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Edited Transcript of NTIC earnings conference call or presentation 12-Nov-19 2:00pm GMT

Q4 2019 Northern Technologies International Corp Earnings Call

CIRCLE PINES Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Northern Technologies International Corp earnings conference call or presentation Tuesday, November 12, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* G. Patrick Lynch

Northern Technologies International Corporation - President, CEO & Director

* Matthew C. Wolsfeld

Northern Technologies International Corporation - CFO & Corporate Secretary

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Conference Call Participants

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* Auguste Philip Richard

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* James J. Dowling

Jefferies Capital Partners - MD

* Joe Furst; Furst Associates; Owner

* Thomas Claugus; Ampla Capital, LLC; CEO

* Timothy Clarkson

Van Clemens & Co., Inc. - Stockbroker

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Presentation

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Operator [1]

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As part of the discussion today, the representatives from NTIC will be making certain forward-looking statements regarding NTIC's future financial and operating results as well as their business plans, objectives and expectations. Please be advised that these forward-looking statements are covered under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and that NTIC desires to avail itself of the protections of the safe harbor for these statements. Please also be advised that actual results could differ materially from those stated or implied by the forward-looking statements due to certain risks and uncertainties, including those described in NTIC's most recent annual report on the Form 10-K, subsequent quarterly reports on Form 10-Q and recent press releases. Please read these reports and other future filings that NTIC will make with the SEC. NTIC disclaims any duty to update or revise its forward-looking statements.

I would now like to introduce your host for today's conference, Patrick Lynch, CEO. Sir, go ahead and begin.

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [2]

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Good morning. I'm Patrick Lynch, NTIC's CEO, and I'm here with Matt Wolsfeld, NTIC's CFO. Please note that the financial results for our fiscal 2019 fourth quarter and full year fiscal 2019 were included in a press release issued earlier this morning, a copy of which is available at ntic.com. During this call, we will review various key aspects of our fiscal 2019 fourth quarter and full year financial results, give a brief business update, comment on our net sales and earnings guidance for fiscal 2020, and then conclude with a question-and-answer session.

Our fiscal 2019 financial results demonstrate the benefits of the market and geographic expansion that we have undertaken over the past 4 years driven by significant sales growth in China as well as sales growth of our Natur-Tec compostable bioplastic products. In fiscal 2019, nearly 32% of NTIC's net sales came from Natur-Tec compared to just slightly over 14% in fiscal 2015. In addition, during the same period, we successfully launched our Chinese subsidiary and grew annual sales at NTIC China to over $13 million. Overall, NTIC's sales have increased 84% to a record $55.8 million since fiscal 2015, while earnings per diluted share have increased 189% over this period to $0.55 per diluted share. In addition, since fiscal 2015, we initiated a quarterly cash dividend, which has been increased twice and have grown our cash and cash equivalents and available for sale securities 103% to $9.4 million at August 31, 2019.

These long-term financial results demonstrate the success of our strategic plan, which is focused on double-digit sales growth, controlled expenses and strong free cash flow generation. Unfortunately, however, NTIC's core ZERUST corrosion prevention business has not been immune to the continued global manufacturing slowdown, which impacted ZERUST sales during the fiscal 2019 fourth quarter and full year both in North America and across the territory served by our global joint ventures.

We are actively watching our industrial end markets for any further signs of deterioration as ongoing global trade negotiations progress slowly, if at all. Despite these macroeconomic conditions, we believe we are well positioned to grow our global market share as a result of our expansive geographic footprint, strong operating joint ventures and global corrosion prevention expertise.

So with these highlights, let's examine the drivers for the fourth quarter. For the fourth quarter ended August 31, 2019, total consolidated net sales decreased 8.8% to $13.4 million as compared to the fourth quarter ended August 31, 2018. Broken down by business unit, this included a 30.3% increase in Natur-Tec net sales, offset by a 10.8% decrease in ZERUST industrial net sales, a 34.2% decrease in net sales from NTIC to its ZERUST joint ventures and a 69.6% decrease in ZERUST oil and gas net sales. Total net sales by our joint ventures, which we do not consolidate in our financial statements, were $28.6 million for the first -- for the fiscal 2019 fourth quarter compared to $29.9 million for the same period last year. This 4.1% decline in joint venture net sales was the result of softer worldwide demand across many of the industrial markets we serve.

