EcoSynthetix Inc

TSX:ECO

Earnings Call Transcript 2020-Q3

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the EcoSynthetix 2020 Third Quarter Results Conference Call. [Operator Instructions]Listeners are reminded that portions of today's discussion may contain forward-looking statements that affect 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, November 5, 2020 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 Douglas MacDonald, CEO & Director]

Good morning, and thank you for joining us today. Yesterday afternoon, we released our 2020 third 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 broad-based use of conventional fossil feel chemicals and the carbon footprint they leave is increasingly drawing scrutiny. The investments we have made in developing green chemistries that are more sustainable and healthier were at one stage ahead of their time, but we believe that is changing. Our 3 commercial products displace conventional fossil fuel chemistries that have been well-established in large multibillion-dollar markets. Our products offer value to manufacturers, retailers and end customers as a greener, healthier alternative with comparable or improved performance at a comparable or lower cost. These attributes form a powerful value proposition to take to market.The pace of change in industrial large-scale processes requires patience, but awareness of the consequences of fossil fuel chemistries is clearly gaining momentum. We have laid the foundation to meet this challenge in our target markets. So what does that look like specifically in today's environment? The pandemic is certainly adding to the challenges in our primary commercial market today, paper and paperboard. EcoSphere's sales into the paper and paperboard markets represents the vast majority of our revenue today. Industry reports estimate that graphic paper demand was down approximately 25% year-over-year in the third quarter. That is a significant acceleration of the mid-teen decline the market experienced in 2019. As a result, our sales were $3 million in Q3, down 25% due to volume, which is consistent with the industry reports, and 9% due to selling price.But as part of the strong foundation I mentioned earlier, the changes we have made to the business over the past 3 years have put us in a position to execute our commercial activities in the wood composites and personal care markets. Despite the demand pressures in paper, in Q3, we delivered positive $130,000 in cash from operating activities, and we reported just a $230,000 loss on adjusted EBITDA. This performance is possibly best reflected in our cash position, which stands at $42.2 million as of September 30. The cash used in the first 9 months of 2020 was essentially entirely put towards the normal course issuer bid, where we acquired and retired $1.6 million in shares.The average price of SB latex, the fossil fuel-based binder that EcoSphere displaces, was in the low $0.70 range in Q3, which is off its historic lows of earlier this year, but is still well below its normalized range of $1 or more. Our focus in the paper market is twofold: one, retaining our existing commercial accounts; and two, maintaining margins as best possible in the current environment. All of the mills that were buying from us at this time last year remained buying customers today, however, the decline in demand has impacted their volumes. We have seen pressure on margin, but as the price of SB latex firms up, it helps on that front. We continue to see growth opportunities in paper packaging and barrier coatings. The market pull for us in the packaging vertical is sustainability and the bio-based nature and biodegradability of EcoSphere. Our prospects in this area include accounts that are already active buying EcoSphere today in the conventional graphic paper category. In those instances, their familiarity and recognition of the benefits of EcoSphere give them the confidence to use it in their packaging verticals as well.As an example, we've had a recent contract renewal with one of the larger paper manufacturers. This renewal includes the ability to expand further from conventional paper into packaging materials. While the paper market remains challenging, the foundation it provides to the overall business gives us the runway to successfully execute our commercial strategies in wood composites and personal care.In the wood composites market, even in these more challenging conditions, we're very pleased that we've continued a steady march of progress with our key prospect. They remain highly engaged. The commitment of forward-thinking manufacturers and retailers to reduce VOC emissions and outperform existing regulations is reinforced in the current environment. We're very confident in the technical success of our DuraBind product, but change in large-scale industrial processes requires time. In addition to our ongoing commercial sales of DuraBind, important late-stage trials continue to run on commercial lines at scale. Comprehensive validation of the finished product containing DuraBind is conducted continuously during and after production.No one wants to move further forward commercially with our prospects more than we do here at EcoSynthetix, and we could not be more pleased with the engagement they're showing through this challenging period. Our team continues to work hard to position us for long-term success with these prospects. On the SWISS KRONO front, they continue to run commercial scale product daily using DuraBind and oriented strand board, or OSB, and they're seeding their customers with no added formaldehyde product for particleboard. They are working to gain even greater traction with their customers through this process and are investing real dollars in the marketing campaign for their BE.YOND product. They continue to be enthusiastic about the product and believe it's a differentiator for their brand with customers, and as such, it is a key priority for the business.Moving to personal care. Consumer demand for green ingredients is driving change in the personal care market today, and our all-natural biopolymer plays directly into that shift. Our joint development and marketing partner reports that engagement on application development with their existing manufacturing and brand customers is returning to a more normalized level. The impact of the pandemic has delayed some of their formulation work amongst the broader group of accounts. Based on our discussions with them, our partner remains highly engaged and confident in the opportunity for an all-natural hair fixatives. And based on their progress to date in the first market, they continue to work on formulations for new products beyond hair fixatives.Our bio-based technologies offer manufacturers, retailers and consumers a sustainable and healthier alternative to fossil fuel chemistries. Our multiple shots on goal product strategy addresses large markets. We are engaged with the right partners and prospects to deliver commercial success. Change requires patience, but we're convinced that we're on the right side of the market.With that, I'll turn it over to Rob to review the financials.

