Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the EcoSynthetix 2023 Second Quarter Results Conference Call. [Operator Instructions] Listeners are reminded that portions of today's discussion may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on EcoSynthetix's risks and uncertainties related to these forward-looking statements, please refer to the company's annual information form dated February 28, 2023, which is posted on SEDAR. This morning's call is being recorded on Thursday, August 3, 2023, at 8:30 a.m. Eastern Time. I would now like to turn the call over to Mr. Jeff MacDonald, Chief Executive Officer of EcoSynthetix. Please go ahead, sir.

Thank you. Good morning. We issued our 2023 second quarter results yesterday afternoon. As we move into the second half of 2023, we are beginning to see emerging signs that make us optimistic the business is turning a corner with a return to a growth trajectory. The second quarter, which is now behind us, was certainly a continuation of the macro challenges we experienced in Q1 as we expected and mentioned at the time of our Q1 call in May. Sales were flat sequentially at $3 million and down 29% from the prior year period. This change was due to lower volumes. The reason for our optimism today is twofold. Number one, we are seeing positive signs on the opportunity side, specifically in terms of an expansion of our pipeline in the wood composites, tissue, paperboard and pulp end markets. And number two, we're seeing positive indicators on starch availability and pricing earlier than we had originally anticipated, which should support margins and pricing to win new business. On the wood composites front, the movement toward bio-based glues is gathering momentum. IKEA published its sustainability and climate reports earlier this year, which we've highlighted previously. In those reports, they've highlighted glues for wood panels as one of the critical drivers to reduce their carbon footprint and achieve their climate goals. Wood glues represent 5% of their total carbon footprint. They've set a goal of reducing that impact by 40% by 2030 through the use of bio-based glues, which they are implementing at one of their facilities. In June, CNN did a feature report on IKEA's development journey on its use of bio-based glues from cornstarch in the production of wood panels like particleboard. As one of the largest consumers of wood panels in the industry, IKEA's influence on their supply…

Thanks, Jeff, and good morning. Net sales were $3 million in Q2 2023, down 29% compared to the same period in 2022. The decline was due to a step down in demand primarily from sales into graphic paper end market, which included a $400,000 decline in sales due to destocking at a large distributor. Gross profit was $550,000 in the quarter, a decrease of $570,000 from the same period last year. The change was primarily due to a decrease in sales volume and higher cost of manufacturing. This quarter, we hit an all-time peak on our product costs. We built inventory at a higher cost during 2022 and into 2023 due to the constraints we experienced last year in feedstock availability. We are working through that higher cost inventory this quarter. As Jeff mentioned, feedstock costs have come down off the highs we saw earlier this year, and we anticipate further normalization as we qualify a new supplier and the new corn harvest approaches. This will also likely result in lower average selling prices later in the year as we pass on some of these savings to our customers. Net of manufacturing depreciation, gross profit as a percentage of sales was 25.2% in the quarter compared to 30.8% for the same period in 2022. The lower cash margin percentage was due to the higher feedstock costs. SG&A expenses were $1.2 million this quarter, a decrease of $210,000 compared to the same period in 2022. This improvement was primarily due to changes in foreign exchange gains and losses and lower compensation expense related to performance-based share equity awards. R&D expenses were $630,000 in the quarter compared to $500,000 in the same period last year. The increase was primarily due to new product scale-up costs. We continue to invest in innovation to…

Thanks, Rob. The positive signs we are seeing across our key growth markets give us confidence the challenges of early 2023 are behind us. Our pipeline of prospects running trials in both wood composites and tissue, paperboard and pulp is expanding in depth and breadth. The movement to bio-based glues and the wood composites end market is being championed by the thought leader and leading consumer of wood panels. The benefits of our strength aids in the tissue, paperboard and pulp market are clear, as evidenced by the case study I shared and the expansion of our early account wins into new trials at separate locations. We've united our team behind our next goal of achieving $100 million in sales, and we can achieve that goal with just the customers we're commercial with today, and we're going to win new accounts, too. We're focused on delivering that growth for shareholders. And with that, I'll ask the operator to open up the call to your questions.

[Operator Instructions] Our first question comes from the line of Dan Marks of Stonehouse Capital.

You previously had told us that you had sort of -- I think it was 2 or 3 commercial accounts and 8 accounts that were in trials. You've told us that it's expanded. Can you quantify that for us so we have some idea of what increase has gone on over the last 2 or 3 quarters?

