Nanophase Techs Corp

Thank you for standing by and welcome to Nanophase first quarter 2023 financial conference call. At this time, all participants are in a listen-only mode. After the speaker 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. 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 the number of important factors that 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 activities 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 hand the call over to President and CEO, Jess Jankowski. Please go ahead.

Thank you, Lateef. Good morning to all those listening live. and we also welcome those who choose to listen later online. Thanks for joining us today for a discussion of our first quarter 2023 results, the state of the business, and our outlook for the balance of the year. Kevin Curitan, our Chief Operating Officer, will be joining me on the call today. The first quarter was bumpier than we'd hoped. However, it ended with a good deal of positivity as we saw some of our improvements begin to take shape. As we discussed recently, January was a tough month with a few weeks being devoted more to locking down inventory rather than building and shipping product. Examining the trends throughout the quarter, revenue was back loaded. We had roughly 20%, 30%, and then 50% of our quarterly revenue shipped during January, February, and March respectively. With January being a $2 million month, the entire quarter skewed toward a poor gross profit and to a negative bottom line. The better news is that February was stronger and March was stronger yet, exceeding $4 million. For the entire first quarter of 23, even given a weak January, we still saw a 2% gross margin pickup in direct labor utilization over 2022. We'll cover more of this when we talk about the specific numbers, but margin improvement and profitability are a major focus for us from top to bottom, and you'll be hearing a lot more about it through 2023. Now I wanted to spend a little time talking about our operations function, particularly supply chain and manufacturing. We've been working to fix this part of our organization over the past few years. Through these efforts, we achieved many incremental improvements with a lot of hard work by the members of our operations team, but without enough day-to-day attention at the senior level. The litigation that we're involved in with BSF, which began in August 22, has been a major distraction for our company. It certainly impeded our progress in implementing the changes to our operations functions that are necessary for us to both continue to grow and, more importantly now than ever, to do so with greater profitability and cash flow. The time and money spent on this litigation, were we able to invest it in addressing our operations issues instead, would surely have had a significant positive impact on our gross margin and our bottom line. Speaking for the two of us on this call, Attending to the needs of a rapidly growing, rapidly scaling company while being chronically short on infrastructure was a necessary step in developing the business and something we've been committed to doing, but we weren't able to achieve it quickly enough. The distraction of litigation certainly didn't help us in moving these changes along. Looking forward, the best news here, the news that's keeping all of us at Nanophase and Celestis enthusiastic, is that we're finishing up the process of a major overhaul of our manufacturing organization. Last year, we added a seasoned director of supply chain, and we believe our inventory issues are behind us. We're now focused on improving our purchasing function. We believe there are significant opportunities to take greater advantage of our increased buying leverage, which has been created by virtue of our rapid volume growth. Finally, we concluded our search for a highly experienced VP of manufacturing this week, with an expected start date in early June. We found a professional whom we believe will be an immediate contributor, and our expectations for them and their impact on our manufacturing function and the company as a whole are very high. In 2022, we built out the R&D and sales functions, adding experienced leadership and support staff to handle our increased transaction volume. These areas have been functioning well and are well aligned to support our growth plans. We also added a senior financial leader in the second half of 22, which will allow us to spend more time on identifying and addressing opportunities for cost reduction while remaining compliant with the regulatory load that comes with being a public company. We expect this to allow us more freedom to operate and critically to enhance the enterprise value of our company. Before we continue, let's walk through the numbers. Unless identified otherwise, all numbers will be stated in approximate terms. Our Q1 2023 revenue was $9.5 million versus $8.2 million for the same period last year, so we were up 16%. At $9.5 million, Q1 of 2023 also represents the highest revenue we've ever recorded in the first quarter. Q1 23 revenue also exceeded Q4 22 revenue by 14%. For the first quarter of 23, we had a net loss of just under $1.2 million, or two cents per share, compared to earnings of less than a penny a share in Q1 of 22. The Q1 23 loss had several drivers that I'd like to cover in more detail before moving 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 we expect to see the greatest improvement this year. And second, in operating expenses, where we've made some significant investments in infrastructure, but also got hit by a few notable expenses that were difficult to anticipate or control. For gross profit, we put ourselves in a hole during January by missing too much production time while locking down year-end inventory. We shipped just under 2 million in January, resulting in too little variable margin being generated to cover our fixed costs. We believe we've addressed this appropriately and don't expect to lose more than a day or two during 2023's year-end process. While that doesn't help now, it's indicative of our getting a better handle on materials flow. Ultimately, This will be a critical driver of both throughput and margin increases. As I mentioned during our year-end call, we are now operating three production facilities, all in Illinois. We have 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. On average, our facilities costs are up about $250,000 per quarter, representing a gross margin hit of about 3%. To reduce the near-term burden, we've