FIRST QUARTER 2019 CONFERENCE CALL
Jess Jankowski, President & CEO
Thank you, Norma, Good morning everybody. I appreciate everyone being here, and those choosing to listen later online. I’m happy that you can join us to discuss our first quarter 2019 financial results, our current state of the business, and strategic updates.
I’ll be on this call solo today. We currently have an interim finance leader in place, as we keep focused on building our Solésence business, and ensuring that operations are as efficient as they can be.
Unless identified otherwise, all numbers will be stated in approximate terms.
Our Q12019 revenue was up by 30% over the same quarter in 2018. Year over year, we saw sales within our Personal Care Ingredients product category go down by $300K, and our Advanced Materials product category was up $300K. The major difference was within our Solésence product category, where sales were $900K this quarter, versus $60K in last year’s first quarter, and $1.4M for all of 2018. So, in Q12019, we’re already at 66% of full year 2018 volume, and we expect to record a multiple of 2018 Solésence revenue this year.
As you may have seen in the Release, Solésence had another product launch through a leading natural skin and body care brand in the first quarter of Q1. This resulted in low six-figure revenue, and along with follow-on orders from existing Solésence customers, helped us to achieve solid revenue for Q1. The newly launched product has been lauded as “one of the best in class” in a recent competition, and, we have received the first reorder for this product. We believe this to be a demonstration of strong consumer acceptance, which we continue to see with our Solésence products. In total, by the end of the second quarter, we expect to have Solésence-developed and manufactured products, being marketed by over a dozen different brands.
I’m happy with our progress, and I expect us to not only continue to grow, but also to enter the stage where we can capture more margin from each product, as we become more familiar with the product development and scale-up processes.
Looking at our bottom line, we did a good job in managing our Operating Expenses Year-Over-Year, but we struggled in Q4 last year, and in Q1, on some of the execution issues that plague many companies like ours, companies that are growing aggressively in a newer product area, and ultimately these drove down our initial gross margins. We believe this to be a temporary situation, and it has become a top area of focus for management going forward.
Although we had a better bottom line in Q1 of 2019 than in Q1 of 2018, the last two reporting quarters have reflected a degree of growing pains that have been costly, and their impact has been amplified by the drop in demand from our largest Personal Care Ingredients customer between 2018 and 2019.
As we discussed during the March call, our internal expectation is for a $3M reduction in Personal Care Ingredients revenue year-over-year. Naturally, this puts a lot of pressure on cash as we work to build the Solésence business for 2019 and 2020. This is due to a combination of customer-specific events, none of which we believe are indicative of market weakness. More on that in a few minutes.
The upshot of the decrease in volume, and related decrease in margin, along with our recent results, is that it created a need for operating cash in order to continue executing on our Solésence strategy, and to have some “breathing room” to focus on improving our margins.
Cash management has become more of an issue for us than ever, as we try to manage our growth within our contractual and resource constraints. In that regard, we have been busy shoring up the balance sheet.
As reported in our recent 10-Q, to address these issues, we completed an equity transaction earlier this week, selling 4.1 million shares of unregistered stock for $1.7million dollars. This reflected a price of $0.40/share, which we viewed as an efficient transaction in terms of total cost and dilutive impact. While the buyer has demand registration rights, they are not generally exercisable until after four years. This transaction was also completed quickly, helping us to remain focused on our Solésence growth strategy, while we’re coping with the volume reduction from our other line of business.
Additionally, as you may have read in the 8-K we filed on April 24th, or as described in greater detail in our subsequent 10-Q, we renegotiated our Agreement with our largest customer. We expect this to allow us to have more access to our own balance sheet, by reducing the cash requirements within our contract. Since the 2000s, we had been managing to the tech transfer provision embedded within the previous version of our agreement with BASF. For a number of years, we’d been required to maintain a minimum balance of $1M in cash, at the end of each reporting quarter, to avoid “triggering” a transfer of our technology.
Given inventory requirements, and A/R, among other things, this cash requirement placed a burden on the Company which was difficult to transcend. We often skimped on inventory to avoid risking our quarter-end cash balance, which, in example, led to a situation where we made less material in Q1 of 2018 than was prudent from a purely operational sense, in an effort to reserve enough cash to meet this aggressive covenant.
The new Amendment allows for up to $500K of the $1M requirement to be composed of a combination of raw material- and finished goods- inventory. Along with our existing quarter-end line of credit, which we also renegotiated favorably, this change has enabled us to carry more inventory to meet customer demand, while maintaining a higher free cash balance, and at less commercial risk to the organization. Given our expectation of continued growth, particularly within the Solésence Product Category, working capital is a bigger issue now than has been in the past.
