Solesence Inc (SLSN) 2005 Q2 法說會逐字稿

Good afternoon. My name is Rebecca and I will be your conference facilitator. At this time, I would like to welcome everyone to the Nanophase Technology's second quarter conference call.

(OPERATOR INSTRUCTIONS)

The words expect, anticipate, plans, forecasts and other 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 reflect the company's current belief 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, 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 development and 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. At this time I would like to introduce Mr. Joe Cross, President and Chief Executive Officer of Nanophase Technologies. You may begin.

Thank you. Welcome to the Nanophase conference call to discuss the company's record second quarter in first half 2005 revenues. The company had a strong quarter in first half and we are pleased that you are taking the time to be here today. Jess Jankowski, Nanophase's CFO and I, will be hosting this session. To begin the review, Jess will summarize the financial highlights of the quarter and first half. Jess?

Good afternoon. As I review the financial performance of the company for the second quarter and 6-month period, I'll continue to do so at a strategic level, highlighting points of specific interest and significant variances. More details are included in the financials that accompanied that press release earlier this afternoon. All numbers will be approximate terms for ease of discussion.

Total revenues for the second quarter of 2005 are up 543,000 or 35% compared to the second quarter of 2004. Total revenues for the 6-month ended June 30th are up 863,000 or 30% compared to the same period in 2004. For the 6 months of 2005, product revenue was up 50% to $3,526,000, a new Nanophase record. This increase was largely composed of sales of sunscreen materials and growth in sales of personal care materials to BASF, plus the 375,000 in material that was shipped to a new customer in the medical diagnostics market.

This 375,000 sale reflects business that we believe should be annual in nature, but may not repeat next year at the same level. At this point, it's too soon to tell. We also saw Rohm and Haas electronic materials taking product in keeping with their commitment for 2005. More to follow on this in the margin discussion.

For the 6 month periods presented, other revenue was down 309,000. This decrease in other revenue, when compared to the same period of last year, related to the company recognizing the first two quarterly payments of 150,000, or 300,000 in aggregate, in technology development funding from Rohm and Haas in 2004. This funding was part of the $600,000 commitment to support Nanophase's efforts in jointly developing slurry products for current and future semi-conductor technologies during 2004.

Rohm and Haas's commitment to Nanophase for 2005 will ultimately be greater and be in the form of product sales. As discussed previously, we began shipping to this product commitment in Q2 of this year.

We've generated a positive gross margin of 659,000 for the 2005 6-month period. About 490,000 of this was margin purely on product sales. We view this as a validation of our business plan and our financial modeling. As we continue to discuss, our margins have been impeded by not having enough revenues to absorb the manufacturer's overhead that's required to work with the customers we have and the new ones we expect to have.

The additional product revenue this quarter showed that, as volume grows and manufacturing overhead is absorbed, our solid variable margins have an appreciable impact on gross margins.

The medical diagnostic material I discussed earlier helped to give Nanophase an excellent product mix for this period. Had that material been our lowest margin volume material instead, we still would have had around $400,000 in gross margin and product sales. This continued validation of our business model is an important financial turning point.

As the Rohm and Haas and Altana volumes begin to grow this year and next, our typical margins will continue to grow. The variable margins on the materials we sell to BSF, which are still the lion's share of our sales, are typically lower than those we expect from our other customers in different applications. We're on the path to profitability.

Moving down to P&L, R&D expenses were relatively flat period to period. In SG&A which was up 8% over the 6-month period, we saw increases in auditing and flex 404 related expenses and compensation, offset by reductions in legal fees, business insurance costs and other items.

In total, the company lost $0.14 per share for the first 6 months of 2005 versus $0.17 per share for the same period last year. Note that depreciation and amortization amounted to about $0.04 per share or 640,000 of the company's loss for the first half of 2005.

Moving to the balance sheet. Nanophase ended the second quarter with $8.9 million in cash and investments compared to about 11.6 million at the end of 2004. Looking at cash burn, we used 2.4 million for operations and about 280,000 for capital improvements in Q1 and Q2 of 2005.

Note that accounts receivable were 679,000 higher than at year-end. This created a working capital drain due to timing more than anything else and should swing back favorably as the year progresses. 40% of the June 30th trade accounts receivable was paid before the second week in July.

