Nanophase Techs Corp

Thank you for standing by. We will be starting momentarily. Again, thank you for standing by. We will be starting momentarily. Good day, and thank you for standing by. Thank you for joining the Nanofave fourth quarter 2022 financial conference call. At this time, all participants are in a listen-only mode. After presentation, we will have a question and answer session. If you would like to ask a question, please press star 11 on your telephones. Please be reminded that this conference is being recorded. And before we begin, please keep in mind the words believe, expect, anticipate, plan, forecast, 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's 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 relationship, the impact of competitive products and technology, possible disruption in commercial activities occasioned by public health issues, excuse me, 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 forward-looking statements to reflect new events or uncertainties. I would now like to turn the conference over to Jess Jankowski, CEO. Please go ahead.

Thank you, Lisa. Good morning to all of those listening live and welcome to those who choose to listen later online. We're glad you could join us for our fourth quarter and full year 2022 investor call. Today's discussion will cover current results, the current state of the business, and some of our plans for 2023. Kevin Curitan, our Chief Operating Officer, will be joining me on the call today as well. I'm going to start this call a little differently than I have in the past. After my initial remarks, we'll do a much deeper dive into our financials. The good news is that we continue to see volume growth within our Celestins portfolio. We continue to add new customers and we continue to innovate. You may have seen our recent Fast Company Award where we were recognized as one of the most innovative companies in beauty of 2023. We won the number two spot on the list for our innovations in inclusive SPF-infused beauty that protects all skin tones from sun damage. This is the most recent award we've received relating to our Celescence products, which came atop two other major awards within the beauty industry in 2022. As a company, we found a sweet spot in a key and growing market with products where our core technologies and knowledge represent a commercial advantage and We've been able to successfully bring this to bear, evidenced by the rapid and broad growth we've seen with Celestis. Today, we want to bring you up to speed on what our results mean for the future and why we're so optimistic. I've said in the past, maybe ad nauseum to some of you, that the hardest thing about a startup and getting new technology into the market is in developing products that markets want. We're there. We can sell everything we can make, more than we can make, and we've been able to accomplish this growth on a shoestring. The nature of our financing over the past few years has been a blessing and a curse. We grew faster using fewer resources than most people thought was possible. With the lessons, we went from less than $2 million in sales in 2019 to more than $23 million in sales in 2022. We added $21 million in new revenue through new customers in new markets in three years. We've been entrepreneurial in leveraging knowledge, willpower, working capital, and grit to get where we are. The downside of all of this has been that a $40 to $50 million company requires a much higher degree of administration and proceduralization than we were built for entering 2022. Clearly, we had results in the second half of the year that were disappointing. Some of the notable expense side issues we're contending with have been one-time events, and some relating directly to our planned infrastructure expansion, which weighed us down financially as we worked to improve on our operational execution. I want to be clear. We're not going to grow the company further at the expense of being profitable. We're in a temporary situation that we're confident we can fix. Let's go to some specifics. Unless identified otherwise, all numbers will be stated in approximate terms. Our Q4 2022 revenue was $8.3 million versus $7.4 million for the same period last year, up 12%. Full-year 2022 revenue was up 27% at $37.3 million compared with then-record revenue of $29.5 million for the previous year. For the fourth quarter of 2022, we had a net loss of almost $2 million, or $0.04 per share. This was up $1.5 million, or $0.03 per share, compared to Q4 of 2021. This has had a material impact on our annual results. For the full year 22, we had a net loss of 2.6 million, or five cents per share. The story of this drastic change merits more discussion before I move on. I'll address it in two parts. First, in terms of gross profit impact, which is where we've struggled the most and where our efforts to improve execution are focused, and second, in operating expenses, where we also invested in infrastructure, but saw some one-time events that had an outsized impact. For gross profit, Q4 is typically a weaker quarter in our business and isn't representative of the full year. I'm just going to highlight the year-over-year numbers. For all of 2022, we've operated three production facilities, all in Illinois, one in Burr Ridge, one in Romeoville, and our newest and largest facility in Bolingbrook. All in, this represents approximately 320,000 square feet of space, the largest being the 260,000 square foot facility in Bolingbrook. Well, to reduce the near-term burden, we are subletting about a third of the Bolingbrook space. Our schedule for upfitting the building was some months behind, and we were only able to begin moving production in Q4 of 2022. We were able to run some of our production there late in 22 and finish the transfer of all of our sales filling and assembly late in Q1 of 2023. As a result of all these factors, this space has had several impacts on our costs, mainly our costs of goods. Our facilities costs are up 1.1 million year over year, almost all of which