Solesence Inc (SLSN) 2006 Q2 法說會逐字稿

Good afternoon. My name is Brooke and I will be your conference operator today. At this time, I would like to welcome everyone to the Nanophase Technology Second Quarter 2006 Conference Call. (Operator Instructions.)

During this conference call, the words "expect, anticipates, 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 beliefs and a number of important factors could cause actual results for future periods to differ materially from those expressed in this news release.

These important factors include, without limitation, a decision of the customer to cancel a purchase order or supply agreement, demand for and acceptance of the Company's Nanocrystal lens materials, changes in development and distribution relationships, and impact of competitive products and technologies, possible disruption in commercial activities occasioned by terrorist activity and armed conflict, and other risks indicated in the Company's filings with the Securities and Exchange Commission.

Nanophase undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties. I would now like to turn the conference over to Mr. Joseph Cross, President and CEO of Nanophase. Thank you, Mr. Cross. You may begin your conference.

Thank you, Brooke. Welcome to Nanophase's conference call to review the second quarter and first half of 2006. From a revenue view, we had a record first half with almost 20% year-over-year revenue growth and achieved the highest quarterly revenue in the Company's history during the second quarter, which followed the highest first quarter revenue in Nanophase's history.

We believe it is a very positive start to 2006 and are optimistic for continued revenue growth during the second half. [Sherman Jung], Nanophase's Manager of Accounting and Financial Reporting, and I will be hosting this call. Jess Jankowski, our CFO, is unavailable for the conference today.

To begin our discussion, Sherman will summarize the financial highlights of the quarter. Sherman?

Thank you, Joe. Good afternoon, and thank you for your continued support of Nanophase. As Joe mentioned, the second quarter set another new record for the Company. As I review the financial performance of the Company, I intend to only address significant areas comparing Q2 2006 to Q2 2005 briefly, and the two six-month periods in greater depth. All numbers will be in approximate terms for ease of discussion. Details are included in the financials accompanying today's press release.

Revenues for the second quarter were at 2.4 million this year versus 2.1 million last year. Sales for the first half of this year were at 4.4 million for 2006 versus 3.7 million for the first half of 2005. The second quarter and first six months of 2006 both set new records for Nanophase. Gross margin continues to grow. This is the sign of our business model, as we discussed in depth in April's call, delivering as promised.

Recall that our fixed manufacturing cost structure, the minimum that's required to be in the game, does not need to grow until we achieve a multiple of 2005 revenue. This is a key component of our cash flow breakeven and profitability.

Moving on, we also want to ensure that we have made bottom line progress as we grow. This is not obvious when comparing the relative losses from the first half of '06 to the first half of '05. Our loss per GAAP accounting appears to have grown by 180,000 year-over-year. Two anomalies took place this year that have negatively affected comparative GAAP earnings.

As we discussed during the April call, we abandoned two patent applications along with their foreign counterparts. One patent applied for particle separation technology that we've outgrown, while the other, in the view of the Patent Office, is redundant when viewed against Nanophase patents already in place. We wrote these off in Q1 in the amount of 111,000. Management's assessment of the costs of continuing on the path to grants outweigh our estimates of value gained.

The second and more pervasive issue is the advent of FAS-123R, the requirement that we begin expensing stock options in 2006. To put this in perspective, in the first half of 2005, we had about 28,000 in equity compensation expense. In the first half of 2006, we had 326,000 of equity compensation expense, of which 182,000 related to this new standard. The balance was composed of expenses relating to a change in Board of Director compensation, which added a stock component and past issuances of restricted and performance shares--[grants] was expensed throughout this quarter due to growth in our stock's value.

In total, the Company lost $0.15 per share this year, of which $0.02 relates to two items Jess discussed, versus $0.14 per share last year. Note the first half of 2006 depreciation and amortization amounted to about 620,000, equity compensation expense about 326,000, and a non-recurring patent expense amounted to 111,000, or almost 1.1 million of the Company's 2.7 million loss for the quarter.

Net of these expenses, the 2006 first half loss would have been 1.6 million, or $0.09 per share, versus 2.2 million, or $0.13 per share for the same period last year when adjusted for these same factors.