The company also reduced debt by $238,000 in the first half. Management expect the note to BSF, currently at $343,000, to be paid off no later than mid- 2006.

In terms of gauging future cash burn, last year Nanophase used an average of $1.2 million per quarter in operations and about $175,000 per quarter for capital improvements and capitalized patents. Management expects 2005 operational cash burn to be lower than 2004, heading toward a planned positive operating cash flow run rate by the end of 2006, assuming revenue growth continues as currently forecasted.

Capitalized expenditure should be a little higher this year, with patent costs and the components its more difficult to predict. As an administrative matter, I'd like to discuss our new conference call timing. In order to accommodate those of you who have difficulty focusing on earnings calls during market hours, we've decided to try afternoon press releases followed quickly by our earnings call. We hope that this will work better for all of you and help to stimulate further interest in Nanophase. Thank you for your attention. I would like to turn things back over to Joe Cross, our CEO.

Thank you, Jess. Let me emphasize a couple of critical financial points Jess covered and ensure that the connection between Nanophase's operational strategies and its result in financial performance are clearly communicated. Again, all numbers will be approximated for ease of discussion.

As I stated in the opening conference call of 2005, management's first priority is to grow revenue. Relative to sequential revenue growth, revenue increased 62% from the 4th quarter of 2004 to the first quarter of 2005. And then increased 29% from the first to the second quarter of 2005. We've reached record company revenue in each of the first and second quarter of 2005. While we do not expect such dramatic material increases every quarter, it appears that we have reached new revenue operating level and we remain positive about overall revenue growth during 2005 and in the future. For several quarters, we made a couple of critical points about the company's financial performance that need to be understood.

First, our business model and corresponding financial models predict that gross margins grow quickly with increasing volume and continued company efforts to reduce variable manufacturing costs. Nanophase has the ability to increase output volumes without significantly increasing manufacturing overhead cost and has a consistent track record of reducing variable manufacturing cost. We have actually made significant progress on this during the first half of 2005, as I will discuss later.

The net effect of reducing variable manufacturing for us and increased volume is gross margin growth. As we noted in the earnings release, gross margin in the second quarter of 2005 equated to 24% of total revenues versus 7% in the same period last year. For the first half of 2005, gross margin averaged 18% of revenues versus 7% in the same period of 2004. Stated differently, gross margin dollars were about 3.4 times greater in the first half of 2005. This is the result, both increased volume and continuing decrease of variable manufacturing costs, which we believe affirms our business and financial models.

Moving from financials to an overview of the company's performance in the first half of 2005, let me begin by reviewing operations in engineering. Building on our momentum in continuous improvement variable manufacture and cost reduction and gross margin growth, we again made excellent progress during the second quarter and first half.

Viewing improvements over the half, we continue to increase PBS reactor rates, which equate directly to output per hour and have achieved an increase of about 35% during the first half of 2005, compared to the average rates throughout 2004. This results in a 2-fold financial improvement. First, it reduces capital required for investment in new reactors as volume grows and slower operative production capability is increased by a similar number. And secondly, increased output rates reduced variable costs per unit. With all improvements to date during 2005, the company has increased total capacity on existing equipment by about 40%. As a side note, Nanophase has now increased reactor output rates by an aggregate greater than 700% over the past 5 years.

Conjunction with rate increases. When able to increase PBS reactor yields by 3% and improve equipment up time or reduce the downtime required for maintenance which again reduces reable manufacturing costs and increases total capacity.

During the last quarter Nanophase's facilities were recertified to ISO 9001 and certified to ISO 1401, international environmental management standard. While these certifications clearly reflect the company's world class operations, they are also vital to our revenue growth plans since the designations are required to attract and retain potential large customers.

New Nanomaterial development based on market pull continues in several areas. While we are unable to discuss specifics, the company has a rather robust new nanomaterial development schedule that already stretches into 2006. To expedite new nanomaterial development based on market pull, we have and are taking two definitive actions.

First, we have designed fabricated and will be installing a second generation nanowork synthesis reactor that will be dedicated to alter transparent nanomaterials for UV attenuation and version of scratch resistant coatings primarily for our relationship with BOA taped ME(ph), which has several new products envisioned for these nanomaterials based on market needs from his customers. The second-generation reactor has been designed to produce approximately 20 nanometer nanoparticles at high production rates.

