Northern Technologies International Corporation (NTIC) Q2 2020 Results - Earnings Call
Northern Technologies International Corporation (NASDAQ:NTIC) Q2 2020 Earnings Conference Call April 7, 2020 9:00 AM ET
Company Participants
Patrick Lynch - President and Chief Executive Officer
Matt Wolsfeld - Chief Financial Officer
Vineet Dalal - Vice President, Natur-Tec
Conference Call Participants
Tim Clarkson - Van Clemens Capital
Tim Chatard - Meros Investments
Gus Richard - Northland
Operator
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 desires to avail itself of the protections of the Safe Harbor for 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 its forward-looking statements.
Ladies and gentlemen, thank you for standing by and welcome to the Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Patrick Lynch, CEO. Thank you. Please go ahead, sir.
Patrick Lynch
Good morning. I am Patrick Lynch, NTIC’s CEO and I am here with Matt Wolsfeld, NTI’s CFO as well as Vineet Dalal, Vice President and Director of Global Market Development for our Natur-Tec business. Please note that the financial results for our fiscal 2020 second quarter were included in a press release issued earlier this morning, a copy of which is available at ntic.com. During this call, we will review various key aspects of our fiscal 2020 second quarter financial results, provide a brief business update, and then conclude with a question-and-answer session.
Our fiscal 2020 second quarter financial results were significantly influenced by the economic and business impact of the COVID-19 pandemic. When compared to either the second quarter last fiscal year or the first quarter of fiscal 2020, demand for ZERUST industrial products slowed substantially in North America, China and across our joint venture network. Demand for Natur-Tec compostable bioplastics however remain comparable to the prior fiscal year quarter and ZERUST oil and gas sales increased significantly as several delayed projects from our first quarter were installed during the second quarter. With many of our global customers currently running at a fraction of their regular capacity or lockdown altogether, we anticipate sales for our third quarter to be down considerably compared to the prior fiscal year quarter. Furthermore, since the COVID-19 crisis continues and is evolving, we are withdrawing and suspending specific full year fiscal 2020 guidance.
On behalf of the entire leadership team and the Board of Directors of NTIC, our thoughts are with anyone who has been affected by the COVID-19 pandemic. While we have had to adjust our near-term priorities, our long-term market opportunities and growth strategies remain intact. Our current intent is to continue providing uninterrupted order fulfillment and customer service while ensuring the safety of our customers, joint ventures and employees. Overall, we are entering this period of uncertainty from the position of strength as a result of our asset-light and highly profitable business model, experienced leadership team and excellent capital structure. We currently have over $12 million in cash and cash equivalents and available-for-sale securities. Additionally, we are evaluating the availability of government support programs associated with the CARES Act that was signed into law on March 27, 2020.
So with this overview, let’s examine the drivers for the second quarter. For the second quarter ended February 29, 2020, total consolidated net sales decreased 0.6% to $13.2 million as compared to the second quarter ended February 28, 2019. Broken down by business units, this included a 198.6% increase in ZERUST oil and gas sales and a 0.3% increase in Natur-Tec net sales offset by a 4.2% decrease in ZERUST industrial net sales and a 65.4% decrease in net sales from NTIC to its ZERUST joint ventures. Total net sales by our joint ventures which we do not consolidate in our financial statements were $24.3 million for the fiscal 2020 second quarter compared to $27.7 million for the same period last fiscal year. This 12.5% decline in joint venture net sales at first the result of already softening worldwide demand across many of the industrial markets we serve and then later in the quarter was compounded by the effects of the COVID-19 pandemic.
Net sales by our wholly-owned NTIC China subsidiary increased 0.6% to $3 million for the fiscal 2020 second quarter compared to the same period last fiscal year. NTIC China benefited from higher sales earlier in the second quarter prior to Chinese New Year and the impact of the COVID-19 pandemic. NTIC China sales had returned to 75% of pre-pandemic levels last month and we are cautiously optimistic that they will return to 100% of the sales, of the prior sales level by the end of the third quarter as China has recently restarted its economy and lifted business restrictions previously imposed to mitigate the spread of COVID-19. Overall, we remain optimistic about the long-term potential in China as we intend to further expand our presence within this large and growing market.