Now I’d like to get back to our key markets. Earlier, when I mentioned the reduction in Personal Care Ingredients volume this year, I said it was more discretely related to our customer, not weakness in the markets for our products. To better explain, I’d like to spend a few minutes discussing the demand in the markets we address with our minerals-based skin- and sun-care ingredients. I’ll also discuss the strengths we see relative to our position, both as an ingredient supplier, and through Solésence finished products, in the market.
The outlook for minerals-based sunscreens continues to improve. I think that the underlying market dynamics continue to validate our broader strategy of focusing on the sun- and skin-care markets, and within that, the Solésence-specific strategy of delivering safe and effective prestige cosmetics that enhance people’s lives.
First, there has been a worldwide shortage of zinc oxide and titanium dioxide, most noticeably to us beginning in early 2018. Industry sources have been predicting a 300% increase in demand for zinc oxide, our primary mineral product, over the next five years.
We don’t know what share we can expect from that growth, but it certainly supports our strategy. You may also recall that over the past few years, some of the most common chemical sunscreens have also been banned due to their environmental impacts. They are not considered safe for use near coral reefs. This has been a positive for us in the market.
Then, the Food and Drug Administration’s recent announcement of the 1st new proposal, in decades, was issued on sunscreen ingredient safety. There are 16 active ingredients currently listed on what the FDA calls the “Monograph.” This is the list of ingredients currently allowed to be used in human sunscreens in the United States. The FDA has concluded that two of these ingredients are unsafe for humans, and that “there is not enough data” to determine if 12 more of these ingredients are safe for human use.
Combined, those fourteen active ingredients represent all of the ingredients currently allowed in the monograph that we refer to as “chemicals-based sunscreens.” They are our most significant market competition, and they make up fourteen out of the sixteen of the ingredients in the monograph. Zinc oxide and titanium dioxide, the two remaining options in the current monograph, are the only two that the FDA has deemed to be safe for human use. This should be another big positive for us.
Our technologies and our expertise, developed over the years, and every day, are allowing us to make enabling materials and products. Products that feel better on the skin, are easier to use, and help to reduce the “whitening” effect that has been viewed as the main detriment of minerals-based products over the years. Further, the Active Stress Defense™ technology, marketed to “Brands” through Solésence, also allows us to formulate with non-nano minerals, and achieve the same performance. This presents another marketing advantage, as “non-nano” is important to many consumers of cosmetics.
Other consumer benefits that we have proven are:
· Comprehensive environmental protection, including protection against pollution;
· Broad spectrum UV protection, protecting the skin from damage that can be caused by both UVA and UVB light; and,
· Stopping the formation of free radicals, which contribute to premature aging, such as wrinkle formation & skin discoloration.
These claims for Solésence products help the Brands to provide evidence of “anti-aging” benefits, which continue to be one of the biggest drivers of demand from consumers.
We often refer to our Solésence clients as “Brands.” That’s because these clients will be marketing these products, with their brand names on them, using their distribution channels, enabled by our Solésence technology, our formulating expertise, marketing support, and regulatory and production backbone. We’re marketing Solésence products to luxury and prestige brands, and we’re having good success, not just in terms of effectiveness, but in terms of feel and appearance.
Within the footnotes of our latest 10-Q, you’ll see that we’re now breaking out our revenue in three Product Categories:
These are:
1) Personal Care Ingredients;
2) Solésence; &
3) Advanced Materials
I’ve explained these in greater dept during our previous call, and will devote more time in the future to doing the same, but don’t want to belabor the point today. With these changes, now you’ll be able to track our progress more easily in our public filings.
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 to share your comments.
Norma, would you please begin the Q&A session?
Q&A SESSION
Thank you Norma.
I wanted to mention that I have received several calls from investors over the past weeks that coincided with our “blackout” period. I didn’t respond because I can’t address questions between the close of the quarter and the time we issue the press release and have this call. We were also in a “quiet” period related to the equity offering during this time.
Given that we have found our growth engine in Solésence, and it has clearly become the area of our business where we can exert the greatest degree of influence, I’m looking forward to reviewing our progress in future calls as we discuss our ongoing strategy.
In the meantime, in addition to following us on Instagram and Twitter, I suggest that you visit the Solésence website, which is constantly evolving.
We’re at: www.solesence.com
While we have our challenges, we are in the right markets, with the right strategy, at the right time. I expect 2019 to continue to be an excellent year for Solésence, and I’m looking forward to the opportunity to discuss the business with you again soon.
Thanks again to all of you, who have taken the time to listen, and to support Nanophase and Solésence. Have a great day everybody!