Solesence Inc (SLSN) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Nanophase Q1 2018 Financial Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

The words 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 that could cause actual results for future periods to differ materially from those expressed in this news release. These important factors include, without limitation, a decision of the customer to cancel a purchase order or supply agreement, demand for and acceptance of the company's nanocrystalline materials, changes in development and distribution relationships, the impact of competitive products and technologies, possible disruption in commercial activities occasioned by terrorist activity and armed conflict, and other risks indicated in the company's filings with the Securities and Exchange Commission.

Nanophase undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

I would now like to turn the conference over to President and CEO, Jess Jankowski. Sir, you may begin.

Thank you, Shelby, and good morning, everybody. I appreciate all of you being here and those choosing to listen later online. We're happy that you're able to join us to discuss our first quarter 2018 financial results, along with business updates that I know you'll find interesting. Joining me on the call today is Jaime Escobar, our new Chief Financial Officer.

During the call, I'll be giving an update on our progress and new business developments, particularly within Solesence, along with updates on our advanced materials business and, of course, first quarter results.

As you digest this information, keep in mind that we're heading toward what may be a record in Q2 revenue, driven by our personal care ingredients business and Solesence, leading to what may be a record first half.

Given our ongoing experience with Solesence, I can say that we feel that our current opportunity set is very strong. We're working as hard as we can to take advantage, both of the strategic position we've developed and the markets that are aligned with our product benefits. We're on track with our Solesence launches, which represent 6-figure revenue in Q2, and more importantly, a major building block for our Solesence finished products going forward. We've had some timing issues in Q1, which I'll discuss, but your company looks good.

Our first quarter 2018 revenue was $2.9 million, down about 17% from the same quarter in 2017. As I mentioned in the press release, there were several factors impacting first quarter results that were timing related, including a lower-margin product mix when compared to Q1 of 2017. We also spent a good deal of time and energy ramping up for our Solesence product launches, 2 of which occurred April 1 and May 1, respectively, with one more planned by the end of June.

In our advanced materials business, we also saw a dip in architectural coatings revenue in Q1 that may be related to this spring's weather and the delays it may have had on outdoor projects.

Throughout 2017 and now this year, we continue to invest in product development for our Solesence suite of fully formulated skincare products. Our plan is to shift more of our investment toward market development later this year. This investment reduced last year's earnings improvement, but has been necessary to establish our Solesence products in the beauty and dermatology markets.

We continue to believe that Solesence will be our greatest growth driver over time, having the ability to eclipse our advanced materials business in the next several years.

Now I'd like to introduce our new CFO, Jaime Escobar, who will give us a quick overview of our financial results. Jaime?

Thanks, Jess, and good morning. Before I begin, please remember that all financial information is stated in approximate terms.

Our first quarter revenue was $2.9 million in 2018 compared to $3.5 million in 2017. We had an increase in our losses quarter-over-quarter, resulting in a $924,000 net loss or $0.03 per share in 2018 compared to $46,000 in net income or $0.00 per share for the same period in 2017. This loss was largely a function of lower revenue volume and a reduction in finished goods inventory, resulting in less overhead absorption, along with less favorable product mix, production cost increases and an increase in R&D expenses. Jess will discuss this further in a few minutes.

We ended the first quarter with a $1.2 million cash position and $200,000 drawn on our working capital line of credit. Jess?

Thanks, Jaime.

While I know we can always improve, we need to look at Q1 in tandem with Q2. We're looking at a robust first half of 2018, with growth in Q2 revenue from both our advanced materials business and our Solesence business. Demand continues to be strong for our zinc oxide active ingredients for the personal care market, and we expect demand to continue to expand for our Solesence line of products.

As I mentioned, we may well see record revenue in Q2, possibly to the extent of creating another record first half. For those of you that haven't yet read our annual report and for any investors new to our calls, I want to better explain the terms I've been using to define our commercial areas. You'll be hearing more and more about our advanced materials business and our Solesence business. It was important to differentiate these 2 broad areas in order to help us think about the way we develop our strategy and, very pertinent today, the way we explain our commercial activities.

