Solesence Inc (SLSN) 2004 Q2 法說會逐字稿

Good morning. My name is Michelle and I will be your conference facilitator. At this time, I would like to welcome everyone to the Nanophase Technologies Second Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would 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 then the number two on your telephone keypad. The words expect, anticipate, plans, forecast and similar expressions are intended to identify forward-looking statements. Statements contained in this news release that are not historical facts are forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements reflects the Company's current beliefs and a number of important factors could cause actual results for future periods to differ materially from those expressed in this news release. These important factors include without limitation, of the customer canceling a purchase order or supply agreement, demand for and acceptance of the Company's nanocrystalline materials, changes in development and distribution, relationship, the impact of competitive products and technologies, possible disruption in commercial activities, occasions by terrorist activity and armed conflict and other risks indicated in the Company's filings with the Securities and Exchange Commission. Nanophase takes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties. Thank you. I would now turn the call over to Mr. Joe Cross, President and CEO. Please go ahead sir.

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

Good morning. Thanks for your continuing interest in Nanophase. As I review this financial performance of the Company for the first six months and the second quarter, I intend to only address significant financial areas comparing 2004 versus 2003. All numbers will be in approximate terms for ease of discussion. Total revenues for the second quarter of '04 were $1.540m up $230,000 or 18% compared to the second quarter of 2003 and they were also up 19% sequentially compared to the first quarter of 2004. For the six-month period of '04, total revenues were $2.84m versus $2.97m in 2003, a 4.6% decrease. To dig down a little bit, for the same six-month period, other revenue was up $80,000. This increase in other revenue when compared to the first half of '03 related to the first two quarterly payments totaling $300,000 in technology development funding from Rohm and Haas Electronic Materials, offset by the sale last year of the PVS reactor to C.I.Kasei, our Japanese licensee. This funding from Rohm and Haas is part of its $600,000 commitment in 2004 to support Nanophase's efforts in jointly developing slurry products for current and future semi conductor technologies.

Ignoring the sale of the PVS reactor to a Japanese licensee in Q1 of '03 for $226,000, which was essentially in a regular event. Total revenue would have grown by 3% over the same period. For the six-month period, product revenue was down 8% to $2.4m compared to the first half of last year. Sales for sunscreen and personal care materials were above expectation and up 9% relative to the first half of 2003. The negative fluctuation that has inhibited growth in product sales relates to CMP material, which were down more than $400,000 between the two six months period. Rohm and Haas Electronic Materials product purchases are down in 2004 as they continue to reduce their inventory of our Nanomaterials dispersion shift in 2003. This reduction has been largely offset in other revenue by the previously discussed technology development revenue in this period. At current revenue levels with the contribution from other revenues, we generated a modest positive growth margin. Gross margins continue to be negatively impacted by not having enough volume and associated revenue to absorb the manufacturing overhead required to work with the customers we have and those we expect to attract. A large part of this infrastructure cost above depreciation, quality systems designed for ISO 9000 and GMP compliance and for compliance with FDA and USP standards for sunscreen materials as well as EPA and other governmental regulations. In example, for the six months ended June 30, 2004, depreciation relating to the operations group, which includes manufacturing and quality, amounted to $500,000, or about 19% of our cost of revenue. As we have stated before, Nanophase's existing manufacturing infrastructure can support a multiple of current volume without significant overhead or infrastructure augmentation. This means that we expect growing variable margins to drive the expansion of gross margin, and our financial models show that this will occur as volume grows. In total, the Company lost $0.08 per share this quarter versus $0.10 per share for the same quarter last year and $0.17 per share for the first six months of this year versus $0.20 per share for the same period in 2003. Note that depreciation and amortization amounted to about $0.04 per share, or $700,000, of the Company's loss for the first half of 2004.

