Northern Technologies International Corp (NTIC) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Northern Technologies International Corp. Second Quarter 2019 Earnings Call. (Operator Instructions) As a reminder, today's call will be recorded.

As a part of the discussion today, the representatives from NTIC will be making certain forward-looking statements regarding NTIC's future financial and operating results as well as their business plans, objectives and expectations. Please be advised that these forward-looking statements are covered under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and that NTIC desires to avail itself of the protections of the safe harbor for these statements.

Please also be advised that actual results could differ materially from those stated or implied by the forward-looking statements due to certain risks and uncertainties, including those described in NTIC's most recent annual report on Form 10-K, subsequent quarterly report on Form 10-Q and recent press releases. Please read these reports and other future filings that NTIC will make with the SEC. NTIC disclaims any duty to update or revise its forward-looking statements.

I would now like to turn the call over to Patrick Lynch. Sir, you may begin.

Thank you. Good morning. I'm Patrick Lynch, NTIC's CEO, and I'm here with Matt Wolsfeld, NTIC's CFO. Please note that the financial results for our fiscal 2019 second quarter were included in a press release issued earlier this morning, a copy of which is available at ntic.com.

During this call, we will review various key aspects of our fiscal 2019 second quarter financial results, give a brief business update, comment on our net sales and earnings guidance for fiscal 2019 and then conclude with a question-and-answer session.

I am pleased with our overall growth and strong performance, which is a testament to the diversified business model we have created. Nevertheless, the softness in North American ZERUST industrial and NTIC China sales we mentioned last quarter continued during the fiscal 2019 second quarter. We believe this was primarily due to slowing global growth and the ongoing concerns regarding the U.S.-China trade dispute.

Offsetting this softness was significant growth at Natur-Tec, our bioplastics business. Natur-Tec represented almost 32% of second quarter net sales compared to nearly 17% for the same period last year. This growth demonstrates the strong platform we have created to expand NTIC's product, end market and geographic diversification.

Due to the ZERUST industrial end market softness during the last 6 months, fiscal 2019 has started slower than expected and has caused us to adjust our full year guidance. Therefore, we now expect fiscal 2019 net sales to come in between $58 million and $60 million and earnings to be between $1.70 and $1.80 per diluted share. Based on these estimates, we are forecasting net sales to grow at least 14% and earnings to grow at least 22%.

We're currently monitoring our markets for any signs of further weakening but currently expect that the second half of our first -- of our fiscal year will show growing sales and earnings as a result of better global demand for our ZERUST industrial products and Zerust Oil & Gas solutions. We also anticipate continued strong growth for our Natur-Tec compostable plastic solutions.

So with these comments, let's examine the drivers for the second quarter. For the second quarter ended February 28, 2019, total consolidated net sales increased 9% to $13.3 million as compared to the 3 months ended February 28, 2018. Broken down by business units, this included a 108% increase in Natur-Tec sales, partially offset by an 8.6% decline in ZERUST industrial net sales, a 12.9% decline in net sales from NTIC to its ZERUST joint ventures and a 38.3% decline in Zerust Oil & Gas net sales.

Total net sales by our joint ventures, which we do not consolidate in our financial statements, were $27.8 million for the fiscal 2019 second quarter compared to $30.2 million for the same period last fiscal year. This 8.3% decline in JV net sales was the result of softer global demand across many of our end markets.

We believe the decline in North American ZERUST industrial sales during the fiscal 2019 second quarter was due to ongoing macro concerns and uncertainties, which are, in turn, having an impact on the supply chain and purchasing decisions of certain customers. Currently, we still do not believe this is indicative of a deeper slowdown. But we continue to actively monitor global market trends, and we will adjust accordingly if demand deteriorates further.

Net sales by our wholly owned NTIC China subsidiary were $3 million for the second quarter of fiscal 2019 compared to $3.2 million for the same period last fiscal year. The approximately $200,000 decline in NTIC China sales during the fiscal 2019 second quarter was primarily the result of market-related weakness for our ZERUST products, partially offset by new customer growth and approximately $250,000 of Natur-Tec sales in China that didn't occur last fiscal year. The compostable bioplastics market in China is strong, and we anticipate sales momentum to accelerate in the coming quarters.

As we have stated in the past, Zerust Oil & Gas sales are volatile based on timing and shipments of orders. After a strong first quarter, net sales for the second quarter of fiscal 2019 were down approximately $220,000 compared to the same period last fiscal year. Year-to-date, Zerust Oil & Gas net sales were $1.3 million, up nearly 56% from the prior fiscal year period. Based on our current anticipated oil and gas sales, we expect net sales within this segment to grow during the second half.