The advanced materials business is composed of our personal care ingredients business and the materials businesses related to coatings, solar control, a diverse grouping of customers buying higher-value specialties and the polishing business where we have partnered with M&S.

The products we sell on to these varied customers and markets are essentially enabling ingredients, or in the case of the personal care markets, active ingredients. They may be in the form of an uncoated, coated or dispersed particle, but they all share similar features. They represent only a portion of someone else's finished product. We either sell them to the ultimate manufacturer of the final product, or more frequently, we rely on our partners and customers to sell them for us to the ultimate manufacturer. And in either case, we remain a few critical steps removed from the -- both the marketing and sales processes to the end users, many of which use the finished products in industrial applications.

We expect our advanced materials business to remain solid, and we see opportunity for growth in several areas. The main area where we're investing our product development time in advanced materials is now in personal care.

In the personal care, skincare and cosmetics markets, demand for more and better minerals-based products continues to grow. This has been good for our advanced materials business as we supply quantities of coated zinc oxide to various manufacturers through our largest customer, and it may be even better for our Solesence business. We created our Solesence subsidiary to maximize the value of our patented technologies as well as to take advantage of our strong historical position as a premier ingredients supplier.

To support the finished product business, we've added people with experience in formulating and product development as well as internally developing these strengths within our existing team. This strategic investment is starting to pay off.

Through Solesence, we're developing and manufacturing fully formulated beauty products for brands, using what we refer to as our Active Stress Defense technology. All of our formulations are created using minerals-based active ingredients as their backbone, which is where the demand is. Consumers and dermatologists generally want minerals for best health benefits, but have been limited by many of the existing technologies in the market. To enhance our ability to market our finished products, we continue to expand our portfolio of consumer claim test data to provide proofs for customers, product features and consumer claims.

Some of the key benefits we have proven are comprehensive environmental protection, including protection against pollution, full-spectrum UV protection and stopping the release of free radicals, which contribute to signs of premature aging such as wrinkle formation and skin discoloration. These claims for Solesence products help the brands to provide evidence of being able to provide -- to prevent the signs of premature aging, which continues to be one of the biggest drivers of consumer demand.

We often refer to our Solesence customers as brands. That's because they'll be marketing these products with their names on them, using their distribution channels, enabled by our Solesence technology, our formulating expertise, marketing support and regulatory and production backbone. Our Solesence customers will sell the products we create to consumers through specialty, realty -- retail stores like Sephora or Ulta, through professional channels like spas and dermatologist offices, and through their websites and other online venues.

While we're not selling products directly to consumers, we are helping brands to produce better products to capitalize on growing market demand. This is our time, and we're pushing hard to commercialize more personal care and Solesence products. I suggest that any of you who haven't been on our Solesence website recently, visit us at www.solesence.com. We continue to update and improve our site, which includes some videos and an abundance of compelling information.

While I'm unable to disclose the exact details of our product launches, everybody should be able to start seeing these products in the marketplace. We'll have more information to share, both on the products and sales volumes, over the next few quarterly calls, but we are in the market right now. We believe that Nanophase and Solesence are in the right place at the right time, right now.

Due to scheduling this -- during this call, we're having this on Friday morning, which is atypical, and I apologize for that. There were too many things happening relative to the business and we had to have the call today. I say that because I see we have a lower-than-typical amount of people listening live. Although most of our investors listen to the webcast to review the transcript after the live call, I'd like to invest -- invite those participating in today's call to ask any questions you may have or to share your comments.

Shelby, would you please begin the Q&A session?

(Operator Instructions) And our first question comes from Barry Blank from Divine Capital.

Are you able to give any guidance on -- I know you're giving some guidance on what sales will be, but what they will be -- what will bring down to the bottom line as possible earnings for the next 6 to 9 months?

