Solesence Inc (SLSN) 2006 Q3 法說會逐字稿

Good afternoon. My name is Angela and I will be your conference operator today. At this time, I would to welcome everyone to the Nanophase Technology's Q3 2006 conference call. [Operator Instructions]

During this conference call, the words "expects", "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 that are made pursuant to the safe harbor statement 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 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 SEC. 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. Welcome to Nanophase's Q3 2006 conference call to review the both record third quarter revenue compared to previous years, as well as the largest revenue quarter in the Company's history. Jess Jankowski, Nanophase's CFO, and I will be hosting this session.

Both from a revenue growth and margin expansion perspective, this past quarter reached new highs for Nanophase. In addition to record quarterly revenue, the Company achieved the highest quarterly gross margin in our history.

Since we actively target both revenue growth and margin expansion, this quarter represents the validation of our efforts and our financial business modeling, which predicts disproportionate gross margin growth, with increasing volume, based on our fixed cost business and manufacturing model. It was a very solid quarter for the Company and the team at Nanophase has made it happen.

To begin our discussion, Jess will discuss financial highlights for the quarter and the first nine months. Jess?

Good afternoon and thanks for your continuing support of Nanophase. As Joe mentioned, the third quarter set another revenue record for the Company.

Given that the details are included in the financials accompanying today's press release, I intend only to present a brief overview of key points regarding the Company's three- and nine-month performance. Numbers are in approximately terms.

Revenues for Q3 were $2.4 million this year versus $1.7 million last year. For the nine months of this year, revenues were $6.8 million versus $5.4 million for the same period in 2005. As a matter of fact, the nine months sales numbers for 2006 plainly exceeded our total revenue for all of last year.

Gross margin also continues to grow. This is a sign of our business model delivering as promised. We experienced a 30% gross margin for Q3 of this year and a 23% margin for the nine-month period versus 12% and 16%, respectively, for the same period in 2005.

Recall that our fixed manufacturing cost structure, the minimum that's required to be in this business, does not need to grow materially until we achieve a multiple of 2005 revenue. This is a key component on our path to cash flow break-even, then profitability.

On a GAAP basis, as reported, we lost $0.05 per share for the quarter and $0.20 for the nine-month period of 2006, versus $0.09 and $0.23 for the same period last year. Much of this positive change has been obscured, due to the implementation of FAS 123(R) or calendar 2006. This change resulted in $400,000 more non-cash equity comp expense being recognized in the first nine months of '06 than in the same period last year.

To further illustrate, for the recent nine-month period, Nanophase had $1.6 million in non-cash expenses related to depreciation and amortization (D&A), equity comp and a onetime patent write-off. Of these - and I add this as a technical courtesy to our analysts - D&A amounted to 59% and stock options and other equity comp amounted to 28% of the total.

For 2006, $712,000 of this non-cash expense was in cost of revenue, $691,000 of it being depreciation. The non-cash portion of cost of revenue was $719,000 in 2005, almost all of it being depreciation.

In order to impart a better sense of the progress reflected in the comparative numbers, I'd like to highlight a new term - "EBITDA-O" or EBITDAO". EBITDAO reflects Earnings Before Interest Income and Expenses, Taxes, Depreciation, Amortization and now equity comp expense, which primarily relates to Options.

For the nine-month period, EBITDAO amounted to a loss of $0.13 for 2006, versus $0.19 for the same period in 2005. This represents an improvement of more than $1.0 million in EBITDAO and only $1.4 million in incremental sales. As you can see, this is further evidence that our business model is working.

We are reaping the financial benefits of additional sales volume that requires minimal additional fixed overhead costs to generate, given that the necessary supervision, quality and other infrastructure is already in place. For 2006, as a result of this progress, we've experienced an average operating cash burn of approximately $500,000 per quarter.

In other words, we've effectively cut our operating cash burn to about half of 2005 levels. We would expect cash burn to ratchet up a bit in Q4, as we build the zinc oxide inventory to have a surplus entering Q1 of 2007. We plan on building this inventory in order to prepare for increased potential Q1 and first half demand from our new architectural coatings customer and BASF without incurring significant overtime.

Until the architectural coatings rollout is complete, we won't have a good gauge on where the pace and quarterly demand will be. While we believe we have appropriate capacity to handle expected 2007 business within normal operations, that assumes a degree of level loading and predictability. As we know well and have the scars to prove it, visibility is less than perfect.

