50% compared to the same period in 2019. This change was primarily due to the lower volumes and lower average selling prices, partially offset by lower manufacturing costs.Net of manufacturing depreciation, gross profit as a percentage of sales was 23.6% in the quarter compared to 24.8% in the same period in 2019. The change was primarily due to lower average selling prices that I mentioned earlier partially offset by lower manufacturing costs.SG&A expenses were $900,000 in the quarter compared to $1.1 million in 2019. This 23% change was primarily due to $100,000 in payments received under the Canadian wage subsidy program and lower discretionary spend.R&D expenses were $440,000 in the quarter compared to $380,000 in the same period in 2019. R&D expenses as a percentage of sales was 14% for the quarter compared to 8% 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 $240,000 for the quarter compared to a nominal gain in the same period in 2019.As of June 30, 2020, we had $42.3 million in cash and short-term investments compared to $43.7 million as of December 31, 2019. We've invested $1.5 million in the normal course issuer bid during the first 6 months of the year, including $1 million during Q2. We have acquired and cancelled approximately 1.1 million common shares at an average cost of CAD 1.84 per share year-to-date.We will continue to be disciplined in our approach to cost management. We're confident that our current investment level and our level of cash reserve are each sufficient to deliver significant growth.With that, I'll turn it back to Jeff for closing comments.

[Jeffrey Douglas MacDonald, CEO & Director]

Thanks, Rob.As you just heard, despite the significant headwinds we faced in the paper market during the quarter, our bottom line results have shown remarkable durability. The cash used year to date was essentially entirely related to the normal course issuer bid.We have positioned the business for success with a product diversification strategy beyond the paper market. 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.While the paper market remains under pressure, we do not expect to experience growth in the near term, but we have clearly demonstrated an ability to manage the business with a focus on cash flow breakeven even in these difficult times. 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 appreciate the trust and the patience that our shareholders have shown and I'll look forward to updating you further on our progress.With that, I'll turn it back to the operator to open up the call for questions. Thank you.

[Operator]

[Operator Instructions] There are no questions at this time. I'd like to turn the call back over to Jeff.

[Jeffrey Douglas MacDonald, CEO & Director]

Thanks, operator, and thanks everyone for joining us today. Stay safe and healthy and we'll talk to you again soon.

[Operator]

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