Taking another view, these 2006 non-cash and patent items amounted to 39% of the Company's operating loss. So relatively speaking, we're continuing to see progress where it matters on our path to becoming cash flow positive.

Moving to the balance sheet highlights, Nanophase ended Q2 with 6.2 million in cash and investments. In terms of accounts receivable, over 90% of this balance is made up of receivables from BASF, Rohm and Haas, the [indiscernible] license fees, and our previously discussed customer architectural coating. These same customers also accounted for a cumulative total of approximately 92% of our first half revenue. 23% of Q2 revenue was generated by our new significant customer in architectural coatings.

Equipment and leasehold improvements amounted to 7.6 million in total, which included 1.4 million for capital additions this year. 1.3 million of this related to the equipment specified in our previously discussed 1.6 million loan from BYK Chemie, a subsidiary of ALTANA. Capital requirements for the balance of 2006 will be mainly composed of any remaining build out of this equipment and from smaller unrelated items.

On the liability side, the Company now has about 1.4 million in total debt, net of unamortized discounts. The note payable to BASF was paid off in Q2. The bulk of our remaining debt reflects the previously mentioned 1.6 million loan from BYK Chemie. The debt discount and offsetting deferred other revenue referenced on the balance sheet, relate to the required accounting treatment under APB-21 of this loan, and had no cash impact.

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

Thank you, Sherman. For the discussion today, we'd like to provide a summary overview on Nanophase in two general areas. First, technology and operations. And secondly, status of market partner and customers. From an operational perspective, Nanophase continues to perform and improve. During the first half, we again achieved almost 100% on-time shipping performance with zero customer returns and were able to almost double inventory turns to over 11 on an annualized basis.

From a safety perspective, we have now passed 640,000 hours without a lost time accident. This is an extraordinary achievement for a manufacturing company of our size. Nanophase was also recertified to ISO 14,001, the International Environmental Management System, and ISO 9,001, the International Quality Management System. As our market partners and customers recognize, manufacturing and environment safety is a core strength of this Company.

At the end of the second quarter and into the early days of this quarter, we essentially completed installation on operational readiness of the new NanoArc reactor and volume dispersion facilities that were financed by the $1.6 million loan from BYK Chemie. This equipment has two major benefits for the Company. First, it provides Nanophase the capability to deliver volume nanoengineered products and dispersions to BYK for the industrial coatings and plastics market. And secondly, it [opened scarce] time on a research nanowork reactor to develop new nonmaterial for targeted market, which is critical to our growth plans.

I would also like to note that this is a generation two NanoArc reactor that offers improved particle size control and significantly improved particle size distribution. For example, many of the nanoparticles being produced for BYK Chemie are in the 20-nanometer range. This volume's capability is vital for Nanophase to support the scale up in BYK Chemie products that is forecast for the second half of 2006 and into 2007.

We also made considerable progress on Generation Three of the Company's [PBS] technology, which is a significant and material operational improvement. Generation Three has been designed and built with a 50% smaller footprint, 40% reduced capital cost, alternative feed systems to materially reduce the cost of raw material, increase overall yields about 5%, increase production rates about 20%, and reduce labor content about 40% through reactor automation.

Obviously, all of these improvements will further lower the Company's manufacturing costs and improve margin relative to profitability. We plan to be in testing of the initial Generation Three PBS reactor in the fourth quarter. Obviously, we'll transfer most of these improvements to our current reactors and any future reactor additions that are needed to score volume increases while incorporating the new design improvements and benefits.

Moving to revenue, as we previously stated, revenue growth is Nanophase's first priority. We achieved 52% product revenue growth during 2005, and recognize that such a growth rate is necessary for the Company to achieve its financial goals. The first half is a solid foundation to fiscal 2006, and one the Company hopes to build on in both the second half and then moving into 2007.

