Northern Technologies International Corp (NTIC) Q3 2023 Earnings Call Transcript

Good morning ladies and gentlemen. Thank you for standing by. Welcome to Northern Technologies International Corporation third quarter 2023 earnings conference call and webcast. At this time, all participants are on a listen-only mode. After the speakers’ presentation, there will be a question and answer session. To ask a question during the session, you will need to press star-one-one on your telephone. You will then hear an automated message advising your hand is raised. Please note that today’s conference is being recorded. As part of the discussion today, the representatives from NTIC will be making certain forward-looking statements regarding NTIC’s future financial and operating results, as well as their business plans, objectives and expectations. Please be advised that these forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and that NTIC decided to avail itself of the protections of the Safe Harbor of these statements. Please also be advised that actual results could differ materially from those stated or implied by the forward-looking statements due to certain risks and uncertainties, including those described in NTIC’s most recent annual report on Form 10-K, subsequent quarterly reports on Form 10-Q, and recent press releases. Please read these reports and other future filings that NTIC will make with the SEC. NTIC disclaims any duty to update or revise these forward-looking statements. I will now hand the conference over to your speaker host for today, Mr. Patrick Lynch, Chief Executive Officer. Please go ahead, sir.

Good morning. I am Patrick Lynch, NTIC’s CEO, and I’m here with Matt Wolsfeld, NTIC’s CFO. Please note that a press release regarding our third quarter fiscal 2023 financial results was issued earlier this morning and is available at NTIC.com. During today’s call, we will review various key aspects of our fiscal 2023 third quarter financial results, provide a brief business update, and then conclude with a question and answer session. Record top line sales for our Zerust industrial, Zerust Oil & Gas, and Natur-Tec segments in turn pushed total sales for the third quarter to a new quarterly record as well. It would appear, therefore, that our strong third quarter performance not only revalidates the efficacy of our long term growth strategies, but also the value that our corrosion inhibiting products and services and bio-plastic solutions provide to our growing customer base. I am proud of these results as they show that our team members and joint venture partners have been working hard to support the complex needs of our global customers while also navigating extremely dynamic currents. As planned, we also made considerable progress rebuilding our gross margins and controlling operating expenses this period. Our third quarter gross margin of 36.7% marks a significant improvement on both a sequential and year-over-year basis. This primarily reflects the positive impact of the countermeasures we put in place against supply chain issues, significant raw material cost increases, and challenges across our European and Asian markets. As we look to the fourth quarter and beyond, momentum in our business remains positive. We believe NTIC China sales will improve in the fourth quarter and into fiscal 2024 now that the Chinese economy finally has the opportunity to start rebounding from its exceptionally long self-imposed pandemic freeze. Zerust Oil & Gas and Natur-Tec are both expected to continue to benefit from new customer relationships and incremental orders from existing customers, therefore we believe we are well positioned for a strong finish to fiscal 2023 and believe fiscal 2024 will also enjoy good growth and higher profitability. So with this overview, let’s examine the drivers for the third quarter in more detail. For the third quarter ended May 31, 2023, our total consolidated net sales increased 10.6% to a quarterly record of $21 million, as compared to the third quarter ended May 31, 2022. Broken down by business units, this included a 32.7% increase in Zerust Oil & Gas net sales, a 9% increase in Zerust industrial net sales, and a 7.8% increase in Natur-Tec net sales. Total net sales for the fiscal 2023 third quarter by our joint ventures, which we do not consolidate in our financial statements, decreased year-over-year by 1.1% to $26.3 million, but were up 3.3% on a sequential basis. The slight year-over-year decline was due primarily to softer demand across the territories serviced by our global joint ventures and currency exchange rate fluctuations. Fiscal 2023 third quarter net sales by our wholly owned NTIC China subsidiary decreased by 8.4% to $3.3 million due to weaker economic conditions on a year-over-year basis. On a sequential basis, NTIC China sales were up 15.6%, which we believe reflects stabilizing demand trends, and we continue to expect demand to improve throughout the remainder of this fiscal year. We remain committed to the Chinese market and the long-term opportunities it represents for NTIC. We continue to take steps to enhance and protect our Chinese operations, and we continue to believe China will likely become our largest geographic market in the future. Now moving onto Zerust Oil & Gas, the fiscal 2023 third quarter was the strongest quarter we have ever had for Zerust Oil & Gas, as sales increased 32.7% to a record $2 million. The third quarter of fiscal 2023 is also the fifth consecutive quarter of Zerust Oil & Gas sales over $1.5 million, and on a trailing 12-month basis, we have reported nearly $7 million of oil and gas sales. We believe these positive trends reflect accelerating momentum within our oil and gas business. Interest continues to grow from new and existing customers for our Zerust Oil & Gas solutions, which includes applications to protect above-ground oil storage tanks and pipeline casings from corrosion. The expanding adoption of our Zerust Oil & Gas solutions within the oil and gas industry is supporting bigger opportunities for our Zerust Oil & Gas products and technologies. As a result, we believe that fiscal 2023 will be a transformative year for Zerust Oil & Gas as we expect this business to scale and continue to contribute to profitability. Turning to our Natur-Tec bio-plastics business, as expected, Natur-Tec sales growth re-accelerated in the third quarter after seasonality and the timing of both shipments and orders impacted Natur-Tec sales in our second quarter. Fiscal 2023 third quarter Natur-Tec sales were a record $4.9 million, a 7.8% increase over the prior fiscal year period. We expect Natur-Tec sales growth will remain strong in the fourth quarter, supported by favorable demand in North America and India and significant new customer wins and orders in these geographies. Globally, we continue to see growing market demand for new applications of certified compostable plastic products and resin compounds, as well as increased interest in commercial and municipal programs that use certified compostable plastics as alternatives to conventional plastics. As a result, we believe we are well positioned for long term sustainable growth within our Natur-Tec bio-plastics business. As you can see, our third quarter performance reflects the progress we are making to profitably grow our business and create significant value for our shareholders. This is a testament to the leading solutions we have created, the valuable services we provide, and the strength of our team members and joint ventures. With this overview, let me now turn the call over to Matt Wolsfeld to summarize our financial results for the fiscal 2023 third quarter.

