Jess Jankowski, President & CEO
Thank you, Carmen. Good morning to all of those listening live, and welcome to those who choose to listen later online. Thanks for joining us for today’s call. Our discussion will cover second quarter and year-to-date results, the current state of the business, and some of our tactical plans for 2022. Kevin Cureton, our Chief Operating Officer, is also with me here today.
We can’t deny that our second quarter results fell below our expectations. A great top-line, followed by above average costs led to below average margins. We know that marks two quarters of underperformance in terms of profitability, but there’s a lot to be optimistic about as we’ll discuss.
After the numbers, I’ll expand on this a bit. There are a few themes we’re going to return to today, and probably through the year. We’ve seen phenomenal growth in 2020, ‘21, and so far in 2022. This has been the result of focusing primarily on getting as much product out the door, as quickly as possible. We’re still seeing high demand for our technically enabled products by Consumers & our Brand Partners, all of which has been energized by a favorable regulatory landscape. We’re in that golden period in a growth company’s life cycle, where building more business through sales, of what is clearly a disruptive technology, is being limited mainly by our inability to produce more product. Our profitability has been impacted negatively in recent months, but we’re in a spot where we see many opportunities to reduce costs and get margins back on track.
Before I expand on this, let’s hit the numbers:
Unless identified otherwise, all numbers will be stated in approximate terms.
Similarly to the first quarter of 2022, we had uneven product shipments during the second quarter, with a significant portion of our revenue hitting in June. Our previous monthly revenue record was $3.8M in March of ’22. In June, we hit $4.9M, and we finished the quarter by breaking through with another revenue record, where we had $11.2M in Q2 revenue! This was on top of Q1’s $8.2M, which had been our prior record. Together, this led to $19.4M in revenue for the first half. For reference, we shipped $7.1M in the second quarter of 2021, and first half 2021 revenue amounted to $14.2M. While we enjoy big revenue months like March and June, particularly as they can be representative of future run rates, they can also negatively impact margins when the other months in a given quarter are lower than expected. This can lead (and has) to poor overhead absorption during the lower months, as well as labor inefficiencies. Gross profit margins for the first half of ’22 were 25%, compared to 32% for the same period in 2021.
In our view, the 7% differential for the six-month period, when applied against 2022 quantities shipped, represented a minimum of about $1.3M in lost opportunity. Much of this was due to labor inefficiencies, driven by the use of a higher quantity of inexperienced contract labor, heavy overtime, and a shortage of production management on the floor. Some of this was further driven by our struggles with inventory, and production as we consolidated from several small-to-medium sized warehouse areas to one large one, and we continue to spend lots of management and engineering resources preparing to move key parts of production to our new facility. I use the term “lost opportunity,” here because we know how to fix it, but we couldn’t get that done during the first half of 2022, while driving all of the other things in the business necessary to get the product shipped.
For the first half, Net income was about $110K, or $0.00/share, compared to $400K, or $0.01/share, for the first half of 2021. The 2021 number I’m referring to is before including the $950K in other income generated from the forgiveness of our PPP loan in February of ‘21. That was a one-time event in 2021 that didn’t relate to operations. We built almost $3M of inventory between the end of 2021 and June 30th of 2022. A good deal of this expansion was intentional, as we purchased raw materials in greater quantities than we needed immediately, in order to create a buffer for the supply chain issues that plagued us later in 2021, and for parts of the first half of this year. This has also been a function of our rapid growth, which has created a drain on working capital, and led to production inefficiencies, particularly when operating out of several warehouses.
We finished the consolidation of our warehouses early this month, and, like the story of our labor inefficiencies, this presents us with another opportunity to increase throughput and profitability. Shipping $19.4M in the first half of 2022 was exciting, and it’s more exciting when we contemplate the planned productivity and efficiency gains, yet to be made, that we know will enable us to ship more product, and make more money!
I’m sure you’re tired of hearing me talking about “growing pains,” but they are inescapable. Fortunately, they aren’t baked-in, and we’re addressing them now.
From June 30th, out through the end of 2022, we have $18M in shipped orders and POs in hand. We also expect there to be more 2022 POs coming in. Additionally, in August of 2022, we have more than $10M in 2023 purchase orders in hand. We also know that a substantial portion of our 2023 purchase orders would be happily accepted by our customers in 2022, if we are able to deliver. That is not lost on us.
We’re maintaining our growth strategy, which is now being sustained by the new senior sales and business development leaders who joined our companies during the first quarter. This will allow Kevin and I to focus much more of our attention to achieving operational excellence, as we complete the onboarding process of several new key finance and operating leaders during Q3. There will be more to follow on this.
Shifting gears, we know that we have many new followers on each of our calls, some live, most on the web. Given that, we wanted to make sure our value proposition remains clear.
