EcoSynthetix Inc

TSX:ECO

Earnings Call Transcript 2022-Q2

[Operator]

Good day, ladies and gentlemen, thank you for standing by. Welcome to the EcoSynthetix 2022 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 February 24, 2022, which will be posted on SEDAR. This morning's call is being recorded on Tuesday, August 9, 2022, 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.

[Jeff MacDonald, executive]

Thank you. Good morning, and thank you all for joining us today. Yesterday afternoon, we released our 2022 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.

Our Q3 results were a continuation of the trend we saw in Q1 with $4.2 million of revenue in Q2, the same as Q1 and down 15% compared to the same period in 2021. Our strategy of diversification beyond traditional graphic paper and expanding with greater contributions from our other applications like wood composites, personal care and wet-end paper is working. The diversification is helping to make up for lost ground in graphic paper with wood composites and the wet-end applications poised to be the primary drivers of our top line growth.

Our Q2 results reflect 2 major headwinds, which we have mentioned previously: One, a $600,000 headwind from a graphic paper mill closure in Q3 of last year. And 2, raw material availability and logistics constraints, which we believe resulted in a $500,000 to $1 million headwind on net sales in Q2.

On the supply chain constraints, we continue to experience puts and takes in the market. We have received material volumes of supply from regions that we did not expect, but we've also not received supply from vendors that have historically been quite dependable. All in all, at present, we are a little ahead of where we expected to be as we exited Q2.

And for the first time since March, we are starting to see positive signs that the availability of corn and starch might be loosening. The price of corn has come off its historic highs recently. And in July we received our full contracted allocation from an important supplier for the first time in months.

We still expect the supply constraints to persist, which could have an upward pressure on starch pricing, but we're optimistic that the constraints may be improving, which would open up new growth opportunities, which I'll address in a moment.

On the wood composites front, a key account continues to demonstrate strategic and commercial progress with our DuraBind resin. We are seeing positive momentum and engagement from them as they remain committed to reducing their carbon footprint and see our bio-based resins as one of the important steps they can take in that journey. We expect to see a continued ramp up through the second half of the year with the potential for them to expand the usage of our binder on the first commercial line we have with them.

Our ability to ramp with them on that first line and expand across other lines they operate and into other suppliers they use is a key component of our growth strategy. During the quarter, SWISS KRONO, our first commercial wood composites account, continued their work with us to expand to new locations. We did see volumes decline as a result of changes they made to one line.

We are working progressively together with them on a resin formulation and a process, which enables us to reestablish the full benefit from DuraBind at that line. On the particle board side, they are engaged and committed to further change supporting the commercial launch of their BE.YOND particle board. Their successes are more niche in nature at present, but they continue to believe in the commercial upside of the most environmentally friendly particle board available that delivers the highest indoor air quality.

In terms of new opportunities, the sustainable characteristics of our biopolymer platform received more recognition during the quarter. The Corporate Knights organization named EcoSynthetix, one of the best 50 corporate citizens in Canada. They're ranking places emphasis on both the ESG performance of a company's operations and the environmental impact of its core products. Of the more than 350 organizations in Canada that it measured, we ranked 20th overall, which is a great achievement considering some of the larger organizations we were up against. This recognition follows on the EcoVadis Platinum rating we achieved earlier this year.

Our biopolymer platform helps manufacturers address the carbon footprint needs and demands of retailers and consumers. We delivered meaningful carbon footprint reductions across each of our 3 core markets. As a result, we expect to be a carbon positive company in 2022, which is defined as exceeding a one-to-one carbon cover of the carbon emissions associated with our business compared to the carbon footprint reductions by customers that we enable through their use of our products.

The sustainable all natural benefits of our platform are the key reason behind our momentum in the personal care market. During Q2, our joint development and marketing partner, Dow, a global personal care and home product leader, announced their exclusive agreement with us for MaizeCare in the hairstyling market. They are commitment to greening their product line, which is very important to them and their public announcements reflect the optimism from both sides of the relationship that they are beginning to see some application wins and a solid pipeline going forward.

