Solesence - Earnings Call - Q1 2025

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Solésence First Quarter 2025 conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To participate, you will need to press Star 11 on your telephone. You will then hear a message advising your hand is raised.

To withdraw your question, simply press Star 11 again. Today's call is being recorded. During this call, management will make statements that include forward-looking statements within the meaning of the federal securities laws which are pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. This conference call may contain statements that reflect the company's current beliefs and a number of important factors that could cause actual results for future periods to differ materially from those stated on this call.

These important factors include, without limitation, a decision of the customer to cancel purchase order or supplies, agreement, demand for and acceptance of the company's personal care, ingredients, advanced materials, and formulated products, changes in development and distribution relationships, the impact of competitive products and technology, possible disruption in commercial activities occasioned by public health issues, terrorist activities, and armed conflict, and other risks indicated in the company's filings with the Securities and Exchange Commission. Except as required by federal securities laws, the company undertakes no obligation to update or revise these forward-looking statements to reflect new events, uncertainties, or other contingencies. I will now hand the conference over to your speaker, Mr. Jess Jankowski, President and CEO. Please go ahead, sir.

Jess Jankowski (President and CEO)

Thank you, Carmen. Good afternoon, and thanks to all of you who have joined our call today. With me on today's call is Kevin Cureton, our Chief Operating Officer. I'll begin with a summary of our first quarter results and a business update. Kevin will then discuss our operational initiatives. We will take your questions.

Last quarter, we hosted our first conference call rebranded as Solésence, a brand that reflects our simple yet profound mission: deliver joy. Today, we're hosting our first conference call as a listed company on NASDAQ. In such a short period of time, we've undergone a remarkable transformation that has us well-positioned at the forefront of the beauty market. This is reinforced by our commitment to scientific excellence and innovation as we pioneer industry-leading, award-winning protective beauty solutions recognized globally.

As a high-growth contract development and manufacturing organization, or CDMO, we're leveraging our novel technology suite, unique performance consumer products, and regulatory expertise to empower brands to enhance consumers' lives and well-being. Our vertically integrated patent-protected formulations are used in skin health products spanning skin care, sun care, and color cosmetic market segments. What sets us apart from other CDMOs is our proprietary technology, which enables us to build novel products that allow our brand partners to capture preferred positioning in retail environments and typically become the leading choice of the consumers they serve. Our integrated position of being a platform technology innovator, a developer of unique award-winning formulas, and a CGMP manufacturer further allows our brand partners to reach the market much faster than their competitors.

We believe that our patented technology provides us with a strong competitive position, safeguarding our market position and enabling long-term value creation for both Solésence and our brand partners. Importantly, because of our position as an innovator who can rapidly bring new products to market, we have long-term relationships with private equity-backed beauty brands. These brands tend to be high-growth organizations who look to us for upstream support that few can match. The combination of these key factors is what attracts top-tier brands to us from the $570 billion-plus global beauty market. All of this was on display in our first quarter 2025 performance, where we achieved record revenues of $14.6 million, representing an increase of nearly 50% year over year.

Revenue in the quarter was primarily driven by sales to our largest brand partners, including our new launch partner, Color Science, for our consumer products, and, of course, sales of our active pharmaceutical ingredients to BASF. These results reflect the continued strength of our commercial execution and demand for our products. While we were pleased with the strong performance, our margins were impacted by one-time production startup costs relating to the launch of a new product line by a new key brand partner. Kevin will provide more details here shortly, but I'd like to note that our relentless efforts to resolve this issue successfully kept this critical product launch on schedule. As a result of these startup hurdles, in the first quarter, gross profit was $3.3 million, or 23% of revenue, compared to $3.6 million, or 36% of revenue for the same period in 2024.

Excluding the one-time startup costs, our gross margin would have been similar to last year's margin. Net income for the first quarter was at break-even, compared to net income of $0.9 million for the same period in 2024. We anticipate a rebound in our margins starting in the second quarter as we ship more product to this new brand partner, as well as our many other growing brand partners. It's our expectation that there will be minimal impact in the second quarter from these startup costs, as we believe we completely resolve these issues during the month of April. Turning to our recent uplisting to NASDAQ, on April 8th, we started trading on NASDAQ under the new ticker SLSN. This uplisting marks a new chapter for Solésence, and I'd like to highlight three important reasons why.