As expected, ZERUST oil and gas sales increased significantly during the second quarter as a result of several customers having delayed product shipments from our first quarter. However, oil and gas sales remained volatile primarily due to long sale cycles, overall challenging market conditions and the timing of orders and deliveries. The Russia-Saudi Arabia oil price war and the COVID-19 pandemic have had a significant impact on oil prices with the latter impacting our ability to travel to customer site and to install our solutions. We expect that oil and gas sales will be materially impacted for the duration of the COVID-19 crisis. We remain committed to the oil and gas market and believe we will be successful over time as more oil and gas customers adopt our solutions and replace other forms of corrosion protection.
Now, let me turn the call over to Vineet to review our Natur-Tec bioplastics business in more detail.
Vineet Dalal
Thank you, Patrick. I am happy to join today’s call to review our Natur-Tec business in more detail. I have been a member of NTIC’s leadership team for nearly 16 years and for most of my time at the company, I have focused on Natur-Tec. In addition to my Natur-Tec responsibilities, I also sit on the board of the Biodegradable Products Institute, a U.S. based organization that promotes the adoption and use of compostable plastics.
Natur-Tec has become a leader in the bioplastics industry as a result of our patented and proprietary technologies. Natur-Tec creates 100% compostable plastics alternatives with performance characteristics comparable to those of conventional single use plastics at a price that is affordable and competitive. Over the years, we have also formed important partnerships with key feedstock suppliers and developed strong relationships with key converters and brands around the globe. Over the past few years, societal and political criticism due to the environmental and waste disposal concerns of conventional single use plastics have driven significant interest in and demand for alternatives, which has created a compelling global market environment for Natur-Tec’s bio-based and compostable product solutions. We believe the industry dynamics for bioplastics is sustainable as more countries as well as state and local municipalities are putting in place sustainable waste management initiatives.
For the fiscal 2020 second quarter, Natur-Tec net sales were $4.2 million and were in line with sales last year despite the headwinds facing Natur-Tec associated with Chinese tariffs, the Chinese New Year shutdown and the impact the COVID-19 pandemic had on sales in China and South Asia during the quarter. For the near-term, we anticipate the COVID-19 crisis will continue to impact Natur-Tec sales, because stay-at-home mandates have closed college campuses, stadiums, arenas, corporate office complexes and other large users of compostable plastics. Furthermore, production across the apparel industry has declined sharply as a result of the COVID-19 pandemic decreasing demand from Natur-Tec bioplastic bags, which have become an important part of the sustainability initiatives within this industry. Due to the impact of the stay-at-home mandate in various countries around the world, we expect the apparel packaging business to be soft for at least the next few quarters.
However to-date, we continue to see strong demand from existing and new customers and during the quarter began supplying our proprietary resin compounds to one of the world’s largest manufacturers of cutlery within the foodservice industry. We expect this business to be strong and grow as hygiene considerations from the COVID-19 crisis sustain demand for compostable foodservice applications. As you can see, we have built a strong bio-plastics business that is supported by our patented technologies as well as compelling industry dynamics and favorable environmental and regulatory priorities. We are extremely excited to be a leader within the industry and I look forward to providing updates on our success in future calls.
Now, I will turn the call back over to Patrick.
Patrick Lynch
Thank you, Vineet for the additional insights on Natur-Tec. To conclude my prepared remarks, we all know that there is significant uncertainty due to the impacts of the COVID-19 pandemic. However, NTIC’s longstanding leadership team has successfully navigated in number of prior crises, including the great recession of 2008 and 2009. Since then of course, we have greatly expanded our geographic end market and product diversity. In addition, the size and scale of our business has increased. Finally, the strength of our balance sheet and benefits of our asset-light business model provide us with significant flexibility and resources to help us navigate this time of economic and business uncertainty. I’d like to use this opportunity to thank all of our global employees and joint venture partners. On behalf of the entire leadership team, thank you for your hard work and dedication throughout this crisis.
With this overview, let me now turn the call over to Matt Wolsfeld to summarize our financial results for the fiscal 2020 second quarter.
