Northern Technologies International Corp (NTIC) 2019 Q3 法說會逐字稿

As 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 reports 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.

Introduce NTIC management, Patrick Lynch, NTIC Chief Executive Officer.

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 third 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 third 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.

The strong double-digit net sales growth we achieved in the third quarter reflects the continued success of our diversified business model. That said, market demand during the fiscal 2019 third quarter remained soft for our core corrosion protection solutions causing ZERUST industrial sales to decline year-over-year, both in North America and across our worldwide joint venture territories. As we have been saying throughout the year, we believe that this has been primarily due to slowing global growth and concerns regarding ongoing trade disputes between the U.S. and a series of other countries, including China.

While the fiscal 2019 macro landscape for our core industrial corrosion prevention business has become more challenging than previously expected, the 15.2% increase in NTIC's total sales is thanks to the significant growth we are enjoying within our Natur-Tec business as well as higher sales of our oil and gas solutions. These increases demonstrate the resiliency of our business model.

Natur-Tec represented over 32% of our fiscal 2019 third quarter net sales compared to less than 20% for the same period last year. Natur-Tec has become one of the leading global bioplastic solution providers, and our growth over the past several years demonstrates our strong position within this rapidly growing market. In fact, over the past 8 quarters, Natur-Tec has averaged a year-over-year quarterly growth rate in sales in excess of 55%.

Now permit me to remind you that on June 3, we announced a 2-for-1 stock split that became effective on June 28, 2019. Consequently, all share and per-share data presented on today's call as well as going forward has been adjusted to reflect the new share count. NTIC's Board of Directors approved the stock split based on extensive investor feedback and our desire to improve the trading liquidity of our stock over the long term.

So with these comments, let's examine the drivers for the third quarter. For the third quarter ended May 31, 2019, total consolidated net sales increased 15.2% to a record $14.9 million as compared to the 3 months ended May 31, 2018. Broken down by business unit, this included an 89.5% increase in Natur-Tec sales, a 58.7% increase in ZERUST Oil & Gas net sales and an 8.1% increase in net sales from NTIC to its joint ventures partially offset by a 7.9% decline in the ZERUST industrial 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 third quarter compared to $31.5 million for the same period last fiscal year. This 11.8% decline in JV net sales was the result of softer worldwide demand across many of the industrial markets we serve.

We continue to believe the decline in North American ZERUST industrial sales during the fiscal 2019 third quarter was due to ongoing macro concerns and uncertainties, which are, in turn, impacting the supply chain and purchasing decisions of many customers. While we still do not believe this to be indicative of a deeper slowdown, we continue to actively monitor international market trends and will adjust accordingly if demand deteriorates further.

Net sales by our wholly owned NTIC China subsidiary were $3.5 million for the third quarter of fiscal 2019 compared to $3.1 million for the same period last fiscal year. The 14.4% increase at NTIC China during the fiscal 2019 third quarter was primarily a result of higher Natur-Tec sales. The compostable bioplastics market in China appears to be strong and growing, and our third quarter sales results reflect increasing momentum in this market.

As we have stated in the past, ZERUST Oil & Gas sales are volatile based on the timing and shipment of orders. Net sales for the third quarter of fiscal 2019 were up approximately $326,000 compared to the same period last fiscal year. Year-to-date, ZERUST Oil & Gas net sales were $2.2 million, up nearly 57.7% from the prior fiscal year period. Our 9-month oil and gas sales levels and repeat orders for our oil and gas solutions are reflective of the overall market acceptance of our technologies.

Based on our current anticipated oil and gas sales, we expect full year net sales within this segment to grow compared to the prior year. We've continued to gain additional repeat orders for our tank bottom solutions from existing large companies, and we believe we are well positioned to grow oil and gas sales in the remainder of fiscal 2019 and beyond. However, we continue to expect oil and gas sales will remain volatile with sudden shifts in the timing of purchases -- in timing of purchase orders for bigger projects.