First, we believe that trading on NASDAQ will increase awareness of Solésence within the financial community. Listing on a major exchange like NASDAQ can enhance our visibility and credibility, making it easier to attract diverse, long-term institutional investors. Second, it will increase our marketability, liquidity, and access to the capital markets, all of which we expect to be critical to our growth initiatives down the line. Third, we believe that it will deliver greater value to our shareholders and other stakeholders. We're excited to have achieved this major milestone last month and look forward to building upon our success moving forward. At this time, I'll turn the call over to Kevin Cureton, our Chief Operating Officer, to share an update of our progress and outlook. Kevin?

Kevin Cureton (COO)

Thanks, Jess. As I always like to begin, I would like to thank our amazing team for their tireless effort and commitment, demonstrating through our results their ability to consistently deliver solid performances for our investors, our brand partners, and for ourselves. As Jess noted earlier, we achieved a record first quarter, both in terms of our revenues and unit volumes, reflecting the strong demand for our consumer products. Operationally, as Jess mentioned, we encountered startup challenges related to a new product launch for a key new brand partner. We are pleased to report that these issues related to this launch were resolved, and we have strengthened this customer relationship through our steadfast collaboration. A few points about this launch. First, the production was part of a multi-skew launch in line with bringing our novel technology to a broader audience.

This launch is our single largest product launch to date. Second, prior to the launch, we worked closely with our brand partner to ensure the products were developed to meet the highest standards of quality, including conducting multiple production trials. Third, as a result of the successful resolution, we established what we believe will be a long-term relationship with this leading brand, underscoring our commitment to be a strategic and responsive partner that can help fuel the brand's future growth. I'm pleased to say that we have successfully delivered launch orders in the first quarter, will ramp up order deliveries in the second quarter, and have already received reorders for shipment in the third quarter, all related to this launch. The preservation of this important relationship did come at a cost.

To resolve the startup issues related to packaging, additional labor costs were incurred to meet the demand and ensure that this key product launch would remain on schedule. However, the additional labor costs had an adverse impact on our gross profit during the first quarter. As part of our commitment to continuous improvement, we raised the bar on how we will approach future inbound packaging components. In this situation, as we have in others, every time our dedicated team executes a new product launch, we learn something new that lowers the potential risk inherent with all new product launches. As a result, we are now in a much better position to reduce both the risk and the cost associated with launching new products than we were just two short years ago.

Turning to our technology, during the first quarter, we further strengthened our competitive position with three new patents for our clear technology, our plant-based antioxidant technology, and our skin healing technology. These include an allowance for our clear technology in Japan, an allowance for our new plant-based antioxidant technology in South Korea, and an additional allowance in Mexico for our new skin healing technology that leverages allantoin, commonly used to ameliorate scarring. All of these patents increased our ability to create sustainable competitive advantages for our brand partners and for ourselves, now giving us three technology platforms with global IP protection. I would like to briefly touch on tariffs. As a domestic manufacturer, we anticipate tariffs having a modest impact on our top line as of today.

Solésence has brand partners diversified across skin care, color cosmetics, and sun care categories, as well as those operating in prestige and mass markets. While we won't be immune to market pressures, we believe we are well-positioned should macroeconomic conditions cause demand to soften across certain product categories and segments. Regarding the impact on costs related to tariffs, although we participate in the global supply chain and source raw materials outside of the U.S., the impact will likely be muted on our cost position in the second quarter, and we will likely not see a significant effect from tariffs, at least through most of the third quarter. However, on packaging components, we do expect tariffs to impact us, and we are confident that we will be able to pass all of the new tariff expenses through without adversely affecting our margins.

We continue to monitor the situation closely, particularly as we begin to look beyond the U.S. for further growth. Finally, before turning the call back to Jess, I would like to reiterate that we achieved yet another record unit volume quarter. With many of our production issues behind us, we anticipate our gross margins to increase moving forward. As previously planned, we expect that the increasing product volumes will drive more efficient absorption of our fixed manufacturing costs, which should lead to increased margins. We are also focused on reducing controllable variable production manufacturing costs. This will enable us to grow more profitably and ultimately create more value for our shareholders. I'll now turn the call back to Jess. Jess?