We are seeing some small application wins, individual products that have switched over to Dow's all-natural offering from conventional petro-based chemistries and new products that are getting started in the market for the first time that have chosen to start with formulations that use our biopolymer.

We expect to see some top line contributions from these applications and in a small way already, they're part of the reason for the improved product mix. The legacy graphic paper market continues to experience a deterioration in demand. This pressure, along with raw material and logistics constraints were the primary headwinds to the top line in the quarter.

Our existing accounts continue to use EcoSphere and appear to be holding their own in a challenging market. The price of oil and the conventional petro-based paper binder we replace, SB latex continued to be elevated during the quarter, which helps improve our value proposition. As a result, this dynamic contributed a positive impact to our higher average selling prices, which helped to partially offset the decline in volumes.

The more exciting area of the paper market for us today is in the wet-end application, where our binders are used as strength aids in the early formation of the fiber mix in paper making. This application has potential across a range of opportunities, which include paper, paperboard, corrugated and tissue. We are commercial in this application today and are seeing great results with additional prospects that are trialing our binder, in some cases, remarkable results.

As an example, in a trial with one prospect, they were unable to run the line for a specific product category with the necessary quality and economics. After they added our binder, they were able to produce the product line and achieve their targets. That's a promising result. We are yielding positive results like this across multiple prospects. This is one of the areas where the availability of raw material encumbered growth.

These prospects are on high-volume manufacturing processes. Once we go commercial with an account, they depend on us to maintain a consistent and stable supply. Until we have better visibility on the availability of raw material, we are working patiently with these prospects. While it is still early, we are optimistic based on the signals we're seeing in corn and starch supply that we could engage a key prospect commercially before the end of the year, which would represent a significant boost to volumes.

Our diversification strategy is working. The contributions from our wood composites and wet-end applications are poised for additional growth. The personal care applications with our partner, Dow are beginning to shape up nicely. The current macro conditions with graphic paper demand and raw material and logistics constraints continue to be challenging. However, the progress and momentum we are building with our bio-based platform that delivers material green benefits and value for our customers set the stage for sustainable growth.

And with that, I'll turn it over to Rob to review the financials. Rob.

[Robert Haire, executive]

Thanks, Jeff, and good morning. Net sales were $4.2 million in Q2 2022, down 15% or $730,000 compared to the same period in 2021. Net sales were in line with our Q1 results. The change in net sales was due to lower volumes, which reduced sales $2.1 million or 43%, which was partially offset by higher average selling price and an improved product mix, which increased sales of $1.4 million or 28%.

As Jeff mentioned, supply chain constraints in raw materials and logistics impacted sales. We believe this issue resulted in loss revenue opportunity in the range of $500,000 to $1 million in the quarter. The decrease in volumes was also impacted by a $600,000 headwind from a graphic paper mill closure announced in Q3 2021.

The pricing dynamics of petrol-based chemicals we compete with created pricing tailwinds for us, which allowed us to implement pricing actions to offset cost escalations and improve our margin profile. Gross profit was $1.1 million in the quarter, unchanged from the prior year period. Higher average selling price and improved product mix were offset by decreases in sales volumes and higher manufacturing costs.

Net of manufacturing depreciation, gross profit as a percentage of sales was 30.8% in the quarter compared to 26.3% for the same period in 2021. SG&A expenses were $1.4 million in the quarter, an increase of $80,000 compared to the same period in 2021. The change is primarily due to higher operating costs of $300,000, including lower payments received on to a government funding CEWS program, foreign exchange loss and increased discretionary spend.

These headwinds were partially offset by a reduction in the provision for variable compensation of $200,000. R&D expenses were $500,000 in the quarter, in line with the $150,000 from the same period in 2021. R&D expense as a percentage of sales was 12% in the quarter compared to 11% in the same period in 2021.