Now turning to our Natur-Tec bioplastics business. For the fiscal 2019 third quarter, Natur-Tec net sales reached a quarterly record of $4.8 million, an increase of nearly 90% 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 sales 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 plastics is facing ever-increasing societal and political criticism due to environmental and waste disposal concerns, and this is reflected in the increasing global interest for Natur-Tec products and solutions that we have experienced.

Our recent financial results reflect the success of Natur-Tec oil and gas and NTIC China growth strategies. We are investing in these 3 operations to maintain the positive momentum underway and to take advantage of significant opportunities in the future. Current strategic investments are focused on expanding research and development programs as well as increasing marketing efforts and resources. Higher spending, coupled with reduced income from joint venture operations, impacted profitability during the third quarter, and we reported the first year-over-year decline in quarterly net income in 10 quarters.

Our strong balance sheet, experienced management team and diverse revenue model creates a strong foundation from which to successfully navigate the current challenging macro industrial environment. I am encouraged by the direction we are headed and the opportunities before us to create sustained sales and earnings growth for years to come.

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

Thanks, Patrick.

NTIC's net sales increased 15.2% in fiscal 2019 third quarter as a result of the trends Patrick reviewed in his prepared remarks. Income from joint venture operations decreased 11.8% for the fiscal 2019 third quarter compared to the corresponding period last fiscal year as a result of softer sales at many of our global joint ventures. As Patrick stated, we're making strategic investments throughout our business in order to support current and expected growth opportunities.

Operating expenses increased by 11.7% or by $661,000 versus the same period last year. Despite this increase, as a percentage of revenues, operating expenses were 42.3% during the fiscal 2019 third quarter compared to 43.6% for the same period last fiscal year.

Net income attributable to NTIC was $1.5 million or $0.16 per diluted share for the fiscal 2019 third quarter compared to net income attributable to NTIC of $2.1 million or $0.23 per diluted share for fiscal 2018 third quarter. As of May 31, 2019, working capital is $25.7 million, including $5.2 million in cash and cash equivalents and $2.5 million of 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 -- or will continue to 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 May 31, 2019, the company had $24.1 million of investment in joint venture, of which approximately 56% or $13.5 million is in cash, with the remaining balance invested in working capital.

During the fiscal 2019 third quarter, NTIC's Board of Directors declared a cash dividend of $0.06 per common share that was payable on May 23, 2019, to shareholders of record on May 9, 2019. Our third quarter dividend is a 20% increase over third quarter dividend payment last fiscal year, which reflects continued strength in our financial performance as well as our commitment to increase shareholder value.

Now turning to NTIC's annual guidance for the fiscal year ending August 31, 2019. We currently expect fiscal 2019 sales to be between $57.5 million and $58.5 million, which is a $500,000 decrease of the low end of our prior guidance. We estimate our net income attributable to NTIC will range between $6.2 million and $6.6 million or between $0.65 and $0.70 per diluted share for fiscal 2019. These estimates are subject to significant risks and uncertainties, including those described in our forward-looking statement disclosure 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 is from Scott Billeadeau from Walrus Partners.

Just a question here on -- there appears to be some deleveraging in the business in a sense that you're only bringing the revenue down by kind of less than what net income is -- guidance is coming down. Could you kind of give us a little idea of what's happening there? Is it just because of the pure JV net income hit? Maybe kind of refresh us on deleveraging there.

Yes. I would say there are 2 key impacts to that deleveraging you're talking about. The biggest impact is obviously the joint venture revenue. NTIC typically takes in between 10% and 11%. Our portion of each JV dollar sold is typically between 10% and 11%. So for example, in third quarter, we took in $27.8 million compared to the previous year's quarter of $31.5 million. So it's almost a $4 million decrease, the amount of revenue we took in comparing third quarters. So that amounted to about almost $400,000 of a decrease in the expected earnings from that incremental revenue. So with looking at our fourth quarter, the big question that we have -- we were pretty confident as far as the amount of revenue that we'll have coming in to our top line from the United States industrial, from Natur-Tec, from oil and gas and from China. Still, the big question is where are we going to come in from a JV standpoint? And so the decreased guidance has to do with bringing down the expectations of revenue from the JVs.

