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Edited Transcript of NANX earnings conference call or presentation 29-Aug-19 3:00pm GMT

Q2 2019 Nanophase Technologies Corp Earnings Call

Romeoville Sep 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Nanophase Technologies Corp earnings conference call or presentation Thursday, August 29, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jess A. Jankowski

Nanophase Technologies Corporation - President, CEO & Director

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Conference Call Participants

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* Walter Christopher Ramsley

Walrus Partners, LLC - MD of Research, Lead Portfolio Manager, Compliance Officer and Chairman

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Nanophase Second Quarter 2019 Financial Conference Call. (Operator Instructions)

As a reminder, today's call is being recorded. The words expect, anticipate, plans, forecasts and similar expressions are intended to identify forward-looking statements. Statements contained in this news release that are not historical facts are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current beliefs and a number of important factors that could cause actual results for future periods to differ materially from those expressed in the news release. These important factors include, without limitation, a decision of customer to cancel a purchase order or supply agreement, demand for and acceptance of the company's personal care ingredients, advanced materials and formulated products, changes in development and distribution relationships, the impact of competitive products and technologies, possible disruption in commercial activities occasioned by terrorist activities and armed conflicts and other risks indicated in the company's filings of the Securities and Exchange Commission.

Nanophase undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

It is now my pleasure to introduce your host for today's conference, Mr. Jess Jankowski, President and CEO. Mr. Jankowski, you may begin.

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [2]

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Thank you, Sarah. Good morning to all of those listening live and welcome to those who choose to listen later online.

I'm glad you could join us for our second quarter 2019 conference call. Today, I'll briefly discuss current results and the current state of the business. I am on my own, again, today with an expectation that we should have a new senior finance person in place the next time we talk. Unless identified otherwise, all numbers will be stated in approximate terms.

Today, I'll discuss the growth we continue to drive with our Solesence products, touch slightly on some temporary setbacks within our personal care ingredients business. And most importantly, to all of us, I want to make clear that the demand for minerals-based sunscreens and skin health products continues to grow. The way the markets are moving and the way consumers are beginning to respond tells us that our strategy of focusing on skin health within our personal care ingredients portfolio and our Solesence products, of course, puts us at the right place at the right time. Our Q2 2019 revenue was down when compared to 2018, much of which was related to the burst of orders we received last year from our largest customer in late Q1 of 2018 and into Q2.

In 2018, this was driven by some spot buys and some inventory building that is not expected to be repeated in 2019. This is what I referred to in the press release in terms of an inventory adjustment by our largest customer in 2019 that impacts the 2019 year-over-year revenue comparison. This was all due to a combination of customer-specific events, none of which we can tie to market weakness. Year-over-year, we saw sales within our personal care ingredients product category go down more than $1 million, while our advanced materials product category was up about $300,000.

That said, you've probably all noticed that our 6-month revenue stayed flat at $7 million, even after this anomalous $1 million hit. Yet again, the best part of the story is in our product revenue mix. The major positive difference year-over-year was within our Solesence product category, where sales were up by more than $800,000. This put 6-month volume for Solesence at about 90% of full year 2018 volume and growing. And yes, we continue to expect 2019 revenue to be more than double what we saw in 2018. A good indication of this is that through June, we've completed a dozen new product launches with more coming through year-end.

As I've mentioned, I'm happy with our progress toward more Solesence growth but not with the margins we've been able to enjoy thus far. Product development and scale-up are challenging things to do with initial inefficiencies creating P&L pressure. One serious way to combat this has been to eliminate some of the outside contractors we initially relied on to get our Solesence products up and running.

We've been working to bring most of our filling in house this year and continue to make good progress. In the first quarter and much of the second, we focused on getting our filling processes up and running, smoothing out any bumps and reorienting some of our press's flows to accommodate the related changes to our business.