Moving to the balance sheet, Nanophase ended the first half with $13.8m in cash and investments compared to about $5m at the end of 2003. This increase was primarily related to the $10m equity investment from Altana in March of this year and $1.4m in proceeds from stock option exercises, over 90% of which were from non-current employees. Note that the $10.4m increase in additional paid-in capital reflects these inflows as well, net of offering costs. Looking at accounts receivable, less than 2% of our $770,000 balance is past due. 85% of the total is 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%, 12% and 6% of our first half 2004 revenue, respectively.

As you can see, inventory balances have decreased by 9% to $766,000. Given the Company's Lean Manufacturing discipline, it's a priority to keep inventory levels as low as possible while maintaining the capability 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. But management continues to minimize required working capital by holding inventory to a practical minimum. Moving down, equipment and leasehold improvements for the first quarter of 2004 amounted to only $110,000, bringing the total balance, net of accumulated depreciation, to $7.6m. 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 liabilities side, adding the current and long-term debt and lease obligations together, the Company has about $870,000 in total debt. Approximately 80% 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. Thank you for your attention, now I'd like to turn things back over to our CEO, Joe Cross.

Thanks, Jess. Since we are about half way through 2004, I would like to accomplish two general objectives in today's discussion. First, comment on progress during the first half of 2004 and, secondly, discuss Nanophase's general progress and some tactical objectives for the second half of 2004 and going into 2005. Addressing the second quarter and first half of 2004, we believe that Nanophase made solid and definitive progress in its business development initiatives directed towards revenue growth. Our efforts are specifically focused on revenue growth for 2005 and 2006 targeting the twin goals of reaching break-even and thereafter achieving sustainable profitability. In parallel, the Company continues to make substantial progress further developing its platform of nanomaterial technologies, adding to its technology and intellectual property estate, and, we believe, increasing the Company's lead in nanomaterials technologies. Considering intellectual property, which represents significant value for the Company and its stockholders, Nanophase filed two additional provisional patents during the first half of 2004 and had one patent granted. The first provisional patent was discussed in the last conference call. The second provisional patent was recently filed in conjunction with Altana and describes a method to obtain enhanced scratch and abrasion resistance using nanoparticles and coatings. The Company now has 25 US patents and patent applications and 41 foreign patents and patent applications.

Since 2000, Nanophase has grown its US patent portfolio by approximately 150%. As you remember, during the last conference call, we noted that an unidentified Company had requested that the US Patent officer re-examine Nanophase's most recently granted patent. They cover certain aspects of NanoArc synthesis. After the conference call, note that I said after the conference call, Nanophase management was notified that the Patent Officer had agreed to re-examine that. Since that time, Nanophase has filed its comprehensive response to the Patent office. The re-examination process is lengthy and could take around a year to conclude. Until resolution is reached, the patent that was granted remained issued and valid. We remained confident that during the re-examination process, original patent will be largely reaffirmed. We understand that there has been quite a bit of speculation on this matter among some of our investors. However, management believes that the re-examination is not in any respects a credible challenge to legal protection of our NanoArc synthesis technology or the underlying proprietary technology, which is definitely the larger and more significant of the two. We continued to view this re-exam request as an in effective competitive tactic. Management also specks that Nanophase, largely due to its technology prominence in the nanomaterials field, may be subject to this same tactic on issues perhaps in the future. We remain confident the Company's nanomaterial technologies, the patent process utilized by Nanophase and will address any future challenges or re-examination petitions on a confident and aggressive manner to protect the Company's intellectual property state and technology in the nanomaterials field. Lastly, the Company still has pending patent applications both US and foreign. Our patent counsel believes that these may begin issuing during the remainder of 2004 and continue thereafter.

The Company expects to file several additional patent applications during the remainder of 2004 and in the future. Again, management's highly cognizant of the value of intellectual property in the field and believes that Company has taken an aggressive plan to continue increasing this intellectual property and taking appropriate steps to legally safeguard that property. Now, turning to business development and Nanophase's multiple market approach related revenue growth, I would like to focus on progress with our key partners and then overview status in several major market areas. Do you understand that I'm not covering each and every business and technical development initiatives, since they number over a 100. I am only covering certain of the initiatives, provided general overview. Secondly, since this is the business development in new markets and new applications, all this situations are very dynamic and subject to change quickly. Any information I might provide today could change tomorrow and no longer be accurate.

