Good morning, ladies and gentlemen. Thanks for standing by. Welcome to the EcoSynthetix 2023 First Quarter Results Conference Call. At this time, all participants are in listen-only mode. Following the presentation, we'll conduct a question and answer session. Instructions will be followed for you at that time for 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 such statements are subject to risk and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on the EcoSynthetix risk and uncertainties related to these forward-looking statements, please refer to the company's annual information form, dated February 28, 2023, which is posted on SEDAR.
This morning's call is being recorded on Thursday, March 4th, 2023 at 8:30 A.M. Eastern Time. I would now like to turn the conference over to Mr. Jeff MacDonald, Chief Executive Officer of EcoSynthetix. Please go ahead, sir.
Thank you and good morning. We issued our 2023 first quarter results yesterday afternoon. As we mentioned on our call in early March, Q1 was a challenging period. Net sales were $3.1 million, down 28% compared to the same period in 2022. While that short-term result is certainly frustrating, it's not the best method to evaluate the business. We address multi-billion dollar industrial end markets, replacing fossil-based chemistries that have been used for many decades. We have direct relationships with the right customers to deliver significant growth. Customers like SWISS KRONO, Dow, and our key strategic wood composites manufacturer that is backward integrated into a leading international retailer. The prospects we have in front of us today have never been better. In addition to progress with important existing relationships, this opportunity set is fueled by both new products and new relationships.
The pipeline improved during the quarter with important progress made. Admittedly, that's not yet showing in our sales volumes. The opportunity in front of us has not changed. It is as large as ever. I'm confident in our ability to execute on it. Why am I so confident? Our goal of becoming a $100 million revenue business is achievable with the customers we have in hand today. If we didn't add any new accounts in the coming years, if we went nowhere else, the opportunity set is there for us to surpass the $100 million figure with our key large accounts that each have multiple mills in their supply chains. The opportunities are right there for us to realize on that goal. I believe we can do it.
In fact, we have a broadening pipeline with renewed interest on the wood composites front and continued new interest in our SurfLock strength aid products. During the quarter, the backward integrated wood composites manufacturer published its 2022 climate report. In it, they identified wood-based glues as 5% of their total carbon footprint. The manufacturer and retailer has identified bio-based glues as one of the critical movements in material choices within their supply chain and a key enabler of achieving their overall climate goals. That is a significant step forward in how they've positioned that goal to their supply chain and more broadly through the mainstream press. It benefits us in 2 ways. First, the manufacturer committed to a meaningful step in its implementation of DuraBind for particle board production at the first mill where we are operational.
This step is about further industrialization and implementation beyond earlier commitments as they gained experience with DuraBind in their operation. That is great news that is not showing up in the quarter-over-quarter volumes at this point. While this manufacturer became a meaningful account to us in 2022, we expect their volumes to step up significantly in the second half of this year. Second, and potentially of even greater significance, the climate report and the media reports that followed it made it clear to the retailer's supply chain partners that bio-based glues were critical to achieving its climate goals. That was a strong statement to the supply chain that the ship is sailing. Fossil-based glues are on their way out at the retailer, and bio-based glues are the critical movement.
I think that caught some of the third-party manufacturers in the industry by surprise that this much progress had been made. This international retailer is a forward-thinking thought leader in the market. When they move, it causes their supply chain and the broader industry to move, and we're starting to see that on new inbound interest in DuraBind. In the early days of our DuraBind program, we had several prospects that went quite far in the technical evaluation of DuraBind and its use in their production processes with largely successful results. They stopped short of moving to commercialization because they didn't see the market catalyst to warrant significant industrial change. The demand for more sustainable, healthier alternatives wasn't as evident then. That has changed with the commitment from this international retailer.
They have set the tone for the market. In the meantime, we have made significant improvements in the DuraBind product family. We have new trial programs on the go in the second quarter. We're in a position to be more discerning about who has the capabilities and the conviction to move ahead with DuraBind. We're working with a few key prospects that we think can significantly move the needle for both the industry and for our results as well. Later this month, we'll be attending the LIGNA Conference in Germany, which is a major industry trade show and conference that takes place every 3 years. We expect that the awareness from the international retailers' commitment will drive new attention and interest in DuraBind at the event.
We are poised for greater success in the wood composites end market, and it's supporting our diversification strategy with the multiple shots on goal approach. It's working. While sales have remained stable the past few years, the composition of the revenue mix has changed substantially. The graphic paper end market used to make up more than 90% of our revenue just a few short years ago, and almost all of our gross profit. With the industrial change we've enabled in our newer end markets, we have a good start, where today, our revenue coming from end markets outside of graphic paper is approximately half, and the contribution to gross profit is more than half. The deterioration in the legacy graphic paper market continues. North American coated freesheet paper production was down more than 28% in Q1 versus the same period in 2022.
