Solesence Inc (SLSN) 2005 Q4 法說會逐字稿

Good afternoon, at this time I would like to welcome everyone to the Nanophase Technologies fourth quarter and 2005 year end earnings conference call.

[OPERATOR INSTRUCTIONS]

The words expect, anticipates, 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.

They 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 that 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, acceptance of the Company's Nanocrystalline materials, changes in development in distribution relationship, 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 filing with the Securities and Exchange Commission.

Nanophase undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

Now I would like to turn today's call over to Joseph Cross, President and Chief Executive Officer of Nanophase Technologies, please go ahead sir.

Thank you.

Welcome to Nanophase's conference call to review the fourth quarter and fiscal year 2005. Nanophase year-over-year revenue records for each quarter last year and for the year as a whole. The Company had a strong year and we're pleased that you're taking the time to be with us today.

Jess Jankowski, Nanophase's CFO, and I will be hosting this session. This is typically our longest conference call of the year because we discuss 2005, and then try to provide a sense of direction for 2006. It's a lot of ground to cover. But we believe there's some important information in our comments and encourage your attentiveness. To begin our discussion Jess will summarize the financial highlights of the quarter and the fiscal year.

Jess?

Good afternoon and thank you for your continuing support of Nanophase.

2005 was a good year for Nanophase, our shareholders and our stake holders. It's also served as a good stepping up point for 2006. As I review the financial performance of the Company I intend to only address significant financial areas comparing 2005 to 2004. All numbers will be in approximate terms for ease of discussion. More details are included in the financials accompanying today's press release.

Revenues for the fourth quarter were up 44% to $1.4 million this year versus about a $1 million last year. 2005 revenues came in at $6.8 million versus $5.2 million for 2004, a 31% increase in total revenue and a 52% increase in product revenue. A full 95% of Nanophase's 2005 revenue or $6.4 million was generated through the sale of products.

I'm also glad to tell you that each quarter's 2005 product revenue totals, the driver and most critical success metric of this business right now, set a new record compared to their corresponding quarters from all previous years. For the year, 66% of our revenue came from BASF and 12% came from Rohm and Haas. All of the Rohm and Haas revenue came from products.

We also saw the continuation of a small revenue flow from ALTANA, our newest strategic partner. As our partnerships mature with Rohm and Haas and ALTANA, and product revenue volumes increase, we expect the revenue breakdown to reflect at least several larger customers composing the majority of our revenue volume.

This will eventually lead to a more balanced distribution and this rebalancing should help to reduce quarter to quarter variations in demand while enhancing management's admittedly limited visibility.

I think--before going any further it would be useful to quickly walk some of our newer shareholders through the profit model. From a quick scan of the P&L, it's not always apparent how we'll be able to achieve break even. Nanophase has a fixed manufacturing infrastructure that will support a multiple of current revenue.

We could probably triple 2005 revenue without adding significantly to fixed overhead, so the natural question that follows is why have we maintained this type of structure for a $7 million revenue company.

Well, we built the Company this way because this structure is sized that the minimum we think we can operate with, given the size and sophistication of the companies that we target as customers. We know that it's been a key factor in making us an attractive partner to the large companies that currently we do business with and those we expect to develop significant business with in the future.

Much of this infrastructure supports compliance with FDA and USPA--USP standards for sunscreen and personal care materials, as well as the exacting performance requirements of the electronic chemical industry for CNP and now the medical diagnostics and coding's industries.

We receive positive feedback regularly on this part of the business from both customers and competitors. As an aside, there have been signals that our infrastructure advantage may prove a key barrier to entry for some of our nations competition. In a nutshell, what this all means is that as volume continues to grow we expect our strong variable margins which we continually focus on to lead to overall gross margin growth and then profitability.

Let's look at the numbers. Our 2005's record sales, we had almost a $1 million in gross margin versus $83,000 in 2004. This represents more than 10 X margin growth driven by a 31% increase in revenue.