Jess Jankowski (President and CEO)

Thanks, Kevin. We're pleased to have achieved another record-breaking revenue quarter driven by robust demand for our consumer products marketed through the leading brands that we believe represent the future of beauty. These brands include a long-term exclusive relationship with BASF for our APIs, as well as brand partners Color Science, a leading dermatologist-recommended brand, Tatcha, a Japanese-inspired prestige brand, and Credo, a leading clean beauty retailer. We added to that impressive list with a multi-skew product launch with a key new brand earlier this year, as we have discussed. Although we encountered one-time startup issues that impacted our profitability in Q1, we proactively addressed them and are now well-positioned to scale for future gross margin expansion to drive stronger EBITDA performance.

Turning to our book of business, for purposes of comparison, our shipped and open orders are currently in excess of $45 million, compared to about $40 million in the first quarter of 2024 and $38 million when we last reported in late March. It is important to note that when comparing our shipped and open orders to the year-ago period, our current orders extend into the third quarter of this year, whereas last year's number included volumes through the end of the year. Because our brand partners are becoming more comfortable with our agility, they are shortening their order horizons to better address near-term demand. We anticipate continued top-line growth with record revenues for the second quarter of 2025, and we expect more orders coming in relating to reorder quantities and launches for the second half of 2025.

As consumer preferences rapidly evolve, Solésence remains at the forefront of addressing the needs of consumers. Two of our core strengths are diversification across various beauty segments and our ability to cater to both prestige and mass-market brands. These differentiators expand our potential for market reach and increased volumes. It is why we believe our high brand retention rates will lead to recurring revenue and sustainable growth. At this time, I'd like to share a brief update on our Chief Financial Officer search. In connection with our top-line growth, combined with our rebranding and the successful uplisting to NASDAQ, we made the decision to strengthen our leadership team with the appointment of a dedicated CFO.

We have initiated an aggressive search and hope to announce this key appointment in the coming months. Now, we would be happy to take some questions. Afterwards, I'll offer a few closing comments. Carmen, please open the call for Q&A.

Operator (participant)

Thank you so much. As a reminder, to ask a question, simply press Star 11 on your telephone and wait for your name to be announced. To remove yourself, press Star 11 again. Thank you. Please stand by while I compile the Q&A roster. One moment for our first question, please.

It is from the line of Mr. Rubin. Please go ahead.

Hi, gentlemen. Good afternoon. I sound a little bit like a broken record, but congratulations on truly outstanding sales growth, open order growth, and expansion of the breadth of your product line. However, the operational failures also are a bit like a broken record. I do not know if these numbers are right, but Jess mentioned in the absence of your one-time startup staff, your margin would have been similar to last year. And doing quick math, that is close to $2 million. Is that the true impact of those one-time costs that you mentioned? Again, to sound like a broken record, if so, we have had tremendous success on the sales side, but we have had tremendous disappointments on the operating side. Kevin, you constantly commend your group, which is a nice thing to do, but the group has let the collective down from a margin perspective.

Just to get some color, was it a $2 million one-time issue? I'm glad you salvaged the customer, etc., etc. How can we be assured that these things won't happen? Because in the absence of that, if you had the same gross margins even as last year, your earnings per share, even with a higher share count, would have been 80% higher. It's frustrating.

Jess Jankowski (President and CEO)

Hi, Tony. It's Jess Jankowski. It probably wasn't a full $2 million, but it was up in that range of we just saw some inefficiencies that were kind of across the manufacturing organization, and it lasted longer than we expected. That's really where the issue came. Definitely, none of us are happy about it, obviously. However, part of the reason that the magnitude of it was higher is just we're getting to the point where we're getting a lot bigger initial orders and having a lot more volume pumping through quickly. I don't think it'll be repeated. I

do think that the magnitude of it had a lot to do with the magnitude of the orders, which are just higher than we've ever seen, which is part of the issue. A little mistake becomes a big mistake when you turn up the volume.

