Northern Technologies International Corporation (NTIC) CEO Patrick Lynch on Q3 2019 Results - Earnings Call Transcript

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Northern Technologies International Corporation (NASDAQ:NTIC) Q3 2019 Earnings Conference Call July 9, 2019 9:00 AM ET

Company Participants

Patrick Lynch - Chief Executive Officer

Matt Wolsfeld - Chief Financial Officer

Conference Call Participants

Scott Billeadeau - Walrus Partners

Tim Clarkson - Van Clemens

Joe Vidich - Manalapan Oracle Advisors

Walter Schenker - MAZ Partners

Jake Lubel - Will and Management

Operator

[Call Starts Abruptly]

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.

Introduce NTIC management, Patrick Lynch, NTIC Chief Executive Officer.

Patrick Lynch

Good morning. I am Patrick Lynch, NTIC’s CEO and I am here with Matt Wolsfeld, NTIC’s CFO. Please note that the financial results for our fiscal 2019 third 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 2019 third quarter financial results, give a brief business update, comment on our net sales and earnings guidance for fiscal 2019, and then conclude with a question-and-answer session.

The strong double-digit net sales growth we achieved in the third quarter reflects the continued success of our diversified business model. That said, market demand during the fiscal 2019 third quarter remains soft for our core corrosion protection solutions causing ZERUST industrial sales to decline year-over-year both in North America and across our worldwide joint venture territories.

As we have been saying throughout the year, we believe that this has been primarily due to, slowing global growth and concerns regarding ongoing trade disputes between the U.S. and a series of other countries including China.

While the fiscal 2019 macro landscape for our core industrial corrosion prevention business has become more challenging than previously expected, the 15.2% increase in NTIC’s total sales is thanks to the significant growth we are enjoying within our Natur-Tec business as well as higher sales of our oil and gas solutions. These increases demonstrate the resiliency of our business model.

Natur-Tec represented over 32% of our fiscal 2019 third quarter net sales compared to less than 20% for the same period last year. Natur-Tec has become one of the leading global bioplastic solution providers and our growth over the past several years demonstrates our strong position within this rapidly growing market.

In fact, over the past eight quarters, Natur-Tec has averaged a year-over-year quarterly growth rate in sales in excess of 55%.

Now permit me to remind you that on June 3rd, we announced a two-for-one stock split that became effective on June 28, 2019, consequently all share and per share data presented on today’s call, as well as going forward has been adjusted to reflect the new share counts. NTIC’s Board of Directors approved the stock split based on extensive investor feedback and our desire to improve the trading liquidity of our stock over the long-term.

So, with these comments, let’s examine the drivers for the third quarter. For the third quarter ended May 31, 2019, total consolidated net sales increased 15.2% to a record $14.9 million, as compared to the three months ended May 31, 2018.

Broken down by business unit, this included an 89.5% increase in Natur-Tec sales, a 58.7% increase in the ZERUST oil and gas net sales and an 8.1 increase in net sales from NTIC to its joint ventures, partially offset by a 7.9% decline in the ZERUST industrial net sales.

Total net sales by our joint ventures, which we do not consolidate in our financial statements were $27.8 million for the fiscal 2019 third quarter, compared to $31.5 million for the same period last fiscal year. This 11.8% decline in JV net sales was the result of softer worldwide demand across many of the industrial markets we serve.

We continue to believe the decline in North American ZERUST industrial sales during the fiscal 2019 third quarter was due to ongoing macro concerns and uncertainties which are in turn impacting the supply chain and purchasing decisions of many customers. While we still do not believe this to be indicative of a deeper slowdown, we continue to actively monitor international market trends and will adjust accordingly if demand deteriorates further.

Net sales by our wholly-owned NTIC China subsidiary were $3.5 million for the third quarter of fiscal 2019, compared to $3.1 million for the same period last fiscal year. The 14.4% increase at NTIC China during the fiscal 2019 third quarter was primarily a result of higher Natur-Tec sales.

