EcoSynthetix Inc

TSX:ECO

Earnings Call Transcript 2019-Q4

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the EcoSynthetix 2019 Fourth Quarter and Year-End 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 3, 2020, posted on SEDAR. This morning's call is being recorded on Wednesday, March 4, 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, everyone, and thank you for joining us today. This afternoon, we released our 2019 fourth quarter and year-end results. You can access the slides that accompany today's call on the webcast.One of the greatest uncertainties we've discussed previously is the pace of change, when and how fast does the change agenda take place and gain traction. The world's largest retailers, technology companies and investors are [indiscernible] environmental agendas and carbon targets. We are ahead of the curve. Our proprietary biopolymer platform has the potential to replace conventional formaldehyde and styrene-based chemicals.With a bio-based alternative to these harmful materials, we are positioned as a sustainable technology company that enables our partners and our customers to improve their environmental footprint, and how they position themselves in a world where the ESG agenda is rapidly gaining an importance. The market is moving toward us.As we close out 2019 and move into 2020, we are transitioning the business from one dominated by sales to the paper industry into a strategy of multiple shots on goal. Shot number one, Paper and paperboard, which continues to endure demand pressures. Number two, wood composites, where we are well advanced with key strategic accounts. And number three, personal care, where we have seeded the market through the marketing launch of our partner. Wood composites and personal care obligations are the 2 pillars that we expect to drive meaningful growth going forward.During 2019, we generated $700,000 in positive cash flow from operations, which is an improvement of more than [ $2.6 million ] compared to 2018. Our goal of breakeven on adjusted EBITDA was missed with a loss of $400,000 in 2019, but that was an improvement of more than $1 million compared to 2018.Net sales were $18.4 million, down from $22.8 million in 2018 due to the demand pressures I mentioned in paper. Our cash flow from operations and adjusted EBITDA performance demonstrate that we have successfully rightsized the footprint of the business. And we have the resources we require in place today to deliver material growth going forward, including $43.7 million in cash and short-term investments. The primary headwind we face is falling demand in the [indiscernible] market, and it fell faster than anyone anticipated. RISI Paper Trader reported coated paper demand was down 15% to 20% in 2019, which is a historic drop for a single year, that was not [indiscernible] in a recession.According to the American Forest & Paper Association, U.S. shipments of coated free sheet paper declined 10% compared to December 2018. At the same time, market dynamics driving both oil prices and SB latex prices downward are narrowing the value proposition of our EcoSphere binder for paper. The customers we have today are sticky and continue to buy, but the opportunities for growth are challenging. With paper demand falling, our existing accounts are not growing. And given this historically low price of SB latex, there is little incentive for new accounts to invest and change program today.In terms of the more recent headlines, the rail disruptions have not significantly impacted our paper business to this point. And on the COVID-19 front, it's challenging to unpack the broader paper demand challenges from the impact the virus may be having on demand. On a macro level, where we do see opportunities for growth is in specialty papers, which are typically low-volume applications as well as packaging, where paperboard is a sustainable alternative to plastics. We continue to invest in these opportunities at an appropriate level.Conversely, in wood composites, lower oil prices support our value proposition to particleboard and medium-density fiber manufacturers. Lower oil prices generally reduce the price of pMDI, the co-binder that works with our DuraBind resin. DuraBind and pMDI together replaced formaldehyde-based resin in the particleboard and MDF categories. Lower pMDI prices support our value proposition as a cost-competitive and comparable performance binder alternative to formaldehyde resins. We are engaged with the right players in wood composites to deliver growth, including major manufacturers and backward integrated retailers that set the standard in the market. Our first major customer SWISS KRONO continues to invest in its BE.YOND particleboard market launch. It has positioned BE.YOND as a truly healthy particleboard, with the highest possible natural content and the only existing particleboard with a bioadhesive system. We have regular communication with their senior management. They have a high level of engagement and are pushing the program forward with a long-term growth perspective. They continue to run regular, albeit short production cycles to seed new opportunities in the market. Implementing change throughout the value chain requires patience and SWISS KRONO continues to be confident. They view this opportunity as a true differentiator, making them the leader as the no added formaldehyde player in the market. The retail goal from key strategic players in the market remains as committed as ever. From our side, we have ensured that the resources and technical requirements are in place to enable decisions and execution in the most expedient manner possible. We remain confident that wood composites is the highest value nearer-term market among the 3 pillars of our commercial strategy.During 2019, we introduced our third product category, personal care. 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. Our platform has proven effective as an all-natural film former. 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 replaced 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 their 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. But our partner is very excited about the feedback they've received and the potential market for it. Our partner believes the chemistry could take a meaningful position in the hair fixative space. And when they enter a market, their objective is to be a market leader, which would make it a significant growth driver for our business.So just like in wood composites, we have a great partner that is pushing it across their platform and views it as a differentiator in the market. With a multiple-shots-on-goal strategy, we have the fundamentals in place today to return to a growth trajectory. 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.With that, I'll turn the call over to Rob to review the financial highlights.

