Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the EcoSynthetix 2019 third quarter results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instruction will be provided for you at that time. If anyone has any difficulty hearing the conference, you may press star zero for operator assistance at any time. Listeners are reminded that portions of today's discussion may contain forward-looking statements that reflect current views with respect to future events. Any statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on EcoSynthetix risks and uncertainties related to these forward-looking statements, please refer to the company annual information form dated March 4th, 2019, filed on SEDAR.
This morning call is being recorded on Tuesday, October 29, 2019, at 8:30 A.M. Eastern Time. I would now like to turn the call over to Mr. Jeff MacDonald, Chief Executive Officer of EcoSynthetix. Please go ahead, sir.
Good morning, and thank you for joining us today. Yesterday afternoon, we released our 2019 third quarter results, which you can find on our website at ecosynthetix.com. You can also download a copy of the slides that accompany today's call from our website or alternatively access them on the webcast. We continue to operate the business in a fiscally responsible manner, which was demonstrated by our results in the quarter. Net sales were impacted by the decline in the end market for paper. Market demand for coated free sheet paper has declined nearly 18% year-to-date, and our net sales are down 19% year-to-date, which includes the loss of one account we announced in the first quarter. Despite these challenging market dynamics, we maintained stable bottom-line performance. Adjusted EBITDA loss was nominal at CAD 40,000, and cash flow from operations was positive CAD 297,000.
While we showed improvement in our bottom-line results through the course of 2018, that was on the back of rising net sales in our paper and paper board markets. Our progress toward profitability and the durability of our bottom-line performance is clear based on the tests we've surpassed in the past two quarters. The paper market is one of the three legs of our stool, together with the wood composites market and our recent entry into personal care. While our immediate prospects in wood composites have moved a little to the right, we continue to make good progress and receive positive feedback in that key vertical. It cannot happen fast enough given that attrition in the paper market is moving faster than anyone expected. Today, the majority of our sales still come from the paper and paper board market. Our commercial accounts in the paper market remain intact.
Even in the case of the one account that we lost in the first quarter, they remain engaged, and we are trialing with them in other applications they manufacture. As we've outlined previously, our experience is that once we are commercial with an account, the business is sticky. EcoSphere continues to offer cost savings compared to current SB latex pricing, which is trading at approximately CAD 0.91 per pound. In spite of the downward pressure on SB latex, we have retained our margin effectively in this end market. However, converting new paper accounts is challenging in a market with falling demand and historically low SB latex pricing. Among existing commercial accounts, volumes across the customer base reflect the demand decline in their current ultimate end markets. We do continue to see select opportunities in specialty paper and packaging markets.
Specialty paper is a growth market, typically characterized by higher value, smaller volume opportunities with higher technical standards that require formulation development. In short, a standard coated paper account exceeds the value of a specialty paper account to us. While we derive the majority of our revenue from the paper market today, wood composites remains our primary focus for growth. Our lead commercial account, SWISS KRONO, remains very engaged with the agenda to offer no added formaldehyde products. They continue to engage their customers on the healthier attributes of their BE.YOND brand as an alternative to particle board manufactured with formaldehyde-based binders. They report good responses from their customers and are working diligently to broaden interest. At this early stage of their launch, our volumes are limited. We continue to engage a strong pipeline of prospects, including other manufacturers among the top 10 globally.
The retail pull from key strategic players in the market remains as committed as ever. We are seeing strong engagement within their organization and specifically from parts of their organization that are new to and fundamental in the decision-making and execution cycle. While there is no slippage in terms of the level of their engagement, timelines for decision-making and execution are obviously not within our control, and the process is taking longer than we and our prospect have anticipated. From our side, we have ensured the resources and technical requirements are in place to enable decisions and execution in the most expedient manner possible. Pulling back more broadly, what is clear from our pool of prospects today is that European accounts are more open to an agenda of change away from formaldehyde than North American accounts.
The North American accounts have only recently moved to the CARB 2 standard, and there are new mills coming online while the market is already dealing with idle capacity in some regions like the Southeast U.S. As a result, North American accounts are not showing the same level of interest as our prospects in Europe. Keep in mind that Europeans are working to meet the new German standard of halving the emissions level, which comes into effect on January 1st, 2020. Beyond the forward-thinking European accounts, we are trialing with select prospects that are looking for operational improvements to runnability and line efficiencies, which DuraBind can offer. For example, as a result of its improved tack relative to PMDI alone. Tack is a key element of runnability in commercial scale lines that involves the integrity of the material holding together prior to reaching the press.