While the rapid growth we've been experiencing is phenomenal, it's made the commissioning of our new process scale-ups and the expected related margin improvements move much slower than we had planned. Much of this is due to our primary focus on delivering products to customers to meet new product launches. We haven't been able to furnish the build-outs and meet important customer requirements simultaneously. When faced with this choice, we're going to choose taking care of the customer almost every time. The impact of all of this has been amplified by the drop in demand from our largest personal care ingredients customer between 2018 and 2019. Coupled with our expectation of continued growth, particularly within the Solesence product category, working capital management remains a top priority too.

All that said, I'm expecting the second phase of our scaling process, which is focused on a higher degree of automation and throughput, to begin to show benefits in the fourth quarter. Capturing more margin is our top focus today.

Now I'd like to touch on our key markets and our relative strengths in them, both as an ingredient supplier and through Solesence finished products. The first one I'll mention relates to the recent joint development agreement we closed with Sumitomo Corporation of Americas. Within this relationship, we're focused on creating new minerals-based ingredients, which are outside our current class of offerings. These will relate to other beauty science-related markets, markets that are outside of the sun care space. We expect this to be a durable relationship that will build over time to represent an important part of our personal care ingredients business in several years. This is the type of diversification that is so well aligned with our existing production and markets that we expect to leverage our equipment and our knowledge without negatively impacting our existing personal care ingredients business.

Speaking of that, minerals-based sunscreens continue to see good demand growth, and we feel great about our strategy. In addition to the high quality of our products and their good performance in protecting and enhancing skin health, there are a series of external things happening in the marketplace that we continue to leverage in expanding our market advantage.

You may recall that over the past few years, some of the most common chemical sunscreens have been banned due to their environmental impacts. They are not considered safe for use in the coral reefs, and customers well away from the reefs don't like the thought of endangering themselves or the environment either.

Additionally, the Food and Drug Administration's recent announcement on sunscreens safety -- sunscreen ingredient safety, the first new proposal in decades, by the way, continues to pressure the industry to either prove the safety of chemical sunscreens or eventually withdraw them from the market.

There are 16 active ingredients currently listed in what the FDA calls the monograph or the list of active ingredients currently allowed to be used in human sun care in the United States. Of the 14 chemicals-based active ingredients on this list, the FDA has declared 2 of these ingredients unsafe for humans and the other 12 to require much more data to be submitted to prove them safe for use on humans.

Combined, those 14 active ingredients represent all of the ingredients currently allowed in the monograph that we referred to as chemicals-based sunscreens. They also represent our most significant market competition, and they make up 14 out of the 16 total ingredients included in the monograph.

Zinc oxide and titanium dioxide, the 2 remaining options in the current monograph, are the only 2 that the FDA has deemed to be safe for human use. That's what we make and that's what we sell.

While the industry is pushing back, the FDA has gone to atypical lengths to hold the chemicals-based manufacturers accountable for proving the safety of their products or pulling them from the market. This will unfold over the next year or so, and we expect this to continue to be a positive for us in the marketplace.

Our technologies and our expertise developed over the years and every day are allowing us to make enabling materials and products, products that people are demanding. Now is the time.

Although most of our investors listen to the webcast or review the transcript after the live call, I'd like to invite those participating in today's call to ask any questions you may have or just your comments.

Sarah, would you please begin the Q&A session?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of [Ron Potter] with -- is a private investor.

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Unidentified Participant, [2]

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Could you explain the Sumitomo agreement? What products are excluded and what are covered?

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [3]

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I really can't do it in a lot of detail. I can say that none of the scope of the agreement excludes sun care. So it doesn't infringe any of the existing either markets or agreements that we already have. But it is included in skincare and in the beauty science market. And the thing we like about it is that a lot of the -- actually all of the equipment and the technology that we have here lends itself very well to that same -- to producing those same products, and we intend to build some new products with them to allow them to be more competitive in the U.S. market and abroad.

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Unidentified Participant, [4]

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And will you be selling ingredients or fully prepared formulations?

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [5]

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They'll be ingredients.

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Unidentified Participant, [6]

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Okay. And...