The other piece of that is as the industrial business in North America is off from the expectations, that after second quarter we were down by -- we were only down by a few percent. In third quarter, comparing the industrial business, it was down over 10%. So what we're seeing is that the Natur-Tec business is increasing the percent of our total revenue and making up for the shortfall in the industrial business. And what we have is a higher gross margin in the industrial business, the Natur-Tec business. So that also accounts for some of the deleveraging when you're swapping out sales dollars from industrial compared to Natur-Tec. So those 2 things are the main things that are accounting for the decrease in -- the small decrease in revenue that we're showing from a guidance standpoint, but the increase/decrease in earnings.

Okay. Great. And you had mentioned making some investments but yet OpEx still kind of growing less than sales. So there's -- that's a little bit of a positive effect. Same thing kind of going out, any targeted investments you're planning on at this particular point in time?

We don't have any material. The capital investments that we're planning on making, they will be more than a few hundred thousand dollars over the next -- in the coming quarters. So nothing significant. Still, when you -- Scott, when you talk about the operating expense increases, the interesting things from our standpoint, we've always talked about single-digit operating expense growth where our biggest operating expense growths were in the past quarter and during the year, when I look at the year-to-date data is, we have significant operating expense growth in -- for Natur-Tec India and significant operating expense growth with Natur-Tec China -- I'm sorry, not with Natur-Tec China, with just NTIC China. So when I look at -- when we talk about the investment in the future that we're making, we still see NTIC China and Natur-Tec India as key areas where we expect the growth to continue. So even though operating expenses for third quarter were up 11%, we -- the amount of operating expense increase in North America was still low single digits, it was the increase in operating expenses to really build for the future at Natur-Tec India and to -- and for NTIC China that saw that increase.

Okay. And then just last question. I know it's kind of crystal ball-ish, but again on the ZERUST industrial, it's pretty much just macro slowdown, not -- you don't sense that it's competitive or anything of that nature, it's primarily you are following kind of what's happening in those products that are using ZERUST as opposed to someone taking some business from you.

That's correct. I mean we are seeing an overall decrease in sales across pretty much all the joint venture territories and the United States. So it's consistent in just basic global industrial demand right now is softer than it has been in the past. We are not seeing any increase in competitiveness from -- increase in competition. We're not seeing any increases in other factors, so we just believe it's a macro issue at this point.

Our next question is from Tim Clarkson from Van Clemens.

I just wanted to -- I missed your comments on China. How's business in China right now?

We felt little bit of a pickup in China from an industrial standpoint in third quarter. First and second quarter showed the industrial business being below the prior year. So it's a little bit of a rebound in China from industrial standpoint. As Patrick mentioned, the main growth in China, of being up 14% or 15%, is due to the increased Natur-Tec business in China. So what we're -- the expectations are that going forward with fourth quarter and then on into our fiscal 2020, that we would get, let's say, back on track as far as the number of projects we have that we're working on and the increased revenue that we expect there, we would expect both the industrial business and the Natur-Tec business in China to continue growing.

And what -- how are they using the compostable in China?

Same way in the garment industry as you're seeing in Southeast Asia.

So mostly garments at this point? Yes.

Yes.

Good. And just on the compostable, are you guys aware of any other company that's publicly traded that has a compostable component like this?

Not to our knowledge.

Okay. On the oil and gas, now is there a perception now that this technology is kind of getting accepted with at least some of the key guys, that they just kind of put it in a standardized basis? Is that -- I know that's -- that was the -- kind of the goal is to get this to be an accepted technology. Is that starting to happen?

As far as we can tell, yes. I mean based on the repeat business we're getting from a number of clients and also just that it's expanding into more and more geographies.

And how about in terms of pipelines? Are you still starting to do some business there?