The questions I’d like to address are: Where do Solésence and Nanophase fit in to the larger market environments they serve, and what are some of the tailwinds that have helped to bring us this far?
Our primary business within Solésence is the design, manufacture, and packaging of prestige cosmetics. In our case, all of these provide protection from the skin damage caused by the sun, through the use of natural, safe, mineral-based, full-spectrum UV absorbers. We use our patented technologies to bring a luxury feel, and appearance, to cosmetics that historically haven’t included a great deal of UV protection. We have taken this to another level by primarily using minerals-based absorbers. While generally viewed as safer to use, or healthier, than chemicals-based absorbers, zinc oxide and other minerals suffered from the historic perception that they caused “whitening,” or “ghosting” on people’s skin. This was the perception in the past, largely because it was true! I say, “was true,” because Nanophase with its world-class APIs, and Solésence with its formulation technology, have pioneered zinc oxide that could be engineered to be worked into formulations, in a way that it did not create whitening.
Even after this technology became broadly available, consumers didn’t understand the benefits, so they didn’t embrace it. Manufacturers of active wear sunscreens didn’t get behind these materials either, typically, due to:
· The lack of consumer demand,
· The existence of more than ten chemicals-based alternatives, some of which were inexpensive, and
· Their relative lack of familiarity with zinc oxide in formulation.
When we invented the Solésence technologies, of which there are now several, we decided that we would develop “model” formulations for the industry, with the purpose of showing customers that zinc oxide could be a big winner, in both the sunscreen markets and in cosmetics. The goal was to make our materials much easier to work with than anyone had ever seen in the past, creating products enabled by minerals that companies simply didn’t think were possible. Even then, there was still a good deal of resistance in the market, then the external environment changed in a way that was very beneficial to us.
Beginning with Australia, as they saw damage being done to the Great Barrier Reef by chemicals-based sunscreens, national governments, then even some local governments, began prohibiting the use of sunscreens with chemical active ingredients known to damage coral reefs. Consumers began to take notice, and started demanding “reef safe” sunscreens. Minerals are a natural for this. At roughly the same time, this was all in the late teens, consumers began to better understand three things:
1) Damage from the sun was literally the cause of 90% of premature aging,
2) Skin cancer was a real threat to health and happiness, and,
3) Minerals were a more natural way to stay healthy.
Now, the demand for zinc oxide as a full-spectrum UV absorber began to get legs. Then, in October of 2019, the U.S. Food and Drug Administration made an announcement that resonated through the entire market.
The FDA began publicly questioning the safety of chemical UV absorbers in the form of proposed regulations.
Historically, there were fourteen materials allowed by the FDA to be used as UV absorbers. These are published in what is called a “monograph,” dictating which materials could be used in commerce. In the United States, any product with a “label claim” of UV protection is regulated as a drug by the FDA. In the business we’re discussing, we refer to these as “APIs,” which stands for Active Pharmaceutical Ingredients. Of the fourteen UV absorbers listed in the Monograph, two were mineral-based, zinc oxide and titanium dioxide, while the other twelve were organic chemical- or “chemicals-based.”
The FDA declared that the minerals-based APIs were known to be safe, and needed no further testing. This supported what we already knew, what dermatologists knew, and what was already beginning to dawn on consumers. The FDA went on to say that a few of the chemical absorbers had become known to be unsafe, and needed to be withdrawn from the market, with the rest of the chemical alternatives, every one of them, being put in a category where more testing would need to be presented to the FDA before they could be deemed safe. The big producers of these chemical absorbers have been fighting this proposal by the FDA, which has yet to be put into law. That said, some chemicals are no longer used in the market, you can assume what you will there, while others remain on the shelves. We believe that the reason this hasn’t moved faster, is that there are not nearly as many zinc oxide producers in the market as there are big conglomerates, who continue to pump out these unproven chemicals.
The good news for us, Nanophase and Solésence, is that consumers are becoming more aware of the risks associated with chemicals-based absorbers every day, which can only be good for us. So, today, minerals-based UV absorbers are what the markets want, and most mineral producers are not achieving the performance that we can in this area. This looks a lot like a long-term demand cycle, and our positioning is excellent!
For those of you that are newer to our Companies, the growth seeds for Solésence were planted during 2018 and 2019. You need to know that we have done very little marketing, or new customer development, over the past several years. I mention it, because this means that our customer base, and the excellent growth within it that we are experiencing, has been built upon the merits of our products, word-of-mouth, and the work we did, prior to 2020, in getting our products in front of industry leaders. We’ve changed this with the addition of the senior sales, marketing, and business development resources we added to the Company in the first quarter. We expect to begin to see solid growth from these new efforts later this year, but even more so in 2023.
As you have all recently seen, not without financial some pain, we’re being limited by the constraints put on our organization by the fantastic growth we’ve seen in our Solésence products. The production and operational improvements we need to make, will get done as senior management devotes the bulk of our focus to fixing this, supported by the onboarding of the internal capacity we need to make it happen.