Clearly this disproportionate margin growth validates our business model on assumptions regarding variable contribution. During each quarter in 2005 we not only had a positive gross margin, but margin growth related directly to volume.

The margin analysis we have done show that fixed cost increases are not required to draw expected near term increases in revenue. Beyond a certain volume each new revenue dollar drops its variable margin or variable contribution if you like right to the bottom line.

Moving down, R&D expenses were flat while SG&A expenses expanded marginally year-over-year. In SG&A the largest category increases were in salaries and benefits and fees for the GAAP audit and ongoing costs related to SOX 404. These were somewhat offset by decreases in DNL and package insurances and legal fees. I'll discuss these decreases and the strategy around them further in a moment.

Below the operations line, the $280,000 lease accounting adjustment was a third quarter non-cash charge relating to changes in the amortization periods of our previously existing Romeoville lease to remain consistent within GAAP accounting requirements.

In a related yet far more exciting issue the lease amendment that we renegotiated and announced effective October 1st will result in cash 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-cash charge in Q3, will be recognized quarterly in rent expense reductions over the life of the lease.

Nanophase also began 2006 under a new type of health insurance regime. This change will save the Company $200,000 per year when compared with the quoted increases under the existing form of coverage from 2005. We also expect our directors and officers insurance, which has seen total cost reductions of more than 55% in the past three policy years to be further reduced. Thus far the cumulative savings have topped more than $800,000.

This has been done through the aggressive marketing of Nanophase's management and board practices through a series of DNO insurance underwriters. The underwriters have been impressed that Nanophase has been operating under the spirit of Sarbanes-Oxley without the unfortunate added bureaucratic load that we labor under since we have been a public company.

As you can see controlling expenses remains a priority of Nanophase management. In total the Company lost $0.30 per share this year versus $0.37 per share last year. Note that depreciation and amortization amounted to about $0.07 per share or $1.2 million of the $5.4 million loss for the year. Taking another view, these non-cash items amounted to 22% of the Company's 2005 operating loss. We are beginning to see the progress I spoke of in the margin analysis.

Moving to the balance sheet highlights, Nanophase ended 2005 with $8.5 million in cash and investments. In term of accounts receivable 82% of this balance is made up of receivables from BSF, Rohm and Haas, ALTANA and the CI Kasei license fees. These same customers accounted for a cumulative total of approximately 85% of our 2005 revenue.

Equipment and leasehold improvements netted to $6.6 million which included $290,000 for capital additions in 2005. Capital requirements for 2006 will be mainly composed of the build out of the equipment outlined in the November 2005 loan of $1.6 million from a BYK-Chemie a subsidiary of ALTANA. We are all truly excited about the possibilities that this funding will bring to our strategic marketing attack.

On the liabilities side, the Company now has about $1.8 million in total debt. $200,000 of this represents the note in favor of BSF that was used to finance equipment to produce sunscreen nano materials. Management expects to retire this loan by mid year.

The balance of this debt reflects previously mentioned $1.6 million loan from BYK-Chemie. The debt discount and offsetting deferred revenue referenced in the balance sheet relate to the required accounting treatment under APB 21 of this loan and have no cash impact.

Given that the terms are favorable to Nanophase, including interest free period and a low interest rate we are required under GAAP to adopt this treatment. There will be a more substantial discussion of this issue in our upcoming 10K to be filed next week.

Thank you for your attention, I would like to turn things over to our President and CEO, Joseph Cross.

Thank you Jess.

I would like to review Nanophase's progress during 2005 both from the perspective of year-over-year improvement as well as at a continuing foundation the Company is building for future revenue growth. As we continue to be a recognized leader in the global growing nano materials business.

Beginning with operational improvement which is a continuous effort at Nanophase, we again made significant progress in 2005. We believe that operations, which include manufacturing quality and associated engineering are a core competency and a major company advantage in the global marketplace.

Reviewing selected achievements, we developed five new nano materials targeted for applications of personal care, coatings, fuel catalysts and medical diagnostics. We implemented Generation 2 of our patent and NanoArc synthesis technology.