As the projects become available, those are less steadier than -- in comparison to the tank bottom solutions.

Right. Right. Okay. And in terms of your investments, your investments are -- were up in China and India. What exactly -- how are you investing there?

Specifically in Natur-Tec India, it's a matter of investing in people to be able to support to grow that business. We've had to -- obviously with the almost 300% growth that we're seeing there, we need to get warehousing, we need to get people, we need to make sure we have an operation system in place to handle that kind of growth and those kind of orders. And so we've made some investments there in order to be able to deliver the product -- deliver products and support the customer needs. Also with the expectation that business is going to continue to grow, we want to make sure that we are not just building a system that's going to work for the current level of business, but something that's going to grow, that's going to work for 3 to 4x the amount of business in the coming years that we have now.

In China, there has been investments not just in operations, but also in certain R&D activities for certain products for the Chinese markets that are slightly different than the U.S. markets for some of the opportunities that we're going after there. So we've invested in a research and development lab there in addition to the operating investments we've had to make.

One last question. Is there an opportunity to plug in the compostable products into places like Japan and Germany that are just doing the industrial stuff?

Yes. There are always opportunities for that. But actually, we're seeing certain -- yes. Let's leave it at that for now.

Okay. All right. Good quarter.

Our next question is from Joe Vidich from Manalapan Oracle Advisers.

I had a number of questions which were very similar to the person who just asked about your -- where your key initiatives are. But I guess with a little more detail, maybe if you could just describe your marketing efforts. I don't know if that's possible or not, but -- and where you are spending more of your Natur-Tec money, whether it's internationally or besides just India and China?

Well, Natur-Tec specifically is growing and expanding everywhere the garment industry is. So it's not just in India. You're talking India, Bangladesh, Pakistan, Sri Lanka, Vietnam and China right now, and that -- and the expenses basically in building up a distribution network in those regions. In North America, it's also through industrial but the target market is different. Here, we're supplying more the janitorial and sanitation distribution companies that are supplying major food service companies. So the market segments are different, that was the other thing here.

Right. Have you been -- I know that with the whole straw, the movement away from plastic straws, I was just wondering how that initiative has been going.

Fine from our perspective in that we supply the basic resin compounds to straw manufacturers who are making compostable straws who've been using our technology. Now the total volume of resin compound sold is going to be relatively small just because straws just don't take up that much volume. So we have seen an increase in the demand from that sector, but it's not really that significant that it's really going to have a major impact on our sales in the near future.

Right, right, right. And I guess the other question is just for the quarter, obviously, your operating expenses for both R&D and G&A were up. And I was just wondering if you had any idea what potential run rate would be for those for the next 12 months or...

I think from an operating standpoint, we expect to have a run rate that's going to be pretty consistent with where we are today, with where we are in the third quarter. Kind of going forward as far as operating expenses go and operating expense growth, we would like to peg that to kind of 8%, 9% growth rate kind of year-to-year. The issue that we had is obviously this year, we didn't see the significant -- the traditional growth rate from our industrial market, so the slight increase in operating expenses this year, but didn't have the corresponding increase in sales that we expected to have because of the industrial slowdown.

Going forward, we're certainly doing our best to limit the amount of operating expense, especially during the time period now where things are slower from an industrial standpoint. But kind of going forward, the existing operating expenses or fixed expenses that we have, should be relatively flat compared to -- relatively flatter with small amount of growth compared to the sales growth that we expect to have in all of our different businesses.

Okay. That's great, guys. I really appreciate it and I think it actually -- there's a lot -- very large number of positives in this quarter or so.

Thank you.

Our next question is from [Eric Ramsley] from [R Squared].

I just had a couple of questions about your cost for raw materials, specifically the plastics. And first of all, I'm just wondering what the current tariff was in the imports that are coming out of China.

Currently, on the imports coming out of China, the only products we're really importing out of China are some of the finished bags for Natur-Tec that are being sold in North America, which are at a 25% tariff.

