Solesence Inc (SLSN) 2004 Q1 法說會逐字稿

Good morning. My name is Latasha and I will be your conference facilitator. At this time I would like to welcome everyone to the Nanophase Technology's first quarter earnings release conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. If would you like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press star and then the number two on your telephone keypad.

The words expect, anticipate, plan, forecast, and similar expressions are intended to identify forward-looking statements. Statements contained in this news release that are not historical fact are forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements 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 expressed in this news release.

These important factors include, without limitation: A decision of the customer to cancel a purchase order or supply agreement, demand for and acceptance of the Company's nanocrystalline materials, changes in the development and the distribution relationships, the impact of competitive products and technologies, possible disruption in commercial activities, occasioned by terrorist activity and armed conflict and other risks indicated in the Company's filings with the Securities and Exchange Commission. Nanophase undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

I would now like to turn the call over to Joe Cross, President and CEO of Nanophase Technology. Please go ahead, sir.

Thank you. Good morning and welcome to the Nanophase conference call to review the first quarter for 2004. Jess Jankowski, Chief Financial Officer, and I will be hosting this session. To begin a review Jess will summarize the financial highlights after which I will return to discuss the first quarter and provide a brief overview of certain business and market development initiatives.

Jess, would you please begin the financial review.

Good morning, and thanks for your continuing interest in Nanophase. As I review the financial performance of the Company for the first quarter, I will continue to do so at a strategic level. More details are included in the financials accompanying our press release of April 21st. All numbers will be in approximate terms for ease of discussion.

Total revenues for the first quarter of 2004 were down $370,000, compared to the first quarter of 2003. For the periods presented, other revenue was down $90,000. This decrease in other revenue, when compared to the first quarter of 2003, related to the sale last year of a PVS reactor to CI Kasei, our Japanese licensee, offset by the first quarterly payment of $150,000 in technology development funding from Rohm and Haas Electronic Materials. This funding from Rohm and Haas is part of its $600,000 commitment to support Nanophase's efforts in jointly developing slurry products for current and future semiconductor technologies.

For the periods presented, product revenue was down $280,000 also. Although sales of sunscreen and personal care materials were above expectations and up relative to the fourth quarter, they were down $160,000 relative to the first quarter of 2003. It should be noted that the first quarter of 2003 accounted for 33% of total 2003's zinc oxide volume and exceeded sales of the next highest quarter by almost $300,000.

Also, sales of CMP materials were down by almost $160,000 [ph] quarter to quarter. This reduction relating to CMP materials was largely offset by the previously discussed technology development revenue in this quarter. These types of fluctuations underscore the limited visibility that management has relative to customers and markets.

Current revenues levels, with the contribution from other revenue, we have generated a modest positive gross margin. Our margins have been impeded by not having enough revenue to absorb the manufacturing overhead that's required to work with the customers we have and the new ones we expect to have.

A large part of this infrastructure cost involves depreciation and our quality systems and people who support compliance with FDA and USP standards for sunscreen materials, as well as the exacting performance requirements of the electronic materials industry for CMP materials. Currently, the depreciation relating to the operations group, including manufacturing and quality, amongst the $250,000 per quarter, or about 20% of our cost of revenue.

It's important to note that Nanophase's existing manufacturing infrastructure can support a multiple of 2003's revenue volume without significant augmentation. This means that we expect our variable margins to drive the expansion of our gross margin and we believe that this will occur as volume grows.

R&D expenses and SG&A expenses were relatively flat quarter to quarter. Generally, health care expenses were up while legal fees were down and the D&O insurance premium decreases we discussed during the year-end call have begun to come through. In total, the Company lost 9 cents per share this quarter versus 9 cents per share for the same quarter last year. Note that depreciation amounted to about 2 cents per share or $350,000 of the Company's loss for the first quarter of 2004.

Moving to the balance sheet, Nanophase ended the first quarter with $14.8 million in cash and investments, compared to about $5 million at the end of 2003. The increase in cash and investments was primarily related to two things. First, former officers of the company, in some cases to avoid looming expiration dates, exercised stock options resulting in proceeds to the Company of approximately $1.2 million, and then the Company received a $10 million investment from its new German partner Altana Chemie in return for common stock that will remain unregistered for a two-year period from the March 23rd closing date. Joe Cross will elaborate on this later in the call.