Until these markets mature, we will continually assess the need for safety stocks and in this instance, carry a bit more than we may require in order to avoid placing unnecessary, albeit temporary, restrains on our manufacturing operations.

In terms of other capital uses, so far in 2006, Nanophase has incurred $2.0 million in capital expenditures. Recall that over 80% of this was funded by the loan received from BYK-Chemie, a division of Altana, last fall to speed market penetration and expansion.

Relatively speaking, we're continuing to see progress where it matters, on our path to becoming cash flow positive. It's a satisfying indicator that with sales volume, our actual results are in line with what we've been modeling. Sales growth is being followed by margin growth. This growth is providing to reduce cash burn and keeping us moving quickly to our operational cash flow break-even. The best is certainly yet to come.

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

Thank you, Jess.

To date, 2006 has been a very solid year for Nanophase I both revenue growth and operational performance. The latter is highly important as volume grows. Nanophase cannot afford to stumble on delivery or product quality.

Management's first priority remains revenue growth and close second is gross margin expansion. We're working very hard on both, as we plan to enter 2007. Beginning with our longest-term market partner, BASF, sustained revenue growth, viewed from an annual perspective, continues to appear positive and sunscreens and personal care, the original Z-Cote product continues volume increases year-over-year.

BASF is beginning to see market traction with the new Z-Cote MAX that was launched mid-2005 and recently introduced another product, T-Lite MAX. That brings our sunscreen and personal care product base to three distinct nanoengineered products, with a fourth anticipated in the first quarter of '07. Nanophase has long-term exclusive supply agreements for each.

BYK-Chemie and Nanophase continue to make progress in nanoengineered product development and market penetration. There are now seven nano-booked products in the market, with three to four additional products planned for late Q4 '06 or early Q1 '07. We also have about 60 lab products being tested in various applications by different customers in several markets.

We are beginning to see market traction in the U.S., Europe and Asia on applications for UV-resistance or attenuation applications in UV-curable coatings and architectural coatings. BYK-Chemie expects the momentum to increase and is forecasting appreciable growth for 2007. BYK-Chemie's commitment and confidence and growth is evident in the $1.6 million invested in Nanophase [template] production equipment to support increasing volume.

Rohm and Haas has a long-term corporate strategic commitment to the semiconductor CMP market and has demonstrated that commitment by their recent $5.0 million strategic investment in Nanophase. The new customers that I previously discussed continue their adoption cycle and increasing the use of nanoparticle-based slurries.

We anticipate their technology partners in Asia will start their adoption cycle in late Q4 or early Q1. It's a product that we expect to continue growing. Based on Rohm and Haas' success with this manufacturer and their technology partners, we believe that the industry acceptance for the slurry may be accelerated going forward.

Rohm and Haas and Nanophase are also working on a new slurry product that Rohm and Haas believes will be revolutionary in the CMP industry by providing a performance level previously unattainable. We are in the final stages of product development and we believe that Rohm and Haas plans to launch the new slurry in the near future.

Moving from market partners to customers - and I only intend to cover significant situations here - our leading architectural coating customer, Behr, continues to rollout their new Premium Plus Ultra with nanoguard exterior stain product through a large orange roofed do-it-yourself (DIY) retailer.

Second quarter volume, representing less than 8.0% of retail locations, amounted to over $500,000 in revenue to Nanophase. During the third quarter, the rollout was extended to about 33% of the retail locations and it amounted to about 40% of Nanophase's revenue for the quarter.

Behr has repeatedly forecast to us that the rollout will begin around January 2007 and has, in fact, provided the Company with a letter of understanding, which is non-binding, that forecasts volume for 2007. Based on forecasts and expected volume, we have recently installed equipment to double the Company's dispersion capacity.

We expect that this architectural coating application will be a material source of revenue growth during 2007. Again, as an approximate $40 billion global market, we believe architectural coatings may be a large market opportunity for nanomaterials and is a market that we are pursuing vigorously with our market pointer, BYK-Chemie.

In summary to our prepared comments, prior to this call I reviewed our first 2006 conference call, which outlined some expectations for 2006. I'm proud to say, on behalf of the entire Nanophase team, that we've essentially met or exceeded every expectation entering the year.

We have consistently increased revenue each quarter through the first nine months. We set a Company revenue record in the second quarter, only to exceed it in the third quarter. Through the first nine months of 2006, we've already exceeded 2005 revenues. Our market penetration, through both focused business development and our market partners, has been robust and continues to appear vital going forward.