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [7]

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The other advantage -- our other advantage there is we believe we'll be able to, in conjunction with -- obviously with the partner, which will take a little bit, but we'll be able to help to level load our equipment because essentially as you might recall last year, we ramped up to a capacity that is much higher than we ever had before. And then the volume dropped, we'll be using that same equipment once we get these products into the marketplace, which will be in a few years before they're significant but that's going to really help to level load and also to help out with our margins.

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Unidentified Participant, [8]

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And what was that, that Sumitomo found attractive about Nanophase and its technology? What motivated them to enter into the agreement?

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [9]

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I think the -- probably the primary thing is that we are known for having a very good, basically a very good coated zinc oxide, and then very good technology to coat that, formulate new coatings and to understand what's happening in the surface of any particles and what is -- what needs to happen to get them to work in various formulations. So their goal is to expand their product suite and have, ultimately, a competitive advantage by selling products that you can't get somewhere else, and they are made by the people that are fairly well known in the industry for creating innovative products that way. They also like their infrastructure, they like the fact that we have the cGMP, which is our FDA-related disciplines in place and the expertise we have.

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Unidentified Participant, [10]

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And Sumitomo agreement will restrict your ability to sell the same ingredients elsewhere to others?

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [11]

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Well, it will. Those are ingredients we currently don't sell, and we will have been in competition with them directly for those ingredients. Other than if we were to include those ingredients in our finished products through Solesence, which would be a different area, which is our plan. Our plan is not to continue to turn out a series of new personal care ingredients that will -- our main focus over the next few years is really Solesence and the expansion of it.

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Unidentified Participant, [12]

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Okay. I think in your press release, you mentioned a new BASF sunscreen product. Is that right? What is that?

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [13]

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We've engineered and made some changes to allow them to have a wider -- I mean it's a coated zinc oxide similar to what we've been selling. But it's something new that gives them one more option in the marketplace to capture new business, and it was exciting because we collaborated with them, it was done relatively quickly. We anticipate having some future sales there, and it's -- I think they are realizing that over time, the market for zinc oxide, particularly, is growing so rapidly. There are -- they are being responsive and looking for ways to expand their business, which to us is very exciting because the market -- the experts are expecting this market to grow by 300% into the mid-2020s. And currently, we are the major player in North America relative to providing that, and we're in a position that if we helped with our partner to manage that, we should be able to capture a good amount of their growth.

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Unidentified Participant, [14]

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Okay. Is -- has BASF returned to historical run rate in terms of their orders and purchases?

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [15]

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Not quite yet. They are -- without getting into too much competitive information, they are still working down some of the inventory. We had a better-than-expected first half with them, and it looks like it will be a -- second half looks like it will be good as well.

I think next year, it should normalize and start to increase, and we're all thinking that after that we ought to see some bigger increases based on all the demand and the pressure in the marketplace.

One of the things about them is they are a strong partner, they are very -- putting their name on it and their support is critical for a lot of larger companies that would be buying materials for use in more mass market applications. And I think they're one of the gold standards relative to supplying those, sort of, ingredients. So it's a question of us working together to continue to make sure we have products coming out that people want, keep the quality of our existing products up. And of course, over time, we're always working on costs.

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Unidentified Participant, [16]

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Okay. And last question is what's your current feeling about your access to capital going forward.

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [17]

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I think it's good. I think it's -- I would, of course, always like to have better access to capital and more ready access. The milestones we've been hitting relative to growth are positive and giving people indications that we are doing what we said we were going to do. And I think we'll be able to leverage that fairly well.

Beyond that, we are keenly focused on capital and working capital every day. And that's one of the things in terms of some of the things we're doing. We're probably doing a little bit slower because we're not bringing in external resources to do these things, and that's basically capital management. As we roll in through the year, we're expecting a stronger Q4 than would be typical, and that'll lead to more volume in Q1. And I think that's really going to be big for both companies, for Nanophase and Solesence, the next 4 or 5 months is going to be really important. It's more so in the fourth quarter then the third.

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Operator [18]

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(Operator Instructions) Our next question comes from the line of Walter Ramsley with Walrus Partners.