Which increases production rates three to five times and allows volume commercial production across a broad material pallet of sub 25 nanometer particles with appreciably tighter distribution. GEN 2 will allow the Company to produce nano particles for focused markets both with our market partners and new markets that Nanophase is targeting.

I anticipate that this technology should lead to some interesting new nano materials during 2006 based on our planned development schedule. Again this year we increased reactor rates on our PVS technology by 35% and improved op per labor hour by 43%.

These ongoing year after year improvements are continually reducing the cost of manufacture which directly increases gross margin, while essentially adding additional capacity for no material capital cost. With aggregate improvements since about 2000, we have more than quadrupled capacity with existing reactors.

During 2005, Nanophase's facilities were certified to ISO 14001-2004 the internationally recognized environmental management standard and recertified to ISO 9001-2000 the internationally recognized standard of manufacturing excellence. Clearly this is consistent with our global leadership position in nano materials.

Lastly for the fourth consecutive year, Nanophase achieved essentially 100% customer service levels with 0 customer complaints. Again it is the service and quality that allows Nanophase to obtain and grow global partnerships with world class companies. One further point, at the end of 2005, Nanophase exceeded half a million hours work without a lost time accident in manufacturing. This is an exceptional record for a company our size and demonstrates the Company's sophistication and excellence in workplace safety and manufacturing.

Moving to revenue growth in 2005 despite the end of a $600,000 in development funding in 2004 or about 11% of that year's revenues, we were able to grow revenue 31% year-over-year in 2005. Most importantly and what investors should really note I believe, Nanophase grew product revenue 52% year-over-year which is the kind of growth rate the Company needs at this stage to reach future financial goals.

Also, as just covered the revenue growth experienced in 2005 validates our business and financial models which demonstrate an increasing volume and associated revenue disproportionally increases gross margins or profit. To that point again 2005 gross margin increased 1078% year-over-year.

Moving more to specifics in regard to revenue composition, revenue from sunscreens or personal care products with BSF increased 24% year-over-year comprised of a 21% growth in the original ZCote product line and 3% new products. BSF launched a new sunscreen product line, ZCote Max, during mid-2005 based on the unique coating developed by Nanophase for formulations in the European and Asian markets. This coating and its manufacturing is patent pending. I will be speaking more to new products later in this discussion.

Rohm & Haas Electronic Materials CMP Technologies or RHEM continue to gain market acceptance and adoption during 2005. RHEM revenues grew 26% during the year.

Nanophase was also honored to receive RHEM's excellence in partnership award for 2005 for our proactive support in RHEM's market penetration efforts and new product development. As an aside, but important note, partnering ability is a core strength at Nanophase which we believe is evident from the quality of our market partners and continuing growth with each.

Revenues from policy and for other applications including optics increased significantly during 2005 growing over 600% as we added five new customers during the year. Lastly, Nanophase added new a market partner forming a mutually exclusive relationship with Alfa Aesar, the research chemical unit of Johnson Matthey, to globally distribute research quantities of Nanophase branded nano materials.

Alfa Aesar distributes research quantities on every continent turning 12 million catalogs and offering websites for on line purchase. We anticipate this will significantly extend Nanophase's reach into global research and product development efforts and become a factor in the Company's future revenue growth.

In summary, 2005 was a strong year for Nanophase. We achieved the product revenue growth rate necessary to significantly grow the business and continue to build the platform of capability and products for future revenue growth.

Looking forward, we believe the global adoption rate for nano materials is increasing based on recent market forecasts from Fredonia Group, Semi and our own observations. For instance, Fredonia's forecasting nano materials market growth at 3.7 billion by 2008 and then to 90 billion by 2020.

More specifically Fredonia forecasts a global market over 3 billion for nano particles, particularly oxides and metals, which Nanophase is able to manufacture by 2008. Semi forecast rapid growth in nano materials for electronics at a compounded annual growth rate of 39% through 2010.

We believe that Nanophase is uniquely positioned to take advantage of increased market and customer adoption, growth in existing markets and penetration of emerging markets. Looking forward in 2006 and peering in 2007, we continue to anticipate material revenue growth in 2006 from multiple sources.

We plan to continue revolving our technology and improving operation. Dealing first with revenue, we believe that revenues from the original ZCote product sold through BSF for sunscreens and personal care will grow moderately in 2006 based on new customer adoption.

We anticipate initial growth in the new ZCote Max line launched last year as adoption begins in Asia and Europe and begins to accelerate in 2007. BSF has stated that it believes this new product line will grow to a revenue level approximately equivalent to the current product line without cannibalizing the initial ZCote product since the formulation chemistries are different.

Keep in mind that ZCote and ZCote Max are different products for distinctly different formulation chemistries. BSF also plans to launch two new additional ZCote Max products this year. One product is based on a nano particle we developed and commercially launched last year. BSF is optimistic about rapid market acceptance and adoption of these two products which may possibly impact Nanophase's revenues in the fourth quarter of 2006 and into 2007.

Although the timing of the initial product launches is not solidly fixed at this time and may move. In summary, by the end of 2006 we anticipate we will have four unique products with BSF for sun and personal care versus the initial one product.

Additionally, and quite significantly we believe, we have expanded our relationship with BSF into polymers and plastics working a three way development effort with BSF, BYK-Chemie and Nanophase.

Polymer chemistry is about 30% of BSF's revenues so it represents significant markets for nano materials especially with BSF's increasing focus on nano technology. In that regard, underscoring BSF's commitment to nano technology R&D, Dr. Stefan Marcinowski, BSF's Research Executive Director announced earlier this year the Company was expanding its worldwide research operations in R&D expenditures from 1.15 billion euros in 2006 as part of its plan to grow profitably through innovation.

BSF's total R&D investment approximately two thirds involve nano scale applications and development. As a designated strategic development partner for BSF, which is a classification BSF takes quite seriously, Nanophase is obviously in position to benefit from BSF's focus on innovation through nano material technologies.

The results are obvious synergy with BSF's proficiency in organic nano materials and Nanophase's expertise in inorganic nano materials. Initial development in both of these areas has been positive and we believe that revenues associated with this (inaudible) may begin during late 2006 and grow perhaps materially into 2007.

Turning to Rohm and Haas Electronic Materials CMP Technologies which again I will refer to as RHEM, they have made just tremendous progress in market acceptance and penetration. Understand that I cannot go into all the details out of respect for our partner. RHEM now has two Slurry products in the market using our nano materials dispersions.

The first product has seen market adoption and is being used in semiconductor manufacturing, and continuing adoption is underway. The second Slurry product is a no ammonia Slurry formulation which is unique in the industry and has recently been adopted in mass by a major semiconductor manufacturer in two large operations that are in production now quickly scaling manufacturing and will be major customers of the product by the second half of 2006 or before.

This manufacturer also has two significant technology partners that are also adopting. One is scaling now and the other is stated that it plans to begin scaling to 60,000 wafer starts per month by June or July and will be fully ramped by the end of the year.

This particular manufacturer is also building a second adjacent semiconductor facility with planned usage of the RHEM Nanophase Slurry anticipating the first quarter of 2007 and another 60,000 wafer starts a month. The growth in the Slurry product should be significant during 2006 and 2007 relative to both Rohm and Haas and Nanophase.

Additionally, RHEM is now introducing a third product based on Nanophase's nano particle dispersions and RHEM's novel chemistry formulation that we have been told is lead for all technology. Until now Slurry's either tend to be highly selective or physically stop polishing at a certain layer or point. Both chemistry types have advantages and disadvantages.

RHEM's new Slurry actually offers both, high selectivity and stopping and combines the advantages of both. RHEM believes it's new Slurry will have relatively quick market acceptance and adoption due to its low defectivity performance and in fact, the manufacturers can potentially use one new Slurry for both memory and logic that is standardized and handle one CMP Slurry.

Relative to Nanophase's revenue, we expect moderate growth from sales to RHEM during 2006 with some possible upside depending on the exact scale up and adoption rates at semiconductor manufacturers filed by some multiple of 2006 revenue and 2007. While we are highly positive about growth in CMP to RHEM, understand that the exact rate of market adoption, scale up and associated revenue growth cannot be predicted.

Continuing with CMP but also considering other polishing applications, Nanophase made a leap in PVS technology related to alumina during 2005. We now make three different sizes of alumina, about 20 nanometers, 45 nanometers, and 80 nanometers.

We have also developed the capability to specifically tailor particle size in this process, so if needed we can produce a 60 nanometer particle for example. Rolling to other technology notes and semiconductors especially copper where we believe there are opportunities we can exploit with RHEM going forward. We also believe we can extend our alumina technology and associated spursion technologies to other polishing applications and plan to do so.

During 2005, BYK-Chemie and Nanophase focused hard on new product development and defining market attract strategies for the markets in our mutually exclusive relationship. During 2006 we expect to see these efforts result in appreciable revenue growth.

BYK-Chemie expects to release at least six new nano BYK products by May or June followed by additional new products in the second half. We created at least three new nano particles for nano book applications during 2005 that will result in new products during 2006. And are developing more new nano materials for books.

BYK's now the product line during 2006. Based on BYK-Chemie's forecast of the Company we expect Nanophase's revenue to grow about five times 2005 levels. We anticipate that most of the growth will occur in the second half of 2006.

As I have stated before we believe that the markets represented by our relationship with BYK-Chemie offers significant revenue growth opportunities for Nanophase. As we have announced BYK-Chemie a company of ALTANA Chemie has provided an approximate $1.6 million loan to Nanophase to purchase and install capital equipment.

The expanded capacity will be used to increase development rate of new nano particles using Nanophase's patented NanoArc synthesis technology, Generation 2, as well as provide bottle dispersion capacity.

Nanophase is using the funds to install the additional NanoArc synthesis reactor and associated commercial dispersion equipment for volume production of nano particles and nano particle dispersions that are targeted for current and planned BYK-Chemie nano book additives for coatings and thermal plastics. This capability is no being implemented and we expect it to be operational by mid-summer.

One last thought on this, it appears to me that the investment community may not understand or perhaps appreciate the size that a market opportunity for BYK-Chemie and Nanophase going forward. Chemical Market Reporter estimates the global coatings market is about 60 billion annually which does not include plastics, sealants and inks.

Markets that are also cemented and part of the combined market penetration strategy. If one visualizes markets as a way to revenue pyramid with commodities at the bottom of the pyramid and the more specialized or niche applications at the top, considering the nano materials offer applications at both ends of the market.

On the commodity end nano materials offer improved performance to encompass more applications while at the top nano materials again offer improved performance for even more demanding applications. It's a broad market attack, and Nanophase is fortunate to be a partner with the leading additive supplier to the global industry in every market noted.

During 2006 in addition to the growth anticipated with market partners or in some cases in collaboration with our market partner we also expect the plan for market penetration and/or revenue growth in the following areas, architectural coatings, one product with our nano materials was launched during 2005 and is now available as a kitchen and bath architectural coating in a big box retailer.

We have been told to expect another product launch by Memorial Day which is anticipated to generate additional revenue for Nanophase in the range of approximately $1 million to $2 million per year. Additionally, BYK and Nanophase are focused on several other architectural coating opportunities, some of which may come to fruition in 2006.

Just for information, architectural coatings represent a $39 billion global market according to a report issued by the Fredonia Group and provides a large market opportunity for BYK and Nanophase.

Textile and non-woven nano products, we are continuing application of non-woven product line launched during 2005. Once applied to this market as stated an intense launch product this year and they are developing other products. We don't have the details solidified at this time, but plan to continue robust development, we are working with several companies to develop nano material based products at this time.

And in microbial nano products, we are developing, plan to launch what we believe will be novel nano microbial nano engineered products during the second half of 2006. We are quite excited about this new line of nano materials and anticipate that these would be marketed both through our current market partners, for example personal care applications and coatings, as well as new applications and customers. We believe that there is a definite market pull for these products which offer several advantages over current products.

