Nanophase Techs Corp

Good day, and thank you for standing by. Welcome to the Nanophase Technologies Corporation's second quarter 2024 earnings 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 an automated 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 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 felons 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 conference over to your speaker today, Jess Genkowski, President and CEO. Please go ahead.

Thank you, Shannon. Good morning to all those listening live, and thank you to those following up later online. While we're rolling, we had a strong Q2 following a strong Q1, and we've got our foot on the gas working to make 2024 a record year for nanophase and solescence. Kevin Curitan, our Chief Operating Officer, is joining me again on the call today. We have some prepared comments that will be available for some Q&A afterwards. Q2 of 2024 saw us with quarterly revenue of $13 million. For the first half of 2024, we had almost $23 million in revenue. To put this in perspective, $23 million in revenue for the first six months of 2024 is 33% more than our $17 million in full-year 2020 revenue, which was a major milestone at the time. We believe that second-half revenue will exceed the first half, with the potential for us to achieve more than $50 million in revenue for the year. With upside, we can do better than that. Before I walk you through the numbers, I'm going to spend a minute describing our business at a high level. We've had several investors asking questions about this, and I want to be sure that we bring clarity to the story. The better we understand it, the more exciting our progress is. Nanophase and its wholly-owned subsidiary, Solescence, are almost two sides of the same coin. Nanophase is an FDA-regulated manufacturer of bulk pharmaceutical ingredients. These active ingredients serve as the backbone for everything both companies do. We started with an active ingredients business in Nanophase, providing the safe and effective UVA and UVB protection found in minerals-based sunscreens through BSF. This market grew significantly in the late teens and into the early 20s. There was a limiting factor in the growth of minerals-based sunscreens, however, and that was the whitening effect of most zinc oxide additives. Our initial claim to fame was that our coated zinc oxide active ingredient, which we exclusively supplied to the market through BSF, was superior to other materials-based ingredients, minerals-based ingredients, I should say. This continues to be a good market for us, as BSF continues to be a good partner in that market. In 2016 and 17, we realized that we needed to take a new approach to capitalize on the growing demand for minerals, particularly for zinc oxide in the market for daily wear and functional cosmetics. Dr. Harry Sarkis, along with a cast of talented scientists, was able to take our particle performance beyond the next level. We developed the Celescence technology to allow larger zinc oxide particles, referred to as non-nano in the industry, to be incorporated into various lotions without exhibiting what is referred to as ghosting in the market. We then built a formulating team with solid industry experience to help us to show cosmetics companies, which we refer to as brands, to see the benefits of Celestin's technology. By enabling very uniform and flexible particles, then a series of methods by which to disperse and formulate with them, We were able to create finished Prestige cosmetic products that had the functionality of sunscreens built into everyday cosmetics. We found the holy grail in a respect. People getting ready for their day would be able to know they were getting protected against UVA, UVB, and other skin damage, which everybody wants, but by a product that otherwise seemed just like the high-end cosmetics they would typically use anyway. Coupling this massive advancement with the consumer trend against chemicals-based UV protection, along with the FDA's repeated assertions that minerals are proven safe for use, whereas chemicals-based absorbers lack such public proof, we hit this market at an excellent time. We took our FDA compliant practices, which presented a barrier to entry for many potential competitors, and with whom many were unfamiliar, Many of the FDA-compliant practices, I should say, were unfamiliar to our Celessence customers and coupled it with 25-plus years of experience making safe, minerals-based active ingredients. We created a value proposition that is only just starting to show its true potential. Celessence sells through brands, not direct to consumers. This means you'll rarely see mention of Celessence in brand advertising or on packaging, but we are the enabling feature of the products our brand partners sell. That was a quick summary, I know, but we wanted to take a few minutes to ground our new investors, potential investors, in why we've been so successful and as a refresher for everyone else. Okay, now let's walk through the numbers. Unless identified otherwise, all numbers will be stated in approximate terms. We had a strong second quarter with $13 million in revenue, a 32% increase over first quarter revenue, and a 10% increase over the second quarter of 2023. We had a 29% gross margin, including a write-down of our component inventory of approximately $500,000, reducing our Q2-24 gross margin by about 4%. For the six-month period, we had $22.9 million in revenue with a 32% gross margin. I want to spend a minute discussing our inventory, which you