Looking at accounts receivable, less than 1% of our $930,000 balance is past due. Of the remaining amount, 98% are made up of receivables from our three largest customers, BASF, Rohm and Haas Electronic Materials, and C.I. Kasei. These same customers accounted for 74%, 15%, and 6% of our first quarter 2004 revenue respectively.

As you can see, inventory balances have increased by 5% to $717,000. Approximately $125,000 of this total represents raw materials with the balance being finished goods. Given the Company's lean manufacturing discipline, it's a priority to keep inventory levels as low as possible while still maintaining the ability to respond to requests for material volumes beyond what has been planned. This balance may fluctuate based upon product revenue mix, materials lead times and the overall economics of batch production of various materials. Management continues to minimize required working capital by holding inventory growth to a practical minimum.

Equipment and leasehold improvements for the first quarter of 2004 amounted to only $14,000, bringing the total balance, that's net of accumulated depreciation, to $7.9 million. Most of the current equipment and leasehold improvements on the balance sheet were built during the period from the latter part of 2000 through mid-2002. The Company expects that its known capital needs for 2004 will be somewhat greater than the $220,000 that was spent for all of '03, but at this point, unknown factors, including current and future customer demand, make an exact amount of anticipated capital need difficult to determine.

On the liability side. Adding the current and long-term debt and lease obligations together, the Company has about $1.1 million in total debt. Approximately 75% of this represents the note in favor of our largest customer for equipment to produce sunscreen nanomaterials which you may recall we pay back on a per kilogram shipped basis. Most of the remaining balance relates to finance business insurance premiums.

Payables were up from the end of the year mainly due to differing payout cycles. Accrued expenses were up $110,000, lighting the largest categories of accrued expenses, 41% of the total relate to accrued compensation items and 21% relates to accrued professional fees.

Looking at additional paid-in capital, you will notice that it has increased by $10.4 million since the end of 2003. This is due to the previously discussed exercise of the options by former officers and the March 2004 investment by Altana Chemie net of offering costs.

Thank you for your attention. I would like to turn things back over to Joe Cross, our CEO.

Thank you, Jess. Since our last conference call was only one month ago, I intend to provide a concise summary of business and operational progress. Obviously, it has only been a brief time since our last discussion. As an overview, Nanophase had a solid first quarter for their performance and business development initiatives. The Company continues to make substantial progress in its technology development, and evolution, building on our intellectual property portfolio and, we believe, increasing and maintaining our lead in nanomaterials technology.

During the last quarter, actually, during the last two quarters, we have also made considerable progress in business development that's focused on building revenues during 2004 to 2006. In regard to the latter, given the sensitivity of our business development partners and the prudence of maintaining confidentiality for specific application developments from potential competitors, we tend to avoid details of the breadth and depth of business development.

Suffice it to state that for the last eight months, business development activity has been robust and the Company has made significant progress in several fronts. We are both pleased and optimistic about our current level of initiatives and opportunities.

On a more specific basis, relative to intellectual property, there have been two noteworthy events since our last call. First, as permitted under applicable law, an unidentified person or company has requested that the U.S. patent office reexamine our most recently granted patent that covers certain aspects of the nanoworks synthesis process. Understand that until some action is taken this patent is issued and remains valid. At this time the patent office has not agreed to reexamine the patent, but may at sometime in the future.

We view this as competitive posturing and believe that even should the patent office ultimately decide to reexamine the patent, most of our claims about the patent and invention will survive largely intact. We do not view this as a serious challenge to the legal protection of our Nanoworks synthesis technology, nor the proprietary technologies that surrounds this patent.

Additionally, we have filed a provisional patent application that discloses technology where engineer nanoparticles are employed to control the properties of nanocomposite systems. The nanoparticles enable a wide range of composite properties to be application-tailored including glass transition temperature, transport properties and mechanical properties. The applications we envision include catalyst, personal care and sunscreen ingredients, polymer additives, coatings and others. We believe this technology is fundamentally important to broad target a market applications, and adds to Nanophase's lead in nanomaterials technologies.

Lastly, the Company still has several patents pending both in the U.S. and foreign. We believe these should begin issuing during 2004. In addition, we have approximately three additional patent applications that we currently plan to file during 2004.

Reviewing operational progress, which includes manufacturing and advanced engineering, we are implementing the process of manufacturing improvements that we discussed on the last conference call. Based on the process of innovation developed last year, we are increasing PVS reactor output 20 to 30% for volume products without capital costs.