Not at this point. We've got a lot of moving parts. We're going to definitely improve, certainly, over Q1, but also we're going to have a nice Q2.

To a certain extent, order flow is one of the issues we have to deal with. I'm expecting a very good second quarter, and I know that the beginning of Q3 looks pretty good. After that, our visibility wanes a little bit. And that's the -- that's always the tough part.

In terms of the structure of the business, we have not added significant expenses relative to an ongoing basis. We had some start-up costs in Q1. We also had -- and you'll see that R&D expense went up. We had testing and some patent fees in there, patent legal expense that drove that up, and that won't be a recurring event.

One more question. Are you working on any future products? I mean, not that will be happening in the next 3 to 6 months, but what are you working on for the future to continue the pipeline?

We have a lot of work going on there. That's a good question.

We have -- relative to Solesence, we have the products that are currently being launched that were developed specifically for customers. We also have what we refer to as White Label products, which are products that we have on the shelf that are ready to go, and we can sell those more immediately.

Down the line, you will see products in various formats from Solesence. Currently, we're selling -- the launch involves a couple of lotion products and also one powder product. You will see things like lip products, under eye products, a series of them, as well as additional technologies being brought to bear to address different issues. I don't want to disclose the specifics, but we are spending a fair amount of energy looking to see what we want to launch in 2019 and 2020 relative to the Solesence line.

We're also doing some development, not as much as we are with Solesence, but with our active ingredients business to try to bring some more products out that way. But as I mentioned in my prepared comments, we have a lot less control over the -- over how that goes to market, which is really why we're excited about Solesence and we're pushing that part of the business, because we have more levers to pull, more direct market feedback and, really, a shorter time to market.

One last question. What percentage of your sales go to -- I'm not asking you to name the customer, but goes to your largest customer, what percentage of your total sales?

Typically, on the order of 2/3 on an annual basis; it will be higher in the first quarter, which we'll see in the 10-Q, which will be coming out in about a week. They were heavier -- it wasn't that they were heavier in the first quarter, it was that our -- the coatings business was lighter, and we had a -- first quarter of '17 had a strong coatings volume, but also had some volume moving from Q4 of '16 into Q1 of '17. So the comparison is not great.

Typically, that customer is somewhere between 60% and 70% of our business. The goal, of course, is to have that customer continue to grow, but become a smaller and smaller part of our business going forward.

(Operator Instructions) And our next question comes from Ronald [Prater], a private investor.

Jess, could you describe the sales process for Solesence? How do you identify customers? How do you determine which products you were investing in, in the future? Just what the sales process looks like.

Okay. That's a nuanced question.

We have -- the first thing we did once we develop the technology, so we went out to look at products that were competitive in the market and wanted to make sure that we were, at a minimum, competitive with them. But obviously, we wanted to be better than they were. So we came up with our prototype products.

We -- through that, we have a web presence, we also -- we go to shows and do those things. We also, through Kevin Cureton and some of the other people in the business, as well as some of the work we've done over the years in the ingredients side, we have pretty good rolodexes to start the ball rolling. We meet with customers. We ask them for a -- we describe what our technology can do. We ask them specifically what they want their products to do, what the format should look like, showing them our prototype products, and then we come back to them with that.

The business -- typically, you're talking about, I would say, a 12- to 18-month process, sometimes faster if it's the White Label business. Our goal is ultimately to have a series of products in different formats that can address different markets. And to also be able -- we really, if you look at the Solesence website, we really have 3 different approaches that one of our customers can take using Solesence-enabled products. They can buy the White Label products, which are essentially off the shelf. They can label them and market them. We could help them with the story, we do a lot of work on that.

We can take those products and we can change them, to a degree, if they want a specific fragrance, say, or if -- could this feel a little bit different? Or we can build a product from scratch, which is -- takes the highest level of commitment both from us and then we require the highest level of commitment from the customer just because it's time consuming. That's been the process.