We continue to believe the decline in North American ZERUST industrial sales during the fiscal 2019 fourth quarter was due to the current global manufacturing slowdown and overall economic macro concerns, which are, in turn, impacting the supply chain and purchasing decisions of many of our customers. We continue to actively monitor international market trends and plan to adjust accordingly if demand deteriorates further.

Net sales by our wholly owned NTIC China subsidiary were $13 million for fiscal 2019 compared to $12.5 million for fiscal 2018. The 4.2% increase at NTIC China during fiscal 2019 was primarily a result of higher Natur-Tec sales. The compostable bioplastics market in China appears to be strong and growing, and our fiscal 2019 results reflect increasing momentum in this market. As things stand today, we expect NTIC China sales to be up in fiscal 2020 as a result of anticipated continued growth of Natur-Tec sales and moderate growth in ZERUST industrial sales. We remain optimistic about the long-term potential in China, and we intend to further expand our presence within this large and growing market.

ZERUST oil and gas sales remain volatile primarily due to long sales cycles and overall challenging market conditions. Net sales for fiscal 2019 were down 11.1% compared to last fiscal year, which included a nearly 70% decrease in fourth quarter ZERUST oil and gas net sales. Oil and gas sales during the fourth quarter of the previous fiscal year benefited from multiple large orders for pipeline corrosion control products, but these types of projects did not materialize during this fiscal year's fourth quarter. Additionally, there were several projects that were delayed and consequently were pushed into our current fiscal year. We remain committed to the oil and gas market and believe we will be successful over time as more oil and gas customers adopt VCI technologies to replace cathodic protection and coating corrosion protection.

While it continues to take longer than expected to scale ZERUST oil and gas, our funnel for sales opportunities remains robust, and our applications continue to provide value to our current and potential customers. In 2019, in addition to repeat orders from established customers, we closed sales in several new countries with an expanded product line. We are committed to expanding our presence within the global oil and gas market due to its size and profit potential and believe we will be able to successfully grow ZERUST oil and gas sales over time.

Now turning to our Natur-Tec bioplastics business. For fiscal 2019, Natur-Tec net sales were a record $17.6 million, an increase of nearly 75% over last fiscal year. Natur-Tec continued to achieve significant growth rates as a result of strong demand in North America through our domestic distribution network as well as higher sales of finished products and resin compounds by NTIC's majority-owned subsidiary in India and NTIC's wholly owned subsidiary in China. A couple of highlights of Natur-Tec's growth during fiscal 2019 include increased demand for Natur-Tec's finished products such as compostable bags and cutlery as end customers such, as large corporations, educational institutions and sporting venues in North America increasingly adopt zero-waste initiatives and divert organic waste away from landfills to industrial composting facilities.

In Asia, Natur-Tec saw steady growth in demand for its bio-based apparel packaging solutions, as more and more global apparel brands adopt circular economy, sustainability initiatives for their products and packaging. Furthermore, with heightened concerns about microplastics and plastic residues in the environment and subsequent regulation limiting conventional plastics in countries such as India, Natur-Tec saw increased demand for its compostable resin compounds for food service applications such as drinking straws, extrusion coated paper products, cups and lids. As you can see, the use of conventional polyethylene and polypropylene plastics is facing ever-increasing societal and political criticism due to the environmental and waste disposal concerns. And this is reflected in the increasing global interest for Natur-Tec's bio-based and compostable product solutions that we have experienced. So while global market demand for ZERUST sales remains uncertain in the short term, our business is now more diversified than at any other time in our 50-year history.

In addition, NTIC's asset-light business model, experienced management team and strong balance sheet further reflect the resiliency of the platform we have created. As I look to the next 4 years and beyond, I'm excited by the potential NTIC has to continue creating value for stockholders by profitably growing sales throughout our ZERUST oil and gas and Natur-Tec product categories.

With this overview, let me now turn the call over to Matt Wolsfeld to summarize our financial results for fiscal 2019.

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [3]

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Thanks, Patrick. NTIC's net sales increased 8.4% in fiscal 2019 compared to fiscal 2018 as a result of a 74.9% or $7.5 million increase in Natur-Tec net sales, which was partially offset by a 7.7% or $3.2 million decrease in total ZERUST sales. Lower sales across many of our global joint ventures impacted joint venture operating income, which decreased 4.5% for the fiscal 2019 full year compared to the prior fiscal year. Our total operating expenses increased 5.4% or by only $1.2 million to $24.1 million during fiscal '19, primarily due to an $849,000 increase in general and administrative costs, as we've made certain investments across our global platform to support anticipated future and current sales growth. For fiscal 2019, operating expenses as a percentage of net sales improved 130 basis points to 43.3% compared to 44.6% last fiscal year. We continue to invest in developing new VCI solutions as well as bioplastic products. And during fiscal 2019, NTIC invested $3.8 million in R&D activities compared to $3.5 million last fiscal year.