We have continued to gain more repeat orders for our tank bottom solutions from existing large companies. In addition, we've continued to install our solutions in new global geographies and believe we are well positioned to grow oil and gas sales in fiscal 2019. However, we continue to expect oil and gas sales will remain volatile due to sudden shifts in timing and purchase orders for bigger projects.

Now turning to our Natur-Tec bioplastics business. For the fiscal 2019 second quarter, Natur-Tec's net sales were $4.2 million, an increase of 108% over the same period last fiscal year. Natur-Tec continued to achieve significant growth rates as a result of strong demand in North America through our domestic distribution network as well as higher sales of finished products by NTIC's majority-owned subsidiary in India.

The use of conventional polyethylene and polypropylene plastic bags is facing ever-increasing societal and political criticism due to the environmental and waste disposal concerns. And this correlates with the increasing global interest for Natur-Tec product solutions that we've experienced.

Our fiscal 2019 financial results to date have demonstrated the strength of our diversified foundation. While slowing global growth forced us to reduce our fiscal 2019 financial guidance, we are close to achieving our long-standing objectives and continue to believe we can create sustained sales and earnings growth for years to come.

With this overview, let me turn the call over to Matt Wolsfeld to summarize our financial results for the fiscal 2019 second quarter.

Thanks, Patrick. NTIC's net sales increased 9% in the fiscal 2019 second quarter as a result of the trends Patrick reviewed in his prepared remarks. Income from joint venture operations decreased 7.7% for the fiscal 2019 second quarter compared to the corresponding period last fiscal year as a result of softer sales at many of our global joint ventures.

We continue to proactively control expenses, and I'm pleased that our total operating expenses increased less than 1% or by only $25,000 to $5.4 million during the fiscal 2019 second quarter. The increase was primarily the result of additional personnel and an increase in G&A and research and development expenses, partially offset by lower selling expenses.

Net income attributable to NTIC was $1.4 million or $0.31 per diluted share for the fiscal 2019 second quarter compared to net income attributable to NTIC of $1.3 million or $0.29 per diluted share for the fiscal 2018 second quarter. As of February 28, 2019, working capital was $24.2 million, including $4.9 million in cash and cash equivalents and $1.2 million in available-for-sale securities compared to $22.8 million, including $4.2 million in cash and cash equivalents and $3.3 million in available-for-sale securities as of August 31, 2018.

NTIC's business model does not require significant additional capital, and we expect our financial model will continue to produce strong operating cash flows. We expect our cash balance will increase as the year progresses because of the seasonal benefits we typically experience in earnings from operating activities and anticipated continued business growth and improvements in profitability.

On November -- on February 28, 2019, the company had $24.4 million of investment in joint venture, of which approximately 52.7% or $12.9 million in cash with the remaining balance invested in working capital.

During this fiscal 2019 second quarter, NTIC's Board of Directors declared a cash dividend of $0.12 per common share that was payable on February 22, 2019, to shareholders of record on February 6, 2019. Our second quarter dividend is a 20% increase over the second quarter dividend payment last fiscal year, which reflects continued strength in our financial performance.

Now turning to NTIC's annual guidance for the fiscal year ending August 31, 2019. We currently now expect fiscal '19 sales to be between $58 million and $60 million, which represents a 13% to 17% increase over our fiscal 2018 net sales. We now estimate our net income attributable to NTIC will range between $8 million and $8.5 million or between $1.70 and $1.80 per diluted share for fiscal 2019.

Our guidance for diluted earnings per share represents a year-over-year increase of approximately 19% to 26%. These estimates are subject to significant risk and uncertainty, including those described in our forward-looking statement disclosures in our earnings release.

We continue to be encouraged by our operating and financial results. We've built a strong platform to drive sustainable and profitable growth. And we're excited about the direction that we're headed.

With this, Patrick and I are happy to take your questions.

(Operator Instructions) And our first question comes from Tim Clark (sic) [Tim Clarkson] with Van Clemens.

Just want to get a little bit more color on the newer businesses. How about in terms of the compostable business, where are you seeing the most demand out of?

The most demand is coming out of India and the surrounding geographies, with significant growth, as I mentioned, also coming out of China where we just started. North America is doing fine, but their growth rates are not quite as high as they are out of the Southeast Asian markets.