Destocking is happening throughout the supply chain. As a result, industry operating rates have also dropped significantly over the past six months, from 97% in September to 76% in March. SB latex, the petroleum-based binder our EcoSphere binder replaces, remains below its historical pricing levels. These pricing dynamics, together with the cost profile of our feedstock, has EcoSphere at a disadvantage. We made decisions in 2022 to secure sufficient feedstock to keep our key accounts in supply. That feedstock was higher cost, and it's working its way through our results. More recently, we've seen positive news on both the availability of feedstock and improved pricing than what we were seeing as recently as January, which is great. The accounts that are using EcoSphere see the value proposition in it.
The higher-priced feedstock has impacted demand, but as we work our way through that expensive feedstock and return to more normalized pricing levels, we continue to believe EcoSphere is a valuable contributor to the business. I'm sometimes asked, "Why not just exit the graphic paper market if it's so challenged?" That is not our strategy. First, it is a good base loading level for our operations. It makes a positive contribution, more so in a normal pricing environment. Even in the recent supply constraint situation, it is still a net positive contributor. Second, we've established strong relationships with some of the largest pulp and paper manufacturers in the market. They rely on us, they trust us, and they are important to us as we look to broaden our reach with SurfLock, our wet end strength aid.
The rollout of SurfLock is moving slower than we anticipated due to general softness in the macro market. Interest in the product and the broadening of the pipeline is definitely happening. We're going into new geographies and new accounts on a monthly basis. We have a number of key prospects in the pipeline that we've discussed before, and those prospects remain in place and remain the most important and advanced in the pipeline. We have significantly more irons in the fire, so to speak. Our primary go-to-market approach has traditionally been direct to manufacturers, and it's still key to us, but we've opened up another front, engaging the chemistry service providers that implement and monitor wet end chemistries at the mill level. There are a number of regional players that we're actively engaged with that could prove to be important channel partners for us over time.
Our goal with them is to ensure they understand and can optimize a chemistry package that involves SurfLock. These players have a track record of excellent service to the mills right in the local environment, whether that's Eastern Europe, Japan, or the U.K. We believe this group can be an important part of the go-to-market strategy in the pulp, tissue, and paperboard end markets to realize the full potential of SurfLock. On the personal care side, our development and marketing partner, Dow, continues to make progress on the hair fixative end market. The results have not come as quickly as they expected. They continue to believe they can make a material impact in the market with all-natural formulations. They've also broadened the addressable market with new formulations of MaizeCare for skincare, which they introduced at a recent cosmetics conference.
Based on their feedback to us, Dow is enthusiastic about the opportunity for MaizeCare across both the hair fixative and skincare end markets. We have the products in front of the right partners and the right customers to deliver a $100 million business. It's taking more time than we anticipated, but the opportunity set is as strong as ever, and we're confident in our ability to execute. Rob will address our financials.
Thanks, Jeff. Good morning. Net sales were CAD 3.1 million in Q1 2023, down 28% compared to the same period in 2022. The decline was due to a step down in demand across a number of our end markets, which resulted in lower volumes of CAD 1.6 million or 37%, which was partially offset by higher average selling price, which impacted sales by CAD 400,000 or 9%. This demand pressure also included approximately CAD 700,000 lower sales due to inventory destocking at a large distributor into the graphic paper end market, as well as continued demand deterioration in graphic paper and softer demand due to temporary market related customer mill downtimes. These headwinds have continued to persist into the early stages of the second quarter.
The higher average selling price this quarter was due to the continued need to offset significant inflationary pressures with price increases. Gross profit was $600,000 in the quarter, a decrease of $500,000 from the same period last year. The change was primarily due to an increase in sales volumes and higher costs of manufacturing, partially offset by higher average selling price. Manufacturing costs also included a $200,000 charge in additional depreciation on certain machinery and equipment due to a change in the useful life as a result of our plans to internalize our North American manufacturing. During 2023, we expect to incur approximately $1 million in non-cash related accelerated depreciation charges related to this investment.
Net of manufacturing depreciation, gross profit as a percentage of sales was 32.6% in the quarter compared to 28.9% in the same period last year. As Jeff mentioned, we are holding higher costs, raw materials, and inventory. Based on the recent pricing we're seeing in the market, we expect our feedstock costs to start to normalize in the back half of the year. However, this will also likely impact our selling prices. SG&A expenses were $1.3 million in the quarter, a decrease of $90,000 compared to the same period in 2022. This improvement was primarily due to lower discretionary spending. R&D expenses were $600,000 in the quarter compared to $430,000 in the same period last year. The change was due to an increase in scaleup costs related to new product launches during the quarter.