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Walter Christopher Ramsley, Walrus Partners, LLC - MD of Research, Lead Portfolio Manager, Compliance Officer and Chairman [19]

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Jess, I had a question about the capital equipment that's more than doubled, I guess, so far this year or at least on -- in terms of the cost on the books. Can you discuss what that equipment is, and what, sort of, automation you're pursuing? And how that might affect the capacity, the cost of the products and the quality?

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [20]

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Sure. Almost all of that, if not all of it, I don't remember the minor pieces, is related to the Solesence business, and it's related to several pieces of it. One is as we're manufacturing lotions, the bulk material that gets packaged, we are expanding our capacity to be able to do that, and that's really a -- we're not up and running on that. That isn't causing any issues relative to margin or anything like that this year. That is something that we have to have in place at some point next year because we're expecting further expansion, and it would be inefficient to make it at a smaller scale.

Another part of that capital, which is a small part with more to come, is bringing in an internal and external process for manufacturing that we currently outsource. That's something that will probably be a much bigger focus next year. The bulk of it is in continuing to build our ability to fill our products internally.

So we -- in the first quarter and much of the second, the company's transaction volume and the flow has about tripled. This is a very different kind of the business. It's more complicated in some ways. It's technically not as complicated, but in terms of logistically and supply chain-wise, it is more complicated. And we are working -- we went through a first phase where we got up and running, so that we could do our -- or more of our own packaging. And part of that is with the volumes we're dealing with, you can't go to the kind of company that would package, say, for Procter & Gamble and make 100,000 unit runs every day. And our flexibility was limited, we realized that we'd have to be able to get materials out the door, and some of the customers we have are smaller, some are good-sized customers launching smaller lines. So we got that up and running first and second quarter.

And then continuing into the third quarter, we're enhancing our ability to do a higher level of volume to increase our throughput, which is largely, I believe, it's going to increase the quality of our products. But I know it's going to decrease the amount of labor that's required to fill and package the products and further the timing. We are working on always managing and juggling multiple priorities with varying customers and with new launches, I -- when you get involved in them, we saw this on the ingredient side but it's much more -- it's a much faster moving business where we like it because we have a better customer interface and the time-to-market is quicker. But the changes coming through are also quicker, which often include packaging and components that come in from outside that are not as in our control as they can be. So our goal is when we get that material to be able to efficiently get it through the line as quickly as we can, we're using a fair amount of temporary labor because a lot of it is a campaigning process. So it's -- there are a lot of things we're managing, and the bulk of our focus is getting -- this year is getting that to run more smoothly, more quickly and efficiently. And that's what you're seeing relative to that capital expenditure.

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Operator [21]

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And this concludes today's question-and-answer session. I will now like to turn the call back over to Mr. Jankowski for any closing remarks.

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Jess A. Jankowski, Nanophase Technologies Corporation - President, CEO & Director [22]

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Thank you, Sarah. I wanted to mention again that I've received several calls from our fellow investors over the past weeks that coincided with our blackout period. I want to remind you that I don't respond to those. I can't address questions between the close of the quarter and the time we issue the press release and have this call. We'll have more to share once we're in Q4 as we have the expectation of several customer launches in Q1 of 2020 that we'll be supporting -- that we will be supporting through Q4 of '19 and early Q1 of 2020 in shipments.

In the meantime, in addition to following us on Instagram and Twitter, I suggest that you visit the Solesence website that's www.solesence.com, S-O-L-E-S-E-N-C-E. We've made some videos explaining the technologies and more importantly, the product benefits. It's a nice place to get either a premiere on Solesence or a refresher.

Solesence is our new growth engine and our mineral-based ingredients business continues to expand as well. While we certainly have our challenges, we are in the right markets with the right strategy at the right time. We expect 2019 to continue to reflect the excellence of our Solesence product line and the growth it'll enable. And I'm looking forward to the opportunity to discuss the business with you all again soon.

Thanks again to all of you for taking the time to listen and to support our exciting companies. Have a solid day, everybody.

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Operator [23]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.