may have noticed is up $3.8 million since year end. We intentionally bulked up our inventory to ensure that we could support all of the growth we're seeing now. I want to explain the write-down and how we addressed the circumstances that created it. The write-down was related to components that became obsolete in Q2, most related to two customers. Given our past struggles with supply and the three- to six-month lead times on component supply, we decided to lean forward and order extra components in 2023 without having a guarantee that they would be used. We were focused on strengthening our supply chain by ensuring supply, which you may recall was a major issue at that time. For Q2, the customer's demand changed and product specs came into question, resulting in obsolescence without an opportunity for us to claw anything back. We acquired these components in 2023 prior to implementing many of the changes we're seeing operate so effectively during 2024, which I'll now review. To protect ourselves from production shortfalls, we've done several forward-focused things that we believe will mitigate the demand issues we were plagued with much of last year and certainly during 2022. We increased our staffing in our supply chain area. We're performing regular cycle counts of all of our inventory and we review weekly KPIs with targets for raw materials requirements at four weeks and 12 weeks out. We hover between 98% and 100% on these metrics, giving us a much more comfortable margin of safety as we approach actual production dates. We've also added a full-time dedicated scheduling professional with industry experience. This will allow our operating people to better focus on maximizing efficiencies and dealing with issues on the plant floor more immediately. Having such focus and familiarity with our inventory has resulted in a raised awareness of what our risks are and how to control them. On the other side of the equation, we've adopted a uniform approach in the way we work with our customers in terms of sharing responsibility for financing raw materials inventory and managing market risk. Between our supply chain and sales teams, we've implemented policies that we believe have achieved a good balance between having enough inventory on hand to meet demand not having to finance 100% of it in advance, and avoiding unnecessary cost exposure through the accumulation of inventory without supporting purchase orders or customer deposits, or often both. Without this $500,000 reserve, there would have been a 4% and 2% increase in Q2 24 and first half 2024 margins, respectively, bringing our gross margins up to approximately 33% and 34% for the same respective periods. This was a long way of explaining that we don't believe this type of write-down is something to expect going forward. In addition to our supply chain improvements, we also expect gross margins to improve through the combination of additional order volume, better management of smaller production runs, and the addition of new capacity as we go through 2024. We also expect second half 24 volumes to be at least 20% stronger than the first half. Operating expenses year over year were down about a million dollars. The bulk of the savings in SG&A was due to the BSF litigation costs tapering off as we settled our lawsuit with BSF in Q1. We remain focused here on operating expenses and expect to continue to control expenses. We're also seeing the benefits of our Q4 2023 restructuring as operating expenses have not grown in light of our incredible growth in 2024. The bottom line showed excellent progress with Q2 24 net income of $900,000, a $500,000 improvement over Q2 of 23, even with the $500,000 breakdown we just discussed. For the six months ended June 30th, 2024, we had $1.7 million in net income compared to an $800,000 net loss for the same period in 2023, a $2.5 million swing. In a few minutes, Kevin's going to address our operating performance. Many of our KPIs will be enhanced further through our investments in additional equipment and, at least as importantly, additional experienced technicians to keep them running smoothly. As we've had the opportunity to augment our production staff, we've benefited from bringing in more people with significant industry experience. This has created not just the benefit of having more experienced hands doing the work, but also the advancement of knowledge among our loyal, hardworking, and talented internally developed team members. We expect both our units produced and revenue generated per employee to continue to improve through these efforts. We did a bit of a deep dive into capital projects last time, so today we'll just leave it at a high level. We intend to fund any required capital through operations in 2024, with our initial projects focused on bringing our potential capacity up to about $100 million in Celestin's finished products. Total capital expenditures for this year should be in the $3 to $6 billion range, some of which may well slip into 2025. Operationally, we're focused on improving our labor per unit while also ensuring that our throughput can meet expected demand through targeted capital improvements. We have some opportunities in our current pipeline that could generate significant growth in 2025. This is in addition to the expanded demand we're expecting to continue from some of our existing Solescence customers. Now I'd like to invite Kevin Keraton, our Chief Operating Officer, to share his thoughts on our progress so far and the approach we're taking going forward. Kevin? Thanks, Jess.