In the end, 2006 should be a strong year of Company revenue growth, which we believe, based on customer forecasting information, should continue through 2007.

That concludes our prepared comments. We're available for appropriate questions.

[Operator Instructions] Avinash Kant with Canaccord Adams.

Good afternoon, Joe and Jess.

Hey, Avinash.

A few questions. I maybe did not hear you right. You said Behr was 40% of revenues in Q3?

Yes.

Okay. Now, typically you have given, in the past, how bit a customer BASF has been. Could you break that down? I just need two, BASF and Behr, because they are the largest two.

I'm seeing if Jess has that with him.

Yes, I don't have that with me, Avinash.

Okay. But Behr, you kind of gave 40% but you don't know exactly BASF is how big, right?

I don't know.

We'll report that cumulatively in the 10-Q, which will be filed the week after next. But I don't have that information here to give you.

Okay. Now, looking at the longer-term financial model, of course your margins have improved significantly this quarter. At what revenue run rate -- I know you've talked about it in the past, but given the current situation and you have increased capacity and everything, where do think is the break even in terms of revenues right now?

We haven't changed. We haven't changed our break even number. It's still the same number we've always talked about. I think -- walking in 2007, we're focused on margin expansion. So part of what the management team will be doing this last quarter is negotiating price increases with most of our customers.

Price increases?

Yes. So I suspect that you'll see margin growth beginning in 2007 and you will also see increased revenue growth. But our cash flow break even number that we've talked about in the past is about the same.

Okay and of course BASF has been a big customer for you. Now, of course, Behr has been another big one this year. Going forward next year, do you have other customers or anybody pipeline that you think could become as big as one of these guys?

We expect BYK-Chemie to really grow volume with us next year. So that's one source of revenue that we expect to grow. We also expect, relative to BASF, for some of the new products to start gaining traction next year. We've already received a forecast from BASF, so I know that's true for 2007, at least on their forecast. So those are two areas we see growth pretty significantly and I think in part of the BYK-Chemie growth we're going to see that primarily in coil coatings area and maybe the architectural coatings area.

Okay and talking a little bit about seasonality, your Q4 typically has been sequentially down. Now what do you expect the seasonality to be this year again?

Well, Avinash, that's difficult, since we don't give guidance, okay. But we don't suspect the typical seasonality problem this year. In the past, BASF has been our largest customer and they've always reduced their volume in Q4. We've already received purchase orders for everything from BASF in Q4 and their living with our commitments to us.

So BASF you think would not be down quarter-over-quarter in Q4?

They may be down, but they won't be down to the extent they were last year, which was relatively large and in terms of the seasonality effect of Q3 to Q4, if there were a drop off, we don't have complete visibility on that. It wouldn't be nearly what we've seen. So it's tough to say any more at this point.

And a final housekeeping question. What was the headcount at the end of the quarter?

I'm sorry, say that again.

What was the headcount.

We're at 62.

Thank you. I'll let other people ask questions.

[Operator Instructions] Nick Tishchenko with Global Crown Capital.

Good afternoon. Thank you for letting me ask you questions. Gentlemen, I have two questions and then there could be a follow-up. The first one relates to what Avinash was asking just a moment ago, seasonality and what you mentioned in your prepared remarks. Are we talking now about a change in the seasonal pattern of a calendar year or this is just in itself a new customer ramping purchases from you?

We're not -- okay. That's a hard question to really answer, Nick. We're not seeing as much seasonality as we have seen in previous years from BASF, okay.

We suspect, what we don't know, that as the new products at BASF take off because they're directed towards Europe and Asia, primarily, that some of the seasonality will be balanced by growth in new products. This particular year, relative to a quarterly revenue flow, we suspect that architectural coatings will be a significant part of Q4, at this point in time.

I understand. So we'll take one year at a time.

Yes.

The second question relates to your reference to a previously communicated break even level. Can you remind us what it was?

Hi Nick, this is Jess. We said $14 to $16 million -- actually, $13 to $16 million. This is depending on product mix and we think that's still a good range. We'll probably be able to tighten that up a little more as we get closer to the end of the year, possibly in the year-end conference call. It's just, as you know, our legendary ability to forecast these things are tough and we just don't want to get too much closer until we know more and what you said earlier is correct, in the sense of with the rollouts. We don't have a lot of control over that and that limits our ability to predict things a little bit, and it'll all be a little more clear as we get into next year.

