Nanophase Techs Corp

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Nanophase third quarter 2022 financial conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1-1 on your telephone keypad. 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 this news release. These important factors include, without limitation, a decision of the 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 public health issues, terrorist activity, and armed conflict, and other risks indicated in the company's filings with the Securities and Exchange Commission. Nanophase undertakes no obligation to update or revise these court looking statements to reflect new events or uncertainties. At this time, I would like to turn the conference over to Mr. Jeff Janikowski. Sir, please begin.

Thank you, Howard. Good morning to all of those of you listening live and welcome to those who choose to listen later online. Thanks for joining us on today's call. Our discussion will cover third quarter and year-to-date 2022 results, the current state of the business, and some of our planning for the balance of 2022 and entering 2023. Kevin Curitan, our Chief Operating Officer, is also with me here today. In discussing our results, we're going to separate the gross profit discussion from the bottom-line earnings discussion. The third quarter's margins reflected the trend we've seen in terms of our production costs and the deficiencies we've been discussing this year. We've also seen increases in raw materials costs and labor, some of which we've recouped with price increases where the markets and contracts allow. I take solace in the fact that we've been able to achieve stronger margins in the past on lower volumes and with less sophisticated production equipment. I'm confident that our gross margins will improve. Our bottom line was disappointing with a large Q3 loss bringing us to a loss for the nine months. While the majority of this was a result of our depressed gross profit margin, some of this was also due to strategic decisions we made, and among other things, some was due to litigation costs. Given the incredible market success we've seen with Celestin's products and market demand for minerals-based solutions more broadly, we remain optimistic about our future results and the acceleration of our continued growth. After the numbers, I'll expand on this further. Unless identified otherwise, all numbers will be stated in approximate terms. We had $9.7 million in Q3 revenue this year versus $7.9 million for the same period last year. This brought us up to $29 million year-to-date at 930 versus $22 million at this time last year. Total year-to-date revenue numbers were up 31% in 2022 over 2021. Within that, Celestin's revenue was up 39%, And personal care ingredients revenue was up 61%. Revenues continue to go in the right direction. Kevin will talk more about this, but we're excited to see our strategy continue to unfold. As in Q2 and Q3, Q1 and Q2, I should say, Q3 had a month during the quarter, in this case July, that was about one-third lower than the average month. And we also saw another month in August that was almost one-third above the average for the months within each quarter. While we enjoy big revenue months, particularly as they can point to future run rates, they can also negatively impact margins when the other months in a given quarter are lower than expected. This has led to poor overhead absorption during the lower months as well as labor inefficiencies. Given that we can never get those efficiencies back, we're working hard to stabilize the business within the constraints of what we expect to be continued significant growth. Additionally, we've seen added expenses come through for the expansion of our facilities and our operations team. This expansion was both necessary for us to get our costs down on the volume we currently have, as well as to support future growth with a much more workable footprint. In the short term, these increases added to some of the inefficiencies we've been tackling, leading to gross profit margins of 25 to 26% this year. For the nine-month period year over year, This reflects a 9% decrease in gross profit margin. About a third of this decrease is related to occupancy costs for our new facility, which we expect to better absorb as we continue to grow. And without which, I have to add, we wouldn't be able to pull costs out of the current Celestin's business. Kevin will be addressing this in greater detail in a few minutes as well. Of the remaining 6% shortfall, using 2021 margins as a benchmark meant that we had approximately $2.5 million fewer margin dollars to cover R&D and SG&A expenses and to generate cash. Over the nine-month period in 2022, we had a series of investments in our R&D and SG&A capability that, while helping to facilitate some of our growth immediately, represented more of an investment toward future growth. We saw R&D expenses, which includes engineering, increased by about 600,000 year-over-year. Two-thirds of this related to staffing. This included the expansion of our engineering team to help with equipment installation and optimization, and in addition to our formulation group. I characterize these as changes to both reduce manufacturing costs and to increase throughput. The balance in R&D reflected increases in legal fees for patent and intellectual property development. This is strictly an investment in securing and expanding our franchise within our Solescence products. Our SG&A expenses were up considerably too, an increase of roughly 2.5 million year over year. Almost a million or 40% of this related to additional staffing, primarily within the sales, marketing, and business development teams. We added two new senior leaders in the first quarter, additional marketing resources, and more customer support people. Related recruiting costs amounted to about 15% of this total, which we don't expect to reoccur. The bulk of these additions relate to future business development and demand acceleration, with the balance helping us to catch up with our much higher sales value. Not just in sales and marketing, but company-wide, our business