[Robert Martin Haire, CFO & Corporate Secretary]

Thanks, Jeff, and good morning. From a top line perspective, net sales were $4.4 million in Q4 2019 compared to $6 million in the same period in 2018. This 27% decrease was due to lower sales volumes as a result of the paper demand pressures that Jeff mentioned earlier.Net sales were $22.8 million in 2019, a decrease of 19% compared to 2018. The change was primarily due to lower volumes as well as a $1.3 million reduction due to loss of the European paperboard mill we announced in Q1 2019.Gross profit was $1 million in the quarter, down 15% compared to the same period in 2018. The annual period, gross profit was $4 million, down 10% compared to 2018. The changes were primarily due to lower sales volume, which was partially offset by lower manufacturing cost. Net of manufacturing depreciation, gross profit as a percentage of sales was 27.8% in the quarter compared to 23.5% in the same period in 2018. In the annual period, gross profit percentage net of depreciation was 26% compared to 23.4% in 2018. The improvements in each pyramid -- each period were primarily due to lower manufacturing cost.Adjusted EBITDA was a loss of $240,000 for the quarter compared to a loss of $70,000 in the same period in 2018. The change was primarily due to lower gross profit. Adjusted EBITDA loss for the year was $400,000, an improvement of $1 million compared to 2018. This improvement was primarily due to lower operating expenses partially offset by lower gross profit.SG&A expenses were $1.4 million in the quarter, which is flat to the same period in 2018. In the annual period, SG&A was $4.8 million compared to $5.5 million in 2018, a decrease of $660,000 or 12%. The improvement was primarily due to lower people-related costs and discretionary spending as a result of lower headcount as well as a change in foreign exchange gains and losses.R&D expenses were $470,000 in the quarter compared to $410,000 in the same period in 2018. The change was primarily due to lower government grants recognized. R&D expenses in the annual period were $1.7 million compared to $2.2 million in 2018, a decrease of 21%, the change was primarily due to lower people-related costs and discretionary spend. Our R&D efforts continue to focus on further enhancing value for our existing product lines and expanding our addressable opportunities. We will continue to be disciplined in our approach to cost management. We are confident that our current investment level is appropriate to deliver significant growth.As of year-end, we had $43.7 million in cash and short-term investments compared to $44.8 million as of December 31, 2018. During 2019, we repurchased and canceled 710,000 common shares under the NCIB for total consideration of $1.5 million. We have sufficient cash reserves to execute our growth strategy and will 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 Douglas MacDonald, CEO & Director]

Thank you, Rob. We believe we're on the right side of the change agenda, change toward healthier or all-natural alternatives. The market is moving toward us. In the meantime, we have successfully rightsized the business, generating positive cash flow from operations and retaining our cash on hand, net of the NCIB buybacks during 2019.Our key priority for 2020 is driving our commercial strategies forward in wood composites and personal care by supporting our customers and partners. It is a focused approach. We are engaged with the right players in both markets. Our technology offers sustainability benefits that consumers and retailers want. 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. While we don't expect these opportunities to result in outsized growth in our top line in 2020, 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 patience that our shareholders have shown, and I look forward to updating you further as we progress.And with that, I'll turn it back to the operator to open the call up for questions. Thanks very much.

[Operator]

[Operator Instructions] Our first question is from Raveel Afzaal with Canaccord.

[Raveel Afzaal, Analyst]

I'll just start off with my first question with respect to -- can you speak at least directionally to how much of your revenues are coming from specialty paper packaging, maybe even sequentially, just so we can see what type of traction you are getting in this market?

[Jeffrey Douglas MacDonald, CEO & Director]

Yes. I'd say -- but I would say directionally, specialty papers, packaging applications, probably in the 20% range. Some of the products that go into the mills, our customer mills, are used for both graphic paper and for packaging applications. But in the 20% range is directionally the right thing. Stora Enso, if you recall, was one of the key customers we announced as a new customer a couple of years ago, and they've continued to use our product exclusively in packaging applications. And that's a really important one for us, just given their positioning in the packaging market but as a sustainability leader in packaging. So we're really trying hard to leverage the success we've had there to build other applications in a similar way with other customers.

[Raveel Afzaal, Analyst]

Got it. And it's 20% now and last year or say, 2018, was it like 10% or was it roughly, like, almost nothing in there? Can you speak to that?

[Jeffrey Douglas MacDonald, CEO & Director]

Pretty flat. It's safe to say Stora Enso, when they got started with us, became a substantial contributor to that 20% and that's remained fairly flat. We've seen a little bit of growth in some of the more niche applications. But as I said in the script, those tend to be fairly low volume, at least as a start.

[Raveel Afzaal, Analyst]

Got it. And then with respect to SWISS KRONO. Can you give us some update on what type of pull they are seeing from the customers for NAF products?