NTIC reported net income of $829,000 or $0.09 per diluted share for the fiscal 2019 fourth quarter compared to $2.1 million or $0.23 per diluted share for the fiscal 2018 fourth quarter. For the year, NTIC reported net income of $5.2 million or $0.55 per diluted share, compared to last year's net income of $6.7 million or $0.72 per diluted share. As of August 31, 2019, working capital was nearly $25.5 million, including $5.9 million in cash and cash equivalents and $3.6 million in available-for-sale securities compared to $22.8 million, including $4.2 million in cash and cash equivalents and $3.3 million in available-for-sale securities as of August 31, 2018. For fiscal 2019, NTIC generated $5.5 million of cash from operating activities compared to $609,000 last fiscal year.

NTIC's business model does not require significant additional capital, and we expect our financial model will continue to produce strong operating cash flows going forward. On August 31, 2019, the company had approximately $24 million of investment in joint venture, of which 54% or $13 million was cash, with the remaining balance invested in working capital. During fiscal 2019 fourth quarter, NTIC's Board of Directors declared a quarterly cash dividend of $0.06 per common share that was payable on August 21, 2019, to shareholders of record as of August 7, 2019. On August 23, 2019, the Board of Directors approved an 8.3% increase in the fiscal 2020 first quarter dividend payment to $0.065, which reflects the continued strength in our financial performance and the Board's commitment to create value for our stockholders.

Now turning to NTIC's annual guidance for the fiscal year ending August 31, 2020. We expect our fiscal 2020 sales to range between $62 million and $66 million. We estimate our net income attributable to NTIC will range between $5.6 million and $7.5 million or between $0.60 and $0.80 per diluted share for fiscal 2020. These estimates are subject to significant risks and uncertainties, including those described in our forward-looking statements and a disclosure in our earnings release. As you can see, we've built a strong platform to drive long-term profitable growth, and we're excited about the direction that we're headed.

With this, Patrick and I are happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Tim Clarkson from Van Clemens.

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Timothy Clarkson, Van Clemens & Co., Inc. - Stockbroker [2]

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Solid quarter. Just a couple of questions. It seemed to me like the big difference in the fourth quarter was in the oil and gas part of the business.

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [3]

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I would say that makes up the majority of the shortfall. Yes.

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Timothy Clarkson, Van Clemens & Co., Inc. - Stockbroker [4]

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And that business just tends to be volatile anyhow, right?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [5]

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It certainly tends to be volatile. There were certain projects that we expected to conclude in the fourth quarter that were pushed off into the first half of our 2020, and that certainly led to the significant, let's say, shortfall in what we anticipated to do from a -- both a revenue and from an income standpoint in the fourth quarter.

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Timothy Clarkson, Van Clemens & Co., Inc. - Stockbroker [6]

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Right. I know you mentioned to me that there's been some investments in a joint venture in Europe. Can you talk about the scale of how much money you've spent there and what your expectations are for Natur-Tec?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [7]

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No. There's no joint venture in Europe for Natur-Tec. For the Natur-Tec sales, we're doing everything through subsidiaries, either majority-owned subsidiaries or wholly owned subsidiaries. The increased sales in what we're starting to focus on in Europe with Natur-Tec is not going to be through any kind of a joint venture. It's potentially partnering with some of our existing joint ventures, but not in a similar manner to how we're doing ZERUST.

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Timothy Clarkson, Van Clemens & Co., Inc. - Stockbroker [8]

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Right. How much money have you spent on that so far?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [9]

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Very, very little. We're just in the initial stages of putting together a strategic plan for how to go after certain aspects of the European market.

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Timothy Clarkson, Van Clemens & Co., Inc. - Stockbroker [10]

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How about in terms of -- I know that you've had a lot of success as far as working with people like Levi Strauss in clothing. Are you seeing any results as far as fast food restaurants in the United States and other places like that?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [11]

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Well, we are certainly supplying some suppliers to the fast food industry in North America. We did, this year, enter into an agreement with a fairly large American company to make -- to provide them with the resin systems for the cutlery that they distribute on a national basis. So that promises to be a very significant new business line for us in this coming year.