The compostable bioplastics market in China appears to be strong and growing and our third quarter sales results reflect increasing momentum in this market.

As we have stated in the past, ZERUST oil and gas sales are volatile based on the timing and shipment of orders. Net sales for the third quarter of fiscal 2019 were up approximately $326,000, compared to the same period last fiscal year. Year-to-date, ZERUST oil and gas net sales were $2.2 million, up nearly 57.7% from the prior fiscal year period.

Our nine month oil and gas sales levels and repeat orders for our oil and gas solutions are reflective of the overall market acceptance of our technologies. Based on our current anticipated oil and gas sales, we expect full year net sales within this segment to grow compared to the prior year.

We have continued to gain additional repeat orders for our tank bottom solutions from existing large companies and we believe that we are well positioned to grow oil and gas sales in the remainder of fiscal 2019 and beyond. However, we continue to expect oil and gas sales will remain volatile with sudden shifts in the timing of purchases – in timing of purchase orders for bigger projects.

Now, turning to our Natur-Tec bioplastics business. For the fiscal 2019 third quarter, Natur-Tec’s net sales reached a quarterly record of $4.8 million, an increase of nearly 90% over the same period last fiscal year. Natur-Tec continued to achieve significant growth rates as a result of strong demand in North America through our domestic sales distribution network, as well as higher sales of finished products by NTIC’s majority-owned subsidiary in India.

The use of conventional polyethylene and polypropylene plastics is facing ever-increasing societal and political criticism due to environmental and waste disposal concerns. And this is reflected in increasing global interest for Natur-Tec products and solutions that we have experienced. Our recent financial results reflect the success of Natur-Tec oil and gas and NTIC China growth strategies, we are investing in these three operations to maintain the positive momentum underway and to take advantage of significant opportunities in the future.

Current strategic investments are focused on expanding research and development programs, as well as increasing marketing efforts and resources. Higher spending, coupled with reduced income from joint venture operations impacted profitability during the third quarter and we reported the first year-over-year decline in quarterly net income in ten quarters.

Our strong balance sheet, experienced management team and diverse revenue model create a strong foundation from which to successfully navigate the current challenging macro industrial environment. I am encouraged by the direction we are headed and the opportunities before us to create sustained sales and earnings growth for years to come.

With this overview, let me now turn the call over to Matt Wolsfeld to summarize our financial results for the fiscal 2019 third quarter.

Matt Wolsfeld

Thanks, Patrick. NTIC’s net sales increased 15.2% in fiscal 2019 third quarter as a result of the trends Patrick reviewed in his prepared remarks. Income from joint venture operations decreased 11.8% for the fiscal 2019 third quarter compared to the corresponding period last fiscal year as a result of softer sales at many of our global joint ventures. As Patrick stated, we are making strategic investments throughout our business in order to support current and expected growth opportunities.

Operating expenses increased by 11.7% or by $661,000 versus the same period last year. Despite this increase, as a percentage of revenues, operating expenses were 42.3% during the fiscal 2019 third quarter compared to 43.6% for the same period last fiscal year.

Net income attributable to NTIC was $1.5 million or $0.16 per diluted share for the fiscal 2019 third quarter compared to net income attributable to NTIC of $2.1 million or $0.23 per diluted share for fiscal 2018 third quarter.

As of May 31, 2019, working capital was $25.7 million, including $5.2 million in cash and cash equivalents and $2.5 million of available-for-sale securities compared to $22.8 million, including $4.2 million in cash and cash equivalents and $3.3 million in available-for-sale securities as of August 31, 2018.

NTIC’s business model does not require significant additional capital and we expect our financial model to continue to produce strong operating cash flows. We expect our cash balance will increase as the year progresses because of the seasonal benefits we typically experience in earnings from operating activities and anticipated continued business growth and improvements in profitability.

On May 31, 2019, the company had $24.1 million of investment in joint venture, of which approximately 56% or $13.5 million is in cash with the remaining balance invested in working capital. During the fiscal 2019 third quarter, NTIC’s Board of Directors declared a cash dividend of $0.06 per common share that was payable on May 23, 2019 to shareholders of record on May 9, 2019.

