Nanophase Techs Corp

Good day and thank you for standing by. Welcome to the NanoSafe second quarter 2022 financial conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during that session, you will need to press star 1-1 on your telephone. That was star 1-1 on your telephone. Please be advised that today's conference is being recorded. The words believes, expects, anticipates, 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 could cause actual results for future periods to differ materially from those expressed in business release. These important factors include, without limitation, a decision of the customer to cancel a purchase order or supplier 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 public health issues, terrorist activities, and armed conflicts, and other risks indicated in the company's filings with the Securities and Exchange Commission. NanoFace undertakes no obligation to update or revise these forward-looking statements to reflect new events or incentives. I would now like to hand the conference over to Jess Jankowski, President and CEO. Please go ahead.

Thank you, Carmen. Good morning to all those listening live and welcome to those who choose to listen later online. Thanks for joining us for today's call. Our discussion will cover second quarter and year-to-date results, the current state of the business, and some of our tactical plans for 2022. Kevin Curitan, our Chief Operating Officer, is also with me here today. We can't deny that our second quarter results fell below our expectations. A great top line followed by above average costs led to below average margins. We know that marks two quarters of underperformance in terms of profitability, but there's a lot to be optimistic about, as we'll discuss. After the numbers, I'll expand on this a bit. There are a few things we're going to return to today and probably through the year. We've seen phenomenal growth in 2020, 21, and so far in 2022. This has been the result of focusing primarily on getting as much product out the door as quickly as possible. We're still seeing high demand for our technically enabled products by consumers and our brand partners, all of which has been energized by a favorable regulatory landscape. We're in that golden period in a growth company's life cycle where building more business through sales of what is clearly a disruptive technology is being limited mainly by our inability to produce more product. Our profitability has been impacted negatively in recent months, But we're in a spot where we see many opportunities to reduce costs and get margins back on track. Before I expand on this, let's hit the numbers. Unless identified otherwise, all numbers will be stated in approximate terms. Similarly to the first quarter of 22, we had uneven product shipments during the second quarter, with a significant portion of our revenue hitting in June. Our previously monthly revenue record was $3.8 million in March of 22, In June, we hit 4.9 million. And we finished the quarter by breaking through with another revenue record. We had 11.2 million in Q2 revenue. This was on top of Q1's 8.2 million, which had been our prior record. Together, this led to 19.4 million in revenue for the first half. For reference, we shipped 7.1 million in the second quarter of 2021, and first half 2021 revenue amounted to 14.2 million. While we enjoy big revenue months like March and June, particularly if they can be representative of future run rates, they can also negatively impact margins when the other months in a given quarter are lower than expected. This can lead and has led to poor overhead absorption during the lower months, as well as labor inefficiencies. Gross profit margins for the first half of 22 were 25% compared to 32% for the same period in 2021. In our view, The 7% differential for the six-month period when applied against 2022 quantity shift represented a minimum of about $1.3 million in lost opportunity. Much of this was due to labor inefficiencies driven by the use of a higher quantity of inexperienced contract labor, heavy overtime, and a shortage of production management on the floor. Some of this was further driven by our struggles with inventory and production as we consolidated from several small to medium-sized warehouse areas to one large one, and we continue to spend lots of management and engineering resources preparing to move key parts of production to our new facility. I use the term lost opportunity here because we know how to fix it, but we couldn't get that done during the first half of 2022 while driving all of the other things in the business necessary to get the product shipped. For the first half, net income was about $110,000 or zero cents per share compared to $400,000 or one cent per share for the first half of 2021. The 2021 number I'm referring to is before including the $950,000 in other income generated from the forgiveness of our PPP loan in February of 21. That was a one-time event in 21 that didn't relate to operations. We built almost $3 million of inventory between the end of 21 and June 30th of 22. A good deal of this expansion was intentional, as we purchased raw materials in greater quantities than we needed immediately in order to create a buffer for the supply chain issues that plagued us later in 2021 and for parts of the first half of this year. This has also been a function of our rapid growth, which has created a drain in working capital and led to production inefficiencies, particularly when operating out of several warehouses. We finished the consolidation of our warehouses early this month, and like the story of our labor inefficiencies, this presents us with another opportunity to increase throughput and profitability. Shipping 19.4 million in the first half of 2022 was exciting, and it's more exciting when we contemplate the planned productivity and efficiency gains yet to be made that we know will enable us to ship more product and make more money. I'm sure you're tired of hearing me talking about growing