So to comment a little bit more on that, Tim, what we've seen in North America is kind of the traditional 25% to 30% growth rate. The growth that we've seen specifically in Southeast Asia is significantly higher than that. We're seeing about -- just in the 6 months, we've seen a $2.8 million increase comparing fiscal '18 to fiscal '19 of sales in Southeast Asia. So that's a significant growth market for us, whether it's in India, Sri Lanka or China. That's an area that's doing very well.

Well, now what differentiates your compostable products from your competitors?

That's a long and technical discussion that I'm not quite sure this is an appropriate venue to have, Tim.

Well, what's the -- I guess the key, from my vantage point, it seems like your product is stronger while at about the same...

We believe that our technology allows us to make that our products that are stronger, easier to produce and therefore, are cheaper, better, faster in all categories.

Right. Okay. On the oil and -- are you still getting some additional orders in the pipelines space?

Most of our new orders are coming from the tank bottom space at this point. I think that the -- in the second quarter, our second fiscal quarter, we noticed that oil prices dropped dramatically from about, I think it was about $65 down to almost $40. Now they're rebounding. But I think that decrease in oil -- the temporary drop in oil prices caused a lot of people to hold back on executing some orders that we had expected to come sooner.

There certainly is -- Tim, I was just going to say there certainly is -- the number of oil and gas orders that we kind of have pending for our third and fourth quarter are -- it would significantly show a rebound over second quarter. And we certainly expect that our 6-month year-to-date number for oil and gas will be significantly increased compared to the second 6 months of the fiscal year.

(Operator Instructions) And our next question comes from Scott Billeadeau from Walrus Partners.

Just a couple of questions here. One, on Natur-Tec industrial, maybe give me a little -- or give us a little idea. I know you don't have great visibility there. But can you talk a little bit about what visibility you do have into that business? Because certainly, you kind of saw some of the slowdown coming when we talked last quarter. So any thoughts there at all?

Scott, you said the Natur-Tec industrial business. So I'm wondering if you mean the ZERUST industrial.

No, I'm sorry. ZERUST, yes. I'm sorry. Yes, the ZERUST industrial, yes.

I think that ongoing tensions, trade tensions are causing everybody to be a bit nervous and are minimizing their supply chain orders. We've seen a strong decline in exports for markets such as India and China. And I think that's having an impact on the global supply chain.

Yes. Great. No competitive issues there at all that you guys can sense?

No, no, this is uniform. We're seeing this uniformly around the world at the same time. And it's not that we're losing customers at all, it's more that our current customers are telling us, "We're just taking it a little bit more easy at this point. We're being cautious, and so our orders will be slightly less than before."

Great. Okay. And then just one more question. You mentioned oil and gas. And like, if I can recall, I think you got easy comps. And you kind of mentioned that, I think, a little bit, Matt, that second half of last year was kind of -- so you got pretty easy comps on the oil and gas business. And is that correct?

I'm sorry. I don't understand what you mean by easy comps.

Well, easy comp, I mean, the idea that last year's oil and gas in the second half was pretty weak, if I remember right like -- or especially the -- I'm just trying to figure out, do you have easier comparisons on the oil and gas?

No. Well, the fourth quarter of 2018 was exceptionally strong. Third quarter was a little soft. But just where I'm talking about a stronger second quarter, it has more to do with taking what first quarter is and -- or -- I'm sorry, the first 6 months of the year and comparing to the second 6 months of the year with -- we had a general idea right now as far as what we're going to achieve in the next -- in Q3 and Q4 given the kind of the order time line of when things -- when orders come in and when product gets -- will get delivered and invoiced. So we're pretty comfortable that oil and gas on its own is going to show some sizable growth in the second 6 months compared to...

First half to second, yes, second half to first half, yes. Okay. Great.

Yes.

And our following question comes from Joe Vidich with Manalapan Oracle.

I was wondering if you could, regarding Natur-Tec, if you could comment on some of the recent regulatory developments in states like New York or other countries around the world and how those will impact the demand for your product.

Sure. We're seeing that a lot of the growth from our Natur-Tec group is driven by either local, municipal or state mandates. And so in states like California, where statewide legislation is being passed that's eliminating bags or mandating that companies of a certain size segregate their organics and put an organic diversion policy in place, that's certainly something that is beneficial and helping our business grow with nice solid quarter-over-quarter growth. Similarly, a lot of the growth that we've seen in Southeast Asia when we started a lot of the business in India, it was -- the majority of it was to serve the garment industry.