However, the examples cited do indicate the robustness and breadth of Nanophase's current business and market development efforts directed to revenue growth. Our recently announced partnership with ALTANA is off to a quick, aggressive, and promising start. As you may know, ALTANA AG is about a $3.5b company focused on pharmaceuticals and chemicals, primarily coating ingredients where they are an acknowledged global leader. In the coatings field, ALTANA is known as BYK Chemie, so you will hear us refer to ALTANA and BYK Chemie somewhat interchangeably. The coatings industry is a large global industry; for instance, the Chemical Market Reporter recently stated that the US alone accounts for approximately $21.2b in formulated coating systems. Obviously, the global market is significantly larger. ALTANA is a global supplier of coating ingredients and is focused on the higher value added end segment of this market. We believe that our partnership with ALTANA for nanomaterial applications and coatings, sealants, insulations, and nanocomposites will be a key component of the Company's anticipated revenue growth during 2005 and 2006. I do not believe that I can over-emphasize the importance of this partnership to Nanophase's market penetration and revenue growth over the next 24 months.

While I stated during our last conference call that we expected initial market introduction of nanocomposite products during the second half of 2004, ALTANA has already introduced and announced two new products based on Nanophase's nanomaterials, which they have trademarked NanoBYK. BYK Chemie is actively marketing those products globally, primarily concentrating in Europe and in the Far East at the present time. These products have been well received and are already in active end customer testing in a variety of applications. This quick market movement by BYK Chemie demonstrates the value of the ALTANA partnership to Nanophase – global sales and distribution of nanomaterials by acknowledged industry leader. Nanophase has shipped initial orders of nanomaterials to BYK Chemie and expects continuing orders throughout the remainder of 2004. We also expect additional BYK Chemie and ALTANA product introductions and announcements during the remainder of 2004. Relative to the personal care market, which we believe is and will be a major growth market for nanomaterials. Nanophase has significantly enlarged its market penetration efforts along multiple fronts during 2004 that, again, are focused on revenue growth for 2005-2006. First, we have a solid partnership with BASF for sunscreens and certain new personal care product development. The sunscreen market growth continues to be promising: our customer's annual order for 2004 was recently increased by 13%. Simultaneously, the new nanomaterial sunscreen formulation is proceeding well and is on schedule. We have begun manufacturing scale-up and plan to ship initial quantities by the end of the year. Certainly, we expect the new nanomaterial sunscreen formulation to positively impact revenues in 2005. In a separate, but parallel path, the personal care product development continues as planned with our partner expecting market introduction in early 2005.

Secondly, we have entered a joint development agreement, as announced by Huber Engineered Materials, to develop certain personal care products that are outside of our partnership with BASF. Huber is a $1b plus private company and a major supplier to the personal care market. That development has started with the intent of developing one product towards the end of 2004 and another during 2005. Thirdly, we are now in active development with multiple personal care Fortune 100 companies in a variety of product application areas. This is an area that has seen a great deal of effort movement just during 2004 and is promising for potential revenue growth during 2005 and 2006. Moving to the fine polishing market, this by our definitions compose of semiconductors, hard disk drives, fine optics, and photomasks listed in descending market value, with semiconductor polishing making up the bulk of the market size. As a recent Chemical Market Reporter article noted, driven by the healthy semiconductor market and boosted by further miniaturization, strong growth is projected for CMP that is slurry for semiconductors. John Roberts of Buckingham Research notes that CMP is the only penetrated small fraction of market that the technology could ultimately address. He notes that while wafers with 0.25 micron features typically have 10 CMP polishing steps, wafers with 10 micron feature sizes require up to 23 CMP polishing steps. Buckingham expects feature sizes under 0.25 micron to be about 50% of wafer production in 2005. After a severe semiconductor downturn in 2001, the global CMP semiconductor market rebounded to $425m in 2003 and is expected to reach $650m by 2006 and $804m in 2007. Again, this data is from the Chemical Market Reporter.