Our third quarter dividend is a 20% increase over the third quarter dividend payment last fiscal year, which reflects continued strength in our financial performance, as well as our commitment to increase shareholder value.

Now, turning to NTIC’s annual guidance for the fiscal year ending August 31, 2019. We currently expect fiscal 2019 sales to be between $57.5 million and $58.5 million, which is a $500,000 decrease of the low end of our prior guidance. We estimate our net income attributable to NTIC will range between $6.2 million and $6.6 million or between $0.65 and $0.70 per diluted share for fiscal 2019.

These estimates are subject to significant risks and uncertainties including those described in our forward-looking statement disclosure and our earnings release. We continue to be encouraged by our operating and financial results. We have built a strong platform to drive sustainable and profitable growth and we are excited about the direction that we are headed.

With this, Patrick and I are happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Scott Billeadeau from Walrus Partners. Your line is now open.

Scott Billeadeau

Hi guys. Just a question here on – it appears to be some deleveraging in the business in a sense that you are only bringing revenue down by, kind of less than what net income is – guidance is coming down. Could you kind of give us a little idea of what’s happening there, is it just because of the pure JV net income hit, but maybe kind of refresh us on [what’s deleveraging] [ph] there?

Patrick Lynch

Yes, I would say there is two key impacts to that deleveraging you are talking about. The biggest impact is obviously the joint venture revenue. NTIC typically takes in between 10% and 11%. Our portion of each JV dollar sold is typically between 10% and 11%. So, for example, in third quarter, we took in $27.8 million as compared to the previous year’s quarter of $31.5 million.

So, it’s almost a $4 million decrease the amount of revenue we took in comparing third quarters. So that amounted to about almost $400,000 of decrease in the expected earnings from that incremental revenue. So, with looking at our fourth quarter, the big question that we have – we are pretty confident as far as the amount of revenue that we’ll have coming in to our top-line from the United States industrial, from Natur-Tec, from oil and gas and from China, still the big question is, where are we going to come in from a JV standpoint.

And so, the decreased guidance has to do with bringing down the expectations of revenue from the JVs. The other piece of that is, as the industrial business in North America is off from the expectations that after second quarter we were down by – we were only down by a few percent in the third quarter comparing the industrial business that was down over 10%.

So, what we are seeing is that, the Natur-Tec business is increasing the percent of our total revenue and making up for the shortfall in the industrial business and what we have is a higher gross margin on the industrial business, the Natur-Tec business.

So that also accounts for some of the deleveraging when you are swapping out sales dollars from industrial compared to Natur-Tec. So those two things are the main things that are accounting for the decrease in - the small decrease in revenue that we are showing from a guidance standpoint, but the increase decrease in earnings.

Scott Billeadeau

Okay. Great. And you had mentioned making some investments, but you had OpEx still kind of growing less than sales. So there is a – that’s a little bit of a pause effect. Same thing kind of gone out any targeted investments you are planning on at this particular point in time?

Patrick Lynch

We don’t have any material capital investments that we are planning on making. There will be more than a few hundred thousand dollars over the next – in the coming quarters. So nothing significant. Still when you, Scott, when you talk about the operating expense increases, the interesting things – from our standpoint we’ve always talked about single-digit operating expense growth where our biggest operating expense growth were in the past quarter and during the year when I look at the year-to-date data is, we had significant operating expense growth in – for Natur-Tec India and significant operating expense growth with Natur-Tec China. Or I am sorry, now in Natur-Tec China with, just NTIC China. So when I look at – when we talk about the investment in the future that we are making, we still see NTIC China and Natur-Tec India as key areas where we expect the growth to continue.

So, even though operating expenses for third quarter were up 11%, we - the amount of operating expense increase in North America was still low-single-digits, it was the increase in operating expenses to really build for the future at Natur-Tec India and to – and for NTIC China that saw that increase.