We remain confident that wood composites is the highest value nearer-term market among the three legs of our commercial strategy. On the personal care front, in the second quarter, we highlighted an exclusive license arrangement we had signed with an ingredient and formulation manufacturer in the personal care space. They are marketing and developing our biopolymer as an all-natural ingredient to personal care brands globally. Initial feedback from the early stage of their launch has been very positive. We do not expect significant sales from this end market in the near term, as they advise a successful launch typically takes 12 to 18 months from introduction to shelf. They are excited about the progress they've made with accounts to this point and by the performance of our biopolymer across multiple different formulations.
In closing, the progress and changes we made to the business over the past two years have served us extremely well. We right-sized the business and focused resources on the highest value near-term opportunities. We have a foundational business in paper that, while under pressure recently, has allowed us to maintain a break-even position while we execute on our commercial strategies for wood composites and personal care. As a result of our financial stability, we're in a great position to push forward with these two exciting opportunities. With that, I'll turn it over to Rob to review the financial highlights.
Thanks, Jeff, and good morning. From a top-line perspective, net sales were CAD 4.5 million in Q3 2019, compared to CAD 5.6 million in the same period in 2018. This 19% decrease was primarily due to lower sales volume, which included a CAD 400,000 impact due to the loss of business at a paperboard mill announced in Q1. Gross profit was CAD 1 million in the quarter, down 5% compared to the same period in 2018. This change was primarily due to lower sales volume, which was partially offset by lower manufacturing costs. Net of manufacturing depreciation, gross profit as a percentage of sales was 26.2% in the quarter, compared to 22.7% for the same period in 2018. The increase was primarily due to favorable customer mix and lower manufacturing costs. Operating expenses were CAD 1.6 million in the quarter, flat to the same period in 2018.
We will continue to be disciplined in our approach to cost management, and we are confident that our current investment level is appropriate to deliver significant growth. Adjusted EBITDA loss was CAD 40,000 for the quarter, compared to a nominal loss in the same period in 2018. During the quarter, we generated CAD 297,000 positive cash flow from operations, compared to CAD 170,000 in the same period last year. The company purchased and canceled 319,000 common shares during the quarter under our normal course issuer bid for total consideration of CAD 688,000. As of September 30th, 2019, we have CAD 44.4 million in cash and short-term investments, compared to CAD 44.8 million as of December 31st, 2018. We have more than sufficient cash reserves to execute our growth strategy and will remain disciplined and manage our cash responsibly while continuing to invest in our long-term growth strategy.
With that, I'll turn it back to Jeff for closing comments.
Thanks, Rob. We've managed headwinds in the paper market during 2019 and still generated stable bottom-line results. The business generated positive cash from operating activities in both the third quarter and the year-to-date periods. It demonstrates the durability we've reached at this stage of our evolution. We have engineered the business to ensure we have the resources in place to successfully commercialize on the wood composites front and support the commercial launch of our licensee in personal care, while also servicing our paper and paperboard accounts. We have sufficient cash on hand to support our commercial and development activities. As Rob mentioned, we've been active on the normal course issuer bid, demonstrating our confidence in the business. We believe we're on the right side of the change agenda, change toward healthier, renewable, or all-natural ingredients. It is now a question of timing.
We are at a point where our offerings are in the market with blue-chip partners, and we have a foundation that is generating cash. Looking ahead, we are engaged with the right strategic accounts that are differentiated and are investing resources because they have conviction in what NAF products or all-natural ingredients can mean to their customers and brands. We appreciate the trust and the patience that our shareholders have shown, and I look forward to continuing to update you on our progress. With that, I'll turn it back to the operator to open up the call for questions. Thank you.
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the attendee roster. Your first question comes from the line of Raveel Afzaal from Canaccord. Your line is open.
Morning, guys. Thank you for hosting the call. Just starting off, can you give us some more color on the paper vertical? Based on the discussions that you've had with your customers in this space, do you foresee any additional losses, or do you think this is it for now?