We continue to invest in innovation to improve our value proposition and expand our addressable market opportunities. Adjusted EBITDA loss was $600,000 in the quarter, compared to a loss of $200,000 in the same period last year. This change was primarily due to lower gross profit and higher operating costs while compared to the prior period. Cash provided by operating activities was $300,000 in the quarter compared to cash used in operating activities of $1.6 million in the prior year period. This improvement was primarily due to working capital improvements. As of March 31st, 2023, we had $35.6 million in cash and term deposits, compared to $36 million as of December 31st, 2022. During the quarter, we invested $400,000 in property, plant, and equipment related to our manufacturing capacity realignment strategy.
In 2023, we expect to invest up to $2 million on these production capacity investments. In addition, $200,000 was invested in the NCIB during the quarter to purchase and retire 68,400 shares. We have demonstrated our ability to responsibly manage our cash reserves through multiple cycles while continuing to invest in our long-term growth cycle. With that, I'll turn it back to Jeff for closing comments.
Thanks, Rob. We have direct relationships with customers to achieve our $100 million revenue target with no new account wins. Higher volumes and more mills within the existing account base get us there, and we expect to win new accounts. This will come with the new attention that DuraBind is attracting from the supply chain of the international retailer, the progress we're making in the wet end strength aid market, and Dow opening new opportunities in personal care. We are positioned for growth. With that context and given the softness in capital markets, the board has decided to lean into the NCIB share buyback program.
It will be a balanced approach that recognizes both our belief in the long-term prospects of the business and the importance of maintaining a strong cash reserve in difficult markets, and the value our large customers place on knowing that we have the resources to sustain through market cycles. In the current environment, we see significant value in the stock at today's levels, so we'll be allocating more capital and using the NCIB to address that fact. With that, I'll ask the operator to open up the call for your questions. Thank you.
Thank you. Ladies and gentlemen, we'll now begin the question and answer period. If you'd like to ask a question, please press star followed by one. If you'd like to withdraw your question, please press star followed by two. If you're using a keypad, please lift the handset before pressing any keys. One moment for your first question. Your first question comes from Brian Morrison, a private investor. Brian, please go ahead.
Okay. Good morning, Jeff, can you hear me?
Yep, we can hear you, Brian. Good morning.
All right. Okay, let's start big picture. It seems like no change to the view of the opportunity ahead. You have that slide with a $100 million target and the five customers that it can get you there.
I guess you're talking a very positive story here, but what gives you the confidence in this challenging environment to maintain that guide, both in terms of the quantity of revenues and the timing?
I think it's the conviction and the quality of that customer base that we're working with today. These are high quality, large companies for the most part, that have done their due diligence in what we have to offer and have built us into their plans. When we add up the opportunity from among the ones that we're working with today that are most important to us, that, you know, that gets us to greater than $100 million of opportunity itself. Then the spin-off benefit from that is that those are often the thought leaders in the markets we're working in, and that spin-off impact of them having made moves with us, I think bodes well for us to continue to expand our pipeline with other accounts.
We see the opportunity right in front of us. We see the enthusiasm and the interest in the customer base every day. It's not showing up in our results in this quarter for sure, but the opportunity set has only improved through the last even short-term period of time.
Maybe we can talk about that opportunity in wood products first. It sounds like the commercial relationship with your major customer, it spurned some additional interest from other potential customers. Can you elaborate on that potential opportunity? Are these large market players that have trialed previously? If so, how long from this stage to potentially become commercial?
There are three that we're most excited about, and they are all players who have done work with DuraBind in the past, and in some cases took it quite far toward the goal of commercialization. I think one thing we have to keep in mind is that that was at a time prior to some of the new product introductions we've made to the DuraBind family, we've only enhanced the value proposition since then. If value was a question at all, which it probably was, we've improved that. I think with the catalyst of our large retailer customer, giving greater clarity on where they're going, that's what's sparked this renewed interest.
The trial programs with each of them have come to the forefront pretty quickly, which we're excited about, and we think they have a head start in their trialing activities based on the learnings they've already achieved. You asked about scale. These are two top 10 customers in the wood panel market and one smaller player that we think is, pretty important and interesting strategically as well. One of them happens to be recognized as perhaps the innovation leader within the wood composite space. I think that bodes well for their ability to take something new and drive it industrially, you know, with some reasonable speed and conviction. Yeah, we're excited that the news has caught the attention of some important players and has got us started in some good activity.