As usual, I'd like to begin by thanking our teammates who every day demonstrate that we are indeed best in the industry at what we do, and our investors who continue to trust our leadership as we prove that through enhancing lives through healthy skin, we can profitably grow at more than three times the growth rate of our industry. I also would like to thank the families of our teammates for their energy and support as we take this journey together. During the Q1 conference call, we promised to not only review the operating KPIs we have discussed in the prior calls, but to also introduce and discuss our growth KPIs. So let's jump right in. First, the operating KPIs. Starting with inventory availability, which our purchasing team considers the on-time, in-full, or ODIF metric for the materials and components we buy. We have improved on our performance from last quarter as this metric is now 100% of our target performance, which is to have greater than 95% availability for materials due in 12 weeks and 98% availability for materials due in four weeks. This is both an excellent and vitally important result, as without this outstanding performance, we wouldn't be able to achieve our other two operating KPIs. Our purchasing team has also made good progress on implementing our vendor development and management programs, which includes, amongst other elements, bringing in additional qualified sources from around the world for key materials to minimize our out-of-stock risk and reliance on single source suppliers where possible. Their work gives us a high level of confidence in our ability to support even greater volume growth with minimal risk of supply shortages. Our second operating KPI, throughput, remained essentially unchanged from Q1 at 72% of target. However, this was done on an overall volume increase of 158% over Q1. This improvement in total units produced achieved by our manufacturing and supply chain teams, is what enabled us to achieve the record performance for Solescence. In Q3, we will need to achieve a similar 150% improvement in throughput to meet what is record levels of demand for our products, which is largely a result of substantial increases in both domestic and European sell-through for our largest brand partner, ColorScience, and over a dozen successful new launches with new brand partners such as Tatcha. Our final operating KPI, ODIS, or on-time in full, remained below target at less than 50% of our goal. As you will hear when we discuss our growth KPIs, our growth in Q2 significantly outstripped our improvements in output, which has meant that we had to make tough production decisions, such as operating at suboptimal production runs to ensure our brand partners have the product quantities they need for a successful new launch. To put even greater focus on improving ODIF, our company is implementing overall equipment effectiveness or OEE methodology to target the specific changes needed to improve our operating uptime and therefore throughput. Our work in this area only began a little more than 60 days ago. and we are already achieving small wins as we have made solid progress in increasing uptime. This improvement resulted in our company achieving the best revenue month in our history during July. Let's now spend a little time on our growth KPIs, order velocity, customer acquisition cost, and pipeline value. Order velocity measures the rate that we are generating new sales orders for our business. While we measure this weekly, it is particularly informative when we look at the year-to-date order velocity versus plan. On a year-to-date basis, our order velocity is running at 125% of plan, an excellent result. Kudos to our business development and our product development teams for their outstanding work in this area. Similarly, the BD, PD, and marketing teams are driving improvements in pipeline value which measures the total value of new business opportunities we expect to convert to revenue, and our customer acquisition costs, or CAC, which measures how much it costs us to acquire the new business. While our pipeline value is not yet meeting our very lofty goal, which is essentially to double 2024 revenue, we are at over 60% of target, still a very respectable result given the more than 40% year-over-year growth we will achieve in 2024. Further, we are doing this while lowering our customer acquisition costs by 30%. While this is a solid performance, it also suggests that it's time for us to consider even greater investment in departments that drive revenue growth. We've already started this work with programs underway to expand both the staffing and capabilities of our product development and quality teams. In closing, as I mentioned in the press release, our company, through the close collaborations we have had with our brand and supplier partners, is redefining what it means to have healthy, beautiful skin. This work is possible because of all the fabulous teams within our company. We have talked again and again about handling heart better, and they answered the call. We then asked them to raise their expectations for what great looks like, and they are achieving this, too. We have and will continue to push our teams hard, but every time, every team, from finance to quality and everyone in between, rings the bell. While our technology and know-how is second to none, it's our people that ultimately make the difference, and we and will be the reason we continue to outperform our market in terms of growth and profitability.