[Robert Martin Haire, CFO & Corporate Secretary]

Thanks, Jeff, and good morning.From a top line perspective, net sales were $3 million in Q3 2020 compared to $4.5 million in the same period in 2019. This 34% decrease was primarily due to lower volumes, which impacted sales by $1.1 million or 25%. Lower average selling price impacted sales by $400,000 or 9%. The decreases were primarily due to 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 $400,000 in the quarter, down 56% compared to the same period in 2019. The 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 21.7% in the quarter compared to 26.2% 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 $1.2 million in the same period in 2019. The 22% decrease was primarily due to a $200,000 payment received under the Canada Emergency Wage Subsidy Program. R&D expenses were $330,000 in the quarter compared to $440,000 in the same period of 2019. R&D expense as a percentage of sales was 11% for the quarter compared to 10% last year. R&D efforts continue to focus on further enhancing value for our existing product lines and expanding our addressable opportunities.Adjusted EBITDA loss was $230,000 for the quarter compared to a nominal loss in the same period in 2019. As of September 30, we had $42.2 million in cash in short-term investments compared to $43.7 million at year-end. As Jeff mentioned, we invested $1.6 million in the normal course issuer bid during the first 9 months of the year. Year-to-date through October, we have acquired and canceled more than 1.4 million common shares at an average cost of CAD 1.92 per share. We 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. The pandemic has brought greater awareness to 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 adopt their processes to meet this demand. Our technology offers a more sustainable and healthier alternative to existing chemistries. As momentum grows to reduce our carbon footprint and reduce our dependence on fossil fuel chemistries, we believe that customers and retailers will increasingly demand greater focus on these attributes. Our bottom line results are holding up despite the significant decline in demand in the paper market. The draw on our cash on hand during 2020 has been entirely related to the normal course issuer bid. We have a diversified product strategy beyond paper that targets large markets. We are engaged with the right players in both the wood composites and the personal care markets to make a material impact for investors. We're 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 look forward to updating you further on our progress.With that, I'll turn it back to the operator to open up the line for questions. Thank you.

[Operator]

[Operator Instructions] Your first question comes from the line of Dan Marks with Stonehouse Capital.

[Daniel Marks]

Jeff and Rob, good quarter keeping the cash burn under control. A couple of questions for you. First off, the -- your pending key partner in the wood composite space, comparing last quarter's commentary with this quarter's commentary, has there been a hurdle or something that you've come across that -- in the process that has caused you to think it takes more time?

[Jeffrey Douglas MacDonald, CEO & Director]

Well, good morning, Dan. Thanks for joining us, and thanks for the question. I think for us, it's probably a lot more granular than it appears for you and other investors. I mean there are regularly hurdles that come up that we have to continue to knock down together with our partner. There hasn't been a significant one, though, that caused us to think this will take longer than we thought a quarter ago. And I guess the sentiment I was trying to convey through the script part of it was that I think we're really pleased that despite these conditions, our partner has really, really persevered and really continued to push the agenda forward. I mean this environment would represent maybe the best opportunity for excuses if you didn't have the conviction to drive things through, and that certainly has not been the case. They've continued to drive ahead, and we've been able to provide them support, sometimes in a little bit different ways, but continue to provide them support to keep on the agenda that they've established. We haven't seen a setback at all. There are still some boxes to tick, for sure, but we're really confident that, together, we're ticking those off appropriately and according to how we saw things a quarter ago. So short answer, I don't see change, but I feel really good with the backdrop of this environment that they're pushing ahead the way that they are.

[Daniel Marks]

Okay. So more boxes were ticked just in Q3, so we didn't stall out or anything?

[Jeffrey Douglas MacDonald, CEO & Director]

No, no. No, absolutely not. More boxes were checked, important ones, too granular and within the confidentiality umbrella to give a lot of detail on, but the boxes that needed to be ticked were ticked, a few more here to go through this quarter as usual. So I would say steady progress.

[Daniel Marks]

Excellent. Okay. Second question, and just about your tweet on your website added a month or so ago regarding Unilever and their position that they were thinking to do exactly what you talked about on your commentary earlier, that they're looking to replace fossil fuel-based chemistry with natural chemistry. I'm assuming that since you retweeted their tweet that -- are these -- these are products, I assume, that you believe EcoSynthetix can help Unilever with. I assume that you won't be able to tell me if you actually are working with Unilever or not, but can you give us some flavor as to those products that you think you can help with and whether Unilever would be the type of account that you would work with?