Thank you. If I may, another question? When I look at R&D spending, it's kind of bouncing up and down throughout this calendar year 2006. I understand that you are introducing and ramping new products. But my question is related to the following. How flexible are your installed production base, how difficult for you to address different applications for different customers coming to you, what it takes? How flexible is the platform? What kind of incremental spending you need to address new products?

Okay. Again, that's kind of a tricky question to answer, because for making nanoparticles, we generally have the production capacity in place to do that. Some of the R&D expenses we've had this year is we generated a whole new series of nanoparticle in the 20-nanometer range for our coating applications, primarily, for products that we're working on with BYK-Chemie.

In the nanoparticle-coating arena, we have plenty of flexibility to do this. With the investment of BYK and the expenses we just talked about, for the capacity, we think we're in pretty good shape. The coating is a plastic [mark] that's going to require nanoparticle dispersions in several different solvents, okay. There are a possible 300 variations and we believe that we have the equipment in place to be satisfactory for our visible future.

I understand it's pretty flexible. Thank you very much.

You're welcome.

Andrew Braswell with Newbridge Securities.

Hi, good afternoon, gentlemen.

Hey Andrew.

Congrats on the continued progress. Jess, can you walk us through, one more time, your breakdown of the non-cash stuff? You were speaking just a little faster than I could write there.

Sure, no problem.

Thanks.

We had, in the nine-month period, $1.6 million in non-cash expenses that related to D&A, equity comp, the bulk of which was stock options due to FAS 123(R), and we had the onetime patent write-off, which was $111,000 that we've talked about previously.

In terms of the non-cash expenses in COG, there was $712,000 in the nine months. Cost of revenue, $691,000 of that was depreciation and that was versus about $719,000 in the prior year, 99.5% of that was depreciation then.

Okay, thanks.

Sure.

And Joe?

Yes?

The announcement, I think it was in August, from BASF and their work with another nanomaterials company, which I believe was on zinc oxide as well. And it certainly seemed that the relationship there with BASF and Nanophase in the sunscreen materials segment seems to be certainly quite strong.

I think many of us, or at least I was hoping, with the very broad reach of BASF, that that relationship would evolve into other application areas. Can you comment at all on what your read on that development is, since it isn't a material that you supply to BASF, even though it seemed to be focused on other application areas?

Sure. The company they invested in is a very small company. As I recall, it uses a solution-based chemistry, so they really can't probably get zinc oxide in a dry form coated very well, okay. BASF is a big company. It's a $60 billion company. I forget how many employees. And the people in the cosmetics group didn't even know if this was happening until they read it in a paper. Okay, so that's kind of how big BASF is.

We are actually in conversation with the BASF executive who headed that investment and we expect to have conversations with him. I will be in Europe with BASF here in a couple weeks and we have a conversation on that topic and we're also working with BASF in both plastics and films with nanoparticles. So I know they made the investment. I'm not exactly sure why they made the investment.

So you're understanding of it is that it's not any type of an alliance or argument between those companies that take those application areas off the table from your relationship [inaudible - multiple speakers]?

No. This is solely an R&D thing. It's only an R&D thing.

Okay, very good. Thank you.

[Priti Duvi] of Thomas Weisel Partners.

Hi. Thanks for letting me ask a question. I have a question regarding the gross margin. The gross margin in this quarter was 30% and when I compare it with what you did in the last quarter, which was 22.8%, I'm a little confused. Because the sequential increase in revenue is not that high, while the gross margin has moved up significantly. So, if you can, would you explain to me what has caused the gross margins to go up so much, sequentially?

Well, I will only explain it on a limited basis. It's a product mix thing, Priti. But I don't want to get into it any further. One of the misfortunes to our customers of us being a small public company, is they all, once they hit 10% of revenue, they become significant and nobody wants anybody to be able to back-calculate what pricing looks like.

I will say that product mix was better in Q3 than it was in Q2 and hopefully next year product mix will be better yet, generally. But that's what it's been. It's more of a product issue as well as we've done some cross-cutting, but that's something that's been going on, on an ongoing basis, and we've been seeing that throughout the nine months.

Okay and regarding Behr, your expectation from Behr for this year was about $1.5 to $2.0 million and obviously you have already crossed $1.5 million in revenue from Behr. So I just want to know what your expectation is now, for the fourth quarter and that's pretty much it, I think.

I can only answer that this way. It's going to be above $1.5 million, by the end of the fourth quarter, YTD. I just really can't tell you how much. I'm not trying to be difficult, but I really can't.

Okay and another clarification on Behr. Now that Behr is buying quite a bit of nanomaterials from you, are they building up their inventory and therefore going forward next year they may not be, revenues may not be as high as they high as they have been this year? Maybe because they have already bought quite a bit of materials in 2006?

We have a non-binding letter from Behr that provides a forecast range for next year and based on that letter, it would be significantly greater than their revenue this year.

Okay and what's your expectation from Roche Diagnostics for next year? Can you give any kind of information there?

Actually, we've already received their purchase order for next year and it's up. It's double-digits up. Let me just say it that way, a double-digit percentage increase.

Okay and my last question. When do you expect a revenue ramp up from Z-Cote MAX?

We expect it starting next year. We already got pretty much BASF's forecast for next year, although they owe us a revision the first part of November. But right now it looks like Z-Cote MAX starts taking off next year.

Okay and I'm sorry, one more question. I just saw this one. You mentioned in your prepared call that you witnessed higher volumes year-over-year in Z-Cote and it looks to me that the revenue probably wasn't as high from BASF this quarter, as it was say a year ago in the September quarter. Did I get that right or was there something else? Was it a YTD number, volume number that you were referring to?

No, again, there's a mix number in BASF and we have the advantage of knowing what we're going to ship them in the fourth quarter that still to come.

I believe he was talking about the calendar year-over-year.

Yes.

Greg Schneider of Wachovia Securities.

Joe?

Hey, Greg.

Jess, how are you?

Good, how are you?

Nice quarter, great. Listen, concerning investor relations, have you made any progress with any of this or?

Yes. Actually, we're working with a company now. We've got a proposal from the company and we actually have a conference call with them in the morning and we intend to move forward on that.

I'm glad to hear that. And concerning Big Box, do you anticipate being in all the stores of the Big Box or have they given you any indication?

Say that one more time, Greg.

Concerning the Big Box.

Yes?

Okay are you expecting to have Behr product in all their stores?

Yes.

Yes. That's great.

The target is, again, start the full rollout around January of '07. I can't be more precise than that, because that's all I know.

Joe, one other concerning Behr and competition. You're not limited to Behr, are you?

No.

So, but I understand that they're your first love, in that situation, but you could actually venture out if you had to?

Yes, actually, we're working with several different architectural coating companies at the current point in time.

Great.

Okay?

Okay. Thanks, guys.

Thanks.

James Lieberman of Merrill Lynch.

Greetings. That was a fine quarter. It shows the progress is really coming in and you're beginning to get traction. Something I don't know if you're able to comment on, are you able to give some idea about any interest in the antimicrobial carpet area or the catalyst area?

We've been working hard on antimicrobial products this year. Nick noticed some of the gyrations in R&D costs. We've been doing a lot of testing at EPA approved labs and FDA approved labs for antimicrobial. So, yes, Jim, we're working really hard on antimicrobial.

It's not a simple problem, because the advantage we'd like to bring to the marketplace in the antimicrobial area is pretty definitive, at this point in time. And we also want it to be persistent. So getting all the materials exactly right and getting all the test data exactly right is just taking longer than we originally suspected. But that is a big focus for us.

There's a big market pull for antimicrobials in personal care, in coatings and in plastics. So there's a definite market pull and assuming we're successful, this will be about the first inorganic antimicrobial material in the market.

Okay, that's good, and catalysts. Can you comment at all on that?

We're still working in the catalyst area. We haven't gotten quite as much traction in the catalyst area. We are working with a large, international catalyst manufacturer, but it's just going very slow, Jim.

Okay. That's understandable. Thank you very much.

Thank you.

Follow-up from Avinash Kant; Canaccord Adams.

Hi Joe and Jess.

Hey.

Sorry to harp on this point, but I'm trying to just figure this one out. Now is it a good rate to think about the next quarter that if BASF does show -- okay. BASF is going to show some seasonality, but not as much as they have shown in the past and if they do, maybe the ramp that you're seeing from Behr may offset that.

Okay. We suspect that's possible. That's as definitive as I can be.

Right. So, basically, Behr would more or less ramp, not slow down in Q4.

That's what we suspect.

Good enough. Thank you so much.

There are no further questions at this time, sir.

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

Thank you.

Thank you.