is charged to manufacturing. This accounted for about a 3% reduction in 2023 gross margin. Another critical factor was direct labor, or DL, the labor it takes to make the product, which was significantly higher than we expected it to be in 2022. Our product revenue was up 25% last year, but our direct labor was up over 40%. This trend was in the opposite direction of what we expected, given more automation and higher production volumes, both of which should have increased our labor efficiency. As a percentage of sales, direct labor expanded 2% year over year. A good number of these inefficiencies related to our facility issues as well. As timing stretched out on our move, the gains we expected to achieve through a more linear and less compressed filling and assembly layout obviously didn't come to fruition in 2022. We had additional labor costs relating to this move as we had to maintain multiple lines in two different facilities while we pushed to get Bolingbrook up and running. Now we accomplished all of this while we continued to produce at record levels. Lastly, The timing of the move and getting the building ready for production has delayed our ability to get a much higher degree of automation in place. Most of this automation has already been paid for with the bulk of the installation beginning in Q1 of 2023. All of these factors caused our expected direct labor numbers per dollar of sales to balloon year over year. The combination of the extra time it took us to move, along with the related postponement of the planned gains from a new layout, and the resulting delay in adding automation contributed to this large margin hit. Had we operated at 2021 labor efficiencies, which none of us were proud of, we would have seen another 2% pickup in gross profit last year. We expect to see a significant reduction in the labor cost per dollar of sales in 23, with more of this happening in the second and third quarter than in the first. Total 2023 direct labor should come in closer to 2021 direct labor than that of last year, which could lead to another 5% to 6% of improvement in gross margin. We made investments in 2022 that are going to bear fruit, not just in supporting more growth, but also in pulling costs out of existing production. Our supply chain team has been expanded and reorganized. Our warehouse is operating well, and we're continuing to improve upon that, which leads to greater throughput as well as reductions in costs. This has helped us put our inventory issues behind us, having remediated our material control weakness during 2022. Another benefit we expect to see in 2023 gross profit, beginning in Q1, has been a series of price increases we were able to implement, generally effective in Q1, to offset increases in materials costs and labor costs we saw in 2022. Kevin will cover this more during his comments. We were forced to be much more reactive than proactive in our pricing during 2022, as we have been in many areas. This was due to prioritizing growth, which we believe is critical in these types of quickly growing markets, over beefing up our lean overhead model. In terms of the expansion of our operating expenses, we need to separate investment from some of the singular costs we were hit with in 2022. We had two unfortunate events happen in Q3 and Q4 of 22, the bulk of which hit Q4. We were the victim of cyber theft, which resulted in a loss of $660,000. And we recognized $440,000 in legal fees relating to our ongoing litigation with BSF, which they initiated in Q3 of 2022. 2022 also saw a few other things that are indicative of ongoing operations. A year-over-year increase in non-cash expense of $460,000 for stock compensation relating to the accounting treatment for stock options. which were granted in December of 21 at a modern high in stock price. We also recognized $180,000 in accrued G&A consulting expense. This related to our application for an employee retention credit under the CARES Act. If we do not receive this credit from the U.S. Treasury, the expense will be reversed and no cash will have changed hands. And finally, we recognized about $300,000 in bad debt expense, which Between aggressive changes in our credit policies, along with additional resources to follow up on late payments, we expect to drop significantly going forward. Taken together, these items made up over $2 million, almost 80% of our loss for 2022. So most of these expenses are things that we don't expect to be structurally ongoing, but we do know there will be more legal fees due to our litigation with BSF. Regarding stock comp expense, It's a non-cash expense that's directly related to the price of our stock. Looking at the areas and operating expenses at the more structural changes we made to the business, let's start with R&D. R&D expenses, which in our company include engineering, were up $800,000 year over year. About 40% of this related to adding a few more engineers to support the plant expansion, equipment installation, and throughput optimization. The engineering increases are directly related to improving both production costs and throughput in the near term. They will pay for themselves this year and help us to support future growth more efficiently, avoiding some of the snarls of 2022. The balance of the increase was in more traditional R&D and was split in two roughly equal parts. First, we rounded out staffing in our R&D group to support the growing new product development and commercialization process. This includes the collaborative work required to coordinate this complex process with their counterparts at the brands we work with. This is becoming a strength of our company. When added to our strong formulation team, along with our long history making these regulated products, we are viewed as an excellent partner. This is true both for up-and-coming brands as well as brands that are adding sun care to their offerings and haven't the internal experience to approach a heavily regulated market on their own. This is something that will help us to ship more products to meet our