Nanophase Techs Corp

Good day, and thank you for standing by. Welcome to the Nanofaith's fourth quarter 2023 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 the session, you will need to press star 1 1 on your telephone. You will then hear a message advising your hand is raised. To withdraw your question, please press star 1 1 again. Please be advised that today's conference is being recorded. The words beliefs, expects, anticipates, plans, 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 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 conflicts, and all the risks indicated in the company's filings with the Securities and Exchange Commission. Nanophase understates no obligation to update or revise these forward-looking statements to reflect new events or uncertainties. I would now like to hand the conference over to the President and CEO, Jess Jankowski. Please proceed.

Thanks for that introduction, Carmen. Good morning to all of those listening live and welcome to those who choose to listen later online. Thanks for joining us today for a discussion of our full year 2023 results and, more importantly, an update of the state of the business and our outlook for 2024. We've seen many changes over the past year, and we believe we're beginning to see some of them pay off. Kevin Keratin, our Chief Operating Officer, is joining me on the call today. We have prepared comments, then Kevin and I will be available for some Q&A afterwards. Today, we plan on covering 2023 results, the ongoing litigation between Nanophase and BSF, and critically, how we position ourselves to turn the corner to sustainability and profitability going forward. We'll spend the bulk of our time today talking about the future as it reflects why we're all here. In discussing this, we'll also share some of the major efforts we've made to measure and manage to our 2024 plan through KPIs and a high degree of focus on critical areas that have presented chronic problems in the past. In Q4, we added an experienced purchasing manager, followed by an experienced buyer in Q1 of this year. We've seen the impact of our new VP of Operations, supported further by our purchasing ads, yield a higher degree of control and greater efficiencies in our operations. We've also just concluded an additional financing, which will give us some breathing room in terms of supporting the rapidly expanded working capital demands that our incredible growth has placed on our companies. We expect a degree to which this will help to enhance our operations this year to become obvious to everybody in the coming months. Before we continue, let's walk through the numbers. Unless identified otherwise, all numbers will be stated in approximate terms. Performance in Q4 2023 was similar to Q4 2022's, both falling short of our plan and our expectations. We saw $8 million in 2023's fourth quarter versus $8.3 million in revenue for the same period in 2022, and losses of $2.1 and $2 million, respectively. A marked difference between the two periods was that Q4 of 2023 represented a period of conscious investment in restructuring the business for greater efficiency. We were also able to lock down our inventory for 2023, which had historically been difficult. We invested a great deal of time in working through raw material shortages, helped substantially by the addition of our new purchasing resources. This hurt us in Q4. in the first part of this quarter, but we believe we now have it under control and have adopted a systematic approach to our supply chain management backed by experienced professionals that have already paid for themselves. Looking at the full year comparable numbers, we had $37.3 million in revenue for both full years, 2023 and 2022. In terms of revenue mix, Soleson's revenue was up 9% to $25.2 million in 2023, while personal care ingredients and advanced materials were down by 17 and 9% respectively. Some of our struggles with working capital, along with material shortages, kept our Celestin's growth lower than it should have been and lower than it will be in 2024. We were unable to satisfy all of the demand that we've had for Celestin's finished products, and demand continues to grow. We see the light at the end of the tunnel here, and expect these shortfalls to be much more manageable as we get further into 2024. This coalescence growth was largely offset by the 17% reduction in year-over-year BSF revenue I mentioned, amounting to $1.8 million. While we expect BSF revenue, which, as you may recall, relates to sunscreen active ingredients, to stabilize, it is something over which we have less control than in the finished products business we've built through coalescence. Analyzing the dynamics in each market, ingredients versus finished products, it's easy for us to draw the conclusion that our development of Celescence was the right strategy to maximize the value of our companies. For the full year of 2023, we had a net loss of $4.4 million versus a net loss of $2.6 million for the same period in 2022. This trend was certainly a disturbing one and one that we believe we've addressed effectively for 2024. I'll cover operating expenses first, then discuss our vision for improving gross margins and throughput materially in 2024. R&D expenses, which include engineering, were up by about 26% year over year. This was due to increases in staffing, product testing, and intellectual property development. These things are necessary to allow us to remain in front of the prestige cosmetics market, as well as to support new technologies, which we expect will keep us in the rapid growth curve