Ignoring facility cost, Nanophase will add capability equivalent to almost $1 million of current reactor capacity and output for little to no capital investment. Since we began focus process improvement in late 1999, we have now increased PVS reactor output almost eight times the initial rate. We're also completing implementation of a work cell reengineering scheme in Burridge that reduces our reactor labor requirement by about 25%. To put this in perspective, since we began instituting a state-of-the-art manufacturing practices in Nanophase we have now reduced labor content and cost per reactor by a total of over 80%.

As we discussed on the last conference call, since 1999, Nanophase has reduced total variable manufacturing costs by about two-thirds or almost 70% and improved equipment output with result in growth in variable product gross margins. We believe that there are some significant points of the Company's continuous improvement in technology and manufacturing that include the following: First, these repeatedly demonstrate that the Company's technologies are robust and commercially scalable with improvements continuing to increase or maintain Nanophase's technology leadership and competitive position.

Secondly, these improvements facilitate future volume growth but significantly reduce capital investment. Thirdly, they cumulatively position the Company for expected improved financial performance with increased revenue and product volume. Relative to the Nanoworks synthesis process, we are continuing to develop new materials on our prioritized schedule based on target market demand or market-driven development, project agreements with our customer partners. We expect to be announcing new nanomaterial availability periodically throughout the year.

Turning to market and business development, our new marketing identity campaign entitled, "Driving Product Innovation Today" is showing positive results. Our improved website has been further enhanced during the first quarter relative to identification capability by major search engines, and we are seeing approximately double the site visits. This has increased contacts and potential application opportunities for Nanophase.

And parallel, we have placed banner ads on Small Times, which is a leading nanotechnology Internet site magazine publisher and our first identity print ad appeared in "Chemical and Engineering News" during the week of 4/19. Additional ads are planned for targeted publications throughout the 2004, especially around nanotechnology publication features. Coupled with industry conference participation and attendance, we believe that the marketing effort is increasing Nanophase's identity and recognition, and in response, our business development activity.

In the business development arena, obviously the lead item is our recently announced partnership with Altana Chemie. We believe that this relationship is a key event for Nanophase and definitely provides global entree to certain large potential markets that Nanophase has previously has had difficulty penetrating. The strategic partnership plans to develop nanocomposite products for markets including paints, coatings, inks, polymers, plastics, overprint varnishes and electrical insulation.

Each of these applications of markets we believe represent quite significant opportunities for revenue growth for both Nanophase and Altana. We also firmly believe that our partnership with Altana will reduce Nanophase's time to market in the noted application areas and become a significant driver to the Company's future revenue growth. Altana enjoys a preeminent presence in its market as one of the top chemical ingredient companies in Europe, having grown their businesses by 18% per year while maintaining an operating margin of 20% EBITDA over the last 10 years.

With this partnership, Altana's strategic objective is to further accelerate growth by providing innovative products that utilize Nanophase's nanomaterials. Altana's commitment to this relationship is exemplified by its $10 million investment in Nanophase which demonstrates their confidence in the Company's technologies, manufacturing capabilities and employees.

At the current time this partnership has products containing nanoparticles or nanoparticle dispersions in eight different end-use applications with several of these products undergoing customer testing. We expect this already robust product development effort to enlarge over the coming quarters during joint market and technical planning meetings. We currently expect initial market introduction of nanocomposite products during the second half of 2004.

Moving to our partner in the sunscreen and personal care business, BASF, there are now three aspects to this relationship, the continuing sunscreen business, a second-generation sunscreen, and development of personal care products. In regard to the current sunscreen product, we're continuing to see progress in current sunscreen formulations and sales. During the first quarter, sunscreen sales were above the expectations entering 2004, with some indications of a potentially continuing trend in the second quarter. It is truly to state the impact for the entire year, but the early trend, which is above the 2004 annual purchase order level is encouraging.

The development of the second-generation sunscreen [inaudible] nanomaterial continues on track. The provisional patent application I mentioned earlier relates directly to this product. We continue to expect market introduction during the last quarter of 2004. Under a joint development agreement, BASF and Nanophase are collaborating on a personal care application which may see initial market testing during the last part of 2004, however, in the development project do understand that the timing is always difficult to predict.