Good morning, Raveel. Thanks for joining us. We don't foresee any further losses of accounts. I think we have to bet on the attrition of coated paper continuing, hopefully not at the same pace that we're seeing through the course of this year. There is structural decline. I think the most important thing is that we are shifting in the paper space to focus on those opportunities that our customers are focused on for growth in packaging and specialty paper. Of course, filling and more in for those losses with the new verticals of wood and personal care that we're focused on. No imminent losses that we can see in terms of accounts moving away from us or moving out of the business.
Got it. How much does packaging and specialty paper represent of your revenues right now? Is it five, 6%, or is it even below that?
No, it would be more than that. We don't segment it out, but just keep in mind that paper and paper board packaging still represents 90% plus of what we do today.
Got it. Just one more question on this before I move on. For modeling purposes, do you think we should be forecasting something like a 10% decline on the paper side for 2020, or how would you think about it from a modeling perspective?
Yeah. The numbers that the paper industry themselves publish puts it in the sort of 4%-6% decline range. I think that's probably the best guidance we could go with ourselves. Of course, we're looking for those opportunities that can fill in those gaps. We'd like to hold our own in paper while we grow the other spaces.
Perfect. Moving on to the wood vertical. The standards are coming in place, as you mentioned, at the beginning of 2020. What are some of the players in the space doing at the moment? Are they just planning on using more scavengers to be on the right side of the regulations, or are many of them offside, many are in compliance? Can you just give us some color on how the market looks today?
Yeah, I think everybody's anticipating that the change that Germany's putting in place will become a pan-European change. It's just so difficult to control where things are produced and then sold in such an open market. What we see is a lot of people are considering this a real European-based change in the making. What companies can do and are doing in the short term, given that this has come upon them so quickly, they can substitute out more expensive resins, which, as you said, have additional scavengers in them. In doing that, they assume more cost, and they also assume the cost of having their line slow down. When these modified resins for lower emissions are put in place, the line actually slows down. We had discussions just in the past couple of weeks with one very large European player.
Yeah, I won't share specific numbers, but I was surprised personally at the cost penalty that they will pay, just by switching over to these more expensive resins and slowing their lines down. We think that presents a really good opportunity for us to have customers considering whether they just go all the way at this point.
Got it. Just based on some of these wood players servicing Germany at the moment, are many of them offside at the moment as we stand today, or are many already in compliance in anticipation of these 2020 regulations?
I don't anticipate that as we transition into 2020 that anyone serving the market will be at least knowingly offside. They have the means in place today to be able to switch over. It's just a matter of buying a different, more expensive material and adjusting the process. They can basically do that overnight, but just at a cost.
Got it. Then just moving over to IKEA. It seems like your discussions are moving along very well. Do you know what some of the gating items are right now that are probably holding back a commercial contract with someone like IKEA?
Yeah. There's lots of work still to do on both sides. When I say both sides, it's us supporting some of the work that they have to go through. There is technology that has to be installed on their lines. Probably the most important thing that's happened in the last quarter is just the broadening of organizational involvement in the initiative. We're seeing new faces on the program, faces that need to be there in order to see this through to implementation. We see that as really positive and moving from a special project to a really organization-wide project. Of course, when you do that, and I guess especially in a consensus-driven organization like they have, you have more stakeholders that you need to satisfy, and they have questions that need to be answered.
Overall, though, I see it as a real positive that we're seeing all the people really necessary to move this to execution.
Perfect. One more question, and then I'll get back in the queue. On the personal care side, are you in a position to speak about the margin profile of this vertical, and the revenue opportunity that you see based on your discussions with your customer?
I think it's still too early to talk about what the revenue expectations would be, but I'll say just given the size of that organization and their current standing and their ambition in this market, they wouldn't do this for a few hundred thousand CAD. They have significant ambitions, and that's what gave us the confidence to enter into an exclusive arrangement with them. In terms of the margin profile, I'll simply say that it is a much, much higher margin profile than the two other verticals that we're serving. Yeah, even at lower volumes, the amount that drops to the bottom line for us is very attractive.
Perfect. I'll just get back in the queue. Thank you.
Thank you, Raveel.
Again, if you'd like to ask a question, you may do so by pressing star one on your telephone keypad. Your next question comes from the line of John Van Leeuwen, who is a private investor. Your line is open.