we've enjoyed with Celestins to this point. We expect to see these expenses flatten in 2024. In terms of SG&A expenses, they appear to be relatively flat year over year, but they included some items that we don't expect to repeat. The greatest of these are legal fees relating to the BASF litigation. They amounted to $1.3 million in 2023 versus $400,000 in 2022. Almost 90% of the $1.3 million in fees were incurred during the first nine months of 2023. Related fees for Q4 of 2023 amounted to $130,000, or 10% of the total, showing a marked decline. Legal fees have gone down as we continue to work with BSF toward a mutually beneficial solution, focusing on business issues more than legal issues. While it's not over until it's over, We're optimistic that we'll resolve this litigation soon and be able to focus all of our attention and energy in building the value of the business. Not reflected in any of our 2023 SG&A numbers is the reduction in force and rationalization of operating expenses we implemented during mid-Q4. We expect to see people-related expenses go down, which will contribute further to what we expect will be a reduction in overall SG&A for 2024. We also had an additional $500,000 in interest expense due to increases in interest rates and our need to finance our expanded working capital demand, mainly through debt. Our recent financing will help us to reduce our dependence on debt in this regard, along with expected interest expenses. In addition to manufacturing efficiencies, which we'll touch on in a minute, all of the things we just discussed will contribute materially to 2024 profitability. Now I'd like to address the changes we're implementing in manufacturing that we expect to yield material improvements. A function of having to wrestle with our working capital needs to such a great extent in 2023 was that we were forced to delay a series of relatively modest capital equipment enhancements that have hard cash payback periods ranging from 15 to 30 months, not to mention the advantages of higher throughput in helping us to capture our growing demand. I have three projects in mind that, given our recent financing and the stability it has added, we're currently completing. The first is the installation of a lab that will allow us to complete more of our microbial testing in-house. Every run of Celestin's products that we produce currently gets sampled and sent to an outside lab for microbial testing. This is a time-consuming and expensive process. Our QC costs have climbed as we've grown, and more and more batches, a good thing, have resulted in higher and higher testing costs, as well as the associated delays with sending samples to outside labs. We're required to run tests that take more than a week and must be completed in final packaging. We've had our microbiologists working to build our own lab beginning in 2022. We started the equipment investment in 2023 and had to hold off due to cash pressures. This was a double-edged sword, costing more money in outside testing, which is a direct hit to our gross margin, His volumes increased, causing more tests, and we were unable to capitalize on our investment to that point. We'll invest less than $400,000 in 2024 to finish this project. It will have a hard dollar payback of less than two years, saving approximately $300,000 per year at current volumes, and it will take a week or more out of our cash cycle. This will also lead to happier customers. The second project involves the transition of our wet processing lines from Romeoville to our Bolingbrook facility. When we found extra time in Q4 as production was held up, we invested some of that time in beginning to transition our wet processing to our Bolingbrook facility. Given that we now do 100% of our filling and assembly in Bolingbrook, this is the logical next step. This project has a two and a half year payback, and we expect it to yield more than $400,000 per year in hard cash savings, or even more as volume increases. The third project involves the further expansion and automation of our filling and assembly processes in Bolingbrook. We have five clean rooms running, or runnable, in Bolingbrook, two of which are fully utilizing a high degree of automation. For a relatively small investment, we'll add automated capacity to two of the remaining three rooms, which will increase throughput while reducing costs per unit. As our business volume and product suite has expanded, We found that it's much more efficient to have different rooms dedicated to different types of filling and assembly, be it for tubes, toddles, sticks, bottles, or whatever configuration the market desires. Some equipment is currently serving double duty and needs to be reconfigured as we switch between product types more often than it makes sense, given our growing volumes. We expect this project to have a roughly 15-month payback period. These three projects in total will cost just over $2 million, with some of this total expenditure having already been made in 2023. We expect payback for the combined projects to be less than two years. We also expect that these three projects will allow us to produce up to $100 million in Celestin's finished products. This additional capacity will become available by late summer. While we're not nearly satisfied with our 2023 results, We are doing the things we must to capitalize on the fantastic products we continue to develop and sell. Now, I'd like to ask Kevin Curitan, our Chief Operating Officer, to share his comments and his optimism around the progress we're making and the approach we're taking through 2024. Kevin?