Continuing in the personal care market we have signed a new product development agreement with a $1 billion company, Comodone [ph] personal care products apart from those we are collaborating on with BASF. The first development project is now underway, while the second project is currently being defined and characterized. We view this relationship as a major market opportunity for Nanophase.

In the fine polishing market we continue to focus on CMP for semiconductors, hard disk drives, optics and photomasks. Since we covered this area thoroughly about 30 days ago, I will only provide a brief summary. Our partner Rohm and Haas Electronic Materials, CMP technologies, formerly Rodell, continues to make solid strides in penetrating two major wafer technologies within CMP, STI and SON Technologies. RHEM has a dynamic market introduction effort in the U.S., Asia and Europe with approximately 19 semiconductor fabs at various levels of testing and trials. RHEM is continuing to improve the performance of the slurry product and testing is showing extraordinarily low defectivity data relative to current industry product performance.

We also continue to plan development of the second slurry product which is now underway and believe that initial market testing should occur during late 2004. We will have a market review meeting with our partners scheduled during May, and I will be able to provide a better picture of market introduction activities during the next conference call. And hard disk substrates composed of glass and our ceramic materials for the next generation of disk drives we continue to make definitive progress in co-development with the market-leading manufactures. We have advanced to the second round of development testing since our last conversation and expect this effort to continue in a positive manner. Again, I expect to be able to provide more color on this during the next call.

Continuing in fine polishing our foray into polishing fine optics continues to be positive. A manufacturer of polishing and equipment that I mentioned on the last conference call, has decided to standardize on our nanoparticle dispersion for all lines of equipment by summer and will be a routine customer for the Company. Additionally, a manufacturer of high quality lenses for an application that we are not at liberty to divulge has also standardized on Nanophase's nanoparticle dispersion for polishing and will now be a routine customer. Both of these represent new customers and new applications for the Company.

Our other business development initiatives are robust, remain on track and the Company has continued at a high level of business development activity. In addition to those already discussed, we have several initiatives in multiple market areas that are progressing and we're continuing to experience increased new interest across several market areas. Based on our initiatives in progress, we expect the level to likely increase throughout 2004. We hope to be able to be somewhat more specific on some of the developing new opportunities by midsummer or early fall.

Considering business development and revenue growth going forward. Let me just note that the Altana partnership, coupled with BASF sunscreens and personal care and Rohm and Haas and semiconductor CMP offers global access to significant markets that we believe should provide a solid foundation for revenue growth and financial performance for Nanophase.

These partnerships align the Company with a dominant partner in key markets, each of which has global presence and technical service, as well as large established customer bases. We are pleased with our large market partners and optimistic about revenue growth as we progress. We fully expect to add other opportunities and market partners to this foundation as we move forward. Several of these are in development, but they are confidential and we are unable to elaborate at this time.

That concludes our prepared remarks. We are available for questions at this time.

If would you like to ask a question, please press star then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Bruce Brewster of Brewster Asset Management.

Hello. You mentioned paint. I'm interested in paint and ink as an application for nanotechnology. Can you produce -- what are the advantages of using nanotechnology on paint? Can you produce colored pigments in nanosizes?

We don't produce colored pigment in nanosizes other than iron oxide and that's typically not used in paints.

You produce just the base.

What we tend to produce, we're producing products -- Bruce, I really can't go into this very deeply because of agreements we have in place with people, but we produce materials that improve the quality of the paint, relative to both wood and metal. Relative to bleach roof as we understand it and relative to corrosion resistance on metals. Relative to inks, there's three areas with inks that were active and one of which is UV protection of inks so inks don't fade, abrasion resistant inks so you can't scratch it, and the third area would be overprint varnishes which is a growing area in labels and other applications to prevent scratching and removal of whatever is printed.

Same capability as that flooring covering, probably, oxide?

Quite similarly.

Oxide?

Yes.

Thank you.

Your next question comes from Doug Allison of UBS.

Hi, Joe.

Hey, Doug.

Sounds very exciting here with Altana. Can you kind of characterize the type of -- for revenues that we're expecting from Altana. Is it similar to Rohm and Haas and that their customers have to adopt the new products that they are putting out? Or is this going to be a more rapid revenue because Altana is going to be ramping up production for their own personal use? Something along those lines? Can you fill us in on that?