We’re really excited to see what our team can do with our products and technologies. We will get past our growth-related operating issues, which will allow us to grow as fast, and as profitably, as we know we can. Now I’d like to introduce Kevin Cureton, our Chief Operating Officer, and my partner in all of this, to discuss progress in these strategic areas, and their drivers, in greater detail. Kevin?
Kevin Cureton, Chief Operating Officer
Thanks, Jess. As always, I will begin by thanking our talented team for their continued efforts in our work to not only transform our company but to simultaneously transform a market. As I am the “the Glass is Always Full guy”, I will add a couple of additional remarks to Jess’ reflection on our history and transition. In the almost 33 years since our company started – in only 6 of those years has the company’s annual revenue exceeded this quarter’s performance. Three of those 6 years includes this year, 2020, and 2021. This is not to say that we are pleased with the bottom line performance, but it certainly is appropriate to celebrate the realization of the meaningful and sustainable organization we are in the process of building. Continuing on, While we mentioned a number of important milestones in our earnings release, here are a few additional items to consider:
1. First, we remain confident in our ability to address the primary factors that contributed to our gross profit margin issue in the first half of this year - namely labor efficiency. In fact we spoke about this a bit in the last conference call. As we noted in last quarter’s call, we are implementing programs, specifically process automation, that will significantly improve labor efficiency. Through these process changes, we are targeting to increase gross profit margins by greater than 5 points over the next several quarters. The first of these new capabilities is, as of just this week, operational in our new building, where we are seeing the expected reduction in labor cost as a result of increasing output per labor hour. We will refrain from providing more specific details at this time on the degree of improvement, but we are on track with the goal mentioned above.
2. As with most company’s we have been impacted by the unprecedented increases in materials costs and wages this year. One of the important challenges that manufacturer’s like us have is to implement price increases to help address these purchased cost increases. We are making solid progress here as well, Compared to 2021, our average price per unit in our Solesence business, through changes in product mix and needed price increases, is up by over 6%. Since this hasn’t offset all of the margin erosion of the increases in materials cost, we believe there is still more room for improvement here, and are continuing to make additional changes in product mix and implement further price increases.
3. Turning back toward the revenue side of our business, we have on-hand orders that will enable us to exceed first half revenue results, good news. We can also with this good news say that the products we develop with our brand partners are now available in all major beauty retailers in the US, and several major beauty retailers in Canada, the EU, and Australia – literally thousands of stores.
4. As a further peak into the future - Our pipeline for new opportunities is expected to contribute solid double digit growth in 2023. Our continued success in winning industry acclaim for our products and services – including winning best formulation at the Cosmopack awards, being named a finalist for two other industry awards, and continued success of our brand partner’s as they achieve their own note worthy achievements in being mentioned in top sunscreen product lists in multiple publications – help make us a desired destination for brands seeking best in class skin care and cosmetics products with SPF.
As I prepare to pass the mic back over to Jess, I will say that being the glass is always full guy isn’t the same as the being the guy wearing rose colored glasses – we, I , clearly see the challenges and we are aggressively moving our company forward to address them. While we are also keeping capable and talented resources focused on aggressively and yes more profitably grow our company, your company and become the globally sought after brand we aspire to be.
Jess Jankowski, President & CEO
Thanks, Kevin. A few short observations before we get to the Q&A.
Of course we’re not happy with the results for the first half, but it would have been difficult to avoid excess expenses while focusing on rapid expansion.
We believe that the greatest way to enhance the enterprise value of Nanophase, and Solésence, started with expanding our footprint in a series of prestige cosmetics brands.
We’re doing that well. Now it’s time to tighten up the operating side of the business to allow us to continue to build, a formidable, and higher-profile presence.
In the end, we have a great business here that we are confident will become quite profitable, and much more valuable.
Now, we’d both happy to answer some questions. Although we know that most of our investors listen to the webcast, or review the transcript, after the live call, we’d like to invite those participating in today’s call to ask any questions you may have, or to share your comments.
Carmen, would you please begin the Q&A session?
10:25 AM
Q&A SESSION PLACEHOLDER
11:00 AM
Thank you, Carmen.
While our top focus is getting past some operational issues, another dear goal to us is to increase the flow of information to our shareholders and stakeholders. This won’t happen right away, but we know it’s a critical part of our journey to build a more exciting and valuable company, and things remain exciting right now.
There’s going to be some heavy lifting during the balance of 2022, but we know what to do. We’ve defined a path forward that we expect to help us enhance our value in all respects and we’re looking forward to delivering a big win for all of you, our fantastic team, and everyone that has worked so hard and supported us in the process! We’ll look forward to the opportunity to discuss the business with you again next quarter. Thank you!