Thanks, Jess. To our investors, thank you for your continued commitment, and to our teammates, thank you for your tireless efforts in helping us achieve our mission. Today, my role is to provide more details about how we are evolving our management practices to enable our company to translate revenue into sustainable, profitable growth. While I'm sure some of our shareholders would prefer that we just do it, we also realize that several of our investors would like the reassurance that we understand the sources of the issues we have faced and therefore also understand and moreover can fix them. To begin, in part because there has been some discussion on the message boards to the contrary. I want to be sure that our investors understand the connection between our ability to bring the world's most innovative SPF-infused skin care, complexion, and color cosmetics products to market and our ability to manufacture the novel aspects of these products. The characteristics of the zinc oxide and the dispersions that we produce to build our formulations are at the core of what drives our market differentiation. These methods are at a minimum novel, and in some cases, one of a kind in terms of how they are practiced in our industry. This makes us unique as a vertically integrated manufacturer, still the only manufacturer of this type that we are aware of in our industry. This integrated structure means that we manufacture over 30% of all the materials that we use to make the products that our brand partners take to market. It also adds a level of complexity to our business that our competitors don't have, which also gives us a competitive advantage that they have a challenge to match. Our investment in IP further buttresses this critical point of difference. While in fact there are some elements that we could outsource, we also would take a risk of teaching the market more about what we do and how we do it. As those of you who are familiar may know, rendering patented know-how into physical products typically will include trade secrets that make all the difference in terms of achieving the performance attributes and the aesthetics that we seek. It's vital to our future and ultimately our profitability that those secrets remain so, and therefore we continue to make the unique materials internally. Obviously, these elements of the business add to the complexity of how we manage and scale our company. The good news, as Jess has already mentioned, is that we have at long last built a strong operating team, the strongest we believe since the inception of Nanophage. which has a unique ability to both build the processes we need to improve internal controls and execution, and the capability to operate the company as we grow to a nine-figure organization over the years to come. An important part of the change in our operating model is the implementation of key performance indicators, or more commonly referred to as KPIs. The KPIs we have established are how we measure both our company's performance and the performance of our teammates. The three KPIs I will talk about today, and we will discuss on a continuing basis as we measure our measures that most significantly impact profitability and customer satisfaction. These are inventory accuracy, throughput, and on-time info. I'll discuss what each of these are and their implications for our company a bit further. We'll start with inventory accuracy. This KPI measures whether we have both the quantities of material we need to make our products and if we have them at the time they are needed to fill the orders from our brand partners. Failure in this area was the overwhelming contributor to our poor performance in the second half of 2023. causing frequent production delays as we found ourselves short of the necessary raw materials and packaging to meet production demands. Needless to say, this led to substandard margins, unmet customer demands, and related inefficiencies. In order to achieve any of the other KPIs requires us to be at 90% or greater for the inventory accuracy KPI. Not simply at the end of a given reporting period, but every day. During Q4, this number never exceeded 80%, being as low as 50% at the beginning of Q4. At the beginning of Q3 and in mid-Q4, we made some changes to our supply chain team. Again, this is something we continue to mention because it's so important to our company. including bringing in an experiencing purchasing leader and bringing this group under the responsibilities of our VP of operations. In Q1 of this year, we further augmented our buying team, and now we expect to bring this KPI, inventory accuracy, in compliance with our goals by the end of Q1 2024. The next KPI is throughput. fundamentally measures how we perform relative to leveraging our assets and meeting our cost targets as related to labor efficiency. This measure is used at each of the process levels, at making the zinc oxide, making the bulk lotions, and finally, the finished goods. As you can imagine, because of the poor results related to inventory accuracy, we have poor throughput in both Q3 and Q4. Because of the high percentage of our material requirements that are produced in-house, our performance related to throughput can be a vicious cycle if we underperform on internal production or a virtuous cycle if we are meeting our performance metrics. During Q4, we were less than 80% of our target for the entire period, though the performance steadily improved throughout The final KPI we will discuss is our on-time and full KPI, which is commonly referred to as OTIF or OTIF. We reference this as a customer satisfaction measure as it is one of the two key requirements for retail brands to succeed. Meeting this measure means that brands have the products they need to sell at the amounts they need to sell them at the time they need them. in the retail store. As this measure is an outgrowth of the prior two, it will be no surprise that we underperformed with ODIF well under 70% in Q4. Note that the top organizations in our industry and in others seek to be greater than 95%. This is our goal for 2024. And further, we expect to reach greater than 90% in Q2 to early Q3. In closing, I do want to mention one other item. I'm sure many of you are familiar with the phrase and philosophy coined by Kara Lawson, handle hard better. This phrase and moreover what it embodies is an important KPI of sorts for us. Handle hard better is for those people and organizations striving to do great things And it is about changing your paradigm from expecting things will get easier over time to expecting that they will not. According to Coach Lawson's concept, what must happen for any person or organization who wants to achieve greatness to do what others have not is to learn to handle what is difficult better. Our company is regularly doing things no other company has done before in terms of the innovations we create and the manufacturing techniques needed to bring them to fruition. We are seeking to do and be great. So this is our challenge, to handle hard better. We are funded and most importantly have the right team to get this done. As my father would say to this statement, Your actions speak so loudly, I can barely hear what you have said. So we will and do expect, in fact, to let our results in 2024 and beyond be our statement. We look forward to discussing these KPIs further in just a few weeks as we report Q1 2024 results. Thank you for your time and attention. Back to you, Jess.