Thanks Patrick. Compared to the prior fiscal year period, NTIC’s consolidated net sales improved 10.6% in the fiscal 2023 third quarter to a quarterly record. This growth was driven by the positive trends Patrick reviewed in his prepared remarks. Actions to improve gross margin successfully offset a 1.1% decrease in third quarter sales across our joint ventures to drive a 0.5% increase in third quarter joint venture operating income compared to the prior fiscal year period. Total operating expenses for fiscal 2023 third quarter were $8 million, a 12.8% increase over the prior fiscal year period which was primarily due to increased personnel expenses and expenses incurred during the current fiscal year period in connection with the start-up of a new indirect majority-owned subsidiary formed to assume the operations of a former joint venture in Taiwan. Operating expenses as a percentage of net sales were 38.3% compared to 37.5% for the prior fiscal year period. Gross profit as a percentage of net sales increased 36.7% during the three months ended May 31, 2023 compared to 32.9% during the same period last fiscal year. The 380 basis point improvement was primarily a result of successful actions taken by the company to address inflationary pressures and the increased sales of higher gross margin Zerust Oil & Gas solutions. NTIC’s reported net income increased 52.5% to $1.5 million or $0.16 per diluted share for the fiscal 2023 third quarter, compared to $1 million or $0.11 per diluted share for the fiscal 2022 third quarter. NTIC’s non-GAAP net income adjusted for amortization expense was $1.6 million or $0.17 per diluted share, compared to $1.1 million or $0.12 per diluted share for the fiscal 2022 third quarter. A reconciliation of GAAP to non-GAAP financial measures is available in our third quarter earnings press release that was issued this morning. As of May 31, 2023, working capital is $23.7 million, including $6.2 million in cash and cash equivalents, compared to $23.2 million, including $5.3 million in cash and cash equivalents as of August 31, 2022. As of May 31, 2023, we had outstanding debt of $8 million. This included $5.2 million in borrowings under our existing revolving line of credit compared to $7.1 million as of February 28, 2023. During the fiscal 2023 third quarter, the company’s wholly owned subsidiary in China, NTIC China, entered into two term loan agreements. Both loan agreements have an annual interest rate of 3.5% and the total outstanding balance was $12.8 million as of May 31, 2023. The proceeds of these term loans were used to pay off inter-company loans that NTIC China had with NTIC. We generated $3.5 million in operating cash flows for the nine months ended May 31, 2023, including $1.3 million in the third quarter which was driven primarily by stronger profitability and waning inventory levels. On May 31, 2023, the company had $22.9 million of investments in joint ventures, of which approximately 53.2% or $12.1 million was in cash, with the remaining balance primarily invested in other working capital. During the fiscal 2023 third quarter, NTIC’s board of directors declared a quarterly cash dividend of $0.07 per common share that was payable on May 17, 2023 to stockholders of record on May 3, 2023. To conclude, our third quarter and year-to-date financial results demonstrate the continued progress we have made to increase sales across our diverse end markets and geographies and the success of our near-term initiatives to improve profitability. I’m encouraged by the direction we’re headed, and while the economic environment remains extremely fluid, we continue to believe fiscal 2023 will be another good year of sales and profitability at NTIC. With this overview, Patrick and I are happy to take your questions.