We continue to invest in innovation to improve our value proposition and expand our addressable market opportunities. Adjusted EBITDA loss was $230,000 in the quarter compared to a loss of $180,000 in the same period in 2021. The change was primarily due to higher operating costs, which were offset by higher gross profit and improved product mix. Cash provided by operating activities increased to $80,000 in the quarter, an improvement of $310,000 compared to the cash used in operating activities of $200,000 in the same period in 2021. The change was primarily due to changes in working capital.

As of June 30, we had $39.4 million in cash and term deposits compared to $42.2 million as of December 31, 2021. We invested $400,000 in NCIB share backs during the quarter, bringing the year-to-date investment in 2022 to $1 million. We have demonstrated our ability to responsibly manage our cash reserves through multiple cycles while continuing to invest in our long-term growth strategy.

With that, I'll turn it back to Jeff for closing comments.

[Jeff MacDonald, executive]

Thanks, Rob. In the face of the serious geopolitical and economic challenges in the current market, sustainability remains a major theme. Manufacturers, retailers and consumers are searching for alternatives that can make a difference. Our biopolymer platform has proven its capabilities across multiple applications in large-scale manufacturing processes. Change can be difficult. It can take longer than expected.

We have built a platform that gives us multiple shots on goal in markets that are billion-dollar opportunities, a platform that delivers material green benefits and performance benefits to our customers. We are managing the current supply chain constraints and setting the stage for future growth in wood composites and wet-end paper applications and in personal care.

We are working with major manufacturers and partners that recognize the benefits of driving further implementation and adoption across new lines. We're in a great position to deliver long-term sustainable growth. We appreciate the trust and 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] And we will take our first question from Meaghen Annett with TD Securities.

[Meaghen Annett, analyst]

First off, can you maybe talk a bit more about the availability of corn starch and the improvement you're seeing there? So you saw some receipts in July. You sound quite optimistic for a new wet-end prospect. Just want to understand how you're positioned to drive the top line in the back half of this year? And what kind of revenue run rate we could be looking at if you do get the starch that you need?

[Jeff MacDonald, executive]

So I think by far, the most practical and important indicator we saw was that a major supplier came back online fully for us in July after several months of not supplying. I mean, we're otherwise looking at the same things probably the whole world that's looking at, corn is looking at. We're looking at the shipments that are beginning to happen out of the Ukraine now.

We're looking at the corn futures market softening over the past couple of months. And we're looking at signals in the starch market like the practical thing I just mentioned. So those are the signals that we are looking for. In order to have the growth that we can realize in the back half of the year, it does require those major suppliers to continue to be able to supply for us in the way that they did in July. And for some of the additional supply we've had out of some of the newer regions we've developed that are affected by the conflict. And with that, I mean, we have orders in hand that would allow us to generate some pretty substantial growth in the second half, probably not getting us all the way to the targets we would have set at the beginning of the year, but it has the potential to get us pretty close to that.

[Meaghen Annett, analyst]

Maybe if you could just give us your thoughts on how volumes are trending Q3 to date, perhaps? Should we expect to see some supply chain challenges reflected in those numbers and then potentially an acceleration in Q4?

[Jeff MacDonald, executive]

Yes. Certainly, there's still some continued impact of supply chain challenges, but what we did receive from that major supplier definitely helped. Yes, I would say as important as starch supply right now or just some of the logistics constraints, it's actually still very tough getting product moved into us and getting it moved out on a timely and predictable basis. So we're hopeful that, that begins to ease as well.

We've seen some of the transportation logistics numbers begin to fall off pretty rapidly just in the last few weeks, and we're hoping that, that bodes well for the availability of logistics and the cost of logistics. So that's been a bit of a double whammy for us. We actually see signs that both are easing. Yes, Q3 is off to a better start for us. I'll just say that. And we're optimistic that we can continue to build some input starch and get some of these new opportunities in the wet-end served the way that we need to.