pains, but they are inescapable. Fortunately, they aren't baked in, and we're addressing them now. From June 30th out through the end of 22, we have 18 million in shipped orders and POs in hand. We also expect there to be more 2022 POs coming in. Additionally, in August of 22, we have more than 10 million in 2023 purchase orders in hand. We also know that a substantial portion of our 2023 purchase orders would be happily accepted by our customers in 2022 if we are able to deliver. That is not lost on us. We're maintaining our growth strategy, which is now being sustained by the new senior sales and business development leaders who joined our companies during the first quarter. This will allow Kevin and I to focus much more of our attention to achieving operational excellence as we complete the onboarding process of several new key finance and operating leaders during Q3. There will be more to follow on this. Shifting gears for a minute, we know that we have many new followers on each of our calls, some live, most on the web. Given that, we wanted to make sure our value proposition remains clear. The questions I'd like to address are, Where do Celescence and Nanophase fit into the larger market environments they serve? And what are some of the tailwinds that have helped us to bring us this far? Our primary business within Celescence is the design, manufacture, and packaging of prestige cosmetics. In our case, all of these provide protection from the sun damage caused by the sun, skin damage caused by the sun, pardon me, through the use of natural, safe, mineral-based, full-spectrum UV absorbers. We use our patented technologies to bring a luxury feel and appearance to cosmetics that historically haven't included a great deal of UV protection. We have taken this to another level by primarily using minerals-based absorbers. While generally viewed as safer to use or healthier than chemicals-based absorbers, zinc oxide and other minerals suffered from the historic perception that they caused whitening or ghosting on people's skin. This was the perception in the past largely because it was true. I say was true because Nanophase with its world-class APIs and Celescence with its formulation technology have pioneered zinc oxide that could be engineered to be worked into formulations in a way that it did not create whitening. Even after this technology became broadly available, consumers didn't understand the benefits, so they didn't embrace it. Manufacturers of active wear sunscreens didn't get behind these materials either, typically due to the lack of consumer demand the existence of more than 10 chemicals-based alternatives, some of which were inexpensive, and their relative lack of familiarity with zinc oxide in formulation. When we invented the Solescence technologies, of which there are now several, we decided that we would develop model formulations for the industry with the purpose of showing customers that zinc oxide could be a big winner in both the sunscreen markets and in cosmetics. The goal was to make our materials much easier to work with than anyone had ever seen in the past, creating products enabled by minerals that companies simply didn't think were possible. Even then, there was still a good deal of resistance in the market. Then the external environment changed in a way that was very beneficial to us. Beginning with Australia, as they saw damage being done to the Great Barrier Reef by chemicals based on screens, national governments Then even some local governments began prohibiting the use of sunscreens with chemical active ingredients known to damage coral reefs. Consumers began to take notice and started demanding reef-safe sunscreens. Minerals are a natural for this. At roughly the same time, this was all in the late teens, consumers began to better understand three things. Damage from the sun was literally the cause of 90% of premature aging. Second, skin cancer was a real threat to health and happiness. And third, minerals were a more natural way to stay healthy. Now, the demand for zinc oxide as a full-spectrum UV absorber began to get legs. Then, in October of 2019, the U.S. Food and Drug Administration made an announcement that resonated through the entire market. the FDA began publicly questioning the safety of chemical UV absorbers in the form of proposed regulations. Historically, there were 14 materials allowed by the FDA to be used as UV absorbers. These are published in what is called a monograph, dictating which materials could be used in commerce. In the United States, any product with a label claim of UV protection is regulated as a drug by the FDA. In the business we're discussing, we refer to these as APIs, which stands for Active Pharmaceutical Ingredients. Of the 14 UV absorbers listed in the monograph, two were mineral-based, zinc oxide and titanium dioxide, while the other 12 were organic chemical or chemicals-based. The FDA declared that the minerals-based APIs were known to be safe and needed no further testing. This supported what we already knew, what dermatologists knew, and what was already beginning to dawn on customers. The FDA went on to say that a few of the chemical absorbers had become known to be unsafe and needed to be withdrawn from the market, with the rest of the chemical alternatives, every one of them, being put in a category where more testing would need to be presented to the FDA before they could be deemed safe. The big producers of these chemical absorbers have been fighting this proposal by the FDA, which has yet to be put in the law. That said, some chemicals are no longer used in the market. You can assume what you will there, while others remain on the shelves. We believe that the reason this hasn't moved faster is that there are not nearly as many zinc oxide producers in the market as there are big conglomerates who continue to pump out these unproven chemicals. The good news for us, nanophase and coalescence, is that consumers are becoming more aware of the risks associated with chemicals-based