Scott Billeadeau

All right. Thanks so much and then just last question, I know it’s kind of crystal ball-ish but, again on the ZERUST industrial, it’s pretty much just macro slowdown. I sense that it’s competitive or anything of that nature is primarily you are following the kind of what’s happening in those products that are using ZERUST as opposed to someone taking some business from you.

Patrick Lynch

That’s correct. I mean, we are seeing an overall decrease in sales across pretty much all the joint venture territories and in the United States. So it’s consistent in just basic global industrial demand right now is softer than it has been in the past. We are not seeing any increase in competitiveness from – or increase in competition. We are not seeing any increases in other factors. So, we just believe it’s a macro issue at this point.

Scott Billeadeau

Okay. All right. Great. Thanks, Patrick. Thanks, Matt.

Operator

Thank you. Our next question is from Tim Clarkson from Van Clemens. Your line is now open.

Tim Clarkson

Hi guys. Hi, Matt. Yes, I just wanted to – I missed your comments on China. How is business in China right now?

Matt Wolsfeld

We saw a little bit of a pickup in China from an industrial standpoint in the third quarter. First and second quarters showed the industrial business being below the prior years. So we saw a little bit of a rebound in China from an industrial standpoint. As Patrick mentioned, the main growth in China being up 14% or 15% is due to the increased Natur-Tec business in China.

So, what we are – the expectations are that, going forward with fourth quarter and then on into our fiscal 2020 that we would get, let’s say back on track as far as the number of projects we have – that we are working on and the increased revenue that we expect there, we would expect both the industrial business and the Natur-Tec business in China to continue growing.

Tim Clarkson

And how are they using the compostable in China?

Patrick Lynch

Same way in the garment industry as you are seeing in Southeast Asia.

Tim Clarkson

So, mostly garments at this point? Yes, yes.

Patrick Lynch

Yes.

Tim Clarkson

And – good. And just on the compostable, are you guys aware of any other company that’s publicly traded that has a compostable component like this?

Patrick Lynch

Not to our knowledge.

Tim Clarkson

Okay. On the oil and gas, now is there a perception now that this technology is kind of getting expected with at least some of the key guys that they just kind of put it on a standardized basis, is that – I know that was the kind of the goal is to get this to be an accepted technology. Is that starting to happen?

Patrick Lynch

In this part, we can tell you, yes. I mean, based on the repeat business we are getting from a number of clients, and also just that it’s expanding into more and more geographies.

Tim Clarkson

And how about in terms of pipelines? Are you still starting to do some business there?

Patrick Lynch

As the project become available, those are less steadier than – in comparison to the tank bottom solutions.

Tim Clarkson

All right. All right. Okay. And in terms of your investments, are your investments were up in China and India? What exactly – how are you investing there?

Matt Wolsfeld

Specifically, in – at Natur-Tec India, it’s a matter investing in people to be able to support to grow that business. We’ve had to obviously with the almost 300% growth that we are seeing there, we need to get warehousing. We need to get people. We need to make sure we have an operation system in place to handle that kind of growth and those kind of orders.

And so, we’ve made some investments there in order to be able to deliver products and support the customer needs, also with the expectation that businesses are going to continue to grow. We want to make sure that we are not just building a system that’s going to work for the current level of business, but something that’s going to grow, it’s going to work for three to four times the amount of business in the coming years that we have now.

In China, there has been investments, not just in operations, but also in certain R&D activities, for certain products for the Chinese markets that are slightly different than the U.S. markets for some of the opportunities that we are going after there. So we’ve invested in a research and development lab there in addition to the operating investments we’ve had to make.

Tim Clarkson

One last question. Is there an opportunity to plug in the compostable products into places like Japan and Germany? They are just doing the industrial stuff.

Patrick Lynch

Yes, there are always opportunities for that. But, actually, we are seeing certain – yes, let's leave it at that for now.

Tim Clarkson

Okay. All right. I am done. Thanks. Good quarter.

Patrick Lynch

Thanks, Tim.