strong demand. On the product development side, we'll also be able to continue to innovate and update our products to keep us competitive in a marketplace that requires innovation for there to be growth. And the second half, The other piece of the increase in R&D expenses represents something Kevin and I are very focused on, our continued investment in intellectual property. This spending is relating to legal fees for new patent applications, shepherding those applications through various patent offices in the U.S. and internationally, and maintaining all of our patents, as well as staff costs and testing costs. Nothing is more important to our brand partners than bringing safe, effective, and innovative technology to the market through Celescence. Let's discuss a key example of the doors our technology can open. In early 2023, we received a notice of allowance by the U.S. Patent and Trademark Office for our CLEAR technology, which is part of the active stress defense technology platform offered exclusively through Celescence. The Notice of Allowance covers Clear with a series of claims that are highly sought after in skin health and cosmetic applications. They are for use as a method of protecting skin from light damage. This is in our traditional wheelhouse. Another claim is in using Clear as a method of suppressing lipid peroxidation, which I know is a mouthful. Think of it as a way to reduce the formation of free radicals and the damage they can do to the human body internally and externally. Another is a method of preventing or reducing lines and wrinkles on skin. Also, as a method of preventing loss of skin elasticity. As a method of preventing thinning of the skin. And lastly, the use of our CLEAR technology as a method of protecting antioxidants in formulations. This technology represents a broad group of features that are marketable in a series of skin health and cosmetics applications. It will also provide the company with substantial added intellectual property protection in the health-infused beauty product space in the United States. This patent further builds upon the company's existing IP in skin health, including our original active stress defense technology patent, which was issued in March 2020. In addition, as we continue to drive innovation in skin health for all on a global scale, we received additional allowances for our plant-based UV absorber technology in Australia, an area with the highest incidence of skin cancer on a per capita basis, along with some in Israel. We expect to be greeted with similar success as we roll this out to other countries as well. Like minerals-based technology, plant-based technology represents our leadership in innovating marketable, next-generation technologies that benefit the health of end consumers. The investment in intellectual property is ongoing. It has to be. We're actively protecting our existing products which also means protecting our brand partners and our position in the marketplace. We're also continuing to develop and protect new technology. Much of this has not yet been introduced to any of our markets, but we expect it to be part of our next generation of product offerings. Moving to SG&A expenses, these were up 3.5 million to 7.5 million for 2022. Of this increase, 1.3 million or more than a third, related to the cyber theft, stock cop expense, and accrued consulting fees. These were some of the expected non-recurring costs mentioned earlier. Also as mentioned, we saw $440,000 in legal fees relating to our ongoing litigation with BASF in 2022. This will be an ongoing expense in 2023 as we work our way through the process. We feel that our case is a good one. but will also pursue a negotiated settlement with the goal of resolving this issue as quickly as is practical and beneficial to our company. Further, as I mentioned, we recognized about $300,000 in bad debt expense, which, with the additional resources we've added to our sales and customer experience team, we expect to control much better going forward. These items make up more than half of the year-over-year increase in SG&A. The balance of the increase is made up of staffing increases, making up about 20% of the total, then trade shows, exhibitions, and marketing, software costs, and a spike in our business insurance related to our growth. It's worth mentioning that the growth in Solescence hasn't only been in dollar volume, but our unit volume from incoming inventory through sales has expanded exponentially. We went from having 10 SKUs or product codes to having and managing hundreds of them in a few years. We also went from having thousands of items in inventory to millions of items. Our transaction volume throughout the company is a multiple of what it was a few years ago. Of course, with this complexity and the managerial challenges related to it, we've had to work on this. Companywide, as we work to absorb all the additional production volume, the new building, and the learning curves of a series of new people, frequently in newly established roles, There was too much happening managed by too few people and not enough germane experience in place entering 2022 to keep it all balanced efficiently. We added some critical senior leadership in sales, marketing, and business development, as well as in accounting and finance function. We also strengthened our customer experience team to help with the big increases in unit volume in total customers, new products, and new product launches. All of these things, whether in supply chain, engineering, R&D, or SG&A amount not only to an investment in our future, but also to allowing us to better control expenses and increase throughput. We also spent about $2.8 million in capital equipment in 2022, following $1.9 million in purchases during 2021. This investment represents much of the spending required to support the automation that we expect to profit from in 2023. I'd like to introduce Kevin Curitan, our Chief Operating Officer, to discuss progress in these strategic areas and their drivers in greater detail. Kevin?