Yes. Until we are seeing some real predictability where we can build a model around it and tie a pipeline of trial activity to actual wins, commercial successes and then revenue growth, we're not going to share that as a model. I used 8 at the time as just an example of where we were at that point in time, and it's safe to say that with all 8 of those opportunities, we've continued to advance and we've expanded to new customers and additional lines within existing customers. So the pipeline has only built, and we're going to be, obviously, very forthcoming when some of those opportunities do translate into commercial wins and we're shipping product continuously to customers, which I feel like we're advancing very well and very close to.

The only item I would add, Dan, is that we do still continue to sell commercially to 3 mills today.

Okay. And the trials are obviously a number greater than 8 because none of those 8 have dropped out or had any negative trials or anything that's changed their path forward?

No. And maybe -- I mean that's where I can give a little color in terms of the trial activity and how it works. It's not like digitally ticking a box that you get a trial, you get a win, each one is quite different. We've had iterations with customers, which have gone extremely well. And I think the best example of that is where a second mill at an existing customer took our product in for what we all felt was a trial and that first trial worked well enough that they just continued buying the product. So it can work that well. I would say that's the -- that's probably the extreme case. During the quarter, we had an example where we produced a batch of material for 2 different accounts. It was a batch that was going to be shared between those accounts and something went wrong with the batch of material somewhere between us and the customer. And those are the kinds of things that can go wrong. We've figured it out, we've corrected it, and both customers are back trialing as of this month. So those are the kind of sort of setbacks and delays. I would say we've definitely -- I mentioned in the call, it's a testament to the value we're offering with this product that these accounts have continued while they're going through layoffs and mill closures. We've managed to advance despite that. And I think we're starting to see the bottom in their stocks of inventory, and we're starting to see order books being fuller where this can have a real advantage to their costs as they begin to come out of their lowest periods as well, which, from everything we're hearing from them, is starting to see some light at the end of the tunnel as well.

Jeff, are there any, I guess, external benchmarks that investors can follow to maybe get an idea of when those wet-end customers might pick up? Sort of, if you will, on the supply side, we've grown to watch corn futures pretty regularly. And so we monitor that for the -- as a rough proxy for where cornstarch might be going. Is pulp prices the one we should use for that market? Or is there something else that obviously, we don't -- we can't talk to your customers, but what can we follow to maybe get a feel for when things have bottomed and things are moving higher?

Yes. I would say pulp prices are really only relevant to the value proposition that we hope we're going to be able to offer that looks very interesting for pulp manufacturers themselves. So when we can help to enhance the value of lower grade pulp, that's the advantage that they're getting with our product to make it closer to higher-grade pulp. That's the closest link to a macro figure like that. I think you have to remember in this space that, today, we have essentially 0% market share. And so the indicators are really our ability to convert accounts with wins based on the value we're offering. And we're going to have to start to draw a line from that as we get some traction here. I don't see that there's an indicator like we can see on the supply chain side with the cost of our materials in terms of wins, just given that we're disruptive in building from basically no market share.

Okay. Got it. Related to the pulp side, your -- the manufacturing opportunity upstream. Is the product the same that goes to them? Or is it a variation of SurfLock? And I guess, more importantly, my question would be is when they sell that to the customer, does the customer -- does their customer have to go through a full qualifying process like your direct end market customer would be. And I think you've mentioned in the past, maybe there's some capital expenditure required to upgrade a line. Does your customers' customers have to upgrade their line? Or can -- is the product able to just flow in like it would on a non-enhanced pulp wood flowing?

Yes. Good question. So I mean, we don't want to give away too much of the secret sauce of what makes SurfLock work, but it's safe to say that both products for the end applications and for the pulp mills come from the SurfLock family. There may be some variations but otherwise coming from the same family, running through our same assets. The end customers of the pulp manufacturers definitely have to go through a qualification period, like -- very much like what we would have to do with an end customer if we're working with them directly. So yes, they have to go through that iterative cycle. And I guess, just given that there's really 2 steps to it, it's kind of a testament to the fact that we've been working with this customer for a fair bit of time now. And it is a little bit more multistep and iterative that it takes some time for them to do their trials in the mill and do their qualifications and their lab and then get it to customers and sort of hold their hand through the next step. But the ultimate goal is really to have it be a drop in that their customer is able to just take the pulp as they normally would, recognize the enhanced properties and take some cost out of their own end products.

Okay. So the role of them, theoretically, if you have to qualify each line, whether it's your direct customer or an indirect customer, there's still a qualification process. So it's not like you could go to this end guy and go, here's $100 million worth of product has out or he's going to qualify it with all those guys first.

Yes. Absolutely.

Got you. A question on the wood composite side. Obviously, you've been in the wood composite market for a long time now. SWISS KRONO has been a customer for 5, 6, 7 years, whatever it is. What makes you feel that things -- like other than -- yes, I get that IKEA is now -- is the leader and they are pushing green products and so on. But given the economics, obviously, currently favor non-green solutions, what makes you feel like there's enough of a catalyst to get people beyond the economics of it in the wood composites market?