Matt Wolsfeld
Thanks, Patrick. NTIC’s net sales decreased less than 1% in fiscal 2020 second quarter as a result of the trends Patrick reviewed in his prepared remarks. Lower sales across many of our joint ventures impacted joint venture operating income, which decreased 17% for the fiscal 2020 second quarter compared to the prior fiscal year. As alluded to in the first quarter earnings call, total operating expenses increased during the second quarter and totaled $6.5 million compared to $5.4 million for the same period last year. The 19.7% year-over-year increase was primarily due to the timing of higher G&A expenses incurred during the quarter. We continued to proactively control expenses and year-to-date total operating expenses increased 6.8%, which is in line with both our budget and expectations. In addition, we expect operating expenses to decline year-over-year in the fiscal 2020 third quarter.
Our fiscal 2020 second quarter income tax expense increased 88.2% to $464,000 as a result of foreign taxes paid on higher level of dividends and distributions we received from our joint ventures during the quarter. We expect the effective rate to reduce greatly in our third and fourth quarters. NTIC reported net income of $180,000 for $0.02 per diluted share for the fiscal 2020 second quarter compared to $1.4 million or $0.15 per diluted share fiscal 2019 second quarter. As of February 29, 2020, working capital was $29.4 million, including $5.6 million in cash and cash equivalents and $6.5 million in available-for-sale securities compared to $25.5 million, including $5.9 million in cash and cash equivalents and $3.6 million in available-for-sale securities as of August 31, 2019.
As a note we are currently evaluating the opportunities afforded to us by the CARES Act that was signed into law, March 27, 2020. While the extent of the support is uncertain at this time, the CARES Act includes sweeping set of financial relief measures in the form of federally guaranteed loans that can be forgiven based on payments made for payroll utilities, healthcare benefits and other approved efforts to retain employees. On February 29, 2020, the company had $21.3 million in investments in joint venture, of which $48.7 or $10.4 million is in cash with the remaining balance primarily invested in working capital. During the fiscal 2020 second quarter, NTIC’s Board of Directors declared a cash dividend of $0.165 per share and was payable on February 19, 2020 to shareholders of record on February 5, 2020. As Patrick commented earlier in this call given current circumstances, we are suspending full fiscal year guidance. With this overview, Patrick, Vineet and I are happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from the line of Tim Clarkson from Van Clemens Capital. Your line is now open.
Tim Clarkson
Hi, guys. Hi, Pat. Hi, Matt. Just some questions I know that we are putting a little bit more emphasis on the compostable part of the business just with some basic questions that are I think critical to understanding this. Can you explain the difference between compostable products and biodegradable products?
Vineet Dalal
Hi, Tim. This is Vineet. Yes, I will take that. So biodegradable products are – is a very general term. There is a lot of spurious products in the market, which use conventional plastics and they will add additives to it and they will call them also degradable. Unfortunately these kind of products are not considered biodegradable, especially in places like the state of California and there are rules which prohibit the marketing of such mislabeled products. Our products are the products that Natur-Tec sells are certified compostable. And what that means is that in a compositing environment, 100% of the product gets converted to – is consumed by the microorganisms in the disposal environment as a food source and gets converted to CO2 water and biomass. So these are certified compostable by independent third-party labs.
Tim Clarkson
Great. Now what are the characteristics that make Natur-Tec’s compostable products superior to the competitions?
Vineet Dalal
The main advantage really is our products are stronger. We formulate them. We have extremely good understanding of the chemistry behind these materials and we use that understanding to formulate products that are stronger, cheaper and easier to process on conventional plastics processing equipment.
Tim Clarkson
Right. Now, can you explain how that dynamic played into, I know you mentioned this significant new opportunity you have for the company that makes cutlery, can you explain how that factored you getting that contract?
Vineet Dalal
So this is a large brand. They sell a lot of cutlery single-use disposable cutlery in the U.S. market. They have been working with polylactic acid or PLA which is one of the raw materials for over 5 years and they didn’t have any success. They came to us and we actually had a compound or a resin solution that actually would work in this situation. So, we work closely with one of our conversion partners in Asia and develop a solution that met rigorous performance requirements for this brand. And it’s the unique understanding of the chemistry as well as the processing that allowed us to create a solution that met the performance tolerances for this specific brand.
Tim Clarkson
I heard that the competitions products will get clogged into machines?
Vineet Dalal
Yes. Well, the competitions product, they would get warped or they wouldn’t perform as well. They didn’t have the heat resistance or the strength required for the application.
Tim Clarkson
Right. Okay, can you explain this that – the concept of having a close system in a cafeteria or fast food and how that would work to divert commonly trashed organic waste into a compostable system?