Curing Catalysts, I cannot provide details to our plan market attack on this area due to the intellectual property involved. We are planning to launch specific nano engineered products in this area beginning in the second quarter of 2006. We have been testing our new nano materials and applications for several months with a recognized industry test lab and are quite excited about the performance improvements gained with our nano materials. This would be a new and significant market opportunity for Nanophase.

Medical diagnostics, as we announced earlier this year we have an extended supply agreement with Roche diagnostic to supply nano material for a medical diagnostic device. We are working with Roche to extend this technology to other areas. Based on our agreements with Roche and due to the confidentiality of several aspects of the relationship we are unable to elaborate further.

In addition to the markets and areas I have just summarized Nanophase has active business development initiatives in both Europe and the U.S. with well known companies in a variety of markets from textiles to catalysts to electronics. We expect these initiatives to continue and expand. From a technology or operational perspective we have definitive plans for 2006.

We expect to develop an additional and perhaps quite novel NanoArc nano material based product solution for several targeted markets and applications as I have discussed today. We are also working on a substantial improvement to our PVS technology for Viant products that would reduce our manufacturing costs quite significantly, which again would improve gross margin similarly.

Initial proof of concept tests are quite encouraging and we anticipate implementing the improvements around year end. We believe this would be a major event for this technology and substantially improve our financial model going forward.

In summary, we believe that Nanophase is well positioned entering 2006 and recognizes that the Company must continue the product revenue growth rate experienced in 2005. We anticipate material revenue growth during 2006 and plan to continue revenue growth through 2007.

We continue to maintain and perhaps even grow our leadership position in the global industry and believe that we will remain optimally positioned. That concludes our planned remarks, we're available for questions at this time.

[OPERATOR INSTRUCTIONS]

Your first question comes from Avinash Kant with Canaccord Adams.

Good afternoon, Joe and Jess. Had a few questions. I think you did give us the break for the last year as far as BSF and Rohm and Haas are concerned, could you please give us some idea about what percentage was BYK-Chemie and of course how much revenue did you get from CIKC last year?

CIKC was in the $300,000 range. They have a $300,000 license fee, then we ship them some parts.

BYK, we haven't disclosed that exactly, it was less than CIK, but we don't want to get into the habit of disclosing that until it gets to be a little more material in nature. We do plan on that being a material number growing this year and then growing further next year though.

Okay, and on BSF I think you did say that Rohm and Haas all of it was product revenue. How much was the product revenue portion of the BSF percentage, I think it was 66% of total, but how much was product?

All of it's product revenue.

The only thing in other revenue, Avinash, right now is the license fees from CIK, there will be some shipping charges and things like that in there. There is no development in there right now. Then next year we will see some other revenue relating to that EPB loan treatment, I will get that in another call, because it's not really pertinent to 2005.

Okay. Rohm and Haas you did talk about some of the new applications coming along. The customers for Rohm and Haas, the ones you're talking about, are they logic customers or memory customers?

They're memory customers right this minute.

All memory, right?

So far. There are customers in the STI/SLN space, but departmentally memory.

Okay, and in the past, you have given us some idea about year-over-year growth of some of the customers. What's the expectation for calendar year '06 when you talk about BSF and Rohm and Haas?

We don't provide guidance. We have had this discussion, so look, we expect material revenue growth this year. Management team and Nanophase is happy with the 50% product revenue growth we had last year. We think we've got to be in the same range for the next two years and that's our goal.

Okay, and of course one final question, typically Q4 always tends to be seasonally weak, that's what I have observed. Now, what's the particular reason for that, could you give us some examples why?

Basically because BSF has been such a large part of our business. I don't believe that will occur so much this year. We expect, I expect fourth quarter to be relatively heavy in CMP and relatively heavy in products from BYK-Chemie.

Has BSF become a smaller percentage of the revenue you expect that seasonality to go away, right?

Yes.

Thanks so much, that's pretty much it.

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

Good afternoon. Amazing numbers, amazing projections, but together with these projections I have some concerns.

Yes, sir.

The first one is are you capable of ramping such strong growth in your revenues and the number of products? Do you have enough cash and capable work force?

We have the infrastructure in place to ramp. The only additions we would make to the business would be direct laborers. Over the years as we have worked on our manufacturing process Nik we have reduced the direct labor content a lot, an awful lot.

So we are not concerned about the ramp. We have sized all our manufacturing equipment for huge volume, in our coating equipment, I was doing some calculations today we do a ton every eight hours coating nano particles. We got about 2 million pounds of dispersion capacity.

So from a capacity standpoint as the volume ramps and as the orders increase we feel very comfortable with that. The supervision is here, the engineering is here, all we have to do is hire direct laborers.

Joe, does it mean that there would be no need to raise cash in 2006?

I didn't say that. We are not actively out in the marketplace looking for cash, okay. However, if a strategic partner wanted to make an investment in us we would definitely have that discussion.

So you're not going to issue a debt, you would accept investment from your customers?

Yes, I think, I think actually our stockholders in the market would find an investment from one of our strategic partners in the Company to be a good thing.

Oh, yes, and I agree with this. Last two questions related to ongoing operations, you have shown amazing progress in your gross margins. In order to make some kind of quantitative projections I would really appreciate if you could give me the gross margin on the product sales? And if possible two points to draw the line?

The easiest way to calculate that, there's $300,000 relating to license fees.

Yes.

That are, there's no cost associated with that any further. So if you take the $974,000 for the year, take $300,000 out of that, of the $50,000 that's related in there, that's hard to break down exactly, a lot of those are shipping charges and they may be close to one for one costs to, cost to selling price. The best way is take the $300,000 out on the front end to try to calculate that.

What you will find, one of the things we did this year and I alluded to in margin analysis is if you go through the four quarters of 2005 and you see the lowest quarter of product revenue--gross margin of product is roughly break even. You will see that the ramp beyond that speaks to the variable cost model and that for every so many dollars increase margin roughly you get an increase percentage that's commensurate in gross margin and that may be off a little bit here and there due to product mix, but basically you have a floor that you have to hit.

Changes here and there by (inaudible) but somewhere in that 1.2 million range per quarter to have a positive gross margin. It's possible to do it at a lower basis because there's inventory relief and other items, but that's the way to approach it.

This was exactly my approach based on the results I'm getting you are very likely to pass the cash flow break even within the next two quarters. Am I right?

Our target is by the end of the year, Nik. Our target is still the end of the year.

I'm quite satisfied with this answer, thank you very much and congratulations.

Thank you.

Your next question comes from Ted Sullivan with Watts Research.

Thanks a lot, Joe. I just had a couple quick questions. The first one obviously you're moving into life sciences application with Roche. Do you see yourself in the future moving more in the direction of life sciences applications?

Yeah, I think our relationship with Roche and some of the other development we're doing, I see us moving more into that. The time to market as you know in that is appreciable, there are other markets such as polymers and plastics and anti-microbials that I think are a shorter time to market, we will be focusing harder on those, but, yes, we want to move into that as a market area.

Can you speak anything other than you said in the conference call about the depth of your relationship with Roche?

I wish I could, but I can't.

Okay, I understand, but I have to ask. Another thing, you mentioned that you were pursuing architectural coating with BYK? Is that distinct from the architectural coating that is the big box retailer?

The architectural coating that's in the big box retailer and the subsequent order we anticipate that's us, that's not BYK. Further work in that field is both BYK and us. When we sign the agreement with BYK we specifically excluded this in the agreement.

Okay.

Your next question comes from Andrew Braswell with Newbridge Securities.

Good afternoon gentlemen, how are you?

Good, how are you doing?

Good thanks. Congratulations, a solid quarter, obviously a lot of exciting things going on at Nanophase. I really only have one question. On the two new ZCote Max products that you discussed through BASF, can you give any more color, I mean essentially these are further formulations of sun screens?

They're going to be additional sunscreen ingredients. While I know what they are I don't think I should really say, because my-- we have a customer management issue with big customers. They're going to want to launch this, make the announcement and we need to let them do that I think.

Okay. Sure, that makes sense. I guess I wasn't sure what area of the sunscreen market was left uncovered by the first two products.

Okay, so, I can tell you without telling you, so here we go.

Great.

If you go to Asia, in the United States for instance it's culturally nice to have a little bit of a tan, okay. If you see somebody that's kind of got a little bit of a tan we actually impart to that a certain amount of health.

I'm in south Florida, you don't have to tell me about that.

Yeah, I know that. So in Asia it's just the opposite. It's very milky white skin is the mark of beauty, so in Asia, what tends to happen is they like things like SPF 50 to 100, they want real high concentration. What we're doing essentially, without giving away exact products, is we're making nano particles about one half the size of our current products for these new products. So they can be loaded very highly with nano particles and still be totally transparent. And that's about as far as I can go to tell you.

Okay. I've got you, understood.

Okay.

Now, perhaps in more general sense with BASF, you touched on their R&D outlook as far as R&D expenditures for '06 and the relative proportion of that that's devoted to your nano scale applications.

Now, do you get a sense from your dealings with them, obviously your relationship seems very strong, when they might desire to bring the more of these things in house, is that something that you foresee or do you foresee it too far down the line to really give a lot of thought to today?

No, BASF's expertise and it's incredible expertise is in organic chemistry, polymers, plastic. Our expertise is in inorganic chemistry. Okay, that's not really their bailiwick. So, for instance, we have people over there now and been working, over there two weeks working with BSF. BSF's sending a contingent of their top scientists over here probably in April.

Between travel back and forth and working development agreements, we have a close relationship with BSF. What we bring to the party is the inorganic nano materials and I don't think there's much better polymer chemistry company in the world probably than BSF, that's where the marriage exists.

Okay. Makes sense. Thanks, and wish you the best.

Thanks.

[OPERATOR INSTRUCTIONS]

Your next question comes from Doug Allison with UBS.

Hi Joe.

Hey, Doug.

Great job this quarter, sounds really exciting for the future. One of my friends bought a top of the line Mercedes, he hasn't got it delivered yet for '06, and the sales literature accompanying the car talked about a great new Nanotech paint finish. It makes it almost scratch proof. Is it this a Nanophase product?

No, that actually is a PPG product. It's essentially a silica to put into the top coat. That's not a very good answer actually.

That material, every time you go through a car wash, silica is attacked by alcalye so every time you go through a car wash it eats the silica out of the top coat and leaves pin holes in the top coat. That's not a solution the industry is adopting.

Mercedes happens to have a special relationship with PPG. But most of the rest of the automotive world is looking for a different solution that's not attacked by, detergents, because people tend to wash their cars. BYK actually is working with every major automotive manufacturer in the world including Mercedes to try to come up with a better abrasion resistant nano material approach for the top coats and we're actively involved in that. In fact we're making material today for that.

Okay. Not a big volume product still test market product?

It would be a fairly significant volume, but it's probably the toughest coating application in the world just because the clear coats on cars vary in thickness by a factor of almost 20.

And there's no real way to test how transparent they are, because if you go out and look at your hood from several different angles, from polishing your car it looks really good, you change the angle and see a swirl mark or something, right? It's a hard thing to test, but it's a demanding application. Again we're working with BYK to develop solution for this. We have several development efforts underway. We think we will have a solution in the marketplace.

It does point out that it is a great marketing tool for the high quality cars so good luck on getting it it out quick.

Thank you.

Super job this year. Let's hope we keep it up in '06. Thanks, Joe.

Thank you.

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

We would like to thank everybody for being on the conference call again today. Again, we are expecting an exciting 2006, we have high expectations for the year. We will see you at the end of the next quarter, thanks a lot.

This concludes today's Nanophase Technologies fourth quarter and 2005 year-end conference call. You may now disconnect.