has been impacted by the growth in our Celescence business in a way that is difficult to understand from the outside. I'd like to put a finer point on what we mean when we talk about catching up with growth. On an annual basis, Celestin sales have grown from less than $2 million in 2018 and 2019 to $7 million in 2020 during the pandemic, then to $18 million in 2021. At our current level, we will have tripled the size of a 30-year-old company in the past three years. Given the different business model for Celestin, which requires many more shipments of smaller quantities of material, While the size of our entire organization tripled in terms of dollar volume, our transaction volume has been a multiple of that again. This tremendous increase in volume and its related activity put a huge strain on our organization, but it was worth it. Another third of the $2.5 million increase was due to a series of growth-related items. The enhancement of our marketing suites, as well as the increase in the number of users throughout the company, plus a big push toward automation resulted in higher software spending. Also, we finally felt it safe enough to start exhibiting at trade shows again, and we saw insurance costs increase significantly as a function of both our rapid growth in volume and assets, as well as the general insurance markets. We incurred approximately $250,000 in bad debt expense, which is an unfortunate consequence of rapid sales growth with limited resources to apply to collections and regular frequent customer contact earlier in the cycle. We may be able to collect a portion of this in the future, but we're reserving for it now. With more experience and deeper staffing, we don't expect this to continue at this magnitude going forward. Several other items, ones that I would characterize as being outside the normal course of business, This is the $530,000 we mentioned in our earnings release, made up most of the balance of the change in SG&A expenses. We accrued some contingency fees for what we hope will be a successful recovery of our staffing commitment during the pandemic under the employee retention credit. We hope to have this finalized early in 2023. Also, we saw increases in legal fees relating to our pending litigation with BSF, which I'll address in a few minutes. Lastly, to follow up on our note in the release, we're in the process of investigating instances of cyber theft that appear to have begun in September 22 and persisted into October. There were six instances of cyber theft totaling $660,000. We've been engaged actively with federal and local law enforcement within the banking system and with our insurance company. We're pursuing the recovery of these funds aggressively. If unrecoverable, Our insurance may reimburse 25% of the losses. We elected to recognize a loss of $188,000 in Q3, reflecting the portion that occurred in September. We believe we've put controls in place to stop this from happening again and are undergoing an independent assessment of our related systems to ensure that we'll be operating in a best practices environment going forward. It's been a rough quarter in these respects, but we can see our way through them. Our bottom line was impacted by a series of items that we don't expect to be repeated. This is highlighted even further when comparing year-over-year numbers, given that 2021 income included almost a million dollars related to the forgiveness of our PPP loan. Regarding the strategic spending we made in 2022, in the end, we had a series of planned increases that we were unable to offset due to our gross profit margins falling below our expectations. Unfortunately, as it concerns staffing and some other strategic spending, the expenditures are planned and incurred well in advance of current results becoming clear. I'm sure that many of you are curious about the litigation we've been involved with and with BSF, our long-term personal care ingredients customer. Given that this litigation is pending, I will tell you what I can and can't expand much on this during Q&A. BASF filed a complaint in New Jersey in August, claiming that we were in violation of our supply agreement. They alleged several issues, the one having the biggest potential impact on nanophase being a claim that our sales through Celestins violate the exclusivity provision of the agreement. Also, in the same complaint, and I know that this may make a number of you more comfortable, BASF expressly states that it is not seeking termination of the agreement. In September, Nanophase filed a complaint in an Illinois court asking the courts to declare, contrary to BSF's claims, that, among other things, the exclusivity provision of our contract does not prohibit Nanophase's sales of Celestin's products containing zinc oxide as an ingredient. Although we believe BSF claims are wrong, we intend to keep negotiating with BSF in good faith to resolve these issues. If this can't be accomplished and litigation proceeds, the ultimate resolution would be difficult to determine with certainty at this point in time. All this being said, management believes that nanophase will ultimately prevail under the terms of the agreement and under governing law. Let's switch over to some more upbeat news. As I mentioned before, and this hasn't changed, your management team is optimistic. We'll share some of that good news with you during the rest of this call. We also intend to prove it with our results. From September 30th out through the end of 2022, we have more than $9 million in shift orders and POs in hand. Additionally, in November of 2022, we have almost 16 million in 2023 purchase orders in hand. For the most part, this demand, this future demand, this growth that has pushed us to become a $40 million company, is all based on brand partners and customers that we were working with before 2021. We've nurtured them, we've given them new products to sell, and the customers in their markets have demanded more of our products. Speaking of good news, now I'd like to introduce Kevin Curitan, our Chief Operating Officer, to discuss where we are and where we're going in greater detail. Kevin?