Okay. Your major customer, the expansion goals on that front, are they still tracking a doubling of sales in 2023, or do you have better visibility on that?
Yeah, we would hope so. We did suggest that they had done that last year as they became commercial with us through the course of last year. The expectation from the plans that we've looked at together would be that they would do that again, and I'd say that remains on track.
Okay. Can I turn to the wet end? Last quarter, you said you had engaged potential clients that were trialing. I realize it's only been about eight weeks since the last call, but you did say there's more irons in the fire. Just can you elaborate on the expansion of this catchment area? Then maybe along those lines with your SurfLock product, maybe discuss how the success rate has been in your trialing.
The trialing success has been pretty much universal at this point. Where we've been able to get it in industrial settings and give it a good run, results have been positive step-by-step. We're really excited about that. That gives us great confidence that this is gonna fly to a greater extent commercially. The trial pipeline, I would say the open end of the funnel has continued to expand as we've gone into new geographies and introduced ourselves and SurfLock to new customers. I'm still really focused on the ones that, you know, we would've alluded to before as being furthest along in the pipeline. Part of the reason for that is, I guess, just while we've introduced SurfLock to a new customer set, we're introducing it in a market that's overall down.
Including with the 8 or so that we've had in the pipeline, activities have been slow at literally every one of those accounts. That's resulted, I think, in a little bit of a slowdown in trialing activity and implementation, but we've broadened the interest. I did mention that we've started to open up another channel, which we think is gonna be pretty important to our commercialization of SurfLock, and that's through the wet end chemistry service provider companies. In many cases, I'll even say in most cases, pulp and paper mills have farmed out a significant part of servicing the wet end of the mill to these third-party service providers that are actually in the mills 24/7.
We think they're an important partner in introducing and implementing SurfLock and can no doubt have us going faster to realize the potential we think this product has.
This should expedite the process of market penetration service providers.
I believe so. That's... We're pursuing it with that in mind for sure.
Okay. Just through the trialing, I know it varies by client, but help me understand the cost savings. You know, I know the filler replacement's different, but how should we think of in terms of savings per line for a packaging client and for a tissue client?
Yeah, it does vary by account and even by line within account. But it's all predicated on the ability to improve strength. As we've said in the past, you know, nobody really needs a stronger sheet of tissue or a stronger piece of paper. It's really what you do with that strength advantage that makes a difference. Typically, customers are using that strength advantage to substitute in lower cost fibers, recycled fibers in some cases, and even inert fillers. Really cheap products that just take up space in the paper matrix. What we've heard from one mill manager is that for every percentage on a large paperboard line that you can substitute filler in for expensive fiber, it can be up to $1 million in savings.
We're seeing in our trialing activity several percent increases in filler addition levels. It's, you know, we're talking about for large paperboard lines, significant in the millions of dollars of cost savings on an annualized basis. That's what's got the attention of those large paperboard manufacturers. In the tissue manufacturing side, the strength improvement is of similar magnitude, so say 15%-20% improvement in strength. Those are smaller lines, therefore smaller revenue opportunities for us and smaller savings. Seems to be working, you know, equally well in all of the different paper and paperboard applications.
Sorry, those savings. With that amount of savings, what's the revenue per line on a packaging client to you, ballpark?
For a large packaging line, we believe it's in the $3 million-$5 million revenue opportunity for us. In a tissue line, it's in the several hundred thousand dollars of opportunity. It's almost an order of magnitude difference between the two. There are more tissue mills, and so far from experience, it seems to be easier to get our product implemented on a smaller line like that.
I guess big picture, Jeff, what's the reason once the restocking environment or the destocking ends and restocking starts, what's the reason not to see migration to your SurfLock product?
We can't see any based on the results we've seen so far, Brian. It seems to have a really strong value proposition, and it seems to have the attention of the right players. I believe it's just getting time on these lines and then realizing it. It was a constraint for us for a time, and we've talked about this on past calls. We were concerned and actually didn't wanna put our foot forward until we had material to support these customers. That's no longer the case. It is expensive inventory, as you can see in our statements, but we have inventory ready to go as these accounts are ready to go in their use of our product. That part of it's no longer a constraint.
Right. In terms of the inventory, what are you seeing in terms of starch prices? Is that the reason why you didn't get more aggressive with building your inventory near-term for growth?
What we're seeing is first and foremost, availability. There was a time we couldn't get a starch salesperson to call us back. They're back. They're interested in business and in new business. The availability has opened up. Pricing was a little bit slow to follow initially, but even just in the last few weeks, we're seeing some indications of pricing beginning to come off. There's still a long way to go to get back to where we were. Pricing of our feedstock more than doubled for a period of time.