Okay. And once -- is the cost of that going to change once the production is moved to India?

Yes. I mean obviously, this tariff would go away plus we would have other -- call it, other economies of scale where we would expect to be able to produce that at a lower cost than what we're producing at now.

Okay. And when do you plan on move to India taking effect?

Probably by the end of the calendar year, beginning -- right around December, January time frame.

Our next question is from Walter Schenker from MAZ Partners.

But my questions were just answered about the run rate and the SG&A level.

Okay. Yes.

Our next question's from [Jake Lovell] from Wilen Management.

Can you give us any color on how the finished products piece of Natur-Tec is doing relative to the entire segment?

How the finished products are doing compared -- I guess...

Yes. How they're growing relative to the total segment -- faster, slower, a lot faster. Just any color to kind of understand that piece of it.

You mean as far as from our sales standpoint or the overall market growth? You are talking about the...

For the -- for you guys.

Yes. We're still seeing -- the main growth that we're seeing in Natur-Tec obviously from -- in north -- look at it in 2 different areas. You obviously have the North American Natur-Tec market and the growth that we're seeing there is the 25% to 30% year-over-year growth, and that growth is made up of generally, probably 2/3 of that is going to be made up of growth of finished products, meaning cutlery, trash bags, bag liners, things like that. The other piece is going to be the increased resin that we're now starting to sell to companies so they can make their own finished products out of our proprietary specialized compostable resins. So in North America, that growth rate is kind of coming from both areas.

In India, where we have the Indian subsidiary and also then the wholly owned Sri Lankan subsidiary, the majority of those sales are still in the finished products being sold to the garment industry. There's some resin sales that occur in that market, but the majority of it is finished product.

Got you. Got you. Have you guys ever given color in terms of the just rough margin profile of resin versus finished products just so we can have -- understand kind of the guideposts going forward?

Yes. They're pretty similar. I mean at this point in time, over the past 5 years, we've seen an increase in our gross margin from Natur-Tec up into kind of the high 20s if it's nice, if it's -- depending on how we're able to make the product and where we're shipping it, even the low 30s. The current tariff that we're seeing with the product being made in China, obviously, a 25% tariff on your main product coming in is going to have an impact to gross margin. So gross margins in Natur-Tec have slipped a little bit with the 10% margin, and then the expectations of it now that the 25% margin is in place, we're going to see a continued slip in that gross margin obviously until we're able to move operations out of China or until the tariffs are lifted. But traditionally, the gross margin for Natur-Tec has been in that upper 20s, low-30s area. And that's where we would expect to see that going forward.

Got you. Got you. And one quick question for you.

And for resin, it's going to be similar margins.

Okay. And just -- and one quick question for you on oil and gas. Are you starting to see -- you guys talked about these trials, how long these trials take with customers. Are you starting to see more trials convert and that leading to the really strong growth in oil and gas? Or is it more customers who already adopted kind of really ramping up and just finding more applications to this point?

We are seeing mostly repeat business from existing customers as well as new business from new territories. So we are putting in certain installations now in Africa that we hadn't been -- hadn't had before and in other geographies. Those are new, but we're also getting repeat business in North America from large tank farms -- tank farm owners that are giving us more tanks over time.

Just to add 1 point to that. While we're seeing the repeat business from customers, what we haven't seen and what we would expect to see at some point in time in the future is, going from -- not going from 1 tank to 2 tanks to 3 tanks, but start seeing the -- going from 3 tanks to 5 tanks to 10 tanks to 15 tanks, we'd like to see that kind of an implementation, and that's ultimately what we're going for. But the adoption of this technology into the oil and gas space is still slow, and I'd say it's obviously a very cautious slow market. But we're certainly seeing the acceptance of the product. And the results that we're seeing from all of the different trials and all the different installations that we've done are very positive and very encouraging. And that's one thing that's helping us to do the repeat business with the existing customers and also show the data to new customers to validate the technology.

At this time, I am showing no further questions. I would like to turn the call back over 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.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.