Our partner in the semiconductor market is Rohm & Haas Electronic Materials, which we were referred as RHEM, formerly Rodel, which currently holds a dominant global market share in semiconductor polishing pads and conditioners and a sizable position in silica slurries. RHEM is making definitive progress penetrating a difficult and increasingly demanding market. RHEM's global efforts remain focused on STI and SON technologies in the US, Europe, and Asia with approximately 19 semiconductor fabs in various levels of testing and trials. RHEM's current product is demonstrating extraordinarily low defectivity, high selectivity, and good planarity relative to competitive products. As feature sizes become smaller and wafers become larger, defects that could have been tolerated in the past are not acceptable today. We continue to be optimistic and positive about RHEM's ability to penetrate this market and become an increasing important revenue source for Nanophase in 2005 and thereafter. This is our last conference call, we have begun initial development of a nanomaterial-based CMP product for the bare copper segment of semiconductors. Again according to the Chemical Market Reporter, copper is projected to be big driver in the CMP market for the foreseeable future. Since this development has some technical challenges, we expect the efforts to continue for at least the remainder of 2004. In hard disk drive substrates composed of glass/ceramic compositions for the next generation, we continue to make definitive progress in co-development of a CMP solution outside of our relationship with Rohm & Haas with a market-leading manufacturer. We believe that we have now successfully passed development testing and the manufacturer is now in the process of defining a POR or process of record for manufacturing usage. Based on the customer's information, we currently expect this application to begin adding potential revenue during 2005.

In fine optics polishing, business and CMP development continues to be positive. A leading manufacturer of polishing equipment for optics is standardizing on the Company's nanomaterial dispersion as the polishing media of choice and is in the process of converting all of their lines of equipment during this summer. Additionally, a manufacturer of high quality lenses has also standardized on a Nanophase nanomaterial dispersion and is now a valued customer. Other fine optics polishing applications continue in development. In summary, we continue to believe that the fine polishing markets, notably semiconductor CMP, potentially represents significant future revenue growth areas for Nanophase for 2005 and thereafter. In other key target markets, business and technical developments continue to make measurable progress. In the catalysts area, Nanophase continues to focus on the catalytic converter segment of the market with a major automotive OEM, which is now in second round testing, and a major catalytic market supplier, which is in co-development with the Company. Assuming that development efforts continue to be successful, we believe that this area represents a significant revenue opportunity for Nanophase over the next 24 to 36 months. Continuing the catalyst discussion, Nanophase is beginning to develop the catalyst market for chemical manufacturing and we'll focus on this segment during the second half of 2004 and 2005.

In an application area that is difficult to categorize, and one, which we are not at liberty to publicly explain, we have made quite significant progress. For the purposes of this discussion, let me refer to it as a personal care textile application series. There have been two product developments. First, we have been pursuing an application that is directed toward a non-woven textile consumer product with antimicrobial properties. This product application has been developed and is now in testing with a leading consumer products company. At this time our co-development partners predict initial production quantities late in the fourth quarter of '04 or early in 2005. The second application is a hypoallergenic application in a woven textile product, based on current customer information, the time-to-market is currently estimated at mid '05.