Yes. I would just qualify a little bit what you said that the economics between the 2 solutions do fluctuate. So we've been in periods where we've been economically advantaged versus the incumbent formaldehyde resins. We're definitely at a period right now with the high starch prices that we're enduring and the crash of methanol, in particular, which is a component of formaldehyde resins that we'd be at a cost disadvantaged position. I think when you have a thought leader like IKEA looking at this and making commitments the way they are, they're looking at this over the long run and they have to look through those cycles. And yes, it frustrates a purchasing manager probably over a period of a few months or a couple of quarters. But over the long run, with the commitments they've made, there's no doubt that they're going to make this change. We do know that they've gone out to their entire supply chain and set the mandate for the level of change that they expect with respect to sustainability with respect to recycled wood, the use of renewable energy and in particular, the use of bio-based glues. So it's really that conviction that gives us the confidence. The market is going to move there. And if we look at history and the changes that have taken place even within -- if we use IKEA, as the example, even within their use of materials in their supply chain, they've changed away from things like lead paint and have been the thought leader in that. And it's really that whole -- a whole level of conviction and they're sharing that conviction now really for the first time as openly as they are that gives us that confidence.

Okay. Do you have any concerns? You mentioned you were the incumbent in the EcoGlue arena. Obviously, you're in with IKEA. They had set in some of their stuff that they were continuing to look at alternatives. Can you give us a view of where you see ECO in the competitive arena? Any fears that IKEA is going to help fuel a competitor?

Yes. I think the other thing that we look at -- so we obviously take what you just said very seriously, and we're looking at that all the time, and I think we have a pretty good handle on what all the alternatives are and where they're positioned. Yes. I guess what gives us confidence is a little bit of what was in that CNN video when they talk about the journey that they've had to go through to get to where they are with the cornstarch-based glue, which you could read into that, but that's us. It's a long journey. And I think everybody else that has a potential solution is going to have to walk a very similar journey. There are alternatives out there that we know of that reduce carbon footprint, but don't necessarily get you out of formaldehyde. So I'll try to be as nontechnical as I can be here, but you can create formaldehyde by deriving some of the inputs to formaldehyde from bio-based sources. But at the end of the day, it's still formaldehyde. And if you try to source the bio-based ethanol today, you're going to be buying that at 3 to 4x the cost of petro-based ethanol. So those kind of hurdles are still in front of the other solutions that still need to be solved. But it's also absolutely no surprise that a manufacturer and a purchasing machine like IKEA is and they're going to always be looking at other solutions. Our job is to continue to innovate to stay ahead. And I mean, just over the past few years of working with them on top of the basic DuraBind we've brought to the table, we've brought other cost savings and performance enhancement improvements to show that, that innovation cycle continues to bring them better and better products. We don't have anything that's ready enough yet, but safe to say that within our labs and our R&D team here, we've got a few more tricks up our sleeve to continue to improve the value of DuraBind.

Excellent. One last question on the -- and this is just looking for a little bit of expectation management, I guess. In your AGM call, you mentioned that you had some stuff that you thought, in the near term, you'd be able to talk more about wins in the wet end. Is that -- have you talked about that today? And if not, just -- and as well, you mentioned Dow had some things in the near term you were excited about. Can you give us an idea of what do you mean by near term? You're talking weeks, months, quarters? Just so we have an idea of when to maybe look for new developments.

Yes. We rely on the opportunities that you just mentioned for the best predictability we can have on that ourselves. And we try to share as much of that as we can in a responsible way with you guys. Safe to say, though, that the predictability that's been shared with us has not panned out as fast as it -- we've been told it would in any respect, in any of the markets that we're serving. So that predictability hasn't been solid. I would have expected -- based on where we were at AGM time, I would have expected another win by that time. We've definitely gone through a few more iterative steps in a slower market due to the macro conditions on the wet end side. But the pipeline has grown. I still believe we have some things that are within this year for wins. And then I think, with Dow, I think, for a large account to go through the qualification, getting all the way through hair salons and stuff like that, I think we're probably in a 6- to 12-month time frame before a really big win. But in the meantime, the little wins with some niche brands are continuing to come in. We're running in the back here today, so Mazecare is product based on a new order we just received. So there's some good little wins that are beginning to fill some things up here.

[Operator Instructions] And there are no further questions at this time. Please go ahead.

I'd just like to thank everyone again for joining us this morning, and we look forward to talking to you again soon.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you disconnect your lines.