Hi, guys.
Hi, John.
Long time no talk. Just questions, I guess, about the personal care market. It's interesting to talk about that. What do you see as the main drivers for the EcoSynthetix technology versus what's out there today, and can you comment a little bit on the market size? You probably have in the past, but I just don't recall.
The key driver in it, and it's by far the most important one, is just the move toward all natural ingredients within the personal care space. It's what everyone wants, and it's what a lot of the traditional ingredient manufacturers are lacking in their portfolio. With that pull from the largest customers of our partner, they needed to broaden their portfolio of all natural ingredients, and they're seeing a need to have a much greater share of their products coming from sustainable, renewable ingredients, not only within personal care, but just more broadly. We fit that profile very well. The ingredient that we're replacing is a high-value ingredient, and I think initially what they were targeting was to have parity on performance to this ingredient.
What's got them quite excited is that we're seeing performance in our product, which is beyond what the incumbent petroleum-based chemistry is capable of. Basically, they're seeing greater performance from an all-natural ingredient at competitive pricing. For us, that competitive pricing, as I said, translates into a nice margin opportunity. The size of the market, there's so many ways to segment it down, but we're being conservative. We're looking really at the haircare space where our product has been introduced initially. Our partner is already trialing us in other applications beyond just haircare. There we're in the sort of, the incumbent ingredient that we're looking to replace is in the sort of half a billion to a CAD 1 billion range, in terms of value. Obviously, our partner is looking to take a meaningful share of that incumbent chemistry away.
The second question is, I remember EcoSynthetix worked with a fairly large player in this space before, and if I'm not mistaken, they withdrew from the business because of microplastics. I'm hearing a lot of noise, especially in Europe, about legislation coming in place to eliminate microplastics from products, cosmetics, but also packaging, because of the whole environmental impact of these things. Can you comment at all about your products versus technologies that have microplastics in them as to what the impact could be?
Today we don't have an offering that directly replaces microplastics, but one of the things for all ingredients that are going into personal care and even more broadly, as you said, in Europe, they're looking for biodegradability, ocean biodegradability, compostability, so that the ingredients that are going in go away under natural conditions. There we have a biodegradable offering in our standard product. That's obviously very attractive for the personal care space. Microplastics has been solved to a large degree with alternative ingredients. We don't have something directly today to replace that. The other areas, though, that in Europe and beyond, here in Canada as well, we're seeing just the backlash and the ban on certain elements of packaging that are not renewable.
There, I think our offering for paperboard going forward becomes more and more important because essentially you're coating paperboard with a styrene-based coating. Styrene is a plastic. We have in the specialty space where it's not only a backlash from environmental conditions, you have some applications where you have, for health reasons, certain chemistries that are being banned. In wraps for sandwiches, for example, the predominant barrier material that's used in the wraps that McDonald's and Subway uses are coated with fluorocarbons. That's a known nasty chemistry that those companies are looking to get out of. We have an application there of our biopolymer that is effectively replacing that as a grease barrier coating, which some of our customers are introducing to the market today. Those kind of trends definitely play in our favor.
We can't be everything to everybody. We think we've got some pretty neat offerings in actually in all of our verticals.
My last question is on this partner in the personal care space. You're talking about that it's a large partner. Can you say anything about their reach? Are they North American? Are they a global player? Are they looking at this in a certain region to launch? Often your penetration will be a function of how many samples they put out and how many products get approved. Can you give us an idea of the magnitude of how many samples they're putting out, or is it in the tens? Is it in the hundreds? That would probably help.
It's one of the largest of the global players, and they see the global market as their market. They use a combination of direct distribution and a network of resellers in different geographies, and depending on the scale of the end customers, they do distribution, I would say, like no one else. They have formulation capability like no one else. We really couldn't ask for a better partner. Sorry, I'm forgetting the second part of your question.
The sampling.
Oh, yeah. The sampling, right.
Yeah.
Those distribution channels have responded really well to what we've put in their hands. Basically, they launched in May, and I think we were among four important launches for them, and they've said that we're among the best, if not the best, relative to the other group that came out and launched this year. The response they've had, I'll just say it's in the hundreds of companies that have been sampled, and they've already got some things that have filtered all the way through the pipeline with early adopters, where they're starting to see it make its way into applications. Although they've said, "Don't expect anything meaningful for 12 to 18 months after launch," there are some early adopters in a small way to get started that are moving.