[Jeffrey Douglas MacDonald, CEO & Director]

Yes, they're seeing -- I don't want to give away too much of their strategy or where they're seeing success. But it's fair to say that they're seeing some success in emerging markets, where no added formaldehyde is high on the agenda for change, which is encouraging to see. And they're also quite focused on the Western European and kitchen and home furnishings manufacturers who are on the agenda of wanting to change the healthier products. And so if you can imagine going from a raw piece of particleboard into a finished kitchen, the change that has to happen within that value chain is substantial. But those are the opportunities that they're working to try to drive change in that market. So it's fairly European high-end looking-for-all-natural-products-centric on one side and a little bit of interesting opportunity from emerging markets that are keen on moving to no added formaldehyde.

[Raveel Afzaal, Analyst]

Perfect. And I don't know if you can speak to this, but can you speak about the pricing differential between NAF products and the products that you were selling before?

[Jeffrey Douglas MacDonald, CEO & Director]

So safe to say that our customers are looking to position it as a premium-priced product, given that they are first to the market. But yes, the pricing strategy and exactly how they position is really up to them. We feel like we're in a position to offer them something that's quite competitive to today's ultra-low emitting formaldehyde solutions.

[Raveel Afzaal, Analyst]

Perfect. And then any update that you could provide on IKEA to the extent possible?

[Jeffrey Douglas MacDonald, CEO & Director]

So as I've said in the past, we're not in a position to be giving details on progress in the program with them. But safe to say that, as I said in November, they have continued to be committed to this program. And I think if you look on a macro level, just in the last month, senior people from IKEA have been really pushing their emphasis on being leaders in the whole ESG agenda. And of course, this program fits very nicely into that. They remain as committed, let's say, maybe even more committed than ever as they continue to move forward here. So we're engaged in planning and getting ready for execution, but we can't give you any more detail than that today.

[Operator]

[Operator Instructions] And we have no further questions at this time. I turn the call back to Jeff MacDonald for closing remarks.

[Jeffrey Douglas MacDonald, CEO & Director]

Yes. Perhaps I'll give Raveel a chance since he did say that he had further questions. If you do, Raveel, please go ahead.

[Raveel Afzaal, Analyst]

Yes. Can you guys hear me?

[Jeffrey Douglas MacDonald, CEO & Director]

Yes, we can hear you.

[Raveel Afzaal, Analyst]

Yes. Perfect. And then can you just directionally speak to the sequential growth that you guys are seeing in the resin being used by -- in the personal care line? Like is this chemicals company buying a lot more resin -- bought a lot more resin in Q4 '19 versus Q3 '19?

[Jeffrey Douglas MacDonald, CEO & Director]

No. So we can't say that at this point. What we can say is that they've really broadened the base of customers, really on a quarter-by-quarter basis that are looking at the product or use it in trials with new formulations. So that's what they're most excited about at this stage of a launch program as it's gone out to a large number of accounts and has made its way into formulations for trials, which is in a very optimistic scenario, where they would expect to be at this point. So they're encouraged. I think it's still probably a few months away from starting to see results that show up in increased orders on our side.

[Raveel Afzaal, Analyst]

Got it. And you said it's about 9 to 12 months of development time before a product is launched in the -- like...

[Jeffrey Douglas MacDonald, CEO & Director]

Yes. They've told us 12 to 18. And we have seen a few small wins from what they would consider to be early-adopter customers. But again, that doesn't have a meaningful impact on our results at this point.

[Raveel Afzaal, Analyst]

Perfect. And final question. This is, obviously, difficult predicting adoption rates is very difficult to do. But is this something that you have learned from SWISS KRONO in terms of the product uptake that they have seen and how that might translate into what you could see if IKEA decides to partner with you? I'm just trying to understand how quickly we could see no added formaldehyde products coming to the market based on what you've seen with SWISS KRONO? And what -- how that could change with IKEA coming on board?

[Jeffrey Douglas MacDonald, CEO & Director]

Yes. I wouldn't say we've learned anything that could be a predictor from one to the other. They are 2 very different companies, they have very different positions in the value chain. SWISS KRONO has positioned themselves as being a leader in healthy products, which they want to sell to a wide variety of retailers, whereas IKEA is that retailer. And so it's really about how they market themselves as a consumer-facing brand and how this fits into it. So very, very different. I would say that both are extremely well-equipped to execute on this and ramp quickly if the demand is there for it. So -- and that's partly due to the work we've done with both of them over the last several years, just to be at that state of readiness.

[Raveel Afzaal, Analyst]

Perfect. Well, as you said, you are on the right side of the changes and I wish you the very best in 2020.

[Jeffrey Douglas MacDonald, CEO & Director]

Thanks very much, Raveel.

[Operator]

And we have no further questions at this time.

[Jeffrey Douglas MacDonald, CEO & Director]

Okay. Thanks to everyone for joining us today, and we look forward to speaking with you again soon.

[Operator]

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