Secondly, we have decided to build and install additional nanoarc reactor based on product and product development demand. We currently expect this reactor to be funded by a loan from one of our market partners. Once all the details are finalized we plan to make the appropriate announcement.

Relative to revenue growth in 2005 and forward, we remain positive. We are encouraged for the 50% increase to first half 2005 product revenues year-over-year and the progress of our market partners. We continue to believe that expected revenue growth will be driven by our market partners and Nanophase's internal business development initiatives.

Beginning the revenue growth discussion with our market partners. BSF sun chair and personal chair product demand continues to grow, are gaining growth in the original product lines, which are now trademarked as Z-coat, that we're expecting to increase around 25% during 2005, now appear to be in excess of 30% for 2005. Based on recent discussions with BSF, we have been lead to expect continuing organic market growth through out 2005 and into 2006.

As you may recall BSF loaned Nanophase 1.3 million to first install nanoparticle coating in package and equipment to support the initial sun care and personal care business. Since Nanophase has been designated a strategic partner, BSF has agreed to extend the original loan for equipment until June 2007, or an additional 2 years. However, based on expected volume, we believe that the loan should be repaid by our normal discount on product pricing during early 2006. Once repaid, Nanophase expects to see about 0.5 million improvement to the company's annual cash flows.

In the new product area, the second-generation sunscreen, trademarked Z-coat max, which was developed using Nanophase's patented Nanoparticle coating technology, is now well into initial market introduction phase and appears to be gaining solid acceptance based on our feedback from BSF. You can access information on this product at www.zcoatmax.com. While BSF believes there is a solid market interest and demand for the new product it is too early to predict volumes in a revenue ramp for Nanophase. However, we believe that the production ramp should begin in early 2006 and positively impact revenues in 2006.

Continue with new products. During the last quarter we signed specific developments agreements with BSF for 2 new personal care products. Product development testing and market evaluation is underway. Additionally, there are 3 additional new products under consideration and in various stages of development. In summary, revenue growth to our partnership with BSF is expected to be driven by organic market growth in current products, new revenue from the second generation sunscreen and new product development and market introduction.

Turning to semiconductor CMP, Rohm and Haas electronic material CMP technologies appears to be building momentum in the marketplace and remains upbeat for 2005 and 2006. We expect - we continue to expect the revenue growth of about 25% in 2005 versus 2004. Development also continues for nursilary(ph) products in the copper and tungsten technology nodes. BYK-Chemie and Nanophase continue development in several product areas. Development efforts range from new product market introduction, product development, which has several levels, to new nanomaterial development.

We continue to believe that our market relationship with Altana will be material revenue growth area for the company over the next three years and the foreseeable future.

Moving to business development. We added new customers during the first half of 2005. First, we are pleased to have received the first production order for a medical diagnostic application from a multi-national company, which we are not at liberty to identify. Based on forecast from this customer, we expect this to be continual annual business. As we stated previously, we continue to grow our glass polishing business, which is a rather pragmatic market, primarily for high-end applications. We had two new customers and continue to expect to grow revenues from these applications over time.

Lastly, I previously discussed the potential of securing a major new customer in a company revenue stream. That situation continues to mature. There are two products involved that will be distributed to a big box retailer. According to our customer, the first product has been approved by the big box. It is now expected to stock onto retail shelves in August and be in full retail distribution by Labor Day. Nanophase is already delivered nanomaterials for this product. The second product, which is the large vim and potential revenue stream in Nanophase, is still in a cycle between our customer and the big box. Our plans have changed several times and may again in the future.

Our latest and current information is that our customer expects it should move into retail production at the big box during the third quarter of 2005. Once this occurs, we will of course make the appropriate announcement. Once ramped into full production vim (ph), we anticipate, based on our customer information, that this should be an annual revenue stream between $1 and $2 million. Our other business development initiatives continue to progress, the business of development pipeline remains robust and growing, and is more active than any time in our history. We believe that our current growth with our market partners and new customer additions from biggest business development should support our progressive revenue growth plans for 2005 and 2006. This concludes our prepared remarks. We are now open for questions.

(OPERATOR INSTRUCTIONS)

Your first question comes from John Roy with WR Hambrecht.

Hey guys. Hey Joe, in terms of the capacity that you already have available or easily brought online without necessarily spending a whole lot more. Can you give us some idea either units or percentage or dollars of revenue you might be looking at?