In another new application area that we're similarly not at liberty to define, Nanophase has made significant progress in the last six months. We believe that this could eventually be a multimillion-dollar annual revenue opportunity for the Company. The customer has informed us that it plans to place its initial order in the near future and, if indeed that happens, we expect revenues to begin during the fourth quarter and be in full production during 2005. This represents a potentially significant revenue opportunity for the Company and, equally as positive, opens further horizontal marketing and sales opportunities in similar applications. Lastly, during the next 30 days to 60 days, Nanophase intends to introduce its NanoExpress concept towards market. Understand that the conundrum we and others in nanotechnology often face is that the value of a nanomaterial in an application is not known until it is tested empirically in an application. A further fact is that nanomaterials produced under laboratory conditions rarely, if ever, have the same properties as those produced in a production environment. It is for this reason that Nanophase develops new nanomaterials in production systems. NanoExpress is a commercial scale Nanoarc synthesis manufacturing system that is specifically designed to be able to make smaller lots economically. At this point of time we are having market, not technical pull for new nanometerials from a variety of markets, and indicate capability the ability to develop new nanometerials at reasonable but not large-scale volumes. NanoExpress is designed to accomplish just that. Strategically, NanoExpress should reduce the time-to-market for new nanomaterials and application testing, which, we believe, should lead to faster revenue growth. Again, we expect to launch NanoExpress within the next 30 days to 60 days. Turning briefly to operations, we continue to pursue our plans in Six Sigma Lean Manufacturing and we believe that the Company is achieving excellent results in this regard.

Nanophase is completing its plans to increase PVS reactor output by 20% to 30% for volume products without capital costs. Ignoring facility cost, the Company is adding PVS capability equivalent to almost $1m of current reactor capacity and output for little to no capital investment. Since we began focused process improvement in late 1999, we have increased PVS reactor output almost 8 times the initial rates. The Company has also completed implementation of the work cell reengineering in Burr Ridge that reduces reactor labor content by about 25%. To put this in perspective, since Nanophase began instituting its state-of-the-art manufacturing practices in 1999, we have now reduced labor content cost per reactor by a cumulative total of over 80%. Nanophase's production quality and customer service continue to be excellent. Year-to-date in 2004, we have had no defective material reported shipped to our customers and we have shipped every order on time. We have also added manufacturing personnel, principally at the Burr Ridge site, to increase the number of production shifts preparing for planned higher production levels during the second half of 2004 and into 2005.

In summary, the Company's drive to grow revenues toward -- first towards break-even and then profitability is proceeding and gathering momentum. Our business and technical development initiatives are robust, cover an increasing breadth of markets and are now active on three continents, and the opportunities have continued to grow during 2005. Management firmly believes that its business and technical development initiatives will advance the Company's revenue growth goals and corresponding financial performance. This concludes our prepared remarks and we are ready for questions at this time.

At this time I would like to remind everyone, in order to ask a question please press the star and 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 the line of Doug Alison with UBS.

Hi Joe.

Hi Doug.

How are you?

Doing fine.

I just listened to the conference call on from Cabot and they were continued to be indicate there is still lot of different -- they mentioned four different manufacturers of slurries for the 90-nanometer in nodes and that had been selected by the five top. Can you tell us if Roman horse is one of those four that has been selected at this point?

A roman horse has slurry products in the marketplace. It is hard just to talk about the node without talking about the technology for the wafer itself. So, you know the people took tender devices into the tungsten market, the STI/SON market and the copper markets. So, what we know without their breakdown it is kind of tough to comment on that frankly. But, roman horse had a meeting with them about two weeks ago. They significantly had grown their slurry business throughout the silica slurries, which primarily in the tungsten ILD market area. To my knowledge, they are one of the leading competitor products in the STI/SON market. They are getting back from their customers that is better we are getting back from them. So, that is kind of what we typed.

Okay. Cabot has also made an investment in a company called Nanoproducts and indicating that they were going to Nanotechnologies through for the slurries I cannot take that as a compliment and endorsement of Nanophase. Do you have any comment on that relationship or Nanoproducts Company is a Private company I don't know if you know them. And are they -- any other slurry manufacturers that are using Nanotechnologies currently if you are aware of?