Vineet Dalal
So if you look at municipal solid waste streams, pretty much in any city or state about 50%, 55% of the municipal solid waste stream is what is called organic waste. This is food waste, yard waste, compostable paper. And typically, a lot of these municipalities and states have fast regulations, which prohibit the dumping of this organic waste into landfills. These have to be collected separately and sent to industrial composting facilities. And the reason for that is this organic waste actually in a landfill would generate methane and methane is 25x more dangerous as a greenhouse gas as compared to CO2. So what our compostable products do is they assist in the collection of this organic waste. And if you look at universities or school districts or large office campuses, they have cafeterias onsite and they will use our compostable cutlery. They will use our compostable bags. They will collect the food waste as well as the back of the kitchen vegetable peels and other waste and they will divert all of that organic waste away from landfills to composting. And so that’s what is called zero waste systems, closed-loop systems and that’s where our compostable products really come in and help enable the implementation of these closed loop initiatives.
Tim Clarkson
And would that work in fast food places too?
Vineet Dalal
Yes, it’s starting to. A lot of the if you look at cities out in the West Coast, they are now saying that fast food or QSR restaurants have to comply with the organic diversions mandates in those cities so large QSR chains like McDonalds are now looking to implement specially in the eat in the restaurant options they are looking to implement compostable products.
Tim Clarkson
Sure. One last question, I'll quit hogging. And this is to the, I guess, to Matt and Pat. I mean is there a consideration ever of spinning off the Natur-Tec division and may be raising some money separately?
Vineet Dalal
We have talked about that but we don’t have any specific plans for that in place at this time.
Tim Clarkson
I mean just periodically if you did do that what would be potentially some of the advantages of doing that?
Patrick Lynch
I think the clear advantages of these that Natur-Tec as a stand-alone entity could potentially drive – it would be potentially drive, not necessarily a different investor set, but certainly with the current environment from investing as far as the opportunities with Green Technologies I think it would potentially be valued a little differently and probably a little bit higher than the traditional Northern Technologies market that serves more industrial applications and oil and an industrial applications in oil and gas applications so as a standalone I think it would pull with potentially be a very clear nice environmental investment but I think ultimately we are waiting we would like to see revenues grow significantly higher than where they are now in order to be able to do that.
Tim Clarkson
Right. And I think Northern Tech is the only publicly traded company right now that has a compostable packaging product like this?
Patrick Lynch
Correct.
Tim Clarkson
Correct. Okay, I asked a lot of questions. So thanks. I really appreciate you really putting some additional focus on this Natur-Tec division. So I am done. Thank you.
Vineet Dalal
Thanks, Tim.
Operator
Thank you. Our next question comes from Tim Chatard from Meros Investments. Your line is now open.
Tim Chatard
Good morning. Just on the expenses it was a little bit higher in this quarter can you maybe help with what would the year might look like in absolute dollars for expenses?
Patrick Lynch
Sure. As I take look at it, one of the things the company is always – not always but certainly over the past years has strived to do is have total operating expense growth in the mid single-digits. So when I look at the year-to-date number, total operating expense has grown by about 6.8%. That’s pretty much in line with where we expected to be for the full year. However, given what’s going on right now with the COVID-19 no travel, people working from home, I would anticipate that for the next at least probably three or four months we are going to see a dramatic decrease in our operating expenses. So for the full year, I would probably anticipate that going down as far as the growth year-over-year going down to the low single-digits maybe 2% or 3% operating growth, so something in the low $20 million number.
Tim Chatard
Okay, fine. Thank you.
Patrick Lynch
Yes.
Operator
Thank you. Our next question comes from the line of Gus Richard from Northland. Your line is now open.
Gus Richard
Yes. Thanks for taking my questions. Just real quick kind of announced early this year a ban on single use plastic, lot has changed since then, could you talk a little bit about what you are seeing there, is there an opportunity for you as they try to move to compostable or eliminate its use?
Vineet Dalal
You are talking about China, right, yes, so this was announced right before the Chinese New Year shutdown and then they had COVID-19 crisis, it’s a positive development in our view, but there is still – you still have to kind of figure out the exact details because the proof is going to be in the pudding to say as in, the implementation is going to be very critical. The enforcement of that ban is going to be critical. And so with all this uncertainty, it still remains to be seen how that’s going to pan out, but yes, our team in China is looking at that as a potential opportunity for us.