Yes, we have increased capacity, about 40% of our average capacity in 2004 with minimal capital investment.

Right. Then how much free capacity do you think you have now?

I'm sorry, say that again, John.

How much free capacity do you think you have now? What utilization are you running at would be another way to put it.

I don't have a ready answer for that. And I would rather not make up a number. But I will tell you what I will get you that number and get back with you.

I appreciate it. Thanks.

Your next question comes from Nik Tishchenko with Global Crown Capital.

Thank you very much. Joe, most of my questions were answered on the one you promised to get back to the previous person. But, there are many questions following. You have paid taxes before. It is not the case for the first two quarters. Are you going to pay taxes in the rest of the year?

Hi, Nik. This is Jess Jankowski. Those taxes were based on payments required on the foreign license we get from CIK. So we were paying $30,000 a year in foreign taxes. The tax treaty changed as of the second quarter. So, there is another item that is a reversal of that previous tax accrual. We no longer will be paying those foreign taxes based on the U.S./Japan tax treaty. So we should not see that going forward until we start working off our NOL (ph).

Oh, I see. The second question is I know that you don't like to talk about this but, nevertheless, I will try. What kind of gross margins you could expect for instance, for a $4 million run rate in the quarter?

We haven't modeled that exact scenario. But, our variable gross margins are typically well over 50%. So that is another way of answering the same question.

Thank you very much. Thank you.

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Your next question comes from Jim Lieberman (ph) with Advest.

Greetings. I can see the continued improvement and it is looking very exciting down the road. Are you able to discuss any further the mention of the Rohm and Hass CMP technology and how that is proceeding? Or is it still very much undercover?

I can't go into a great deal of it. They are still about 20 engagements going, Jim. They have shared with me their customer expectations which are very solid and very promising. But, we are under a confidentiality agreement and because of their market competition they have asked that we not discuss it, so I will honor that request.

Thank you very much.

At this time we have no further questions. Do you have another question, sir, if you would like to take it?

Sure.

Your next question is from Doug Allyson (ph) with UBS.

Hi, Joe. Real exciting quarter, nice revenue growth again. You didn't mention much about the Altana previous quarterly reviews, we heard that there were dozens of different proposals out with the Altana committee. Can you bring us up to date with any of those proposals?

There is a lot of activity in Europe and Asia and in the U.S. at the current point in time. The areas we are concentrating in would be general industrial coatings; automotive coatings are our two biggest areas. There are a lot of customers in pilot and prototype testing at this very moment. I don't have the exact number because it changes frequently. But there is a lot of activity on three continents. So, we are very comfortable, frankly with that relationship and we have defined a very solid in our mind new product development plan for several new products based on market testing and market pull. Which is exactly the reason we wanted to have a partner like BYK Chemie and Altana. It is because they really help us focus product development and understanding the market demands since they are a leader in that market. So that is really all about it I can say about that right now, Jim -- I mean Doug.

Okay and you had about $2 million in product revenue. Could you break that down between BASF, Rohm and Hass, Altana, and the medical diagnostic, and glass polishing? Is that something you want to do?

Well, when our queue comes out about 77% of that for the six months was BASF. About 10% was the medical diagnostic customer. Four percent of that was the CIK license and the rest of that we are not going to break out.

Okay. Well, very good that sounds again encouraging. We are all hoping things continue along these lines.

Thank you, Doug.

Your next question comes from Chris Gardner with Nichol (ph) Capital.

Yeah, hi. I was just wondering if on the medical customer, maybe I'm not clear on the number you put on that. But can you give us an idea of the gross margins on that. I think you just said it was higher than your regular gross margin. And then, is that sort of one off for this year and should return next year, or should we see something sequentially in the course to come. Thanks.

Let me answer it this way. We don't like talking about gross margins. And we prefer not to. This is not a one off this was a significant piece of business that we cultivated. The customer has given us a five share forecast. We expect it to reoccur every year. We are also working with that customer to enlarge our relationship and into other diagnostic applications. So, we see this as a viable long-term growing area for us.

Okay, thanks.

At this time we have no further - -.

Hello. I think we just lost them.

One moment.

If there are no further questions, we'll end the conference call. Thank you for attending and we'll talk you again next quarter. Thank you.

This concludes today's Nanaphase Conference Call. You may now disconnect.