Operator

Thank you. Our next question is from Joe Vidich from Manalapan Oracle Advisors. Your line is now open.

Joe Vidich

Good morning and thanks for taking my questions. I had a number of questions which were very similar to the person who just asked about your – where your key initiatives are in. But I guess, it was a little more detail maybe if you could just describe your marketing efforts, I don’t know if that’s possible or not. But and where you are spending more of your Natur-Tec money? Whether it’s internationally or besides just India and China?

Patrick Lynch

Well, Natur-Tec specifically is growing and expanding everywhere the garment industry is. So it’s just not in India. We are talking India, Bangladesh, Pakistan, Sri Lanka, Vietnam and China right now. And that’s – and the expenses basically in building up a distribution network in those regions.

In North America, it’s also through in the industrial, but the target market is different. Here we are supplying more the janitorial and sanitation distribution companies that are supplying major food service companies. So the market segments are different that was sort of the thing here.

Joe Vidich

Right. Have you been – I know that with the whole straw, the movement away from plastic straws, I am just wondering how that initiative has been going?

Patrick Lynch

Fine from our perspective. In that we supply the basic resin compounds to straw manufacturers who are making compostable straws using our technology. Now the total volume of resin compounds sold is going to be relatively small just because, straws just don’t take up that much volume.

So, we have seen an increase in the demand from that sector. But it’s not really that significant. That’s really going to have a major impact on our sales in the near future.

Joe Vidich

Right. Right. Right. And I guess, the other question is, I know, just for the quarter, obviously, your operating expenses for both R&D and G&A were up and I was just wondering if you had any idea what potential runrate would be for those for the next 12 months or…?

Matt Wolsfeld

I think from an operating standpoint, we expect to have a runrate that’s going to be pretty consistent with where we are today, with where we are in the third quarter. Kind of going forward, as far as operating expenses go and operating expense growth, we like to peg that to kind of a 8%, 9% growth rate, kind of year-to-year.

The issue that we had is, obviously this year we didn’t see the significant, the traditional growth rate from our industrial market. So the slight increase in operating expenses this year, didn’t have the corresponding increase in sales that we expected to have because of the industrial slowdown.

Going forward, we are certainly doing our best to limit the amount of operating expense, but especially during this time period now where things are slower from an industrial standpoint, but kind of going forward, the existing operating expenses or fixed expenses that we have should be relatively flat compared to – relatively flat or with small amount of growth compared to the sales growth that we expect to have in all of our different businesses.

Joe Vidich

Okay, that’s great guys. I really appreciate and I think it actually is a lot very large number of positives in this quarter or so. Anyway, that’s all I got. Thanks very much.

Patrick Lynch

Thank you.

Operator

Our next question is from Eric Ramsley[Ph] from R Squared. Your line is now open.

Unidentified Analyst

Hey guys. Just got a couple questions about your costs for raw materials, specifically the plastics and first of all, just wondering what the current tariff was on the imports that are coming out of China?

Matt Wolsfeld

Currently, on the imports coming out of China, the only products we are really importing out of China are some of the finished bags for Natur-Tec that are being sold in North America, which are at a 25% tariff.

Unidentified Analyst

Okay. And once – is the cost of that going to change once that productions move to India?

Matt Wolsfeld

Yes. I mean, obviously the tariff would go away plus we would have other, call it, other economies of scale where we would expect to be able to produce that at a lower cost than what we are producing that now.

Unidentified Analyst

Okay. And when do you plan on that move to India taking effect?

Matt Wolsfeld

Probably, by the end of the calendar year beginning right around December, January timeframe.

Unidentified Analyst

Okay. Sounds great. That’s all I had for you.

Matt Wolsfeld

Yep, thanks.

Unidentified Analyst

All right.

Operator

Thank you. Our next question is from Walter Schenker from MAZ Partners. Your line is now open.

Walter Schenker

Thank you. But my questions were just answered about the runrate and the SG&A level.

Matt Wolsfeld

Okay.