But we're -- by my measure, we're behind on getting new products out to market, and we expected internally to have more done last than we did. So we are getting to the point where we're having -- we've got the data sets built, we've the consumer claim sets built, we have some nice products, we have products in the market that will filter through. And that's where I mentioned we are going to spend more time doing market development, essentially and advertising toward the end of the year as we get everything else lined up by.

I'm pretty optimistic, Ron, about where this is going to go. And the sales process, we're fortunate that Kevin Cureton is an expert in personal care finished product sales, the exact market we're in. Jaime actually has some background in the same area. We've brought in the formulators that are -- in this business, a formulator really also does a little bit of business development because they have contacts with these people and they talk about where we're going to go. We'll frequently, we go to a show, it will be Kevin and the sales team and some of the formulators. I'll be at some of the shows, depending on scheduling and which show it is, but it's a very deeper -- it's a deeper sales process, and it's one that I think, compared to selling ingredients and advanced materials, where it's highly technical, it's long lead time.

You've been around long enough to have seen us going after the outdoor stain markets, where it's 2 years' worth of free spa testing, and then every time there's a slight change, there's 2 more years. This is a much different path. And we do believe that Solesence can be equal in size to the advanced material business in several years. I mean, it's got a different, very different profile.

Has your phone started to ring yet? Have you developed a presence in the market where customers have heard of you and are coming to you?

Our phone is ringing; it's not ringing enough. I'll never agree that it will be, I suppose.

The hit rate in all of this is not high, but we have a funnel that we continue to fill. Our website, as it is, which we are spending some time and resources on it, but not a ton, yet, is bringing in leads on a regular basis.

I believe these launches are really going to help because some of the -- the customer spend, there are companies that are $2 million companies and there are companies that are $1 billion in this market, and the smaller ones are more geared toward our White Label business. But the larger, stronger opportunities or the stronger brands will be moved, I believe, more by these product launches than they will be by -- we've got to have a claim set, we've got really nice test data, we're continuing to build clinical test data which is important.

But being in the market and success in the market is more important, and it's kind of that old saying that nobody ever got fired for buying IBM, they used to say. Well, it's similar. The more success we have, the easier it's going to be to get the next one. And also, the product that we sell to our largest customer, the Z-Cote HP-1, for years was the industry standard product in the marketplace. And so that's good, to be able to look back on that. The Solesence product, specifically, will be better in terms of kind of gluing our position in the market and helping people to gain confidence.

Okay. One final question. What happened to cost of revenues this quarter?

It's up. It's -- there were a series of things that happened there. We -- although our revenue, our inventory stayed relatively flat, we actually had a shift from finished goods to raw material inventories. There was about 300,000 of finished goods that came out of inventory. So essentially for those, we didn't absorb any overhead.

Volume wise, volume was down. That was largely timing. Product mix wise, we didn't lose the customers from Q1 that had the higher margins than the average in -- for Q1 of '17, that have a higher-margin average than the one we have now, but they're not in Q1. And so it's kind of a confluence of events that makes that weaker. Additionally, we also -- we're all hands on deck to get this launch off the ground for Solesence. So we spent money that will be start-up expense related, that won't be repeatable. That was in COGS, so I'm expecting that to improve significantly going forward.

And I would now like to turn the conference back over to Mr. Jankowski for any closing remarks.

Thank you, Shelby. And thanks to all of you for taking the time to listen and to support Nanophase and Solesence.

Given the work we've done in commercializing Solesence, even at this early stage, I can reiterate that we feel that our current opportunity set is very strong. We're pushing as hard as we can to take advantage of our current momentum, and we're in an excellent spot. As 2018 unfolds, we'll have more to share and I expect our outlook to continue to improve. Our second quarter looks good, and we're working on locking in more Solesence product launches for the fall of this year and spring of 2019. I'm looking forward to the opportunity to discuss the business with all of you again soon. And I want you to enjoy the sunshine responsibly, and have a great day. Thank you very much.

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