Thanks, Jess. As always, I would like to begin by thanking our team for their effort in helping fulfill our mission in enhancing people's lives through the world's best skincare products, as we also work tirelessly toward creating a more valuable company for our shareholders. There is no doubt that we have work to do to improve our performance relative to becoming a customer-centric, world-class manufacturer. Many of the foundational investments, as Jess has already noted, needed to achieve this have been made. So our improvement now comes down to having the right personnel and procedures in place, both of which we have been working to address. We remain certain in our ability to achieve this result. We also have the certainty in what this past year has affirmed, that our company is not just world-class, but a world leader in the creation, formulation, and marketing of skincare and color cosmetics infused with SPF, and clearly a transformative organization in our market. We believe this has solidified our opportunity to create a significant business that will also generate world-class shareholder value and remain very confident in our ability to achieve this. With all of the above in mind, today I would like to share with you some of the fundamentals around our growth business, Solescence, that we hope will also build your certainty in the same outcome. To begin with, as Jess has already noted, our product revenue growth year over year is approximately 25%. I should also mention here, however, that delays from receiving packaging from brand partners during the second half of the year reduced revenue by about $2 million. The growth in revenue that we did experience was from a combination of revenue from existing brand partners, which grew around 17% year over year, and new brand partners. Growth as a share of revenue from these new brand partners which we define as companies in their first year of purchases from us, grew by over 50%. Further, the number of new brand partners we added in 2022 nearly doubled as compared to the number of brand partners we added in 2021. I know many of you have asked in the past about the disclosure of the names of these brand partners. We are limited in what we can reveal, excuse me, as most of our brand partners prefer to keep our business relationship confidential. However, a small set of clients have allowed us to mention them publicly. These companies include our longest standing and still one of our largest clients, Color Science, and other business segment and industry leaders such as Credo, Bloom Effects, Kinlo, and Relevant. In addition to these clients, we can also say that our brand partners also include multi-million dollar dermatology companies, a couple of those, and a couple of leading clean makeup brands. Each of these clients are influential in changing how consumers buy and use skincare and color cosmetics, and we are honored to be an instrumental part on how they succeed in serving the market. Coming back to our metrics, while achieving the growth noted earlier, we were also able to increase our average price per unit in 2022 by almost 9% above 2021's level. This is a result of a combination of price increases and product mix. However, The net increase in price per unit, despite having experienced significant increases in raw materials and transportation costs, helped us to achieve materials margins in 2022 equal to those in 2021. This is very positive as it turned around a trend at mid-year 2022 when our material margin was lower than in 2021. It also helps position us well for a stronger growth profit performance in 2023 than we have achieved in either of the prior years or really any of the prior years in our Celestin's business. All of these metrics, these key performance indicators are an affirmation of the fundamental strength of our business. They also help affirm our ability to grow our top line while we focus our investments and resources to improving overall profitability. I'll now turn it back over to Jess for some closing comments. Jess?