absorbers every day. which can only be good for us. So today, minerals-based UV absorbers are what the markets want, and most minerals producers are not achieving the performance that we can in this area. This looks a lot like a long-term demand cycle, and our positioning is excellent. For those of you that are newer to our companies, the growth seeds for Solessence were planted during 2018 and 2019. You need to know that we have done very little marketing or new customer development over the past several years. I mention it because this means that our customer base and the excellent growth within it that we are experiencing has been built upon the merits of our products, word of mouth, and the work we did prior to 2020 in getting our products in front of industry leaders. We've changed this with the addition of the senior sales, marketing, and business development resources we added to the company in the first quarter. We expect to begin to see solid growth from these new efforts later this year, but even more so in 2023. As you have all recently seen, not without some financial pain, we're being limited by the constraints put on our organization by the fantastic growth we've seen in our Celestis products. The production and operational improvements we need to make will get done as senior management devotes the bulk of our focus to fixing this, supported by the onboarding of the internal capacity we need to make it happen. We're really excited to see what our team can do with our products and technologies. We will get past our growth-related operating issues, which will allow us to grow as fast and as profitably as we know we can. Now I'd like to introduce Kevin Curitan, our Chief Operating Officer and my partner in all of this, to discuss progress in these strategic areas and their drivers in greater detail. Kevin?

Thanks, Jeff, and good morning to everyone. As always, I will begin by thanking our talented team for their continued efforts in our work to not only transform our company, but to simultaneously transform a market. As I am the glass is always full guy, I will add a couple of additional remarks to Jess's reflection on our history and transition. In the almost 33 years since our company started, and only six of those years has the company's annual revenue, I'll repeat, annual revenue, exceeded this quarter's performance. Three of those six years include this year, 2020, and 2021. This is not to say that we are pleased with the bottom line performance, but it is certainly appropriate to celebrate the realization of a meaningful and sustainable organization we are in the process of building. Continuing on, while we mentioned a number of important milestones in our earnings release, here are a few additional items to consider. First, we remain confident in our ability to address the primary factors that contributed to our gross profit margin issue in the first half of this year. And Jeff mentioned it also, our labor efficiency issues. If you reflect back, and for those of you who were on the past conference call, you'll remember that we did speak about this a bit in that call. As we noted in last quarter's conference call, we are implementing programs specifically process automation that will significantly improve labor efficiencies. Through these process changes, we are targeting to increase gross profit margins by greater than five points over the next several quarters. The first of these new capabilities is, as of just this week, operational in our new building, where we are seeing the expected reduction in labor costs as a result of increasing output per labor hour. We will refrain from providing more specific details at this time on the degree of improvement, but we are on track with the goal mentioned above. As with most companies, we have been impacted by the unprecedented increase in materials costs and wages this year. One of the important challenges that manufacturers like us have is to implement price increases to help address these purchase cost increases. We are making solid progress here as well. Compared to 2021, our average price per unit in our obsolescence business with changes in product mix and needed price increases is up over 6%. Since this hasn't offset all of the margin erosion of the increases in materials cost, We believe there is still more room for improvement, and in fact, we are continuing to make additional changes in product mix and implement further price increases. Turning back toward the revenue side, as Jeff has already mentioned, we have on-hand orders that will enable us to exceed first half revenue results. Good news. We can also, with this good news, say that the products we developed with our brand partners are now available in all major beauty retailers in the US, several major beauty retailers in Canada, the EU, and Australia, and literally thousands of stores around the world. As a further peek into the future, our pipeline for new opportunities is expected to contribute solid double-digit growth in 2023. Our continued success in winning industry acclaim for our products and services include winning Best Formulation at the COSMOPAC Awards, which we announced earlier this week, being named the finalist for two other industry awards, and continued success of our brand partners as they achieve their own noteworthy achievements and being mentioned in top sunscreen lists in multiple publications. helped make us a desired destination for brands seeking best-in-class skincare and cosmetic products with SPF. As I prepare to pass the mic back over to Jess, I will say that being the guy who is the always, glass is always full guy, isn't the same as being the guy wearing rose-colored glasses. Where I clearly see the challenges we are aggressively moving our company forward to address them. While we are also keeping capable and talented resources focused on aggressively and yes, more possibly grow our company, your company, and become the globally sought after brand we aspire to be. Jess, I'll turn it back to you.