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Operator [12]

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And our next question comes from Jim Dowling from Jefferies Capital.

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James J. Dowling, Jefferies Capital Partners - MD [13]

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Would you be more specific in terms of the end markets that are showing weakness for your ZERUST both in North America and abroad?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [14]

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Yes, specifically from an end market standpoint with ZERUST, there's obviously -- the auto market was obviously the biggest impact to what our expectations were from a sales standpoint. We've seen pressure throughout Europe and throughout Asia and certainly in the United States when you look at the number of cars that are being produced. With everything that's happened from a tariff standpoint, from a global trade standpoint, just overall economic softening, the auto market being down this year is what's had the most significant impact on us from an overall sales standpoint worldwide.

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James J. Dowling, Jefferies Capital Partners - MD [15]

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Well, 2 ways to get at the quantification of that. What percentage does the auto industry make up for -- either directly or indirectly for the ZERUST sales?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [16]

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It depends on a -- on which market we're talking about. In our Asian markets, specifically in China, it's up in the 60%, 65% range as far as the reliance on the automotive market comes down slightly when we look at our European market. And then our North American market is probably 40% to 45% automotive-based.

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Operator [17]

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And our next question comes from Thomas Claugus from Ampla.

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Thomas Claugus; Ampla Capital, LLC; CEO, [18]

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How much of the ZERUST oil and gas revenue is outside of the U.S.? Or is it entirely U.S.-based currently?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [19]

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Percentage-wise?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [20]

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I would say, percentage-wise, it's probably 70% North American-based revenue. It tends to fluctuate just because of the size of the projects, but we've now completed projects all around the world.

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [21]

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We've gotten projects in Europe, India, Africa, in Azerbaijan...

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [22]

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But we still find that the -- a lot of the business and a lot of the sales activity still takes place in the Texas, Oklahoma area.

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Thomas Claugus; Ampla Capital, LLC; CEO, [23]

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Okay. And then since PMIs have fallen since August, do you expect Q1 -- is that sort of going to be the low watermark, do you think? Or is business holding up better than expected?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [24]

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Well, we're a couple of months into Q1, and Q1 certainly looks stronger than Q4 did from a sales standpoint, at least from where we're starting. But obviously, we only have, from a visibility standpoint, about 1.5 months, 2 months in. But certainly, from a revenue standpoint, it looks like it is better than Q4, which is a positive sign. So our hopes -- with putting together guidance for next year, we looked at the low end of guidance being things remaining relatively flat across the ZERUST product line worldwide and with some traditional 20% to -- 20%, 25% growth from a Natur-Tec standpoint globally. The expectations are, if we see some recovery in the industrial markets, then that's how we can get up to the higher level of expectations from a revenue and earnings standpoint.

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Thomas Claugus; Ampla Capital, LLC; CEO, [25]

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Yes, because I thought the guidance was a little higher than -- I mean your run rate right now is $54 million, in fact it has annualized this quarter. So the visibility mainly is coming from Natur-Tec and then -- and expected -- do you think there was just destocking -- some destocking going on in ZERUST?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [26]

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From the low end of our guidance standpoint where -- the expectations are that it, again, would be relatively flat. We'll see what happens from a stocking standpoint if and when there is a recovery during the year. Certainly, the expectations with the products that we're selling is that there would be a relatively quick bounce back as far as the amount of stocking that would take place both at the customer level and then also at the distributor level. It's almost like there's 2 bites of the apple as far as where the inventory is held and from where we've seen a decrease in, as you mentioned, the destocking levels at those 2 areas. I'm -- I can't come out right now and say that fourth quarter was the low watermark from a revenue standpoint. But certainly, the first couple of months of our fiscal year are stronger than what we saw in the fourth quarter.

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Thomas Claugus; Ampla Capital, LLC; CEO, [27]

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Okay. And my final question. The last one is, Natur-Tec sales -- I've read other transcripts for you guys. And how important, from a business strategy standpoint, is it to produce finished goods versus resin? I'm asking from a strategic standpoint. Is it better for you guys to make finished goods? Or is it better to ship resin?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [28]

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For us, we would prefer to be selling the resin systems. Initially, when we got into this market, we wanted to make finished products mostly as a proof of concept so that we could prove in the marketplace that there was a demand for these and that they would function well enough to satisfy customer needs. So now as I mentioned just a few minutes ago, the contract, for example, that we just got with this large American manufacturer is to supply only truckloads of resin that will be converted into compostable cutlery primarily. And then they will be selling those products under their own brand.