Thank you.

I’d also like to mention that Vineet Dalal is joining us this morning, so if you have any questions regarding Natur-Tec.

One moment for our first question. Our first question is coming from the line of Timothy Clarkson with Van Clemens. Your line is open.

Hey, so I’ve got a few questions here. Just on a big picture basis, what’s the impact of this trend towards electric cars? Does it change the need for rust corrosion products in an electric car versus a gas car?

It will, because there are simply fewer parts in an electric vehicle than in an internal combustion engine. We have not seen yet, and our sales are currently growing in the EV market, but we do ultimately expect a transition as the industry shifts more towards electric vehicles.

I wanted to ask about the compostable aspect. What are the key differentiating factors of Natur-Tec’s compostable products compared to those of competitors?

We create products that can be easily processed with standard plastics equipment, are cost-effective, and offer enhanced properties. Our unique approach allows us to be versatile with base materials, using BLAs, BHAs, and BBATs. We collaborate with brands to understand their packaging needs and then engineer solutions that fulfill those needs at a reasonable price.

Okay. At what point does the typical McDonald’s or the typical fast food restaurant start to be using these kinds of products? I know they use them in the airports, but at what point does it become a standard?

I think it’s a function of regulation. Obviously, a lot of the quick-service restaurants are price-conscious, so widespread adoption is still further out; but in those areas where bylaw they are required to use compostable products, we are seeing adoption happening.

What would be the typical extra expense on a compostable packaging versus conventional packaging?

It depends on the type of product. It could be anywhere from, let’s say, a 10% to 20% premium to maybe 2 or 3 times.

Okay, all right. Okay, and then just another question here on the oil business - I mean, how big is that market versus the legacy market?

We think that the oil and gas market has more potential than everything we’ve done in Zerust so far.

Okay. I always tell my customers that for about a 1% cost, you can extend the life of these tanks from 10 years to 30 years. Are those kinds of payoffs actually occurring in the field?

Yes, we’ve seen the evidence in the installations we’ve done. We’ve proven it to our customers that the solutions work in that manner, yes.

Right, right, and it’s not just replacing the tank, it’s all the problems with leaking oil and EPA and production problems that are associated with that if the tanks start leaking, obviously?

There’s a huge incentive by the tank farm owners to implement a solution like we’re offering.

Right. You know, you guys haven’t talked anything about Brazil. Is there anything new going on in Brazil?

Nothing worth mentioning on this phone call today.

Okay. All right, well that’s my questions. Great quarter. Good to see the profitability come back. Thanks.

Thanks Tim.

Thank you. Our next question comes from the line of Gus Richard with Northland Capital Markets. Your line is open.

Thank you for taking my question. I was curious if you could provide more details. You mentioned acquiring new customers in Natur-Tec in both North America and India. Could you clarify whether this is related to garment bags in India or compostable products for consumers? Also, any updates on the pipeline in North America would be appreciated.

Sure Gus. In North America, we have expanded our distribution network and we are starting to see some market share pick-up, so hopefully over the next few quarters, we will be able to accelerate the sales of the finished products that we sell in North America. Our traditional resin sales for food service, their demand is consistent, but we expect some additional pick-up in sales in Asia. We are seeing some new customers in the garment space in Asia, in South Asia for example, where we have had some good wins, so I think overall we are starting to see new customers come in. We’ve got a good pipeline of opportunities, especially as things kind of calm down and the supply chain challenges ebb. We’re seeing some of these customers starting to adopt our solutions.

Go it. Then sort of a similar question for oil and gas - you know, just wondering, you’ve got a lot of work in the Caspian Sea, talk about additional orders from existing customers and new customers coming in. Can you give a little bit of color on that pipeline as well?

We are receiving repeat orders from our current customers and consistently bringing in new ones, so our market is continuing to expand. We've actually noticed some developments.

Okay, got it. Then just switching over to the cost side, energy prices have been fluctuating. I would expect given the heat waves and whatnot, that natural gas prices could increase. How are you positioned on cost escalators? How are the commodities impacting the gross margin line currently, or is it just a mix issue that’s going to drive upside going forward?