[Meaghen Annett, analyst]

And just last question on the gross margins. You're seeing some nice improvement there. So what do you see as a run rate for that -- for the business throughout this year? And do you see any major mix shift in revenue that could bring that back down or anything on the cost side that we should be thinking about?

[Jeff MacDonald, executive]

We're thinking that the mix should probably remain similar and healthy to what we've been seeing. That's -- I mean, that is the great news here is that there's a lot of our diversification efforts showing up underneath what is a pretty flat number otherwise. If we see pressures on the margin side, it's going to be due to cost.

And I think one thing we've said is we're not going to compromise the growth. So we are out there every day looking for starch that is available. And if we have to pay a premium for it to secure some of these growth opportunities in the short-term, we'll do that. That could result in some margin pressure. But there's nothing there yet that's certain enough to say it's going to have a material impact on margin, but that is -- that's the one thing we are watching.

[Operator]

[Operator Instructions] And we will take our next question from Daniel Marks with Stonehouse Capital.

[Daniel Marks;Stonehouse Capital;Analyst, analyst]

You mentioned a couple of the difficulties in the quarter being $600,000 of year-over-year business loss as well as the $0.5 million to $1 million due to supply constraints. Are those numbers additive? If you did not have supply constraints, you still would have not been able to achieve the $600,000 from the paper customer. So should we add those together, or are those different types of starches that impacted things or give us a little more flavor on that?

[Jeff MacDonald, executive]

Well, there are definitely different types of starches that would serve some of our new growth opportunities, and there are also different geographies, which is pretty important to us right now as well. So that was -- that account was lost in the North American geography with probably the most vanilla, I would say, of our products, whereas what we're looking at in Europe as the missed growth opportunities is in some of our newer products, which require, in some cases, a different starch and different manufacturing processes. So they are additive though, when we talk about the volume shortfall that we had, they're additive in that sense, but they're not -- where I think your question was going, they're not sort of a one-to-one replacement for each other.

[Daniel Marks;Stonehouse Capital;Analyst, analyst]

With that in mind, I find it unusual that your raw material inventory went from basically $1 million to $1.5 million quarter-over-quarter. Why would that be if you're having such a hard time getting corn starch?

[Jeff MacDonald, executive]

So part of it is the pricing of those raw materials. And part of it is because of where we're sourcing some raw materials and then where they end up having to be processed, there's more material tourism today than we've ever seen before, just trying to get starch from wherever we can get it and then process it at the right place. So those are some of the impacts. Rob, anything to add to that?

[Robert Haire, executive]

Yes, no. Dan, it is primarily the geographic issue and the product mix issue that's playing into that. And like Jeff said, the increased cost of that inventory.

[Daniel Marks;Stonehouse Capital;Analyst, analyst]

Last question. Obviously I heard what you said in terms of you aren't starting customers in the wet-end until you can ensure their supply. You don't want to get them going and then stall them out, which makes perfect business sense. Given that, are you able to get enough starch to get more guys trialing? Can you give us an idea of how many companies are in a commercial level, how many are at the trial level now?

And if as and when corn starch supply is freed up, what sort of time line could we be looking at where those trials could turn into commercial accounts? And sort of just give us a better idea of what that wet-end opportunity could lead to? Obviously, you mentioned one that could be coming online by end of year, but give us a little more flavor on that? And in particular, if you could give us numbers of companies that are trialing?

[Jeff MacDonald, executive]

Yes. So let's start with what's commercial already. We can point to clear and sustained success that the product is working in applications. So we have 2 tissue mills, which are lower volume users of our strength aids products. They've been going concerns now for a few quarters. We have a large packaging customer that's gone all the way to the end of their trialing and commercial evaluation process to the point where they represent a significant part of that shortfall that we talked about within Q2. They're ready to go as soon as we're ready to go. And as soon as that happens, they become a significant uptick to our volumes.