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Operator [29]

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(Operator Instructions) Our next question comes from Gus Richard from Northland.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [30]

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A couple of things on the Natur-Tec products. You guys are working on fibers for apparel lines. Just -- I know that's often the distance, but can you talk a little bit about that program and where that stands?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [31]

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I think it's a little bit premature to really talk about that. That's still very early in the process.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [32]

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Okay. And then can you talk a little bit about the supply of PLA? I think there were some constraints earlier last year. Have those been relieved? Is there more capacity coming on in that raw material?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [33]

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We expect more capacity to be coming, but we're not exactly sure in what the schedule of that is. But for right now, we are being allocated enough material to meet our demand.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [34]

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And then can you talk a little bit about the seasonality in the ZERUST business? I know we're in an industrial slowdown. How does that seasonally typically behave as the August quarter usually is the weakest when autos are weak? Or how does that normally play out?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [35]

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Generally speaking, third and fourth quarter are stronger for us, primarily when you get into rust season, any time you have heat and humidity, things tend to rust faster. You do see some of the slowdown in August when certain plants, particularly in Europe, shut down for a month for summer holidays, but that's pretty much how the season would work for us.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [36]

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Okay. And then on the oil and gas, I think you said that revenue pushed out of the August quarter, but into the -- is it the next couple of quarters you're seeing evidence that those projects will move forward? Or are they just on delay and not sure when they'll pick up?

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Matthew C. Wolsfeld, Northern Technologies International Corporation - CFO & Corporate Secretary [37]

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I would say the first half of -- our expectations are that, that revenue will be realized in the first 2 quarters of fiscal 2020.

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [38]

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Current fiscal year.

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Operator [39]

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And our next question comes from Joe Furst from Furst Associates.

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Joe Furst; Furst Associates; Owner, [40]

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I just had a question about the oil and gas business, particularly to the tank item. What's it going to take for you to be able to increase your business in that because it's such a vast market?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [41]

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Well, right now, as we've been stating for a number of years, we are getting repeat business for our tanks and expanding the number of tanks we on an annual basis. One of the key things that we have been working on over the last several years is trying to get a standard approved by both NACE, the international organization for corrosion engineers as well as the American Petroleum Institute that are now jointly working on this standard for applying VCI technologies to tank protection. My understanding is that the preliminary drafts for this standard have already been approved and they expect to finalize those within the next year to 18 months. Once those are approved and it becomes a well-established standard, then we expect our sales to increase significantly.

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Operator [42]

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(Operator Instructions) And our next question comes from Tim Clarkson from Van Clemens.

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Timothy Clarkson, Van Clemens & Co., Inc. - Stockbroker [43]

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Just for some people who are maybe familiar with compostable products, what would be -- on a big picture basis, what makes your compostable products superior to the competition?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [44]

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Well, we have managed to modify the resin systems manufactured or produced by other larger chemical companies like BASF and NatureWorks to, first of all, be able to compatibilize the blending of various resin systems that are not otherwise compatible to get better mechanical properties and functionality out of the finished products. We've also managed to add certain fillers that reduce the overall cost of the finished product. And also we've now just filed for a patent this year based on the formulations we've generated that dramatically -- the process we have dramatically increases the tensile strength of the finished plastic films. So our bags wind up -- or our film products wind up being much stronger than you would expect for similar equivalent products manufactured that way. So we basically have a product that is stronger, more easily processable and producible at extruders and also overall lower cost to the -- for the finished products.

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Timothy Clarkson, Van Clemens & Co., Inc. - Stockbroker [45]

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Right. So just in practical terms, if you're carrying out a bunch of heavy wet grass, the bag doesn't explode, or if you're eating a salad, the fork doesn't snap like some of these cheaper, inferior products do?

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [46]

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The fork won't snap or melt or wilt on you when you're stirring a spoon through hot coffee or hot soup, for example.

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Operator [47]

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Thank you. And I'm showing no further questions, so I would now like to turn the call back over to your host, Patrick Lynch, CEO, for further remarks. Thank you, sir.

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G. Patrick Lynch, Northern Technologies International Corporation - President, CEO & Director [48]

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I'd like to thank everyone for participating today and for your interest in NTIC. Hope you have a pleasant day. Thank you.

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Operator [49]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.