[Jeffrey Douglas MacDonald, CEO & Director]

Yes. So the message from Unilever was a pretty broad-based one in terms of what they intend to do, and I would say that the intent of us retweeting that was broad-based enthusiasm for what a leader, a clear leader, in the sustainability agenda over the past several decades has done to push that agenda forward. I've personally been a watcher and a supporter from my past career of some of Unilever's activities, and we continue to watch them as a trend-setter today. And that was really the primary point of retweeting that, was really just to highlight the momentum that we've been highlighting to you as investors, that large companies like this are on the change agenda. At a more granular level, and I think we have to be careful to draw too many direct lines, but the things that they are working on from an ingredient perspective, that they want to accomplish from an ingredient perspective, both in personal care and in home care and our agreement with our partner covers both of those bases. That's what we're doing, so we're providing them with all-natural ingredients to support customers like Unilever, and I believe Unilever is a very important customer for our partner. So we hope that it does get that granular and that the direct link is made, I think the right activities are probably happening to do that. But the intent of the tweet wasn't to draw to that granular level, but really to show the momentum of a really important player in the world and in the space is really taking hold.

[Daniel Marks]

Okay. So the -- your personal care and home care partner, they would be the ones responsible for dealings? So you won't deal directly with an entity like a Unilever?

[Jeffrey Douglas MacDonald, CEO & Director]

No, not in personal care and home care for sure. Our agreement with our partner is an exclusive agreement. So we know they work with them, and we hope all the right activities are happening to get our ingredient in front of them and into their formulations.

[Daniel Marks]

Okay. Jeff, could you maybe give us a little bit of a breakdown as to -- perhaps 2 parts: the time line to helping a Unilever-type entity in terms of easier product, something that could be plugged and played right away, is it something that takes a while to develop? And then second part of that, can you maybe let us know who, between you and your partner -- where the responsibilities lie? Like who does the formulation? Who mixes up the recipe, if you will? And maybe even on the marketing and business side, who goes out, tries to win the account? And sort of what are the division of duties between Eco and your partner?

[Jeffrey Douglas MacDonald, CEO & Director]

Sure. So we are the ingredient supplier, and we don't pretend to have deep knowledge in the formulation of personal care or home care products. That would be a massive undertaking for us to transform ourselves to have that formulation capability and then at least again as big to have the marketing capability of the scale that our partner does to serve these brands around the world. So our role is in providing them with the primary ingredient, their role is in developing formulations, either for or alongside their customers and on the marketing efforts that go into it to support that activity. They told us at the outset of our arrangement with them that it typically takes a year or so to get into formulations with customers. I think it's different depending on whether you're talking about getting your ingredient into an incumbent brand or starting something fresh. And you might think that starting something fresh would take longer, but I'm not sure that that's the case.I think some of the small wins that we have seen them make have been with smaller entities who are launching new products and have the ability to formulate with all kinds of new ingredients and choose those ingredients for their compatibility with each other to achieve the desired properties in the personal care product. It can be harder to get your ingredient as a drop in into something that's been a leader on the shelf for years, let's say. They have to make sure that all of the compatibility is there, that color and things like that don't change, and that can be a bigger undertaking and with greater risks, in fact, if you're putting it into a big established, successful brand. So there's no one formula. I think the other interesting thing is that we know that our partner works very closely in the formulation labs with some customers, where it's a very, very collaborative effort, and they have other customers where it can be more secretive, and they're essentially throwing the ingredient over a wall and hoping they do the formulation well and come out with a good result.And I guess maybe the other thing in the channel that's been really encouraging, just in the last couple of months, our partner, as a large entity, focuses a lot of their efforts on the large players, the large brands, and they do that very well. But they recognized, I think, in far-flung geographies and with small players, that there are others out there that could do that better. So they've engaged some of the best distributors at the next level down to take that marketing torch and do the formulation work with some smaller players. So it's encouraging to us that they're making that level of investment just in the last couple of months to take this even further afield and down to smaller chunk opportunities. No lack of enthusiasm at all. I think maybe just to sum it up, the pandemic has definitely made it more difficult to develop formulations and has put a bit of a damper on a market with people not being maybe as worried about their hair these days. But they're starting to see that some of those dynamics are changing.

[Operator]

[Operator Instructions] And at this time, there are no further audio questions. Are there any closing remarks?

[Jeffrey Douglas MacDonald, CEO & Director]

I'd just like to thank everyone for joining us today, and we look forward to talking to you again soon.

[Operator]

And thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect.