Solesence Inc (SLSN) 2005 Q3 法說會逐字稿

Good afternoon. My name is Wes and I will be your conference facilitator. At this time I would like to welcome everyone to the Nanophase Technology's third quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After these speakers' remarks, there will be a question and answer session. [Operator instructions]

The words expect, anticipate, plans, forecasts, 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 reflect the company's current beliefs and a number of important factors that could cause actual results from 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. Thank you. I would now like to turn the conference over to Mr. Joe Cross, President and CEO. You may begin your conference.

Thank you. Welcome to Nanophase's conference call from sweet home Chicago, the home of the world champion Chicago White Sox.

Nanophase reported the highest third quarter revenues in the company's history and record first nine months revenues. The company had a strong quarter and first nine months and we're pleased that you're taking time to be here today. Jess Jankowski, CFO, and I will be hosting this session. As we normally do to begin our conversation, Jess will summarize the financial highlights of the quarter and first nine months.

Jess?

Good afternoon.

To review the financial performance of the company for the third quarter and nine month period, I will continue to do so at a strategic level. More details are included with the financials that accompanied our press release earlier this afternoon. All numbers will be in approximate terms for ease of discussion.

Total revenues for the third quarter of '05 were up to 297,000 or 22% compared to the third quarter of '04. For the nine months of 2005, total revenues were up 1.2 million, or 28% compared to the same period 2004.

For the nine months of 2005, product revenue was up 36% to 5.1 million, another new Nanophase record. This increase is largely composed of sales of sunscreen materials and growth in sales of personal care materials to BASF and also $375,000 in material that was shipped to a new customer in the medical diagnostics market.

We also saw Rohm & Haas Electronics Materials taking product and keeping with their commitment for 2005. For the nine months period presented our revenue was -- our other revenue was down for under 447,000. This decrease in other revenue when compared to the same period of last year related to the company recognizing the first three quarterly payments of 150,000 or 450,000 in aggregate in technology development funding from Rohm & Haas during 2004.

This funding was part of a $600,000 commitment to support Nanophase's efforts in jointly developing slurry products for current and future semiconductor technologies during 2004. Rohm & Haas' commitment to Nanophase for 2005 will ultimately be greater and will be in the form of product sales. As discussed previously, we began shipping to this product commitment in Q2 of this year.

We generated a positive gross margin of 867,000 for the 2005 nine month period. About 640,000 of this was margin purely related to product sales. We view this as an ongoing validation of our business plan and our financial model.

As we continue to discuss, 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. 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.

Moving down to P&L, the nine month period R&D expenses were up 67,000. This is largely due to increase in compensation expense and SG&A which was up six percent over the same period, we saw increases in auditing and SOX 404 related expenses and compensation, offset by reductions in legal fees, business insurance costs, and other items.

Now I would like to take a moment to explain a non-cash charge we took in Q3 related to recognition of straight line rent expense referred to as a lease accounting adjustment in the amount 280,000 as a separate line item in the operating expense section of our P&L.

In 2005, the SEC published guidance regarding the observance of the convention of amortized rent expense of the same term as any underlying lease hold improvements.

Beginning in the year 2000, we amortized rent expense only over the first six year term of our lease, while opting to amortize lease hold improvements over 16 years, a term that includes the two available five year option periods in that same lease.

This $280,000 item represents the portion of 2006 through 2016 escalated rent that we would have recognized in the last five years and about $13,000 per quarter that we calculated a straight line rent expense over the long term initially. We recognize this expense prospectively in Q3 in light of the fact that the SEC has said in its recent guidance that this was the appropriate treatment. They maintain that this interpretation was not new. I am sure that prior to this 2005 letter, many companies large and small did not observe this convention in the way that the SEC has now dictated was appropriate.

As a matter of fact, McDonalds Corporation has recognized the exact same issue in its most recent 10-K.

Post Sarbanes Oxley, many long standard practices are being examined in a new light and this just happens to be one of them.

In a related issue, the lease amendment that we renegotiated and announced effective October 1st will result in a savings of almost $600,000 over the life of the original lease. This savings as well as the $280,000 accrued liability we created to take the non-case charge this quarter, will be recognized quarterly in rent expense reduction over the next 20 years.

Needless to say, practically and GAAP accounting are not always congruent .

In total, the company lost $0.23 per share for the first nine months versus $0.27 per share for the same period last year. Note that depreciation and amortization amounted to about $0.5.5 per share or 980,000 of the company's loss in the first nine months of '05 and the non-cash rent expense charge accounted for about 1.6 cents per share of this loss, also.

Moving to the balance sheet, Nanophase ended the third quarter with $8.5 million in cash and investments compared to about 11.6 million at the end of '04. Looking at cash burn, we used to $2.8 million for operations and about $405,000 for capital improvements thus far in 2005.

The company also reduced debt by 355,000 in the nine month period.

Management expects the note to BASF, currently at 236,000 to be paid off in mid to late 2006. Thank you for your attention and I would like to turn things back over to Joe Cross, our CEO.

Thank you, Jess.

Today I intend to focus my comments solely on revenue growth since it is our highest priority at Nanophase and I'm sure at least one of your top concerns as investors and shareholders.

Before entering specifics, I would like to discuss the critical factors that we believe directly have and continue to influence the company's ability to grow revenue and the rate of growth. Based on several recent conferences and sessions, it seems to us that many in the investment community have an uncertain appreciation of the market situation. From an understanding perspective, we think it is worthwhile to communicate our views on revenue growth and the revenue growth rate.

Starting with 10,000 ft view, consider this -- nanotechnology is and remains a new science and emerging technology. Despite the promise of nanotechnology and all the hype, it is still an emerging science and technology that should continue to grow at least over the next two decades and likely longer.

We firmly believe the adoption rate is increasing and the rate of revenue growth will increase accordingly. For discussion simplicity, I am separating the critical factors to revenue growth into roughly three piles. Those where we have major or direct control, those where we have some control, and those where we have limited or indirect control.

Let me speak to each of those and try to provide a qualitative assessment on how they affect Nanophase and how we are managing these factors. Under the major control pile, at one time in our history, revenue growth for Nanophase was hindered due to our limited ability to advance the nanomaterials to a readily usable format for the market or customer.

We have, rather uniquely in a global industry, I believe, eradicated that hindrance with our technology advances that have resulted in our current and growing platform of integrated nanomaterial technologies where we provide nanoparticles - surface treated nanoparticles using a variety of patented and proprietary materials and nanoparticle or surface treated nanoparticle dispersions on a wide variety of media featuring high stability and non-agglomeration of nanoparticles.

While this platform of technologies may not be well understood or appreciated, we firmly believe that building a large sustainable nanomaterials business requires a combination of these technologies to address market applications and be successful. We have taken a new science, created underrated (ph) technologies, commercialized these technologies and continue to advance our expertise in these vital areas over the past two years or so.

Again, we believe Nanophase is uniquely positioned. In our assessment, most of our potential global competitors still have much of this basic hindrance.

Under the some control pile there is application development. This is the, and I'm using capital letters, current focus area for Nanophase because it is largely research in many targeted application areas such as coatings where the market payoff is potentially significant. The difficulties involved in application development and testing, a nontrivial task in and of itself, product development, market introduction and subsequent growth is a major reason that Nanophase has chosen to align ourselves with premier market partners, BASF, Rohm & Haas, and Altana Chemie, as well as other customer partners that we may not discuss, where valuable development under way and our partner brings vital application expertise coupled with detailed market knowledge.

Appreciated or not, this is a major it vantage for Nanophase and the reason that in many corners we continue to be told that we're doing it right. However, understand that this is a critical researching and time consuming area with both a timeframe and success level that is difficult if not impossible to predict.

Application development or an optimal nano (inaudible) solution remains a critical factor to revenue growth rate. It is one where we have been fortunate to secure solid partners, increase the company's knowledge base - and let me emphasize how critical that is in an emerging technology company and gather momentum over the past few years.

Lastly, let's consider the pile where we have limited or indirect control which leads to the revenue growth. While much is written about nanotechnology, especially related universities and national labs that have received huge funding and are writing exciting, almost fictional articles about future advances, the real measure of success for nanotechnologies is industrial adoption and the rate thereof.

Make no mistake about that, we influence the adoption rate through conferences, company capability presentations, articles and similar measures but the cycle for industrial acceptance and adoption is real for nanotechnology as it is and has been for r all new technologies.

Again, our market partners are an asset in this area since they push down material adoption it in a wide variety of markets and create new nanomaterial based products.

The positive news is that we're seeing global acceleration and industrial interest across a broad variety of markets based on development of new or improved products. Not a centralized R&D effort, which we have painfully learned is a valley of lingering debt for new technologies.

From the amount of increasing effort, we perceive a growing industrial mass heading towards adoption of nanomaterials as part of their product new tool box and fully expect this trend to gain momentum. We are discussing this topic because we realize waiting is difficult and a plethora of publicity is confusing and tends to cause expectations.

The fants (ph) Jess outlined are real. For Nanophase and everybody else in nanotechnology. But as industrial interest and adoption gains momentum, and it clearly is, Nanophase is uniquely positioned to exploit opportunities. Our assessment leads us to believe the rate of growth should continue for nanomaterials at least over the next five years.

This assessment is buttressed by a recent study by the Predonia (ph) Group, which forecasts nanomaterials to be about a $90 billion world market by 2020. Moving closer, Predonia forecast metal oxides will comprise about 58% of the total market in the 2008 with a reported value over $2 billion, going to about $6.5 billion in 2013.

In summary, the factors that we believe influence revenue growth and the rate thereof are positively improving. It is this assessment that leads management to be quite positive about the two to five year horizon.

Delving down into greater specificity, let me provide a summary update on our primary market partners. Dealing with BASF, we continue to make progress building and expanding the base business with our initial product, Z-Cote in both personal and sun care applications. Based on current forecasts, we now believe this business will have increased approximately 20% in 2005 versus 2004.

According to BASF they are still adding customers for this product, most recently in Asia and Canada and we expect moderate growth in this line during 2006. The new formulation for sun and personal care products, Z-Cote Max, which is based on our patented and patent pending coating technology is now in a market introduction face and according to BASF is receiving positive response.

We expect this line to begin ramping in 2006 and will continue to build in 2007 and 2008. BASF has stated that they envision growth in this product to eventually equate to a level comparable to that of the current product.

As announced, we developed a robust process for manufacture of 35 nm zinc oxide particle at the request of BASF, as well as BYK Chemie, which is now in the application development side.

Again, to reemphasize a point we made on previous conference calls, this is one of the values of having market partners, focused new product development and market introduction.

BASF intends to introduce this product for high end sun care and personal care applications during 2006. In parallel, BASF and Nanophase are collaborating on a second new- product for introduction in 2006 that I am unable to discuss.

Additionally, in another new product area, we're having success in our healthcare application development. Through BASF, our nanomaterials are currently being used in healthcare products but we'd like to increase and broaden the usage. BASF is working very closely with a major consumer products company in a joint development to incorporate nanomaterials in their healthcare products.

In parallel, Nanophase's is in co-development with another major consumer products company for similar products.

While it is impossible to forecast revenues at this time, we have been told by both companies that they expect new consumer product introductions to begin in 2006.

Finally, we have new product development with BASF outside of personal care for thermoplastics and films. This initial effort has been underway for about three months and has demonstrated great positive results related to market needs.

Going forward, we will be partnering with BYK Chemie, which already has a close relationship with BASF to guide the product development into the market and revenues. Based on information from BASF, we believe this is a significant opportunity with a relatively short time to market and anticipate initial market introduction as early as 2006.

Moving to Rohm & Haas Electronics CMP Technologies, which I refer to as RHEM, considerable progress has been made in market penetration. RHEM is beginning to see the market synergies from their dominance in the pad and pad conditioner market extend to the slurry market. Rohm & Haas stated that they made a corporate, strategic, long-term commitment and intend to be a major player over time. RHEM' current view is that they should have between four and six separate semiconductor fabs in various stages of ramping up actual production during the fourth quarter of '05 and first quarter of '06.

RHEM believes that they are building market momentum that should lead to several customer wins over the next few years.

We continue to believe that fine polishing applications, including semiconductors represent a considerable revenue growth opportunity for Nanophase over the next two to three years. BYK Chemie continues to make progress in our nanobook product line. We have made excellent progress in improving scratch resistance for UV curable coatings where we have approved abrasion resistance of the neat film by 10 times with the addition of nanoparticles. We're currently working with solvent based and acreage (ph) based systems and anticipate similar success over the next three to six months.

Again, the primary market application focus at this time is scratch resistance and UV protection for industrial coatings and films. BYK Chemie is currently working on approximately 20 direct application opportunities with their customers in the U.S., Asia and Europe and continues to grow that effort on a weekly basis.

We believe that penetration of this is estimated $60 billion global market is a critical effort for Nanophase relative to revenue growth over the next five years. This market commitment and confidence in Nanophase's ability is shared by Altana Chemie and BYK Chemie, as evidenced by the $1.6 million loan Nanophase announced earlier today to enhance Nanophase's development and manufacturing capability.

This is in addition to the $10 million equity funding from Altana Chemie in March 2004. This new funding will be used to purchase and install the new dedicated nano arc (ph) reactor to develop specific new nanomaterials for targeted markets and installation of a commercial dispersion line to manufacture high volume nanoparticle dispersions.

We anticipate the equipment should be on-line and available around mid-2006. Note that this loan is interest free to Nanophase until approximated December 2006. In addition to our market partners, we continue to experience robust business development opportunities. We enlarged our business development efforts to include both technical market attacks and specific customer application opportunities.

From a technical market penetration basis, we have plans in place for two new markets where we believe nanoparticles and nanomaterials solutions bring application value and process product improvement. We have developed highly targeted plans to develop and introduce products directly and with our market partners and to a new catalyst market an anti microbial market, which includes both industrial and personal care. We believe these are significant market opportunities as was also noted in the Fredonia Industry World Study on nanomaterials, where integrated technologies bring a distinct competitive edge in value.

We're in the process of implementing our plans and initial results definitely show impressive performance improvements on application testing. We plan to begin market penetration leading to initial revenues during 2006 and believe that both areas could be major contributors to revenue growth over the next five years.

Another application area that has received considerable interest in recent months is fuel-borne catalysts and heavy fuel applications, diesel applications and in fuel applications. We introduced and announced a new nanomaterial directed for specific applications in this area during the last quarter and will continue our application of them for at least the next six to nine months with three or four different companies.

Relative to company and application specific product development, we are currently engaged with over 100 different opportunities in a variety of markets. While this may seem like a large number, there are application synergies that allow us to progress with our current resources. Application of this is progressing and we're optimistic for revenue growth.

One such application that we have discussed before has moved during the last quarter. As you know, we carl (ph) in involved in the potential securing of a major new customer with treatestin (ph) products in the consumer and do-it-yourself market that is sold through a big box retailer. The initial product is now on the shelves, noted as nanoproduct and was recently featured in advertising, at least in Chicago.

The second product release in the big box which has a large volume and revenue potential to Nanophase appears to be early 2006. Again, relative to the time to the big box we have no control, but are positive it will happen some time around this timeframe.

Our direct customers have already scaled production in three different manufacturing facilities and is awaiting for word from the box. Based on customer information, we anticipate this should result in a new annual revenue stream of approximately $1 million to $2 million annually.

Lastly, Nanophase is deciding to broaden its focused role (ph) in multifaceted nanomaterial technology that is synergistic with our business model, current technologies and market partners. Our recent announcement regarding our exclusive arrangement with Competitive Technologies is part of this strategy.

CTT has relationships with over 200 universities and national labs and will actively seek new nanomaterial related technologies that may be of interest to Nanophase. CTT provides a direct window on to the research that is occurring throughout the U.S. and some areas of Europe which is a capability that Nanophase needs. We expect to continue pursuing strategic initiatives to maximize the company's value to its shareholders and build a substantial, sustainable business.

This concludes our prepared remarks. We're open for questions.

[Operator instructions]

Your first question comes from John Roy of WR Hambrecht.

Hey guys. Kind of a dull question, but on the lease accounting adjustment, that is not going to continue obviously. It is going to go to zero or very, very small from now on?

John, what that is ...

That is just backlog, right?

You take 16 years' worth of lease payments that's schedule, divide it by 64 quarters and recognize it evenly over that, we elected initially a six year term. According to what they're recently saying, we should have done it over the 16 year term. So that is a catch up of 13,000 quarter for the last 20 quarters that basically it's expense that does not exist anymore. We've got the October 1st lease which is less than that so it was basically the accrual of future lease payments that no longer exist. And I will see that feeding back over the next 20 years.

Realistically it is just a GAAP thing and we should take it out, probably.

It is a GAAP thing. It is a one time non-cash charge and will not be repeated.

Right. Thank you.

Sure.

Your next question comes Nicholas Pei (ph), a private investor.

Good afternoon, Joe.

Hey, Nicholas.

Nice progress. It would appear that the forecast you made in previous quarters of organic growth of 25% from Rohm & Haas and roughly 20% from BASF is about what is happening here. Revenues for the third quarter were up 22%. So it would appear to be an increase from these two basic customers

But my question is our gross profit margins in the fourth quarter 12%? Whereas at the end of the second quarter it was 24%, twice as much. And yet, these, as I say, seem to be just more of the same products from the same two customers. Why such a difference?

The product mix in the first and second quarter was different than in the third quarter. Our margins are directly related to product mix, and we anticipate that they will be lumpy. If we look forward to the next quarter, we would expect to see gross margin growth just because of the product mix that is on the books at the current time.

Are to we essentially selling the same product to Rohm & Haas and BASF as we did in the second quarter?

If you recall, in the second quarter we had a $375,000 sale for the diagnostic medical company which had a higher margin, typically than we normally had. We also have a larger volume help to absorb overhead, as well, so there was kind of an anomalous quarter from that perspective.

OK. Thank you.

[Operator instructions] Your next question comes from Doug Allyson (ph) of UBS.

Looks like a pretty good progress again this quarter. Could you review the revenue agreement with Rohm & Haas and where we are in that, the length of that agreement right now?

The length of that agreement. The revenue agreement that we currently have with Rohm & Haas goes for another two years as I recall off the top of my head. I stand to be corrected but I think that's right. I was just at Rohm & Haas with the CEO. They're going to make their commitment this year and they're going to make their commitment the next year.

Are they expanding it in any way?

They are going from one customer to somewhere between four and six customers. And the reason I am giving a range is it is hard to predict the ramp up in production. They have six customers committed to ramp up in actual production between now and either the end of 2005, which, understand, is not that far away, or by the end of 2006 -- I am sorry, the end of the first quarter of 2006.

So I think that is significant progress. And they have another four or five customers starting down the same path. The fact of the matter is that Rohm & Haas is getting wins in the marketplace especially in this area.