Another area is specifically dealing with clothes manufacturing. What we're seeing now in India is the plastic ban that is taking place has driven a lot of the extra growth that we didn't necessarily anticipate at the start of the year and one thing that's led to significant growth that I talked about earlier in Southeast Asia. So the bans that we're seeing throughout Europe and at the state level in the United States are having a significant impact in driving kind of the overall business growth of Natur-Tec. But we're obviously also seeing from just the overall political environment, obviously, how the environment and the environmental concern is certainly driving a lot of decisions as well. And some of the projects that we're looking forward to over the coming 1 year, 3 year, 5 year has to do with working with other companies to provide them a plastic -- a compostable plastic product to manufacture products that they're currently making with traditional plastics. So we still see Natur-Tec in North America being a tremendous growth opportunity for us as the market continues to expand dramatically.

Great. Can I also ask you -- last year, there was a lot of restaurants globally that are doing away with straws, plastic straws. And I'm just wondering if you could just comment on what type of interest or business you're seeing in that area.

Yes. No, we certainly are seeing interest in that area. And we have a compostable resin that we are selling to straw manufacturers in -- specifically in Asia, where a lot of the straws are being manufactured. It's a growth area for us. But the total amount of resin that we're selling to them, the amount of resin it takes to make the straws is as much as what you'd anticipate. So it is a growing sector for us. And it is something that we anticipate to roll out more in North America as more straws are being converted to compostable straws. It seems like the general market isn't real happy with the -- a, people like their plastic straws, and b, it seems like people don't really like the paper straws. So certainly, it's more specifically fast food and other areas where they use a lot of straws are converting to an entirely compostable system, meaning they would have a compostable cup, a compostable top, a compostable straw. That's certainly a market that we anticipate being in as more transitions take place at those fast food companies.

And our next question comes from [Jerry Well] with -- as a private investor.

Say, just wondering, so on the second half of the year then, you're still projecting to basically make at least $0.50 a quarter, which would be above last year's third and fourth quarters. So where are you seeing that profitability? I know Natur-Tec revenue is growing fast, but it's not your highest gross margin business. So to hit the, what you say, $0.50 a quarter roughly, where are you seeing most of the profits in the second half coming from?

Sure. No, that's a good question, Jerry. The -- just to kind of -- looking at it from a business-by-business standpoint, we certainly are anticipating that Natur-Tec continues to be strong. We'll see if it's able to keep up its current growth rate from the first 6 months into the second 6 months. As far as where we expect the increased earnings to come from, we certainly expect that increased earnings in the second half of the year from oil and gas. Obviously, very little contribution came in the second quarter from the oil and gas group, but we expect, certainly, in the third and fourth quarter, as some of these larger projects and other items come in, that we're going to see increased revenue from -- or increased revenue and earnings from that group.

Additionally, from a ZERUST industrial standpoint, our third and fourth quarters have always been significantly stronger than our first and second quarters. If you look back at it from a historical standpoint as far as how sales go, we tend to have our 2 best quarters in the third and fourth quarter. So just naturally, right there, we expect to have an increase in sales during that 6-month period. We certainly feel like the -- just the normal increase that we have during the rough season, if you will, which tends to fall during our third and fourth quarters, will be able to get us up into the averaging $0.50 plus a share for third and fourth quarter to get us to our guidance number. But our guidance number, to dig into your question a little bit, our guidance number is not anticipating a huge rebound in the overall economy. It's not -- what we're factoring into our guidance has more to do with just the seasonal difference that we see in third and fourth quarter.

Okay. And then 2 other quick questions. You -- I know you've been -- the oil and gas, it's got a huge market potential, and you've been working that, chipping away at it, finally starting to get some results. Are you still seeing that -- even though it's a very variable business as far as contracts and awards and all that, but do you still see it as a really large opportunity for the company?

Absolutely. We are getting tremendous demand for -- well, increase for new projects. Our pipeline is very full. The only thing that we have seen lately is, like I mentioned earlier in the call, that due to the strong decline in oil prices in -- during the second quarter, our second quarter, a lot of these oil companies that had projected to put -- to place firm appeals with us said, "Hey, we're going to hold off a little bit, and we're going to push it into a later quarter this year."