Walter Schenker

Thank you anyway.

Matt Wolsfeld

Yes.

Operator

Thank you. Our next question is from Jake Lubel from Will and Management. Your line is now open.

Jake Lubel

Yes, hey guys. Can you give us any color on how the finished products piece of Natur-Tec is doing relative to the entire segment?

Patrick Lynch

How the finished products are doing compared – I guess…

Jake Lubel

Yes, how they are growing relative to the total segment, faster, slower, lot faster, just any color to kind of understand that piece of it?

Patrick Lynch

You mean, as far as from our sales standpoint or the overall market growth? You are talking about our…

Jake Lubel

What are your guess?

Patrick Lynch

Yes, we are still seeing – the main growth that we are seeing in Natur-Tec, obviously from – I look at it in two different areas. You obviously have the North American Natur-Tec market and the growth that we are seeing there is, the 25% to 30% year-over-year growth and that growth is made up of generally, probably two-thirds of that is going to be made up of growth of finished products meaning cutlery, trash bags, bag liners, things like that.

The other piece is going to be the increased resin that we are now starting to sell to companies, so they can make their own finished products out of our proprietary specialized compostable resins. So in North America, that growth rate is kind of coming from both areas.

In India, where we have the Indian subsidiary and also then the wholly-owned Sri Lankan subsidiary the majority of those sales are still in the finished products being sold to the garment industry. There is some resin sales that occur in that market. But the majority of it is finished products.

Jake Lubel

Gotcha. Gotcha. And if you guys ever given color in terms of the just rough margin profile of resin versus finished products? Just so we can understand kind of the guidepost going forward?

Matt Wolsfeld

Yes, they are pretty similar. I mean, at this point in time, over the past five years, we have seen an increase in our gross margins from Natur-Tec up into kind of the high 20s. It’s nice depending on how we are able to make the product and what we are shipping it even in the low 30s.

The current tariffs that we are seeing with the product we made in China, obviously have 25% tariff on your main product coming in is going to have an impact to gross margins. So gross margins in Nature-Tec have slipped a little bit with the 10% margin and then the expectations are that now that the 25% margin is in place, we are going to see a continued slip and that gross margin obviously until we are able to move operations out of China or until the tariffs are lifted.

But traditionally, the gross margin for Natur-Tec has been in that upper 20s, upper 20s, low 30s area and that’s where we would expect to see that going forward.

Jake Lubel

Got you. Got you. I mean one quick question for you.

Matt Wolsfeld

And for resin, it's going to be similar margins.

Jake Lubel

Okay. Just one quick question for you on oil and gas. Are you starting to see – you guys talk about these trials, how long these trials take with customers. Are you starting to see more trials convert and that leading to the really strong growth in oil and gas? Or is it more customers who’ve already adopted kind of really ramping up and just finding more applications to this point?

Patrick Lynch

We are seeing mostly repeat business from existing customers as well as new business from new territories. So, we are putting in certain installations now in Africa that we hadn’t had before and in other geographies. Those are new but we are also getting repeat business in North America from large tank farms – tank farm owners that are giving us more tanks over time.

Matt Wolsfeld

I’d - just to add one point to that. While we are seeing the repeat business from customers, what we haven’t seen and what we would expect to see at some point in time in the future is going from – not going from one tank to two tanks to three tanks, but start seeing the - going from three tanks to five tanks to ten tanks to 15 tanks, we’d like to see that kind of an implementation and that’s ultimately what we are going for.

But the adoption of the technology into the oil and gas space is still slow and I’d say it’s obviously a very cautious slow market. But we are certainly seeing the acceptance of the products and the results that we are seeing from all of the different trials and all the different installations that we’ve done are very positive and very encouraging and that’s one of the things that’s helping us to do the repeat business to the existing customers and also show the data to new customers to validate the technology.

Jake Lubel

Got it. That was great color. Thanks guys.

Matt Wolsfeld

Yes.

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’d like to thank everyone for participating today and for your interest in NTIC. Have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect.

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