The launch, was it by press release, or was it by at a trade show?
Multiple trade shows. It seems like the springtime is the time for cosmetics trade show launches. They were launching in New York and Paris and in Asia. They got, by all accounts, a pretty good response.
Okay, very good. It sounds like it's a global approach for them.
Absolutely. Yeah. They are global and they wouldn't do it any other way.
All right. Thanks, Jeff.
Thanks a lot, John.
Your next question comes from the line of Raveel Afzaal with Canaccord. Your line is open.
Thank you, guys. Just a quick follow-up. Two follow-ups. You mentioned that on the personal care side, it also leads to greater performance at competitive price. Can you touch upon greater performance? What are some of the characteristics that are leading to greater performance, and how are you measuring that?
Well, that's a fun one to answer, actually. The test that I think is the most visual that people can get their heads around is a test for what's called curl retention. In their laboratories, they have these frocks of hair that are hung, and they apply different competitive products to them and then subject them to different environmental conditions. Our product has demonstrated significantly better curl retention, and I guess especially under humid conditions, versus the incumbent product. That is apparently one of the most important attributes for a film-forming hair fixative like ours, and that's one of the things that has them so excited. That's just one example.
On the manufacturing side, too, on the wood side, we speak a lot about the speed of the lines. Are there any attributes that improve the manufacturing of this product as well, or anything you can speak to on that side?
You mean on personal care as well?
Yeah, on the personal care, yeah.
I think there, what they measure is just ease of getting our product into formulations, and those were kind of gating tests that we had to pass early on, and our product works very well at getting into formulations. They want to be able to put an ingredient in the hands of their customers that they can use to replace incumbent ingredients or develop new formulations really easily. So far, that's played out very well. Our product's pretty easy to use.
Perfect. A question for Rob on the gross margins. Can you elaborate a little bit more on the favorable customer mix and lower manufacturing costs? Are we talking about the favorable customer mix within the paper side? Can you just elaborate on both of these a little bit more?
Yeah. Good morning, Raveel.
Morning.
Yeah, probably the simplest way to think about it is when we sell to companies in a dispersed form, that has a higher manufacturing cost than when we sell to customers in a dry form. We just have a bigger book of our business that's sold in a dry format. One customer in particular installed last year, a large packaging account installed material handling equipment to be able to receive it in a dry form versus a wet form. Just by the simple shift off our customer mix there has lowered our manufacturing costs. Also, if we look at last quarter compared to this quarter, we have just seen some of the input costs go down, and that's more so on the processing aids that we use. That's not the biggest component. It predominantly has been driven by customer mix.
Perfect. With respect to acquisition opportunities, are you guys now at a point where you would consider acquisition opportunities, or is that still some time away?
We're constantly looking at strategic relationships of all kinds in the industry, people we can partner with, channel partners we can sell through, as we've done in personal care. We've got our ear to the ground on really anybody that's important to the verticals that we're serving. We're always looking. I'll just say, there's nothing imminent, but if something came along that was ideal for us to be combined with, we'd certainly consider it.
Thank you. That's it for me. Thank you.
Thanks, Raveel.
Thanks, Raveel.
Your next question comes from the line of John Van Leeuwen, who is a private investor. Your line is open.
Yeah, guys. Jeff, just one follow-on question. This, what you're talking about here is haircare. Is there any application for your products in skincare, which I think is a larger market even, right?
All I can say right now is that there's optimism that our product can be used in those spaces, and our partner is looking at applications in their labs today that go beyond haircare. At this point, nothing proven yet where it's been adopted in any other formulations beyond haircare. That's certainly the idea, is to broaden it out from there. Things like, if you think about our product being a really good all-natural film former, think about skin masks, for example. That's exactly what you want to do, and you want to do that without sticking nasty ingredients on your face. Applications like that, we're optimistic we can play in.
All right. Thank you.
Thanks, John.
There are no further question at this time. I will turn the call back over to Mr. MacDonald for closing remarks.
Thanks again to everyone for joining us. Great to have some good questions at the end there. We'll talk to you again soon.
This concludes today's conference call. You may now disconnect.