We understand that silica -- fused silica is the least Nanometer and the least one to match depending on the exact process using the maybe Nanometer in all dimensions. So, fused silica has been around for a long time. That is produced by people like cabot corporation or cabot micro or cabot corp and then deep cabot corp typically is the supplier of particles two cabot micro to the best of our knowledge. I am not surprised that somebody in who especially gave a micro whose entire company is based on slurries would be going in Nano. Taking all the factors that has feature sizes has decreased as wafers grow from 200mm to 300 mm. You know the fact is that future performance has become a very much more stringent. There is also a new series of test out in the wafer role relative to highlighting defects on testing CMP slurries, which is much more stringent to anything that is ever been out there before. So, the quality board for slurries has gone way up. So, I am not surprised that cabot micro decided to invest in the Nanomaterials company. We are familiar with Nanoproducts and that is what I would like to say about Nanoproducts.

They also kind of indicated that -- it sounded like semiconductor industry was kind of dragging here feet on going forward the 90-Nanometer and that their business was picking up at the 130 level and does Nanophase have competitive product at the 130 years that's something we are not interested in going back up or down that ladder.

We have decided not to go backwards. The situation out there that we have based introducing this product into the market with roman horse is that going forward its our impression that semiconductor fabs will not talk to a company unless they have a technology road map beginning nano going five years in the future. We in roman horse have worked very hard to develop a technology road map out five years in the future. And you know relative to the STI/IOS SON slurry we first introduced in the market over a year ago. We are now in the third generation of that.

Okay.

Fine tuning it as we get production information. We've come to learn frankly that while Rohm and Haas has invest $20 or $30m in metrologic equipment, and indeed has it's own way for fab line and spends, I don't know - $3 or $4m a year buying wafers and testing the wafers. That data is wonderful, but production data is even more wonderful because there are so many more data points involved. So, as we warrant, we modified the slurry product to spin and reduce the market. And the recent one is now being used; it's probably about three months old. It's just generating incredible data. So, we decided that we are going attack the STI & SON node, we are going to attack the copper node and we are going to work on our future studies in geometries going from the 0.25 to 0.15 micron, and both. We have a joint technology development roadmap after five years on those products.

Okay. The Huber relationship is there anything more that you can say on that which can us a thumbnail sketch of Huber itself.

Well Huber is -- as I said, I think it about a $1.3b total sales. It is a very large, very well managed, highly respected private company. The materials engineering division sells a lot of products into the personal care market. I really can't say who the customers are without violating confidence, but just think of the big consumer personal care market. Names you know have been, that's probably that. So, it's another entry into different products in our marketplace. We are pretty much excited about it. We've already begun development like, I said, on one product. We've shipped our initial samples, or we are shipping initial samples to Huber on that product this week. We made tremendous progress on the technical side here and we feel like we are going to meet the time line. And we are in the process of defining the second product. Both of these would be new personal care products in the market primarily based on nanotechnology. And on parallel to that with Huber and frankly several others, we've got a very aggressive new material development schedule at Nanophase between now and the end of the year. As I said in my prepared comments, we are getting a lot of market for -- and the reason I think that is important frankly as in the past, we've had technical pull, and technical pull was nice, but it takes forever seems with technical pull. We are getting a lot of market pulls for actual products for nanomaterials. We've got a pretty aggressive schedule between now and the year-end. We are looking at similar materials we are developing, Huber is quite interesting for other products in the personal care market. So, we think it going to be a good relationship with Huber.

Okay. And the Altana $10m investment. Was that earmarked for any specific production line or products?

No, there was an equity investment in the company, and in the equity investment, I gave them exclusively in certain market areas. Primarily the coating ingredient in market place is the big arena, we believe at the current time and classics. That's an area Nanophase has had -- that's a market we've had difficulty penetrating. First of all it is a global market, and it's a tough market to penetrate. And Altana is really acknowledging ingredients provider in that market. They've been in excellent reputation, and they attack the higher value added segments of that market, which is exactly what we would like to be. So, we are pretty excited about the relationship.

Okay. Thank you, Joe.

Thanks.

Again, I would like to remind everyone, in order 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. At this time there are no further questions. Mr. Kowski, you have any closing remarks?

Not particularly. Thank you for attending the conference call. We'll talk to again next quarter.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.