Okay. Last question -- and congratulations on the growth by the way with the Natur-Tec. It's beautiful to see that you guys could grow it so fast. But it's kind of challenging to have such a fast-growing division when -- within somewhat of a more cyclical business, if you will, right? Have you -- I mean, if you look at 5x revenue for value on Natur-Tec because of the growth rate, it's not out of line, and the market is conservative, in my opinion. That's $20 worth of stock value just to Natur-Tec, in my opinion, so -- but how do you monetize that longer-term view? What's been the board discussion relating to monetizing the value that you've built to Natur-Tec, whether it be splitting it off or at some point, looking at other opportunities, et cetera? So give me your latest thoughts on that, if you would, then I'm done.

Well, I think with Natur-Tec, it's a great opportunity for us to do different things. I mean, at this point in time, we have certainly taken advantage of the opportunities around the world as far as setting up the facility in India. I think -- but it still is -- this year, we're still at a $16 million to $17 million run rate. So we still have an awful long way to go with Natur-Tec, I think, before it is -- before we're really able to monetize that growth. But obviously, if we can keep up the growth rates and keep up the projects and the opportunities that we're working on and the current environment for the compostable products market continues to grow, I think Natur-Tec is a huge opportunity. We're certainly looking at different ways that we can take advantage of that. But I still think that we are a couple of years away from doing something different with Natur-Tec.

Okay. Well, guys, thanks for all your hard work that you do out there. And very conscientious, I'm very comfortable with you guys running the show out there and thanks for everything you do. I'm done.

And our next question comes from Charlie Pine with Van Clemens.

I just have a brief question. It has to do with the upcoming annual NACE conference, which, if I am correct, is supposed to be in -- coming up the next 10 days to 2 weeks, I believe.

It's over.

It's already been completed for 2019?

To the best of my knowledge, yes. I think it was 2 weeks ago.

Really? Because I just had -- I just googled it this morning, and it looks like on my machine, it showed -- that starts on the 4th -- I thought it says...

I reserve the right to be wrong, but that was my impression. But anyhow, I'm sorry to interrupt you. Please go ahead with your question.

All right. Well, were you anticipating that or expecting anything at all that might be coming out of the NACE conference as far as any papers or any decisions that could have any impacts on Zerust Oil & Gas or your -- basically, the tank bottom application?

To my understanding, the level of interest expressed at the NACE show was quite significant, so we're getting more interest. We will -- I wasn't attending it myself, but -- and I don't think that there was any major decisions made at this point. There are still some ongoing work being done at -- on the committee level, but nothing new worth mentioning at this point.

So no new papers or anything represented regarding the tank bottom -- your tank bottom protection system, anything like that?

I think we made certain presentations, but I'm not immediately aware what those were.

All right. Well, I'll circle back on that then at a later point.

Sure.

And our following question comes from Walter Schenker with MAZ Partners.

You had mentioned when we met in New York that an Asian customer had stopped using your technology. Is there any further input or -- from you as to whether it's likely that they will resume using it?

At this point in time, no. That was just one customer that made a transition in product. But at that point -- at this point in time, we have not transitioned that customer back to our product.

Okay. And I apologize, but I had -- market opened, I had some other stuff. As you look at this year, it is reasonable to expect that you will again have pretty good free cash flow?

Yes.

And your capital, like if you haven't forecasted, your capital requirements this year are likely to be in what broad vicinity?

I don't see really the capital needs of the company changing significantly compared to prior years. One thing I'll say is that, obviously, the wholly owned subsidiary in India, we've seen the dramatic increase in sales. And given kind of a long pipeline of producing the Natur-Tec product, of having product going from China to India, from the sales process, the whole cash cycle in India, that has eaten up a lot of our -- not a lot of our free cash, but it's certainly eating up a significant portion of our free cash. So we have much more of a working capital sitting in inventory and receivables compared to before, specifically because of the growth that we've seen in India.

Which explains the year-over-year -- largely explains the year-over-year increase in inventories?

Correct.

Not the slowdown, it's just the way the timing of the growth in Asia and where you have to commit cash...

Yes. It just takes the whole cycle for Natur-Tec as far as purchasing raw materials that we're purchasing either in North America or in Europe and then shipping them to a different country to be tolled and then shipping them to another area or another country to then be manufactured into final product and then sold and then ultimately waiting 30, 60, 90 days in some situations for collections. When you have a 200 -- when you see the increase in sales, that's obviously going to eat up a lot of cash. But the nice thing about the company is we've had a pretty strong balance sheet and have available cash to be able to invest in these and be able to handle the working capital needs of these growing businesses.

And there are no further questions in the queue at this time. I would now like to turn the call back to Patrick Lynch for closing remarks.

I'd like to thank everyone for participating today and for your interest in NTIC. Have a great day. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.