Sure. I'll do my best. Altana's niche in all the markets I discussed is on the higher end of those markets. Altana has about $1 billion in sales relative to specialty chemical part of that business. They are part of Bic [ph] Chemie, which is about a $4 billion company. Altana tends to provide ingredients to all the markets I mentioned, plastics, coatings and all the rest. They're known and looked at, again, as a preeminent, high-quality supplier in these markets. They have a very established customer base and, again, they are considered to be a leader.

Our suspicion and our belief at this time is revenue growth will be quite rapid with Altana. As I said, there's already eight projects in development. Many of which are in the field being tested actually on products. We expect, at this point -- we would believe that we would start seeing revenue in the second half of 2004, but most of it will probably start -- we'll see in 2005. We expect the volume from Altana to approach what we're doing with BASF, frankly, in the relatively near future.

Again, we believe this is a major opportunity for this company. The nanocomposite market, as we attend conferences and people try to forecast market growth, I've seen at least two presentations on the nanocomposite market. Understand that future forecasting is done by MBAs kind of grab the numbers, but I'm not going to relay those numbers because they are just too high and we don't quite believe them, but suffice it to say, this is reported to be a very significant market.

And the new personal care customer, have we seen any revenues from them yet?

No, we just signed a company to company product development agreement with them. We defined, as I said, the first development project which is a very interesting product and we hope to be in the market in about six to nine months from now. And we're defining the second market area. But this is a very -- it's very high-quality company. It's a very good partner for us, and, again, it's a major opportunity for revenue growth, especially in 2005, we believe.

And Rohm and Haas, the Cabot conference call that just ended, they indicated, again, that they had two of the five major semiconductor manufacturers that are moving into 90 nanometer production, and that there were two others that had chosen someone else. Can you tell us at this point whether it's Rohm and Haas that were the other two that they mentioned that had chosen someone other than Cabot.

I have an agreement with the CEO of Rohm and Haas that I won't talk about his customers. Okay?

Okay.

I will tell you this. The data coming back from three continents is showing pretty incredible levels of defectivity. During the first quarter we worked really hard with Rohm and Haas to really optimize the slurry. We have actually seen several wafers with no defects. That's pretty much unheard of in the semiconductor industry to our knowledge. And we've been told that by Rohm and Haas. So we believe that they have a really good product, and they are getting a lot of market attention, and we're very optimistic about this. In fact, I think we're much more optimistic today than we have ever been. They have a very dynamic market introduction effort. Our relationship with them has significantly improved. We are privy to a lot of confidential information, that a lot of partners wouldn't share, frankly. And we're very hopeful about this.

Okay. Thanks a lot, Joe.

Again, I would like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your next question comes from Lenny Brecken of Brecken Capital.

Hey, guys. I may have asked you guys this question in a more private forum, but I'm going to ask it again now. I was wondering if you can just -- in terms of Altana just describe why you chose them for as broad of application or applications as you did? Rather than trying to go after it -- being a typical IP company, trying to go after any vendors in the products that they address?

I think there are three major overriding reasons. The first one is technical. As we have worked with coatings, in particular and in plastics. We have found from the technical standpoint, it's much easier to be successful and to incorporate nanoparticles at the lowest possible chemical level. Typically, if we work with coaters, they have a complex formulation of polymers and different additives that they don't want to share exactly with somebody like us or anybody, because it's considered proprietary knowledge. So we always wind up with chemical interaction problems that are hard to understand. Whereas, with an ingredient supplier to these industries, it's much more easy and much more likely to be successful incorporating nanoparticles in an ingredient and we have already seen that, frankly, in the eight applications that are out in the field testing. I think that's the first reason.

I also think from a market penetration standpoint, a company like Altana, with $1 billion in sales and really a superb reputation in the industry I discussed, gets much more attention than a $5 million nanotechnology company. So from a market access and customer access arena, they will be much more successful than we are going to be in a much faster fashion.

Thirdly, rather than develop customers, Altana is bringing a stable of customers to this, and bringing business leaders, for instance, the global business leader for their plastics additive business visited us last week, and developed plans to attack the plastic market. We don't have that kind of talent in our 50-person company and we don't have those contacts on a global basis with the people we need to have. So I think the relationship with Altana from a technical standpoint, from a market introduction standpoint, from access to customers and time to market and revenue growth, it's a win/win/win all the way around for us.

Okay. Thank you guys.

At this time, there are no further questions. Are there any closing remarks?

We would like to thank you for joining us today, and we will talk to you again at the end of the next quarter. Have a good weekend.

This concludes today's conference call. You may now disconnect.