Kevin may want to comment somewhere on that as well, but I see it as a learning experience, and I do not see it as something that I expect to be happening again.

Kevin Cureton (COO)

Yes. Good afternoon, Tony.

Operator (participant)

Hi. Sorry.

Kevin Cureton (COO)

Good afternoon, Tony. Are you able to hear us clearly?

Yes. You're both loud and clear.

Okay. Okay. All right. Thank you.

Jess Jankowski (President and CEO)

I'm there.

Kevin Cureton (COO)

Yeah. We had a couple of background noise, so we were not sure. Thank you. Yes. As Jess mentioned, as you said, the frustration is pretty significant. There are things that we are changing relative to addressing this issue. How this issue came about, I briefly mentioned, was really related to some issues we had relative to the packaging that came in. It was a variance from what we had originally done with the setups and with the testing that we did on the trials. That said, we should have seen this faster.

We are making some changes, which I do not really want to go into the details of what those are, but they are to make sure that this type of issue does not occur to the extent that it occurred.

Just being fully transparent here, one of the challenges that happens with any new launch is particularly in the space that we operate, where we're trying to get these things to market pretty quickly as part of the point of difference that we offer in the marketplace. There are usually some unknowns that come about that can affect the performance. The difference here is that, as Jess said, it was large, but also that it didn't get noticed until relatively late in the initial startup phase of the process. That is really where we're emphasizing making sure that these types of things don't go that far, that there are proper screening checks, evaluation of the performance of the line and performance relative to meeting the specifications of the product much earlier in the production process.

Definitely frustrating after really expecting a much better result given the scale of the revenue that we did have.

Okay. Thank you. Would you venture an estimate as to full-year gross margins, assuming this is a one-time thing, as you mentioned?

Jess Jankowski (President and CEO)

We expect them to be certainly above 30%. Again, it's hard without knowing. We're not going to give guidance relative to the full year just based on the fact that there's a lot up in the air. We are perfectly capable of generating margins in the 30s with our goal of exceeding that. I don't expect them to be significantly lower for the year than that. I do think this is going to be an anomalous quarter with the worst margin we would have seen for the year.

Thank you.

Operator (participant)

Thank you. Once again, ladies and gentlemen, if you do have a question, simply press Star 11 to get in the queue. One moment for our next question that comes from Wayne Ruin. Please proceed.

Yeah, Jess. I appreciate your dedication, both of you, Kevin, for your hard work. Should we have been able to anticipate some of this, and are we in position to correct this before it happens? This was kind of disappointing that the end of last year was not so hot and now this year. Are we going to get better at anticipating these problems before they make such a significant impact on our margins?

Jess Jankowski (President and CEO)

Hi, Wayne. Yeah, we are. We are already better than we were. I think it's not a super complicated business, but there's a lot of moving parts. I think this area was one that exposed something that we didn't have enough coverage on in terms of catching something like that in advance. That said, we have put presses in place to avoid that from happening again. As Kevin mentioned, part of it was just the magnitude of the, there was a big rush to get this thing out the door.

As usual, nobody wants to fail. We did an incredible amount of it and realized too late that we needed to do some rework. I think we're better positioned to not have that happen again. I always expect there are going to be errors. I mean, you don't have a perfect fill rate.

You always have some issues. The question is, to your point, do you have a strong enough quality system that you catch the error after you make 100 of them instead of a million of them? That is really where we're focusing and dialing in on how we're managing the organization. In a nutshell, I think we do have a better visibility now of this potential issue. I'm sure there's another one that we may not notice, but I think even saying that, we are looking at our procedures completely to make sure that during the trial phase, we're continuing to investigate all these potentials. If there is a last-minute change, which in this case, there were some changes later in the game, we need to address it at that time. I think we will.

Kevin Cureton (COO)

Yeah. Just to follow up with that question, Wayne, there are a couple of things that we should mention. First is the quality issue really was on just a portion of the total production that is related to this launch, but it was a significant early portion of the production, but significantly less than half of the total production. That meant for us to first be able to correct it, which meant we had to go into a pretty heavy rework process, which is a heavily manual process. That is why the costs were so high. We also had to put in place the proper changes to the production process where we were making prime or first production on additional goods.