Are combined product, Nanophase and Rohm & Haas is outperforming the leading competitor in the marketplace over the last several months, which happens to be Hitachi. Hitachi's pot life (ph) in semiconductor manufacturing is told to me to be 90 minutes, ours is two years. That is a major advantage in that particular market.

Our performance is equal to or superior than the leading competitor, which is Hitachi. The other major player in that market, Cabin Micro (ph) is not winning business according to everything we're hearing. Especially in the new technology nodes. We think Rohm & Haas is a pretty strong horse to ride. The CEO of the company, Raj Gupta, who runs the entire $6 billion company, has made a statement to me that this is a strategic long-term initiative for Rohm & Haas. And they intend to be the major market player at the end of the day.

So that's coming from the $6 billion company. I think that is a fairly strong commitment.

Sounds like they should be able to exceed their revenue commitments. Is that something we should look forward to?

I think there is a possibility next year that would happen. We would not forecast that or provide guidance to that effect, but there is a possibility.

And the fuel catalyst -- can you expand on that? At what point in achieving some revenues from something like that -- is there a timeline on that?

Like I said in my comments, I think it is very difficult in application development, especially in this type of application development. Put a timeline on it. Like I said, we're involved with three distinct applications. Heavy fuel applications which are used for power generation, diesel fuel and regular fuel.

In both the direct market and the additive market. Initial results have been interesting. I think this is not an unappreciable application development cycle. There are a lot of EPA regulations and a lot of testing required in this particular marketplace, which is the reason we have not put a lot of effort into it until recently.

But it is an interesting application. And we think of nanomaterials and how small they are going through the various mechanical parts of engines. It is an interesting proposition. And we have three to four very well-connected companies in that marketplace that are working with us. And that is a good thing.

OK. Thanks a lot, Joe. Sounds good.

Your next question comes from Ted Sullivan (ph) of Lux Research.

Thank you very much. I just had a quick question. We were recently in China checking out similar nanoparticle producers. And I was curious how you were going to handle the threat of similar low-cost producers from China looking to do very similar things with nanoparticles, dispersing them in slurries and whatnot.

I would not want to minimize the threat from China. I strongly suggest -- and I think many in the investment community miss this -- making a nanoparticle is a small part of the equation to success. Getting the nanoparticle in an application is a large part of success.

I think that - and I firmly believe that without the combination of the integrated technologies to take the nanoparticle or the nanomaterial to more of a solution aspect in application development in a format that is readily usable is a severe hindrance.

And I do not have detailed market knowledge of China. I have more knowledge of Japan. But I have not seen that capability yet. Does not mean that it will not come. But I haven't seen it yet.

OK. Thank you.

Your next question comes from Nicholas Pei, private investor.

Joe, just a follow-on question. I do not recall that I heard you say mention Altana by name-- some of the things you mentioned may have come up out of their efforts. I know there has been a lot of activity but is there any business, anything happening there?

Altana Chemie is the parent company of BYK Chemie.

Oh, I see. OK.

So my relationship is with this CEO of Altana Chemie as well BYK Chemie. BYK Chemie is the leading ingredient supplier for coatings in the world. And typically there market is high niche applications, which is exactly where nanomaterials ought to go.

So it's a very good relationship for us. We have made a lot of progress this last quarter. I think we will make more progress. BYK is reorganizing their approach relative to the experience we've gained in the marketplace. They're reorganizing their nanotechnology initiative to be more of a direct country (ph) initiative across the globe. And I think all the changes they're making -- the R&D that is going underway - I think BYK Chemie now has 21 people employed in nanomaterial applications with our materials..

When will we see some sales?

We are going to start seeing a ramp up next year, we believe.

OK. Thank you.

Gentlemen, at this time I'm showing no further questions.

Thank you for your attendance on our conference call today. I offer my condolences to the Yankee fans and Red Sox fans. And we will talk to you next quarter. Thank you.

Ladies and gentlemen, that concludes the Nanophase Technologies third earnings results conference call. We appreciate your time. You may now disconnect.