Gus, this is Matt. If you take a look back over the past nine months, obviously before we started this year, there were really high commodity prices for a lot of our base materials. Over the past nine months, we have seen that come down to a much more reasonable level, and that’s one of the things that fueled the rebound in the gross margin; it’s kind of back to meeting what our typical gross margins were before we saw the spiking of raw material pricing. I would say even right now from a natural gas standpoint and the derivative resin pricing, we’re still seeing relatively low levels, so we’re not seeing, at least at this point in time, or have an expectation that the raw materials, or specifically the resins are going to be increasing anytime soon. Right now, we’re continuing to see that rebound in gross margin as we see it flow through all of our existing inventory and the pricing that we’re giving to our customers.

Got it. In sort of your long-term contracts, am I correct in assuming that there’s sort of escalators if there is a spike in raw material?

Yes, I mean, there are, and obviously in most situations we’re doing spot pricing. In about 70% of our business, we’re doing spot pricing based on the price of raw material at that time. The other 30%, some of it is just purchasing of our stock inventory, which we can control but it takes longer for us to adjust that pricing and then have that flow through the inventory we have on hand. A small portion of our total business is blanket orders for a full year, for a longer period of time. That tends to be a situation where we potentially could get caught with either negative or positive impacts on margins. We think we have a much better handle on where we are right now from a pricing standpoint, and I think we are positioning ourselves now to act quicker than we did 12 to 15 months ago, when we saw some of the volatility that we’ve talked about over the past five quarters.

Got it, got it. Then just flipping over to China, there’s been a lot of commentary in the press about the strength and duration of the recovery. Any comments on what you’ve been seeing over the last quarter in terms of the trajectory - is it just stabilized, is it improving, is it moving beyond auto? Any help there?

It’s difficult for us to say exactly where it’s hitting and what’s going on from a sales standpoint in China. It’s existing customers that are ordering less is what we’re seeing, so there’s just kind of a general slowdown compared to when I look at the revenues that we achieved in all of our fiscal 2021 and the first half of our fiscal 2022. We’re simply at lower sales levels, and that’s been the recovery and the rebound that we expected to see. We did have better sales in Q3 than Q2, but we’re still a half million dollars to a million dollars off on a quarterly basis where we were through the majority of our fiscal 2021. What we’re looking to see is that kind of recovery take place to get back to that level, and then ultimately grow the market in China beyond that. It still is a very large potential market for us, and obviously it’s a bit of a headwind given that we are basically hovering right at breakeven point on that subsidiary.

Got it. Last one from me, you mentioned foreign exchange impact on the joint ventures. Is that a dollar-euro impact, or any color on that?

The majority of it involves two main, or really three, key exchange rates that we handle. The euro, from a joint venture perspective, has remained relatively stable between 1.07 and 1.1 over the past few quarters. A secondary impact can be seen in India, where there has been a consistent increase in the exchange rate, causing some challenges in terms of payments for resins and receivables, which slightly affects our overall revenue. The third variable, which tends to fluctuate more, is in China. To mitigate some of the exchange rate fluctuations there, we shifted the debt from NTIC China to be localized within China. Our Chinese entity took out just over $2 million in term loans and repaid that to NTIC in North America. This adjustment helps reduce some currency volatility, but there will still be fluctuations in China due to sales and overall profitability.

Got it, got it. Very helpful, appreciate it. That’s it for me.

Great, thanks Gus.

Thank you. Our next question is coming from the line of Richard Hillman, a private investor. Your line is open.

Yes, good morning gentlemen. I had two questions. First thing was about, I guess, the sales cycle in oil and gas, what it was before and what it is now to sign up a new customer, basically, and also how did you get to the inflection point you’re at right now? Was there some sort of industry accreditation for those products, or can you talk about that a little bit, please?

What we're seeing is a shift in the oil and gas sector regarding sales volatility. We're finally beginning to establish a consistent level of ordering, which allows us to maintain a reliable baseline of sales on a quarterly basis. Over the past five quarters, we've experienced notable growth, increasing from $1.5 million to $1.6 million in Q3 of last year, then slightly up to over $1.6 million to $1.8 million, and now reaching $2 million. The oil and gas industry does have a longer sales cycle, requiring more time to integrate with customers, test products, and demonstrate their benefits to the overall infrastructure. Historically, this market has been slower to adopt new technologies. However, we are pleased that our recent sales come from a diverse range of customers and applications, suggesting substantial potential for growth within each customer relationship. We're not just making one-off sales; instead, we're engaging in opportunities where customers may require multiple units for various infrastructure needs. This is why we're optimistic about the oil and gas market—once we integrate with our customers and show them the potential returns, there are significant growth opportunities beyond individual sales.