been subletting about a third of the Bolingbrook space. Our schedule for upfitting the building was some months behind last year, and we were only able to begin moving production in Q4 of 2022. Today, we have substantially all of our filling and packaging operations running out of Bolingbrook. We also have a much greater capacity to generate more revenue volume with greater efficiency. We expect our new facility to be a net contributor to margins in 2024. Given the headwinds we've had, it's important to remember that we continue to produce at record levels. This alone makes this the area that will yield the most immediate and greatest return in terms of our profitability than our valuation, which is why we're all here. For Q1 of 23, The fact that we saw a 2% increase as a percentage of sales in direct labor utilization, even after our January struggles, shows the initial return we're getting on the investments we've made in Q1 to streamline operations. In terms of 2022 volume, this modest gain alone would have added $750,000 to our bottom line. We are going to grow in 2023, so the benefits will multiply. Given the addition of our new manufacturing leader, On top of the installation of new automation that we began in Q1, we expect to be able to add at least two more percent, more likely four percent or more, to our gross margins as we continue to improve our process during 2023. Another major opportunity for margin improvement, which I alluded to earlier, will be better management of our monthly volumes. Volatility of both monthly customer demand and our own production has eaten into profits significantly over the past 18 to 24 months. The past two Q1 reports underscore this. With the higher functioning supply chain team in place, and now the addition of a seasoned VP of manufacturing, we're expecting to smooth out some of the monthly production and shipping volatility that has been a problem since the Celescence business really took off in 2021. The ability to match production and sales to fixed costs is a practice that we expect will have a marked impact on our bottom line, and we're pursuing this aggressively. Also, Another margin contributor that's coming online is the benefit from a series of price increases we put into place that were generally effective beginning sometime in Q1. This will help to enhance our margins and offset cost increases as we continue through 2023. Speaking of cost increases, the last focused area of improvement we're counting on will be the impact of a stronger purchasing function. As the other changes we've made, including the June start of our VP of Manufacturing metabolized through the organization, will apply greater focus to purchasing and should see some relatively immediate benefits. As you can see, we're going at margin improvement from every angle that we can, and I think this will play out well for the company and all of its stakeholders. There will definitely be more to follow on this. Looking now at operating expenses, we saw R&D expense, which includes our engineering group, up by 50% year over year. About half of that was related to compensation expense and part of that related to the addition of engineering staff in 2022 to help us with the upfitting and optimization of our new facility in Bolingbrook. We expect these engineering ads to pay for themselves in 2023. Another 25% of the variance in R&D expenses was from increases to legal spending relating to securing our intellectual property. These legal expenses help us to actively protect our existing products and our position in the marketplace by deepening the moat around our technology. We're also continuing to develop and protect new technology. This is a technology that will drive the next generation of product offerings. Although we've won many awards, coveted awards, for our Celestis products over the past few years, this is an area that requires continued investment to keep us in the premium end of the markets we serve and to continue to drive growth. Moving to SG&A expenses, These were up $750,000 to a little over $2 million for the first quarter of 23. Of this increase, 65%, or almost $500,000, related to increased legal fees incurred due to the BSF litigation. The bulk of the remaining increases related to compensation, primarily due to the 2022 additions of senior leadership on our sales, marketing, and business development team, and the addition of our controller. We also saw interest expense more than triple $110,000 increase from the same period in 2022, primarily due to rapid increases in the prime lending rate in the last 12 months. Having much of this organizational work completed or near completion, we're now in a better position to increase our focus on capturing the bottom line benefits that these changes were designed to deliver. We expect this to allow us more freedom to operate and, critically, to enhance the enterprise value of the company. I'd like to introduce Kevin Keratin, 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 efforts 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. I will also add a thank you to all of our investors who remain steadfast in their support of our company. As Jess has already mentioned, our primary focus is on returning to profitability. We know that until the bottom line results are seen, these are empty words given what has been four consecutive quarters of results that are not reflective of our standards and expectations. To this end, I will keep my prepared marks very brief but certainly look forward to answering questions that our investors may have. Over the past two months, we have spent an incredible amount of time identifying and recruiting the operational leaders that will further our profit objectives while empowering key engineering personnel to drive changes that have had a significant impact in uptime and throughput. We are further supporting this investment by taking advantage of the strength of our pipeline and our solid backlog to redirect a portion of our investments in business development toward improving operations. This does not mean we have stopped innovating and creating the best products in the industry. In fact, we hope to have several more exciting announcements in this area in the next couple of quarters, but that we are fully embracing the need and our ability to drive cash-positive growth. We remain completely confident and certain in our ability to achieve profitable performance in the very near term. With that, I'll turn back to Jess for some closing comments. Jess?