We're starting to see some relaxing of that, and we expect that with the outlook for corn and the supply demand dynamics that are out there right now, it looks like we're heading to a more favorable environment as we get toward the back half of the year.
Okay. I'm sorry to dominate the call, but I have two last questions.
Sure.
On the previous call, there was talk about an opportunity on the pulp side, and you had them in discussions. This is obviously a huge market. Can you discuss how big a potential pulp customers could be in terms of lines, revenue per line potential, and where your progress on this front currently stands? Can this equipment that you're writing down be utilized in another geography if necessary?
Okay. Yeah. If I talked about a tissue mill leading to a packaging board mill being a magnitude of difference in revenue opportunity, a pulp customer would be another magnitude of difference. We're talking about potentially tens of millions of dollars of opportunity by modifying pulp. The strength improvement part of that has been proven, and I would say proven quite far through technical validation, probably a couple of steps to go. But it is a much bigger undertaking simply because these are large mills, with much more complex value chain. Pulp is going to the kinds of customers we're selling SurfLock to for modifying packaging products or tissue products, and then has to make its way all the way through the supply chain.
The opportunity, although maybe a little bit more difficult to get at, is of a much greater magnitude. It's gonna take some time still, but worth investing the time, just given the opportunity there. We're talking about, in this case, modifying pulp that would be typically lower value, shorter fiber pulp and making it behave more like the longer fiber, higher value proposition pulp, which is quite attractive to those in geographies that are producing a lot of short fiber pulp product.
Okay, last question. NCIB, you alluded to it on the call. It sounds like you're gonna get a little bit more aggressive here, which I think is appreciated, certainly from my front. Did I hear it right, maybe in terms of, you'll be increasing that notably and will that be inclusive of an automatic share purchase plan?
Yeah. We actually renew our NCIB annually in the coming week, and we'll be renewed with the ability to do an automatic purchase plan as well.
Okay. I guess last question. What are the data points we should look for in terms of progression towards your targets? What's on the near term horizon?
I think a big one for us has been what you alluded to, was just an sort of a resetting of the feedstock market for us. We're really encouraged that the availability and I believe the value proposition coming from flowing back through our feedstock is gonna be more attractive going forward. That not being a constraint and playing out for the second half of the year is an important one. I think we're pretty much pretty close to ticking that box now. Otherwise, of course, it's about revenue growth. I think it's just wins at customers, number one.
I believe just given the velocity of implementation on tissue mills, albeit that they're smaller in revenue size, I think we're best poised to achieve some wins there in the nearer term. I would also say, just given the, you know, the uptick in overall interest from the large retailers' announcement, we'll be talking obviously in our next call about progress on trial programs with other wood panel manufacturers. Progress on that front is gonna be important too. You know, remember there again that each mill is a $3 million-$5 million revenue opportunity for us, very similar in size to a large packaging board mill.
You know, what gets us excited, we feel we're pretty much at that point today, but it's just one of these mill opportunities at the margins we can achieve there that gets us to being positive on the EBITDA side. That's a, that's a nearer term goal for our team than the $100 million revenue target, which we consider our midterm goal.
Okay. I've used enough of your time, Jeff. I look forward to seeing the progression.
Thanks for your interest, Brian. Thanks for the questions.
Ladies and gentlemen, as a reminder, should you like to ask a question, please press star followed by one. Your next question comes from Steve Hyland, a Private Investor. Steve, please go ahead.
Can you hear me?
Yeah, we can hear you, Steve.
Okay. Just a question on your cash balances. The interest rates are moving up. Are you getting good rates on the short-term cash?
Yeah, we are, Steve. Definitely better than we were, a year, a year plus ago. It's really on a, on a rotating basis, so we have kind of a staged investment program in different facilities. Definitely the interest is starting to show up in our, in our numbers again. Yeah, I think we're, I think we're investing at what everybody should consider competitive rates today with our term deposits. That's definitely improved in the last year.
With respect to the share buyback, did you ever consider a modified Dutch auction?
No, honestly not. Have not considered that. I think we can get done what's really within our capabilities of our balance sheet and relative to the value we see in the stock using the NCIB. We've got the ability to, you know, purchase a meaningful volume of shares back over the course of the next year and we expect to be able to do that.
Okay. All right. That's it.
Thanks, Steve.
There are no further questions at this time. I'll turn it back to you.
Great. Thanks again to everyone for joining us today, and we'll update you again soon.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.