Okay. Then Matt, also I wanted to ask you about R&D across the company. Basically, do you consider yourself to be a specialty chemical company, and also, what are you doing to improve your R&D effort on the divisional level for your companies, your joint ventures, and also with universities or outside partners?

Sure. I can provide some insights regarding R&D from the Zerust perspective, and I'll allow Vineet to discuss the R&D aspects related to Natur-Tec. From Zerust's perspective, you can see our progress in the oil and gas sector, as I've described, where we have shifted over the past decade from research to a more development-focused approach that emphasizes integration with sales. We are genuinely observing this transition taking place. We don’t collaborate much with universities in the industrial domain. Most of our development occurs in our R&D facility or in partnership with Excor in Germany. This development often involves refining existing products and creating new formulations or products to offer to our current clients and potentially to new markets. Over the past five to ten years, we have entered several new markets with products developed internally. The R&D capabilities at Zerust are primarily internally focused, aimed at selling and supplying products to the markets we currently serve.

From a Natur-Tec perspective, we do have a good strong core R&D group here in Minnesota, but we also have R&D labs in India and some R&D going on in China. On the Natur-Tec side, we also partner very heavily with Michigan State University, which is probably one of the leading bio-materials programs in the world, and then we do have some arrangements with Clemson University for usage of testing capabilities and some specific advanced development capabilities. We do work with universities also in India to kind of develop specific aspects of new product development that we are engaged in in those areas, but in general, a lot of that strategic direction in terms of R&D is driven out of the U.S. here.

Okay, thanks. In terms of Natur-Tec, what other areas are you going into besides just compostable materials?

The Natur-Tec business is focused more on compostables and bio-materials, so we are looking at bio-based products, we’re looking at multi-layer structures for packaging, consumer packaging and food packaging, and then on the longer term, we are also looking at fibers especially for textiles.

Compostable fibers?

Yes, bio-based compostable fibers, yes.

Thank you, and our next question is coming from the line of Gregory Weaver with Invicta Capital Management. Your line is open.

Yes, good morning gentlemen. Thanks for taking my questions here, and glad to have Vineet on the call. I guess I’ll start with Vineet. Has there been any go-to-market changes for Natur-Tec here over the recent time frame in terms of some of this traction you’re seeing?

Nothing significant. I think we’re just executing to kind of our strategic plan. I think getting over the supply chain challenges of last year was critical because that meant raw material was widely available. We are also executing better on some of the opportunities that we had in our pipeline.

How’s it going with bulk resin sales?

We don’t sell bulk resins; we sell our compounds, and those are growing very nicely.

Okay, I thought there was some opportunity. Maybe I’m mistaken. Years back in Europe, when they were implementing some of those bag laws, it was characterized, I thought, as bulk resin, but I guess I’m mistaken. Patrick, I’ve known you since the beginning of your leadership here, and I’ve never seen you this enthusiastic. People have asked you about some of the oil and gas topics, but I’m really glad to see your excitement. Is it just that the phone is ringing now, rather than you having to go out and find opportunities, which contributes to your excitement?

Yes, we’re receiving numerous inquiries from the same sources. Additionally, we are discovering new applications and expanding into different market segments geographically, so everything is really moving forward successfully.

In terms of the base level of sales that Matt mentioned, it doesn't really involve much from Petrobras these days; it's mainly small orders from various customers. I'm unsure if the significant BP project has begun yet.

We are fulfilling our obligations for the BP job and continue to engage with Petrobras, although they have not yet purchased any of our tank bottom solutions. However, this is a technology they are actively considering.

Okay, all right. Well, super excited to hear the enthusiasm here on oil and gas, because given the margin structure there, it seems like it could do wonders for the overall business, so keep up the good work and thank you.

Appreciate it, thanks.

Thank you. I am showing we have a follow-up question from Gus Richard with Northland Capital. Your line is open.

Yes, thanks for taking the additional question. Just based on some of your comments, I’m wondering, are you starting to work on recyclable products for Tetra Paks?

Gus, we’re not working in recycling, but we are looking at compostable versions of those multi-layer structures. There’s an increasing demand from brands for fully compostable versions of those solutions, but there are some specific barrier requirements, so it’s still in development form.

Okay, I’m assuming that given the inability to recycle those products, there is a growing desire to do so.

Yes, absolutely.

and you’re working on the development of that, and that could be an incremental market for you down the road?

Yes, potentially.

Thank you. I see no further questions in the Q&A queue at this time. I will now turn the call back over to Mr. Patrick Lynch for any closing remarks.

Just wanted to thank everybody for their interest in NTIC this morning and wish you all a good day.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect. Good day.