And we do believe that we're going to be able to get that going during the second half of the year. Again, depending on the starch outlook that we're seeing right now coming through, which is still a question mark, but it looks like we're going to be able to get them going. Beyond that, we've gone through trials with, I'm going to say, 8 different accounts in earnest at various stages from lab to, I'll say, the first of their large production line trials. And they represent a mix of everything from a few more small tissue opportunities, the graphic paper opportunity, more packaging, and they represent a more diversified geography than where we got our existing -- where we got our starch with the existing customers.

So I guess to the first part of your question, our ability to trial more was constrained by materials. So we were careful in our allocation to people who we don't believe are just kicking tires because it really was in short supply. But we were able to get enough trial material to get serious candidates moving and to be ready for what we hope will be in late this year, early next year in terms of getting them started commercially.

[Daniel Marks;Stonehouse Capital;Analyst, analyst]

Did I hear you correct that the one account that you have that's gone all the way through their trials and is ready to go was a substantial part of the $500 million to $1 million -- $500,000 to $1 million of loss revenue?

[Jeff MacDonald, executive]

Yes. And when we -- I guess, just to put that in the right perspective for you, for everybody, that's not us saying, "Oh, we could have had $0.5 million to $1 million more." Those are real customer commitments. So from that customer specifically in order to show their seriousness and to keep their place -- first place in line, they placed significant purchase orders for us or with us. So I just -- I wanted to just provide some clarity on where that number came from. It's not just us saying we think we loss that much. There's real demand there that we were unable to satisfy due to material and logistics.

[Daniel Marks;Stonehouse Capital;Analyst, analyst]

And so that would be I guess, not deferred revenue that you expect to double that number in the next quarter when you're actually able to fill it, that's sort of like a run rate, if you would, of $1 million to $2 million a year kind of -- or $2 million to $4 million -- I guess that would be $2 million to $4 million a year of demand?

[Jeff MacDonald, executive]

And that's right. It's not a deferral where it becomes double. It's just -- it's a delay in getting started.

[Operator]

And we take our next question from Gerry Wimmer with Investorfile. It appears Mr. Wimmer has drawn his question back. [Operator Instructions] And we have a question from Brian McIntyre with TD Wealth.

[Brian McIntyre;TD Wealth;Portfolio Manager, analyst]

I was talking to [ Glenn ] this morning, and he had asked about the trajectory on the $100 million top line and really related to the prior discussion of a 3 to 5 year window to get to that level was pre the discussion on the wet-end opportunity. So I don't know if you can give any sort of color to how that balances with supply issues, whether that trajectory is intact or shorter?

[Jeff MacDonald, executive]

And you guys are right. That target we set prior to understanding really what we had with the wet-end opportunity. And if you recall, when we broke down our components of the $100 million goal, we expected paper in different forms to sort of hold its own at kind of the $20 million range within the $100 million. But we certainly see now and believe and we feel like we're on the trajectory to realize quite a bit more than that through the wet-end opportunity.

I still believe that this could be more faster than wood. I believe, wood is more proven in its industrial application, and therefore, I continue to sort of put it at the head of the line. But with what we're seeing in wet-end applications and how fast the adoption can happen there relative to wood lines, we think this can have a significant impact.

What I would say about the $100 million goal is certainly the first 2 quarters of this year. We're disappointing for us for all the reasons that we've discussed. And I mean, that's a bit of a setback in whatever time line we think about the $100 million in. We're still thinking about it though within that 3- to 5-year timeframe and we're more than a year into having set that goal.

We believe that the wet-end opportunity can help us make up for some of that lost time and provide quite a bit of upside to it if what we're seeing pans out into the multiple line opportunities that we see in front of us. Does that put in the context you're looking for?

[Brian McIntyre;TD Wealth;Portfolio Manager, analyst]

Yes, it does.

[Operator]

And as we have no further questions, I would like to turn the call back over to Jeff MacDonald for any additional or closing remarks.

[Jeff MacDonald, executive]

Yes, I'd just like to thank everyone for joining us again today, and we'll be in touch again quite soon.

[Operator]

Thank you. And that will conclude today's conference call. Thank you for your participation. You may now disconnect.