During that, we were able to double down relative to ensuring that we were making the product right the first time through doing some additional quality checks at the front end and at the back end in order to make sure that the changes that we had made on process and in the machining or in the filling process specifically were actually working.

That's, again, going a little inside baseball on the issue, but given the magnitude of it and given the concern that this is something that could linger on, I wanted to ensure you that there is know-how within the organization on how to make sure this doesn't happen again, to first and foremost, look for these issues prior to starting production, which are basically variances against the specification on the package or variances in the way that the equipment was set up, and making sure that we're going to do things right the first time when we start the production. All of that is a pretty heavy emphasis for us, not just this coming quarter, but on a going-forward basis.

Operator (participant)

Thank you. One moment for our next question. It comes from the line of Ran K. Please proceed.

Good afternoon, gentlemen. Yeah.

Jess Jankowski (President and CEO)

Hey, Ran.

Good afternoon, gentlemen. A couple of questions regarding the tariff situation. A while ago in the 10-K, you guys stated that China was single source on some key raw materials. I guess it was zinc, and that you were looking for other sources. Okay. Have we second-sourced, to your satisfaction, this issue, especially with China?

Yeah. Ran, good afternoon. First of all, China is not a source for our zinc metal or for any single source of any key raw material. It's always been for us a second source, actually, if we source from China at all. Just to make sure it's clear, we do not source zinc metal for our processes from China. We are very comfortable with our sourcing within the scope of the tariff situation as well. It's actually European or domestic where we typically get the zinc metal.

What is the one issue that we single-sourced from China if it wasn't zinc?

You might be thinking, I don't know if it's in the most current 10-K. The prior ones, we used to get all of our cerium oxide from China for the polishing business. That's something that we don't have much of a business or any of a business in that anymore. That's not an issue. That would be the poster child for a tough thing to be dependent on China. That falls into the rare earth category, which we're happy we don't have any of that right now that we have to deal with.

Okay. From a cost perspective, do tariffs affect more raw materials or packaging materials?

Yeah. For us, it's more packaging materials. Really, for the beauty industry, that's the lead, is packaging materials are broadly sourced from China. That's where you would see the most impact.

As two of the previous callers mentioned, gentlemen, again, I do not want to beat a dead horse, but I am very disappointed that we keep having these trial and error situations where we will get it this time. The thing that I am a bit concerned with is that in Jess's discussion, we are pretty sure this is not going to happen again, or we hope this does not happen again. I just wonder if there is a mindset that drills down a little more hard line throughout the organization that says, "This cannot happen again and will not happen again." I guess my question specifically is, did this mistake come because we did not have somebody in the position, quality, either first article or whatever, or prototyping?

If not, is there now, is it an issue that the mechanism wasn't in place, or was it a mechanism where whoever was in place wasn't doing their job properly?

Kevin Cureton (COO)

Yeah. Ran, there were a couple of different questions there. I think the gist of what you're getting at is, do we understand how it happened, and do we have the wherewithal, both in terms of our knowledge and the organizational, we'll call it, chutzpah, to make sure it doesn't happen again? We do understand what happened. We understand what the cause of the error was. We do have, as I mentioned earlier, corrective actions put in place. We do also have our organization tuned in to what this cost us as a company and that on both sides, there was an opportunity to win bigger with success, but there's also a consequence for failure for all of us.

I think everyone is tuned into that in the appropriate level of concern that they should have or we should have as an organization to make sure that we do not have these types of issues again. I just want to make sure it's clear, though, that with this issue, it should have been not a significant seven-figure issue. It should have been maybe a few thousand to $10,000 type of issue for us, not the scale. These types of issues will happen in launches of this magnitude. They should be stopped earlier. That is really the emphasis, to make sure that we know if we've set it up to do it right the first time, we should do it right the first time.

If there is some mistake that's being made, that it's caught early and it doesn't manifest itself in the manner that it did this time this past quarter.