Gus Richard
Got it. Thanks. And then can you talk a little bit about as the travel restrictions etcetera went into place in China, what that trajectory look like? And then now that it’s coming out, what that trajectory look like? And then can you compare and contrast that to the U.S and Europe, what you have seen so far as these regions have shifted to adopt to the reality of COIVD-19?
Matt Wolsfeld
Sure. When looking at China basically what we had is we had sales that we are really setting to rebound in the first – with what we are starting to see coming out of first quarter into the second quarter, we are having some relatively strong months as we talked about during the prepared remarks. It’s China year-over-year including through this 6 months is basically flat and given what we saw basically with the entire shutdown of everything in China starting on January 15 pretty much through the end of the quarter to be flat was it’s a little bit surprising to us. Obviously, we had a strong December and strong first half of January to be able to achieve that. So coming out of the shutdown, basically the entire month of March, things are starting to ramp back up. The second half of March was significantly stronger than the first half and ultimately March finished – marked our China numbers from March finished where they were operating at close to 80% of what the call it pre-January 15 run-rate was. And so with the discussions that we have had with that leadership team and looking at their anticipated product shipments kind of throughout April and then the rest of the quarter and the rest of the year, they expect to be back up operating above 100% of what the run-rare was pre-pandemic, they expect to be above that run-rate basically staring with the end of April and May. So, we are seeing a pretty quick rebound in the Chinese market kind of coming out of the shutdown.
As far as how that kind of slowed through the rest of the world, it seems like at least to us with kind of talking to various partners that obviously what’s going on in Europe and what’s going on in North America is probably about 3 weeks to 5 weeks behind, 3 weeks to 6 weeks behind where China was during that time period as we have seen things spread. And obviously if you look at the charts, you can kind of see almost exactly the number of days everything is behind. I don’t know if the United States is going to be as capable as China was and is shutting things down and then coming back out of it. Similar to Europe, China basically shutdown from January 15 until let’s say the end of February and so basically 45 days. I would guess that it’s going to take the Europe and the United States if you are on that same trajectory would potentially be two times that, but still it looks, if it follows that kind of that same path, we are looking at a couple of months of things being very slow or we anticipate our sales to drop dramatically in kind of April and May and then hopefully at that point in time, we are going to start seeing the sales rebound. So that’s kind of what our – what we are modeling internally as far as how we are keeping things on hold, how we are working through sales. I do know that because of I would say especially in North America we have the most visibility into our customers, I think a lot of our customers have the ability to at least see what was going on in other parts of the world and so we saw little bit of a stacking up take place in March. So even though things were staring to slide a little bit in February and people getting a little bit cautious, there certainly were some opportunities that we had, where people were shutting down plants or stocking up for when they were going to restart business that made March not as – March was stronger than what we anticipated would be even though everybody at NTIC was basically working from home except for the operations team and the shipping teams and things like that. So that’s really what we are keeping our eye on is how quickly the United States would be able to kind of come out of that – kind of come out of when we will bottom out and then when we will start to rebound from that.
Gus Richard
And just one follow-up, the peak to trough in China versus the peak to trough in U.S. and Europe, was that 100%, 25% or whatever it was in China, what did that look like? Has U.S. and Europe shut off as tightly at this point or not quite so much?
Patrick Lynch
Well, I don’t think it certainly hasn’t shut off. I mean, in China what happened is everything was shutdown and nothing shift. I mean, literally when they did a shutdown it was – there was not one quarter delivered place during that 45-day period. I mean, people they just did not leave their homes, anybody. And what we are seeing in Europe, what we are seeing in North America is people are still going to work, people are still shipping products, people are still – it’s just everything from an industrial standpoint as far as car production and things like that was still taking place. Now, we know that the big three auto companies have since put in place a 2 to 3 week shutdown that they are in the middle of, but what we saw in China was dramatically different than any other responses that we have seen in Europe or in North America.
Gus Richard
Got it. Thank you. Very helpful.
Patrick Lynch
Okay.
Operator
Thank you. At this time, I am showing no further questions. I would like to turn the call back over to Patrick Lynch for closing remarks.
Patrick Lynch
I would like to thank everybody for participating today and for your interest in NTIC. I hope you have a great week. Thank you.
Operator
Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.