Covering our market partners first, let me begin with BASF. To be clear in this discussion, Nanophase has what we term market partners as well as customers. Market partners include ALTANA Chemie, BASF, Rohm and Haas, Electronic Materials, CMP Technologies, and Alpha Azar. With market partners, we have long-term exclusive relationships for specific markets or fields of application where we provide nanomaterial products and the market partner offers application development, global sales and distribution, as well as focus in the product development for the respective markets based on their intimate knowledge of customer or market needs. Customers are typically obtained through the customer's business development initiatives, have little or no exclusivity, and order nanomaterial products from Nanophase.

With BASF buy-in from personal care and sunscreens for the original Z-Coat product remained strong through the first half and our current expectation is that BASF will meet their annual buy-in forecast for 2006. This has been a long-term volume product for Nanophase and we are now approaching 2,000 metric tons shipped since the contract began. The new product launch mid-2005, Z-Coat Max, is on target with the new product launch plan and we anticipate increased volume in the second half of 2006. Again, this product features a novel patent pending nanoparticle coating that was developed by Nanophase to provide formulation compatibility and high loading levels with European and Asian personal care sunscreen products. As announced, we have signed a long-term exclusive supply agreement with BASF for this new product line.

BASF plans to launch two additional new products in the Z-Coat Max line. Nanophase plans to produce the initial qualification launch for the first new product in August, which we understand will be followed by testing and a formal market launch during late 2006. The second product is now planned to be launched in early 2007. We anticipate that both of these new products should be added to the volume and revenues during 2007.

We are also working to extend our relationship with BASF to develop nanoengineered structures for films. Films and plastics are the category of polymers [that] make up about 40% of BASF's revenues and nanomaterials offer specific performance advantages. We are in active development with BASF directly, and in combination with BYK Chemie, and are optimistic that efforts will continue to expand and grow.

BYK Chemie continues to make significant progress in nanoengineered product development and new product availability. BYK Chemie now has seven nanobook products, which is their brand label in the market for coatings and plastic additives containing Nanophase's materials, anticipates launching roughly an additional two to four nanobook products by the end of 2006, and is market sampling and testing about 50 other new potential products.

Having just met with key management, including Dr. Matthias Wolfgruber, ALTANA's CEO, I can tell you that they are optimistic on the last half of 2006 and 2007. We continue to believe that this is a vital long-term market partner that provides access to very large markets that are difficult for Nanophase to access without a partner like BYK Chemie. And the co-development and marketing relationship will help drive Nanophase's revenue growth in the future.

Rohm and Haas [AMPT] continues to make market inroads in semiconductor CMP and gain market share for STI and IOD zero technology nodes. The new customers that I discussed previously continue to scale production and we continue to be positive about market penetration and growth. The holistic integrative approach that Rohm and Haas is taking to the market with innovative pad designs, pad conditioners, and processors and slurries, seems to be having a positive impact on market penetration and growth, and we believe, gives Rohm and Haas a unique sustainable performance advantage in the market.

We are working with Rohm and Haas going forward to broaden our relationship across additional slurry products for CMP. As we can discuss additional aspects of ongoing product development, we will do so.

Alpha Azar is now delivering 33 Nanophase branded nanomaterial products to the research and development community, which is a product offering increase of 50% since April 2006. According to Alpha Azar, interest is considerably above expectations. Alpha printed 6,000 nanomaterial brochures advertising Nanophase brand of products and has had to go to a second printing to meet demand. Again, we anticipate that this global marketing relationship will help Nanophase reach the worldwide research and development community, and potentially drive future revenue growth as Nanophase products are incorporated into commercial applications.

Moving to customers, I now only intend to cover significant situations. During the second quarter, we began volume deliveries to a major new customer in architectural coatings for a consumer product that is being introduced at a primary do-it-yourself retailer. The new exterior stain product is being advertised as self-priming and offers a lifetime guarantee. Second quarter volume, which was over $500,000, represented less than 8% of the retail locations for the initial rollout. Our customers recently informed us that the launch was quite successful. The rollout is being quickly extended to about 33% of the retail locations in the second half of 2006 and we are already receiving [indiscernible] orders for the stage two rollout.

During 2007, we have been told by the customer to anticipate rollout to the remaining 1,400 retail locations nationwide. In total, we now have nanoengineered materials in two products with this customer and are continuing to develop new products for the do-it-yourself architectural coating marketing. Based on customer information and orders received to date, we anticipate increasing revenue from this new application entering the second half of 2006 and through 2007.

Architectural coatings are a market focus for Nanophase. The [Fidelity Group] estimates the global architectural coatings market at about 39 billion. BYK Chemie and Nanophase have several existing and new product offerings in this market area, have already received initial production orders in architectural coatings, and are optimistic going forward.

In parallel, our business development efforts, both with our market partners and Nanophase's own initiatives remains robust and growing. We are actively addressing broad new markets, for example, antimicrobial, textile, catalyst, as well as pursuing specific applications with several new customers. We believe that some of these efforts will be successful and have a positive revenue impact during late 2006 and 2007. We remain positive on revenue growth the remainder of this year and into 2007.

That completes our prepared statements and we're available for any questions you may have at this time.

(Operator Instructions.) Your first question comes from Avinash Kant with Canaccord Adams.

Good afternoon, Joe and Sherman.

Hi, Avinash.

Good afternoon.

A few questions here. The first one is that in the press release you did mention that you have a $0.01 impact of the extraordinary charges. And where--which line item contains that?

Avinash, I don't know off the top of my head. I can't answer that. Sherman, do you know off the top of your head?

It's a combination of the equity compensation plans and the FAS-123 optioning expense.

Okay. So the $0.01 is coming from the stock options, right? Most of it.

Not entirely. There was also some one-time charges.

Okay. And that's what I was trying to understand - which line item contains that.

I think they're in G&A. Yes.

G&A? Okay. Now, Joe, if I heard you right, you said that Q2 revenues, 23% of that came from this new customer that you've been talking about for the architectural coating, right?

Yes, sir.

Okay. And you said that was only--you were shipping only to the 8% of the retail locations and that could grow to the 33% level by the end of '06?

No, it is growing to the--it is growing. Maybe I didn't state that clearly enough. You've got to understand, we're not trying to be obtuse here. We have a customer management problem, so we're trying to provide information without stating it totally obviously. Okay?

Right.

The initial rollout, which was about $500,000 in sales for us last quarter, is being extended as fast as we can run actually right now to 33% retail locations. We are literally almost receiving orders every day. Okay? So that's rolling out fast. Typically, a rollout is a shelf plus one backup. The remainder of the retail outlets, which would be 1,400 stores, are--will start rolling out January 1, 2007. The bulk of the production though and our revenue will probably occur late Q1, into Q2, and Q3, as best as we can forecast it now, Avinash.

But if I had to understand it right, if you go from 8% to 33%, does that mean your revenues go from like 500 to 1,500?

[Indiscernible.]

If it's an additional--it's like four times, so you--the total revenue--the 2 million, take out half a million, so it's 1.5 remaining--1.5 million of new business.

In the second half. Is that what you're saying?

Right.

I think that would be a reasonable estimate.

Okay. And, of course, on the profitability side, I remember you talking earlier about being EBITDA-positive by the end of this year. Are you on track for that?

We--that is still our goal. That is still our goal. We've had some difficulty and we're a little bit behind the gun in the sense that commodity prices have really increased this year. For instance, our cost--a precursor for zinc oxide has more than doubled. Copper has doubled. Tin has doubled. IPO has doubled. I mean, almost all of the commodity prices have doubled. So when things start doubling, we've hit our customers with surcharges. But when--those of you who are familiar with this know this. Surcharges are behind the curve. Okay? So the curve goes back and we catch up. We're behind a little bit on the gross margin side.

Okay.

I mean if--zinc oxide is a good example. Between December 2005 and February 2006, it physically doubled.

Okay. Now, one final question, if I may. Do you see some sort of seasonality in your business? Given that some of the customers that you sell to are kind of making personal care products or architectural coatings. People don't do many of those projects in the latter half of the year. Would you be likely to see some seasonality in your business?

We see seasonality--okay. So let's take this by piles. If you look at the Z-Coat--the original Z-Coat product we manufactured for BASF, that's a North American/South American product. That's heaviest for us Q1, Q2, and it starts tailing off in Q3. We suspect, but do not know yet, that the Z-Coat Max formulation, which is scaling up now and is for Europe, Australia, and Asia, will be heavier in the second half of the year. Okay?

The--we suspect, but do not know yet because we're still early in this relationship, that the heaviest periods for architectural coatings--the bulk of the architectural coatings will be Q2 and Q3 of a given year. Does that make sense, Avinash?

Right. So if Q4 in general from both perspectives may be softer.

Q4 may be softer. The only--the offset to that is we have new customers coming on board we anticipate between now and year-end.

Right.

And I know for a fact that the CMP is scaling up the second half of the year - our CMP business.

Good. That helps. Thank you so much.

Okay.

(Operator Instructions.) Your next question comes from Andrew Braswell with Newbridge Securities.

Good afternoon, gentlemen.

Hey, Andrew.

Just a few quick things. One thing that jumped out at me. It seems to be relative to the revenue growth. Sort of a spike in payables. Is there any specific situation that led to that or--?

--It has to do with the build out of the reactor from the [loan] from BYK that's about to subside right now.

Okay. And we said that--was it 22 or 23% of total rev for the quarter was from the new architectural coating partner?

Yes. 23%.

23%. So if we sort of back that revenue from that customer out, who--and they were not a customer in Q2 of '05, it looks like we would have seen revenue from the other customers down. Is that--?

Now do--what's--the effect you're seeing I think really, Andrew, is the loading from the CMP business in 2005 was much more level than it is this year. It's totally ramped up through the second half of the year.

Okay. So we had a higher level of business from the CMP?

CMP was pretty evenly loaded quarter by quarter last year, as I recall. This year it's not. It builds rather quickly in Q3 and Q4.

Okay. But again, it's still--if we back out [Behr], who was not a customer in Q2 '05, I'm still not seeing how specifically the CMP relationship, which was probably a de minimis portion of revenue a year ago--.

--I don't think CMP was de minimis in 2005. I mean, I don't remember the numbers, Andrew, but I don't think it was de minimis.

Okay. Maybe I just need to look things over again. On--.

I'll tell you what. Jess isn't here today. But feel free to call Jess next week and ask him a question. He'll be back Monday.

Okay, great.

Feel free to call Jess.

Thanks. Will do. On the recent tin oxide announcement, was the development of that material in collaboration with an identified customer or for a specific targeted market application?

Yes it was. Yes it was. And we're working that development project. You know, typically we announce material, we have access to about 75 technical magazines that that announcement goes in. So typically, we print that announcement for free and it winds up with a whole lot of phone calls for us. So for us, you understand, those announcements are also a marketing thing.

Okay.

Kind of a guerilla marketing thing, but it seems to work.

Okay. And this might be sort of building on a previous question. The $111,000 charge for patent write-off, is that the correct amount, $111,000?

Yes.

That was all in this quarter, or is that first half?

First quarter. It was in the first quarter.

That was in the first quarter.

Which was the first half of this year.

Okay. That makes sense. That's why I couldn't find it in this quarter's numbers. Okay, I appreciate it, and congrats on another solid quarter.

Thank you.

Your next question comes from Jim Lieberman with Merrill Lynch.

Greetings. This sounds like a lot of excitement where you guys are right now. A question - when you talked about the higher commodity prices and how that might hurt a little bit in terms of your near-term costs. Would that actually help you longer term because your products are so economical and efficient and perform better?

I don't know if it will help us longer term. I would tell you--and that's actually an interesting question. We had dinner recently with BASF management, okay, and this was the top management team at BASF and [indiscernible]. And they told us, most companies want a second source. That's just good business. They've been looking for a second source for Nanophase, for our material for sunscreen for three years and they can't find anything that works. We know for a fact that's true in CMP and we also know for a fact that's true in architectural coatings. It turns out the material we supply has surprising efficacy in the application, by both laboratory testing and field testing.

So I think, again, we believe this, but as we get more market experience and get more feedback, we are finding that our materials behave and perform better in most applications than competitive materials. So that gives us some leverage from a pricing standpoint, Jim.

Right.

It just so happens that, and those of you in the financial markets know this probably better than I do, but the commodity prices zoomed from say, December 2005 to February 2006, and it was hard for companies to keep up with surcharges in pricing.

Right.

And so--and we have big customers, and so we just can't send them a letter and say, effective next Monday, you know what I mean? We have to talk to them. So we were a little bit behind the eight-ball. And honestly, while margins have grown year-over-year, it's only in the second--really in the second quarter that we were able to get ahead of the surcharge curve across the board with all our customers. And so--and that--and so, as we go forward, my expectation is that situation will immediately raise us then from the--to the point where you'll see our gross margins climb even higher and we will maintain the surcharge even when commodities go down - and our customers know this - until we recover what we believe we have lost in margin.

That's a good arrangement. It's good to see how things are beginning to ramp up on the CMP and other products. Would you say that--as you have said, that you're guerilla marketing. Is that also--relate and apply to your recent announcements about catalysts?

Yes. We've got--we have--we have been working on catalysts on our own for a couple years. We've recently had some breakthroughs I think in that market, specifically in a generic area that I would call curing catalyst. So right now, we actually have a very large initiative in curing catalysts, and I really can't go into that publicly. But it's very broad across a couple of very large markets. And we have obtained development partners and we're working furiously to get into the marketplace. And our materials are just providing incredible performance in all testing, so that's one area.

We also have an initiative, believe this or not, in fuel catalysts and a partner who came to us. And we have a field test starting now on diesel generators and semis. Okay? Now whether this pans out or not, I have no idea and would rather not speculate. But I'd just say there's a lot of interesting catalysts. And then, thirdly, BASF bought Engelhard.

Right.

And as the dust settles with this, we expect to get involved with that.

That's very exciting as well. Thank you so much for your updates.

Thank you.

(Operator Instructions.) Your next question comes from Avinash Kant with Canaccord Adams.

Hi, Joe. This is Avinash once again. Talking about the commodity prices going up, have you tried to arrange some sort of--or at least have a discussion with some of your partners about passing through the price of these materials?

Yes. Actually, we've already accomplished that, Avinash. It's just that from the time it started hitting us to the time we got that discussion done--we love BASF, but it's like turning the Titanic in a creek. So it just--it took a while to get what we needed done. And unfortunately we had to eat it in gross margin for a bit. But we have the surcharge in place with BASF and we all appreciate that's a big hunk of our volume. And so, if you look at the gross margins, the gross margins are growing as the surcharges have kicked in.

Again, we were behind the eight-ball. So in the first quarter, especially, we lost some gross margin due to the gross metal increase--commodity price increase. But we'll recover that on the backend as commodity prices come down probably the end of third quarter and into the fourth quarter, as best as we can guess right now.

Okay. So the impact that you had to see, you've already seen now. And you already have a price to arrange a passing through the price. Basically, you are doing that now, right? So it should not impact you negatively going forward then.

No, it should not.

Okay. Thank you so much.

Your next question comes from Andrew Braswell with Newbridge Securities.

Hi. I just wanted to follow-up on one of the questions I asked before where I was sort of back of the envelope trying to back out that new revenue from the architectural coating customer and see where the revenue through the other channels has changed year-over-year. I think what was throwing me, and correct me if I'm wrong, but didn't we have a sort of one-time order in the Q2 '05 range of 400,000 for medical device application?

Yes, we did.

Okay. So I think that was the--.

--That's probably what--that's not a--our business with Roche in medical diagnostics is not a routine quarterly thing. That's typically one or two quarters a year they make a purchase. Because we have this--because of the way this material is, we have to produce--we want to produce a large quantity of it at one time.

Okay. And we haven't had a significant order since Q2 '05?

I believe we had an order in the first quarter and we're anticipating an order in the fourth quarter.

Okay. Very good. Thanks.

At this time, there are no further questions. Mr. Cross, do you have any closing remarks?

We want to thank you for your time today. We think the Company's had a very good first half. And I can tell you honestly that the Management Team and most of the people in the Company are more optimistic than we've ever been. So we'll talk to you again after the end of the next quarter. Thank you for your time. Goodbye.

Thank you. This concludes Nanophase Technologies Second Quarter 2006 Conference Call. You may now disconnect.