All right. I got to say, from a standpoint of being disappointed, I'm extremely disappointed because I really thought this was done. I really thought these oops we didn't take into account. And here it is again. I am really concerned a little bit, gentlemen, with both of you, that, well, we hope it doesn't happen again, but it could. I think that fundamentally, I don't know.

I just have been, in my experience, consequences like this need to be dealt with effectively. If people need to be cut loose as a result, that's how it goes. I'm just wondering if the mindset is steely enough and tough enough to send a message throughout the organization. Yeah. We want to reward our people with praise and so on and so forth. This should not be a situation where the ramifications of which, well, it happened.

Big deal. I just.

Jess Jankowski (President and CEO)

You do want to make sure that you should praise in public and criticize in private. I know that probably gets old listening to it on the other end.

It does. It does, Jess. It does specifically because of these kinds of situations.

Sure. In terms of your interpretation of my comment, my comment is that issues are going to happen. The magnitude of it should never happen. That was the problem. I always think there's going to be everybody has a there's a failure rate in the business, and it should be a few percent tops. You should winnow that down to nothing or as low as you can, which is something that we obviously want to be. This is at the highest level of the company. We're talking about it. We're talking about it with the board. This isn't something that anybody is taking lightly.

Operator (participant)

One moment for our next question, please. It comes from the line of Mr. Ronan Richards. Please proceed.

Jess, can you hear me?

Jess Jankowski (President and CEO)

Hi, Ron. Yep. We can hear you.

Yeah. On your balance sheet, there's a big new liability for accounts receivable, and there's a bigger liability for inventory line of credit. What are those all about, and why were they necessary?

Accounts receivable is relating to just the increased volume. As we said, that was the launch that we were supporting and are supporting, was probably the biggest one we ever have. A lot of it ballooned based on volume. We're not in a, from that perspective, naturally, it's hard on cash, but it's something that just happens. In terms of the accounts receivable related to the line of credit, that's just, we use that to support working capital. The other line that you did not mention, which is something that we are focused on, is we have a high degree of inventory, even though it did not change a lot quarter over 12/31.

Year over year, it has, which, as you know, is a drain on working capital, which supports some of that borrowing. When it was at zero at 12/31, that was anomalous.

That also related to the fact we had done the financing last year. We also had, in the fourth quarter, we did not have that rapidity of growth that we had in Q1. It kind of all came together. I think that comparison, if you compared it to the average of last year, the average of this year, it will be higher this year because sales are higher. I expect us always to have something there.

How soon will these be extinguished? I mean, your accounts receivable is a lot higher.

Sure. The days outstanding are not that high on the accounts receivable. Again, it's just that we have a lot of them. We had a lot of shipments. I don't expect it to be materially older than any other receivables that we've had from that perspective. Internally, we're working to cut into our inventory. Part of that, one of the things that we've done, because of the tariffs coming on, because of the length of time it takes for things to get across the water, we do have a larger inventory than we would like if we could do just in time, which is really not possible at this point, at least, and maybe never in this industry.

Those things are a drain on cash. If you look at when we get together a cash flow statement, we're also in the process.

We are continuing to invest some capital in the business, not so much in Q1, but last year, we did quite a bit. This year, we'll probably be less than last year or similar. That comes out of operating cash. We're not at the point. We're trying to avoid financing all of that to the extent we can while not being hamstrung to operate the business.

Operator (participant)

Thank you. This concludes our Q&A session. I will turn it back to management for any final comments.

Jess Jankowski (President and CEO)

Thank you, Carmen. Thank you to all of those who took the time to join us today. Solésence's ability to deliver innovative, regulatory-compliant, and market-ready products, coupled with our strategic partnership approach, positions us as the preferred CDMO for brands seeking to achieve sustainable growth, market leadership, and unparalleled products spanning skincare, sun care, and color cosmetic market segments to consumers worldwide. In closing, we owe our continued success and our expectation of yet another record-breaking year to the dedication of our team and the ongoing support of our brand partners and shareholders. We thank them and look forward to updating you on all of our progress in the next call. Carmen, you may close the call.

Operator (participant)

Thank you, everyone, for participating in today's conference. You may now disconnect.